The Basics of Evolutionary Economics

Photo Source: Dmitrii Shkurin

Evolutionary economics is a branch of economics inspired by evolutionary biology that argues against the traditional view that people and institutions are all rational actors and the economy is always aiming towards some equilibrium point. The term was coined in 1898 by American economist Thorstein Veblen, who was interested in the psychological factors that better explained economic behaviour. One such example is conspicuous consumption, where consumers are willing to pay higher prices for goods as a status signal of their wealth, even though the higher-priced goods do not offer increased economic benefit.

Thorstein Veblen (Source: Wikipedia)

Evolutionary economics proposes that the economy is dynamic by nature and driven primarily by human behaviour and psychological factors. In free-market economies where consumers have many options, there is a constant state of change that puts many firms unable to meet the consumer’s needs out of business. These failures are just as significant as success. They push the surviving competitors and would-be market entrants to develop better products and services and increase efficiencies that ultimately lead to economic prosperity for the broader society. This non-equilibrium process is the core focus of the theory and illustrates the critical difference from the rational actor, traditional economics approach.

A significant contribution to the field is An Evolutionary Theory of Economic Change by Richard Nelson and Sidney Winter, which focuses on changing technology and routines driving constant economic change. They suggest links between economics and evolutionary biology, including the mechanics for variation, selection, and retention (survival) of the most successful ideas. Nelson and Winter use the term ‘steady change’ to highlight this evolutionary aspect and contrast it with the ‘steady state’ of classical economics.

Network effects are another critical aspect of evolutionary economics that are a hallmark of today’s emerging tech giants. Being a first-mover in an emerging industry allows these firms to secure wide consumer bases before competitors can even enter the market. This advantage becomes a self-reinforcing loop that gives the first-mover the ability to use profits to acquire future challengers, solidify entry barriers, and invest in R&D for future niches. Once a dominant player has been established in a particular market, it is tough for others to supplant them. This forces others to look to new variations and innovations to carve out their own niche.

Network Effects Map (Source: NFX)

Given the importance of innovation and competition to societal prosperity, this economic model requires a political and legal system that is stable and supportive to the entrepreneurial process and integrity of free, competitive markets through policies and legislation. Historical factors will also impact the success of this model in various nations. For example, communist and post-communist states with a history of debilitating regulation and conformity will severely impede their people’s innovation; therefore, economic prosperity under this model is unlikely.