INSTITUTIONAL ECONOMICS: EVOLUTION OF INSTITUTIONS

We shall discussion the nature of metaphors in economics. In particular, we shall examine the idea of institutions as genes. We then investigate the significance of mechanistic and biological metaphors in economics. Finally, we shall outline a classification system for economic evolution.

We will turn to the biological metaphor to help us build an alternative economics.

Institutions refer to commonly held patterns of behaviour and habits of thought, of routinised and durable nature, that are associated with people interacting in groups or larger collectives. Habits and institutions play an evolutionary role similar to that of the gene in the natural world. Institutions have a stable and inert quality, and tend to sustain and pass-on their important characteristics through time. The power and durability of institutions are manifest in a number of ways. In particular, institutions play an essential role in providing intellectual habits or routines for transforming information into useful knowledge. Reference to the cognitive functions of institutions and routines is important in understanding their relative stability and capacity to reproduce, they provide stability in socio-economic systems, and they remove internal variations and stabilise individual behaviour in social settings.

Institutions can be taken as the units of analysis. This contrasts with the idea of the individual as the irreducible unit of analysis in neoclassical economics. Examples of institutional units of analysis include money, organisations, property rights and norms and conventions. Though the metaphor of the gene provides a useful insight, they are some differences.

• While institutions are stable and durable, they are mutable and changeable. The capacity to adapt to change is different at different levels. However, they have nothing like the degree of permanence of the gene. ‘Institutional mutation’ is not the same as genetic mutation. The latter involves the gradual accumulation and selection of small mutations over long periods of times, whereas in the case of institutions adaptation is much more rapid with much less opportunity for any efficiency-breeding selection to work.
• Another major difference between biological and economic evolution is that habits and routines (analogous to the genes in the economic sphere) are much more likely to change than the biological genes.
• Furthermore, biological genes are transmitted through sexual reproduction, whereas in economic habits and routines can be acquired and transferred by people through word by mouth, informal networks and imitation.

While institutional variation occur much more rapidly and extensively than mutation in the biological world, nevertheless the observed inertia of cultural and institutional evolution suggests that there are strong stabilising forces at work – i.e. locked into a path of development. For example, the idea of ‘national systems of innovation’ refers to some of the more rigidity at the higher system level than at the micro level relating to incremental innovation. Other examples of paths of development include work culture of an organisation and economic growth trends.

There are some implications for policy-making. As selective processes will not ensure a rigorous drive towards greater efficiency, and the path of development will be determined by its past than by its adaptation to the present. There are no grounds for proclaiming that evolution will produce greater efficiency. In policy terms, it leaves open the possibility of the planned transition from one path of development to another. Indeed, such a transition may be necessary if the path of development leads to a crisis.

There are many metaphors in economics: business cycle, human capital, nature rate of unemployment, economic growth, consumer sovereignty, market forces, production functions and economic machine and fine tuning.

Economists often regard metaphors as merely literary ornaments. However, there are several points to note:

• metaphors provide a distinctive mode of achieving insight, and are more than a decorative literary device;
• metaphors may lead or mislead;
• by their nature, they are never complete, precise or literal mappings;
• they are central to reason. For example, to describe the economy as ‘evolving’ is not simply to state that the economy develops like an organism or a species in the natural world. It may also prompt the investigator to consider the many meanings and ambiguities in the term ‘evolve’ and the many extensions and transfer of meanings between the natural and social world. The use of the metaphor generates a novel semantic context;
• they are important because they have the power to jolt us into new ways of thinking;
• there is no question of truth or falsehood. Metaphors can only be better or worse than other metaphors;
• they help to generate responses leading to novel and creative results.

Metaphors are indispensable in economics. Economists are reluctant to use metaphors and try to remove them from their work. But this strategy has its own pitfalls. All economists are forced to use language and concepts, even if their presentations are largely mathematical terms. Accordingly, metaphors will always be used intentionally or unknowingly. We have already noted the extensive use of metaphor in economics. Even mathematical economics uses metaphors: ‘groups’, ‘sets’ and ‘transformation’.

The mechanistic metaphor dominates mainstream economics. Adam Smith appealed to Newtonian scientific method. However, there are some deficiencies of the metaphor taken from classical mechanics. Classical mechanics describes the processes of motion as reversible, and does not give rise to any qualitative changes. Neoclassical economics borrows the ideas of rationality and equilibria from classical mechanics – economic agents optimise to the point of equilibrium as if they were mere particles obeying mechanical laws. The rational individual is guided by logical and consistent thought. Within neoclassical economics, there are no systematic mistakes, no human understandings, no blind passions, no surprises, no real chance and spontaneity.

Yet, the economic system involves human agents, not merely particles who mutually interact with each other according to Newtonian laws. Indeed, economic agents have knowledge and purpose, and this is difficult to incorporate in a classical mechanistic system. The mechanistic metaphor excludes knowledge, choice, purpose and qualitative change of a more complex and irreversible kind. Clearly much is missing here.

The strength of the alternative, biological, metaphor is that a place can be found for all these important features of economic life. Clearly, real world economic phenomena have much more in common with biological organisms and processes than with the mechanistic world of particles. The economy involves living human beings, not merely particles, forces and energy. In addition, economies are part of ecosystems, containing other forms of life.

The application of an evolutionary approach to economics has a number of advantages over the mechanistic approach.

• It enhances a concern with irreversible and ongoing processes in time, with long-run development rather than short-run marginal adjustments, with qualitative as well as quantitative change, with variation and diversity, with non-equilibrium as well as equilibrium situations, and with the possibility of persistent and systematic error-making and thereby non-optimising behaviour. In short, an evolutionary paradigm provides an alternative to the neoclassical ‘hard core’ idea of mechanistic maximisation under static constraints.
• Ideas from biology are of relevance to economics is that economic and biotic systems are highly complex. They encompass tangled structures and causalities, involve continuous change and embrace huge variety.

• The adoption of an evolutionary metaphor involves some loss of the capacity to predict that is associated with mechanistic modelling. However, the greater weight in science of complex systems should be on explanation rather than prediction.
• The biological science exhibits a theoretical pluralism, and helps to challenge the intellectual monopoly of the economics discipline.
• The use of the biological metaphor helps remind us of human beings’ place in the natural world. Biology is concerned with the conceptual division between the social and natural world. While human beings are regarded as thinking, allocating, legislating, consuming and producing persons, they are living beings alongside others in a natural environment. Accordingly, there are limits to the natural resources available and to the tolerance of the ecosystems on the planet.

Evolutionary ideas in economics have enjoyed a remarkable revival in 1980s. Nevertheless the use of the term ‘evolutionary’ by economists is often vague and imprecise. It is important to disentangle the many different meanings of the term ‘evolutionary’. A classificatory system is proposed (see Table 1). The distinction between ontogeny and phylogeny is borrowed from biology. Ontogeny involves the development of a particular organism from a set of given and unchanging genes. Its environment will also affect this development, but nevertheless the growth of the organism is the result of genetic instructions. Hence the genes represent a given set of developmental possibilities. In contrast, phylogeny is the complete and ongoing evolution of a population, including changes in its composition and that of the gene pool. It involves changes in the genetic potentialities of the population, as well as their individual phenotypic development. The term ‘genetic’ refers to a detailed causal explanation involving the interactions of component units of a system.

Table 1: Economic Evolution: a classificatory system

One example of this type would be the Marxian idea that history is progressing through a series of stages, from ‘prmitive communism’ through classical antiquity, fuedalism and capitalism, to socialism and communism in the future. The driving force has a holistic quality as if development was in accord with a pre-ordained plan. In contrast, when historical movement is made to proceed in terms of Darwin’s biological principles, it is impossible to predict the character and form of social change. On the basis of Darwinism, change would occur as the result of chance variations, these are a source of unpredictability, and these deny evolution any predetermined goal. The idea of change resulting from a process of natural selection among a population of individual entities exhibiting great diversity and variety is markedly different from the conception of history as the clash of collectives engaged in class struggle.

Multilinear refers to the possibility of multiple pathways of the future, involving different sequences of historical stages.

The ‘genetic’ notions of economic evolution need not be taken to imply explanations in terms of biological genes. Here, however, a broad and general meaning is implied. A ‘genetic’ evolutionary process is one that derives in some way from a set of fairly durable human entities including human habits, organisational routines, social institutions, economic system as well as biological genes.

There is a theory of economic evolution in the writing of Adam Smith. He starts from the idea of a set of individuals with given predispositions, motives or sentiments (by analogy, genes in the natural world). He, then, examines the development of an economic system, including its prices and allocations. The outcome is unintentional: the result of the ‘invisible hand’. In other words, the economic system is explained by motivated individuals; by analogy, organism is explained by genetic material.

Phylogenetic evolution involves the development of different genetic rules through cumulative process of feedback, and the subsequent effects. This could simply involve changes in the composition of the human population, or changes in habits, routines, institutions or systems. But in phylogenetic evolution there is not necessarily a final outcome, a state of equilibrium or rest.

Here economics is evolutionary, where instincts, habits and institutions are taken analogous to genes. Habits and routines have a stable and inert quality and often sustain their important characteristic through time. However, all elements may change in a process of cumulative causation.

Veblen argued against the idea of finality, end-point or consummation in economic evolution. Evolution is a scheme of blindly cumulative causation, in which there is no trend, no final term, and no consummation. In part, this is because of the role of creativity and novelty in the evolutionary process.

Despite his emphasis on entrepreneurial creativity, Hayek argues that the system gravitates towards some kind of equilibrium – spontaneous order, consummation.

In the context of economic theory, ontogeny is a means by which the concept of equilibrium can be preserved within an evolutionary framework. In contrast, phylogenetic evolution emphasises natural selection, where equilibrium is far from inevitable. Where creativity and variety are not ultimately constrained, equilibrium may only be temporary. There are several principles involved in phylogenetic evolution.

• The principle of variation: this emphasises the essential, developmental role of variety and diversity. This establishes the importance of ‘population thinking’ in which variety and diversity are paramount. How does variation arise and how is it retained? It involves constant error-making as well as continuous selection of the more adapted forms. Variety is also generated through creative acts of agents themselves. Economic institutions and routines do change through selection and creativity.
• The principle of heredity: this suggests that the units of selection in economic evolution must have some durability and resilience. There must be come mechanism through which characteristics are passed-on to other units. Economic habits and routines have a stable and inert quality, and often sustain their important characteristics through time.
• The principles of natural selection and struggle: these state the existence of some selection mechanisms, in which better-adapted types of unit can increase their numbers. Some institutions become extinct because they are not well adapted to their general socio-economic environment. As in the case of biological selection, the selection of some institutions and the extinction of others do not necessarily imply that the favoured institutions are morally just, or that they are superior in an absolute sense. One reason for this is that selection always operates relative to a given environment. Possible mechanism of selection includes the markets, centrally planned systems and custom-based communities.