Adapting To New Economies

Darwin 200
Adapting to a New Economy

An evolutionary perspective on economics can explain how we got into this current mess, and how we might find our way out.

by Rob Mitchum • Posted February 12, 2009 08:00 AM

Illustration by Tyler Lang.

IN A WORLD where a harsh, unforgiving environment creates scarce resources and fierce competition between its inhabitants, minute changes can mean the difference between dominance and death. Amid the chaos, former behemoths find themselves hurtling toward extinction, while scrappy underdogs get the opportunity to reach new heights.

So which is it: a movie-trailer narration of Darwinian natural selection, or this morning's business section?

You'd be forgiven for confusing the two in the midst of the financial mayhem tormenting the world's economies. Armchair observers, financial leaders, and increasing numbers of economists are using the language of Darwin to describe the current crisis.

"There is vicious natural selection going on right now in the financial services industry, and it's appropriate," said Mark Carney, governor of the Bank of Canada, in a November BBC interview. "Those who weren't on top of things are gone or going."

But can the relation of evolution to economics go further than skin-deep terminology? Can it actually change the face of the discipline? For more than a century, the scientific undercarriage of economic theory has been physics, the neoclassical idea that predictions can be based on a series of unchanging and universal laws. Swapping out the forecasts and equilibriums of physics for the complexity and chaos of biology's main engine would require a complete makeover.

Yet with the neoclassicists and free-market cheerleaders bearing (fairly or not) the brunt of the blame for the current financial meltdown, some economists say the time has come for just such a philosophical reset.

"Mainstream models have not had a very good record of prediction," says Geoffrey Hodgson, a British economist who has written several books and dozens of papers on evolutionary economics. "No one predicted the state of affairs in the last few months; no one predicted the financial crash of the last few years."

Perhaps it's time, evolutionary economists argue, to focus less on finding the best way to foresee the economic future and more on explaining how the economy works. That discovery may lie in modeling the economy as a complex system based upon the three core concepts of Darwinism: variation, selection, and inheritance. "We're not saying it's identical. We're not saying the mechanisms are the same," Hodgson says. "The key issue is whether there is an ontological similarity in terms of the structure of reality that crosses the two domains, that's similar in biology and similar in the economic sphere."

"The fact is, some firms are surviving more than others. There is a differential capacity to survive amongst a population of entities that carry information, engage with their environment, solve problems, and pass on problem solutions to others. That happens in a biological world in a very different way than it happens in the economic world, but nevertheless, in abstract terms, the ontology fits in both cases. So what Darwinism does is give you that framework to think about that problem."

PAINTING A PORTRAIT of the economic system with Darwin's palette is hardly a new concept. In fact, evolutionary economists like to point out that Darwin may have never even sprouted an -ism were it not for economics, citing the pivotal influence of Thomas Malthus's early-19th-century theories about resource scarcity upon Darwin's work. That dialogue between disciplines continued after The Origin of Species was published. Inspired by Darwin, University of Chicago economist Thorstein Veblen's 1898 essay "Is Economics Not an Evolutionary Science?" laid the groundwork for the field.

But Veblen's foundation gathered dust as the distortion and perversion of Darwinian ideas into Social Darwinism and its genocidal offshoots put evolutionary economics in the cellar for much of the 20th century. The reign of neoclassical economics, with its love of physics-based assumptions and predictions, also did its part to keep economists and evolutionary biologists on separate sides of the theoretical playground.

In 1982 economists Richard Nelson and Sidney Winter attempted a forced mingling of those crowds with their book An Evolutionary Theory of Economic Change. Their model saw all the key elements of Darwin's theory in the world's economy: a variety of species/businesses endlessly competing in a changing environment/market and mutating/innovating new "routines" that, like genes, would replicate and spread if successful/profitable in a given context.

It was a powerful analogy, but some, such as Hodgson, thought that it could be more: It could change the core assumptions of economics. Viewing economies as complex systems constantly in flux rather than stable, predictable systems in equilibrium could help economists, and the governments who trust them, to understand the machinations of the economy more accurately and dictate policy accordingly.

IN HIS 2006 BOOK on evolutionary economics, The Origin of Wealth, McKinsey Global Institute Fellow Eric Beinhocker suggests that new ways of thinking could take economic policy beyond the simplistic paradigm of left versus right. Harnessing the unpredictable complexities of evolutionary selection to spur economic growth and social well-being should be the goal. "We may not be able to predict or direct economic evolution," Beinhocker writes, "but we can design our institutions and societies to be better or worse evolvers."

Viewing economies as complex systems constantly in flux rather than stable, predictable systems in equilibrium could help economists, and the governments who trust them, to understand the machinations of the economy more accurately and dictate policy accordingly.

An evolution-informed policy would not merely let the free market sort out the strong and profitable from the weak and bankrupt, as Milton Friedman (who used the natural selection analogy in his own essay "The Methodology of Positive Economics") would have had it. In biology, Hodgson reminds us, evolution does not produce objectively "better" species, but merely species effectively adapted to their current environment. The current crisis environment, where banks have become risk averse and innovation is poorly supported, is a case in which the unbridled free market could leave us with businesses that are well-adapted but ineffective in the long run.

"The crisis doesn't actually give us a very good way of bringing about more effective firms," Hodgson says. Instead, he says, it provides a context for restructuring the banking system. According to Hodgson, government intervention is applicable even within the framework of evolution: "We shouldn't rule out intervention of the government to create a more effective context where competition can occur."

So gifting hundreds of billions of dollars to the world's largest banks — so long as they agree to redistribute that cash — would be strong evolutionary economic policy, Hodgson argues. That infusion of capital would foster innovation, be it the development of new technology or business plans, and encourage active competition and growth. Bailing out the reeling auto industry, with its outdated business plans and stubborn resistance to change, would be less advisable through a Darwinian lens, he says.

BUT CRITICS OF EVOLUTIONARY economics argue that the abstractions of equilibriums and rational action are still necessary to sort through the overwhelming complexity of a system running on Darwinian rules. No less a figure than recent Nobel Prize winner Paul Krugman argued in a 1996 talk to the European Association for Evolutionary Political Economy that even evolutionary biologists utilize their own "useful fictions" to make sense of complex systems.

"By all means, let us use simulation to push out the boundaries of our understanding; but just running a lot of simulations and seeing what happens is a frustrating and finally unproductive exercise unless you can somehow create a 'model of the model' that lets you understand what is going on," Krugman told the conference.

Others, while supportive of introducing Darwinian ideas into economics, maintain that its potential remains untapped on a macroeconomic level that could more directly inform economic policy. Though behavioral economics, the field that applies evolutionary theory and psychology to better model individual economic behavior, has made great strides in recent decades through the work of economists like Samuel Bowles and Richard Thaler, larger models that incorporate those advances into higher-order economics remain undeveloped.

"At the moment, we're a ways from that. It's a big disappointment," says Lawrence Blume, professor of information science at Cornell University and an external professor of the Santa Fe Institute. "In order to talk about evolution, you have to talk about diversity, and there are no serious economic models which take diversity seriously."

For now, an evolutionary perspective on economics can help explain at least broadly how we got into the current mess, and how we may find our way out, Blume says.

"In a Darwinian way, I think there were a lot of incentives for investment managers and fund managers to act in ways we are now criticizing," Blume says. "But whatever happens, the market regime is going to change, with new institutions and new kinds of oversights. At the end of the day [the crisis] could actually end up helping by making markets more transparent. It's not as if there's going to be a totally new group out there doing things in a different way, but we are going to see adaptation going on within the same corporate shell."

But from the middle of that brutal economic selection pressure, Hodgson warns that the evolution driven by the current crisis won't be easy: "National economies can adapt a lot, but it takes time and it's often very painful."
Darwin 200

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