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CRIC Project - Evolutionary Theory Underpinnings Of Innovation Systems and Policy
(Project completed)

The Problems Addressed
Theoretical Approaches
Significance of Results and Outcomes
Key Publications

The Problems Addressed

This part of the CRIC programme has investigated the role of innovation in the competitive process, the dynamics of growth in capitalist economies, and the nature of innovation policy. The purpose is to develop a framework of analysis that connects the wide range of historical, sociological and managerial literatures with an analysis of growth, competition and innovation policy. More precisely, it has begun to develop and integrate an evolutionary approach based on micro variety and the bounded rationality of decision processes with an instituted economic approach to competition, markets and distributed innovation processes.

This ambition cannot be achieved within frameworks of analysis that are macroeconomic, that treat competition as a structural phenomenon and that rely on equilibrium methods of analysis. Rather we claim that evolutionary frameworks with their emphasis on variety and complex dynamics are more suited to this task. These frameworks are naturally growth orientated, they emphasise the primary importance of micro diversity of behaviours, and they place central importance on a wide variety of devices for co-ordinating and shaping interaction between agents. Thus the focus is on change and transformation not existence and stasis, in short, becoming not being. Frameworks with these attributes are essential if we are to understand the role of enterprise in modern knowledge-based economies. (See The Innovation Performance of Small Firms, Defining the Role of Knowledge-Intensive Business Services in Economy and The Role of IPR in Services Innovation.

Theoretical Approaches

The first body of work under this heading has been focused on the understanding of competition and growth as adaptive, evolutionary processes. Work on evolutionary dynamics and Schumpeter's idea of competition as creative destruction was completed in the first six months of CRIC's programme. A further paper identified the content of key evolutionary ideas, adaptation, selection, variation, making the point that they have no intrinsic relation to biology. Evolutionary theory is a style of analysis in its own right that is based on population thinking, not essentialism, and the relevant evolutionary outcomes are emergent phenomena arising from processes of interaction. This work identified the important limitations to rational decision making, the significance of routinised behaviour and the ways in which competition depends upon diversity of innovation performance.

This work has been further developed via three themes

in relation to economic growth and competition;
in relation to the competitive processes; and,
in relation to innovation systems and innovation policy.

Theme 1. Economic Growth, Competition and Innovation

The relationship between economic growth and the competition process provides a series of important challenges for the CRIC programme. Until recently orthodox growth theory had two key characteristics. A substantial element in measured economic growth appeared to be due to technical progress, yet no clear understanding of that phenomenon was reflected in the prevailing models of growth. Consequently, as is now well understood, growth accounting systematically underestimates the contribution of innovation to economic growth. Secondly, the theory of growth was not a theory of the growth rate but an explanation of the properties of economies growing at an unexplained rate.

The emergence of the so-called theory of endogenous growth aims to address both deficiencies. Work in CRIC has sought to develop an alternative approach to endogenous growth, one compatible with the known micro-dynamics of innovation and competition. The first results of this programme are spelt out in a series of papers. The principal features of this framework in its present state of development are as follows:

Growth is not an equilibrium process, rather it is kept far from equilibrium by the endogenous generation of novelty. In this we follow the Schumpeterian insight that the modus operandi of change in capitalism must be explained from within.
Growth arises out of the market co-ordination of the diversity of microeconomic behaviours in the economy. When the nature of markets is changed so is the connection between innovation and growth. The instituted nature of markets is a key focus of the CRIC programme. Other institutions are crucial too, particularly those related to the broadly defined notion of innovation systems. Thus there is an important but so far unrecognised connection between the ideas of Schumpeter and K. Polanyi.
The principal motivating factor in the growth process is enterprise in relation to investment and innovation. New models of business, their development and selection are the sources of economic growth. Needless to add, the treatment of the entrepreneurial function requires a non-equilibrium framework in which no explanatory role is given to the idea of the uniform (representative) agent. It is innovation that keeps the economic system far from equilibrium, and it is this fact that underpins the ongoing evolution of modern capitalism.
The corollary of innovation based, market co-ordinated growth is pervasive structural change within and between industries, regions and whole economies. The consequences of this can be measured macro-economically but they cannot be understood macro-economically. Consequently, a critical analytical problem is the determination of the correct rules of aggregation from micro through meso to macro levels of analysis. The solutions to these problems are not trivial. Our work indicates that the rules for aggregation depend upon the specific process of market co-ordination.
Increasing returns play a major role in this framework through the central place of knowledge accumulation in the innovation-competition-growth process. Because of the role of knowledge accumulation we use the label 'restless, experimental economies' to capture the essential dynamics of modern capitalism.

Theme 2. The Competitive Process

A second strand of this evolutionary work has been focused on the competitive process and alternative dynamic perspectives on competition. This work is in sharp contradistinction to the view of competition as a state of equilibrium induced by a particular market structure. The focus is upon how the micro-diversity of firm's behaviours results in changing market positions, and on how competitive advantage is defined and leads to particular patterns of change.

In this context we have explored a number of technical problems under the general heading of competitive dynamics:

How the interaction of distributed learning processes between suppliers and users results in particular patterns of competition. The main idea is that of 'compound learning', in which what one firm can learn depends on the learning process in its rivals and its customers. (See Innovation in Service Systems: Airports) This process of interaction of learning outcomes is modelled using neural nets and is tested in a set of simulation trials. The conclusion is that a firm can benefit in terms of profitability and competitive advantage from learning more quickly than its rivals but not if it learns more quickly than its customers.
The extension of a model of the competitive selection process to allow for the entry and exit of firms and a test of this development on data from the Italian steel industry. The model is based on the so-called Fisher Principle in which the change of average behaviour in one dimension in a population is dependent on variances and co-variances in that and other dimensions. Despite the data limitations the central idea gains some support.
The development of a complex, non-linear model of competitive behaviours in oligopoly, to test the conjecture that the more efficient firm has the higher probability of survival. This is rejected in a higher proportion of cases. This work requires the mathematical modelling of complex processes that are chaotic for different combinations of parameter values. The argument shows the importance of adjustment dynamics in a framework where there are no conventional equilibria.
An important role of efficient market institutions is to produce and disseminate accurate information on the performance characteristics of competing products. When this does not occur a form of Gresham's Law can operate and 'bad' products destroy the market for all the 'good' products that they compete with and produce market instability. (See Innovation and Organisation Across the Food Chain: The Tomato for a recent example in relation to genetically modified tomatoes).

Theme 3. Policy and System Failure

The final strand of the evolutionary related work has been focused on the analysis of technology and innovation policy. The groundwork for this was laid down in the OECD paper in which policy based on market failure is contrasted with policy based on systems failure - imperfections in the composition and connectivity of innovation systems. The OECD appears to have accepted the importance of these evolutionary arguments and a number of presentations of these ideas have been made to senior officials in the UK, Netherlands and Australia.

Significance of Results and Outcomes

Within theme 1, this framework has led us to advances on a number of fronts:

The development of evolutionary foundations for growth theory based upon the interaction between selection processes and development processes. This has been further developed to enquire into the appropriateness of the complex, adaptive metaphor in the study of growth. This was the subject of the international workshop organised by CRIC and the University of Queensland in July 1999.
The development of new measures of evolutionary change based on the structural analysis of the economy. An example drawn from the detailed NBER data set of 458 US manufacturing sectors is shown in figure 1. It shows the movement of the Herfindhal index of employment shares for this data set, this movement being a measure of the amount of structural change in this economy. Further econometric work is being carried out on the estimation of technical progress functions and increasing returns. Figure 2 shows the distribution of estimated productivity growth-output growth elasticities for this same data set, and confirms the pervasiveness of dynamic increasing returns.

Figures: Adjusted Herfindhal Index and Distribution of Returns Coefficient

A deeper understanding of growth as an emergent property. An emergent phenomenon is one that arises from the co-ordination of the activities of agents and creates a pattern of order not contained in the intrinsic properties of those agents. Thus the growth rates of firms are not intrinsic to them unlike their investment and innovation behaviours. Rather, growth comes from market co-ordination and the resulting growth rates are mutually determined. Hence the central importance of understanding markets and innovation institutions in the competitive process.

All of the technical concerns of the research under theme 2 fit into the broader picture of how markets are instituted and how this influences the competitive process. However, the link between innovation and competition runs both ways, and treatment of the issue of how competition influences innovation must be balanced by a careful treatment of the wider institutions of the innovation process and how they are influenced by competition. This takes us to the questions of innovation systems and innovation policy in theme 3.

The work within theme 3 provides part of the underpinning for CRIC work on DIPS and we believe makes a number of original contributions:

It shifts the questions to the dynamics of the development of innovation systems not simply to their existence.It provides a different set of system failure based rationales for the policy maker, who is now given the attributes of an adaptive, boundedly rational and rule making decision maker, not a decision maker imbued with Olympian calculative powers. Indeed it suggests that several so-called market failures are essential for the competitive process to operate efficiently. Thus we conclude that the notion of market failure is a very incomplete and distorting rationale for innovation policy.

Finally, and most importantly, it provides a new research hypothesis in the link between innovation and competition. Specifically it has led us to the conclusion that "firms assemble and, in collaboration with others, institute innovation systems in the search for competitive advantage". While S and T capabilities exist at national level and are contained within communities of practitioners and networks, their articulation in pursuit of innovation depends on specific actions by firms. This leads us to the importance of the external organisation of the firm and the way in which firms combine internal and external capabilities. This hypothesis is being investigated further in a number of CRIC studies. The management and related problems associated with the external organisation of the firm are also addressed in Outsourcing of R&D, Analysis of Innovation Performance of Small Firms, Analysis of Innovation Flows using Input-Output Tables and Theorising Multi-Firm Innovation.

Key Publications

Metcalfe, J.S., 1998, Evolutionary Economics and Creative Destruction, Routledge.

Metcalfe, J.S., ( 2001), 'Evolutionary Concepts in Relation to Evolutionary Economics' in Dopfer, K., (ed), The Evolutionary Foundations of Economics, Cambridge University Press

Metcalfe, J.S., 2000, ' Instituted Economic Processes, Increasing Returns and Economic Growth', in Louca, F., and Perlman, M., (eds), Is Economics an Evolutionary Science?, Edward Elgar, London.

Metcalfe, J.S., (2001), ' Restless Capitalism and the Sources of Economic Growth', in Bartzoukas, F., Frontiers of Growth Economics, Oxford University Press.

Metcalfe, J.S., and Calderini, M., 2000, ' Chance, Necessity and Competitive Dynamics in the Italian Steel Industry', in Cantner, U., Hanusch, H., and Klepper, S., (eds), Economic Evolution, Learning and Complexity, Springer Physica, Berlin.

Metcalfe, J.S., and Currie, M., (2001), 'Firm Routines, Customer Switching and Market Selection under Duopoly', Journal of Evolutionary Economics.

Burton, M., Metcalfe, J.S., and Smith, V., (2001), 'Innovation and the Demand for Food Labelling in an Evolutionary Model of Industry Dynamics', Structural change and Economic Dynamics.

Metcalfe, J.S., and Georghiou, L., 1998, 'Equilibrium and Evolutionary Foundations of Technology Policy', Science Technology and Industry Review, No. 22, pp., 75-100.

Foster, J., and Metcalfe J.S., (2000), Frontiers of Evolutionary Economics, Edward Elgar, London.

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