Economic Darwinism During Recessions
| Peter Klein |
Some version of the survivor principle, or “economic Darwinism,” underlies much economics and strategy research. While the term “survivor principle” was coined by Stigler (1968), the idea is usually attributed to Alchian (1950) and Friedman (1953). Alchian argued that even though theories about rational decision makers making “optimal” choices are clearly unrealistic, the predictions of such theories need not be. The quest for profit, combined with competitive selection forces, ensures that the average firm will tend to behave like those described by theories of rational behavior (Alchian, 1950). Friedman (1953: 22), defending the profit-maximization hypothesis, puts it this way:
[U]nless the behavior of businessmen in some way or other approximated behavior consistent with the maximization of returns, it seems unlikely that they would remain in business for long. Let the apparent immediate determinant of business behavior be anything at all — habitual reaction, random choice, or whatnot. Whenever this determinant happens to lead to behavior consistent with rational and informed maximization of returns, the business will prosper and acquire resources with which to expand; whenever it does not, the business will tend to lose resources and can be kept in existence only by the addition of resources from outside. The process of “natural selection” thus helps to validate the [maximization] hypothesis or, rather, given natural selection, acceptance of the hypothesis can be based largely on the judgment that it summarizes appropriately the conditions for survival.
The problem with Friedman’s strong version of the survivor principle is that we know little about how such competitive selection processes actually work. Are these processes fast and precise enough to justify the assumption that surviving firms are “efficient,” or at least approximately so? What if environmental conditions change, such that the selection process has a moving target? What if imitation eats away at competitive advantages, so that efficient first-movers do not survive? These and many other problems question the use of the survivor principle in applied research.
Lasse Lien and I have several papers in progress looking at applications of the survivor principle. To whet your appetite for those (not yet circulating) papers, check out these items on the Darwinian selection process during the recent Japanese recession:
Kiyohiko G. Nishimura, Takanobu Nakajimab, and Kozo Kiyotac, “Does the natural selection mechanism still work in severe recessions? Examination of the Japanese economy in the 1990s” (JEBO, September 2005)
This paper investigates whether the natural selection mechanism (NSM) of economic Darwinism works in severe recessions. Based on micro data, we constructed a comprehensive firm-level panel dataset for Japan from 1994 to 1998 to analyze a firm’s entry, survival, and exit and its relationship with TFP. Empirical results show that efficient firms in terms of TFP exited while inefficient ones survived in the banking-crisis period of 1996–1997. Further, this phenomenon is observed mainly for new entrants and contributes substantially to a fall in macro TFP after 1996. These facts strongly suggest a malfunctioning of NSM in severe recessions.
Tae Okada and Charles Yuji Horioka, “Comment on Nishimura, Nakajima, and Kiyota” (NBER Working Paper 13298, August 2007)
Nishimura et al. (2005) analyze the entry/exit behavior of Japanese firms during the 1990s and find that relatively efficient firms exited while relatively inefficient firms survived during the banking-crisis period of 1996-97. They conclude that the natural selection mechanism (NSM) apparently malfunctions during severe recessions, but we offer a more plausible interpretation: NSM continued to function effectively even during this period, but aberrant banking practices caused a shift in the type of natural selection from directional to disruptive selection, with the most efficient as well as the least efficient firms being favored and firms of intermediate efficiency being selected against.