Many of our criticisms of orthodox analysis are familiar enough, at least within the individual theoretical contexts to which they refer. Less familiar, and more controversial, is our suggestion that the dif ficulties of such analysis are largely a reflection of fundamental limi tations arising from orthodoxy’s canonical assumptions of profit maximization and equilibrium. If this suggestion is correct, the problems are not fully inherent in the subject matter, but on the other hand there is no reason to thi nk that orthodox theorizing will ultimately overcome them. They will persist, though perhaps in al tered form, until theoretical tools of quite different design are directed at them.
In economic theory, as in other spheres, novel designs are never innovative in all respects; they borrow heavily from what has gone before. This is certainly the case with our own propos al. Following is a concise statement of our key differences with orthodoxy-and also of the main points of agreement.
First, we believe jt is a powerful theoretical hypothesis that eco nomic actors-particularly business fi rms- have objectives that they pursue. Profit is an important one of these 0 bj ectives. Indeed, in the specific models we present in this volume, profit is the only busi ness objective explicitly recognized. And this assumed obj ective operates in our models of business behavior in the standard way- that is, as a criterion for choice among contemplated alterna tive courses of action. If this much were all that “profit maximiza tion” implied, our models would be models of profit- maximizing behavior.
The profit maximization assumption of formal orthodox theory is, however, much stronger than the view with which we have ex pressed agreement. It involves very definite commitments on the na ture of the alternatives compared and the comparison process. We explore these commitments in detail in Chapter 3. Here we make the point concisely and a bit too starkly: the orthodox assumption is that there is a global,· faultless, once- and-for-all optimization over a given choice set comprising all objectively available alternatives.6 This clearly conflicts with, for example, an assumption that the firm operates at all times with a status quo policy, the profitability of which it inexactly compares, from time to time, with individual alternatives that present themselves by processes not entirely under its control-changing policies when the comparison favors the pre sented alternative over the current status quo. This latter assumption is more in the spirit of evolutionary theory: it is an assumption of “profit seeking” or “profit-motivated striving,” but certainly not of profit maximization.
In a sufficiently calm and repetitive decision context, the distinc tion between striving for profit and profit maximization may be of little moment, but in a context of substantial change it matters a great deal. Strict adherence to optimization notions either requires or strongly encourages the disregard of essential features of change the prevalence of Knightian uncertainty (Knight, 1921), the diver sities of viewpoint, the difficulties of the decision process itself, the importance of highly sequential “groping” and of diffuse alertness for acquiring relevant information, the value of problem-solving heuristics, the likely scale and scope of actions recognized ex post as mistaken, and so forth. Many years ago Schumpeter remarked: “While in the accustomed circular flow every individual can act promptly and rationally because he is sure of his ground and is sup-ported by the conduct, as adjusted to the circular flow, of all other individuals, who in tum expect the accustomed activity from him, he cannot simply do this when he is confronted by a new task . . . Carrying out a new plan and acting according to a customary one are things as different as making a road and walking along it” (Schumpeter, 1934, pp. 79, 85) . In a similar vein, Baumol more re cently said: “In all these [maximizing models] automaton maxi mizers the businessmen are and automaton maximizers they remain. And this shows why our body of theory, as it has developed, offers us no promise of being able to deal effectively with the description and analysis of the entrepreneurial function. For maximization and minimization have constituted the foundation of our theory, as a re sult of this very fact the theory is deprived of the ability to provide an analysis of entrepreneurship” (Baumol, 1968, p. 68) . Change, in short, presents distinctive problems that automaton maximizers are ill- equipped to solve, and that theories incorporating automaton maximizers are ill-equipped to analyze.
We are similarly in partial accord with orthodoxy (with similarly important qualifications) on concepts of competition and equilib rium. Competitive stimuli and pressures are, we agree, an important part of the environment for the decision making that goes on in each of the firms in an industry. Competitive forces not only shape volun tary business decisions- they help to set involuntary, survival related constraints on business decisions. And it is certainly useful, in attempting to understand the overall tendencies of a model con stellation of competitive forces, to ask where the whole dynamic process is likely to wind up- that is, to look for a stable equilibrium configuration in which those particular forces would no longer be producing change.
Again, orthodoxy goes much further. In the most typical formula tion, notions of competition and equilibrium are employed in tandem at an early stage of the modeling logic, and produce a drastic narrowing of the range of possibilities contemplated. Such models do not explicate the competitive struggle itself, but only the structure of relations among the efficient survivors. Obviously, they cannot address such questions as the duration of the struggle or the durabil ity of the mistakes made in the course of it.
This theoretical neglect of competitive p rocess constitutes a sort of logical incompleteness, noted in the discussion of the preceding sec tion . It is only in equilibrium that the model of optimizing behavior by many individual actors really works. Disequilibrium behavior is not fully specified (unless it is by ad hoc assumptions) . But this means that there is no well-defined dynamic process of which the “equilibrium” is a stationary point: consistency relations, and not zero rates of change, define equilibrium. The question of how equi librium comes about cannot be posed in fully orthodox theoretical terms (without ad hoc assumptions), and thus necessarily cannot be answered.
We propose, in short, that orthodoxy’s basic intuitions about eco nomic reality are potentially much more helpful in understanding economic change than are the modern formalizations of those intui tions. While purpose and cogitation are fruitful assumptions to make in modeling the hehavior of firms, strict profit maximization is not. Similarly, although it is legitimate and fruitful to model the processes by which actions taken by individual firms impinge on the others and in turn cause them to modify their actions, it is not fruitful to view that process as being always at or near equilibrium.
Why does the orthodox approach ultimately prove to be so crippling? It is because of the combined force of two shortcomings, neither of which would be fatal in itself. The first is the oft-noted lack of descriptive realism in the characterization of behavior and events. By adhering tenaciously to its extreme abstractions, orthodoxy forces economics into increasing isolation from sources of information and insight that could be of great value to it-from management theory and practice, psychology, organization theory, and business history, for example. The severe abstractions and the isol:ltion they entail might be a justifiable cost if they adequately performed their func tion of facilitating analysis of complex systems. But it is only at the textbook level that the abstractions truly have a simplifying effect. This is orthodoxy’S second critical shortcoming: in advanced theoret ical work, and in many applied contexts, its apparatus is cumber some. Faced with the facts of uncertainty and change, it attributes great explanatory force to elaborate hypothetical structures of prefer ence and subj ective probability. In gross disregard of Occam’s Razor, it multiplies these entities far beyond the empirical necessities im posed by any reasonable prospect of endowing them with opera tional content.
If the foundations were empirically secure, the attention lavished on the ornate logical superstructure would be understandable. If the superstructure were austere and of immediate practical use, expedi ent commitments to shaky foundations might be justified. Increas ingly, orthodoxy builds a rococo logical palace on loose empirical sand.
Source: Nelson Richard R., Winter Sidney G. (1985), An Evolutionary Theory of Economic Change, Belknap Press: An Imprint of Harvard University Press.