EVOLUTIONARY PERSPECTIVES IN ECONOMICS

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EVOLUTIONARY PERSPECTIVES IN ECONOMICS

• Luigi Orsenigo
• University of Brescia
• KITeS CESPRI, Bocconi University
• Open University

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Outline

• Basic concepts and inspirations of evolutionary
  economics
•  
• Methodology and the essence of the evolutionary
  approach
•  
• Evolutionary Models of industrial dynamics,
  innovation and technical change
•  
• Developments in Evolutionary Modelling

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BASIC CONCEPTS AND INSPIRATIONS

• Antecedents Marshall, Schumpeter, Alchian, etc..
•  
•  
• The invisible hand and the natural selection
  metaphor competition like natural selection
  (survival of the fittest)? (Milton Friedman)
•  
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• Institutionalism Veblen, Hodgson

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The new evolutionary economics

• Nelson and Winter 1982
•  
•  Innovation, technical change
• Dynamics
• Bounded Rationality
• Organizations
• Institutions
• Schumpeterian competition
• Economic growth
•  
• How is it that some kind of order emerges out
  of the actions of heterogeneous agents, who do
  not understand very well the constantly and
  endogenously changing environment in which they
  live?
•  
• Dynamics first
• Bounded rationality
• Disequilibrium

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The Principles (from S. Winter)

• 1.      Realism!
• It may not be a necessity for good theory, but it
  is often a virtue at least at the prevailing
  margin. There is no need to take off one head and
  put on another one when you step reading the
  business page and start doing economics
• 2.      Dynamics first!
• To impose on dynamic theory the burden of
  supporting a pre-existing static equilibrium
  analysis, is essentially to put on blinders,
  making it inevitable that obviously significant
  issues will be overlooked
• 3.      No free calculation!
• It is an abiding scandal that the
  self-proclaimed science of scarcity routinely
  treats all forms of deliberation and information
  processing as free. This scandal reaches
  Monica-gate proportions in rational expectations
  and other sophisticated equilibrium concepts that
  implicitly endow each actor with the ability
  solve every actors problem many times over.
• 4.      Firms are profit seeking!
• It is a true fact of nature that firms are
  typically profit seeking, but it is not a true
  fact of nature that they are typically profit
  maximizing. Profit maximization is a theorists
  crutch and ought to be abandoned when it is too
  stark to capture the reality of profit seeking or
  too cumbersome to permit analysis of any but the
  most extremely stylized models

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• .5.      Innovation is always an option!
• One thing a profit-seeking firm can do rather
  than optimize over a given set of possibilities
  is to think of some new possibilities. Hence,
  every analysis of such optimizing behavior
  deserves an asterisk leading to a footnote that
  says unless, of course, there is a better idea.
• 6.      Firms are historical entities!
• They typically display pronounced inertial or
  quasi-genetic traits (e.g. scale/ routines) that
  are clearly persistent enough to shape their
  actions over interesting prediction periods.
  They ought to be represented that way in theory,
  positioned in model history the way real firms
  are positioned in real history.
• 7.      Firms are repositories of productive
  knowledge!
• In most contemporary societies they are in fact
  the key repositories of technological and
  organizational knowledge and among the key agents
  of historical change. The storage and advance of
  knowledge, the maintenance and improvement of
  organizational capabilities, are complementary
  roles.

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• 8.      Progress is co-evolutionary!
• Technological and organizational innovation is
  generated by a variety of firm-level search
  processes. But firms do not search independently,
  they look to rivals, suppliers and customers for
  ideas, technologies and practices. And these
  firm and industry processes go forward in the
  context of a variety of public and private
  institutions and programs, which in turn are
  shaped by the firms. I could tell you that itís
  really simpler than that, but That Would be
  Wrong.
• 9.      Anything can happen for a while!
• As Schumpeter said, only when things have had
  time to hammer logic into men is it safe to
  assume that some level of rationality will
  characterize economic outcomes. Market discipline
  and economic natural selection constrain outcomes
  over time, but in the short run anything can
  happen.

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The Evolutionary Approach

• Analysis of changing systems
• Change is partly exogenous, but partly
  endogenous
• Change is partly stochastic and partly
  deterministic
• Agents are different, do not understand perfectly
  the world and cannot look too far ahead
• Selection
• Learning
• Institutions
•  
• Methodological commitments
•  
• start from stylized facts
• empirically-based assumptions
• appreciative theorizing
• models

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The Evolutionary Metaphor

• Heterogeneous Populations (agents, routines,
  technologies, etc)
•  
• Selection define fitness and how fitness selects
  among things. But fitness can be
  multidimensional, may change over time
  (Hyper-selection, co-evolution) and may be partly
  endogenously determined.
•  
• Units of selection genotypes and phenotypes
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• Mechanisms of selection
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• Adaptation and variation bounded rationality,
  learning and discovery
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• Does selection optimize?
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Applications

• Economic History and History of Technology
  (Rosenberg, Chandler, Galambos, Mokyr, Vincenti,
  Basalla, Freeman) technology and organizational
  institutional forms co-evolve over time
•  
• Business and Management (Teece, Utterback,
  Rosenbloom, Pisano, Henderson, Winter..)
  competence-based theories of the firm
•  
• Individual and Organizational Learning (Dosi,
  Marengo, Malerba)
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• Consumer Behaviour (Dosi)
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• Industrial Organization (Dosi, Malerba, Klepper,
  Metcalfe..)
• - empirical studies of the evolution of
  particular industries
• Innovation studies (Freeman, Pavitt, Cantwell,
  Archibugi,.)
• Industrial dynamics
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Applications (ctd.)

• Growth (Dosi, Silverberg, Verspagen)
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• Trade (Dosi, Verspagen, Cantwell..)
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• Policy (Metcalfe, Winter,.)
•  
•  
• Methodologies
• Case Studies
• Experimental Economics
• Econometrics

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Evolutionary Models of Industrial Change

• Build a formal argument to reproduce and
  explain specific stylized facts
•  
• The argument is derived from appreciative
  theorizing
•  
• Dynamic stochastic systems when analytic
  treatment is impossible, simulate the model
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• Derive simplified, compact versions of the model
  and solve it analytically
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Simulation

• Heuristic technique, widely used in other
  sciences
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• Inductive approach
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• Theory-driven and disciplined
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• Problems of validation robustness, sensitivity
  analysis, ability to reproduce facts, calibration
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• Nelson and Winter 1982, Winter 1984
  Schumpeterian competition
•  
• Heterogeneous firms, characterized by capital
  stock and routines, produce, invest and search
  for new techniques
• Invest in RD or imitation a fraction of turnover
• Double draw scheme first draw from a
  distribution to determine whether the effort was
  successful or not if yes, draw from another
  distribution to determine the extent of the
  improvement
• Produce and sell with the new technique,
  determine profits
• More profitable firms, invest more in capital
  stock and RD and grow (success breeds success)
• Markov process
•  
• In Winter 1984 entry, exit
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Applications and results

• Emergence of concentration in industries
  undergoing technical change
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•  
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• Endogenous market structure concentration
  increases with conditions of opportunity,
  appropriability and cumulativeness (technological
  regimes)
•  
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• - Technical change is higher in concentrated
  industries
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History Friendly Models

• CLOSER RELATIONSHIP WITH HISTORICAL AND EMPIRICAL
  ANALYSIS
•  
• INDUSTRY-SPECIFICITIES
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• PUT MORE RESTRICTIONS ON MODELS
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• DERIVE TIME-PATHS, NOT SIMPLY LIMIT PROPERTIES
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• FORMALIZE AN APPRECIATIVE ARGUMENT (Sources of
  industrial advantages)
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The Evolution of the Computer Industry

• Four eras
• early experimentation and mainframes
  (transistors)
• introduction of integrated circuits and
  subsequent development of minicomputers.
• personal computer, made possible by the invention
  of the microprocessor.
• networked PCs and the Internet.
• Discontinuities concerning both components
  technology (transistors, integrated circuits, and
  microprocessors) and the opening of new markets
  (minicomputers, PCs).
• One firm - IBM - emerges as a leader in the first
  era and keeps its leadership also in the
  successive ones, surviving every potential
  "competence-destroying" technological
  discontinuity.
• In each era, however, new firms have been the
  vehicles through which new technologies opened up
  new market segments.
• The old established leaders have been able to
  adopt the new technologies and - not always and
  often facing some difficulties - to enter in the
  new market segments, where they gained
  significant market shares but did not acquired
  the dominant position they previously had.

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Questions

• What determines the emergence of a dominant
  leader in the mainframe segment?
• What are the conditions that explain the
  persistence of one firm's leadership in mainframe
  computer, despite a series of big technological
  "shocks"?
• What allowed IBM to enter profitably into new
  markets (PCs) but not to achieve dominance?

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The era of transistors, entry and the mainframe
industry

• At the beginning, the only available technology
  for computer designs is transistors.
• N firms engage in efforts to design a computer,
  using funds provided by "venture capitalists" to
  finance their RD expenditures.
• Some firms succeed in achieving a computer that
  meets a positive demand and begin to sell. This
  way they first break into the mainframe market.
  Some other firms exhaust their capital endowment
  and fail.
• Firms with positive sales uses their profits to
  pay back their initial debt, to invest in RD and
  in marketing.
• With RD activity firms acquire technological
  competencies and become able to design better
  computers. Different firms gain different market
  shares, according to their profits and their
  decision rules concerning pricing, RD and
  advertising expenditure.
• Over time firms come closer to the technological
  frontier defined by transistor technology, and
  technical advance becomes slower.

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The introduction of microprocessors

• After a period t', microprocessors become
  exogenously available. This shifts the
  technological frontier, so that it is possible to
  achieve better computer designs.
• A new group of firms tries to design new
  computers exploiting the new technology, in the
  same way it happened for transistors.
• Some of these firms fail. Some enter the
  mainframe market and compete with the incumbents.
  
• Some others open up the PC market.
• Incumbents may choose to adopt the new technology
  to achieve more powerful mainframe computers.
• Diversification in the PC market

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Computers in the space of characteristics
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Customers and Markets

• Computers are offered to two quite separate
  groups of potential customers.
• "large firms", greatly values performance and
  wants to buy mainframes.
• "individuals", or "small users", has less need
  for high performance but values cheapness. It
  provides a potential market for personal
  computers.
• Each of the two user groups requires a minimum
  level" of performance and cheapness before they
  are enticed to buy any computer at all. Then, the
  value that customers place on a computer design
  is an increasing function of its performance and
  its cheapness.

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Demand

• The probability, Pi, that a particular submarket
  will buy a computer i is
• c0 is specified so that the sum of the
  probabilities adds to one.
• Mi denotes the "value" of computer i.
• "mi" is the market share of the firm who produces
  computer i
• the market share variable can be interpreted
  either in terms of a "bandwagon" effect, or a
  (probabilistical) lock-in of consumers who
  previously had bought products of a particular
  brand.
• The constant parameter d1 assures that even
  computers that have just broken into the market,
  and have no previous sales, can attract some
  sales.
• "A" is the advertising expenditure of a firm.
• The constant parameter d2 performs here a similar
  role to d1 for firms who have just broken into
  the market and have not yet invested in
  advertising.
• If consumers in a particular submarket decide to
  buy computer i, then M is the number of machines
  they buy.

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Innovation

• In every period the "merit " of the computer each
  firm is able to achieve along its technological
  trajectory --performance and cheapness improves
  according to
• R, is the firm's RD expenditure, where i1 is
  performance and i2 is cheapness.
• T represents the number of periods that a firm
  has been working with a particular technology.
• Li-Xi, measures the distance of the achieved
  design from the technological frontier. The
  closer one gets to the frontier, the more
  technological progress slows down, for every
  given level of RD expenditure. There is also a
  random element to what firm achieves, given by e.
  

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Profits, prices, RD

• Profits ?t Mp Mk,
• Price pt k (1?t)
• Mark-up ?t 0.9?t-1 0.1(mi/( ?- mi ),
• Where ? is demand elasticity
• RD expenditures Rt, ? ?t (1- ?)
• Advertising

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The dynamics of concentration
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Counterfactuals
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Counterfactuals 2
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Policy experiments
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Theoretical experiments failed adoption
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Experimental Users
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Pharmaceuticals

• Innovation as a quasi random process
• Innovation and imitation
• Market fragmentation
• Low concentration, despite high RD and marketing

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Pharmaceuticals
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• Random search, patent
• Development
• Product launch and marketing
• Imitation

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Counterfactuals

• Costs and economies of scale
• Market size and demand growth
• Market fragmentation
• Innovative opportunities
• Patent protection

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CHANGING VERTICAL SCOPE OF FIRMS IN OF THE
COMPUTER AND SEMICONDUCTOR INDUSTRIES
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Understanding the determinants of specialization
and vertical integration in related industries
in uncertain and dynamic environments,
characterized by technological
discontinuities. Major factors capabilities,
technical change and market size Co-evolutionary
processes
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• A capability-based, dynamic theory of vertical
  integration and specialization
• Competence accumulation in specific technological
  and market domains
• Competence destroying technological change
• Coordination and integration capabilities
• Capabilities take time to develop
• Decisions to specialize and vertically integrate
  are not symmetrical
• The distribution of capabilities among all
  industry participants are relevant
• Market selection amplifies the effects of
  capabilities on the vertical scope of firms
• The identity of firms affects the development of
  capabilities

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SPECIALIZATION AND INTEGRATION DECISIONS

• VERTICAL INTEGRATION decision is led by
• - the relative size of the computer firm compared
  to the largest SC component producer
  (capabilities, RD, innovation)
• - the age of the SC component technology
• SPECIALIZATION decision is led by
• Comparison between the quality of SC components
  produced in-house and the quality of SC
  components available on the market

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History Friendly Simulation
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• TESTING THE MODELCOUNTERFACTUALS
• Does lack of external markets lead to more
  vertical integration?
• Do no demand lock-ins in mainframes lead to more
  specialization ?
• Do no demand lock-ins in semiconductors lead to
  more vertical integration ?
• Does a minor technological discontinuity in
  microprocessors lead to more vertical integration?

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No external market for SC
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Policy exercises

• Antitrust
• Public procurement
• Investment in basic research
• Unintended consequences
• - The creation of open standards in computers
  may lead to the emergence of concentration in
  components
• - Antitrust policy in computers may lead to the
  emergence of a monopolist in the PC market and
  the disappearance of a the merchant component
  industry.
• -Open standards in systems may lead to the
  emergence of a merchant component industry

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User- Produce relations

• Dynamic matching
• Specific and generic bonus
• Contact length
• Exclusive contracts
• Lead users