Relevant Aspects of Evolutionary/Behavioral Economics in Regimes of Rapid Technological Change

Evolutionary economics and the behavioral theory of the firm are separate but related frameworks. Both have been in existence for half a century or more. Both embrace firms and markets as we see them. Both recognize a capability to discover new technologies and business models in the economic system. Entrepreneurial activity by individuals and enterprises is critical to this capability.

Some endogenous generation of innovative opportunities is likely. Evolutionary theories recognize some process of imperfect (mistake-ridden) learning and discovery on the one hand, and selection on the other. Whereas neoclassical theory can recog- nize bad outcomes due to bad luck and uncertainty, evolutionary theory accepts the systematic mistakes associated with ignorance or wrong-headed understanding. Clearly, the canons of rational choice theory and equilibrium economics provide only a very lim- ited basis for the study of innovation.

Neoclassical theory almost completely neglects the specificities of competencies and skills that each firm possesses. The relatively tacit and organizational capabilities which cannot be imputed to individuals are especially neglected. This neglect impedes any sat- isfactory analysis of the innovative capabilities of firms.

Bounded rationality is assumed as agents have an imperfect understanding of the environment they live in, and what  the future will deliver. Because of limits to rationality, enterprise behavior is often rule guided/based. There are relatively invariant routines shaped by the learning history of the enterprise.

Adaptation and learning generate variety. Managerial action inside firms (at headquarters)5 and market and factor market com- petition between firms act as selection mechanisms, leading to the disappearance of some firms and the rapid growth of others.

Knowledge of specific technologies determines how technology is going to advance. Technological paradigms shape the direction of future change. There is no innovation possibility frontier.

Technologies develop along relatively ordered paths (or trajec- tories) shaped by specific technical properties, search rules, tech- nical “imperatives”, and cumulative expertise. As a consequence, diversity between firms is a fundamental and permanent charac- teristic of environments undergoing technical change.

Firms differ because of different technological capabilities with respect to innovation, differing degrees of success in adapting tech- nologies developed externally, and different cost structures. They may also differ because of differing search/sensory procedures and capabilities, and differing strategies (behaviors).

One should expect path dependencies when there are increasing returns of some kind. This will be especially true for (a) information goods and (b) cumulative technological advances. How strong path dependencies are is mainly an empirical question.

Market concentration is a function of two opposing forces: (a) selection mechanisms which tend to increase the standing of innovating firms, while (b) learning and imitation mecha- nisms spread innovations/new knowledge throughout the poten- tial adapters, thereby reinforcing existing disparities via cumulative mechanisms internal to the firm.

Abilities to innovate and imitate are firm specific and depend on a firm’s past innovative record—learning is cumulative. Chance matters, but chance favors those firms which are prepared.

Although some of the economic benefits from innovation and the adaptation of new products and processes can be appropriated by the innovators themselves, there are learning  externalities. The ease of imitation depends on the  intellectual  property regime (strong or weak) with the nature of the relevant knowl- edge (codified or tacit). Skills and  know-how  almost  always leak out from individual generators/first adapters to the whole industry.

Innovation in products and processes is nevertheless to a fair degree endogenous via-in-house R&D, technological acquisition (e.g. in licensing), as well as by learning mechanisms.

There is considerable dispersion in costs and profitability and growth rates inside an industry. Asymmetries in capabilities are a direct consequence of the cumulative, idiosyncratic, and appropri- able nature of technological advances. The more cumulative are technological advances at the firm level, the higher the likelihood of success breeding success.

Moreover, the higher the opportunity for technological progress, the higher the possibility of differentials between innovators and laggards. High technological opportunity associated with a high degree of appropriability provides incentives to innovate for a firm on or near the frontier; but possibly low incentives for firms with relatively lower technological capability.

“Normal” technical progress proceeds along trajectories defined by an established paradigm and extraordinary technical advance associated with the emergence of new paradigms. As shown by others (Dosi, 1984), market processes are generally weak in direct- ing the emergence and selection of radical technological discon- tinuities. Put differently, when the process of innovation is highly exploratory, its direct response to economic signals is weaker and its linkage with scientific knowledge is greater. Institutional and scientific contexts are more important than the market.

Institutions and markets coevolve. Industrial, technological, and institutional factors interact. In particular, research and training bodies and the intellectual property system help shape industrial outcomes. The competitive strengths of individual enterprises as well as the industry depend on such factors. For instance, accord- ing to Murmann, German firms achieved global superiority in dyestuffs by 1914 not because they had superior strategies and organization, but because there were a large number of new entrants, and a large number of exits, giving the German dye industry more room to experiment with different firm strategies and structures. By 1900 the leading dye firms had all developed in-house R&D capabilities and could match new product intro- ductions by competitors in the UK and the USA, as well as in Germany. The German firms also patented heavily in the UK, and their innovative efforts at home were built upon an extremely strong university system in chemistry. “Germany had it easier than Britain in bringing forth competitive firms” (Murmann, 2003: 51). The British government also imposed higher tariffs on industrial alcohol, an important input in dye making. Strong organizational capabilities in R&D, manufacturing, marketing, management, and strong patent portfolios, allowed the German dye industry to cap- ture 70–90 percent of world market share (Murmann, 2003: 92).

Strength in both the supplier industry and in supporting insti- tutions aids innovation. The German firms actively shaped their selection environment—particularly education and training, tar- iffs, and patents. German firms not only benefited from govern- mentally supported education and training; they helped upgrade them.

Indicators of dynamic competition include heterogeneous firms engaging in experimentation and innovation. New products and processes are developed and introduced, and internal processes are reworked and adjusted. Firms constantly battle unanticipated events. Rivalrous behavior is the norm.

An evolutionary approach underscores the importance of main- taining variety in the economic system. Competition policy author- ities as well as other agencies must be concerned with protecting economic diversity and meaningful variety in organizational forms. The focus need not be a particular market—it should be broader as what’s outside the market tends to be amongst the best candidates for Schumpeterian entry and radical innovation.

These propositions, derived mainly from behavioral and evo- lutionary theories of firms and markets, promise to expand our understanding of firm behavior particularly in domains of rapid innovation. Following Joskow (1975: 278), I would like to believe that the field of industrial organization to which antitrust eco- nomics owes so much can “play an important leadership role in the extension and revision of the conventional theory of the firm rather than be its prisoner”.

Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.

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