evolutionary economics

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More on What’s Missing

I suspect economic theorists are not alone in shunting to the side issues or phenomena that might upset the applecart.  But they appear to do it with a determination that other disciplines mind find somewhat alarming.  This is why I relentlessly and repeatedly mention Cause and his 1937 question about the existence of the firm.  It isn’t because I imagine that theories of the firm began in 1937, or that they are somehow restricted to a peculiar Anglo-Saxon view — Coase would have been an ideal advocate of such a view having spent his career on both sides of the Atlantic — but because he typifies the dilemma he raised.  He cannot quite accept the enormous ramifications of his question, and so he wanders off and tries to invent a reason for firms to exist that can be kluged together with the pre-existing purist view of marketplace superiority.  Firms, in the theoretical tradition born to help Coase out of the box of his own making,  are made out to be exceptions rather than the rule.

Well, when you have theorized utopian markets, how can any other phenomenon be anything other than a sullied alternative?  You’re stuck with trying to make everything else out to be a result of some mysterious “failure”.

Economists have done a wonderful job of hiding from the demons that reality might unleash and the damage such demons might wreak on their pristine imaginings.

A much broader scale of avoidance was suggested by Sraffa in 1926:

“In the tranquil view which the modern theory of value presents us there is one dark spot which disturbs the harmony of the whole. This is represented by the supply curve, based upon the laws of increasing and diminishing returns. That its foundations are less solid than those of the other portions of the structure is generally recognised. That they are actually so weak as to be unable to support the weight imposed upon them is a doubt which slumbers beneath the consciousness of many, but which most succeed in silently suppressing. From time to time someone is unable any longer to resist the pressure of his doubts and expresses them openly; then, in order to prevent the scandal spreading, he is promptly silenced, frequently with some concessions and partial admission of his objections, which, naturally, the theory had implicitly taken into account. And so, with the lapse of time, the qualifications, the restrictions and the exceptions have piled up, and have eaten up, if not all, certainly the greater part of the theory. If their aggregate effect is not at once apparent, this is because they are scattered about in footnotes and articles and carefully segregated from one another.”

Whenever economists trip over an uncomfortable counterpoint to their core ideas they have, throughout the course of their discipline’s development, had a wonderful ability to bury inconveniences like the firm in the footnotes.  Sraffa was, of course, trying to put forward a more sweeping critique, but I get the feeling that most economists do what he is suggesting they do whenever they have to tackle production, innovation, and all the other things that firms do.  They compress it into as small a space as possible and bury it in the footnotes where it can be ignored while they press on chatting about the glories of general equilibrium, set-in-stone preferences and the other paraphernalia of orthodoxy.  And, yes, I am aware that economists are a broad church, so don’t waste your time letting me know I am missing something, but I have that annoying habit of looking at what they teach the kids instead of what they argue about behind closed doors.

Speaking of a broad church, this is from Witt in 2006:

“Evolutionary economics focuses on the processes that transform the economy from within and investigates their implications for firms and industries, production, trade, employment and growth.

These processes emerge from the activities of agents with bounded rationality who learn from their own experience and that of others and who are capable of innovating. The diversity of individual capabilities, learning efforts, and innovative activities results in growing, distributed knowledge in the economy that supports the variety of coexisting technologies, institutions, and commercial enterprises. The variety drives competition and facilitates the discovery of better ways of doing things. The question in evolutionary economics is therefore not how, under varying conditions, economic resources are optimally allocated in equilibrium given the state of individual preferences, technology and institutional conditions. The questions are instead why and how knowledge, preferences, technology, and institutions change in the historical process, and what impact these changes have on the state of the economy at any point in time.”

This makes sense.  Notice the introduction of time.  Notice the emphasis on change occurring within the system rather than being some magical “exogenous” phenomenon.  And notice the implied feedback between the creation of knowledge and the state of the economy. I have mentioned too many times that I am at a loss as how to explain the absence of knowledge from the standard production function that serves to suffice as a description of what a firm is in most economic theory.  The increase in our collective inventory of useful knowledge is one of the most obvious features of our relatively modern acceleration towards universal prosperity.  This accumulation of knowledge is far more important to our current state of wellbeing than, for instance, any accumulation of capital.  After all, what is “capital”?  As an aside: those of you foreseeing the imminent demise of “capitalism” need first to stipulate what you mean by capital.  Personally I think it foolish to predict the end of something that remains ill-defined.  Capital, as in the bricks and mortar, or even of the financial assets, of an economy will surely continue to exist.   So if it’s simply the transference of ownership you are predicting, we have examples from history.  Not very helpful ones if you are imagining a great improvement in outcomes.

Anyway, back to the firm as a problem for economics.  This is from Teece and Pisano in 1994:

“What is it, then, about firms which undergirds competitive advantage?

To answer this, one must first make some fundamental distinctions between markets and internal organization (firms). The essence of the firm, as Coase (1937) pointed out, is that it displaces market organization. It does so in the main because inside the firms one can organize certain types of economic activity in ways one cannot using markets. This is not only because of transaction costs, as Williamson (1975, 1985) has emphasized, but also because there are many types of arrangements where injecting high powered (market-like) incentives might well be quite destructive of the cooperative activity and learning. Indeed, the essence of internal organization is that it is a domain of unleveraged or low-powered incentives. By unleveraged we mean that rewards are determined at the group or organization level, not primarily at the individual level, in an effort to encourage team behavior, not individual behavior, in order to accomplish certain tasks well. Inside an organization, exchange cannot take place in the same manner that it can outside an organization, not just because it might be destructive to provide high powered individual incentives, but because it is difficult if not impossible to tightly calibrate individual contributions to a joint effort. Hence, contrary to Arrow’s (1969) view of firms as quasi markets, and the task of management to inject markets into firms, we recognize the inherent limits and possible counterproductive results of attempting to fashion firms into clusters of internal markets. In particular, learning and internal technology transfer may well be jeopardized.”

I include this in my random set of quotes because it both mentions Coase [yeah!], and get to another aspect of economics that seems to be missing: notably that we live in a collective world where some element of solidarity is essential to the understanding of how value is created.  Orthodox economics builds itself up from a purely individual perspective.  This is because it started out as an exploration of demand more than of production.  It attempted to put consumers in the center of the arena, which was forgivable in an era when industry was primitive and production was of simpler goods and services.  But we have moved way beyond that era.  Production nowadays is complex spatially, informationally, and with respect to the time it consumes.  If it depends on the mobilization of “teams” how, exactly, does the concept of a wage being fixed by a person’s marginal production fit in?  The elegance of the marginal approach is its main attraction — economists swoon over elegance — suit its realism in a modern context is somewhat suspect.

And to double down on my view that knowledge is central to any understanding of economic growth, this is from Soo, Devinney, and Midgley in 2002:

“The notion that knowledge is a source of competitive advantage has been advocated extensively in the management literature over the past decade (i.e., Winter, 1987; Quinn, 1992; Nonaka and Takeuchi, 1995). The value of intangible assets increases as goods and services become more sophisticated in content and production and the foundation of competition becomes intensively knowledge-based. As hypothesized by Teece (1998: 76), “the key sources of wealth creation at the dawn of the new millennium will lie with new enterprise formation; the renewal of incumbents; the exploitation of technological know-how, intellectual property, and brands; and the successful development and commercialization of new products and services”.

I think that stands for itself.  Innovation and knowledge accumulation, as expressed through the vehicle we call a “firm” is a central phenomenon of interest to economics.  The missing middle looms large.  But there are a ton of people looking at it.  I wonder when it will be moved from the footnotes and into the main text.

Lastly, just to rub it in.  This is from Simon in 1979:

“In the views of Mason and Friedman, fundamental inquiry into rational human behavior in the context of business organizations is simply not (by definition) economics – that is to say, political economy – unless it contributes in a major way to that purpose. This is sometimes even interpreted to mean that economic theories of decision making are not falsified in any interesting or relevant sense when their empirical predictions of micro-phenomena are found to be grossly incompatible with the observed data. Such theories, we are told, are still realistic “enough” provided that they do not contradict aggregate observations of concern to political economy. Thus economists who are zealous in insisting that economic actors maximize turn around and become satisficers when the evaluation of their own theories is concerned. They believe that businessmen maximize, but they know that economic theorists satisfice.”

He gets us back to Sraffa’s critique.  Economists dither endlessly.  They postulate great certain edifices and then waffle weakly about their foundations.  I have always loved the Friedman dodge on the need for realism in assumptions or on the approximation that theories have to reality.  Economists theorize one way and then live their own lives another.  Just how many of them “optimize” or “maximize” their own economic activity?  How would they know if they did?  And how many of them actually believe that the farce they call a production function is how stuff gets produced and distributed in a modern economy?

I think we can all agree not many do.

They just bury their own experiences in the footnotes so as not to muddle the utopia they teach.

 

Addendum:

I realize that I used the phrase “universal prosperity” in the above text.  I mean it.  As Philippon recently remakes, economics has two major questions to answer: how is that prosperity grows; and how is it that prosperity is distributed.  The first is about the timeless and universal battle against scarcity.  The second is about the equally timeless and universal apportionment of the spoils of that battle. The great leap forward in our useful knowledge during the past two to three centuries has solved the first.  We know how to overcome scarcity — perhaps a little too well given the abundance of consumerism in some places.  We are yet to solve the second question to everyone’s liking.

So, yes, we are living in an era of universal prosperity.  Whether that prosperity is well distributed is an entirely different matter.

 

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Ontology, Framing, and All That Jazz

The collection of papers edited by Uskali Mäki and published in 2001 under the title: “The Economic World View, Studies in the Ontology of Economics” seems to be quite pertinent given the reaction to my recent comments on complexity.  It is a wonderfully rich source of thought about what, exactly, economics is, which is something that seems to confound a great number of people.  Quite often I get the sense that some critics are upset with economics because it isn’t physics, or chemistry, or, more controversially, biology.  No it isn’t.  Nor are they economics.  Hopefully we all agree on that.  Nor is it history or any other thing.  It is economics.  Which is something that has coalesced around certain ideas over the last couple of hundred years.  Quite what it is, though, remains a work in progress.

Economics is way more complex than the “natural” sciences simply because it involves us and our confounded intentionality, controversy, whimsy, and so on.  Physicist have it easy: atoms don’t “think”.  Which is why those economists who try to nail people down as if they are atoms do what they do.  It simplifies what is otherwise an enormous fog.  I happen to think they oversimplify, but I don’t criticize them for trying.

Buried in Mäki’s own contribution, which is rather cheekily entitled “The way the world works”, is an illuminating comment from Ronald Coase who, as you know, is one of my favorite economists.  Coase let’s us know that he sees the relentless fixation on economics as being a theory of choice as harmful because it detracts from other significant features of real economies:

“This preoccupation of economists with the logic of choice … has nonetheless had, in my view, serious adverse effects on economics itself.  One result of this divorce of the theory from its subject matter has been that the entities whose decisions economists are engaged in analyzing have not been made the subject of study and in consequence lack any substance.  The consumer is not a human being but a consistent set of preferences.  The firm to an economist … ‘is effectively defined as a cost curve and a demand curve’ .  Exchange takes place without any specification of its institutional setting.  We have consumers without humanity, firms without organization, and even exchange without markets.”  — Coase, 1988, “The Firm, the Market, and the Law”.

Narrowing economics down to being a theory of choice fits within the tradition of what I have called, at my peril apparently, the war on scarcity.  It allows for the excessive formalization I and many others decry.  It makes economics into a kind of applied mathematics which satisfies the sort of economist who might have started out early in in life studying mathematics, physics and so on, but leaves aside other perspectives that reveal insights intractable to that approach.

The existence of scarcity is a primordial condition of humanity.  The battle for subsistence in a landscape that presented few opportunities for prosperity was the basis of existence for millennia.  It created the illusion of stability.  Yet within each of those periods there was a low level but relentless improvement taking place.  Invention or innovation was slowly allowing our ancestors to cope better with scarcity.  In other words despite the illusion of stasis it was becoming possible to tame nature.  We were winning the battle with scarcity.

Eventually, of course, it was possible for the economy, whatever we decide that is, to escape from the social and ethical limits put on it through those millennia.  There is even a good argument to be made that it was entirely due to the steady erosion of scarcity that society became affluent enough to turn its attention to costly activities such as religion, politics, and state building.  What appeals to me about economics is that it is the study of how that affluence is created and distributed.  Or, rather, that’s my basic point of view.  And in order to get at answers to those questions we need to think about what an economy is. Which is where I wander into thinking about information and so on.

Which returns me to the Mäki article.  Information is something economists talk about a great deal.  It is usually in the context of communication rather than structure or learning in the way that Hidalgo sees information.  To my mind this is excessively narrow, but it is the way in which economists devoted their early attention to information.  Mäki quotes Richardson, another of my favorite thinkers on economics, as being critical of how restrictive this focus on communication has become:

“if we are led to study the informational aspects of social systems only in terms of a rigid conceptual framework borrowed from physics, we shall certainly obtain a distorted picture.  Prices, for example, and particularly the current values of prices, assume from this point of view an undeserved prominence, because it is in terms of them that a quasi-physical signaling mechanism can be elaborated and given mathematical expression.”  Richardson, 1960, “Information and Investment”

Richardson’s belief is that looking at an economy is such a limited and almost mechanical way leaves too much out.  I agree.  Which is why I think we need to look for an expression of reality that better accommodates itself to the task of economics.

But that brings us back to deciding what task[s] that is.

To reveal my hand a little more, two articles in the Mäki book stand out to me: “Economics without mechanism” by John Dupre; and Jack Vromen’s”Ontological commitments of evolutionary economics”.  The latter, in particular, is worthy of further discussion as we all ponder what economics is.

Before I came across the Mäki collection I was influenced by Tony Lawson’s “Economics and Reality”.  So I will end this little grab bag of thought with a longish quote from Lawson as he gets to grips with the issues of economics:

“Economics, then, in a more obvious way than natural science perhaps, is necessarily historical-geographical.  In addition, if by virtue of their dependency upon human agency, social structures must continually be reproduced, it follows that economics is concerned with inherently dynamic matters.  The terminology of process is thus fundamental to social science.  By this I do not mean … merely a sequence of events.  Rather, process denotes here the genesis, reproduction, and decline of some structure mechanism or thing, the formation, reformation and decay of some entity in time.  Clearly, if society is intrinsically dynamic, social science must be alert, and its methods tailored to, this condition.  Furthermore, the dependence of social structure upon human agency also entails an inescapable hermeneutic moment in social science, one that … may be of greater consequences than any similar or comparable moment in natural science.  In addition, the impossibility of engineering, and the absence of spontaneously occurring, closed social systems, necessitates a reliance upon non-predictive, purely explanatory, criteria of theory development and assessment in the social sciences.“

One last thing, the introduction in Robert Ayres terrific book “Information, Entropy, and Progress: A New Evolutionary Paradigm” sets up the terms and concepts nicely for anyone who wants to follow Lawson’s path.  It’s always worth remembering that the paths we tread are well-worn, and that, more often or not, our revelations are humdrum in the context of the entire conversation that is economics.  The classic along this path, of course, is Georgescu-Roegen’s “The Entropy Law and the Economic Process”.  But that’s for another day.

 

 

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Some Critical Responses

It is always interesting to read what people say in response to what you write.  It is also always educational.  I enjoy the learning.

I recently wrote a short piece meant to be a little on the light side pondering the odd comparison of the use of the word essential in our vernacular understanding of it, and the way in which standard economic theory suggests we compute our various levels of worth.  I quoted J.B. Clark with respect to this latter point.  I made the point that Clark’s method is still the most well-worn within economic theory.

And then I was criticized for not reading enough economics to understand that there is no such thing as “economic theory”; there are, I was admonished, a large number of such theories, and that we are all entitled to pick and choose between them.  There was then mention of a number of economists who all sit outside the framework of standard economics and have been critics to one degree or another of it.  The implication was that I am unaware of these good folk otherwise I wouldn’t look at economics through the prism of having a central set of ideas that I , presumably erroneously, refer to as “standard economics”.

Well, allow me respectfully to re-assert my belief that there is, indeed, such a thing as standard economics.  It’s the kind of thing you will read in any well-selling textbook.  I have never asserted, however, that standard economics is an impenetrable monolith.  There are shades of grey within it sufficient to accommodate a great percentage of practicing economists.  It was to help encourage the creation and spread of an even greater plurality of ideas that I re-engaged with economics a couple of decades ago.

I don’t think that the existence of a standard set of ideas is controversial.  Why else would the literature be full of the arguments in the mid-twentieth century?  Why else would there be bookshelves groaning under the weight of critiques of the “Chicago School” etc? That there was a decisive shift in the profession of economics away from one set of standard ideas and towards another is indisputable.  So I take it, to borrow a vexed word from the subject itself, as axiomatic that there is such a thing as the standard set.  That this set is the only one in existence is not the issue.  No one would argue that.  But it is the dominant set.  It is the sharp end of economics as manifested in our cultural, social, and political discussions with respect to the economy, business, markets, regulation, and government policy.  It has infested more distant terrain like the law.  It has exported many of its methods and principles into common practice by ordinary people who have never studied economics, but accept its findings as “laws” or “scientific”.  The everyday lingua franca of business is positively brimming over with references back to standard theory.

It is this expansive impression of the modern discipline of economics upon our society that I am most interested in.

I am well aware that, within the safety of their profession economists, are generally willing to discuss the variety of ideas that comprise standard theory.  They are also usually careful to let everyone know that many — unfortunately too many — of the critical intellectual components of their overall edifice are somewhat frail when exposed to the rigors of reality.  I happen to believe that marginal productivity is one of those frailties.

I don’t think it ideologically extreme to write about this.

So, allow me to press on with my enquiry of economics.  The articulation of the web of ideas centered on marginal analysis, of which marginal productivity is a part, is very much alive and well in standard economics.  It is rolled out, often in subliminal form, to justify the distribution of incomes in our modern economies.  And it does appear to be an inversion of what most of the rest of society thinks as essential.  Jeff Bezos earns far more than the average worker in an Amazon warehouse.  Standard theory seeks to explain why.  Yet it is the latter, not the former, deemed essential.  The paradox exists.

None of this implies that someone like Simon hasn’t tried to describe the pay of CEOs.  The literature relating the various theories of the firm, which is my particular interest ever since I read Coase decades ago, is full but mostly marginal.  It is marginal because, as Coase pointed out, the very existence of something called the “firm” is a denial of the perfection of the markets that the more committed members of the standard theory favor.  Since this contradiction is hard, if not impossible to resolve without re-inventing a century’s worth of theoretical structures, it has been ignored.  This is despite the best efforts of Williamson, Winter et al.  And, yes, we all know about the so-called “capital controversy”, and that the Robinson argument was victorious in the battle but defeated in the war.

Just for the record: I like the idea that an economy is dominated by rule-based decision making rather than by a more extreme form of rationality.  Satisficing is a very comfortable concept.  I happen to think that the ignorance revealed by total factor productivity could be reduced by the abandonment of both “capital” and “labor” from a production function and replaced by more accurate inputs such as energy, raw materials, skill, and information or knowledge.  Heck, I would even find room for management in there.  I don’t think it possible to “maximize” anything in an economy because of the irreducible uncertainty facing decision makers.  Equilibrium is more an illusion than a fact because the system is bothy open and dynamic.  It may be useful as an investigative tool, but as a description of reality?  Oh, and I tend to see the world through the prism of evolution and complexity.  Yes, I am aware those things exist.

Finally: I see economic activities as as inextricably intertwined with other social and political activities.  They are not separable.  So I would expect there to be as many forms of economics as there are of politics.  I am encouraged that a number of economists are now being more empirically driven.  It’s about time.  Hopefully the days of grand and elaborate theories with intricate machinery that all has to fit neatly together are gone.  Economics needs a more modest moment. Perhaps the pluralism that I and others have been encouraging for a while will help in both making economics more humble and more useful.  Even so the residual effect on our culture of the ideas within standard theory, most notably the power of unfettered markets, will create a great deal of inertia that a modest economics might find difficult to overcome.  But it’s worth trying.

Meanwhile I will continue to poke a little fun at the more odd aspects of standard theory.  Even if it reveals a little of my own ignorance.

Odd things like marginal productivity.  And don’t get me started on revealed preference.

Doh!

Did I just say that again?

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Limits

I don’t understand why people get upset when I say that economics is a waste of time. I suppose it’s because I don’t make a clear enough difference between economics as a general topic and economics as a formal, mainstream, body of knowledge. It’s the latter that is a waste of time. The former is wonderfully interesting.

At its heart economics is a study of human behavior, where that behavior is specific to certain activities. It is thus deeply rooted in psychology, so it is more closely associated with biology than physics. This is not a new idea: some of the greatest economists of the past have argued as much. Trying to transfer in ideas from physics, even metaphorically, therefore tends to lead to dead ends.

Like the notion of efficiency. That’s something of great interest to engineers, but has little to do with economics. You can have an efficient physical system. You cannot have an efficient social system. There’s just too much we don’t know and can never know. Still economists all over the world are obsessed with efficiency. So what do they do? They start to abstract and simplify. They model and fine tune. They test and re-test. And still their ideas run afoul of reality: human beings are not efficiency seeking machines, and so any system filled with humans is likely to be darned near impossible to steer towards efficient outcomes. Nothing daunted economists press on. If humans are unlikely to be efficient the logical next step is to construct a theory to exclude actual humans. That’s what’s happened in economics: the faulty decision to root economics in a physics-like setting rather than in a biology like-setting forced subsequent generations of economists to “refine” their thinking and, eventually, to force real people out of their theoretical world. Voila! Modern economics ends up as a wonderful edifice with extravagant claims as to its ability to understand human behavior precisely by eliminating all contact with humanity. Weird.

Ergo, if your goal is to understand real economies replete with real humans, modern economics is a waste of time.

Go study something else. You can learn a great deal about real economies by reading psychology literature. Behavioral economics — which despite all the press it gets has had only a marginal impact on the mainstream and on textbook economics — is an attempt to do that. The behavioral economics project is in its infancy. Go get involved.

By the way: anything that refers to strategic behavior is also useful. Real humans are constantly trying to outwit each other. That’s when they’re not cooperating, which is another human characteristic economics determinedly overlooks.

Humans are complicated. Too complicated for an economics built on an exclusive belief in relentless rationality.

Furthermore, many psychologists are now challenging the entire premiss that humans are calculating machines in the manner of computers. Our ability to compute sits uneasily with a far more powerful and deeply rooted set of survival skills that are experiential and heuristic. We are not rational information processors. We cobble things together. We try things out. We are really good at pattern recognition. As calculators we, well, suck. Yet economics bases itself on the notion that we are computational wizards. There is nothing in modern psychology to support this idea, but it persists in economics. Indeed economics is proud of its ersatz psychology and exports its “insights” into other social sciences with imperial abandon. It ought not. Its insights are embarrassingly rotten.

Worse: so proud is economics of its [bad] understanding of human behavior that it insists all economic theorizing be based on it. Thus we have the insistence on building macro theory on micro-foundations. At the risk of upsetting thousands of dedicated and well-meaning economists: garbage-in garbage-out just about sums up the micro-founded enterprise.

There is in evolutionary biology, as I am sure you all know, a notion called a “fitness peak”. Roughly speaking, this is the idea that a species refines its survival strategy and succeeds in a certain context. As it does so it “climbs” higher up a successful strategic slope that defines it relative “fitness”. Problems arise when the context subsequently changes. The more superbly refined fitness becomes, there more difficult it is to go back down and climb a different and more relevant slope. Yesterday’s cleverness becomes todays’ ignorance. The advantage of the old peak becomes a hindrance in the newer landscape.

So it is with economics.

It began in the context of the mid and late-1800’s obsession with physics. It’s greatest critique is situated in mid-1800’s industrialization. Economics began its climb up its own fitness peak back then. But the context has changed. Science has moved on. Economics hasn’t kept up. Instead it keeps on refining its obsolescence. It keeps on getting more and more specialized at something that is less and less relevant.

It needs re-doing.

Which is what a lot of people are working on: socio-economics; behavioral economics; evolutionary economics; experimental economics; institutional economics and many other fields are veritable hives of activity, they just haven’t made it into the textbooks.

Meanwhile what we call mainstream economics is, indeed, a waste of time.

 

Addendum:

This article in Aeon is a good example of the kind of thinking we need to import into the new economics mainstream.