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The New Economics: Harnessing Complex Adaptive Systems for Business Growth

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The new science of complex adaptive systems in economics has transformative potential for business. This new science reveals how competitive entrepreneurial exploration of new technologies, products, and services can drive continuous economic growth. Think of it as a new law of economics, centered on the roles of value and selection in evolving entrepreneurial systems.

Traditional economics has struggled to identify unifying laws. However, the science of complex evolving systems provides a fresh perspective. An evolving system comprises many interacting components that increase in diversity, distribution, and patterned behavior over time. This seems to contradict the second law of thermodynamics, which states that natural phenomena become increasingly disordered over time.

A New General Law of Economics

By applying the principles of complex evolving systems, we can identify a new general law of economics: the emergence of new economic value over time, driven by competitive entrepreneurial discovery.

Characteristics of Evolving Systems in Economics

Analyzing the economy as a complex evolving system reveals three key attributes:

  1. Resource Configurations: There are countless ways to combine resources and inputs into new configurations.
  2. Discovery Processes: These processes generate new configurations.
  3. Selection: Certain configurations persist due to their value.

Increased order in such a system results from selection: some configurations have advantages that make them more likely to endure. Similarly, the economic system evolves through the selection of advantageous configurations.

The Economic System as an Evolving System

In economics, new configurations emerge from the diverse resources and capital structures. Entrepreneurship drives the discovery process by experimenting with new combinations. The end-user market then selects for value, ensuring that only the best configurations survive.

Therefore, the three characteristics of evolving systems—component diversity, configurational exploration, and selection—are fully demonstrated in the economic system and underpin the law of increasing value. This law can be generalized: economic systems with many interacting agents display an increase in diversity, distribution, and patterned behavior when numerous entrepreneurially generated configurations are subjected to value selection pressure. Value is the universal basis for selection in economic systems.

Three Orders of Value Selection

  1. Foundational Value: Configurations evolve to a point where they can self-maintain, with no need for reorganization or recombination. This value is associated with reliability, repeatability, trust, reputation, and ethics.
  2. Adaptive Value: Entrepreneurship drives knowledge building and information processing, supporting the creation of new configurations. Economic entities adapt dynamically to market changes, leading to growth, innovation, and competitiveness.
  3. Evolutionary Value: In complex systems, entirely new functions can be imagined and created, opening up new possibility spaces. This value is associated with the ability to invent new functions continuously.

Selection as the Key to Evolution

Selection is the primary enabling constraint in this model. A system will evolve, or increase value creation, if many different configurations are subjected to selection for value. For this to occur, markets must be free to select, entrepreneurs must be free to innovate, and selection pressures must be allowed to intensify.

Underlying Principles

  • Information Richness: Greater and faster flows of knowledge and data can open new possibility spaces for value creation.
  • Selection Pressure: The competitiveness of the market system is crucial for driving value creation.
  • Potential to Evolve: Systems vary in their potential to evolve. Increasing current value can enhance future value potential.
  • Rate of Change: The evolution rate can be influenced by increasing the number and diversity of interacting agents, the number of different system configurations, and the selective pressure on the system.
  • Interdependence: Evolving systems are overlapping and interdependent. Information transfers within these systems create an “information field.”
  • Value Selection: Systems that select based on Foundational, Adaptive, and Evolutionary Value will see increased value creation.

Understanding and applying these principles can help young professionals navigate the complexities of modern business economics and drive continuous growth and innovation.

Economics In The Digital Age Is Different.

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Steve Denning is one of our most important and insightful writers at the intersection of economics, business, and management. He has been in the lead in alerting the business world to the imperative of new thinking about organization, embracing agility and the end of hierarchy, agile processes, and digital transformation. His message: management must change to keep up with technology.

Recently, he turned his attention to economics. His conclusion: economics must change to keep up with technology. Mainstream economics that is; we Austrians may claim a special position, as I’ll argue below.

A school or tradition of economics (such as “mainstream economics”) tends to be defined by stacking dead economists and their theories one on top of another and calling the resulting intellectual edifice a definitive body of work for the filling of textbooks. Later arrivals to the school limit themselves to publishing marginal elucidations. Keynesian economics continues as a set of theories derived from the conditions between the first and second world wars in socialist Britain. Keynesian economists in 2021 continue to insist that these theories still hold, and, in fact, they are the backbone of US Government economic policy today, and the reason it is so disastrous.

In his article Why Mainstream Economists Miss Digital Innovation, Denning drives home just exactly why this backward-looking process of economic theorizing takes us so far off base. Mainstream economists (he quotes Nobel prizewinner Robert Solow) had a very difficult time even recognizing the contribution of digital services to economic value. The “real economy”, Solow opined, was about physical products. Now the largest firms in the world are those delivering primarily digital services. So much for the validity of Nobel rise recognition.

Denning also calls out Robert J Gordon, who asserts that the great innovations occurred before 1970  – innovations such as electricity, household appliances that reduce work, air conditioning that increases comfort and productivity, flushing toilets that improve sanitation and health. Gordon dismisses innovation after 1970 as narrowly focused on entertainment, communication, and information technology. He referred to the arrival of the iPhone as a minor event in entertainment and communications. He failed to realize how a handheld computer in the hands of billions of people radically increases productivity and economic growth, which has been associated with the eradication of poverty, as well as changing how people are educated, given access to healthcare, and put on a pathway to higher aspirations and better lives.

Denning uses this example as an illustration for his conclusion that mainstream economics misses “that digital innovation has changed almost every aspect of human life”. Of what relevance is a field of study that is so oblivious to real life?

Fortunately, there’s a school of economics that understands the dominant role of digital innovation: Austrian economics. There are several points of difference with mainstream economics. One is the understanding that Austrians have of the market as a process and the economy as a constantly changing capital structure. Mainstream economists’ main tool is the study of equilibrium: under what conditions would the economy be perfectly balanced with no more change? Austrians understand that there is no equilibrium, and equilibrium is not a state we desire. The market is a flow of continuous, often dramatic and always accelerating change. Technologies build on technologies and change becomes exponential in terms of impact on growth and improvement. More and more customer value is generated, without limit.

Austrian capital theory recognizes capital in the economy as a flowing river of technology enabling more and more customer value, and constantly changing and improving in response to customers’ never-ending demand for betterment – faster, cheaper, more efficient, more convenient, more comfortable, more productive. Customers demand this continuous change, and technology helps to deliver it.

Another tool in the Austrian economists’ toolbox is the understanding of the role of the entrepreneur, entrepreneurship, and the entrepreneurial method. The entrepreneur has no role in mainstream economics. No one has figured out a mathematical equation to represent this most human of innovative influence. Entrepreneurs are those who look at the world and ask themselves how they can make it better than it is. That’s why Steve Denning can quote an entrepreneur like Marc Andreessen who wrote  “Why Software Is Eating The World” but can’t find any economists to quote.

He could have referred to W. Brian Arthur’s paper, Competing Technologies, Increasing Returns, and Lock-In By Historical Events, where he anticipated exponential growth and the rise of the tech titans. Brian Arthur calls his brand of economics “complexity economics”, which is a strand of Austrian economics. Denning might also have quoted Todd H. Chiles on Organizational Emergence, his theory about how firms and markets advance rapidly through stages of dramatic change and increasing value generation as a result of both technology and changing consumer preferences.

Steve Denning is right to say that it’s imperative that mainstream economics catches up with technology. He should go further and call for the widespread recognition of Austrian economics as the economics of radical economic change. It’s already the go-to theory to explain bitcoin, free software, and the economics of video games. Mainstream will never catch up.

The Age Of Strategy Is Over. The Replacement Is Explore And Expand

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Business schools, business writers, including retired CEO’s writing their memoirs, business bloggers, magazines and conference presenters all insist that strategy is the one mandatory for any individual or team that’s leading or managing a business. There’s no business without a strategy.

Well, I am here to tell you there is. In fact, strategy is way overblown as a business tool or business skill. Not only that, the way it is taught and written about is founded on an entirely false premise.

Strategy is presented to us as a knowledge tool, with the promise that, when the tool is well-used, it can influence future outcomes. When a strategic firm, or a strategic plan, or a strategic CEO, or a well-designed and implemented strategy goes to market, the result, we are assured, will be superior performance: more growth or revenues or market share, a stronger relative position vis-à-vis competitors, stock price appreciation, or some other objective measure of business success.

However, as a brief study of complexity economics makes clear, no market future is predictable, or even subject to influence, via strategy. The knowledge flow that is an input to strategy tools and debates is dynamic and constantly changing, always incomplete, and mostly tacit and non-quantifiable, impervious to the spreadsheet calculus of the strategic planning department. The confidence of the strategist, backed up by charts and graphs and data analytics and presented in powerpoint and video, is false and misplaced. Expertise in strategy development may be good for individual careers, but it has no value in business management because it can not possibly paint an accurate picture of the future. It  can not account for changes in the business environment, whether exogenous or endogenous or (in what is usually the case) a combination of both. Decisions made on the basis of a strategic plan for the future will be blessed with no more certainty as a result of all the effort that went into the planning exercise.

Yet strategy and strategic planning remain a core product of the business education and publishing industry. Why? Mostly because of a lack of alternatives. If businesses don’t have strategy tools to utilize for making the one year and five year plans with which they guide resource allocation and tactical implementation, what’s their alternative? Until recently, there has not been one.

Now, however, an alternative is emerging. That’s a careful choice of wording, because the idea of emergence is core to navigating the business world without strategic planning. Emergence is a property of complex systems such that outcomes occur that are not predictable from the properties of the components of the system or from their interaction. The new properties that the system produces are not shared with the components from which the system is made up or with prior states. Emergent outcomes can not be predicted, they can only be observed.

Peter Corning, one of the early students of complex systems wrote:

Rules, or laws, have no causal efficacy; they do not in fact “generate” anything.

He used the analogy of a chess game, which has very precise rules, but they have no predictive power.

Even in a chess game, you cannot use the rules to predict “history” – i.e. the course of any given game. Indeed, you cannot even reliably predict the next move in a chess game. Why? Because the “system” involves more than the rules of the game. It also includes the players and their unfolding, moment-by-moment decisions among a large number of available options at each choice point. 

If emergence is the characteristic outcome of complex systems, and it can’t be predicted, where does that leave business strategy? It’s a process for which its protagonists claim the capability of prediction: business results will be better with the adoption of the recommendations of strategic planners, who study data, trends and business conditions and competition and markets to arrive at formulations of how to allocate resources optimally, sometimes described as “where to play and how to win”. 

The theory of complex systems suggests that it is impossible to identify where to play and how to win, and dangerously hubristic to try.  The alternative to strategy is a balanced process we can call explore and expand. A business should organize around the activity of exploration: attempting as many new initiatives as possible, and allocating authority to do so to the outermost edges of the organization, those operating directly with customers, active in local markets with all their local variation and distinctive conditions. If any initiatives appear to be effective in meeting customer goals and therefore meeting the goals of the business, quickly expand those initiatives so that more parts of the organization can utilize the learning and more resources can be brought to bear in their activation.

Where strategy pursues standardization and conformity around one set of plans, Explore And Expand prizes variation, and looks to identify more and more ways to pursue value improvements. This is a way of harnessing complexity, as Robert Axelrod and Michael Cohen refer to it, in the book with that title.

Axelrod and Cohen point to a couple of organizational attributes that render the Explore And Expand approach viable. One is the existence and maintenance of rich networks of engagement, between the firm and its customers, within the firm between individuals and decision-making units, and amongst customers. The more information that can flow through these networks from acts of exploration, and the faster it flows, the greater the economic productivity of value improvement.

Second is the development of short-term, fine-grained measures of success, so that the exploration activities can be relieved of the time burden of long wait periods to read results. Although it remains important to be alert to misattribution of outcomes to actions, getting more learning more quickly is generally advantageous, and measurement systems should be aligned with this need for rapidity.

In sum, we should consider the age of strategy in business over, and prepare ourselves for the age of Explore And Expand.