Retrospect of the Evolutionary Theory

We would not have been drawn to try to develop the evolutionary approach had we not come to believe that the canonical ideas of orthodox microeconomic theory obscure essential features of the pro­ cesses of economic change. The insistence on strict “maximization” in orthodox models makes it awkward to deal with the fact that, in coping with exogenous change and in trying out new techniques and policies, firms have but limited bases for judging what will work besti they may even have difficulty establishing the range of plau­ sible alternatives to be considered. It is an essential feature of such situations that firms do different things, and some of those things turn out to be more successful than others. Over time the least satis­ factory of the responses (from the point of view of the organizations making them) may tend to be eliminated and the better of the responses may tend to be used more wide1y, but it is another essen­ tial feature of such situations that these selection forces take time to work through. Since orthodox microeconomic theory is based on the ideas that fi rms maximize and that the industry (or, more generally, the system of firms involved) is in equilibrium, we think it inevitable that models built according to the orthodox blueprints miss com­ pletely or deal awkwardly with these features of economic change. We do not deny the enormous flexibility of the ideas of maximization and equilibrium, and readily concede and admire the ingenuity that theorists have employed in turning these ideas so that models based on them can cope with aspects of the economic change process . But we contend that the analytic task would be much easier, and the intellectual endeavor would proceed more smoothly and fruitfully, in a different conceptual framework.

We  have  expounded  three  basic  concepts  for  an  evolutionary theory of economic change. The first is the idea of organizational routine. At any time, organizations have built into them a set of ways of doing things and ways of determining what to do. Our con­ cept of routine cuts across the more orthodox notions of capabilities (the techniques that a firm can use) and of choice (the maximization part of the orthodox theory of the firm) and treats these as similar fea­ tures of a firm. To view firm behavior as governed by routine is not to say that it is unchanging, or that it is ineffective, or that it is “irra­ tional” in the everyday sense of the term. It is to Say, however, that the class of things a firm is actually doing or has recently done de­ serves a very different conceptual status than a hypothetical set of ab­ stract possibilities that an external observer might conceive to be available to that firm. Most important, it is to recognize that the flexi­ bility of routinized behavior is of limited scope and that a changing environment can force firms to risk their very survival on attempts to modify their routines.

Second, we have used the term “search” to denote all those orga­nizational activities which are associated with the evaluation of cur­ rent routines and which may lead to their modification, to more drastic change, or to their replacement. We have stressed that these kinds of activities are themselves partly routinized and predictable, but that they also have a stochastic character both from the point of view of the modeler and the point of view of the organization that undertakes them. Routines in general play the role of genes in our evolutionary theory. Search routines stochastically generate muta­ tions.

Third, the “selection environment” of an organization is the en­ semble of considerations which affects its well- being and hence the extent to which it expands or contracts. The selection environment is determined partly by conditions outside the firms in the industry or sector being considered- product demand and factor supply condi­ tions, for example -but also by the characteristics and behavior of the other firms in the sector. Differential growth plays much the same role in our theory as in biological theory; in particular, it is im­ portant to remember that it is ultimately the fates of populations or genotypes (routines) that are the focus of concern, not the fates of individuals (firms) .

These concepts provide the foundations for a variety of models of considerable scope and power. The first set of models we considered were focused on questions of the nature of a competitive industry equilibrium and on the response of firm and industry behavior to changed market conditions. These are the kinds of questions with which orthodox models have coped with considerable success. Even here, on the home grounds of orthodox theory, models based on the ideas of firm routines, search, and selection can perform adequately and interestingly. Evolutionary models are consistent with, and can “predict” the same sorts of characteristics of equilibrium and the same kinds of qualitative responses to changed market conditions, as can models built out of more orthodox components. However, the explanations for these patterns are different, and so are the assump­ tions that delimit the circumstances under which these patterns might be expected to obtain. Further, the focus of analytic interest should realistically be on the character of the path to a new equilib­ rium, and evolutionary models provide insight about adjustment mechanisms that orthodox theory’s ad hoc treatment of disequilib­ rium adjustment processes does not.

With regard to processes of long-term economic change fueled by industrial innovation, orthodox modeling approaches have had moderate (but not outstanding) success in explaining time paths of aggregate variables. This success, however, has been at the expense of confining the analysis within a framework that is inconsistent with known empirical aspects of the processes of technological ad­ vance. Our models, based on the canonical ideas of evolutionary theory, have been shown capable of the same kind of qualitative con­ sistency with the aggregative data as are orthodox models. But ours also are consistent with at least the broad features of the processes of technological advance, and can generate predictions that are qualita­ tively consistent with such microeconomic phenomena as the size distribution of business firms and the qualitative shape of “diffusion curves”-topics on which orthodox models are mute.

Similarly, it seems clear that orthodox conceptions of maximiza-tion and equilib rium must be stretched severely if they are to en­ compass much of the Schumpeterian formulation of the competitive process . Although some recent orthodox work has responded to this ch allenge, the models put forward do not contain a serious dynamic disequilibrium analysis. Such an analysis seems essential to a fully Schumpeterian model, especially if one concedes the importance to the story of Phillips’ proposal that concentration arises as a conse­ quence of innovation. Our models contain such a dynamic analysis. And they point clearly to some key determinants of industry struc­ ture and performance under Schumpeterian competition: ease of imitation, the degree to which large fi rms restrain investment, the character of the technological change regime.

Finally, our qualitative examination of the problems of normative economic analysis, albeit a preliminary one, makes it clear that an evolutionary perspective can provide insight into what the economic system “ought” to be doing. In our analysis, the concept of a social opti mum disappears. Occupying a central place are the notions that soci ety ought to be engaging in experimentation and that the infor­ mation and feedback from that experimentation are of central con­ cern in guiding the evolution of the economic system. Hidden-hand theorems disappear, or at least recede to their proper status as para­ bles. In their place, however, one can discern the basis for arguments in favor of diversity and pluralism. More important, when one views normative economic questions from an evolutionary perspective one b egins to get a better appreciation not only of why our current eco­ nomic system is so mixed in institutional form, but why it is appro­ priate that this is so.

Most generally, evolutionary theory identifies a more complex “economic problem” than does orthodox theory, and we think this is an advantage. Evolutionary models tend to be more complicated than orthodox ones, if the examples presented in this volume are indicative. In part this is due to the natural affinity of evolutionary theorizing and simulation techniques that permits models to en­ compass greater complexity than is acceptable in models constrained to be analytically tractable . But the basic reason is that evolutionary theory is intrinsically dynamic theory, in which the diversity of firms is a key feature .

Of course, willingness to recognize complexity is not an unmiti­ gated virtue. Models in economics must be greatly simplified ab­ stractions of the situation they are intended to illuminate; they must be understandable and the logic must have a certain transparency . Artful simplification is the hallmark of skillful modeling. In spite of their somewhat greater complexity,  several of our evolutionary models are significantly more “transparent” than some models we might cite that are of orthodox descent. And the greater flexibility built into evolutionary theory gives model builders more choice regarding where to make their simplifications and where to recog­ nize the complexities.

The advantages show up even when we explore within evolu­ tionary theory the hoary q uestion of the effect of changes in prices on the behavior of key economic actors. Does it not seem correct that the response of firms to the increase in energy prices should involve their trying to do things that they had not thought of seriously be­ fore? Is it not highly likely that firms differ in the extent to which they find ways they can cope? The ability to see those features, which is lent by an evolutionary perspective, seems to us to be well worth the increase in the complexity of the analysis. Indeed, it is hard to see how it could be possible to make real contact with the policy issues of energy pricing, and to make responsible recommendations con­ cerning them, without taking these features into account. They are, after all, prominent realities for the actors that policy seeks to influ­ ence. As we have noted, economists do seem to become a great deal more flexible and openminded about the way things work when they enter the policy arena in a serious way. But orthodox theory provides them with very little support.

To return to the point that launched this discussion of complexity, it seems to us that one of the central present tasks of norm ative mi­ croeconomics is to begin to recognize and try to understand the great institutional complexity of Western market-based economies. For several reasons, evolutionary theory provides an appropriate frame­ work for this undertaking.

First of all, its view of business firms as complex organizations in­ vites extension to other sorts of organizations and subsequent exam­ ination of the important distinctions. The notion of an organizational memory embedded in routines is as relevant to organizations with highly ambiguous objectives, such as universities, as it is to organi­ zations with the modestly ambiguous objective of making money. Issues relating to the control and replicability of routines are of at least as much interest in connection with teaching first-graders to read as they are in providing the population with ready access to fast-food hamburger stands.

Second, evolutionary models break out of the trap of regarding prices and markets as the only social mechanisms that actively trans­ mit information-a trap that still restrains virtually all orthodox theorizing, including the most advanced. Our simple models of imi­ tation, and of industrial R&D that seeks to realize a “latent produc-tivity” level determined elsewhere in the system, are only the begin­ ning of a formalized treatment of other mechanisms . But the general framework is readily adapta ble to the task, and the task is an impor­ tant one. If anything is clear about contemporary institutions, it is that they pass a lot of information around.

Third, as we stressed in Chapter 16, the process of institutional development is an evolutionary process, both linked and akin to the process of evolution of firms and industries. It is a groping, incre­ mental process, in which the conditions of each day arise from the actual circumstances of the preceding day and in which uncertainty abounds. Thus, at the level of the larger social system it is clear­ even clearer than at the level of the firm or industry- that the evolu­ tionary perspective is the appropriate one} In the face of the enor­ mous complexity of that system, our main hope for understanding and predicting it rests on the fact that there is substantial temporal continuity. Accordingly, our task is to understand the s tructure and sources of that continuity .

Fourth, the evolutionary perspective is fully and necessarily con­ sistent with a view of normative analysis that a number of econo­ mists have taken before us: the proper task is the analysis and comparison of existing institutional structures and the design of al­ ternatives that show promise of superior performance in the actual situation as it exists . It is also, we would emphasize, a task best ap­ proached in a practic al and undogmatic spirit, with considerable wariness regarding the possibili ty that institutional change will pro­ duce important unanticipated effects . Abstract analysis of institu­ tional arrangements that would be 1/ optimal” in idealized situations is at best only one useful heuristic for the main work, and at worst a diversion from it.

Finally, it seems likely that, in comparison to orthodox analysis, normative analysis guided by evolutionary theory would sound more sensible and be more accessible to other participants in the pol­ icy discussion. This is really a point of broader significance, for in positive economics, too, the language of contemporary economic theory is a factor that tends to inhibit constructive dialogue and exa­ cerbates other tendencies to intellectual autarky that also derive from t he character of orthodox thought.

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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