New and Revived Schools of Economics

A number of relatively new and revitalised schools of economic analysis are attempting in complementary ways to address the fundamental inadequacy of the conventional conceptual framework. As indicated above, the information school has—contrary to the conventional assumption of perfect information—pointed to the costliness of information, to its asymmetrical distribution and to the inadequacy of pricing signals for coordinating economic activity in the real world. Revised institutionalist and sociological approaches are seeking to explain more fully how economic behaviour occurs in a complex web of social relationships and institutional arrangements, which vary from society to society and which exhibit features of historical contingency and path dependency. The effect is to undermine the belief that there is a universal model of the capitalist system that we can aspire to imitate. In this regard, the ‘National Systems of Innovation’ approach to innovation studies emphasises that innovation by firms cannot be understood in terms of decisions at the firm level and emphasises the role of the complex interactions between the firm and its economic and social environment in promoting innovation. This approach draws attention to the importance of country-specific institutional arrangements for innovation, technological development and economic performance more generally. Similarly, political economy schools point to the pervasive presence of power relationships in the economic system—and the impossibility of isolating the two influences. Of course, the impacts of those complex power relationships are not open to simple modelling, least of all by neoclassical models.

Importantly, the evolutionary school denies that the social and economic world is a machine. Furthermore, it has abandoned the idealisation of the market, methodological individualism, Pareto-optimality, the concepts of market failure and the Newtonian metaphor in favour of the biological metaphor of a living system. In such an interdependent system, the behaviour of the system in aggregate cannot be deduced by simple extrapolation from the behaviour of typical individuals. Rather, it is the result of complex interactions throughout the system—a system that learns and adapts.[82] Furthermore, it means that there is also macroeconomic behaviour that cannot be traced to microeconomic foundations. Consequently—and contrary to Thatcher—there is such a thing as society,[83] something the rest of us knew already.

What this all means is that the evolutionary school has abandoned the Enlightenment’s utopian dream of reorganising society on the basis of a priori reasoning. This represents a historically important paradigm shift, and a return to an earlier and more fruitful master narrative. It also denies the possibility in practice of achieving an optimal allocation of resources. Consequently, Ormerod tells us:

The behaviour of the system may well be quite different from what might be anticipated from extrapolation of the model of [the] behaviour of individuals. Individual behaviour does not take place in isolation. On the contrary, there are impacts on the behaviour of other individuals, which in turn cause feedbacks elsewhere in the system, and so on and so forth. Behaviour is altogether too complex to be captured by a mechanistic approach.[84]

Instead, the evolutionary approach sees the economy as an emergent complex, interdependent system subject to positive feedback, uncertainty, path dependency and historical contingency. The last two teach us that history matters in economic development. Ormerod, citing mathematician Henri Poincaré, tells us: ‘The distinguishing feature of chaotic systems is that their behaviour is impossible to predict in the long run, a property which cannot be encompassed by a view of the world which regards it as an enormous machine.’[85]

There has therefore been a great increase in interest in chaotic and non-linear systems in the natural sciences. Importantly, in such systems, the connection between the size of an event and the magnitude of its effects is no longer simple or linear. Small initial differences can lead to enormous differences in outcomes and, consequently, outcomes are extremely difficult to predict or control. For example, although such systems might remain stable in a wide range of circumstances, the presence of tipping points could lead to wholesale changes of behaviour. This has led Ormerod to emphasise that ‘unpredictability is an inherent part of the processes that underlie a very wide range of economic and social phenomena’.[86] In contrast with mainstream economic analysis, it employs a very sophisticated form of mathematical analysis made available only recently through the development of chaos and complexity theory.

This perspective is not open to the reductionist modelling employed in mainstream economics, or to simple prediction. Nevertheless, it employs simulations to compare theoretical speculations with real-world data. For example, its simulation of the growth and decline of business firms has successfully shown patterns that are encountered in experience. Interestingly, the evolutionary and institutional economists are generating new growth models that dispense with the neoclassical assumptions and which are proving to be consistent with real data. Similarly, such modelling is capable of generating the main characteristics of movements in unemployment over time, in volatile financial markets and in the clustering that results from the geographical location decisions of businesses.[87] As Michael Porter has already told us, there could be good sense in trying to seed cluster development.[88] Such modelling can also throw light on the impact of random decisions on the selection of new technologies. In respect of the latter, it follows clearly that government support to get new products to market quickly is well justified. Indeed, the evolutionary perspective fits well with organisational theory, with its emphasis on the strategic interdependence between firms, uncertainty, asymmetrical information and increasing returns.[89] Nevertheless, this form of modelling cannot finally escape the ontological objections raised by Lawson, as it also is inherently deterministic. While it could illustrate phenomena that occur in practice, it cannot provide adequate causal explanations. That does not apply, however, to non-mathematical forms of evolutionary theorising, which seem to offer significant promise.

An evolutionary perspective—although not discounting the above insights into the inability of prices to capture fully the social costs and benefits of economic activity—draws particular attention to the experimental nature of all economic institutions, policy decisions and policy structures. Additionally, in the presence of uncertainty, decisions can be made only on the basis of guesswork, and economic agents and decision makers learn as they proceed, groping towards better outcomes and arrangements. In particular, such uncertainty can result from the path-dependent nature of innovation, where things are learned sequentially as experience accumulates through time, where the range of choice defies analysis or where the situation is ill defined. This approach therefore places great store on the capacity and willingness of economic agents to experiment and absorb knowledge and experience and—contrary to the recent emphasis on rationalisation—on the value of redundancy and variety.

This situation, contrary to Hayek, does not reduce the policy maker to impotency. It does require phronēsis or practical wisdom. It should lead to a far stronger emphasis on learning from international experience and from policy experience more generally. Policy development should, therefore, wherever possible, rest on experience, including the tacit learning of market participants, with all the contingencies that this involves rather than on the reductionist analysis of conventional theorising. Importantly, this perspective denies the conventional assumption that returns to investment—adjusted for risk—tend to equalise in practice. It points to areas of investment that will potentially deliver greater benefits than others. This is a policy approach that fits well with the recent East Asian, European and US experiences with their strong emphasis on the creation of comparative advantage through innovation.

Consistent with the above, Lipsey, Ken Carlaw and Clifford Bekar argue that the long-term growth that has raised our living standards to undreamed of levels has been driven by technological revolutions that have periodically transformed the West’s economic, social and political landscape in the past 10,000 years and allowed the West to become, until recently, the world’s only dominant technological force.[90] They point to a series of technological revolutions, from the domestication of plants and animals, through writing and printing, to the factory system, the dynamo and information and communications technology (ICT). Because of their widespread effects throughout the economy, these general-purpose technologies have driven economic growth in the past 10,000 years. Importantly, they suggest that the development of such technologies has sped up in recent centuries and that this provides a point of strategic policy leverage. They therefore suggest that policy makers should pay particular attention to the development and diffusion of technologies with these general-purpose characteristics, and in particular to ICT, nanotechnology and biotechnology.

Bromley, an ‘old’ institutionalist, draws attention to the important distinction between the institutional framework within which day-to-day economic decisions are made and those day-to-day decisions themselves. He reminds us that the market is simply the artefact of a large number of prior collective actions. The market cannot, therefore, logically constrain other collective actions.[91] Nevertheless, Bromley counsels particular care in making institutional change. I would also counsel particular care in making significant organisational changes with widespread impacts. Because it sets the framework for economic activity in general, and the distribution of its benefits, institutional and significant organisational changes should not be treated as if they are simple welfare-enhancing transactions. It is in that context—and with a firm recognition of the gross limitations of the concept of economic efficiency—that many of the changes made in the name of microeconomic reform should have been considered. What was required was not simply a trite assertion that competition was inevitably good because it promoted efficiency, which in turn promoted welfare, but a historically informed analysis of the purposes served by those institutions and arrangements, and a more realistic assessment of the real welfare consequences of change. In short, we deserved more from our political leaders and policy advisers.

It should by now be clear that economics, Lockean political philosophy and their advocates can claim no privileged position in public discourse, standing in judgement of the public’s collective policy wishes and of government action.