Niches and transitions in complex adaptive systems
The year 2020 will be marked as eventful in history. The surprising onset of a tiny virus caused a global pandemic; a bear emerged in the stock market. Future generations will ponder those numbers and figures logged in Wikipedia as we are absorbed by them today.
Naturally there has been much talking of a recession. Will the post-pandemic recovery be U- or V-shaped? Could we get into another Great Depression? Following a Keynesian approach, governments poured out money with an unprecedented magnitude quickly to save the economy. The effectiveness of these gigantic rescue efforts remains to be seen; their impacts will manifest in coming months and years.
Meanwhile, the Coronavirus crisis provides an opportunity to re-examine the fundamental mechanisms of recessions. There are different theories, but economists still don’t agree on their causes. While Keynes was right about the effect of demand and that government interventions are necessary to boost demand for restarting a depressed economy, Schumpeter saw deeper and more clearly about long-term economic transitions resulting from technological change.
The complexity science has something to offer. We can connect Keynesian and Schumpeterian views from a perspective of complex adaptive systems. We can examine change of niches to explain Schumpeter’s creative destruction and transitions in complex systems in general. Doing so we arrive at a better understanding about the fundamental mechanisms of recessions. I look back at three major recessions in the 20th century to illustrate these mechanisms.
In the light of the new understanding about the mechanisms, we will be able to see how the Coronavirus crisis is different from regular recessions and yet may develop into one and what short-term interventions might be effective. It will be shown that recessions are embedded in the capitalist economy, and reduced demand is not the cause but a symptom of recessions. Therefore, government spending is a symptom-based cure to recessions; a more fundamental approach to mitigate their potential impacts in the long run is needed. I will discuss what could be done for long terms.
Amid the Coronavirus crisis, I dug out some writing I did six years ago and read Schumpeter’s Business Cycles and Creative Destruction. I am glad to find support from his work, and this is a revision of the old piece.
The thesis
Technological change is the fundamental driving force for long-term economic transitions which inevitably lead to structural change in an economy and recessions – although this force is largely playing on the background, while speculations in the financial markets play an indispensable part – this is also why each recession always started with stock market crash. Both are inherent in the capitalism system and are inseparable.
Niches and creative destruction
Complex adaptive systems (CAS) comprise of heterogenous agents that act and interact locally to give rise to macro-level structures and patterns. Agents in CAS adapt over time responding to other agents’ actions and changes in the environment. Thus, a CAS is path dependent, and its evolution is important for understanding its present state. Because of interactions and adaptation of agents, such systems usually exhibit nonlinearity and are rarely in equilibrium though they may at times appear to be in a quasi-equilibrium. There are multiple basins of attractions that a system tends to move toward and can make abrupt transitions between critical states. There are also feedback loops: negative feedback loops tend to bring a system back toward equilibrium, and positive ones drive it away from equilibrium.
Complexity scientists have largely focused on examining macro-level agent actions and interactions to explain macro-level structures and patterns. Here I look at niches at the meso level – resulting from micro-level actions and interactions of agents – to explain transitions of complex adaptive systems.
John Holland discussed various definitions for niche in Signals and Boundaries: Building Blocks for Complex Adaptive Systems. He was interested in explaining the general mechanisms for niche formation and change and defined niche as “a tangle of local interactions with recirculation, allowing resources to be used over and over again.” He applied a model of Bandits with Queues to examine agent interactions and explain the emergence of niche-related phenomena, such as carrying capacity, crowding, competitive exclusion, and “multiplier effects” resulting from reuse of resources.
Here I define niche differently from John Holland and more in line with Brian Arthur’s as discussed in The Nature of Technology: niches are potential opportunities in a system that can be explored by agents for survival. If a niche is eventually occupied by an agent who survives, we call it realized niche. I place change in niches – formation of new niches and destruction of realized niches – at the center of the dynamic mechanisms that drive state transitions in CAS.
Tropical rainforests are a prime example of complex adaptive systems. The nutrients in a tropical rain forest are very poor due to heavy rainfalls. The organisms in a rainforest have developed a range of complex interactions to survive in the rainforest. Insects, bacteria and fungi convert dead plant and animal matter into nutrients which are absorbed by plants and trees which in turn produce fruits and seeds in addition to leaves for the animals. Because of such interactions a large array of organisms and species have established niches that are mutually beneficial, and the nutrient-poor rainforest is able to support and sustain tremendously rich lives.
This picture of a rainforest is, however, only a snapshot of the ecosystem after niches have been realized; it takes a long evolutionary process – which we cannot observe today – to arrive here. We get a better understanding of niche formation and change by studying ecosystems under disturbances. The extinction of the large blue butterfly in Britain illustrates that introduction of new species to an ecosystem can lead to a cascade of change, destroying realized niches for some and creating new niches for others.
The large blue butterfly thrived in dry grasslands and had a rather unique way to reproduce. The female laid an egg on a flower bud of wild thyme. After hatching, the lava fed on the flowers and seeds before falling to the ground where it induced an ant – by a secretion similar to that of ant larvae – to bring it to that ant’s nest and feed it till about a year later the caterpillar matured and emerged to the surface as an adult.
The ecosystem of dry grasslands includes other plants, of which woody shrubs compete with grasses for spaces, and supports other animals like rabbits. To control growing populations of rabbits, the myxoma virus was introduced in many parts of Europe and worked wonders to rid of rabbits very quickly. But certain grasses also declined, overgrown by woody shrubs, because browsing of rabbits had promoted the growth of the grasses. It was in the roots of the grasses that ants built their nests. The decline of rabbits thus led to the reduction of the grasses and ants, which eventually led to the distinction of the large blue butterfly.
Creation and destruction of niches in ecosystems occur from time to time. Usually a system goes through reorganization till a new equilibrium – more accurately, quasi-equilibrium – achieved, under which the system could contain a different group of organisms and species that have established their niches through a set of new interactions.
Niche formation and destruction happens at large-scale evolution too. The rise of humans (enabled by distinction of dinosaurs) had destroyed niches for large mammals in north America. In fact, we have been dramatically modifying the biosphere, removing other species at unprecedented scales by destroying their niches. When we remove one species in an ecosystem, it can cause a cascade of change, driving the system transition into a different state. This has been happening to ecosystems across the world, leading to ecosystem degradation, which feeds back to affect human well-being; the sustainability endeavor is essentially about preservation of ecosystems and ultimately human well-being.
The history of life is punctuated by sudden explosions of lifeforms and mass extinctions. The Cambrian explosion that led to the emergence of most animal phyla is still a great mystery. While in the Pre-Cambrian Period the biosphere was dominated by bacteria and other simple single-celled organisms for 3,900 millions of years, most basic animal body forms came into being in just 10 million years between 530 and 520 million years ago. There is no consensus on the causes for this “big bang.” A possible explanation is that once the basic body form emerged, it opened up tremendous possibilities for variations and thus potential opportunities for new phyla; the Cambrian explosion resulted from the exploration of these niches.
At least five mass extinctions marked the history of life. The fossils found in the Ediacara Hills in South Australia demonstrated extinction of Precambrian organisms with multicellular forms. In fact, about 99.95% of all species that had appeared on earth have become extinct according to fossil records. The paleontologist Peter Ward said, “Extinction is the fate of all species.” What happened with each extinction was that those niches occupied by the species were destroyed. It could be due to the rise of other species, environmental changes in our planet’s biosphere, or external disturbances like meteorites. While destroying old ones for some, environmental changes and external disturbances always create new niches for others.
The evolutionary biologist Van Valen emphasized the biological origin for extinctions. He saw evolution as a process in which species change just to remain in the evolutionary game; extinctions occur when no further changes are possible to a species. Experiments with bacteria reproduction in the laboratory show that periods of stasis followed by rapid changes after a new form was introduced to the bacteria population were quite common.
For a great discussion on evolution and extinction, see Solé, R. V., & Goodwin, B. C. (2000). Signs of life: how complexity pervades biology. Basic Books.
Similar processes occur in economic systems. When an important technological innovation occurs, it can open up possibilities and opportunities for a slew of economic activities, and further innovations will happen when these niches are explored. Meanwhile, as new niches are realized, old ways of doing things become uncompetitive, and those niches associated with them are either significantly reduced or entirely gone.
The creation and expansion of niches associated with a new technology and the destruction and suppression of existing niches associated with older technologies can well explain Schumpeter’s creative destruction.
We know at the very beginning of the industrial revolution how mechanization and factories significantly improved productivity over manual work, destroying the cottage industry in the UK. Consequently, many weavers lost their jobs because the niches they used to occupy were suddenly gone. The industrial revolution comprised of a cluster of innovations that transformed the Western economies.
In more recent history the invention of the automobile did not only revolutionize transportation systems but also created potential opportunities for a range of businesses: production of parts, car dealership, maintenance and repair service, highways and roads in general, fuels and gas stations, fast-food restaurants, drive-in movie theaters, motels, and housing in suburbs. Gasoline demand from automobiles propelled a petroleum industry. When Ford made the Model T affordable to a majority of the public, the impacts of these new niches began to manifest at a large scale. But the invention of the automobile also destroyed or suppressed niches for other businesses: bicycles, horses and carriages, railways and trains.
In our time the invention of computers created needs for all sorts of software systems, giving birth to an entire new IT sector. It changes how things work in all other sectors and industries, revolutionizing our entire economy. Computer-controlled or computer-operated systems are replacing workers in factories, warehouses, transportation, stores, and even chefs in restaurants. As these niches have been explored and realized, overall productivity has been improved, creating tremendous amount of new wealth for some and society as a whole. Meanwhile, those who don’t have IT skills find their niches vanished or vanishing.
A complex network of niches created and affected by invention of computers.
The internet and smart phones were important later innovations made possible by the invention of computers. The internet has further altered the fundamental way of our lives, enabling online banking, online shopping, online entertainments, online socializing, and teleworking. Physical stores are disappearing, and people are not going to movie theaters as frequent as before. CDs and DVDs will soon vanish, so will CD and DVD players. Smart phones are replacing personal computers for many in China, and Chinese smart phone-based payment systems leave a credit card industry completely out. The internet and smart phones are also connecting people in entirely new ways, which already created new businesses like shared vehicles and will continue to create more person to person business transactions; this may destroy traditional ways of business organization. There is even a new money form bitcoin; I will leave it for you to imagine its potential revolutionary impacts.
The creative and destructive effects brought by computers are unprecedented in breadth, depth, and prospects. The impacts are so dramatic that it’s probably more appropriate to say there have been multiple interconnected waves of innovations associated with the invention of computers. And this cascade of technological innovations is still unfolding. As the IT revolution continues, old niches will continue to disappear.
In comparison earlier waves of innovations, such as automobiles, electricity, and railroads, had relatively smaller destructive effects because there was relatively little in the economy to destroy yet. They also created jobs for many, and their impacts were mostly constructive and positive. The great economic expansion from the end of World War II to the early 1970s resulted from realization of niches brought by such innovations, and that expansion produced a strong middle class – the backbone of the Western economies.
Since the industrial revolution started, economic productivity has grown dramatically driven by waves of technological change. Each wave includes a cluster of innovations, large and small, led by a key technological innovation. Each wave and sometimes multiple interconnected waves push the economic system up a stair on a ladder.
Theoretical economic growth curve – if all other factors had been constant over time. Each technological revolution brings the system to a higher plateau and at a faster speed.
We may even consider tool making as the first technological revolution that had led to the rise and dominance of homo sapiens over other species, with the second revolution occurring when hunter-gathers settled to sedentary agriculture. But before the industrial revolution, innovations all came from natural experiments, and that was a long slow process. We may also consider innovations in automobiles, electricity, railways, and airline industry as a continuation of the early industrial revolution, and together they formed multiple interconnected waves that propelled the tremendous growth of the industrial sector, before the IT revolution kicked in. The latter three technological revolutions created an agricultural, industrial, and IT sector, re-orienting major economic activities around the new sector.
Since a key new technology creates a network of niches for economic activities, causing a cascade of technological innovations, economic growth associated with each revolution is nonlinear. The height of each stair on the ladder is largely determined by the size and complexity of the network of niches associated with each revolution. The industrial revolution in the broader sense (including later industrial innovations) brought about a much larger network of niches than the first and second revolutions, and the IT revolution creates still more complex networks of niches.
It takes time for new niches to be realized and filled up. But eventually this will happen, and when this happens, the effects of technological change will have been largely absorbed by the economy; the system reaches a plateau, and stagnancy could set in.
This is where Keynes’s demand thesis comes into the picture. When the economy has largely absorbed the effects of technological change, destruction of niches in older sectors or industries happens, and a large segment of people can become unemployed. This reduces consumption, which in turn affects production, profits, and wages in other sectors and industries, which leads to further reduction in consumption, which again feeds back to the system, pulling the whole economy down to a trap. To get the system out of the trap, interventions are necessary; government spending can boost consumption and help the system move again.
Linkages and feedbacks in an economy. It is when the interconnections between these parts go wrong that an economy becomes sick. Technological innovations disrupt the system creating positive feedback loops that drive the system away from equilibrium.
Stock market crash further reduces the wealth of both unemployed and employed, exacerbating the economic conditions. There is more to say about the stock market and the financial sector.
The good and bad of money
When a new technology comes into the far horizon, it is impossible to know precisely the right amount of investment; this is essentially a problem with incomplete information and uncertainty. Over investment occurs naturally amid the hype of high returns. A bubble is thus created and will eventually burst as the technology matures and materializes. The burst of the bubble acts sort of like natural selection to get rid of those inefficient firms. This is a necessary part of economic growth, and its harm is usually confined to a relatively small number of firms and workers and investors.
But speculative activities in the financial markets always accompany each round of investment in new technologies. They greatly inflate the bubble created by natural over investment and can bring tremendous damage when bubbles burst.
And once financial markets become a platform for speculation and financial speculation a means to make money – we are talking about a huge amount of money, manipulation can occur with dire consequences.
As a financial sector grows large, it may even need to create its own investment opportunities in order to sustain the sector. In retrospect, the housing bubble in 2008 can be considered as an example of this: following the dot-com bubble’s burst, there were no immediate places to park capital, and banks created their own opportunities in financing houses to unqualified customers.
The economic powerhouse of capitalism comes from coupling of innovation and capital within a general framework of private properties and free markets. Capitalists and entrepreneurs were already married through the financial markets at nascence of capitalism; the tie between the three has become tightened due to increasing mutual interests.
As waves of IT innovations left many behind, economic inequality rose sharply. The stock and financial markets further inflated that inequality, and the middle class is shrinking. The economic inequality does not only feedback to affect the economy but also poses a political risk.
Rethinking the Financial Crisis (2013) compiled new empirical data on the growth of the financial sector and its relationship with economic inequality and many of its innovative manipulative practices. The volume was edited by Alan Blinder (the Gordon S. Rentschler Memorial Professor of Economics and Public Affairs at Princeton University), Andrew Lo (Charles E. and Susan T. Harris Professor at M.I.T. ), and Robert Solow (Institute Professor, Emeritus, at M.I.T.).
The Nobel winner economist Joseph Stiglitz has written a series of books that illuminate the causes of economic inequality and its social, economic, and political consequences.
Recollecting and refreshing our memories
Let’s take a look at how these two forces played out in three major recessions in recent history. Each wave of important technological innovations gives rise to a new sector or industry, driving economic growth. As the new sector or industry becomes the forerunner of the economy, older sectors and industries are rendered relatively less important and fall to the background becoming the routine part of the economic life. (Innovations continue to happen in the older sectors and industries but usually at a small scale.) Major and great recessions occur when the impacts of important innovations manifest to a large extent, leading to structural changes in the economy. This economic transition produces winners and losers.
When there was a significant structural change coupled with heavy speculation, we got a great recession or depression like that in 1929 and 2008. In such cases, usually a huge investment bubble bursts creating a financial crisis, which exposes and exacerbates the problems of the structural change. The economy would fall to a trap due to positive feedbacks and interconnections as we explained earlier. Overly heated investment and extensive speculation in dot-com companies associated with the birth of an internet industry produced a major recession in the 1990s.
Since 1929 there have been eight bear stock markets in addition to these three that were involved in major and great recessions. Those eight bears led to minor recessions that were associated with overinvestment and speculation on minor innovations and specific technologies.
Schumpeter distinguished three types of cycles based on duration: Kondratieffs, Juglars and Kitchins. Kondratieffs are long waves of about fifty years; Juglars are intermediate waves of about nine to ten years; and Kitchins short waves of about forty months. He took much pain to illustrate these cycles using historical data.
But there are so many factors contributing to economic growth, and it is also hard to separate waves of innovations. Ignoring the specific number of years of duration, we might say in general long cycles are produced by a revolutionary technology that creates multiple interconnected waves of innovations that engender a whole new sector, Juglars by major innovations that could result in a new industry, and Kitchins minor innovations perhaps linked to a specific technology within an industry. The Great Depression and the Great Depression are associated with Kondratieffs, the dot-com bubble Juglars, and the other eight minor recessions Kitchins.
How well will we survive the Coronavirus crisis?
The Coronavirus induced an abrupt reduction of business activities in certain industries, which can reduce general demand and affect other industries. On the surface this is very much like what happens with major recessions. However, there is an important difference: those economic niches destroyed in regular major recessions are lost forever, but niches affected by the pandemic are still there, though specific businesses to fill those niches and the way to operate businesses may change after the pandemic. Therefore, the prospect is not as dreadful as the Great Depression. Yes. There will be a painful time ahead, and its length and the degree of pain has to do with how we handle the pandemic.
That how bad this recession will be really depends on whether affected businesses will be able to restart easily and when they will get back to normal. A short-term ER treatment should facilitate affected businesses to restart easily and quickly get back to normal.
Think about a patient with a temporarily paralyzed leg due to an error in anesthetic use, or in a coma induced by an unusual shock. What a doctor can best do is to help the patient preserve the basic functioning of the body so that once anesthesia expires or the shock is resolved, the body will start functioning. There will a period of adjustments, but it should be manageable.
The European countries’ therapy seems right. By subsidizing businesses to pay their employees, the government helps businesses maintain their structure and assist people to overcome financial difficulty as well. Once the virus is under control, businesses can restart and function as usual. On the other hand, if affected businesses can stay basically intact through the Coronavirus crisis and people without financial difficulty, and the pandemic does not last long enough to significantly reduce general demand, no need for heavy stimulus packages.
So far I have described an optimistic prospect, but there are serious risks that the post-Coronavirus recovery may become a lengthy recession. The reduction of business activities in industries affected by the virus crisis can spread to and affect other industries significantly if the pandemic lasts long. We still have a large segment of people left behind from the IT revolution and globalization; their economic situations have not improved much since 2008. A bubble has exploded in the stock market writing off a chunk of money for many. How large was that bubble? The unprecedentedly long bull market before the Coronavirus crisis might suggest something about it. Businesses may not be able to restart easily and quickly, and some may never come back. For sure, those will be replaced by others and even other types of businesses, but reorganization will take time and produce pain.
Most dangerously, all these together could create rippling risks in housing and other markets – if people cannot survive the pandemic financially – which could drag the economy into a severe recession and even depression. When many cannot pay rent or mortgage by missing one paycheck, there is a serious concern. There can be rippling effects from global markets too: the Coronavirus crisis might bring globalization to an end, and supply chains will likely have to reorganize, which could be good for the economy in the long run but a pain for recovery. We have not considered any political and geopolitical factors yet. All in all how long we can bring the virus under control is an extremely important factor.
Below are two articles that offer some insight into the general financial health:
Who Has Enough Cash to Get Through the Coronavirus Crisis?
Taking the Nation’s Financial Pulse in Uncertain Times
What is a healthy lifestyle for the long run?
Technological change is inevitable and good for economic growth. As discussed earlier, the network of niches created by the invention of computers is tremendous and has not been fully realized yet. We will see more of its creative and destructive impacts in the future, which will continue to produce winners and losers. Add another fact about the IT revolution that we will employ more machines and fewer humans. There are no winners forever; today’s winners will be tomorrow’s losers. It’s as simple as that. What does this mean for individuals, businesses, and governments? How can we foster a healthy economy for the long run?
Borrowing from the future can stimulate economic activities and spur economic growth, but we cannot live too much or entirely on the future. Businesses should not pocket all profits in good times and would have to shut down without a government billout once a bad time sets in. Neither should be individuals. All got to have reserves for bad days.
Owning one skill – no matter how proficient – is not likely to be enough to survive a lifetime amid rapid technological transitions. We all need to learn and adapt throughout our lives. The fundamental ability to learn and adapt is more important than honing a specific skill. By the way, education systems got to do more than narrowly focusing on training a single trade but importantly to enhance people’s broader capabilities that enable people to learn and adapt throughout a lifetime.
Government programs must be in place to assist citizens living through difficult times due to macro-level forces that are beyond individual control and prevent them from falling behind as technological innovations continue to revolutionize our economy. This means, at a minimum, a social welfare system that provides sufficient safety net and policies and funds to support life-long learning and adaptation. Economic inequality is real and must be mitigated to keep the interconnected parts of the economic machine running smoothly and to sustain long-term economic growth.
Governments cannot bill out companies or people at each crisis (think about all that government debt which is just another form of borrowing from the future and try to imagine what the picture would be like if people, businesses, and the country all live off the future!) but must facilitate improving the well-being of people and the health of businesses for the long run. Instead of emphasizing monetary instruments, perhaps pay more attention to employment and place labor dynamics at the center. Regulation of the financial markets is absolutely necessary.