Journal of Bioeconomics (2006) 8:193–196 DOI 10.1007/s10818-005-2029-x

© Springer 2006

Book Review

J. Stanley Metcalfe & John Foster (ed.). 2004. Evolution and Economic Complexity. Edward Elgar, Cheltenham. xi + 227 pp. $100.00.

Standard neoclassical economics often assumes that firms in an industry are homogeneous and that their identical capital stock has a fixed life expectancy. Increases in demand, result in the entry of new firms that are identical to existing ones and decreases in demand, result in exit, as firms decide not to replace capital that has depreciated. The evolution-based models in this volume could not be more different from the standard neoclassical fare. Normative models of rationality are replaced by bounded and procedural rationality. Divergent learning and innovation create path dependency, heterogeneity, and variation across firms in an industry. Evolutionary processes require three things: that the relevant entities vary with respect to certain traits; that those traits be heritable; and that there is selection of entities based on the variation of their traits in the relevant environment. The evolutionary models in this volume contain the requisite variation across entities on which selection can work. With natural selection the entities are genes or organisms, and here the question arises, as in cultural evolution in general: what are the entities being selected – that is, what are the units of selection? In the context of replicator dynamics, what is being replicated? Typically in cultural evolutionary models, the units of selection are variously routines, rules, habits, technologies or firms themselves. At a more basic level, what is being replicated is knowledge or information. Following Adam Smith and F. A. Hayek, production is knowledge driven, where specialization and the division of labor can be taken to be the division of knowledge. In this volume it is the creation, replication and selection of that knowledge that is the essence of the evolutionary process. Since the analysis is conducted at a systems level where the individual elements form an interconnected network, with multiple feedback channel, a complex systems approach is taken. The volume contains a collection of papers presented at the second Brisbane Club Conference in Manchester in July 2002. Like all such collections, the individual papers vary in quality, but all are worth reading. In the introduction the editors present a brief overview of the evolutionary approach to economics as well as an introduction to the contents of the various chapters.

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The first chapter, by Kurt Dopfer & Jason Potts, provides a detailed introduction to evolutionary economics. The authors start out by distinguishing between order and organization, where order ‘appears in the form of a pattern’, but ‘[o]rganization is more than order because an organization also does something functional’ (p. 4). Standard economics is good at explaining order, but the evolutionary approach is necessary to explain organization where ‘agents and rules are the basic units of organization’ (p. 5). Rules are the fundamental components of knowledge where knowledge includes preferences and production technologies. Key to the authors’ evolutionary approach is the idea of meso objects, which consist of rules and systems of rules, where the evolutionary process is a meso trajectory, involving first the emergence, then the diffusion and adoption, and finally the stabilization and retention of rules. Here rules adopted at the level of the agent, the micro level, can bring about economy-wide macro changes as new rules replace old ones in a process of creative destruction. If this description of the contents of the chapter seems a little vague, it is because the authors’ introduction to the evolutionary approach is very general and lacks detail as to how the process actually works. It seems, however, that ‘evolution’ is the evolution of knowledge and that ‘process’ involves a hierarchy of complex interactions between individual agents, between agents and firms, between firms and at the aggregate level of the economy. The second chapter by Paul Ormerod & Bridget Rosewell, describes an agentbased evolutionary model of the business cycle. The model consists in part of rules that determine, first, the process by which firms enter the market; second, the process by which firms gain or lose market share; third, how individual firms react to competition; and finally, how consumers choose between firms. All this, as in the first chapter, is placed in the context of heterogeneous firms, uncertainty and imperfect information. For purposes of verification the model must be expected to produce results that are consistent with the relevant facts that pertain to the business cycle. The evolutionary economic approach places much more emphasis on the selection of firms within an industry then does traditional economics. The reason for this difference is that the evolutionary approach focuses on fundamental differences between firms in an industry. Once again, these differences are brought about by differences in knowledge or capabilities, where ‘capabilities’ is the term used to describe appropriate or usable knowledge. Capabilities reflect an organization’s ability to facilitate its production processes. Appropriate knowledge in this context consists of both explicit and implicit or tacit knowledge. Tacit knowledge ‘is hard to articulate, communicate and codify. . .’ (p. 64). It is often acquired in a ‘learning by doing’ process and is costly to communicate, and thus is an important reason for the path dependent nature of the firm. The evolution of knowledge over time and the variation in the distribution of that knowledge across employees drives the division of labor. Path dependency and the process of the evolution of knowledge implies that there will be significant variations in the firms operating within an industry.

BOOK REVIEW

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Selection occurs on this variation, where some firms will be more successful than others in satisfying consumer preferences, responding to exogenous technology and cost changes and, importantly, discovering new technologies – that is, new knowledge. Chapter 3, by Paolo Ramazzotti, and Chapter 4 by Peter Hall, do a good job of presenting these issues and they conclude the first section of the volume. The second section consists of two chapters dealing with the modeling of evolutionary complexity. In Chapter 5 Peter M. Allen, using a simulation approach, models a complex evolutionary system, where heterogeneous agents experience feedback effects from all other agents in the system and where the strength of those effects is inversely related to a measure of the distance between the agents. Feedback is both positive and negative and the agents compete for scarce resources. The author then shows how the model aids in understanding the workings of the economy, for example, how ‘firms explore possible functional innovations, and evolve capabilities that lead either to survival or to failure’ (p. 102). In the second chapter of this section, Esben Sloth Andersen develops a simple single-good model in which labor is homogeneous and the only factor of production, but firms vary in their productivity. Obviously, firms with higher productivity will out-compete those with lower productivity, employ more labor, and, given the linear nature of the model, come to dominate in the long run. To avoid this not very novel outcome, Andersen allows for changes in the individual firm’s productivity that can be thought of as a mutation process. He then uses the Price Equation to decompose the change in system-wide productivity into the sum of two effects. The Price Equation is typically used in evolutionary biology to examine the efficacy of an altruistic trait in a population that is broken up into subgroups. Because altruistic behavior benefits others, by increasing the other’s fitness, at a cost to the altruist, who by conferring the altruistic benefit has a lower fitness, other things equal, in any group that has both altruists and nonaltruists, the altruistic trait will die out in the long run. If, however, there is assortative grouping, so that in each generation altruists tend to form new groups with other altruists, groups from which nonaltruists tend to be excluded and if the benefits of the altruistic act sufficiently exceed the cost, then the altruistic trait can prosper. Alternatively altruistic individuals may have the ability to identify and exclude nonaltruists from receiving benefits, so that the altruistic benefits largely go only to altruists. The Price Equation decomposes and measures two component effects of this process. The first is that in any mixed group, altruists are at a disadvantage. The second component measures the strength of the assortative grouping process. If a sufficiently strong assortative mechanism exists so that altruists mostly find themselves in groups with other altruists (or in some other way mostly interact with other altruists) and nonaltruists end up in groups with other nonaltruists, then it will be primarily altruists that find themselves on the receiving end of altruistic acts. If the benefits conferred by altruists are sufficiently large relative to the costs, it will be the case that the costs that altruists incur by their behavior are

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more than made up for by the benefits they receive from the altruistic acts of others, and as a result, altruism can thrive. Here the author uses the Price Equation to decompose changes in overall productivity into two separate effects. With the first effect, called a selection effect, economy-wide productivity increases because of the fact that variations in firm productivity will result in more productive firms surviving and less productive firms going out of business. Secondly, productivity can increase as a result of mutation (innovation) that results in increases in the productivity levels of individual firms. Andersen goes on to extend the model to two activities and then multiple activities. The final section of the book consists of three chapters on empirical issues. The first chapter of this section, Chapter 7, is worth the price of the book by itself. Here Francisco Louc¸a˜ presents a mini history of econometric thought focusing on the nature of the error term and more generally on the ‘nature of errors in economic theories, models and equations’ (p. 151). This is important from an evolutionary perspective because selection works on variation, which brings about a disturbance of equilibrium and, depending on how the error term is interpreted, it can provide this disturbance and variation. Though given many names, the author traces the history of the error term from being the result of measurement error and missing variables, implicitly assuming that the true model is deterministic, to the residual from the estimation, to, finally, the dominant current interpretation as an exogenous ‘perturbation’ or ‘shock’. Exogenous shocks to the system can provide the variation on which selection can work in a cultural evolutionary framework, just as random mutation does in biological evolution. ¨ The final two chapters, Chapter 8 by Uwe Cantner & Jens J. Kruger and Chapter 9 by Andeas Pyka, Berbd Ebersberger & Horst Hanusch, present evolutionary economics in the context of the evolution of actual firms and industries. In fact, I would recommend that those unfamiliar with evolutionary economics to start with Chapter 9, because it contains an excellent easy-to-follow introduction to the topic made so, in part, because it is placed in the context of an example involving a specific industry. This book provides a useful introduction to evolutionary economics. Of particular importance is the fact that the firm is the product of an evolutionary process in which order and organization emerge to a large extent spontaneously, rather than as a product of pure reason. This evolutionary process is path dependent, where small initial differences can result in significant variation across firms. These differences can be thought of as differences in the accumulation of knowledge and, importantly, they result in differences in the likelihood of discovering new products, new technologies and new refinements of existing products, differences upon which selection can work. ADAM GIFFORD, JR. Department of Economics, California State University, Northridge, CA 91339-8374, USA ([email protected])