Uncertainty, Evolution, and Economic Theory — Armen Alchian on Foresight, Maximums, and Grasshoppers

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Uncertainty, Evolution, and Economic Theory — Armen Alchian on foresight and maximization in economics

Uncertainty and the guide to action

In his paper, Uncertainty, Evolution, and Economic Theory, Armen Alchian throws away the assumption of profit maximization that characterizes much of mainstream economics. It’s the problem of uncertainty, Alchian argues, that makes maximization an impractical presumption. 

Indeed, firms have incomplete information about their position, competitors, customers, and strategic options. Not once in my consulting career have I seen a client draw up a demand and supply curve to find their so-called ‘best’ response. Could they even?

Imperfect foresight and complexity, Alchian reminds, makes it difficult to find an optimum. While methods exist to grapple with uncertainty in economics and game theory, they usually invoke stronger assumptions and computational abilities on the decision maker’s part. “In the presence of uncertainty”, Alchian writes, “there is no meaningful criterion for selecting the decision that will ‘maximize profits’”. Profit maximization, in other words, “is not a guide to action”.

Positive profits and relative efficiency

If not maximum profits, what is it then that motivates the firm? To Alchian, the answer is obvious: positive profits and success. This is similar to Herbert Simon’s distinction between satisficers and optimizers in his theory of bounded rationality. 

Alchian is less concerned with the mental faculties that guide decision makers there. Some decision makers are rational, while others are complete ignoramuses. What matters is the survival condition: “relative efficiency”.

“The essential point is that individual motivation and foresight, while sufficient, are not necessary. Of course, it is not argued here that therefore it is absent. All that is needed by economists is their own awareness of the survival conditions and criteria of the economic system and a group of participants who submit various combinations and organizations for the system’s selection and adoption.”

Armen Alchian. (1950). Uncertainty, Evolution, and Economic Theory.

Survival, adaptation, and imitation

Competition and bad luck will eliminate the relatively unsuccessful. Firms have little choice but to combine trial-and-error with learning, feedback, imitation, entrepreneurship, imperfect foresight, and good fortune to adapt and survive. While we’ve said little of imitation so far, we cannot understate its attendance. After all, people tend to imitate and replicate profitable ideas. Alchian himself recites the old proverb: “nothing succeeds like success”.

Survival, adaptation, and imitation can unfold in many ways. Proliferating imitators, for example, might spur new innovations and differentiation in others. These developments may in turn lead to more diffusion and imitation as competitors vie for positive profits and success.

Think of the fashion maker who invents a new style or design process. Upon seeing this, their competitors are sure to try their hands at imitation or one-upmanship. And with their wins fleeting, the original maker must, at some point, return to the drawing board. In a sense, it’s as if the environment switches from a game of chicken to a prisoner’s dilemma (or arms race), and back again — and so continuing the economic circle of life.

“Imitation affords relief from the necessity of really making decisions and conscious innovations… Unfortunately, failure or success reflects the willingness to depart from rules when conditions have changed; what counts, then, is not only imitative behavior but the willingness to abandon it at the “right” time and circumstances.”

Armen Alchian. (1950). Uncertainty, Evolution, and Economic Theory.

Shotgun economics

The process of trial-and-error, learning, and adaptation may, over time, move surviving companies towards some “unknowable optimum”. But it also may not because of the uncertainty, complexity, and dynamism that is inherent to economic systems. Who knows where the local and global optimums hide, if they even exist, in a system that’s always moving.

As Alchian describes:

“Trial and error becomes survival or death. It cannot serve as a basis of the individual’s method of convergence to a “maximum” or optimum position. Success is discovered by the economic system through a blanketing shotgun process, not by the individual through a converging search. … All the preceding arguments leave the individual economic participant with imitative, venturesome, innovative, trial-and-error adaptive behavior”.

Armen Alchian. (1950). Uncertainty, Evolution, and Economic Theory.

Nearsighted grasshoppers

Alchian provides an analogy of the “nearsighted grasshopper”, whose path to the top of the mound is not a steady upward march but a bumpy series of descents and ascents. We can extend his analogy to a population of grasshoppers, hopping madly (and sometimes cluelessly) in some endless race — just hoping to stay a little higher for a little longer than every hopper below them. Indeed, Alchian’s analogy provides plenty of room for play.

Perhaps some grasshoppers are big and heavy. They leave less room for other hoppers and struggle to jump themselves. Small, resourceful hoppers, on the other hand, might find tiny perches to feed on and grow. Maybe the conditions change with altitude. Does it get clearer the higher up we go, or is the fog all the same? Where these analogies stumble reveals something about our innovation, economic, and social processes in turn. But I’ll leave that to you and for another post.

“Complex systems involve a very different kind of search, where the mountain range is not only rugged but also fog-bound, and perhaps even undulating with every step we take… In such a world, even if we hike up the fog-bound hill without error, we might miss the highest point on the landscape. Indeed, we might find ourselves victoriously standing on top of a molehill, falsely thinking that we have made it to the top of the mountain. To avoid making mountains out of molehills, we need new ways to search in complex worlds. In particular, introducing errors into our search process — that is, occasionally taking random steps downhill — may allow us to escape the trap of the molehill and head to the mountaintop.”

John Miller. (2015). A Crude Look at the Whole. 

Fresh air and local hills

As you can tell, Alchian draws inspiration from the foundations of biology. He even parallels the processes of heredity, mutation, and natural selection in life with imitation, innovation, and positive profits in business.

While his paper was written just five years after the end of the Second World War, I don’t believe its essence is sufficiently incorporated into undergraduate courses (although his contributions have influenced many economists since). Many programs to this day continue to teach maximization as the only guide to action.

As it is currently taught, mainstream economics continues to, in my opinion, suffer from the “one-thing-at-a-time” syndrome that Herbert Simon observed in the social sciences more than three decades ago. Economists, much like Alchian’s grasshoppers, find themselves planted on rugged, foggy terrain. For how long, I wonder, will they rest on their local hill?

“My concern is that the economics profession has exhibited some of the serial one-thing-at-a-time character of human rationality, and has seemed sometimes to be unable to distribute its attention in a balanced fashion…. The Heartland is more overpopulated than ever, while rich lands in other parts of the empire go untended.” Organizations. 

Herbert Simon. (1978). Rational Decision-Making in Business

Sources and further reading