Political Economy: Evolutionary Economics

1. Political Economy: Evolutionary Economics Early contributions

2. Recap • Modern evolutionary theory much richer than “survival of the fittest” • Feedback between organism & environment • Positive as well as negative feedbacks • Symbiosis as well as competition • Interdependence of firms/sectors as well as raw competition • Collective behaviour as well as individual • “Web of life”/ “Web of commerce” • Directed evolution • Essential concepts variation & environment/organism feedback

3. Darwin’s influence • Darwin’s “Origin” published 1869 • Influence substantial on Victorian mindset (from “primogenesis” to “science” to explain species) • Some influence on economics, but generally developing under its own steam • Marx’s Das Kapital 1867 final, anti-capitalist Classical economics • Collapse Classical school, development of neoclassical…

4. The “new” economics circa 1870 • Dominant analytic techniques static • Jevons’ marginal optimisation of utility • Walras’ General Equilibrium • Marshall’s profit maximising firms • Mathematical functions for maximising utility/profit • Work out point at which change stops • No evolution from the optimum… • Some recognition of superiority of dynamic/evolutionary approach:

5. The “new” economics circa 1870 • Aware of importance of evolutionary dynamics… • “If we wished to have a complete solution ... we should have to treat it as a problem of dynamics. But it would surely be absurd to attempt the more difficult question when the more easy one is yet so imperfectly within our power.” (Jevons 1871 [1911]: 93) • “The Mecca of the economist lies in economic biology rather than in economic dynamics. But biological conceptions are more complex than those of mechanics; a volume on Foundations must therefore give a relatively large place to mechanical analogies; and frequent use is made of the term “equilibrium”, which suggests something of statical analogy… (Marshall, “Principles”, 8th edition, p. 19)

6. And since then… • Clear expectation that theory would develop dynamical/evolutionary approach from static beginnings: • “The main concern of economics is thus with human beings who are impelled, for good and evil, to change and progress. Fragmentary statical hypotheses are used as temporary auxiliaries to dynamical—or rather biological—conceptions: but the central idea of economics, even when its Foundations alone are under discussion, must be that of living force and movement.” (Marshall: 22) • But that’s not what happened… • Hence Veblen’s “Why?” paper: Skip “warning”

7. Reading Veblen… • Yep, he’s a verbose bastard… • But there’s a certain poetry to his prose… • Read on and you’ll see gems of wisdom amongst the words…

8. Why is economics not an evolutionary science? • Veblen: dominant tendency in economics is to uncover “natural law”: • ‘This natural law is felt to exercise some sort of a coercive surveillance over the sequence of events, and to give a spiritual stability and consistence to the causal relation at any given juncture… Any causal sequence which is apprehended to traverse the imputed propensity in events is a “disturbing factor”.’ • A scientist, on the other hand • ‘is unwilling to depart from the test of causal relation or quantitative sequence. When he asks the question, Why? he insists on an answer in terms of cause and effect…’

9. Neoclassical economics as non-evolutionary • Evolution based on variation and adaptive selection • Economics uses ideals (General Equilibrium/Pareto Optimality…) from which by definition their can be no adaptive improvement • Economic theory ‘is a projection of the accepted ideal of conduct. This ideal of conduct is made to serve as a canon of truth, to the extent that the investigator contents himself with an appeal to its legitimation for premises that run back of the facts with which he is immediately dealing, for the “controlling principles” that are conceived intangibly to underlie the process discussed, and for the “tendencies” that run beyond the situation as it lies before him.’

10. Neoclassical economics as non-evolutionary • Heavy criticism of role of equilibrium metaphor ‘in which the concept of normality and propensity to an end has reached an extreme attenuation’ • ‘it is this facile recourse to inscrutable figures of speech as the ultimate terms of theory that has saved the economists from being dragooned into the ranks of modern science… By their use the theorist is enabled serenely to enjoin himself from following out an elusive train of causal sequence. He is also enabled, without misgivings, to construct a theory of such an institution as money or wages or land-ownership without descending to a consideration of the living items concerned, except for convenient corroboration of his normalised scheme of symptoms.’

11. Neoclassical economics as non-evolutionary • Economic vision of humans also unamenable to change • People are ‘conceived in hedonistic terms; that is to say, in terms of a passive and substantially inert and immutably given human nature. The psychological and anthropological preconceptions of the economists have been those which were accepted by the psychological and social sciences some generations ago.’ • And now, the greatest ever put-down of the neoclassical “utility-maximising/budget constraint” view of human behaviour…

12. Bananas 10 9 8 7 6 5 4 3 2 1 0 0 Biscuits 1 2 3 4 5 6 7 8 9 10 Neoclassical economics as non-evolutionary • ‘The hedonistic conception of man is that of a lightning calculator of pleasures and pains who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift him about the area, but leave him intact. He has neither antecedent nor consequent. He is an isolated definitive human datum, in stable equilibrium except for the buffets of the impinging forces that displace him in one direction or another. Self-imposed in elemental space, he spins symmetrically about his own spiritual axis until the parallelogram of forces bears down upon him, whereupon he follows the line of the resultant. When the force of the impact is spent, he comes to rest, a self-contained globule of desire as before…’ versus the evolutionary view...

13. Neoclassical economics as non-evolutionary • ‘it is the characteristic of man to do something… the desires under whose guidance the action takes place … are elements of the existing frame of mind of the agent, and are … the products of his hereditary traits and his past experience, … and they afford the point of departure for the next step in the process. The economic life history of the individual is a cumulative process of adaptation of means to ends that cumulatively change as the process goes on, both the agent and his environment being at any point the outcome of the last process. His methods of life today are enforced upon him by his habits of life carried over from yesterday and by the circumstances left as the mechanical residue of the life of yesterday.’

14. Neoclassical economics as non-evolutionary • One difference (?) w.r.t. biological evolution • Human action is purposeful (“teleological” from Greek “Telos” meaning “end”) • Economic action is teleological, in the sense that men always and everywhere seek to do something. What, in specific detail, they seek, is not to be answered except by a scrutiny of the details of their activity; but, so long as we have to do with their life as members of the economic community, there remains the generic fact that their life is an unfolding activity of a teleological kind.’ • However, its ends aren’t necessarily those assumed by economists (utility maximisation, profit maximisation, optimal allocation of resources…):

15. Neoclassical economics as non-evolutionary • ‘It may or may not be a teleological process in the sense that it tends or should tend to any end that is conceived to be worthy or adequate by the inquirer … The question of a tendency in events can evidently not come up except on the ground of some preconception or prepossession on the part of the person looking for the tendency. In order to search for a tendency, we must be possessed of some notion of a definitive end to be sought… The notion of a legitimate trend in a course of events is an extra evolutionary preconception, and lies outside the scope of an inquiry into the causal sequence in any process. The evolutionary point of view, therefore, leaves no place for a formulation of natural laws in terms of definitive normality…’

16. Neoclassical economics as non-evolutionary • What should evolutionary economics be? • ‘the theory of a process of cultural growth as determined by the economic interest, a theory of a cumulative sequence of economic institutions stated in terms of the process itself.’ • Why can’t neoclassical economics achieve this? • Evolutionary economics would attempt ‘to trace the cumulative working out of the economic interest in the cultural sequence. It must be a theory of the economic life process … a hedonistic psychology … does not afford material for a theory of the development of human nature… It is therefore not readily apprehended or appreciated in terms of a cumulative growth of habits of thought…’

17. Neoclassical economics as non-evolutionary • Why has academic economics failed to become evolutionary? • Because the ‘taxonomic’ (equilibrium) approach • ‘… is the easiest, gives the most gratifying immediate results, and best fits into the accepted body of knowledge of the range of facts in question… The well worn paths are easy to follow and lead into good company. Advance along them visibly furthers the accredited work which the science has in hand. Divergence from the paths means tentative work, which is necessarily slow and fragmentary and of uncertain value.’

18. Neoclassical economics as non-evolutionary • “Taxonomic”? Foundations of neoclassical economics • ‘are certain very concise assumptions concerning human nature, and certain slightly less concise generalisations of physical fact… These postulates afford the standard of normality… whenever a departure from this normal course of things occurs, it is due to disturbing causes… Such departures … are constantly present in the facts … but … have no place in the body of the science… The science is, therefore, a theory of the normal case, a discussion of the concrete facts of life in respect of their degree of approximation to the normal case. That is to say, it is a taxonomic science.’ (1919: 163-164)

19. Neoclassical economics as non-evolutionary • Economics has evolved into a dead end… • ‘Like other men, the economist … is a creature of habits and propensities given through the antecedents, hereditary and cultural, of which he is an outcome… Methods of observation and of handling facts that are familiar through habitual use in the general range of knowledge, gradually assert themselves in any given special range of knowledge. They may be accepted slowly and with reluctance where their acceptance involves innovation; but, if they have the continued backing of the general body of experience, it is only a question of time when they shall come into dominance in the special field.’

20. Veblen’s alternative: cumulative causation • ‘The sciences which are in any peculiar sense modern take as an (unavowed) postulate the fact of consecutive change. Their inquiry always centers upons some manner of process… a sequence, or complex, of consecutive change in which the nexus of the sequence, that by virtue of which the change inquired into is consecutive, is the relation of cause and effect.’ (1919: 32) • This is ‘post-Darwinian’ versus ‘pre-Darwinian’ science as “taxonomic” (classification rather than causation) which still continues in economics • ‘The scientists of that era looked to a final term, a consummation of the changes which provoked their inquiry.’ (1919: 36)

21. Veblen’s alternative: cumulative causation • Pre-Darwinian thought considers ‘how things had been in the presumed primordial stable equilibrium out of which they, putatively, had come, and how they should be … as the outcome of the play of forces which intervened between this primordial and the definitive stable equilibrium’ (1919: 37) • Anyone for comparative statics?… • In post-Darwinian science, ‘the interval of instability and transition … has come to take the first place of the inquiry… Questions of a primordial beginning and a definitive outcome have fallen into abeyance…’ (1919: 37) • This makes true science fundamentally dynamic, not static:

22. Veblen’s alternative: cumulative causation • ‘They occupy themselves with “dynamic” relations and sequences. The question which they ask is always, What takes place next and why?’ (1919: 84) • Versus economics where ‘the pure theory … deals not with the dynamics, but with the statics of the case… The process is rated in terms of the equilibrium to which it tends or should tend, and not conversely.’ (1919: 165) • ‘Professor Marshall’s work… remains an inquiry directed to the determination of the conditions of an equilibrium… It is not … an inquiry into … institutional development … it is the movement of a consummately conceived and self-balanced mechanism, not that of a cumulatively unfolding process or an institutional adaptation to cumulatively unfolding exigencies.’ (1919: 173)

23. Veblen’s alternative: cumulative causation • [originator of marginal productivity theory]’s ‘view of dynamics is ‘The more “dynamic” the society, the nearer it is to the static model; until in an ideally dynamic society, with a frictionless competitive system … the static state would be attained…’ (1919: 190) • ‘Economics of the line represented … by Mr Clarke has never entered this field of cumulative change. It does not approach … questions of genesis, growth, variation, process… hedonistic economics does not, and cannot, deal with phenomena of growth…’ (1919: 192)

24. Veblen’s alternative: cumulative causation • Pessimism that post-Darwinian thinking will ever dominate economics—an inability to break away from “final ends” type thinking: • ‘Even the evolutionary process of cumulative causation as conceived by the adepts of these sciences is infused with a preternatural, beneficent trend trend; so that “evolutionary” is conceived to mean amelioration or “improvement”… Whether such a shifting of the point of view in these sciences shall ever be effected is still an open question…’ (1919: 55)

25. Veblen’s contribution • Cogent criticism of neoclassical theory • Conviction that truly evolutionary economics cannot be built upon neoclassical foundations; but • No developed technical means to embody evolutionary thinking in economics • Strong contrast with Schumpeter • Acceptance of neoclassical economics • Analysis of change/instability complements, not contradicts statics • Processes of growth and disturbance coexist with processes of movement towards equilibrium:

26. Schumpeter • ‘what is missing in the static apparatus and what accounts for the dissatisfaction with it and for the attempts to force such phenomena into its cracking frame—instead of, as we think it natural to do, recognising and explaining this as a distinct process going along with the one handled by the static theory.' (1928: 379/65) • But at the same time, instability • Fundamental to capitalism • A good thing: leads to change & growth • Explains cyclical nature of capitalism

27. Schumpeter • In contrast to neoclassical belief in stability & equilibrium • the ‘economic structure and the social and political structure which were based upon it, therefore also that civilisation or system of values, were inherently unstable… there can be no such thing as a stable social system. Any system transforms itself simply by its mere working and if history teaches us nothing else it teaches that.’ (Lowell Lectures: 342) • Transformational Growth & Creative Destruction • Growth leads to social change • Progress causes destruction of old means of production/social arrangements • A ‘dialectical’ vision of cycles—prosperity contains the seeds of its own destruction:

28. Schumpeter • ‘While a new thing is being built and financed, expenditure is on a supernormal level… When such a period of advance has gone on for a time,… the products of these new constructions … begin to pour out and these products compete with the products of the old methods. In fact, that’s the way in which progress is accomplished in capitalism and the old eliminated.’ (349) • Cycles & “out of phase” expectations inevitable: • ‘when everyone observes value and profits to increase, he is likely more or less to project this rate of increase into the future and to enter into commitments which will turn out to be ill-conceived and untenable as soon as that rate of increase is interrupted.’ (349)

29. Schumpeter’s model • Conventional interpretation of neoclassical economics • Utility analysis of consumer behaviour • Marginal productivity theory of income distribution • Say’s Law in static equilibrium • ‘somewhere in the economic system a demand is … ready awaiting every supply, and nowhere in the system are their commodities without complements… the sellers of all commodities appear again as buyers in sufficient measure to acquire those goods which will maintain their consumption and their productive equipment in the next economic period…' (1936: 8)

30. Schumpeter’s model • Semi-Austrian “roundaboutness” theory of production • All means of production reducible to land • ‘we finally come to the ultimate elements in production for our purposes… labour and the gifts of nature or “land”… But the remaining products, … the “produced means of production”, are, on the one hand, only the embodiment of those two original production goods… we have no reason … why we should see in them an independent means of production. We “resolve them into labour and land.”’ (1936: 16-17) • Subject to “Cambridge critique” of aggregate capital (see History of Economic Thought lectures)

31. Schumpeter’s model • No profits in static equilibrium • ‘Hence, in an exchange economy, the prices of all products must, under free competition, be equal to the prices of the services of labour and land contained in it... Consequently, net profit cannot exist, because the value and price of the original productive services will always absorb the value and price of the product…’ (1936: 30-31) • Money only a veil over barter in static equilibrium • 'To employ a customary expression, we can say that money thus far represents only the cloak of economic things and nothing essential is overlooked in abstracting from it.' (1936: 51) • Money as gold equivalent: no net credit

32. Schumpeter’s model • Profits come from discontinuous & disequilibrium forces, which statics can’t explain • ‘“static” analysis … can neither explain the occurrence of such [discontinuous] productive revolutions nor the phenomena which accompany them. It can only investigate the new equilibrium position after the changes have occurred.' (1936: 61-62) • To explain change, an evolutionary approach needed…

33. Schumpeter’s model • Evolutionary basis to thinking: • ‘the evolutionary idea is now discredited in our field… with all the hasty generalisations in which the word “evolution” plays a part, many of us have lost patience. We must get away from such things… then two facts still remain: first the fact of historical change... [and that] These changes constitute neither a circular process nor pendulum movements about a centre.’ (1936: 57-58) • Economic evolution & hence development is • ‘spontaneous and discontinuous change in the channels of the flow, disturbance of equilibrium, which forever alters and displaces the equilibrium state previously existing.' (1936: 64)

34. Schumpeter’s model • Development occurs when an entrepreneur seeking profit either • Introduces a new good • Introduces a new method of production • Opens up a new market • Introduces a new source of supply • Reorganises an industry • Assumes • entrepreneurs not involved in existing firms (treats intra-firm innovation as negligible) • Reorganisation of employment of existing resources rather than employment of previously unemployed (treats latter as negligible)

35. Schumpeter’s model • To be able to develop, entrepreneur needs credit • ‘the possessor of wealth ... must resort to credit if he wishes to carry out a new combination, which cannot like an established business be financed from returns from previous production. To provide this credit is clearly the function of that category of individuals we call “capitalists”… (1936: 69) and ‘The banker… has himself become the capitalist par excellence…’ (1936: 74) • Entrepreneur as agent of evolutionary change: • ‘The carrying out of new combinations we call “enterprise”; the individuals whose function it is to carry them out we call “entrepreneurs”.’ (1936: 74)

36. Schumpeter’s model • Net profit emanates from development • ‘he has, if everything has gone according to expectations, enriched the social stream with goods whose total price is greater than the credit received and than the total price of the goods directly and indirectly used up by him... Furthermore, the entrepreneur can now repay his debt (amount credited plus interest) at his bank, and normally still retain a credit balance (=entrepreneurial profit) that is withdrawn from the purchasing power of the circular flow.’ (110-111)

37. Schumpeter’s model • Net credit (credit in excess of asset backing) arises from development: • ‘money, and … other means of payment … perform an essential function, … processes in terms of means of payment are not merely reflexes of processes in terms of goods… (95)… in real life total credit must be greater than it could be if there were only fully covered credit…’ (101) • Disruption to equilibrium, net entrepreneurial profit, net credit, leading ultimately to a new equilibrium:

38. Schumpeter’s model • ‘But now comes the second part of the drama. The spell is broken and new businesses are continually arising under the impulse of the alluring profit. A complete reorganisation of the industry occurs, with its increases in production, its competitive struggle, its supercession of obsolete businesses, its possible dismissal of workers, and so forth… the final result must be a new equilibrium position… Consequently, the surplus of the entrepreneur in question and his immediate followers disappears … Nevertheless, the surplus is realised … And their profit, the surplus, to which no liability corresponds, is an entrepreneurial profit.’ (131-132) • This process occurs in cycles:

39. Schumpeter’s model: the business cycle • Cycles occur ‘because the new combinations are not, as one would expect according to general principles of probability, evenly distributed through time … but appear, if at all, discontinuously in groups or swarms.’ (223) • ‘Three circumstances increase the effect of the swarm-like appearance of new enterprises… • the vast majority of new combinations will not grow out of the old firms … but compete with them… • the fact that entrepreneurial demand appears en masse … starts a secondary boom… • errors must play a considerable role at the beginning of the boom and during the course of the depression.’ (225-227)

40. Schumpeter’s model: the business cycle • ‘Why do entrepreneurs appear, not continuously … but in clusters? Exclusively because the appearance of one or a few entrepreneurs facilitates the appearance of others, and these the appearance of more, in ever-increasing numbers.’ (228) • ‘Reality also discloses that every normal boom starts in one or a few branches of industry … But the pioneers remove the obstacles for the others not only in the branch of production in which they first appear, but, owing to the nature of these obstacles, ipso facto in other branches too… Hence the first leaders are effective beyond their immediate sphere of action…’ (229)

41. Schumpeter’s model: the business cycle • Boom leads to bust • During boom, financing of new innovations expands net credit, general business activity, increases wages & rents • Once innovations produced • new/cheaper goods undercut existing enterprises • Repayment of net credit (with entrepreneurial profit deducted) contracts credit system • Both deflate prices, causing financial distress • ‘The average time which must elapse before the new products appear … fundamentally explains the length of the boom. This appearance of the new products causes the fall in prices, which on its part terminates the boom, may lead to a crisis, must lead to a depression, and starts all the rest.’ (233)

42. Discordant fathers • Two different foundations for evolutionary economics: • Veblen • Evolutionary view incompatible with neoclassical statics • Evolutionary perspective needed for everything from consumer behaviour up • But no systematic alternative developed • Schumpeter • Evolution can be pasted onto neoclassical statics • Statics suitable for consumer behaviour, circular flow • Evolution needed for growth & development • Attempt at systematic analysis

43. Discordant children… Main branch of evolutionary economics combines • Veblen’s scepticism re statics • Non-neoclassical theory of value • Simons’ “satisficing” vs neoclassical optimising • Markup pricing vs marginal cost pricing • Schumpeter’s “creative destruction” and focus upon • Business cycle dynamics • Role of entrepreneur • Evolution of technology • Some “evolutionary” approaches not considered • “Evolutionary game theory” • Austrian economics (Hayek/Mises/Rothbard)

44. References • Schumpeter, J.A. • (1928). “The instability of capitalism”, Economic Journal 361-386, reprinted in Essays of J.A. Schumpeter, Addison-Weslay, Cambridge MA: 47-72. • (1936). The Theory of Economic Development, Harvard University Press, Cambridge MA. • Veblen, T. • (1904). The Theory of Business Enterprise, Augustus M. Kelley, New York, [1965]. • (1919). The Place of Science in Modern Civilisation, B.W. Heubsch, New York. • “The evolution of the scientific point of view”, 32-55. (1908) • “The preconceptions of economic science”, I, II & III, 82-113, 114-147, 148-179. (1899, 1899, 1900) • “Professor Clarke’s economics”, 180-230. (1908) • “The limitations of marginal utility”, 231-251. (1909)