Evolutionary Economics

Very interested to hear anyone's thoughts on the field of evolutionary economics. In particular the use of complexity theory and systems analysis:

'Complexity economics is the application of complexity science to the problems of economics. This new mode of economic thought rejects traditional assumptions that imply that the economy is a closed system that eventually reaches an equilibrium. Instead, it views economies as open complex adaptative systems with endogenous evolution. Complex systems do not necessarily settle to equilibrium — even ideal deterministic models may exhibit chaos, which is distinct from both random (nondeterministic) and analytic behavior.

Complexity economics rejects many aspects of traditional economic theory. The mathematic models used by traditional economics were copied from early models of thermodynamics. These mathematic models of economics were solely based on the first law of thermodynamics, equilibrium. Later, the second law of thermodynamics, entropy, was discovered. Proponents of complexity economics claim that traditional economic models never adapted to the latter discovery and thus remain incomplete models of reality.

Complexity economics is built on foundations of a long-standing tradition of heterodox economics that includes areas such as behavioral economics, institutional economics, Austrian economics, and evolutionary economics.'

from: http://en.wikipedia.org/wiki/Complexity_economics

This kind of approach has been adopted by IEPE (Institutional Evolutionary Political Economy) theorists. Phillip O'Hara:

'IEPE is dynamic, circuitous perspective on the world in the process of uneven development and varying levels of divergence due to the asymmetric distribution of information, resources, power and networks. It tends to eschew equilibrium analysis in favour of the complex interplay of endogenous forces operating through circular and cumulative causation. History plays a critical role in its theory and practice through the notions of hysteresis and path dependence, as well as a systems view of economy set in a social and ecological environment. It seeks to be a realistic view of the evolution and metamorphosis of economic systems, recognising the change is ongoing and, therefore, principles are always in the process of revision and reassessment in light of new evidence and developments.'

Read more:
http://en.wikipedia.org/wiki/Evolutionary_economics

Here's a good introduction to evolutionary economics by Ulrich Witt:

http://ftp://papers.econ.mpg.de/evo/discussionpapers/2006-05.pdf

'Evolutionary economics focuses on the processes that transform the economy from within and investigates their implications for firms and industries, production, trade, employment and growth.

These processes emerge from the activities of agents with bounded rationality who learn from their own experience and that of others and who are capable of innovating. The diversity of individual capabilities, learning efforts, and innovative activities results in growing, distributed knowledge in the economy that supports the variety of coexisting technologies, institutions, and commercial enterprises. The variety drives competition and facilitates the discovery of better ways of doing things. The question in evolutionary economics is therefore not how, under varying conditions, economic resources are optimally allocated in equilibrium given the state of individual preferences, technology and institutional conditions. The questions are instead why and how knowledge, preferences, technology, and institutions change in the historical process, and what impact these changes have on the state of the economy at any point in time.

Posing the questions this way has consequences for the way theorizing is done in evolutionary economics. First, preferences, technology and institutions become objects of analysis rather than being treated as exogenously given. Second, following from the very notion that evolution is a process of self-transformation, the causes of economic change are in part considered to be endogenous, and not exclusively exogenous shocks. More specifically, these causes are identified with the motivation and capacity of economic agents to learn and to innovate. Third, the evolutionary process in the economy is assumed to follow regular patterns on which explanatory hypotheses can be based, rather than forming an erratic sequence of singular historical events.'

[my emphasis added]

This approach is interesting (to me anyway....sad I know :slanted because it challenges the basic premises of mainstream/neo-classical economics:

'The assumption of a rational agent with a maximising behaviour and stable and given preference functions..., together with the absence of chronic information problems and a focus on economic equilibrium.' (Hodgson, 1999)

This exogenous view of preferences underpins the conceptualisation of homo economicus, i.e. the self-interested, isolated individual who chooses freely and rationally between alternative courses of action after doing a simple cost-benefit analysis.

But surely this is an ahistorical and abstract picture of the individual leading to a warped (individualistic) reading of social reality?

Instead economic activity should be seen as embedded within the complex fabric of social interaction/relationships. From this perspective the formation of preferences are in a large part shaped by social institutions (defined as the formal and informal rules governing human interaction; the formal - laws and constitutions; the informal - customs, traditions, codes of conduct etc) which provide both constraints and incentives and thus tend to create durable and routinized patterns of behaviour. This is not to say that human activity is mechanistically determined by institutions, for human beings have a will - the capacity to change both our behaviour and goals without external stimulus.

As Karl Polanyi argues:

'The human economy then is embedded and enmeshed in institutions, economic and non-economic. The inclusion of the non-economic is vital. For religion and government may be as important for the structure and functioning of the economy as monetary institions or the availability of tools and machines themselves that lessen the toil of labour.'

Thus, from a methodological perspective, can economics really be separated from the analysis of social totality? What is the point of models which are idealised but in reality never (or only rarely) occur? Is it not very dangerous to use such models to recommend policy choices?

(For instance the rapid market liberalisation policies used in the transition from command economies to market economies post the collapse of the USSR. The expectation amongst 'shock-therapy' proponents was that equilibrium would be quickly achieved and people would immediately assume the role of rational agents with a working knowledge of the market system. Little attention was paid to the necessary transition in the institutional structure of the societies involved. And look at the subsequent mess.....)

For anyone interested here is an institutional perspective on economic transition and development:

Douglas North - "The Contribution of the New Institutional Economics to an Understanding of the Transition Problem"

http://www.wider.unu.edu/publications/publications.htm

(From the mainpage select 'Wider Annual Lectures' in the side menu and scroll down to the 1997 Lecture - downloadable as a PDF)

EDIT: Its a long peice - all worth reading - but especially interesting is section IV: Understanding Transition Economies.

Institutions and Development...

So what is that is that creates the incentives and constraints which govern human interaction? The answer (at least according to this model of political economy) is INSTITUTIONS.

What are institutions? The definition provided by Douglass North - one of the founding fathers of New Institutional Economics - is:


North differentiates between what he terms ‘formal’ and ‘informal’ institutions; the former tend to be explicit rules embodied in law or constitution, while the latter tend to be implicit codes of conduct and norms of behaviour embodied in custom and tradition.

Furthermore North draws a vital distinction between institutions as ‘the rules’ and organizations defined as ‘groups of individuals bound together by some common purpose to achieve objectives.’ Thus bodies which are commonly referred to as institutions such as the World Bank and International Monetary Fund (IMF) are, by this definition, considered to be organizations, as are States, firms and all manner of social bodies.

Laws, norms and codes of conduct evolve to regularise patterns of human interaction in order to promote stability and reduce the uncertainty of outcomes. The functionality of any given institutional arrangement requires a set of enforcement mechanisms – a system of formal and informal punishments – which ensure that actors, on the whole, adhere to the rules.

Such constraints on behaviour limit the opportunity set available to actors and define the relative rewards they can expect for exploiting these opportunities. These rewards, which North terms the ‘pay-off structure’, in turn affects the types of organizations which evolve within the society in question. Particularly important in this regard are the formal economic institutions governing property rights and the enforcement of contracts. If these formal institutions are weak and as a consequence the greatest pay-offs are made to rent-seeking behaviour, then organizations are likely to cultivate such opportunities (for instance expropriation of property, exclusive monopoly privileges, and the like). By contrast, if property rights and contract enforcement are well protected then the highest returns will go to organizations engaging in productive activities. If the latter is the case then ‘we will expect organizations to devote resources to investing in skill and knowledge that will increase productivity.’ Thus, it becomes clear that the institutional structure of a society is a key determinant in its economic performance. The incentives offered by this structure influence both the way in which resources are distributed and the way in which they are used.

What is missing from this analysis is an account of the factors which underlie continuity and change within the institutional structure of any given society. Developing an understanding of this requires an examination of the complex interplay between beliefs and power in shaping institutions. The cultural beliefs of a society - its norms, values and ideas governing interaction - are transmitted from one generation to the next as a form of acquired knowledge. For this reason, North maintains that cultural heritage – or ‘path dependency’ - explains the relative continuity of societies through time and acts as a powerful impediment to radical change. Such continuity occurs because informal institutions provide a historically accumulated framework which is not typically amenable to deliberate human manipulation. Furthermore, since organizations (which include the State apparatus don't forget) emerge to take advantage of the opportunity set provided by the institutional framework, they have a vested interest in preventing any alteration to the framework that threatens their survival.

Therefore, it must be recognised that institutional change is a two-tiered process. Changes in the formal rules of a society can be achieved relatively quickly and easily through decisions taken by those who hold political power. However, such changes are likely to occur only if they are perceived by the existing elites to be incentive-compatible with their interests. By contrast, informal constraints, due to their embedded nature in custom and tradition, cannot be altered in the same top-down manner. Therefore, as a rule, societies change by building on and modifying their existing institutional structures rather than radically reversing their direction overnight; and thus ‘the huge variation in the world today in both economic and political outcomes is the result of long-run historical processes.’

So from this 'institutional perspective', human interaction is embedded in the institutional arrangements of society. Furthermore these arrangements are a key, if not the key, determinant of political and economic performance.

They are crucial in understanding the causes behind the divergent levels of prosperity amongst states in the international system today. Some societies (like those of Western Europe, North America and parts of East Asia) have evolved institutional frameworks which facilitate widespread impersonal cooperation and exchange, encourage high levels of investment in productive activities, and allow dynamic change without inducing instability and civil-war. This has led them on a path to self-sustaining economic growth and the creation of unprecedented levels of wealth within their territorial boundaries. However these 'developed countries' are the exception, not the rule. According to Mary Shirley (an expert on 'institutions and development') the picture is very different in most contemporary societies:


Therefore it seems clear that the process of economic development necessarily entails a transition from a situation where exchange is primarily limited to personal networks, to one where impersonal exchange becomes commonplace. For such a transition to occur, the institutions of a given society must evolve to offer increased trust and certainty surrounding contract enforcement. Furthermore the property rights of the masses must be protected against expropriation, both from other private actors and from the State itself. However, as outlined above, the possibility of such changes occuring is severely hindered by both (1) the vested interests of powerful economic and political actors; and (2) by the prevailing beliefs and norms which underpin the existing status quo. Evidently, progressive institutional reform can take place, as witnessed for example in Western Europe and parts of the Far East. But Mary Shirley argues that such a process is both arduous and lengthy:


*****

Questions:
(1) How/why do changes in informal norms of behaviour and codes of conduct occur which are conducive to greater transparency/accountability in governance, and good economic policy?
(2) What kind of outside assistance can be given to help what is essentially an endogenous (internal) process which takes place within a society? Foreign aid is often counter-productive - at least in its current format.

[cross-posted here]

Just been reading 'Lawlessness and Economics' by Avinash K. Dixit and I'd highly recommend it.

Here's what google books say:


His approach draws heavily on game theoretic modelling as well as empirical data, case studies and ethnographic research. Vim - you'd love it!

As for a primer on game theory, check out: 'Games of Strategy' by Dixit and Skeath - an introductory textbook used at undergrad level. Also have a look at this listing on GT by the Economics Network (this is a good place to look for info on any subdiscipline/field within economics). Here is their page on institutional economics.