What is Evolutionary Economics?

Evolutionary Economics is a field which looks at the economy as an evolutionary system, not a system constantly in or tending toward equilibrium. From that simple idea springs a discipline which offers a radically different view of the economy, and profoundly important practical implications for industry and government.

I’ve come across many fields of economic thought in my studies; Neoclassical, Austrian, Post-Keynesian, neo-Ricardian, and Institutionalist Economics, Radical Political Economy, and even Feminist Economics amongst others. But I want to take a little time to introduce you to the one that started it all for me: Evolutionary Economics.

I’m currently attending the 10th European Meeting on Evolutionary Economics in Strasbourg. The field has advanced so far that most of the presentations would bewilder those without an extended period of instruction, they are quite specialised and advanced. I always find it beneficial when in such environments to go “back to roots” and mediate on the field’s core teachings.

As an undergraduate at the University of Queensland I heard Jason Potts offhandedly mention it in a first year lecture. At the time it seemed mysterious, odd and arcane. Little did I know that the University of Queensland was at the forefront of the development of this field which would eventually, upon my first encounter with it immediately become and remain the unchallenged core of my view of the economy. This field affected me so profoundly that it was the progenitor of the “UQ model” of economies as complex evolving networks formed by individuals acting on the basis of their psychology and social position which I contributed to building in my Doctoral research.

Ulrich Witt wrote an excellent scholarly paper on the nature of evolutionary economics, but I’d like here to introduce the field as I would to someone with no acquaintance with it. And, further, I’d like to show you why you should care about it very much indeed because of the radical change it brings to one’s view of the economy, and its practical implications for industry and government.

Stick with me. It’ll take a little time, but I promise you’ll get to the end and think, like I did, “hey, that’s really cool”.

Origins of modern evolutionary economics: Nelson and Winter

Evolutionary economics traces its roots to the works of Joseph Schumpeter and Thorstein Veblen in particular, as well as the ever-profound Alfred Marshall. But the modern field originates in the rediscovery of Schumpeter in particular by Richard Nelson and Sidney Winter in their monumental work of 1982: An Evolutionary Theory of Economic Change.

Nelson and Winter’s contribution can be thought to begin with a simple question: what if Darwin’s evolutionary theory were applied to economic systems? Evolutionary theory proposes that an evolutionary system contains a three-step process:

1. Variation: There is variation of some set of characteristics between the members of some population.

2. Selection: Certain of these characteristics effect the degree to which the system selects certain “units of selection” amongst the population for retention, and certain others for non-retention.

3. Retention: The system retains those members of the population with the characteristics which are selected, and ejects those members with those characteristics which are de-selected.

The outcome of this process is colloquially (and crudely) called “survival of the fittest”.

In biological theory the population is a population of organisms, the unit of selection is the gene, selection pressures are exerted on that population by different survival rates resulting from genetic variation, and retention is signalled by the survival and procreation of carriers of particular genes.

Nelson and Winter’s proposal, later defended valiantly by Geoff Hodgson was that in economic theory, the population was a set of firms, the unit of selection the goods and services offered thereby, and variation therein the result of production routine variation (or “technological” variation). Selection pressures were exerted by differential sales growth resulting from (literal) selection of goods and services by buyers for their characteristics, and retention was to be signalled by the maintenance of those sales.

This was the beginning of the field of modern evolutionary economics. The genius of it was that the mathematics of this field (known as “replicator dynamics”) needed only to be carried over from evolutionary biology with the symbols renamed. Stan Metcalfe provided a captivating introduction to this mathematics in his classic book Evolutionary Economics and Creative Destruction.

Yes, captivating. I distinctly remember working in awe through every single equation as a lad of but twenty years.

Adding self-organisation to the mix: Foster, Witt and Metcalfe

Towards the end of the 1980s and the early 1990s, three economists in particular came to doubt that the evolutionary theory of Darwin alone could explain all aspects of the economy: John Foster (later my Doctoral advisor), Ulrich Witt, and Stan Metcalfe. They noted a critical distinction between biological and economic evolution. In biological evolution variation is typically considered random, there is nothing more to be said about it. In economic evolution, variation is most definitely not random, it is the outcome of purposeful behaviour to lower costs, prices, change product characteristics, and develop entirely new products, to innovate.

Foster, Witt and Metcalfe proposed a refinement of the evolutionary theory used in economics; that economies are self-organising systems which originate and diffuse novelty. The process of diffusion is more or less equivalent to the process of selection and retention. The process of origination is not only variation however, but the origins of that variation, the process of variation.

Seeking to understand the process of variation led Foster, Witt and Metcalfe down routes most definitely not kosher for the traditional economist. Understanding the process by which variation comes to exist in an economic system requires us to investigate such traditionally fuzzy concepts as creativity and imagination. But by studying these concepts, into the realm of evolutionary economics was brought an understanding of bifurcation, a critical concept in economics which, one might say, provides the missing link between retention and variation and “closes the loop” of old-fashioned three-step evolutionary theory.

As the evolutionary process proceeds, variety is resolved into uniformity by selection. This creates pressure to adapt if members of the economy are seeking to maintain their livelihood.

If members of the population are sufficiently adaptable — can use their imagination and creativity to think up new processes and new products — they create new variety and start a new evolutionary process by the origination of novelty. If the members of the population are not so adaptable, the system collapses to the drudgery of uniformity which is utterly vulnerable to the origination of novelty by other populations.

Either a particular population continually creates variation and rejuvenates the basis on which the evolutionary selection process operates, or it does not. If it does not, the population collapses, and is replaced by a new population which does so rejuvenate the basis on which the evolutionary selection process operates.

Evolutionary economics thus expanded provided a fully dynamic theory which explains the Phoenix-like nature of economic systems. From the ashes of a mature market dominated by a few “hyper-fit” entities rises a new one, either from within that market or from a new one conquering it.

The Brisbane Club makes the link with networks: Dopfer and Potts

Something was still not quite right with this vision. Logistic diffusion curves, replicator dynamics and Lotka-Volterra equations reflecting the self-organisation of the economy through origination and diffusion were all well and good at explaining the aggregate data describing economic systems. But there was no real vision contained within these equation systems of the actual interactions, the interpersonal exchanges which comprise an economic system.

Put slightly differently, there was no vision given (within the mathematics at least) of where the “selection flow rates” of the populations the equations were describing were coming from.

The solution to this most fundamental problem of evolutionary economics came, as it always seems to, from an obscure kid out of nowhere. That kid was Jason Potts, who had eventually found his way to the tutelage of Peter Earl at Lincoln University in Christchurch, New Zealand. In his PhD, later a book (the book), The New Evolutionary Microeconomics, he realised the fundamental difference between “old” economics and “new” economics was the recognition that the economy was not a field like an electromagnetic system, a complete network in which everyone interacts directly with everyone else. The structure of fields cannot evolve — there are no new connections to be made.

The economy must therefore be an incomplete network, it can evolve because there are connections which aren’t made, which can yet be made.

John Foster, by now Head of the School of Economics at the University of Queensland, immediately recognised the profoundity belied by this simple idea of economic systems as evolving network structures and brought Jason Potts to the University of Queensland. For good measure, he brought Peter Earl across as well and turned the University of Queensland into the powerhouse of evolutionary economics which it was from 1999 to 2009, the year I showed up on its door as a freshman.

Together, with regular appearances by Stan Metcalfe, Kurt Dopfer, Ulrich Witt and the originals, Richard Nelson and Sidney Winter, the University of Queensland became the home of the “Brisbane Club” of evolutionary economists. Together they developed the vision of the economy as an evolutionary system which became the basis for the heavy-duty mathematics of the “UQ model”.

The Brisbane Club’s vision was most fully developed in what remains the best-known paper written within the School of Economics at the University of Queensland: Kurt Dopfer, John Foster and Jason Potts’s “Micro-meso-macro” in the 2004 Journal of Evolutionary Economics. The economy is a network of interactions between individuals making connections by following behavioural rules (also known as “routines” or “institutions”). It is an evolutionary system in which the rules which guide economic behaviour are originated and diffused — subjected to variation, selection and retention.

Evolutionary pressures are exerted on economic networks by origination of new rules at the microeconomic level, but they manifest in higher level phenomena as well. As we broaden our view we observe that the rules applied by various individuals have a degree of commonality which allows us to conjecture the existence of a “meso-rule”. This allows us to class individuals who use some variant of that rule into a corresponding meso-population. The macroeconomy becomes a network between meso-populations of individuals applying microeconomic variations on meso-rules to form connections.

The origination of new rules at the microeconomic level is what feeds the origination and diffusion of new meso-rules, drives their variation, selection and retention, and the evolution we observe in the macroeconomy.

This matters a lot: evolutionary economics in industry and government

The view of the economy which emerges from this is quite different to the view we obtain from looking at the economy as a system constantly in or tending toward equilibrium.

Economies aren’t stable unless they’re desperately unhealthy. They’re always dynamic, and if anything, they’re chaotic. They don’t tend toward a stately stable equilibrium of moderately sized firms. They tend to a violently hollowed out distribution of a few small niche survivors and a few massive corporations conglomerated from the hyper-fit competitors. They are “scaling” systems, winner-take-all systems with feedback effects which literally make the rich richer.

But they’re also, beneath the chaos and violence, deeply ordered. They are always subject to variation, selection, and retention. And as variety is resolved into uniformity, pressure builds to innovate, originate novelty and begin the whole process of diffusion again.

Sounds nice enough right? But why does it matter?

It sounds like a lot of philosophical high theory, but why should you care about evolutionary economics? What is different not only about the vision it offers us of the economy, but its practical implications?

The first, sharpest advice it gives is to the government: failure is absolutely as essential to economic systems as success, and no economic system is healthy in which the preservation of liberty is not the fundamental political principle.

We need to know what is not desired by society for without this being revealed we cannot know what is desired. Discovering this knowledge is exactly what the evolutionary process in economics does. It is a process by which society literally selects certain goods and services for retention and selects others for rejection.

Governments are loathe to allow failure, especially when those failing vote, have loud enough voices to effect votes, or can buy votes. And that’s fine, that’s how democracy works. But the more the government intervenes in the evolutionary process to prevent failure (which isn’t the same as preventing individual people from falling into penury), the more the cost to our discovery of knowledge about what society wants and doesn’t want.

The first lesson of evolutionary theory in any field is that the development of any system is directly correlated to the variety within it. This is actually a mathematical fact known as Fisher’s Fundamental theorem of natural selection, and in extended form the Price equation. It’s a very simple idea; if there’s no variety, there’s no “better” options for the evolutionary process to select, so the economy doesn’t develop, it stays static. In the economy, where variation is originated by individuals introducing new ideas and developing new rules to guide economic behaviour, this dictates the necessity of their liberty to so innovate.

Governments also loathe things they cannot control, and even more giving up their control over things. That’s fine too, it’s their nature — they exist to control things. But the less they are restrained, the more constraints they place on liberty, the greater the cost to the origination and diffusion of innovation and the development (which isn’t the same as growth) of the economy.

Evolutionary economics also offers advice to those engaged in what Marshall called “the everyday business of life”, to those in industry trying to earn a living by barter and trade. The core of that advice is that lowering price-cost is not enough to compete and survive in an evolutionary system. If that’s what you focus on exclusively you’re probably going to fail and fall foul of the selection pressures in the economy.

That’s because there’s more than one platform upon which selection pressures are exerted. Competition also proceeds on the basis of product innovation, not just process innovation (“making things cheaper”). In fact, it is product innovation — changing non-price attributes and creating new products — which is the primordial basis for variation amongst the units of selection in the economic system.

The advice offered by evolutionary economics to industry goes beyond this warning and offers a positive message too. There is a way to maximise your chances of being selected by the evolutionary process, survive, and earn a living and that is to maximise your knowledge, creativity and adaptability. Those concepts are much less fuzzy than you might think and they’re intertwined — to maximise your knowledge is to maximise your creativity, and adaptability is nothing more than the willingness to act on that.

Maximising knowledge is about learning as much know how and know why as possible; learning as many rules as possible for economic behaviour and when they are best applied. This maximises one’s ability to respond to changing environments and to think creatively about how new ones might be addressed (I have written about this elsewhere). One then needs only the courage to act upon this to be able to adapt to changing economic environments and survive.

So that’s evolutionary economics, that’s the field that started it all, at least for me. It offers us a radically different view of how the economy works. It offers profoundly important implications for industry and government. It’s not just a cool way to think about the economy. It matters. A lot.