Evolutionary Economics: Organic Analysis of Economic Growth

Abstract: This essay explores whether it is possible or desirable for present-day economic theory to incorporate biological or evolutionary insights of the type suggested by Alfred Marshall but not fully embraced by him.

If the study of economics is to function as a progressive system that guides and explains the behaviors of men as free and creative agents, it is necessary to examine the study in an open and dynamic way that emphasizes the growth of knowledge and qualitative factors as the prevailing force of change and progress.  Early on Marshall (2009) discovered the inherent error with rational mechanistic economic systems when he said “economics, like biology, deals with matter, of which the inner nature and constitution, as well as the outer form, are constantly changing” (p. 637). Whether Marshall knew it or not, the problem between statical and biological theories is fundamentally a philosophical one. This essay will explore this problem, delineate its philosophical roots, and build a case in favor of evolutionary economics.

The central thesis of this essay argues that neoclassical economic models operate in the outdated modernist paradigm that utilize rational closed systems which are, as a result, authoritarian and unsustainable with respects to free market innovation and evolution. The argument presented here is that economic models need to shift away from quantitative measures emphasizing ideal equilibrium states and towards a post-modern conception that accounts for freedom and change. In this way economics will reflect nature accurately, i.e. men are individual and free agents acting interdependently within an evolving economic landscape. This will provide holistic and sustainable model for interpreting progress by individuating agents according to inevitable qualitative changes within an economic system.

Much like the science of biological evolution, evolutionary economics is concerned with growth and progress (Langlois & Everett, 1994). More specifically, it seeks to address economic problems that occur as a result of changes in time. Neoclassical theory operates from a relatively simple, circular, closed system that does not permit internal variations. Evolutionary economics emphasizes the role of variation, and the accompanying selection processes, as the centerpiece for identifying trends and understanding economic progress.[1]

In their article Evolutionary Theorizing in Economics, Nelson and Winter (2002) present a keen summary of three questions that provide economic analysis a starting point for understanding the workings of economies: “One question concerned order…The second concerned was the challenge of explaining the prevailing constellation of prices, inputs, and outputs…The third question addressed the processes of economic progress, or development.” (p. 23). They noted that the first two questions orient economics toward equilibrium states of neoclassical theory, whereas the third emphasizes disequilibrium found in evolutionary theory. It is in this disequilibrium that evolutionary economics makes its case.  But why is it necessary for economic models to diverge from equilibrium and rational economics? The answer lies in the role of change over time as it pertains to matter.  The problem of equilibrium states can be simplified by examining Hume’s notions of ‘relations of ideas’ and ‘matters of fact’. [2]

To summarize in brief: ‘relations of ideas’ are independent of experience and rely on deductive reasoning that utilizes the laws of thought to produce truth and falsity; in contrast, ‘matters of fact’ are wholly dependent upon experience and rely on inductive reasoning that utilizes frequency to produce probability distributions.[3] In this way ‘relations of ideas’ operate rationally and can only make truth-falsity claims in a system closed to time and change in order to prevent contradiction. On the other hand, ‘matters of fact’ deal with qualitative properties of experience and material entities which change through time. [4]

The philosophical problem lies between the inherent assumptions gathered in neo-classical economics; emphasis is rational and quantitative, with equilibriums emphasizing ‘profit maximization’ and rational expectations (Nelson & Winter, 2002). Neoclassical thinking favors an atomist ontology dealing with external relations of irreducible atomistic entities (Hodgson, p. 408). This contrasts with evolutionary thinking that favors organicist ontology ‘in which relations between entities are internal rather than external and the essential characteristics of any element are outcomes of relations with other entities’ (Hodgson, p.408). In short, rational programs can only function ceteris paribus and therefore cannot make predictions pertaining to organic systems due to their internal and external changes over time. While Marshall frequently alluded to the organic nature of economic systems his theories diverged from organicism and drifted towards utilizing mechanistic atomism methods.

As an example, Hodgson (1993) points out Marshall’s failure to depart from atomism and mechanistic thinking when he employs the conception of the representative firm (p. 408). The description of the representative firm is ideally rendered as an imaginary firm representing essential qualities of the population. Marshall’s description is a means of ‘depicting the long run equilibrium for the industry as a whole, by means of a theory of the firm’ (p. 408). However, despite Marshall’s diminished emphasis on the ‘role of variety’, he preserves the notion elsewhere by describing ‘entrepreneurial activity leading to variations in organization and innovation’ and mentions ‘the tendency to variation is a chief cause of progresses’ (Hodgson 1993). It is evident from these remarks that while Marshall failed to devise a fully bio-economic account he nevertheless recognized the importance of variety as an impetus for growth.

As a corollary, Hodgson posits that the application of statical methods necessitate ‘typological’ thinking and the employment of theoretical ideals, such as representative firms, ‘typical individuals’ and homogenous economic agents, in order to maintain ceteris paribus (p. 409).[5] He proposes ‘population’ thinking so that theories can be positioned in terms of the relations and interactions of population properties and magnitudes (p.409).[6] In this way variety is prioritized as the chief facilitator of growth within the economic system. Drawing from the maintenance of variety in Darwin’s theories, Hodgson sees error making, or continual rejection, as the catalyst for creating variety and change (p. 409).

While Marshall’s biological analogies failed to gain widespread support early on there were many economists who saw the merit of undertaking economics from an evolutionary perspective. Among his most celebrated admirers early on was Joseph Schumpeter, an Austrian-born professor at Harvard. Schumpeter’s work described the nature of market innovation within capitalist societies and emphasized the role of less quantitative measures such as sociology as a major factor for economic development. Much of his inspiration was drawn from the economists Marx and Weber who favored dynamic sociological backgrounds, as well as Walrus from whom he borrowed the concept of the entrepreneur.

In 1942 Schumpeter published Capitalism, Socialism, and Democracy. In this work lies the theory of creative destruction, one of his most notable contributions. Originally a term coined by Marx, Schumpeter (1994) employed the “creative destruction” to mean the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one” (p 81-85).  He wrote that the concerns of capitalism were less about how existing structures were administered and maintained and more about how these structures are destroyed and created. Echoing Marshall, Schumpeter held that entrepreneurs are the sole agents of change and responsible for the destruction and construction of new markets and wealth within a society. Rather than intellect, it is the sheer acts of will power and leadership which characterize the entrepreneur’s pursuit to secure economic progress through successful innovation.

In Schumpeter’s analysis, an economy in equilibrium produces products for future consumers who are consuming their present products, and consumers consume products of past producers in a circular flow based on past experience. The expectations and cycles are essentially contained with no new production functions allowing for changes. The entrepreneur operates outside the system and introduces changes to the production function that allow for the creation of new wealth and destruction of the old- hence the term, creative destruction.

According to Schumpeter, capitalist societies did not operate in a static circular flow, or equilibrium, as proposed by Weber where the production function is invariant and preexisting factors of production are combined according to the mechanical technology at hand. Market activity is much more dynamic and changing. It is the entrepreneurs who operate as a non-entity outside of this equilibrium and force new combinations of factors that disturb the circular flow as a means of innovative development. Rather than changing the quantity of factors to change the quantity of products produced, this disturbance creates market disequilibrium as their innovative contributions change the form of the production function. This change in production function form introduces new and higher quality commodities which destroys old wealth and creates new wealth.

Schumpeter’s analysis upholds qualitative nature of entities and the various forces that influence changes within a system. These forces embody the behaviors born from individual psychologies, sociological factors, institutional practices, cultural rituals and conventions, and many more. Alfred Marshall (2003) repeatedly mentions throughout Principles that human behavior is irrational and driven by varying affections driven by the ego or familial sentiments (p. 22).

It is not clear that rational economic systems that utilize ceteris paribus and strive for an ideal equilibrium adequately address behavioral inconsistencies and changes. Nelson & Winter (2002) argue that firms are always ‘maladapted’ or lagging in adjustments and learning because of trial and error learning due to ‘broader currents of historical change in the socioeconomic system’ (p. 26). As a result, firms are forever subject to a variety of exogenous changes which are constantly posing novel problems for firms.  Given a hypothetical analysis of a static economy in the short run, the statical method may have the advantage over evolutionary economics when providing a selection process, but given the dynamic process of long run, neoclassical statics cannot provide any such process, for changes within the system are exogenous and temporaneous (Nelson & Winter, 2002).[7]

In this way neoclassical theory cannot accommodate the disequilibrium dynamics that arise from competitive industries or, for that matter, any growth spurred by technological advancement. In Appendix H Marshall pointed out such failures, saying that “…it was tacitly implied as is commonly done, that there could be only one position of stable equilibrium in a market: yet in fact under certain conceivable, though rare, conditions there can be two or more positions of real equilibrium of demand and supply, any one of which is equally consistent with the general circumstances of the market, and any one of which if once reached would be stable, until some great disturbance occurred” (Marshall, p. 665). This line of thought reflected the phenomenon of hysteresis, or path-dependence, as analogous to consumer demand, where the prediction of output is an internal state of the system, as well as its total inputs. In such a case, examining the internal states of the system or acquiring historical knowledge of inputs is essential for determining a system’s output. Any theory failing to account for hysteresis and denies qualitative and irreversible changes in the supply side schedule was deemed ‘out of touch with real conditions of life’ (Marshall, p.666).

In conclusion, economic models must not be closed rational models, as they are not reflective of nature as a function of change over time. The arguments presented rest on the creative and adaptive enterprises of humans as the central cause for disequilibrium and, as a corollary, outdated rational economic models dealing with the long run.  In this way economic models must utilize a function incorporating both rational and empirical claims that exist to capture the historicity and structure of systems and units, as well as the innovation and creativity that gives way to novel systems and units. The achievement of such a function will allow for accurate models predicting economic growth and explain such phenomena as hysteresis and supply irreversibility.

 

Works Cited
Hodgson, G.M. (1993). The Mecca of Alfred Marshall. The Economic Journal, 103(417), 406-415.
Hume, D. (1993). An Enquiry Concerning Human Understanding, 2nd ed.. Indianapolis: Hackett.
Langlois R.N., Everett M.J. (1994). What is Evolutionary Economics? In W.J. Samuels (Ed.), Evolutionary and Neo-Schumpeterian Approaches to Economics (pp. 11-47). Dordrecht: Kluwer Academic Publishing.
Marshall, A. (2009). Principles of Economics, 8th ed., New York: Cosimo.
Nelson, R.R, Winter, S. G. (2002). Evolutionary Theorizing in Economics. The Journal of Economic Perspectives, 16(2), 23-46.
Schumpeter, J.A. (1994). Capitalism, Socialism, and Democracy. London: Routledge.

[1] Selection processes include variety, behavioral continuity, profit induced growth, and limited path dependence.
[2] Kant and Leibniz made a similar distinction, with Kant classifying knowledge as ‘analytic knowledge’ and ‘synthetic knowledge’ and Leibniz classifying knowledge as ‘truths of reason and ‘truths of fact’.
[3] The most notable laws of thought supporting the ‘relations of ideas’, or rationality, is the law of non-contradiction which states that ~(p • ~p). This can only hold true for a specific time, so that p is or is not; applications of rationality to systems open to time and change cause contradictions in logical analysis.
[4] “All the objects of human reason or enquiry may naturally be divided into two kinds, to wit, Relations of Ideas, and Matters of Fact. Of the first kind are the sciences of Geometry, Algebra, and Arithmetic; and in short, every affirmation which is either intuitively or demonstratively certain. … Matters of fact, which are the second objects of human reason, are not ascertained in the same manner; nor is our evidence of their truth, however great, of a like nature with the foregoing. The contrary of every matter of fact is still possible; because it can never imply a contradiction, and is conceived by the mind with the same facility and distinctness, as if ever so conformable to reality.” (Hume, 1993)
[5] “In ‘typological thinking’ species are regarded as identifiable in terms of a few distinct characteristics which represent their essence…All variations around the ideal type are regarded as accidental aberrations.” (Hodgson, 1993)
[6] “…in population thinking, species are described in terms of a distribution of characteristics…[It] consists in the idea that theories may be stated relating the interactions of population properties and magnitudes.” (Hodgson, 1993)
[7] Selection process is the trial and error of firms to successfully compete within the market
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