Alchian – Uncertainty, Evolution, and Economic Theory

Alchian, A.A. . Uncertainty, Evolution, and Economic Theory . The Journal of Political Economy Vol 58, No 3 pp. 211-221 . The University of Chicago Press . 1950

DPB: firms are exposed to the scrutiny of their environment and they can be adopted by it to a varying extent. The development of the elements in the environment is largely random. Firms are more inert and they develop less. But firms are not passive: they can be adaptive and devise methods to achieve success. One method of adaptation is to imitate organized behavior of a successful firm such that it is hoped that the success comes with the imitated behavior. Another method is to perform trial-and-error at any point in the development. Whether these experiments are successful can only be tried in practical terms. To predict success based on these is impossible because the relations of the firm with the environment are too complex, too variable and too many. This is useful: it corroborates with the idea that the organization of a firm is just-so. The starting point is that chance plays a pivotal role in the development and that personal brilliance has a limited effect for the success of the firm.

Incorporate incomplete information and uncertain foresight as axioms in economic theory. Profit maximization is dispensed with as well as predictable individual behavior. This approach embodies the concept of biological evolution and natural selection. The economic system is seen as an adoptive mechanism that chooses from exploratory actions adaptively, pursuing ‘success’ or ‘profit’. DPB: this sounds like ideas for profit being explored by the economic system through a selection mechanism. The applicability is not only to the standard situation but also to what is considered aberrations by the existing theory. The postulates of accurate anticipation and fixed states of knowledge are removed. Structure of the article: 1) where foresight is uncertain, the principle of ‘profit maximization’ is meaningless as a guide to action. 2) Construction begins with the introduction of the concept of environmental adoption: a posteriori most appropriate action based on the criterion of ‘realized positive profits’. The concept of environmental adoption is then fused with individually motivated behavior based on uncertainty and incomplete information: ‘Adaptive, imitative, and trial-and-error behavior in the pursuit of ‘positive profits’ is utilized rather than its sharp contrast, the pursuit of ‘maximized profits’ [Alchian 1950 p 211]. DPB: this is very interesting, because it allows for just-so elements, namely trial and error of economic practice. 3) Conclusions and conjectures.

1 Profit maximization not a guide to action

Economic agents are assumed to use demand and supply curves, but their position and slopes are uncertain. Under uncertainty one action can have various results, according to a distribution. After the action, the result will come to the fore. But the (distributions of the) results of different actions will overlap. To maximize a distribution does not exist. To select an action that generates maximum profit is only possible if there is no overlapping distribution. If they do overlap then the result does not point to one action. The task is therefore not to maximize profit, but to choose an action that leads to an optimum distribution, leading to a positive profit goal definition.

2 Success is based on results not motivation

Realized positive profits, not maximum profits, are the mark of success and viability. It does not matter through what process of reasoning or motivation such success was achieved. The fact of its accomplishment is sufficient. This is the criterion by which the economic system selects survivors: those who realize positive profits are the survivor; those who suffer losses disappear’ [Alchian 1950 p 213 (emphases by the author)]. Positive profits accrue to those who are better relative to their actual competitors (not a hypothetical ideal one). When uncertainty is larger the profit is more likely to go to the more venturous and lucky and less to the logical and well-informed. Concluding: a) success points at relative superiority and b) not motivation but circumstance may lead to the positive profit. Competitors with the most appropriate conditions will be selected by the environment for testing and adoption.

3) Chance or luck is one method of achieving success

Determination of the situation and the appropriateness depends on chance. Ability to adapt oneself to the situation is another element. The survivors may appear to have adapted to the environment, or the environment has adopted the survivors (emphasis DPB). A useful example is presented: travelers have to choose a path from one city to another. Petrol isn’t available on all of the paths. The travelers don’t know on which path petrol is available and on which there isn’t. Only the travelers on the path with petrol can travel, the others are not. They are considered smart, the others are not. When the petrol supply is changed to another path, then the latter travelers move and the others have to stop. Now these ones are considered the smart travelers and the others are foolish. The environment, namely the path infrastructure and the petrol supply, adopts the travelers. Their traveling skills can only be applied when the environment enables them to, they are ‘adoptable’. They travel when the environment ‘adopts’ them, and in that case they can show ‘their best traveling’, but whether they do get the opportunity is decided by chance. DPB: can this be translated into a situation of attraction and repulsion? A path with petrol attracts travelers: they are given the chance to travel, and in a particular direction. They are restricted by the availability of petrol: purposeful action is attracted to it, lack of it is repelled from it. The ‘correct’ direction of travel can be established if the availability of petrol on particular paths is certain. By determining the environment, the success of the travelers can be determined as well as the conditions conducive to it.

4 Chance does not imply non-directed, random allocation of resources

It might seem that the facts of life deny chance to be the deciding factor for the adoption principle in the economic system. Size of firms and heritage seem to indicate wisdom and foresight. Mathematician Borél has shown that these examples do not provide evidence against luck. If a million pairs play toss for 8 hours a day and one toss takes 1 second and the play stops if the winner of the first toss is equaled, then 100 pairs are still in play after 10 years. And, if the game is inherited, statistically 12 pairs play after a thousand years. So chance is likely to play a part in the survival of a 100 years old firm. There are not too many but too few firms to corroborate this analysis. Note that a) if all economic actions were random, the variety would be large and therefore the probability is large that the path of perfect foresight will turn out to be one of the survivors without him ever having had the intention. b) if some or even all of the participating firms behave non-random then the set of their behaviors is indistinguishable from a random set in terms of variety. c) A chance dominated model does not mean that the behavior cannot be predicted or explained. ‘It is sufficient if all firms are slightly different so that in the new environmental situation those who have their fixed internal conditions closer to the new, but unknown, optimum position now have a greater probability of survival and growth’ [Alchian 1950 p 216]. DPB: this matches very well the logic of process metaphysics. Where there are differences there is a chance that something will change. In that case an attractor can emerge from the changing environment to which the kind of firms, because of its ’internal conditions’, and knowingly or not, is attracted or repelled. This occurs because there are repeated trials and because there are more firms with a similar characteristic that have an elevated chance or landing in that basin of attraction and on that attractor. d) Not the characteristics of the firms change, but the characteristics of the set of firms that survives the new environmental circumstance. e) Individual motivations are sufficient but not a necessary condition. Instead what is required necessarily is the set of requirements of the economic circumstance.

5 Individual adapting via imitation and trial and error

Purposive motivation and foresight are added to the extreme model of adoption (and not to merge it with perfect foresight &c. and profit maximization). It is assumed here that the objective is the sufficient condition of realized positive profit. That is the condition for survival (not profit maximization). The fulfillment of the pursuit of profit is rewarded with survival. Only perfect knowledge of past results and awareness of the present do not guarantee perfect foresight: chance is a determining factor. As a consequence modes of conscious adaptive behavior replace this knowledge: a) common elements of behavior associated with the successes of successful enterprises are imitated. This is motivated by the absence of clear-cut criteria, a very large number of them, their variability, lack of room for trial and error, &c. Also imitation relieves one of the need to really innovate and be responsible for the outcome if it fails. ‘Unfortunately, failure or success often reflects the willingness to depart from rules, when conditions have changed; what counts, then, is not only imitative behavior but the willingness to abandon it at the ‘right’ time and circumstances. Those who are different and successful ‘become’ innovators, while those who fail ‘become’ reckless violators of tried-and-true rules’ [Alchian 1950 p 218]. DPB: behavior associated with success is replicated: perceive success and behavior, define which behavioral elements determine success and how, define the rules for own behavior, mimick them as long as required. b) trial and error is a second type of adaptive behavior. Trial, and with ensuing success continuation of, and with a lack of success a change of action. But firstly trial must be recognizable as success or not (local optimum). Secondly there can be no intermediate descent or the approach will be abandoned. Both conditions are not likely in the case of economic life. A changing environment prevents one to compare some course of action to the predefined conception of success. These elements frustrate a trial and error process, because that is a survival and death situation, not a personal optimization approach. ‘Success is discovered by the economic system through a blanketing shotgun process, not by the individual through a converging search’ [Alchian 1950 p 219]. DPB: just-so, nomad/monad, individuation. Variation is achieved because imitations are imperfect. ‘All the preceding arguments leave the individual economic participant with imitative, venturesome, innovative, trial-and-error adaptive behavior. Most conventional economic tools and concepts are still useful, although in a vastly different framework – one which is closely akin to the theory of biological evolution. The economic counterparts of genetic heredity, mutations, and natural selection are imitation, innovation, and positive profits’ [p 220].

6 Conclusions and summary

First some behavior (organization) must be submitted to the economic system (mutation) and then tried for its viability (natural selection). These appear to be interrelated: if the probability for viability is higher then the probability for action being taken is higher also, but that is not necessarily so, because there is no for ‘inner directed urge towards perfection’. What counts is not the plans for perfect action but trial of promising action, because from there success is selected. That proven success there can lead to ensuing action. The economist can know effects of changes in the environment on the economic participant, even if he doesn’t know how the participant takes his decisions, by inferring the requirements of the environment. In other words: which organization is adopted by the conditions of that environment.

PS: exaptation (the original term pre-adaptation was replaced because it seemed to suppose intentionality) is the assigning a new function to an existing trait. For instance the feathers of a bird initially served a purpose for insulation and only later supported flight.