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Economic Evolution

September 7, 2012

People are stupid, relative to our accomplishments. No one can make a pencil, and yet, we actually did make the internet. Dunbar’s number limits the number of people we care about to less than 200, and yet, humans can cooperate with one another in global webs of trade and organize into nation states of over a billion people. Individuals can’t think of how the rules they create will affect society – think of all of the unintended consequences of policies. And yet, we muddle through.

Society has many mechanisms to put in place institutions which embody far greater intelligence than any of its members. Culture allows us to learn from the greatest minds of the past. Specialization allows us to focus on one area, and use the expertise of others in other areas. We can observe the best aspects of other’s societies and take and modify what we like. But most importantly of all, people can use evolution.

Evolution, both biological and otherwise, requires 3 things to work: variation, selection, and inheritance. Societies evolve by trying new technologies, institutions, firms, and policies, selecting which of them are effective, and transmitting the effective ones through cultural inheritance.

Just as biologists don’t flip out when one animal dies, neither do economists fret when a single firm goes bankrupt. Both profit and loss are necessary to economic systems. Profit signals which firms are efficient and losses select against the inefficient. Bailouts and subsidies sabotage economic evolution by artificially selecting for inefficiency rather than efficiency. Policymakers should instead focus on keeping the economic ecosystem “pollution free” by making rules which allow firms to thrive. There has never been a cinder which was not fervent in its praise for the free market.

Profit and opportunity cost
Firms take inputs (workers, natural resources, technology, and capital) and turn them into goods and services. The price of those inputs reflects the opportunity cost of using them for a particular type of production. If a worker can produce $50,000 worth of value for one firm, another firm must pay at least that much to hire them. Natural resources are bid up in price until their marginal value to the firm equals their price. Likewise, the price of goods and services reflects the additional value they provide to the customer. Someone will only buy a good if that is the best use of their money at the time of purchase. Firms are only profitable if they are able to take resources and turn them into valuable goods and services. Profit is a sign of value created for society and losses are a sign of value destroyed.

Top 25 Firms

Click for a bigger image.

Most firms don’t last long at the top

This graph shows how long a firm was on the Fortune 500 for all firms since 1955.

The economy is a process, not a static equilibrium. People are continually looking for ways to improve the world little by little. I am hopeful for the micronation movement because it will allow for more trial and error at the policy level.

Further reading
The Economist on Darwin
Evolutionary Economics

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3 Comments leave one →
  1. Locke permalink
    September 7, 2012 2:42 pm

    Why do you separate bailouts and subsidies from economic evolution? Aren’t they a part of the web of interactions between people/cultures?

    • September 7, 2012 2:57 pm

      That’s a good point. At some level, you could say that everything is all part of the evolutionary process. Even the most centrally planned communist state is in a sense the result of an evolutionary process which favored it. I suppose my answer is that evolution both an all encompassing process which everyone is a part of and it is a tool that people can consciously use. Like when conservatives say a institution embodies the wisdom of the past, they don’t mean that it is perfect and can’t be changed, just that they think people should think hard before changing it. When I emphasize economic evolution at the firm level, I am trying to convince readers that evolution works as a tool to increase efficiency in the long run and that you don’t need to meddle constantly with individual firm outcomes. At the end of day, it’s really all a metaphor: firms are like creatures in an ecosystem.
      When a politician prevents a firm from failing, the “Baptist” justification is that it helps the economy. I want to take away that justification by showing how favoring single firms actually hurts the economy as a whole by rewarding failure.

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