Economic evolutionary dynamics is guided by information flows: in formation about new scientific developments, information regarding the success or failure of R&D projects to g uide the next round of R&D decisions, information regarding the characteristics of new products to g uide potential p urchasers, information regarding costs of pro d uction and purchases to guide producers, information about profits to guide investors. The organizational dilemma posed for a predomi nantly market-organized economy is that it is efficient to make avail able information public, b ut the existence of private incentives for information gathering often requires that the information be private. The dilemma of a socialized system is that the information flow over whelms a centralized system if it is open to new ideas and data, that closing the system and forcing the plan to work forecloses alterna tives and risks unhedged mistakes, and that decentralizing without real markets poses the problems discussed by Hayek.
These information problems permeate virtually all economic pro cesses. Some uncertainties are resolved and some information is gen erated in R&D, but m uch of the discovering process is not easily rel egated to an isolated learning activity neatly separated from doing. Consumers learn about the new product after R&D is done, and through experience. Producers learn what consumers will b uy only after consumers find o ut themselves. New information and economic change are integral. The information is about change. In turn, the in formation g uides change, which provides new information, which stimulates and molds the next round of change.
Two kinds of things are represented as evolving in the evolu tionary theory we have been elaborating: one of these is capabilities and behavior; the other is the mix and character of organizations that possess the capabilities and decision rules. This evolution of institu tional structure proceeds in part through the market mechanisms we have considered. Thus, Schumpeterian competition selects both on inventions and on firms, and molds market structure as well as the flow of technology. But it also proceeds in part through conscious so-cial policy. Thus, for example, antitrust laws were put in place to pre vent or retard the growth of concentration, and various regulatory regimes have been imposed to moderate the incentive structure asso ciated with concentration.
The following chapter contains detailed discussion of conscious public molding of institutional change. But it is important to recog nize here that if the anatomy of market failure is a function of institu tional structure, institutional structure itself evolves in part in response to perceived problems with the status quo .
The II anatomy of market failure” discussion in neoclassical eco nomics is focused on equilibrium conditions of stylized market systems. We propose that, from an evolutionary perspective, such a discussion should properly focus on problems of dealing with and adjusting to change . The shift in perspective is important. It involves abandonment of the traditional normative goal of trying to define an II optimum” and the institutional structure that will achieve it, and an acceptance of the more modest objectives of identifying problems and possible improvements . However, the tradi tional literature of market failure does provide a useful rough categorization. There are real p roblems in coping with concentrations of power on the supply side, regardless of the theoretical perspective in which the problems are viewed . Externalities and publicness have similar meanings in evolutionary theory and in orthodoxy, and are seen to pose require ments for regulation and collective-choice machinery. A tension between distri butional equity and efficiency seems to be a fact of life that any theory must comprehend . B ut these problems take on some what different guises within evolutionary theory and neoclassical orthodoxy.
In the orthodox viewt the social cost imposed by private monopoly is describable in terms of a deadweight loss arising from non competitive pricing. The policy dilemma in dealing with monopoly is that monopoly may arise out of economies of scale that would make fragmentation of the industry inefficient. These conceptions remain significant in the evolutionary appraisal, but other aspects come into prominent view. The monopoly problem is also the “single-mind problem”: in monopoly there is o nly one source of in novation. An addition al tension regarding resolution through frag mentation is that there are major advantages to having a coherent overview of R&D.
Orthodox equilibrium analysis sees monopoly as “there.” An evo lutionary theory sees structure as evolving. Indeed, the canonical monopoly problem in evolutionary theory is that in which a firm has achieved dominance in an industry because of past skill or luck. This dynamic monopoly problem poses a severe dilemma for social pol-icy. On the one hand, stepping in and breaking up firms that have grown large as a result of past successes certainly will dampen the in centives for other firms to engage in significant innovation. On the other hand, the consequence of inaction may be an industry that is dominated by a company that has lost its innovative prowess. Many economists are tempted to be optimistic about this problem, positing that if the company loses its innovational effectiveness and zeal , new firms or small firms will be able to enter and grow and the monopoly will turn out to be transient. However, our analysis of the situation suggests that if large firms preserve their capacity to imitate, the in-dustry may be effectively barricaded from the entry and growth of small innovators. This problem of entrenched monopoly may be even more severe in circumstances in which experience counts . The only thing that may save the situation is the development elsewhere of significantly different technologies that can evolve along trajec tories sharply different from those of the past; it was this prospect, of course, that underlay Schumpeter’s rather optimistic view of the monopoly problem. This will give new firms a chance to arise and will wash out some of the advantages that large existing firms derive from their experience and imitative ability.
The concepts of externalities and publicness tend to be linked in the discussion of modern welfare economics . They both are 1/ demand-side” organizational issues, in that they call for regulatory or collective-choice machinery to present incentives to producers that would not be reflected in market prices in the absence of such machinery. In general, but not always, the term .IIexternality” is used to refer to a cost or benefit involving “secondary” effects to which producers would not attend except under regulatory incentives or controls-effects such as pollution, noise, job experience, or safer neighborhoods. In contrast, “publicness” refers to some indivisi bility of the intended principal output (for example, defense) . Although in some contexts this distinction is useful and illuminat ing, its arbitrariness is signaled by the fact that while pollution would thus be labeled an externality, clean air might well be labeled a public good. Also, in these definitions the number of people in fluenced is not an essential element of the distinction. Pollution can damage all people or just a few. Your rose garden may be enjoyed by only you and your neighbors or by the whole community. However, the distinction between small numbers and large numbers does seem to correspond to the distinction between issues that can be settled by small-group negotiation or litigation and issues that require larger scale collective-choice machinery, and the latter distinction is i mpor tant. Here we will not be particularly concerned with the distinction between externalities and publicness but will focus more generally on situations that call for collective machinery of demand aggrega tion. Dealing with externalities such as pollution does call for col lective-choice machinery when the bargaining option is not realis tically available. Somehow this point tends to be overlooked in the maze of arguments about whether effluent charges or other adapta tions of the price system can deal with pollution. Perhaps they can. But the prices on pollution must be set publicly, and their setting in volves all the problems of choosing the level of a public good.
In the evolutionary perspective, the phenomena to which the “ex ternality” tag is applied seem less susceptible to definitive once and-for-all categorization and more intimately related to particular historical and institutional contexts. To a large extent, the externality problems that dominate the policy discussions (and to which aca demic researchers belatedly direct their attention) are aspects of eco nomic change. The processes of change are continually tossing up new “externalities” that must be dealt with in some manner or other. In a regime in which technical advance is occurring and organiza tional structure is evolving in response to changing patterns of de mand and supply, new nonmarket interactions that are not con tained adequately by prevailing laws and policies are almost certain to appear, and old ones may disappear. Long-lasting chemical insec ticides were not a problem eighty years ago. Horse manure polluted the cities but automotive emissions did not. The canonical “exter nality” problem of evolutionary theory is the generation by new technologies of benefits and costs that old institutional structures Ignore.
There is similarly an evolutionary view on the nature of the activities, and of the goods and bads, that society perceives as being of col lective rather than private concern. Publicness is almost always a matter of degree. What is “public” depends in part on certain tech nological attributes of products and services and in part on what people think is important and valuable. The increasing recognition that the air we breathe and the water we drink are strongly public has stemmed in part from the decreasing separation of individual breathing spaces and drinking places, but there is more to it than that. Conscious collective action also has been stimulated by the fact that people now seem to care about these things more than they used to. Whether I care about how the neighborhood on the other side of town looks and how people there live, and the strength of my feel ings, partly determine the extent to which goods associated with those variables are private or public. While modern economics has tended to enshrine the pluralistic notions of Adam Smith, modern societies seem to resonate more with John Donne. There is no reason to believe that the lines between what society wants to leave private and what society wants to make public will remain constant over time. A central part of society’s economic problem, then, is the need to continuously draw and redraw the boundary lines. Whereas orthodoxy stresses achieving optimal provision of goods that by their nature are public, the evolutionary approach focuses on the changing circumstances and demands that call for collective-choice machinery.
Economists increasingly are coming to recognize that the income distribution problem is the inverse of the incentive problem. From the orthodox perspective, differences in income s tem from dif ferences in endowments; the transfer problem is to compensate for these without damping incentives. The evolutionary view empha sizes that a nontrivial part of the income distribution problem is as sociated with people who have been hurt, through no fault of their own, in the course of economic progress. The “gales of creative destruction” blow down the incomes not only of capitalists and man agers but also of workers whose skills have become obsolete and of people who were unlucky enough to live in places where industry has become obsolete. On the one hand, this implies that compensa tion and rehabilitation ought to be viewed as routine aspects of so cial policy in a world of rapid economic change. But on the other hand, efficient economic performance in a dynamic world puts a high premium on job and locational mobility. The income distribu tion problem ought to be looked at more in terms of income security than in terms of transfers to compensate for initial lack of assets and more in terms of easing transitions than of subsidizing outmoded patterns of activity. The policy dilemma becomes: How “secure” can income (or command over standard of living) become before people become disinterested in learning new skills or picking up old stakes? Thus, all the traditional “market failure” problems will have to be attended to by evolutionary welfare economics, although they will have to be analyzed somewhat differently. In addition, there will be a central welfare economic problem that needs to be addressed-a problem that is absent from a static world but strikingly present when information is incomplete and in flux and when tastes and val ues are constantly being reformed. The orthodox theory of consumer behavior posits that consumers have well-established preference or derings over all possible commodity bundles (and, indeed, in all time periods and all possible states of the world). But how do I know whether I will like a new product if I have never tried it? If I try it, will it make me sick? How do I know? Available information is frag mentary and experts disagree. Regarding collective choices, the situ ation is similar. How do I know how much improvement in air qual ity I will get under different legislative proposals? Do I know how much the possible improvements might mean to my enjoyment of life or to my life expectancy?
The world seen by evolutionary theory differs from an orthodox world not only in that things always are changing in ways that could not have been fully predicted, and that adjustments always are having to be made to accommodate to or exploit those changes. It differs, as well, in that those adj ustments and accommodations, whether private or public, in general do not lead to tightly predict able outcomes. For better or for worse, economic life is an adventure.
Source: Nelson Richard R., Winter Sidney G. (1985), An Evolutionary Theory of Economic Change, Belknap Press: An Imprint of Harvard University Press.