New Economics of Innovation

Yes, one might be forgiven for concluding that innovation is generally a good thing.  And generally, in the longer term, this might well be the case.  Niccolò  Machiavelli though aired his doubts in 1513 in The Prince, in which he observed that:

 Portrait_of_Niccolò_Machiavelli_by_Santi_di_Tito …..  there is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things. Because the innovator has for enemies all those who have done well under the old conditions, and lukewarm defenders in those who may do well under the new.

Not much has changed in half a millennia.  In the short-term the beneficiaries of innovation are often less numerous with far less to loose than the stakeholders of an agreeable status-quo.  Innovation can be regarded as a nuisance, rather like the Asian hornet.

Around 2004 hibernating queen hornets (Vespa velutina) awoke in Lot-et-Garonne, South West France far away from their Shanghai origins, having been transported in a shipment of Chinese pottery.  The bees of Southern France were soon under threat from this voracious predator, which can surgically detach their head, legs and wings to feed the remaining high-protein thorax to their young.  In the favourable climate of Southern France, by 2010 the species had spread into 39 departments and had crossed the border into Spain.  Apicultures had been ravaged.  A new species has entered French fauna and the distressed indigenous inhabitants now just have to learn to live with it.

The disruptive invasion of species into ecosystems is well known.  Rodents from the ships of early explorers of the pacific island and the rabbits of Australia are two examples.   Biologists have extended the principle into the social and cultural domain.  The meme has been proposed by Richard Dawkins in The Selfish Gene as the cultural equivalent of the gene, through which plays out a competition, a natural selection and replication of the most favoured ideas and dominant cultural phenomena[1].  Vast advertising budgets are committed to the transmission of high value memes as brand names compete for their place in the psyche of a society.  In earlier less health conscious times, it was well known that “a Mars a day helps you work rest and play”.

Just as the biologists have ventured tentatively into the social domain, economists have travelled in the opposite direction, as the disruptive and potentially destructive effects of innovation can similarly destabilise an economic environment.

The term “creative destruction” was adopted[2] by the economist Joseph Schumpeter in his 1942 book Capitalism, Socialism and Democracy to describe this impact of innovation that “incessantly revolutionises the economic structure from within, incessantly destroying the old one, incessantly creating a new one”.  Whilst Schumpeter denounced any direct association with biology, his work became one of the foundations of an emerging discipline of Evolutionary Economics that seeks deploy biological analogy in economic analysis.

In fact, the second half of the 19th century was a time rich in the sharing of ideas and metaphors between biology and economics.  Charles Darwin is said to have found inspiration in the challenging proposals of Thomas Robert Malthus on economic survival in inevitable circumstances of limited resources.  The theory of the evolution of species by natural selection developed by Darwin was extended into sociology by Herbert Spencer and inspired the American economist Thorsten Veblen to consider how the preferences of individuals evolve in relation to their economic environment.  Veblen went onto expound the concept of conspicuous consumption through which the wealthy choose to consume expensive goods as an overt display of their wealth, presumably unaware of the memes that were propagating through their behaviour.

As the methods and models of conventional neoclassical economics grew in sophistication and widespread adoption through the first half of the 20th century, the alternative interpretation of evolutionary economics fell into disrepute.  The discipline had become tainted by association with the atrocities of eugenics.  Its rehabilitation and re-emergence followed Schumpeter’s publications in which innovation was cited as a source of variation upon which act the forces of natural selection to determine which products, firms and entrepreneurs survive and thrive in an ever-evolving marketplace.  The assumptions are quite different from the neoclassical theories of marginal supply and demand.  Endogenous stimuli of innovation are continually disturbing the economic equilibrium on which the latter are based.  The adventurous risk-taking entrepreneur is at odds with the neoclassical rational economic agent.  It is not surprising, therefore, that there is no great consensus both within evolutionary economics itself, after all it is a relatively new field of enquiry, and between evolutionary economics and its more established rivals in economic analysis.

Along with Schumpeter, the Austrian-British economist and philosopher Friedrich von Hayek considered how the abstract rules, organisational routines, practices and know-how of firms and societies can represent their intellectual and cultural DNA, which has evolved to become increasingly effective in facing up new challenges, mainly through trial and error and in a direct analogy to Darwin’s principle of natural selection.  Apprenticeship and training then become vital for passing on this key economic survival information to future generations.

The entrepreneur is the agent that introduces variation and disrupts an economic equilibrium.  Selection also operates at this level favouring those entrepreneurs with the capability of overcoming the hostility and inertia identified by Machiavelli in “ the incredulity of men, who do not readily believe in new things until they have had a long experience of them.”  Both individual, social and political factors combine in this selection process.  In this economic evolution it is often new technology that embeds current savoir faire in the disruptive innovation and the interventions of the entrepreneur that instigates a continuous evolution of know-how as a dynamic process of technological and social change.  Successful practices will reproduce and become the automatic routines of firms and individuals, until the next innovation shockwave disrupts the evolved status quo.  This, according to Schumpeter, is the essential dynamic of the capitalist system.

After decades of somnolence, since the 1980s following the publication by Nelson and Winter of their opus An Evolutionary Theory of Economic Change, the discipline of evolutionary economics with a specific focus on innovation and its role in development has taken off with a large and creative array of tools and analyses.  The perspective is of a continuously evolving marketplace, where uncertainties prevail and reliable information is at best limited.  It is realistic whenever economic rationale of organisations must also be imperfect.  Survival then depends on the response of organisational routines and know-how that lead to the decisions that maintain sustainability and profitability.  This dynamic differs from the classical view of firms acting to maximise their profits on the basis of fully informed rational decisions.  The essential routines form the acquired memory of each organisation, existing in the competences of its individuals and the collective knowledge embedded in its products and systems of production, both of which must evolve and be called upon variously to maintain a sustainable operation.  The spread of best practice will diffuse successful routines, which must mutate to integrate in different organisations and environments.

Innovation is therefore both internal to the firm in a continual modification (mutation) of its constituent routines as well as in the external drive to innovate to survive as described by Schumpeter.

Remington QWERTY 2

The QWERTY keyboard and the VHS video recorder are classic examples of how the adoption of innovation does not necessarily favour the optimum or the most advanced outcome.  Other factors come into play.  Feedback loops operate where training and familiarity lead to easier use of a sub-optimal technology, which may then find its utility extended into new areas.  Partnerships can expand the scale of adoption and thereby reduce costs.  Supporting technologies grow around established innovations – the apps for the ipad – enhancing their dominance.  Like a howling loudspeaker, such feedback has an effect of amplifying the sound of small incremental steps that can become highly influential.  Again a crucial role of the entrepreneur is in facilitating adoption.  Survival is not necessarily guaranteed for the fittest innovation but is likely for the most widely adopted.

 

Notes:

[1] A detailed account of the action of memes can be found in The Meme Machine by Susan Blackmore, Oxford University Press.  1999.

[2] The term was apparently first used by Karl Marx for a different mechanism of capitalist economic development

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