Characterizing economic selection processes

There is nothing about economic selection arguments that makes them peculiarly transparent, or otherwi se obviates the need for careful logical analysis. Indeed, if anything is transparently obvious about the sort of casual argument typified by the Friedman passage quoted above, it is the existence of gaping holes in the logic. For ex­ ample, the Friedman arguments neglect the fact that the process of prospering and acquiring resources with which to expand does not occur instantaneously; some time is required for the greater profita­ bilities of the firms that approach maximizing behavior to be mani­ fested in a signi ficantly greater relative importance of these firms in the economy. If the immediate determinant of behavior is “random chance or what not” there is no reason to believe that the firms that take actions consistent with profit maximization at one time will also take actions consistent with such maximization at all subsequent times; hence, there is no obvious re ason to believe that there will be any cumulative tendency for the firms that are maximizing pro fits at any given time to grow relative to firms that are not maximizing. To the extent that behavior is random, there may be no systematic selec­ tion at all .

On the other hand, the idea that the immediate determinant of business behavior is “habitual reaction” provides a useful starting point for evolutionary modeling. We have argued in detail the view that organizational capabilities consist largely of the ability to per­ form and sustain a set of routines; such routines could be regarded as a highly structured set of “habitual reactions” linking organization members to one another and to the environment. The tendency for such routines to be maintained over time plays in our theory the role that genetic inheritance plays in the theory of biological evolution. But sweeping claims that economic selection forces drive individual firms and whole systems to optimal behavior cannot be defended merely by adducing a plausible genetic mechanism. There is no reason to believe that at any time the “habitual reactions” of extant firms include the reaction patterns that are the best in a broader set of possibilities. As Alchian has s tated, selection works on what exists, not on the full set of what is feasible. Further, even habitual reactions that are close to maximizing under one set of economic conditions may not be under another. Thus, in models i nvolving an extended process of selection among an initial set of behavioral routines, firms whose behavior would be profit maximizing under conditions of a given time may be eliminated by competition at an earlier s tage, under conditions for which their behavior was not optimal.

To fill in the ranks of behavior patterns d ecimated by competitive struggles of earlier times, or to make possible the appearance of en­ tirely new patterns, some mechanism analogous to genetic mutation must be posited. Otherwise, selection can only bring about the dominance of the best of the patterns that started the contest, or even the less maladapted of the survivors of some early stage. Innovation resulting from s earch by extant firms, and entry of new firms follow­ ing new routines, play this role in our models.

In biological evolution, differential reproduction rates of pheno­ types possessing different genetic inheritances drive the selection dynamics. In models of economic selection, expansion of profitable firms relative to unprofitable ones plays an analogous role . But in cul­ tural selection systems, as contrasted with purely biological ones, there is as well the possibility of imitation. In the selection dynamics of the models we shall build, often both mechanisms will be at work.

That processes of innovation and imitation bring about change in firms’ routines should be kept in mind when thinking about eco­ nomic selection: it is important to d istinguish be tween selection on firms and selection on routines. In an exploration of the possible cor­ respondence between economic selection equilibrium and more orthodox equilibrium concepts, presumably the fates of firms as such are of no great i nterest. The focus is on behavior- that is, on the rou­ tines. But this raises the question: How should the set of routines that are candidates for selection be characterized? The problem does not arise in the simplest model, in which there is no entry by new firms and extant firms are locked into their particular routines. Nor are there particular complications if the model permits entry, so long as the set of all extant firms and potential entrants is finite, and firms do not change their routines . The problem arises when existing firms or those contemplating entry engage in search. Then the set of poten­ tial routines that can be reached by search becomes a major analytic concern. If the end in view is to explore the problem of developing a rigorous evolutionary argument that could serve as a partial prop for orthodoxy, one must accept in some form the orthodox assumption of a sharply defined opportunity set taken as a datum, and also the supposition that the properties of this set are such as to assure that the notion of a I.Ibest” routine for any set of market conditions makes sense. For more ambitious purposes, and particularly for analysis of economic growth and Schumpeterian competition, these orthodox commitments are unacceptable for reasons explained in Chapters 3 and 5. But since the former, limited concern occupies us here, we will make the necessary concession to orthodoxy and consider a given, finite set of possible routines that search may uncover.

It is similarly in the interest of evaluating the evolutionary defense of orthodoxy that we put forward in the following section a model that settles into a static selection equilibrium, in which the only con­ tinuing change takes the form of a futile search for routines profitable in that equilibrium. Such a focus on static equilibrium is plainly unnatural in the context of an evolutionary theory, and to generate such an equilibrium in an evolutionary model requires some delicate contrivances that have no independent rationale. Also, it is probably not entirely fair to those who have advanced the evolutionary de­ fense of orthodoxy to impute to them the view that selection pro­ cesses inevitably drive the system to a static equilibrium exactly like an orthodox equilibrium: they probably had in mind that there is (at most) a strong I.Itendency” for selection mechanisms to mimic ortho­ dox theoretical predictions. Unfortunately, the limitations of ortho-dox formal theory make it impossi ble to do full justice in this particu­ lar discussion either to the proper development of evolutionary for­ malism or to the appreciative insights of Friedman and others. As We argued in Chapter 1, it is not really possible to be fully rigorous and fully  orthodox  and  s till  admit  disequilibrium  as  a  theoretical possibility – and only by entirely suppressing the question of how equilibrium is achieved can one attempt to understand continuing change with the tools of equilibrium analysis. Thus, if we are to sub­ ject the evolutionary defense of orthodoxy to scrutiny in the context of a formal model, it must be a model of static equilibrium. Ortho­doxy offers no other target.

Source: Nelson Richard R., Winter Sidney G. (1985), An Evolutionary Theory of Economic Change, Belknap Press: An Imprint of Harvard University Press.

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