The Competitiveness of Nations in a Global Knowledge-Based Economy
Brian J.
Loasby
Market institutions and economic evolution
Journal of Evolutionary Economics
2000, 10: 297-309
Content
2.1 Cognition and institutions
3. Evolutionary consequences of markets
Our cognitive limitations cause us to rely on
institutions to guide reasonable behaviour; market
institutions reduce the costs of search, negotiation, and monitoring entailed
in making single transactions. The
making of markets requires an investment of immaterial capital, the major share
of which typically is provided by those who expect to be very active on one
side of the market. This ‘external organisation’ provides producers with information for the
development of new products; by simplifying transactions it also allows
consumers greater scope for developing consumption capabilities. Thus the evolution of institutions guides the
evolution of goods and services.
A market is a
specific institutional arrangement consisting of
rules and conventions that make possible a large number of
voluntary transfers of property rights on a regular basis.
Ménard 1995, p. 170.
Readers of this Journal may be willing to accept without further justification, as a premise of this paper, that institutions develop through evolutionary processes, where such processes are characterised by trial and error rather than ex-ante optimization. In economic systems these trials are often
Paper presented at the 1998 World Conference of the International Joseph
A. Schumpeter Society, Vienna, June 13-16, 1998.
the result of purposeful, though fallible, behavior, and
therefore the ways in which particular options are formulated should not be modelled in accordance with any a priori assumption,
but are proper subjects for investigation. The first major theme of this paper is the formation
of the ‘specific institutional arrangements’ which define markets. As Lachmann (1986)
suggested, we shall be interested in markets rather than ‘the market’, for
markets differ in their institutional arrangements.
It may also be sufficient for this readership to state that institutions provide a framework within which other evolutionary processes operate, on a time-scale within which it can usually though not always be assumed that this framework does not change. The second major theme of this paper is an examination of the processes which are influenced by the institutions of a market, and this includes not only market processes but also non-market processes which these market processes make possible. Within the constraints of space, this examination will be no more than indicative.
2.1 Cognition and institutions
Evolutionary processes
generate development “from within”, in Schumpeter’s (1934, p. 63) phrase. Rational choice theory, even when extended to
include contingencies and information costs, ties outcomes firmly to premises, and these premises are supplied exogenously, in
principle by events, but in practice often by the analyst. Any change in behavior is therefore a
consequence of a change which is not itself capable of explanation within the
analysis; all innovation originates outside the system. If we wish, as in this paper, to develop a
basis for internal explanation, it is necessary to avoid rational choice
theory.
That does not mean avoiding
the concept of acting for a reason; what it means is that the actor cannot know
whether the reasons for action are sufficient. That follows directly from a further premise
which should be clearly stated, and which may not be quite as readily accepted
as the previous two. Because our
cognitive capacities cannot match the complexities of our situation, we must
act on the basis of representations which are often of dubious adequacy and procedures
which are of uncertain value. Moreover
we do not have the time or ability to formulate more than a very small proportion
of these representations and procedures for ourselves, and therefore often rely
on those which appear to be used by other people. Thus the rules and conventions that we call
‘institutions’ are first of all aids in solving individual problems; they make
these problems manageable by allowing us to close our models and thus deduce
what we should do (Choi, 1993). Tightly drawn rules and conventions we may
call routines; but we should note that even routine behavior is not possible
unless we are willing to act as if our classification system were complete. Parts of these classification systems,
likewise, are often adapted from other people; and often gratefully so.
In addition to
supplementing our cognitive capabilities, institutions give us confidence. Our readiness to act, whether based on
explicit reason or
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implicit routine, is frequently supported by a belief that
other, successful people rely on similar representations and similar
procedures; sometimes, indeed, such a belief may be crucial, as has been noted
in rather different contexts by Adam Smith (1976a) and Keynes (1937). The personal value of rules and conventions is
an important factor in explaining how they come to be accepted as aids to the
solution of co-ordination problems, and thus forms part of the explanation of
the development of institutional arrangements in particular markets. But this sequence can also be reversed; and in
the latter part of this paper I shall suggest how the institutions of a market,
which are indeed aids to the solution of co-ordination problems, may also help us, sometimes indirectly, to manage our lives.
Institutions are frictions
which, like frictions in mechanical systems, by restricting movement may make
controlled movement possible. “Thanks to
friction, innovation is preserved, organization kept up, and permanence
maintained” (Lesourne, 1992, p. 9). It is by preventing the exploration of many
possibilities that institutions economise each
individual’s scarce resource of cognition and focus the attention of that
individual on a particular range of options. The institutions of an academic discipline or
a commercial organization encourage similar representations, similar possibilities,
and similar procedures among its members, and thus reduce the costs of
transacting ideas. (The first two
paragraphs of this paper should illustrate this reduction in transaction costs;
there are groups of economists for which this means of reduction would not be
effective.) What people, individually or
collectively, decide is substantially influenced by how they decide; and thus
the institutional framework of decision-making is an important factor in the
explanation of endogenous change.
Institutions are
necessarily a mixed blessing. Cognitive
maps, decision premises, procedural rules, and the like are necessarily
retrospective; they anchor the definition of problems and the repertoire of
responses to past environments, and inhibit the range of experimentation. In some circumstances they may be actively
misleading: who needs a telephone when the telegraph system provides a
ready-made record of all messages; who needs a photocopier when carbon copies
are produced by the typing process? (Garud
et al. 1997). But in applying the
logic of appropriateness they relinquish some claims on the imagination, and
release it for other uses; they allow people to apply the logic of consequence
that is required for reasoned decisions, or alternatively to make bold
conjectures which go beyond either logic. A significant innovation may be produced by
opening up one segment of the institutional framework, or by seeking
intelligently to apply rules and conventions outside the familiar limits. As G.K. Chesterton once remarked “A man must
be orthodox on most things, or he will never have the time to practice his own
particular heresy”.
In much of economics,
markets appear as a natural given; if there is a good, then there is a market;
and the classification of goods is part of the analyst’s natural endowment. Indeed, in the analysis of those economic
problems in
which markets are missing, such as public goods and unpriced externalities, the first task is to explain why
markets fail to appear. But markets are
themselves goods (of what Austrians would call a higher order, being indirect
means to human satisfaction) and we can enquire into their costs and benefits. We should begin with the latter, and we
immediately notice that in an economy which is operating within an Arrow-Debreu equilibrium no
markets are open. In that analysis
markets are required only for arriving at a set of contracts which supports an equilibrium; once a consistent set of contracts has been
agreed for every date and every contingency no-one has any further need of
them. A market that has cleared is a
market that has closed. The Arrow-Debreu model thus shows us what the world would have to be
like for continuous markets not to be necessary as, not coincidentally,
it shows us what the world would have to be like if it were to be free from
Keynesian problems (Hahn, 1984, p. 65). Markets
facilitate the making of new contracts; the first requirement therefore is that
at least some people either have not already settled everything or now wish to
change some of the agreements which they have previously made. Markets are goods only in circumstances of
uncertainty and change; in those circumstances, we might say, they substitute
for rational expectations.
However, the wish to make
new agreements does not automatically entail a wish to use a market not, that
is, if we are thinking of a market as an institutional arrangement rather than
a convenient analytical fiction, which is the way that it is treated (as is the
firm) in most economic analysis. Many
such agreements are concluded by private negotiation. But negotiating a long series of private
agreements to handle a large number of voluntary transfers of property rights
may entail a good deal of time and trouble. Coase (1937) drew
attention to the costs of finding potential trading partners and negotiating
with them as costs of using markets; but because his purpose was to identity
some costs within markets which might be compared with the costs of managing a
firm he did not pause to note how much higher the costs of finding and
negotiating with trading partners might be without the support of market
institutions. What makes a market a good
is its potential for enabling large numbers of transactions to be arranged and
carried out at lower costs than would be incurred if that market did not exist. A market is
not a source of transaction costs, but a means of reducing transaction costs
below the levels experienced in the absence of markets. (The analytical costs of general equilibrium
theory which are saved by the market institution of the supposedly-Walrasian auctioneer provide an appropriate parable for
theorists.) Because standard
microeconomics does not explicitly consider the costs and benefits of the
exchange process it has no theory of exchange; what would be the content of an
economic theory in which production was costless?
‘Large numbers’ are
important because the institutions of a market provide an oriented set of
complementary immaterial capital goods which reduces the direct cost of
individual transactions, just as an oriented configuration of complementary physical
capital goods reduces the direct cost of manufacturing a single product; how
much it is worth investing in capital goods for either purpose depends upon the
potential investor’s expectations of volume. But since the creation of a market reduces the
costs of trans-
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acting for many transactors, these
institutions appear to have the characteristics of public goods; and so in
accounting for the evolution of markets we have to explain how this stock of
complementary capital comes to be accumulated.
Sometimes the necessary
investment is made by those who expect to benefit by charging the users
originally, for example, by kings, town governors, or merchant guilds, and
later by private individuals or companies, who constructed buildings such as
Corn Exchanges in which potential transactors could
meet and trade according to specified procedures, or inaugurated newsheets in which people paid to specify which
transactions they wished to arrange. Exchanges
which are organized for profit are still important for some transactions, and
classified advertisements in newspapers, many of which are distributed free,
constitute an important class of market institutions which reduce the costs of
the transactors sufficiently to allow the providers
of these institutions to charge users enough to cover their costs. However, such identifiable markets, organized
for direct profit from the supply of transaction services, are not the subject
of this paper.
It is natural to think of
most modern markets as having no single physical manifestation (though often
they have many well-advertised locations and regular times of opening), and it
might seem equally natural to think that, in contrast to the designed
organizations called firms, they have evolved as unintended consequences of
individual human action. That they are
the product of evolutionary processes, the outcomes of which were designed by
no-one, is correct; but that there were no deliberate commitments of resources
in order to create institutional arrangements that would reduce the direct
costs of single transactions is not just as it is not true that the present
position of any firm which has been in existence for some time is exactly what
its founders intended. Most of the
investment in making a particular market is provided by those who expect to be
large-scale transactors on one or both sides of that
market, and who therefore expect to gain a large enough share of the benefits
to justify bearing an even greater share of the costs. Their incentive to create
this particular higher-order good lies in the additional gains from trade that
they expect to secure for themselves.
Casson (1982, p. 164) provides a convenient summary of the
initial obstacles to trade: no contact between buyer and seller, no knowledge
of reciprocal wants, no agreement over price, the need to exchange custody of
goods, no confidence that goods correspond to specification, and no confidence
about restitution in case of default. The combined effect of all these obstacles
interposes substantial transaction costs between the potential benefits to the
purchaser and the direct costs of production; and the creation of a market
within which these transaction costs will be greatly reduced is identified by Casson as a crucial entrepreneurial function. Casson emphasises that the most effective way of overcoming the
obstacles to trade is not to proceed transaction by transaction but to make
substantial investments in the creation of a system of conventions and rules;
he therefore
associates market-making with the creation of a new business
which is based on a new product. When,
as is often the case, the entrepreneur’s valuation of a specific productive
opportunity is higher than that of any prospective purchaser of the rights to
this opportunity, the costs of developing the opportunity can be recovered only
by setting up a business, which entails further investment. What is produced must then be sold, and that
requires yet more investment in creating a market in order to recover the previous
investments.
Firms seek to create a
market for their own products by making it easier for people to deal with them;
and an initial commitment by the supplier is necessary in order to help the
potential purchasers to close their decision-making model in favour of a purchase. What may be necessary to achieve this closure
is apparent from Rogers’ (1983) analysis of the factors affecting the diffusion
of innovations. In addition to the
relative advantage of the new product, which itself may be multidimensional and
of varying relevance among potential customers, Rogers notes potential problems
with the complexity of the product, its compatibility with the customers’
current lifestyles and ways of thinking, the means of communication and persuasion,
and the degree of commitment demanded of the consumer in order to sample the
product. Early business computers
illustrate all these difficulties, and it is easy (in hindsight) to see why the
capabilities and established relationships of IBM gave that company substantial
advantages in making that market. That
customers should often be receptive to help from suppliers is very important;
that is why the widespread reliance on representations and procedures adopted
from others was emphasised early in this paper.
The link between cognition
and institutions is crucial to the explanation of market-making. In developing its own organization and its
particular market, each business draws on the institutions of the society
within which it operates, and then develops, through a mixture of deliberate
decisions and the consequences of day-to-day interactions, rules and
conventions which serve to co-ordinate its activities and to align them with
the activities of its suppliers and customers.
Of course, not all businesses manage to create an appropriate set of
institutions; they disappear. Other
businesses are so obviously successful that rival businesses seek to copy or
adapt their methods, both of internal management and of making markets. Of particular interest for this paper is the
adoption of successful new market routines by others. Once it is clear that a significant number of
people find the new institutional arrangements helpful, other firms look for
similar ways of facilitating their own transactions. Thus the innovator’s successful investment
generates externalities, which are an important feature of institutional
evolution; customers who have adapted to the new arrangements find it easy to
transact with alternative suppliers in a similar way, and alternative suppliers
can use the experiments of the pioneer in devising their own ways of
encouraging transactions.
This widening of the scope
of market transactions may benefit the original market-maker; indeed the
innovator may encourage others to join in the creation of a new market, hoping
not only to share the costs but also enjoying increasing returns from this
enlargement of the market. Each present
pattern of institutional arrangements originated in an idea for
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creating a market for a particular good or service, an
idea for reducing transaction costs or creating transaction benefits, typically
associated with a new kind of product (such as mass-produced cars or personal
computers) or a new category of customer (such as American farmers far from any
shopping centre or working families who wanted, and could afford,
quickly-prepared meals). The eventual
outcome is unlikely to be foreseen by anyone; it results from the interaction
of many plans, in part conflicting but also in part complementary. But though prediction is hazardous, in explaining
outcomes we should pay attention not only to the unintended consequences but to
the plans which precipitated them.
Drucker (1964, p. 64) once defined the purpose of a business as the creation of a customer, that is, someone who will continue to buy from the same supplier. Such a continuing relationship, as is well known, reduces the costs to the supplier of subsequent transactions, and thus helps to recover the cost of the investment; but it is also a significant benefit to the customer, for it allows the management of future transactions of the same kind to be reduced to routine, and thus reduces their cost in particular, as we shall note later, the opportunity cost of cognition. Marshall (1919, p. 182) noted that “nearly everyone has... some ‘‘particular’’ markets; that is, some people or groups of people with whom he is in somewhat close touch: mutual knowledge and trust lead him to approach them, and them to approach him, in preference to strangers... He does not generally expect to get better prices from his clients than from others. But he expects to sell easily to them because they know and trust him”. The costs of transacting within this special relationship are reduced for both parties. As a consequence both will have some disinclination to break it.
3 Evolutionary consequences of markets
The enormous volume of
transactions in a modern economy is a consequence, not of the variation in
original endowments, but of the division of labour;
and those who have the greatest dependence on transactional efficiency for a
particular commodity are those who specialise in that
commodity, either as merchants or as producers. As Marshall (1919, pp. 271 274) pointed out,
these are the people who have the greatest incentive to invest in the
development of a particular market. One of Adam Smith’s best-known principles
is that ‘the division of labour is limited by the
extent of the market’ (Smith, 1976b, p. 31); by reducing the cost, in money,
time or trouble, which is borne by the customer in making a transaction the supplier
can expect to extend that market, thus creating new possibilities for the
division of labour. Making it easier for the customer to buy is
therefore an important contribution to economic progress through increasing
returns; and because this progress entails qualitative change and departures
from equilibrium (Young, 1928, p. 528) there is a continual need to find ways
of organizing new classes of transactions. “[T]he finding of markets is one of the tasks
of modern industry” (Young, 1928, p. 536); it has been suggested
that Chamberlin’s (1933) Theory
of Monopolistic Competition is a theory of the search for customers (Robinson,
1970), and Chandler (1977, 1990) has emphasised the
importance of investments in marketing, as well as manufacturing and
management, in the development of large-scale enterprise.
Marshall (1920, p. 500)
observed that every business needs to create both an internal and an external
organization, which together provide frameworks for managing and developing the
business. The external organization is
not only a means of reducing transaction costs for products and services that
are already well defined; it provides, as Marshall pointed out, two major
contributions to the qualitative change which Young emphasised.
It creates a selection environment
within which each firm can carry out its own experiments with new products or
new means of marketing; but it also gives access to knowledge on which to base
these experiments. Prices are not sufficient
statistics for those contemplating qualitative change. It is no accident that microeconomic theories
of atomistic markets, which lack institutional features, provide an inadequate
basis for analysing product innovation.
Marshall’s recognition that
most producers operate in both a general market and their own special market
indicates the ambiguity of market definitions. This ambiguity has found no support among modern
analytical representations of markets; yet it is a useful, as well as accurate,
recognition for evolutionary economists. There are two linked causes of this ambiguity:
the products on offer and the market institutions. However similar may be the products of rival
producers, they will hardly ever be identical in the judgement
of all potential customers, and neither will be the conventions and rules which
govern the transactions between different producers and their customers. Yet this does not justify modelling
this situation as a monopolistically competitive equilibrium. As Marshall noted, this kind of
distinctiveness does not support a higher price; it provides an identity which
supports transactions, and provides the friction which makes investment in new
goods and services possible. Moreover,
though there are incentives to differentiate in order to create and retain
customers, there are also strong incentives to follow successful ideas for both
products and market institutions for cognitive as well as financial reasons. As with all innovation, the balance between
novelty and continuity is crucial to success; but what balance will be
successful differs from circumstance to circumstance in ways which, as we can
see, are not easy to anticipate. It
seems a good working principle to assume that any successful new entry changes,
in some way, the definition of either the product or the institutions of a
market or both, since they are often interdependent.
An entrepreneur who cannot find a way of reducing the obstacles to trade may be unable to introduce the new product which she has created, in Schumpeter’s (1934, p. 85) words, as “a figment of the imagination”. Menger ([1871] 1976) noted that the choice of goods for commodity production was influenced by their marketability, to which he devoted a whole chapter, but instead of following that analysis with an account of market-making he concentrated on the very important special case of money as a means of reducing transaction costs. We shall comment on the importance of money from the consumer’s point of view in the final section of this paper.
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Marketability is not simply
an inherent characteristic of a particular class of goods. It is subject to human action. Marshall (1919, p. 181) recognised
that the division between production and marketing costs was somewhat
arbitrary: product design and the manufacturing process are not irrelevant to
both the supplier’s and the customer’s costs of investigating
and deciding on a particular transaction, and the organization of the
transaction is not irrelevant to the design criteria. The marketability of the product depends on
the alignment of product, customer, and the institutions of the market, and
that alignment can be influenced from each direction. This is even more obviously true of service
industries. If one looks, for example,
at the changes in the market institutions for financial services, it is clear
that the products as well as the institutions have changed, and the primary
enabling factor for these changes has been the development of novel transaction
technology. This is nothing new:
Marshall (1920, pp. 674 675) observed that the principal factors in British
economic progress had been developments in transport and communications, which,
by reducing the costs of arranging and executing exchanges, had increased the
scope for both specialisation and integration within
the economy.
That there has been room
for substantial innovation by suppliers in the organization of transactions is
demonstrated by such developments as self-service retailing, supermarkets, and
telephone selling of insurance; there is currently much speculation about the
potential of the internet for reducing the costs of individual transactions. Such innovations usually involve the
substitution of capital costs for current costs, often taking the form of
investment in knowledge which can then be cheaply reused. Each of these developments has entailed a
substantial change in rules and conventions, which required a substantial
investment by the initiating sellers, and the evolution of new market
institutions was marked by the adoption and modification by each participating
firm of arrangements that had been successfully introduced by rivals, as was
suggested earlier.
In the introduction to this
paper I noted the cognitive limitations of human beings and the importance both
of internal representations and external institutions in allowing us to economise this scarce resource. This complex structure of patterns and
procedures, partly developed for ourselves and partly adapted from others,
provides our cognitive capital. In a
highly interdependent society, market institutions, by providing us with
readily-usable knowledge about how to make particular classes of transactions,
are substantial contributors to that capital; they constitute what we might
call, borrowing from Marshall, our personal “external organization”. What is particularly valuable to consumers is
the producers’ major share in developing these institutions, stimulated by the
producers’ incentives to make it easy for us to buy what they have to offer. Frequent transactions in particular markets
lead to well-tried rules for action, and by helping us to discover who will
serve us well (Hayek, 1948, p. 97) competition helps to simplify our decision
making. Transaction costs are likely to
be higher in
less frequented markets, where there is consequently
more scope for suppliers to benefit by offering to bear some of them, for
example by free demonstrations, home trials, and money-back guarantees. The producers’ initiative obviously carries
risks of manipulation, which is occasionally spectacular; but we should recognise that the establishment of market institutions
creates the possibility of developing skills in choosing not for all products
but for more than would be possible if we had to spend much more time in
arranging transactions.
At this point we should
return to Menger’s explanation of money as a device
for reducing the cost of transacting by eliminating the need for barter. This clearly releases time and cognitive
resources; but it also leads to the formation of an elaborate system of money
prices, and this is an institution which not only simplifies the process of
exchange but also provides a numerical scale against which we can assess the
value of any particular product, as Marshall duly noted. It thus helps us to develop a more coherent
pattern of consumption without any need to make direct comparisons between
goods which serve very different needs. The role of prices as conventions is much
underrated in microeconomics. It is
underrated in macroeconomics too; since changes in the price level occur
through a succession of changes in individual prices, such changes undermine
the usefulness of this convention, and people therefore have to devote their
cognitive powers to the interpretation of particular prices, instead of interpreting
them according to familiar routines, and so are unable to give much attention
to improving their skills in consumption. Since price stability is an aid to skilful
choosing, inflation reduces the rationality of choices.
In the present context, two
functions of market organization are important. The first, and direct, function is to give us
confidence in our transaction capabilities, allowing us to plan our consumption
activities on the assumption that the transactions which may be necessary in
order to carry them out will pose no particular difficulty. The importance of this confidence at once
becomes apparent if, exceptionally, our plan requires us to transact in a
market of which we have no experience and which we have no good reason to
believe is like any market with which we are familiar; by contrast, a familiar and
efficient set of market institutions gives us ready access to those who can
supply us with what we may need. The
second function is indirect; by allowing us to cope easily with transactions it
frees our cognitive powers for other uses. Because we don’t need to think carefully about
how to transact, we can think much more carefully about what to transact, and
what uses we can make of whatever it is that we choose to buy.
Individuals and households
may be regarded as producers of consumption activities. However, instead of seeking to analyse these activities with the aid of a household
production function, with the analytical baggage (or ‘institutions’) implied by
that term, it will be more helpful to follow Penrose (1959) and Richardson
(1972) by linking activities to capabilities, or skills and know how (for a
more extensive treatment, see Loasby, 1998). Consumption activities require consumption
capabilities. Capabilities, in Austrian
terminology, are goods of higher order, which make certain first
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order goods attainable; they are also capital goods, which
require investment, and thus the allocation of scarce resources. Stable institutions, among which market
institutions are important, reduce other demands on these resources, and thus
make possible the development of additional consumption capabilities.
People do not consume
goods, or characteristics; they attempt to satisfy needs or solve problems, and
in the process they may create new goods for themselves. Drucker (1964, p.
87) long ago observed that “the customer rarely buys what the business thinks
it sells” because customers and suppliers are thinking in different ways about
different problems. We may add that
different customers who are apparently engaged in identical transactions are
often buying different goods, in Menger’s sense. This is a major reason why the definition of
goods, and of the markets in which they are traded, is ambiguous. To impose a list of goods at the outset of
analysis is to exclude an important feature of economic evolution. Making more effective consumption choices and
using products and services more effectively both require more than the
acquisition of information to which a correct value can be assigned in advance;
they entail an increase in knowledge, which cannot be known before it has been
discovered, and in increase in the skills of certain kinds of decision making. Consumption capital is built up by forming
connections and creating patterns, some of which allow particular groups of
commodities to be treated for some purposes as homogeneous, while others become
closely complementary. Like physical
capital, consumption capital (and indeed all forms of human capital) is not
well suited to aggregation; what matters is its
structure and its orientation. The development
of such capital is particularly likely to exhibit the features which Marshall
(1920, p.318) specified in his “law of increasing return: an increase of labour and capital leads generally to improved
organization, which increases the efficiency of the work of labour
and capital”. (Consumer initiatives are explored in Bianchi,
1998.)
However, this improved
organization imposes a framework which is not capable of rapid and substantial
change; close complementarity which enhances
efficiency is likely to reduce adaptability, except in favoured
directions. The value of consumption
capital may be destroyed by some kinds of change; indeed it may even be
rendered negative. As in Schumpeter’s
(1934, pp. 79 80) account of the producer’s plight when faced with the disruption
of major innovation, “[w]hat was formerly a help becomes a hindrance”. The frictional value of institutions helps to
avoid such destruction, though if the friction is very great it may, by
preventing timely adjustment, allow pressures to accumulate which eventually
precipitate a landslide of competence-destroying change. The continuing development of relevant
capabilities requires variation within a stable ambience. Without variation there is no experience to
act as a basis for learning; without a stable framework there is no assurance
that any valid connections can be made between actions and outcomes that will
have any future relevance. The
appropriateness of institutions, including the institutions of many markets, to
the maintenance of this balance is a major determinant of evolutionary
pathways.
In an evolving economy we
should not assume an unchanging set of preferences. Cognitive limitations imply that individual
preference order-
ings are never complete and are quite likely to be unformed
for goods or services that have never been considered for purchase. When products which are considered for the
first time, either because they are new or because we now think that we can
afford them, it is often the case that the process of choice defines
preference, rather than preference defining choice (Woo, 1992). But it may also be true that a change in
income may lead to a reconsideration of substantial parts of our lifestyle, and
even to new ways of thinking about preferences (Maslow,
1970, p. 37). These new ways of thinking
may well be partially adapted from other people, as, we began by suggesting,
are many of the rules and conventions that we follow; they may very well be influenced
by the institutions of the markets in which we are contemplating new kinds of
transactions.
The evolution of economic
systems depends on the tendency to variation, between individuals, between
organizations, and between institutional arrangements. The institutions of each market provide a
framework within which variations among suppliers can be introduced and tested
by the responses of consumers, which may include direct comment as well as the
potential information contained in their buying decisions; and the results of
this testing, supplemented by other direct contacts between buyers and sellers
notably in industrial markets, which have been consciously neglected in this
paper provide the basis for informed conjecture by suppliers (though never
rational choice) about new products or new services. The availability of markets, and therefore of
transactions which make only limited claims on cognition, also encourages
consumers to give attention to finding better ways of meeting their needs,
sometimes through more roundabout means, and even of recognising
needs that have hitherto been ignored, thus creating new goods. In turn these consumer innovations, and the
enhancement of consumption capabilities, provide opportunities for innovations
by suppliers. Thus a market is not an
arena for the co-ordination of predefined supply and demand functions, but an
institutional setting for the cognitive processes by which supply and demand
are continually reshaped (Dubuisson, 1998, p. 86). Suppliers and consumers differ in their
circumstances and in their interpretations; and these differences are reflected
both in the options that they create and in the selections which they make
among these options. Some innovations
may require the creation of new market institutions, thus modifying the
framework within which further innovation takes place. Economic evolution includes both evolution
within institutional constraints and the evolution of institutions.
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