Evolutionary Economics

J Evol Econ (2002) 12: 539562
c Springer-Verlag 2002
Evolutionary economics and the counterfactual threat: on the nature and role of counterfactual history as an empirical tool in economics
Robin Cowan1 and Dominique Foray2
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MERIT, University of Maastricht, PB 616, 6200 MD Maastricht, The Netherlands (e-mail: r.cowan@merit.unimaas.nl) IMRI, Universit Dauphine, 75775 Paris Cedex, France e (e-mail: dominique.foray@dauphine.fr)
Abstract. Counterfactual conditional statements are ubiquitous in any scientic endeavour. This paper contains an analysis of the nature of counterfactual conditionals and the conditions under which they are considered assertable by scientists. The paper then applies this analysis to the use of counterfactuals in evolutionary economics, arguing that because evolutionary economics is inherently concerned with historical processes it cannot avoid the use of counterfactual history as one of its tools of empirical analysis. We discuss the strengths and pitfalls of counterfactual history. We argue that because evolutionary economics starts from the foundation that randomness may be inherent in any economic system, the very aspects of evolutionary economics that make counterfactual history a desirable empirical tool also make that tool difcult to employ. 1 Introduction This paper is concerned with a methodological question in economics. In particular it examines the role and nature of counterfactual history as an empirical tool in evolutionary analysis of economic phenomena. As a method, counterfactual history has not met with universal approbation, and many economists look upon it with considerable dis-favour. In 1983 the American Economic Review published a paper by Preston McAfee in which he asks about American economic growth under the counter-factual proposition that Columbus had not discovered the new world. McAfee clearly means to ridicule the use of counter-factual history. Part of the goal of the present paper is to explain both why counterfactual history is appealing
We thank the participants of the International Seminar on Evolutionary Economics as a Research Programme in Stockholm, May 1997, for many helpful comments. We also thank Lorri Baier for many helpful substantive and textual comments. Correspondence to: R. Cowan
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as a tool for certain approaches to economic analysis, and why it may appear unappealing to someone deeply schooled in an axiomatic, deductive tradition. Empirical analysis in any research eld is entwined in theoretical analysis. That is, empirical work depends on theory for concepts, denitions and hypotheses, all of which are used as foundations for empirical investigation. Thus if theoretical work in a eld evolves and becomes more complex, the range of tools employed in empirical analysis is also likely to evolve, and in general we would expect the toolbox to grow. One of the changes in theoretical economics in recent years has been an increase in the number of models producing multiple equilibria. Multiple equilibria have been present in analysis almost since the birth of the discipline, but for many years, part of the methodology of economics seemed to be to design models that had unique equilibria. This is certainly sensible in many ways: it simplies comparative statics analysis, and it removes the need for detailed examination of the (difcult) dynamic processes involved in equilibrium selection. But the growth of the literature of path dependence, evolutionary modelling, game theoretic models and much modern macro-economics has brought with it multiple equilibria, which in these elds are generally accepted as a normal and untroubling outcome. The pervasiveness of this result cannot help but affect methodology. For instance, when an equilibrium is unique, the welfare question is restricted to whether this equilibrium can be made better. This is often answered through a comparative statics exercise, which in principle involves small adjustments to parameters, resulting in small changes to equilibrium values: we can adjust a tax rate to move the current equilibrium to a point very near and ask which of the two is preferred. But when multiple equilibria are present, a second question is possible: would a different equilibrium be or have been, better? This cannot necessarily be answered with a simple comparative statics exercise. Kaldor (1934) points out that there are two general types of multiple equilibria models, but that analysis of both will depend on analysis of the path to the equilibrium. First, the (possibly single) equilibrium moves in response to events along the path. Fisher (1983) for example, shows that if dis-equilibrium trades take place, the nal equilibrium value, even if there is enough convexity in the system to guarantee that only one exists, cannot be predicted from the initial data. Simply, in an Edgeworth Box, equilibrium lies somewhere in the lens formed by the initial endowments and indifference curves. An out of equilibrium trade will create a new endowment and thereby a new core. An out of equilibrium trade at a different non-equilibrium price will create a different new endowment and thereby a different new core. Thus the set of possible equilibria will change if out-of-equilibrium trades take place, and will change differently depending on the (almost certainly unpredictable) prices at which those trades take place. Notice that for this view that equilibria move in response to out-of equilibrium phenomena to make sense, time must pass before the equilibrium is reached.1 Kaldors second reference is to cases in which there are several equilibria which do not move in response to the path of adjustment. This is simply the case of multiple equilibria for a given set of parameter values. Given the initial data, the analyst is
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For a similar discussion of the same issue see David (1997).
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able to predict, but can only narrow his predictions to some set of equilibria the market will evolve to one of a set of known equilibria, but which of them it will be is not determined. In a static model, this exists when there are appropriate nonconvexities perhaps some form of increasing returns. The in principle difculty this poses is how one of these equilibria is chosen there must be some selection mechanism. It is in the selection of the equilibrium that the path dependence emerges or becomes important. With some exceptions, of course, it seems again that time is going to play a central role here; the selection of an equilibrium is something that will take place as a process evolves over time. When multiple equilibria are present, there is no guarantee that they are welfare equivalent. This raises the possibility of potential regret (see Strotz, 1956). Whether or not potential regret has a place in a model will depend on the nature of the selection mechanism. How do we get one equilibrium rather than another? For some economists the answer to this question is History. Selection mechanisms are inherently historical. Historical processes can have the feature of path dependence, and this is commonly present in evolutionary models. Here is the moment at which the Potential Regret result arises. Had history taken a different course in the past, we would now be at a different, and better, position. The historicity present here implies that explanations which address the issue of potential regret will necessarily be historical. The questions Is potential regret possible?, or Is regret actual in this case? effectively ask what would have been the case had history taken a different course. This is a counterfactual question, equivalent in this regard to the question What would be the effect on employment if the tax rate were reduced by x%? This paper is concerned with the former type of counterfactual, and in particular how historical concerns and the introduction of path dependence into economic models changes the nature of counterfactuals. The paper is organized as follows: We begin by addressing the role of counterfactual conditionals in science in general, and then turn to their relationship with views of causation. This is followed by a discussion of two distinct views of counterfactual conditionals, the branching view, and the non-actual-possible-world view. The following sections bring these abstract considerations back to economics, addressing both the difculties raised for counterfactual analysis, and suggestions regarding how to strengthen it.2
2 There is a difculty of nomenclature here. It would be convenient to have a phrase that captures the body of analysis for which historical processes are central. This includes work concerned with selection mechanisms, evolutionary game theory, adjustment processes, path dependence, what is known tightly as evolutionary economics, signicant parts of modern macro-economics, and no doubt a variety of other work. With apologies to the members of the Schumpeter Society, we will refer to this collection as evolutionary. The reason is that much of economics that lies outside Evolutionary Economics has evolutionary features concern with processes, positive feedbacks, variety among the agents and so on (see Nelson, 1995 for a characterisation of Evolutionary Economics), and it is the presence of these features in the theory that demand the kind of historical counterfactual analysis that we are discussing here. When we refer to Evolutionary Economics per se we will capitalize it.
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2 Counterfactuals in science The prototypical theoretical result in mainstream economics is the comparative statics result: the number of patents led will increase by 10% for every 25% increase in R&D spending. These results are usually presented as theorems or propositions derived from axioms. Similar results are presented in most sciences, though the degree of precision and extent of generality vary, both within and across disciplines. What is key here is that these statements can all be re-cast explicitly as equivalent counter-factual conditionals, that is, conditionals in which the antecedents are false.3 Indeed, Nelson Goodman (1983) argues convincingly that six types of statements are equivalent, and that any statement of one type can be re-cast as a statement of any of the other ve types. The types are counter-factual conditionals, scientic laws, dispositional statements (p.3), factual conditionals (p.4), statements regarding possible worlds (p.34), and causal statements (Goodman is not explicit about the last category but it is implicit in what he writes on pages 37 and 45). So the following statements are equivalent: If R&D spending were 25% higher than it is, patenting would be 10% higher. The ratio of the change in R&D spending to the change in patents is 2.5:1. Patenting has the tendency to increase (in the ratio 1/2.5) as R&D spending increases. Since patenting increased by 10%, R&D spending must have increased by 25%. In a world like ours but with 25% more R&D spending, we would observe 10% more patenting. Changes in patenting activity are caused by (inter alia) changes in R&D spending.4 Counterfactual conditionals are ubiquitous in science. They can be, and are, used to express causal relations. Further, they are part of the link between theoretical and empirical work. Empirical work is successfully characterized as the investigation of counterfactual conditional claims. Do the data show that if R&D spending increases then patenting increases in turn? 3 Causation Counterfactuals also appear in another place that is germane to this discussion. Philosophical discussions of causation often employ counterfactual conditionals as the key concept. Indeed for many years there were vigorous attempts to unpack causation formally in those terms. The appeal is obvious: C causes E. is very much like the statement If C occurs then E occurs. The problems with this approach
This idea is not new in economics: Fogel (1973) fends off an attack on the new economic history made by Genovese (1962) by presenting a long list of hidden counterfactuals in Genoveses own work. 4 McCloskey (1989, p.150) has a similar list regarding money supply and ination; Cowan and Foray (1997) illustrate using minimum wages and unemployment. A claim that appears impossible to render sensibly in this way might be If R&D spending goes up 25% next year, patenting will increase by 10%. This appears not to lend itself to exposition as a counterfactual, since the future has, as yet, no fact. The counterfactual arises when one notes that the claim is implicitly contrasting a world in which R&D spending does not increase by 25% next year. Now, it is clear that (at least) one of the two contrasting cases will be contrary to fact. The counterfactual can be formed prospectively, even though we cannot know which of the cases will be fact, and which counter to fact.
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turned out to be insuperable when addressed purely in terms of material conditionals, so that endeavour has effectively been given up. Part of the difculty was a tension between logical analysis and physical analysis. To most non-Humeans, causation does seem like a real feature of the world. If one thing did not cause another there would be no reason for the world not to be totally chaotic, and therefore no reason, beyond observations of Humean constant conjunction, to believe that it might not suddenly become so. This is what logical analysis has so much difculty capturing. So we can note that understanding the statement If C occurs then E occurs as a causal statement involves understanding more than simply the formal logic involved. It involves understanding things about C and E, about what links them and how C necessitates the occurrence of E. We can make this point a slightly different way. All counterfactual conditionals, when viewed as material conditionals or read purely truth-functionally, are true. Logically, they can be written as C & (C E).5 Such a statement has the truth value true. Thus, truth-functionally, If R&D spending were higher than it is patenting would be higher than it is. and If R&D spending were higher than it is patenting would be lower than it is. are both true, since R&D spending is not higher than it is. This makes it sound as if the logical conclusion of scientic endeavour is Anything can happen. (which of course is not inconsistent with many of the beliefs of the spiritual movement of the 1990s). But this is clearly not where science is headed or wants to end up. How do we distinguish between these two statements, accepting one and rejecting the other? The rst, brief part of the answer is that it cannot be done purely with logical analysis, and no modern treatment of either counter-factuals or causation attempts to do so. Peter Gallison (1987) shows convincingly just how much this is the case for experimental physics. Experimenters must decide when they have arrived at the correct result, and when errors introduced by faulty equipment, extraneous forces, observation error and so on are not affecting the results in a signicant way. Gallison shows in a series of cases that while formal logical analysis is important, it is probably not the most important factor in making that decision. The longer answer has had two strands in the literature. A meta-linguistic analysis, (associated with writers such as Chisolm, Goodman, and Mackie) gives up on truth and falsity and asks instead about assertability. We are willing to assert that an increase in patenting follows an increase in R&D spending, but we are unwilling to assert that a decrease in patenting would follow an increase in R&D spending. This removes the onerous burden of logical proof, but leaves open the question of what determines assertability. The other strand, following Stalnaker (1968) or Lewis (1973 a,b) for example, retains truth and falsity, but attempts a more sophisticated analysis of what determines it. For our purposes, it is not necessary to choose between these approaches, for the main problem is over-arching: in Goodmans words, it is to dene the circumstances under which a given counterfactual holds while the opposing conditional with the contradictory consequent fails to hold. (p.4).6 Meta-linguistic analysis is relatively clear that assertability
This should be read as C is false, and (C implies E). There may be exceptional cases in which both hold, but for our purposes we need not be concerned with those cases. Lewis (1973b) theory allows for such a possibility.
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follows from being able to infer the consequent from the antecedent plus some additional premises. On the theories of Lewis and Stalnaker, truth or falsity of a counterfactual follows from the same considerations as truth and falsity of a factual conditional, but to evaluate the former we consider a non-actual possible world. The two approaches have similar problems: which additional premises are considered; which possible world is examined.7 But having determined which premises or which world, there is the issue of how to use the set-up to evaluate the conditional. The consequent must somehow be linked to the antecedent. Purely formal links will almost certainly fail to provide the answer in general, just as they do in evaluating many factual conditionals. Goodman is explicit that this link must be causal; Lewis is less so. For Lewis a counterfactual conditional is true if the factual conditional is true in a closest possible world. How do we evaluate factual conditionals? Gallisons work shows that the answer to this question is complicated, but at the very least non-contradiction of known causal laws is one of the strongest criteria. Laws are included in descriptions of possible worlds, and a conditional which was shown to be an instantiation of a causal law (or a system of them) would certainly be judged true. Even if we do not go as far as Goodman (or Elster, see below) in asserting that the consequent must follow from the antecedent by a causal law, our ideas about causation will be central in determining how we evaluate counterfactual conditionals. Emphasizing the place of causation conforms well with the intuitions which make counterfactual claims relatively common in everyday life. Asserting a counterfactual conditional is in essence making a claim about the regularity and coherence of the world. Causal forces connect events and provide the coherence that we seek. The reliability of a counterfactual arises from the same source, namely the coherent, consistent structure of events, even under Humes minimalist, constant conjunction view of causation. To defend a counterfactual conditional is to explicate the causal connections among the events involved.8 If the causal account is judged acceptable, the conditional is judged assertable. This brings us to the nature of causation in economics.
7 Which additional premises to consider is determined by co-tenability. Lewis (1994, pp. 57 and 69) provides a denition which he claims captures the intent of metalinguistic theorists and also makes the two theories identical. 8 Accounts of counterfactuals vary in their explicitness regarding the use of ideas about causation in our evaluation of counterfactuals. Simon and Rescher (1966) are explicit that the acceptability of a counterfactual is determined by the causal models we employ, through their version of modal orderings. Stalnaker (1968), and similarly Lewis (1973a, 1973b), are not explicit that causal analysis is involved, though Lewis makes an explicitly tight connection between causation and counterfactual conditionals in that he seeks to provide a counterfactual analysis of causation. For both authors, though, the acceptability of a counterfactual conditional is determined by asking whether the consequent is true in a world in which the antecedent is true but which is minimally different from the actual world. Jacksons (1977) suggestion is to posit a world in which the antecedent is true and inter alia in which causal laws . . . are identical to ours (p.7). Bennett (1984, p. 73), has a similar approach, though speaks of laws rather than causal laws explicitly. Goodmans exposition is very explicit regarding the causal under-pinnings of counterfactuals, and it is clear that many authors feel there is a tight connection between the two.
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1.1 Causation in economics Within economics as a whole we can see that there are implicitly two notions of causation. Traditionally, the fundamental goal in economics has been to explain phenomena in terms of equilibria.9 Note that in this context, an equilibrium can be dynamic, involving change, growth or even cycles in the variables of interest. Something is explained when it is shown to be held in place by countervailing forces. The economy (rm, market) exhibits behaviour X because there is no incentive to deviate from that behaviour, and in fact deviations are punished. The explanation of X consists in nding the forces that impinge on X and showing that they are in balance. How these forces came to impinge on X, or how they came into balance is not generally considered part of the explanation. It is assumed that some process would produce this result, but that process is rarely spelled out. Further, in abstracting from the actual course of adjustment to the initial shock one is assuming that the adjustment process has little effect on the nal outcome. (Hausman, 1990, p. 171), thus ruling out the processes described by Fisher (1983), mentioned above. This implicit assumption connects well with uniqueness of equilibria. The nal result of an analysis is to nd the effects of some independent variable on a dependent one, R&D spending on patenting for example. Uniqueness implies that the path to the equilibrium is in a very real sense unimportant. If this equilibrium is the only place we can end up, and if we are in or close to equilibrium most of the time (otherwise its usefulness as an explanatory tool would necessarily be called into serious question) what difference does it make how we get there? It is not even that interesting as a curiosity, since the path to equilibrium must be relatively short. Causation, when seen this way, can be called sustaining causation, and from this point of view understanding a phenomenon involves knowing what holds that phenomenon in place, and why there is no deviation from it. There is another type of causation, though, which we can call originating causation.10 The process by which an event, state or phenomenon comes to exist is central to explanation in Evolutionary Economics, and must at the very least be considered when a mechanism to select among equilibria is at play. The general goal of explaining the movement of something over time, or to explain the existence of a phenomenon in terms of how it came to be is common to all evolutionary sciences (Nelson, 1995). Explanations of, for example, the location of an industry would involve a dynamic model of location choice, in which choices made by rms this period depend on the location choices of previous actors. The process might evolve to a stationary distribution, but also might never do so, if the choices of later actors sufciently upset the choices of earlier actors that they provide incentives to change
9 See Reder (1982, p. 12) for example, who describes a dominant, Chicago, view as assuming that one may treat observed prices and quantities as good approximations to the long-run competitive equilibrium values. 10 See Cowan and Rizzo (1996) for a discussion of causation in economics and in particular on the difference between sustaining and originating causes.
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location.11 The cause of the current distribution of activity is seen as historical. We must look back at decisions made in the past, and trace their effects on following decisions, as the choice of one actor affects the incentives of other actors. To understand a phenomenon, then, we must understand the process by which it came to be. There is a sequence of events leading to this outcome, and we must be able to trace this sequence, and the causal links between the events in it, before we really understand why this phenomenon exists. This is all part and parcel of the possible existence of multiple equilibria. When multiple equilibria exist, the selection mechanism gains prominence. Selection mechanisms (in the world) are inherently historical. If there are two possible outcomes, one cannot simply look at sustaining causes to explain which is selected by denition both are sustainable. One needs to address origins. This discussion of causation impinges on counterfactual conditionals in a crucial way. We argued above that unpacking a counterfactual conditional involves examining causal connections. This is the process by which a counterfactual is judged if the causal story is judged acceptable, or credible, the counterfactual is deemed assertable. Clearly, then, the nature of causation will determine what is unpacked during this enterprise. In a science in which causation is ahistorical, examination of the counterfactual claim will not involve history. Contrarily, if causation is viewed as inherently historical, then examining a counterfactual claim will necessarily involve history in one way or another. We can make the same argument in a slightly different way. We pointed out above that a counterfactual claim is implicitly a causal claim, but this is deeper than simply a semantic identication. A claim about a counterfactual condition is about the same thing as a causal claim. Thus the counterfactual will contain within it the nature of causation. What this means is that if unique equilibria are derived from accepted axioms, then simple counterfactual conditionals will be the norm. But if multiple equilibria exist, and events on the path are important in determining which is selected, and perhaps where it is located, then counterfactuals involving history will be common. In the style of economics we have been calling evolutionary, empirical work will involve historical excursus: hence the counterfactual history. This discussion of causation makes contact with the solution of Conrad and Meyer (1964) to the problem of counterfactual conditionals. As noted above, the difculty arises from logical problems with the counterfactual statements themselves. The solution, Conrad and Meyer suggest, is to look for statements that are co-tenable with the counterfactual statement. Consider, for example, the statement, If there had been no Civil War, slavery in the southern US would have been dismantled peacefully. There is no way to prove this analytically, nor is there a direct empirical proof. But, following Conrad and Meyers exposition, this statement would only be true if slavery were unprotable at the time of the war. Thus we can implicitly test this statement by testing the protability of slavery. Notice, however, that this approach makes several assumptions about the causal forces at work. It
11 The lack of an equilibrium is not necessarily considered either a failure or a problem to be addressed. The role of equilibrium in economic analysis is something occasionally debated within Evolutionary Economics. We hope, within the course of the argument presented in this paper, to remain agnostic on that issue.
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assumes that protability is key to the continuance of an institution, and, more tellingly, it assumes that the non-occurrence of the Civil War would not have affected the protability of slavery, nor would it have set in play any other events that would have over-whelmed the effects of the (non)protability of slavery. Both of these assumptions may be valid in this case, but by making them explicit we see that the co-tenability solution runs the risk of being too static. It ts easily with the view of counterfactuals as describing a world as similar as possible to the actual world at the time under examination, but it may not t so well if ones view is more historical, namely that the counterfactual world must be the outcome of some feasible path from some point in the history of the actual world. We turn now to a discussion of these two views of counterfactual statements.
4 Two views of counterfactuals The philosophical literature contains (at least) two views of counterfactuals: counterfactuals as non-actual possible worlds; and counterfactuals as untaken branches in the tree of history.
4.1 Possible worlds David Lewis (1973 a,b) sees a counterfactual conditional as describing a possible but not an actual world. There are many worlds which in principle could exist, the actually existing world being only one of them. A counterfactual conditional is merely describing another. One might be a world just like ours, but in which R&D spending is 25% higher than it is in ours. Lewiss view is that to do science effectively, which of course involves examining counterfactual conditionals, this alternative world should be as much like ours as is possible, and in fact he describes a formal metric. His exposition is largely ahistorical since within it is no constraint that it be possible to get to the alternative world from some point in our own actual history. It is simply a world running parallel to our own in some alternative universe, and which we examine when doing so might tell us something interesting about our own.12
12 Though he does not develop it particularly, Lewis allows for a more historical version of his theory. In effect, it involves putting non-simultaneous dates into the counterfactual: If the roulette ball had landed on red instead of black last week, then today . . . . Since roulette wheels are deterministic, the antecedent involves a minor miracle if we are to keep the world the same up until the time at which the ball landed. But following the landing of the ball, it seems that many major miracles could be necessary to keep that possible world just like ours. So, Lewis (1974, p. 77) concludes, following the counterfactual landing of the ball, we invoke existing causal (and other) laws, to trace out the consequences. What is less clear is what to do if it would have taken a major miracle to change the colour. Should we go further back in time, (to when the croupier got out of bed perhaps) to nd a (counterfactual) historical path that involves only a minor miracle? If this is the case, then this theory becomes very like a branching theory. Other authors, (see Bennett, 1984, or Jackson, 1987 for example) develop possible worlds theories which explicitly include temporal notions and thus share some of the features of explicit branching theories. For a discussion of possible worlds theories, see Sanford (1989, Ch. 7, 9 and 10).
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4.2 Branching There is a second view of counterfactuals, defended by Jon Elster (1978, Ch. 6), which involves a branching view of history. History is seen as a tree, in which each decision taken represents a branching point. We proceed up the tree, moving higher and higher, never descending, as decisions are made and history unfolds. A counterfactual analysis involves moving back down the tree to some branching point, and examining a branch not taken. Sometime last year a decision was taken about this years R&D budget. The analyst returns to the point at which that decision was taken and asks If at that point a different decision had been taken, how would history have unfolded?. Bring this alternative history up to todays date and ask how the alternative present differs from our own. Given the historical nature of evolutionary economics, and the view that small causes can beget large effects, it seems that the branching view of counterfactuals is more apt. But in its most general form, a counterfactual analysis amounts to postulating that something is different than in fact it is, and examining what follows from this difference. Two difculties arise. What is it feasible to postulate as a difference? How do we tell what follows? The key to addressing both of these difculties lies in there being theory that can be employed in the analysis. Theory connes a counterfactual analysis in two ways. First, it restricts what can be postulated as the counterfactual antecedent. Second, it determines what follows from those postulates.13
4.3 Branching and the role of theory in counter-factual construction The branching approach to counterfactual analysis consists in choosing a branching point in our actual history, and tracing an alternative history that would follow from a different branch having been taken. The branching view is common among economic historians. When discussing the new economic history, Fogel (1973, p. 139) states, In order to determine what would have happened in the absence of a given institution, the economic historian needs a set of general statements that will
13 The introduction of theory in this way runs the risk of introducing circularity of two types. If the aim of the empirical work is to test the theory, in the strictest version of testing, then using the theory to guide the counterfactual construction of history runs the risk of assuming what is to be tested. This risk is not always as severe as it is made out to be. Often the basis of scientic judgement has to do with internal consistency, which is not affected by this issue. The second source of circularity is more abstract. It would undercut the very starting point of counterfactual analysis. Theories can be and often are expressed as law-like statements. As Goodman has pointed out, any law-like statement is equivalent to a counterfactual conditional. Thus any counterfactual analysis which employs theory to guide and restrain it rests on further counterfactual claims (since whatever form the theory is expressed in, it can be re-written as a set of counterfactuals). So to argue that counterfactual analysis in general is acceptable because any counterfactual analysis must be grounded in theory fails as a defence of this form of endeavour. It is equivalent to saying that counterfactual analysis in general is acceptable since any counterfactual analysis must be grounded on a set of counterfactual conditionals. This is problematic if one is concerned with defending the technique itself. We leave aside this concern, assuming that is it better dealt with, and indeed has been dealt with, in the philosophical literature.
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allow him to deduce a counterfactual situation from institutions and relationships that actually existed. Elster (1978, p.181) is more explicit, claiming that there are three conditions that must be met to make any such counterfactual analysis compelling. First, the antecedent of the counterfactual conditional must be feasible in a static sense; that is, it must describe a state that is internally consistent.14 The claim that had railroads not existed, GDP would only be slightly smaller, needs, as one necessary condition, that a world without railroads does not contain logical contradictions. Second, the antecedent, railroads do not exist in 1890 must also be insertable; there must be some feasible historical path from a real historical state that would produce the state described in the counterfactual antecedent. Given the actual history of the world to some point, 1840 say, it must be possible to trace a feasible history which includes no logical or physical impossibilities from that point to the one in which the antecedent railroads do not exist in 1890 obtains. Third, the consequent, GDP in 1890 is virtually the same as it is in our world containing railroads, must be linked to the antecedent by a (dynamic) theory. Theory enters twice. It enters into insertability conditions tracing out a history from a real point, obeying all known laws, to reach the antecedent. It can also enter in the link between antecedent and consequent if they are separated in time. It is clear that all three of these conditions are governed by theoretical considerations: internal consistency is a theoretical notion; the feasibility of a hypothetical history implies that it does not contradict held theories of how the world works; and the connection between antecedent and consequent is, if it is to be compelling, based on accepted causal theories. The importance of the role of theory here introduces what Elster (p. 184) considers to be the basic paradox of counterfactual analysis. The stronger is the theory (that is to say the more it restricts what can happen) the better grounded is the deduction of the consequent from the antecedent, and the tighter is the connection between the (actual) world at the point when counter-facts are inserted, and the counterfactual state under discussion; the tighter the connection, for example between the actual world of 1840 and the 1890-world-without-railroads. But on the other hand, the stronger is the theory, the more restrictive are the conditions of insertability, that is, the smaller is the set of antecedents that are consistent with what we know about the world. Any counterfactual analysis must avoid both risks of vagueness and risks of absurdity. An analysis is vague when the model connecting consequent to antecedent is too loose, or not specied completely it allows too many things to happen. Absurdity arises when the antecedent runs awry of a tight theory, that is, a theory that is highly specic about what can happen, and so when used to examine the counterfactual antecedent, reveals a state that is internally incoherent or absurd.15 The branching view of counterfactuals implies a stronger notion of consistency than the possible worlds view. To logical and physical consistency the branching
14 This consistency condition is common to many theories of counterfactuals, Stalnaker (1968) being perhaps most explicit about it. 15 One potential way around this paradox, which cannot always be employed, however, is to observe that the theory determining whether the antecedent is insertable may be different from the theory used to deduce the consequent, provided the theories are not inconsistent.
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view adds historical (or originary causal) consistency as a requirement. Thus to ask what would be the effect on GDP if railroads did not exist in 1890 is not to ask about the world in the instance that railroads were vaporised on the rst of January 1890, since some of the remaining physical and institutional structures would be historically incongruous. Historical consistency rules that out as an avenue of inquiry, and demands instead that we consider the possibility that they were not introduced in 1840, nor between then and 1890. Notice that this permits or accommodates some looseness in the statement of the counterfactual antecedent. Whether the antecedent is stated as railroads do not exist in 1890, railroads were not introduced in 1840, or any time up to 1890, or railroads were never invented, all demand the same analysis. The same theories apply in each case, assuming the counterfactual consequent in each case refers to the state of GDP in 1890.
5 Counterfactuals in economics One of the strengths of the axiomatic, deductive aspect of neo-classical economics, and something which makes the counterfactual analysis used there seem innocuous, is that the theory is very strong. Its strength places severe restrictions on what can be assumed as antecedents. The primitives of the theory, utility functions and production functions, are tightly constrained by the analytical tradition and demands of rigour: a small number of functional forms is acceptable, and all have similar regularity properties. Thus to a great extent the only possible counterfactual antecedents have to do with changing parameter values in the models. In any model with a unique equilibrium consequents follow very tightly from counterfactual antecedents. In fact the theory has been specically constructed so that consequents follow antecedents by the laws of formal logic or mathematics. Tighter connections are not available even in principle.16 Further, when equilibrium is the focus of the analysis the accepted form of causation is sustaining causation, from which it follows that comparative statics analysis tells a complete story (again see Hausman, 1990). We can place this in the context of Elsters three conditions for counterfactual analysis. Because changes in parameter values are by denition exogenous to the model, they lie outside the scope of economics, and so many changes are acceptable. The only constraints are internal, logical consistency, and that the change not create a violation of the functional form regularity conditions that most models contain. The course of history that produces the parameter changes is exogenous to the analysis, and so an economist has little, if anything, to say about it. Further, since the equilibria are typically unique, all possible histories will lead to the new equilibrium. The link between consequent and antecedent is deductive, which is the strongest kind of link we know. So if the tenets of the theory are accepted, counterfactual analysis will be a very strong tool. It is clear that any deductive science will be able to make very strong counterfactual claims, since theory provides a strong link between consequent and antecedent. If one agrees with the premises of the basic theory, one cannot argue with
16 This should not be read to be saying that therefore the theory is correct. It is simply to point out that if the premises of the theory are accepted, then antecedents logically imply their consequents.
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the counterfactual claims that are drawn from it. Some of evolutionary economics ts this mould. Specically, it is often possible to derive, using an evolutionary model, results about patterns of behaviour. Technology choice models, for example, derive results about proportions of agents using different technologies.17 And evolutionary game theory models typically have this feature.
6 Counterfactuals and evolutionary economics Not all of evolutionary economics can be characterized this way though. Many of the models yield probabilistic results. This is not surprising given the underlying view that many processes are contingent (see Nelson, 1995). Probabilistic results are not a difculty when two conditions are satised. The rst is that there is a deducible relationship between the probability distribution and some exogenous variable (a form of a comparative statics result); and second, that the phenomenon under investigation is manifest in a way that permits estimation of the entire distribution. When both of these are fullled, the counterfactual conditional relating changes in the parameter to changes in the probability distribution can be examined since both are observable. It is common, though, that the second condition fails, and that we cannot observe distributions, but rather a very small number of realisations of the distributed variables. This is typically the case with potential regret results. In the technology choice literature for example, a typical result which is provable analytically is that with non-zero probability, the system will standardise on an inferior technology. When turned into a counterfactual conditional referring to a particular instance we get: Had we standardized on gas-graphite nuclear power reactors, we would now be better off. This claim seems much stronger than anything present in the theory which only claims that if there are enough cases of technology competitions, some of them will have the result that an inferior technology wins. It makes no claims about nuclear power, nor about this particular realisation of its development. If we were to confront the theory with the nuclear power case, what would be involved? On the possible worlds view of counterfactuals, we need to imagine a world in which we simply replace all the light water reactors with gas-graphite reactors, and ask whether it would be a better world. 18 This is the thought experiment of a comparative statics analysis, and makes perfect sense if history does not matter. A (formal, analytic) map from technology-type to net-benets-from-use will be
17 See David and Greenstein (1990) or Foray (1989) for surveys of this literature. See Cowan and Cowan (1998) or Bassanini and Dosi (1998) for more recent contributions that derive results deductively. 18 The answer would almost certainly be that it would not, since the current state of gas-graphite reactors is not a particularly good one. Notice in general that if this is the view taken of the counterfactual conditional, it will be rare to nd examples of dominant inferior technologies. If there were one, why would users not switch? Apart from co-ordination problems, which can in principle be solved by making information public, there is no reason for rational users not to create the other possible world. Thus there cannot be dominant inferior technologies. This is the approach taken by strident opponents of path dependence and in our view involves applying a static possible worlds approach when a branching (or dynamic possible worlds) approach is appropriate. (See for example the writings of Liebowitz and Margolis, 1995 e.g.)
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enough to tell us whether gas-graphite would have been better. An ahistorical map renders the possible worlds approach sensible. On the branching view of counterfactuals, we must go back in history, probably to about 1960, and change several of the decisions made at that point, and then re-write the history to the present. (See Cowan, 1990, for a detailed history of this example). This is the approach taken if historical events do make a difference. And this is the approach appropriate to evolutionary economics in a great many instances. This follows from the presence of positive feedbacks in evolutionary models. Changes in decisions can be magnied, and re-enforced by the system. Again, though, if an analytic map from technology-type to benets-from-use existed, the counterfactual conditional would be strong again, even if history were involved in that mapping. What renders this attempt infeasible, from the point of view of many evolutionary economists, is the importance of randomness, coupled with positive feedbacks. When these are both present, at the level of analysis typically conducted by economists any outcome is under-determined by the data, even in an equilibrium model. A central tenet of Evolutionary Economics (and common to much of evolutionary economics) is that there are many sources of indeterminacy in any economy: the identities of interacting agents, which will necessarily be beneath the vision of the analyst; the process of learning, which is often unpredictable; the presence or details of innovation which are, again, unpredictable, are all examples. This indeterminacy implies that model outcomes (at least the details of them) are under-determined, and further, that the actual determination of them is historical. This indeterminacy weakens the link between antecedent and consequent in the counterfactual. Evaluating it is no longer just a matter of formal logic, it now involves judgement. It is important to notice that under-determination notwithstanding, history is not unconstrainedthat would make investigation impossible. But history is only loosely constrained, since even in a world governed by causal laws, the presence of randomness (or even simply ignorance on the part of the analyst, which means he cannot predict everything) implies that within those laws many things are possible. We argued above that law-like statements can be re-expressed as counterfactuals, and that thereby the investigation of law-like statements will be, implicitly at least, an investigation of counterfactuals. Analysts investigate, therefore, the causal link between antecedent and consequent of the counterfactual conditional. If causation is viewed historically, so will be the counterfactual and so the investigation of it. But if history is only loosely constrained, many things can happen, which means that in all probability there is some link between consequent and antecedent. But many things can happen does not mean that everything happens with equal probability. Nonetheless, the fact that many things have non-trivial probabilities implies that tracing a tight link between an event (or counter-event) and its consequences may be problematic, the more so as the two are removed from each other in time. History unfolds by choosing among alternative possibilities. That is, history makes a choice about what today is like. With every possible today, there is associated a set of possible tomorrows. If agents are learning (often in an unpredictable way) and agents are innovating (in an unpredictable way) and interacting with other agents (in an unpredictable way), the choice of todays state does not place strong restric-
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tions on the set of tomorrows possible states. This means that tracing the effects of a (counterfactual) event becomes less secure as the tracing occurs over longer times. The most compelling counterfactual analyses exist when the theory on which they are based is tightest and most restrictive about what can take place. One of the intuitive strengths of evolutionary economics is the premise that in a system as complicated and complex as any modern economy must be, any theory that too tightly constrains what might happen will leave out very important aspects of economic activity. But this makes counterfactual analysis very difcult. If history matters, then counterfactual analysis will often be historical. Without severe theoretical constraints on what history can produce, though, the analysis runs the risk of being far from compelling. We can summarise this section briey. To accept a counterfactual conditional we demand an argument that it is possible to infer the counterfactual consequent from the counterfactual antecedent plus auxiliary conditions. This inference must be causal, so causes and the causal structure must be understood (Goodman, 1978). Hausman points out that for a comparative statics analysis to be coherent, the economist must believe that there is a process that would connect the states before and after the change in the exogenous variable. He argues that for a variety of reasons this process is not of particular interest in general. But, as Tunzelman (1990, p. 296) argues, counterfactual histories represent an empirical working out of comparative statics, that is, they are an explicit rendering of Hausmans process. Evolutionary economics contains a general belief that the process between initial and nal states is important, due to the under-determined nature of outcomes, and so counterfactual history will be an important part of explanation. To come to the same conclusion from a different direction, we note that virtually all sciences embrace some form of causality, and use that notion as part of their explanations and to support their predictions. For Evolutionary Economics, since it is generally accepted that cause refers to originating or genetic causes and that the causal structure is temporal or historical, the argument supporting the counterfactual conditional will necessarily be temporal or historical. But one of the underlying beliefs of many evolutionary economists is that outcomes are under-determined; in general any basic data present more than one possible outcome. Thus theory does not tell us what will happen, it only restricts us to a set of possibilities.
7 Evolutionary economics and counterfactual history The discussion in the previous section seems to be driving toward the conclusion that since empirical counterfactual analysis is so difcult to perform convincingly in evolutionary economics, this branch of economics is fated to be either nonempirical or mere story-telling and therefore highly speculative, and presumably of little practical value. In this section we argue that we need not be driven to this conclusion. We present four different routes away from it three in practice, and one in principle.
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7.1 Weak counterfactuals and appreciative theorizing Counterfactual analysis can be used to buttress theory. The aim of appreciative theorizing is less to formalise general laws, which could be used in predicting the future, than to use general, well-understood theoretical concepts to understand either the past or the present. 19 Evolutionary economics takes almost as a precept the idea that understanding is necessarily historical. Thus to understand the present we must know and understand the history that brought us here. As time passes, the economy is continually eliminating future branches, and thereby producing the present. Understanding this process involves showing either that there were no branching points, and thus the present state is inevitable given the starting point, or identifying the branching points (those at which there was a non-trivial probability of taking a different route), and showing why the economy followed the route it did.20 We refer to this exercise as one of weak counterfactual history, since it involves minimal knowledge or assertions about the non-actual branches. In this regard it is only necessary to argue that the branches not taken would lead to a different present.21 Even more generally, weak counterfactual analysis is restricted to understanding the major events and chains of decisions which, coupled with processes that magnied rather than damped their effects, can be considered as having played a role in disconnecting some sub-regions of the tree from the branches followed by actual history. Advantages of a weak counterfactual argument are clear. Accepting its goals renders Elsters conditions less important, and thus permits economists to treat a large number of problems in those terms. Drawbacks also seem clear however. Weak counterfactual analysis does not give welfare results, and in a sense can only argue that the actual outcome is not the only possible one. This does permit the claim of potential regret, but cannot assert more; it will not make a case for actual regret (see Foray, 1997). For that we need something stronger. 7.2 Strong counterfactual analysis Appreciative theorising, or appreciative analysis more generally, is sometimes considered not enough. In particular, economists are often concerned about making welfare comparisons between two different states. This exercise involves knowing something about the nature of both states. It is difcult enough to know about the actual present. But to compare it to a counter-factual present can be extremely tricky. If, following the arguments given above, we adopt the branching view, rather than the non-actual possible worlds view of counterfactuals, this comparison is made
For an example see Malerba et al. (1999). It is immediately clear that such an approach excludes one view of counterfactuals, namely counterfactuals as non-actual possible worlds. The point of the exercise is to show that certain historical events contributed to forming the present state, and that had different branches been taken at some point in the past, we would be at a different present. 21 It is possible that this argument may be difcult in certain cases, but in general to have identied a branching point is to have identied a moment when one future is eliminated.
20 19
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more difcult as we must compare our state not simply with another state having minimal variations from it, but rather with the state that would exist now following some counterfactual change at some point in the past. The obvious difculty of the exercise is that strong counterfactual analysis consists of (re)-vitalising something that did not happen.22 In contrast to weak counterfactual argument, the restrictions discussed above must be given much more consideration in the analysis. The theory or principles employed in strong counterfactual argument must, therefore, i) constrain the world of potential developments; and ii) use strong laws on the basis of which both to construct and to develop the alternative paths selected from the set of possible paths. The rst principle is relatively easy to illustrate. Consider the hypothesis that environmental problems would be less severe if the internal combustion engine did not dominate personal mobility technology. There are, currently, four serious possible automobile propulsion sources: internal combustion; lead-acid, or more advanced batteries; fuel cells; and hybrid battery-internal combustion technology. An argument that internal combustion is an inferior technology (on the environmental criterion) could only be built using as competing technologies steam and lead-acid batteries. This follows from the fact that the important events determining the outcome of the competition took place at the turn of the century, and the fuel cell technology did not then exist as an automobile propulsion source. Thus the important branching point in the history was a three-way branching in which the internal combustion branch was taken. This is related to Elsters insertability criterion. The fuel cell option is not insertable at the crucial point in time.23 But this is, rather than a weakness, a strength of the analysis. A small set of options implies that a small number of branches need be traced to address the issue of whether the present state is an optimal one. Bifurcation points with few branches make the case for regret stronger, by deriving it from a point with relatively few options. The second condition, that counterfactual history be based on strong laws, is more difcult to illustrate. A causal story is simplest and most compelling when there is a single causal factor that clearly dominates all other considerations. In this case a relatively tight link between antecedent and consequent can be drawn, because the construction of the chain of events is tightly controlled and constrained.
22 It is worth pointing out that facts about paths not chosen are often available. When this is the case, analysis is considerably facilitated. In many cases of apparent total technological standardization, for example, small islands of the non-standard technology can be found. These islands can be used as sources of information about how the technology might have developed had it been more extensively used. Another case might be a particular industry that had different trajectories in different countries or regions: the cotton industry in Texas and Mexico, which were very similar to each other at one point, adopted different strategies for pest control with dramatically different results (Cowan and Gunby, 1996); for a similar case in ferrous casting in France and Germany, see Foray and Gr bler (1989). Thus u counterfactual analysis is not necessarily analysis without facts. 23 It is possible that on a different history the fuel cell could have been available in 1900. But to make this counterfactual analysis would involve going back yet further in time to nd a point at which research on fuel cells could have been taken up. Elster uses this notion to create a measure of difference how far back in history do we have to go to trace a feasible path to the counterfactual present we wish to examine?
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The law must be strong in two senses: it must be general (that is to say, robust) and important. Generality is straightforward. The law must cope with a variety of spatial and temporal contexts. Many macro-and micro-economic laws are general in this sense.24 The other dimension, importance, is less simple. We need a law important enough to cause the counterfactual construction we base on it to be, in effect, isolated from the inuence of other laws. It must be over-ridingly strong. It clearly follows that the strength of a law cannot be dissociated from the context of the enquiry. Network effects, for example, can create forces which underlie a strong law in the eld of telecommunications technologies. But these same forces will not be important enough to build a counterfactual history about, for example, regional polarisation, since it is not plausible that the dynamics generated by network externalities could be isolated from the effects of transportation costs, infrastructure externalities, local labour markets and so on. In this dimension, importance implies that the ceteris paribus clause can be plausibly invoked. There is another problem which must be faced, namely the risk of circularity. Any economic system, agent or phenomenon will have many forces acting in or on it. The discussion immediately above had to do with identifying and examining the effects of the strongest forces. This implies that forces can be identied as primary or secondary. Concentrating attention on primary forces (of which one hopes there are few) connected to strong laws will not generate misleading results. The identication of primary and secondary forces is one typically done in the abstract, or theoretically, and here lies the possibility of circularity, or perhaps assumption of the result. Evolutionary theory, in common with other theories of complex systems, typically has the feature that positive feedbacks, and the interconnections between different parts of a system, can magnify what appear to be secondary considerations into primary ones. Unfortunately, determining whether or not this is a relevant consideration can only be done using counterfactual history. So again the very feature that makes counterfactual history a vital tool makes it a tricky one to use. We can see this in the discussion of Robert Fogels (1964) work on US railroads. One central issue of Paul Davids (1975) criticism is that Fogel ignored this possibility. Fogel made a priori judgements about which forces were primary and which secondary, and then showed that when the primary ones were considered, US railroads had a certain effect on GNP. One interpretation of Davids arguments is that if the forces considered secondary were put into a complete counterfactual history, they would have been acknowledged to be as important as the primary ones. 7.3 Stronger theory to contstrain counterfactual analysis We have just argued that whether or not a law is strong depends on context. This might suggest that a general change in context could have the effect of increasing the strength of laws generally. In other words, it may be possible to make strong counterfactual history more compelling by looking at theory slightly differently, reconsidering what questions are feasible, what count as respectable answers, or
24
On the issue of robustness of economic laws, see Kindleberger (1989).
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what phenomena it is appropriate to analyse, if these have the effect of making the theory in general stronger. If, for example, the theory is seen to be more deductive, and in particular more deterministic, this reduces the anything can happen problem. But because of the underlying tenets of evolutionary economics, to adopt such a strategy implies thinking about economics problems in a slightly different way. Neo-classical economics attempts to make predictions of the behaviour of economic agents, either as individuals or as aggregations. In models of perfect competition all agents are innitesimally small, and thus as individuals have no inuence on outcomes, so deducing market outcomes is facilitated by there being few public effects of individual actions. At another extreme, we observe models with few enough agents that all can be traced and the non-anonymity is tractable. Evolutionary models, though, often have a large but nite number of heterogeneous agents in them, and these agents are affected by each others actions. When this is true, a detailed prediction of agent behaviour is simply not possible.25 It is this large population of heterogeneous agents, interacting with and affecting each other, that causes the serious under-determination of evolutionary models. Even if there is no ontological uncertainty, epistemological uncertainty can be extreme. Whether or not under-determination is important, though, is crucially dependent on the level of analysis. Where in the world it will rain today is certainly underdetermined by my knowledge of the weather system. That it will rain somewhere is not. And with a small amount of research one could almost certainly predict fairly accurately how much rain will fall today. Thus we can reduce considerably the degree of under-determination simply by changing the level or nature of analysis. While the details of the actions of individual agents may be under-determined, general patterns of behaviour may not be. This was an idea present in the work of Hayek (1967, for example), and based on roughly the same arguments there is too much information present in the economy to be processed by any analyst. Any agent will have more or different information than any analyst, thus the goal of predicting detailed agent-level behaviour is un-reachable. There will be general tendencies, however, which are predictable, due, in effect, to the central limit theorem. Consider models of rm location. A rm chooses a location based in part on the locations of other rms. Locating near another rm on the one hand permits encroaching on its market, but on the other reduces ones monopoly power. In early models of such a system, (Eaton and Lipsey 1975, is a good example) the question was where rms would locate in a certain space. It quickly became apparent, though, that in many models attempts to expand beyond very small numbers of rms, or beyond one dimension, created intractable problems, partly because of the economic process involved. (Note that the goal was not to ask where a specic rm, Firm A, would locate but rather a weaker one, whether there would be any rm at all at some location X). The question was un-answerable, possibly even in principle. A different question, though, and one which involves a different level of analysis, is whether rms will cluster or spread out. This is of course related to the central issue in Hotellings (1929) original paper. It is also possible to ask how large clusters will
25 It is inconceivable that the analyst could get enough information, and even if he could get the information, he would not be able to process it.
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be, and how close together they will be. Here the questions do not refer specically to rm behaviour, but rather to the properties of the system as a whole, and in particular the pattern or distribution of location. It is possible to address these questions analytically. By changing the unit of analysis we have recovered strong theory and the analytical results that are produced using deductive tools, yet the models underlying these results retain the evolutionary processes inherent in the economic decisions made by rms. A second approach to making evolutionary theory tighter is to make the analysis statistical. The interacting agents literature models large numbers of (heterogeneous) agents who interact both within and outside the market. Population properties evolve as agents respond both to their own past actions and to the actions of other agents. Here, theory seeks to make predictions about statistical properties of populations rather than about the properties of individual agents (this literature is reviewed in Kirman, 1996, and Durlauf, 1996). Schelling (1978) refers to analysis which explores the relationships between behavioural characteristics of individuals and those of the aggregate. Developing counterfactual arguments is dependent on our ability to calculate aggregate data as determined by individual actions. This is indeed possible for some classes of social and economic interactions. Schelling uses a simple example to illustrate: if we know that every driver, on his own, turns his lights on at sundown, we can guess from our helicopter we shall see all the car lights in a local area going on at about the same time. (Schelling, p. 13). In more complex cases, however, agents behaviour or agents choices depend on the behaviour or the choices of other agents; and those situations often do not permit any simple summation or extrapolation to the aggregates. Then counterfactual constructions must look at the system of interactions between individuals and their neighbourhoods. Both approaches, by changing the focus of analysis, produce strong theory and analytical results. They both reduce the historicity present in the abstract research, and permit counterfactual analysis which is more like comparative statics in appearance. Tight theory and tight counterfactual conditionals are possible. 7.4 A different criterion by which to judge the success of an analysis? There are occasions in which strengthening the theory to make its predictions more precise in one of these ways is the right approach. But there may be phenomena for which it is not appropriate, and some looseness in the theory, and consequent looseness in the counterfactual empirical claims is either desirable or necessary. When this is the case, the arguments given above indicate a problem for empirical evolutionary research. It may fall prey to the fairly common view that while the theory is pretty good, empirical evidence is frequently weak. But this may be too hasty. One can only judge empirical endeavours of an approach by standards appropriate to them; standards to judge success must be consistent with the task undertaken. Intuitive arguments against counterfactual history by and large suppose that it tends to be based on theory which is so loose that it allows anything to happen. If one changes the past one of course can change the present. Any counterfactual claim
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can be asserted given the weakness of the theory involved. Therefore, because the results are loose and are based heavily on the judgement of the analyst, they are of little (or no) value. But this argument is to say that this apple makes bad orange juice. Much of economics has opted for an axiomatic approach involving deductive theory. Counterfactual conditionals are deduced under standard assumptions, and empirical investigation involves checking the values of parameters (traditionally, checking only that they are of the right sign). Predictions about behaviour are arrived at deductively, and are supported by nding an elasticity in the right range. Is the measured elasticity of patenting with respect to R&D spending large or small or negative? Answering this question can corroborate the theory with which the question was generated. The argument is of the form, If assumptions 1 through n hold, then the elasticity of patenting with respect to R&D is large. Measuring the value of the elasticity can provide very strong indications regarding the theory and whether the theory is valuable in understanding innovation.26 When counterfactual conditionals are not (formally) deduced from axioms or assumptions, or when the analysis generates multiple or possibly innite equilibria, this simple argument form is not available. Knowing an elasticity neither proves nor disproves the theory, nor does it permit one to predict the future. The latter follows from the under-determination typical of the approach we are considering. If one opts for a non-deductive theory, empirical analysis will be of a different nature, and it follows that the criteria by which it is judged will also be different. In particular, the assertability of a counterfactual necessarily rests on a different type of argument. A simple statistical test will not, in general, provide the empirical arguments that buttress a theory, simply because under the tenets of evolutionary theory, the counterfactuals that emerge are necessarily historical. To reject evolutionary theory on the grounds that it provides no identiable statistical tests but rather merely the opportunity to tell stories, involves rst justifying the criteria by which it is being judged. Loosely, what empirical work does is to confront theory with the facts. But even Popper admits that the notion of a brute fact, that is, a fact that exists independent of some held theory, is not tenable (see Hollis, 1994, p. 76; or Feyerabend, 1988, p. 155). All facts or observations are theory-dependent; what counts as or constitutes a fact will depend crucially on the theories one holds. This implies that the criteria we use to judge a theory on empirical grounds will also be theorydependent.27 To argue that the theory is weak because it provides no testable hypotheses, where the denition of testable hypotheses follows from the milieu of deductive theory, demands rst a justication of the use of deductive theory. This has yet to be
Recall the stricture that in fact knowing the elasticity does not prove the theory. The only strong statement we can make is that if the elasticity is not large the theory is wrong. This suggests that even on its own criteria, if strictly applied, the empirical evidence in support of much economic theory is fairly weak. 27 We are not arguing here that it is therefore impossible to compare theories (see Kuhn, 1962), rather we are arguing that assertions about the strength or weakness of empirical evidence for a theory must take into account what it is possible to produce as evidence, and how that sort of evidence ought to be judged.
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provided in economics (or, arguably, anywhere else for that matter; see Feyerabend, 1988). To reject particular instances of the analysis as having failed to pass the test of empirical evidence involves accepting the standards of evidence that are implied by the theory itself. If you accept the theory, then you must accept its denition of a testable hypothesis. The idea that you can separate the two was given up with the death of the theory-observation distinction. Arrow (1995, p. 21), suggests that The theory is pretty goood, the empirical evidence may be by denition pretty hard to come by, not just as a practical matter. Indeed, the argument above suggests that creating a robust empirical case for an evolutionary model will be a challenge due to the very nature of the theory. This may make the empirical evidence for the theory appear weak. And perhaps by the standards of axiomatic, deductive analysis the empirical evidence is weak. But if you admit that the theory is pretty good, you must accept that the theory itself implies that empirical evidence will take a certain form, from which it follows that certain standards apply when judging that evidence. The standards developed to judge empirical evidence when the underlying theory is axiomatic and deductive do not necessarily apply to other types of theory. Different standards do. In the context of a path-dependent, evolutionary economics, whether or not a counterfactual conditional is accepted as empirical evidence depends not on the statistical signicance of parameter estimates but rather on whether an historical, causal explanation is compelling, and thus whether the counterfactual is assertable. The evidence looks much stronger when judged on its own grounds. References
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J Evol Econ (2002) 12: 539562

R. Cowan and D. Foray

For a similar discussion of the same issue see David (1997).