Capitalism as a complex adaptive system and its growth

Witt, Ulrich Article Capitalism as a complex adaptive system and its growth Journal of Open Innovation: Technology, Market, and Complexity Provided in Cooperation with: Society of Open Innovation: Technology, Market, and Complexity (SOItmC) Suggested Citation: Witt, Ulrich (2017) : Capitalism as a complex adaptive system and its growth, Journal of Open Innovation: Technology, Market, and Complexity, ISSN 2199-8531, Springer, Heidelberg, Vol. 3, Iss. 12, pp. 1-15, https://doi.org/10.1186/s40852-017-0065-0 This Version is available at: https://hdl.handle.net/10419/240871 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ RESEARCH Open Access Capitalism as a complex adaptive system and its growth Ulrich Witt 1,2 Correspondence: [email protected] 1 Max Planck Institute of Economics, Jena, Germany 2 Griffith Business School, Griffith University, Gold Coast, QLD, Australia Abstract Complex adaptive systems consist of a multitude of agents from whose individual adaptation efforts the adaptive behavior of the system as a whole emerges. In this paper it will be argued that capitalism is a complex adaptive system. Except for its particular mode of production many of its features are typical for such a system. A case in point is the way in which economic growth emerges as a collective outcome of individual adaptation strategies. The complex adaptive systems perspective offers a particular explanation for why the successive extension of the bounds of existing production possibilities is unsteady and rather wasteful in capitalism. Moreover, the strategies by which the agents try to adapt to crises –many of which imply some form of innovations –do not necessarily contribute to a re-emergence of new growth impulses. It is shown that the empirical record of economic growth in the most developed economies indeed reveals a trend of declining growth rates. This seems to suggest that successfully creating new economic growth through innovative strategies is the more difficult, the more prosperous an economy becomes. The paper discusses what can be conjectured to be the cause of this development and what to do about it. Introduction Complex adaptive systems consist of a multitude of agents from whose individual adaptation efforts the adaptive behavior of the system as a whole emerges. At both levels, the level of the individual agents and the level of the system as a whole, viability is contingent on a proper adaptation to the environment. The adaptation of the system as a whole is the collective outcome of the adaptation efforts of all its individual agents. This multi-level adaptation process is neither certain to be a smooth one nor to be necessarily successful in the sense of improvement, progress, or growth. To the contrary, there are cases in which complex adaptive systems mal-adapt as a whole (Wilson 2016). In this paper it will be argued that capitalism is a complex adaptive system. Except for its particular mode of production many of its features are typical for complex adaptive systems. A case in point is the way in which economic growth emerges as a collective outcome of individual adaptation strategies. As will be discussed, a complex adaptive systems perspective suggests that the process by which the bounds of the existing production opportunities are successively expanded in capitalism is unsteady and rather wasteful. Taking such a perspective on economic growth therefore requires © The Author(s). 2017 Open Access This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license, and indicate if changes were made. Witt Journal of Open Innovation: Technology, Market, and Complexity (2017) 3:12 DOI 10.1186/s40852-017-0065-0 turning away from the equilibrium theories of balanced growth (starting with Solow 1956) as well as the more recent endogenous growth theories à la Aghion and Howitt (1998). Once such a turn has been made, an important problem that appears on the screen is whether and how new economic growth can re-emerge after each crisis. Can a high-rate growth be resumed or is capitalist growth leveling off? The unsteadiness of capitalist development is a longstanding theme of economic theorizing from Marx (1867) to Schumpeter (1934[1912]) to Keynes (1937). In contrast, the question of whether economic growth will prevail has only more recently gained increasing attention. It was raised as a consequence of observing secularly declining growth rates in the most developed economies since the 1970s (Durlauf et al. 2005, see also Maddison 2001, Chap. 3). From a complex adaptive systems point of view, an industry’s contribution to national economic growth is the collective outcome of the efforts at the individual level to adapt to a critically changing environment. The interesting point therefore is how the results of individual adaptation efforts may have changed so that declining growth rates result at the national level. As will be discussed, an analysis of the typical individual adaptation strategies to capitalist crises can offer a clue for understanding what obstacles to growth have occurred and what can be done to extend possible limits of capitalist growth. The argumentation in the paper proceeds as follows. Section 2 sets the frame by explaining why capitalism can be interpreted as a complex adaptive system. The vulnerability of the capitalist growth process to crises is then argued to be explicable as a typical feature of such systems. The key point is the role which mass production and its accumulation needs play for capitalism and its unsteadiness. Before starting a theoretical reflection on whether economic growth re-emerges as a result of the adaptive efforts undertaken during the crises, Section 3 briefly highlights the empirical growth record. The analysis suggests that some systematic change is going on as capitalist countries become more prosperous. Section 4 traces the cause(s) of that change. The specific adaptation strategies of industries facing a crisis are explored with respect to what they contribute to a re-emergence of economics growth. All discussed strategies involve some type of innovation, but these innovations differ substantially regarding their effect on economic growth. As will turn out, the differences between them also hint at what is changing when economies get more prosperous and what can be done when, as a consequence, their growth rates decline. Section 5 offers the conclusions. Complex adaptive systems, capitalism, and the unsteadiness of the growth process Before addressing the growth problems of capitalist economies from the perspective of complex adaptive systems it is useful to briefly outline the main features of such systems. A system is called complex if two conditions are met (Gell-Mann 1995). First, it is composed of a large number of parts or agents from whose individual behavior the behavior of the system as a whole emerges. Second, the interactions between the individual parts or agents are such that the emerging behavior of the system as a whole is difficult to predict on the basis of only observing the behavior at the individual level. The distinctive feature of complex adaptive systems –a subclass of complex systems that consists of living systems –is that the individual agents create, and operate in, an evolving environment to which they must continually adapt under competitive Witt Journal of Open Innovation: Technology, Market, and Complexity (2017) 3:12 Page 2 of 15 conditions (Wilson 2016). This means that failure to adapt carries the risk of being outcompeted. The adaptation of the system as a whole is the collective outcome of the adaptive efforts of all of its agents. The latter efforts are not necessarily conducive to a successful adaptation of the system as a whole. Some forms of individual adaptive behavior do contribute to a highly successful collective adaption. Other forms do not or do even harm to the collective adaptation (which may then result in causing damage to the adaptive success of all agents in the system). The individual adaptation efforts can thus result in an unintended and perhaps undesired collective adaption. This means, conversely, that the individually pursued intentions of the agents often do not materialize as envisioned. The economy of a region or a country is obviously a complex adaptive system. It is made up of a multitude of agents. Their adaptive behavior is characterized by a competitive pursuit of their interests, be it in a cooperative or non-cooperative manner. 1 But not only individual agents have to adapt under competitive conditions. All economies are embedded in a changing global economy in which they compete with other economies and face adaptation pressure as a whole in order to catch up or not to fall behind. Turning to capitalism as a complex adaptive system, its distinctive feature is a particular mode of production: mass production. 2 By decomposing and standardizing the various steps of the transformation of materials and information the task of carrying them out can, in part or in full, be transferred to automata. For setting up the corresponding equipment, investment into capital stock is required that gave capitalism its name. In this way, human production knowhow can be applied and reused over and again and in parallel without much further involvement of human labor. The transformation steps of production can be reiterated more often, faster, and more reliably. (The proviso is, of course, that the necessary materials and non-human energy resources can be made available for running the automata at a reasonable cost.) Production of standardized goods and services in very large numbers becomes feasible so that scale economies can be exploited. This means that labor requirements and production costs per unit of output decrease by orders of magnitude as compared to handicraft production methods or information processing by human labor. Labor productivity increases. Capitalist mass production has first occurred in the beginning of the nineteenth century (Mokyr 1990, Chap. 5 and 6). Historically seen, there is no doubt that it has contributed since to the improved “standard of living of the masses”(as Schumpeter 1942, Chap. 7 put it). Capitalism being a complex adaptive system, a positive long run trend like this is the collective outcome of the agents’simultaneous adaption efforts over an extended period of time. Such a collective outcome can neither be taken for granted nor be extrapolated into the future. In fact, the expansion of capitalist mass production has never been a frictionless adaption process. The unsteady and rather wasteful episodes of booms and busts, of rapid growth and temporary decline, are but averaged out in the long run. 3 Moreover, in the present context particularly notable is the recent leveling off of the growth trend in the most prosperous economies. A closer look at how capitalism works as a complex adaptive system reveals why the individual adaptation efforts result in an unsteady collective outcome in terms of growth rates. For every entrepreneur competing by-the-rules in free markets it is an Witt Journal of Open Innovation: Technology, Market, and Complexity (2017) 3:12 Page 3 of 15 imperative to reduce costs, be it for obtaining an advantage over competitors or for keeping pace with them. Realizing scale economies through mass production of goods or services is a prime strategy to do so, particularly if competitors still rely on customized handicraft production or information processing techniques predominantly based on human labor. However, these attempts require investments in creating or expanding a capital stock. The more entrepreneurs in an industry try to realize the cost advantage, the more the industry’s overall production capacity grows. The individual parallel expansion efforts are not coordinated ex ante by the price mechanism. Therefore, their collective outcome –the parallel multiplication of output –sharply increases competitive pressure at the industry level in an unanticipated way, if the demand for the industry’s output is not, or not sufficiently rapidly, growing. This is especially the case when ever more producers of customized goods or services have already been driven out of the market and mass producers remain as sole competitors. Prices tend to fall and so do the returns –often to an extent that losses have to be incurred. Sooner or later producers are then forced into wasteful adjustment processes of the production capacity. Capital is prematurely depreciated; labor is laid off; entire enterprises go out of business, net investment plunges. In free markets, the competitive behavior that appears most advantageous to the individual producer can thus result in an undesired outcome for the industry as a whole or even the entire economy. As mentioned in the introduction, the unsteadiness of capitalism –explained here as a typical feature of a complex adaptive systems –has since long been recognized in economic theorizing. On the basis of his labor theory of value, Marx (1867) argued that, by necessity, the capitalist accumulation process leads to a falling profit rate. He saw a culminating sequence of crises ruining capitalists and causing an increasing pauperization of the working class. This, he believed, would ultimately provoke the transition to a communist economy. But how would such a non-capitalist economy then be run? The answer that was given later (see Lerner 1944) included the replacement of the multitude of independently planning capitalists by a central planning authority. From a complex systems perspective, such an institutional change on the production side (associated with a complete change of the ownership structure) can be seen as an attempt to reduce the complexity of the system. However, as the experience with actual socialist planning showed, the attempt failed. The lack of ex ante coordination in the capitalist accumulation process was just replaced by an equally wasteful lack of coordination. The centrally planned accumulation and mass production rarely met with the actual levels of labor supply and demand for goods and services to which the still independently deciding agents in the economy adapted. Concerns about a secularly decreasing rate of return on investment were issued by Keynes as well. To explain the emergence of crises which he considered symptomatic of capitalism Keynes focused on effective demand failures. They occur when aggregate demand falls short of what is necessary to keep up full employment of all resources, in particular labor. Assuming that private consumption is a fixed share of income (and aggregate savings therefore not a function of the interest rate), Keynes attributed the cause of the demand failure to fluctuations of the rate of investment. His hypothesis was that these fluctuations do not automatically lead back to a rate restoring full employment (see Keynes 1937 for a summary). To resolve the crises, his followers suggested that the central bank should increase money supply to lower the interest rate Witt Journal of Open Innovation: Technology, Market, and Complexity (2017) 3:12 Page 4 of 15 (monetary easing) and thus stimulate additional investment. Where this would not work because of unfavorable liquidity preference in the money market, the effective demand failure should be compensated by government expenditures raised beyond tax revenues (deficit spending). From a complex systems point of view such a policy recommendation largely underrates the problem of predicting the behavior of complex systems as a whole. Both government and central bank are each but one agent among many (albeit more influential than the rest). Government and central bank actions are usually based on more or less refined linear extrapolations of the behavior of all other agents taken together. But this is an assumption that rarely suits complex systems. Not surprisingly, the experience with effective demand management policies, both monetary and fiscal ones, is therefore a rather mixed one. The unsteadiness of capitalist economies is also center stage in Schumpeter’s (1934 [1912]) path-breaking work on innovation-driven economic development. At the core of his theory is entrepreneurship capable of carrying out new combinations of resources, i.e. innovations. Only the most gifted entrepreneurs are assumed to have such a pioneering capacity. In a rather complex argumentation he submitted that these entrepreneurs appear “in swarms”. A new swarm is supposed to enter the scene when the innovative boost brought to the economy by the previous swarm has ebbed away. Once the initial obstacles have been overcome, however, less entrepreneurial talent is required. Imitators get opportunities to participate in exploiting the innovation and massively invest and start producing in parallel. The result is a boom. It gets stuck once the unanticipated excess capacities bring down the profitability and a massive parallel repayment of credits induces an economic contraction. 4 Nonetheless, after each cycle, Schumpeter claims, the economy has been growing thanks to the innovation. Schumpeter's explanation is very much in line with the complex systems view. Yet, in the light of such a view, his growth optimism seems less well founded. It may be an ex post generalization of the growth that Schumpeter observed during the industrialization phase of his time. And it certainly rests on the hypothesis that (innovative) supply creates its own demand –which means that Schumpeter trusted Say’s law. Growth slowdown –the path capitalism is taking? The wasteful unsteadiness of capital accumulation required for mass production is one cause for the observable ups and downs in aggregate output and employment described as alternating periods of booms and crises in various theories of the business cycle. Its unsteadiness notwithstanding, the accumulation process has resulted in an unprecedented growth of income and wealth over almost two centuries now. This was certainly not the balanced growth obeying “golden rules”as equilibrium growth models have it, but rather a process that successively expanded the bounds of the existing production opportunities in an unsteady and rather wasteful fashion. In the complex systems perspective, a collective outcome such as a long period of economic growth cannot simply be extrapolated to extend into the future. In complex adaptive systems, small changes in the agents’adaptation behavior and its success at the individual level can trigger a substantial change in the behavior of the system as a whole. The question is what the consequences may be for the growth performance of capitalism. Most economic policy programs heavily rely on economic growth today and are supported by widespread growth optimism in economics. As a matter of fact, however, the Witt Journal of Open Innovation: Technology, Market, and Complexity (2017) 3:12 Page 5 of 15 growth trend is leveling off in most highly developed economies. In the empirical macroeconomic literature dealing with the trend, attention has been detracted from this fact by a partly esoteric debate on whether the fluctuations in the aggregate economic variables are caused endogenously or by exogenous shocks and, in the latter case, of what kind of shocks. 5 Nonetheless, it is not subject to controversy in this literature that for the U.S. and other highly developed countries the empirical finding is a log-linear shape of the trend in real GDP per capita. Measured in growth rates, this implies a declining trend for the rate of economic growth. Unlike in the newly industrializing, less developed countries and in countries making the transition from socialism to capitalism in the 1990s, this trend can indeed be observed in most developed economies. For demonstrating the rather obvious development a simple statistical exercise of fitting a linear trend for the times series of the GDP growth rates may do here. In order to obtain a timespan that is long enough for avoiding biases by shorter term fluctuations of GDP consider the economies of the 27 countries which were members of the OECD back in 1961. These countries belonged to the relatively most developed in the world at that time. They experienced no significant real structural breaks such as wars or massive natural disasters over the period of half a century from 1961 to 2011 (perhaps with the exception of Germany). When fitting a simple linear trend for the time series of the growth rates of real GDP per capita for each of the countries over this period, the finding is a statistically significant –and partly dramatic –downward slope in the trend of the growth rates of GDP per capita in 23 out of 27 OECD countries. 6 Taking all 27 OECD countries together, the averages of their yearly growth rates displayed in Fig. 1 show the unsteadiness of the growth process in the entire developed economies. Moreover, using all the average values for fitting a simple linear trend results in the plain, downward sloping trend also displayed in Fig. 1 –a clear indication that economic growth is leveling off. Evidently, surging economic growth still happened during the last fifty years. Yet it took place elsewhere: in Asia, in several of the former socialist European countries, and most recently in some places in Africa (see Durlauf et al. 2005). 7 Particularly impressive is the decrease of the growth rates for the 17 Western European countries in Table 1. They all belong to the most prosperous in the world, and they all have left their industrialization phase behind. For all of them, regressing their annual growth rates on the time variable results in a coefficient < 0 for the estimated linear trends which is significant at very low error levels, except Fig. 1 Average Growth Rates of GDP per Capita 1961–2011 for all OECD countries of 1961 in % (deflated) Witt Journal of Open Innovation: Technology, Market, and Complexity (2017) 3:12 Page 6 of 15 for Luxembourg and the U.K. 8 The intercept values are the lowest for Luxembourg, Sweden, and the U.K. The highest intercept values reflecting the initially highest growth rates are those for Ireland, Portugal, and Greece which have been catching-up countries for the first thirty years in the observation period. Portugal and Greece also show the steepest decline of the trend, perhaps not an unusual pattern for catching-up economies. 9 The explanation of the secular trend of falling economic growth rates is far from being uncontroversial (see, e.g., Durlauf et al. 2005, Gordon 2012, Summers 2014). Very likely, in each country some individual particularities contribute to the phenomenon. On the other hand, the fact that the phenomenon is so wide-spread suggests that there is some systematic change going on when countries become more prosperous. The generic pattern of change seems to be that countries which grow rich travel down a path that converges to a lower bound of their economic growth rates. That bound may, or may not, have a value greater than zero. Corresponding to their respective levels of prosperity, some countries seem to have moved further ahead already on the convergence path, others are more behind. 10 Adaptation by innovating, Say’s law, and the problem of market saturation What is the reason for the change that is obviously going on and that causes the observed leveling off of economic growth? A clue can be found by looking more closely into the adaptive efforts by which entrepreneurs try to cope with the increasing competitive pressure. As mentioned, this pressure builds up when, as collective outcome of the parallel expansion of mass production, output multiplies but demand does not keep pace with the growing supply. Since the latter condition implies that Say’s law is Table 1 EstimatedLinearTrendParametersforRealGDPperCapitaGrowthRatesin% 1961–2011 a Country Intercept Regression Coefficients R 2 DW ADF PP Value t p-value Value t p-value Austria 4.25 *** 8.76 0.0000 −0.0636 *** −3.91 0.0003 0.24 1.96 1% 1% Belgium 4.36 *** 8.73 0.0000 −0.0756 *** −4.51 0.0000 0.29 2.02 5% 1% Denmark 3.75 *** 5.98 0.0000 −0.0674 *** −3.21 0.0023 0.17 1.92 1% 1% Finland 4.21 *** 4.82 0.0000 −0.0586 * −2.00 0.0508 0.08 1.27 1% 1% France 4.50 *** 10.62 0.0000 −0.0870 *** −6.13 0.0000 0.43 1.55 5% 1% Germany 3.70 *** 6.64 0.0000 −0.0537 *** −2.88 0.0059 0.14 1.79 1% 1% Greece 6.42 *** 6.25 0.0000 −0.1437 *** −4.19 0.0001 0.26 1.23 n.s. 1% Iceland 4.57 *** 4.15 0.0001 −0.0787 ** −2.13 0.0380 0.08 1.16 1% 1% Ireland 6.90 *** 6.19 0.0000 −0.1032 *** −2.77 0.0080 0.14 1.30 5% 1% Italy 5.32 *** 9.60 0.0000 −0.1136 *** −6.13 0.0000 0.43 1.92 5% 1% Luxembourg 2.96 *** 2.99 0.0043 −0.0096 −0.29 0.7729 0.00 1.50 1% 1% Netherlands 3.63 *** 6.35 0.0000 −0.0522 *** −2.73 0.0088 0.13 1.52 1% 1% Norway 4.46 *** 9.55 0.0000 −0.0702 *** −4.49 0.0000 0.29 1.20 5% 1% Portugal 6.66 *** 7.01 0.0000 −0.1320 *** −4.15 0.0001 0.26 1.34 5% 1% Spain 5.86 *** 8.73 0.0000 −0.1150 *** −5.12 0.0000 0.35 0.76 5% 5% Sweden 3.04 *** 4.74 0.0000 −0.0332 −1.55 0.1283 0.05 1.38 1% 1% United Kingdom 2.76 *** 4.54 0.0000 −0.0262 −1.29 0.2034 0.03 1.44 1% 1% Error Probability: *** 0.01, ** 0.05, * 0.1 a own calculation based on Worldbank WDI dataset: http://databank.worldbank.org/ddp/home.do Witt Journal of Open Innovation: Technology, Market, and Complexity (2017) 3:12 Page 7 of 15 violated, a discussion of the micro foundations of that law is due here: What can be inferred from the analysis of the producers’adaptive efforts regarding the conditions under which Say’s does, or does not, hold? Do their adaptive efforts enable the producers not only to escape from an individual profitability crisis but also to expand sales (reflecting a correspondingly growing demand) and thus to collectively contribute to new economic growth? The main adaptive strategies producers can pursue all reach out beyond the ordinary daily business, i.e. they all require successfully carrying out innovations. By the logic of mass production, six types of innovative strategies can be distinguished. 11 In industries which are highly competitive due to excess mass production capacities, cutting costs and prices is a way of grabbing a larger share in the market and driving out competitors. To achieve this goal, a typical strategy that can often be observed to be chosen in such industries is (i) realizing additional scale economies by mergers and acquisition. Mergers and acquisition can help to concentrate production and marketing activities and thus to enlarge the scale of activities in order to reap the benefits of scale economies, i.e. to be able to move down a falling unit cost curve. Although not all mergers and acquisitions are motivated this way, in the typical mass production industries many are: in recent times, e.g., in parts of the chemical industry, in the steel industry, cement and construction materials industry, car manufacturing, consumer electronics, mobile phone service providers to mention just a few. Another typical strategy is (ii) reducing labor costs and costs of regulations by off-shoring production. Off-shoring production to countries with significantly lower wages and/or less restrictive and, hence, less costly regulations on, e.g., environmental or safety standards helps bringing down the costs per unit of output as well. Off-shoring production usually goes hand in hand with outsourcing to, and subcontracting with, foreign producers in low cost countries. Good examples are the footwear industry (Donaghu and Barff 1990, Frenkel 2001) and the apparel industry (see, e.g., Gereffi 1999). The major innovation implied by strategies (i) and (ii) is industrial (re-)organization. It typically occurs in the so-called “shake out”phase of the life cycle of a maturing mass producing industry (Klepper 2002). If the growth of the industry’s sales is not already stagnating in this phase, growth rates are at least significantly declining. Put differently, the more mature the industry is, the less is its demand curve shifting outwards. The still not sufficiently reduced growth of production capacities puts strong competitive pressure on the producers. The likely result are cost and price cuts and a redistribution of market shares between surviving producers and those being driven out of the market. Extra demand, i.e. an outward shift of the industry’s demand curve, is not induced in this way. (The cost and price reductions only activate additional demand along the given demand curve, depending on the price elasticity of demand.) For that reason it can be expected that, in reaction to an over-accumulation crises, an industry’s adaptation efforts using (i) and (ii) makes a collective contribution to economic growth which is the smaller, the more mature an industry is. 12 Something similar holds for a strategy consisting of (iii) improving standardization, automation, and/or resource efficiency. These activities can be subsumed under the label process innovations. However, a new standardization and new automation hardware can also lead to, or be associated with, the creation of new services particularly in the IT industry. 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