Industrial dynamics’ model

Evolutionary model of industrial dynamics

The model stems from two streams of my research, namely:

  • Computer simulation of evolutionary processes (initiated in 1970s).
  • Joseph A. Schumpeter and evolutionary economics (since the end of 1980s).

For the first time the model was published in 1992 (Kwasnicki and Kwasnicka, 1992) and since that time the model (with minor modifications) and its simulation results have been presented in different journals and books. The list of relevant publications is presented in the end of this note.

The model draws heavily from our earlier model of biological evolution, developed in 1970s and 1980s by Halina Kwasnicka, Witold Kwasnicki and Roman Galar.

There is close interrelationship between the model of industrial evolution and the general model of knowledge development presented in the first part of my book on Knowledge, Innovation and Economy.  In fact most ideas presented in the first part of this book are adjusted to the specific circumstances of industrial development and are expressed in the more formal, mathematical way.

General structure of the evolutionary industrial model

Basic mechanisms of generation of new sets of routines (inventions):

  • mutation (moderate modification) – autonomous research, in-house development
  • recombination, imitation
  • transition
  • transposition
  • recrudescence – search for radical novelty through reshaping of the active set of routines (large number of transpositions and/or frequent modifications by means of mutation)

transition

transposition

From routines to competitiveness, productivity of capital and unit cost of production

 „Look! Here he comes, leaping across the mountains, bounding over the hills.” (Song of Solomon, 2:8)

Examples of industry evolution in the adaptive landscape, i.e., technical competitiveness q(z)
(two dimension, each red star marks a single firm):

Two adaptive peaks: 3D view and contour map
Four adaptive peaks: 3D view

 

Once I have been asked to state the main differences between my model and the well known Nelson and Winter model (presented e.g. in their 1982 book on An Evolutionary Theory of Economic Change, Belknap Press, Cambridge, Mass. and London), here is my short answer to that question.

The Nelson-Winter model and my model

In some way it is an extension of the Nelson and Winter model (NW) presented in their 1982 book. Similarity of my model to the NW model is seen especially in general concept of evolutionary paradigm (selection and search for innovation processes), although there are essential differences, such as:

  • diversity of innovation types  – in the NW model firms are able to improve only the productivity of capital (A), in my model, beside that type of innovation, firms are able to improve product performance (i.e., products’ technical characteristics, (z), technical competitiveness, q(z)), and also to reduce unit cost of production (V). Due to that diversity it is possible to model such classical innovation types asembodied technical change (A) and disembodied technical change(Vq(z)), as well as product innovation Vq(z)) and process innovation (A, Vq(z)) .
  • different price setting procedures – the NW model set uniform price for all products of different firms via global demand function, in my model each firm sets the price individually, taking into consideration such features as current production costs and current products’ characteristics as well as current market structure (the firms’ specific price setting procedures cause diversity of price at the industry level).
  • in my model routines’ and products’ characteristics spaces (analogous to genotype and phenotype spaces in biology) cause different modes of search for innovation. In the NW model economic characteristics (namely, capital productivity) are modified directly. In my model basic inventions and innovations stems from firms’ routines modifications and next through relevant transformations of routines values productivity of capital (A), unit costs of production (V), and products characteristics (z) are evaluated. I distinguish two types of routines, namely active and latent ones. Beside ‘classical’ search mechanism for innovation (invention) as mutation and recombination I consider transitiontransposition and recrudescence.
  • decision making procedure in the NW model has a form of rather simple mathematical formula, in my model the decision making procedure include such important elements as investment constraints, possibility of credit taking, current structure of the market, diversified firms objectives, subjective evaluation of each firm concerning future behaviour of its competitors, etc.

The above-mentioned differences make the model more realistic but natural consequence is that the model is more complex than the NW model.

I think that it is very easy to generate numerous models (especially computer simulation ones) to describe different phenomena within a defined sphere of reality. Probably I represent minority of researchers, but in my opinion   our general aim should be to develop a single, relatively general model of industrial dynamics allowing for description and explanation of different phenomena and also enabling identification of emerging properties of industrial development. Another important aim to build such general model is to use it as an educational tool in microeconomics’ courses of university curriculum (what I do presenting evolutionary economics in  my university teaching). Therefore at the industry level (sometime called mesoeconomic) I propose a general model which can be applied (through relevantly planned experiments) to describe phenomena observed in real industrial processes. Following this proposition, in the previous publications I have used this model to describe important ‘stylised facts’, namely:

  • for a given market, the margin of price and firms’ profit increase with the concentration of industry (for example, from perfect competition, through oligopoly, duopoly, and ending with monopoly) (Kwasnicki, 1996, chapter 6);
  • there is a specific relationship between economies of scale and an industry concentration, namely the larger the economies of scale the greater industry concentration (Kwasnicki, 1996, Ch. 6,Kwasnicki, 2000);
  • ‘the capital/labour ratio is rising more or less in proportion to productivity, and it is highest amongst the richest nations and lowest among the poorest, the capital/output ratio is much the same as between poor and rich countries ? it is no higher in America … than it is in India’ (Kaldor, 1985, p. 67). Kaldor calls it ‘one of the best established ‘stylised facts’ of capitalist development (Kwasnicki, 1996, Ch. 7);
  • in the presence of innovation, there is no uniform price for all products sold on the market but the great diversity of price is observed (Kwasnicki, 1996, Ch. 7, Kwasnicki, Kwasnicka, 1996a);
  • emergence of innovation leads to temporal monopoly of the pioneer firm; at the first phase after innovation introduction the monopoly firm gains extra profit that disappears in the course of time, when competitors imitate the innovation (Kwasnicki, 1996, Ch. 7);
  • skewed distributions of business firms’ size and their long-term stability is the well  established ‘stylised facts’ of industrial demography; size distributions of firms of real industries are very similar (‘look like’) to Pareto, Yule, or log normal distributions (conditions required for  the skewed distributions emergence are presented in Kwasnicki, 1998);
  • in multi-technological substitution processes of industrial development the diffusion of a single technology has a form of the bell-shaped curve (which consists of four phases: an initial, introductory phase when the diffusion rate is not very high, followed by a phase of relatively quick diffusion; the third phase may be called the matured one in which the market share of the technology reaches maximum value; in the fourth phase, the market share of that technology declines, what is caused by emergence of new, better technology). That pattern is  natural phenomena observed in simulations experiments. In (Kwasnicki, Kwasnicka, 1996) we have applied simplified version of that model to forecasting diffusion-substitution processes;
  • industrial development is a unique historical process in which path-dependence and cumulative causation play an important role (Kwasnicki, 1996, Ch. 8). Path-dependency, increasing returns, network effect (network externalities) are natural phenomena observed in the model’s behaviour (current work, presented e.g. Jena lecture);
  • cycles and fluctuations are natural phenomenon observed in industry development (Kwasnicki, Kwasnicka, 1994, Kwasnicki, 1996, chapters 6 and 7);
  • patterns of firms’ entry, exit, and industrial demography observed in the model are similar to records of industrial dynamics collected by David B. Audretsch, Steven Klepper and Kenneth L. Simons, Glenn R. Carrol and Michael T. Hannan, and many others (current work).

“On the basis of the presented results one may draw the conclusion that it is possible to imagine situations (industry regimes) in which highly concentrated industries behave as industry with large number of firms being in a state of pure competition (namely, for very small values of the cost ratio AV) and also industry regimes in which numerous competitors behave as oligopolist (or even as a monopolist), namely, for high values of the cost ratio AV. These findings are purely theoretical and ought to be verified using real data on industrial development. The open question is if in real industrial processes we observe such small and large values of the cost ratio?

As a hypothesis, it may be stated that in real industrial processes, because of introducing innovation reducing unit cost of production, the cost factor is reduced in successive stages of an industry development. Therefore, for matured innovative industries we can expect higher competitive conditions of industrial development.” (Kwasnicki, 2000)

Publications: