Ch 1: An Integrated Approach to Economic and Political Change Part 2

Due to increasing returns, technologies and behaviours tend to cluster around the ‘winners’ in the stable pathways of Figure 1.1. These are the technological routines involving consumers, producers and law-makers referred to by Nelson and Winter (1982), which correspondingly can also be thought of as the co-evolutionary selfreinforcing ‘settled-habits-of-thought’ of Veblen, (1919). Thus the stable state manifests around both physical objects as well as behavioural patterns. This helps explain why transitions are so difficult to effect, even for a superior new technology. Institutional change encompasses not just the politics and government policies shaping the process, but also the settled patterns of behaviour associated with different technological objects. These ‘settled-patterns-of-behaviour’ provide the conceptual link to the contribution of behavioural barriers to literature on path dependence (Simon, 1957, 1991; Gigerenzer, 2003), which is discussed in detail in Chapter 4.

Within the innovation literature, many authors have highlighted the importance of government policy in challenging this stable state (Cowan and Hulten, 1996; Cowan and Gunby, 1996; Freeman, 1989; Perez, 1985; Hughes, 1983). Government policies can be contextualised within the broader process of institutional change, reflected in the political process. Unruch, (2002) argues that slow institutional change seems to be built into parliamentary democracies through a system of checks and balances among different branches of government which means, for the most part, institutional arrangements are characterised by long periods of stability punctuated by infrequent radical change usually accompanied by a change in Government (North, 1990). This is because it is often impossible for policy makers to undertake institutional change without a broad mandate. Thus, in a democratic society at least, broader social change is often seen as a prerequisite institutional change, which is in turn is necessary to drive technological change.

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Figure 1.1 An integrated approach: climate policy and technological diffusion

An integrated approach: climate policy and technological diffusion

Figure 1.2 An integrated approach: organisational mapping of the economy

An integrated approach: organisational mapping of the economy

Figure 1.3 An integrated approach: stable states and out-of-equilibrium states within a partial equilibrium framework

An integrated approach: stable states and out-of-equilibrium states within a partial equilibrium framework

Following a distinction made elsewhere in the literature on innovation (e.g. Schmookler, 1966; Grubb, 2004; Burer and Wustenhagen 2009) two broad types of policy are distinguished in Figure 1.1. Firstly, ‘supply push’ policies focus on the generation and dissemination of new knowledge with an emphasis on supporting producers and the nurturing of new products and processes through the cultivation of technological niches (e.g. education, science and industry policies). The second group of policies are ‘demand pull’, which focus on user demands and changes in incentives within the dominant socio-technical regime (market-based policies).

It is suggested that during the process of reproduction of a technological regime (points b to c in Figures 1.1 and 1.3) market-based policies are particularly effective. This is also consistent with the story of incremental technological improvement as producers in the economy shift up the production function (investment in a well a b d e High carbon pathway A Price highcarbon energy MTC1 MTC2 c Quantity High carbon energy MSB2 MSB1 established technology) and represented in the partial equilibrium framework of Figure 1.3 as the shift in the marginal social benefit (demand) and cost curves (MSB1 and MSC1) to MSB2 and MSC2.

In terms of organisational mapping, this can be appreciated by Figure 1.2 where the dominant actors in the densely connected High Carbon Pathway 1 are nested within a supportive and stable institutional context (the market). Over this range, a low carbon niche exists, but it is weakly connected to the market and cannot compete with the dominant actors and their associated technologies. Instead it is largely comprised of small firms potentially supported by government grants, financial institutions such as banks or existing in universities. Some groups such as NGOs and other social groups outside the dominant political interests may be lobbying for institutional change to the stable state of the existing market to encourage these niches, but their efforts at this stage have a weak effect. Niche technologies are seen to be ‘immature’ and thus, not ‘market-ready’.

Should a low-carbon social and political movement, with its associated technologies and economic routines, begin to find traction, then a shift off High Carbon Pathway 1 beyond point c to either point e (transition) or, more likely, point d (transformation) is possible. It is suggested that these could be considered ‘out-of-equilibrium states’ where the institutional logic (the market rules) has shifted so that the previous organisational map is so significantly out of alignment with actual social and political needs that more significant structural change is brought about. At the firm level, such changes can also be viewed as shifts in the production function (transformation) or a shift to new production function (transition).

Take for example the development of the ethanol market in Brazil (Goldemburg, 2007). In the late 1970s the Brazilian Federal Government mandated the mixture of anhydrous ethanol in gasoline (blends up to 25%) and encouraged car makers to produce engines running on pure ethanol (100%). Brazilian adoption of mandatory regulations determining the amount of ethanol to be mixed with gasoline (basically a renewable Portfolio Standard for fuel) was essential to the success of the programme. The motivation was to reduce oil imports that were consuming one half of hard currency from exports. It also allowed the phasing out of lead additives and reduced sulphur, particulate matter, carbon monoxide and carbon dioxide emissions. The OECD (2012:73) now write how Brazilian subsidies for ethanol production are a thing of the past because new ethanol plants have benefited from economies of scale, learning, and the use of related modern technologies, such as high-pressure boilers, that allow the co-generation of electricity from the process. While initially not making ‘market sense’ to move to ethanol, today it is held up as an example of successful transition to a more sustainable energy source.

In related work regarding the emergence of another ‘winner’, the Danish wind turbine cluster, Karnøe and Garud, (2012) also highlight the importance of sequencing in the technological ‘selection’ environment. In this case sequencing refers to how problems, in this case, energy supply, the social desire to avoid nuclear energy, and recently climate change, come together with solutions (wind energy but also bioenergy and others) and actors who are connected in a disorderly process of interweaving and ordering of resources. Sequencing depends on the ‘simultaneity’ of how elements in this process ‘arrive’ and ‘depart’. According to the authors of 46 this case study, this process matters as much as the policy.

The emergence and success of the Danish wind turbine cluster did not result from a public policy strategy that ‘picked a winner’, but ‘nor was it shaped by pure market forces’, as ‘Danish regulators stepped in with subsidies and grants to nurture and shape the emerging technology’. The authors’, reticence claim ‘policy success’ in this area stems from their observation of far less successful interventions in the markets for biogas and solar power technologies. Instead, they point to the importance of fostering ‘distributed and emergent actions that allow for the interweaving of resources and the transformation of existing ones over time’. That nurturing a new path is more about fostering a fertile ground for a niche to develop rather than a linear process of birth, gestation and growth fostered by strategic policy intervention. Insights form this work have helped inform the adaptive policy learning approach argued for in Chapter 8 of this thesis, highlighted in the summary for policy makers.

The organisational map represented in Figure 1.2 is a stylised view of some of the main elements of an economic and political system which are likely to play a role in this process. This perspective draws inspiration from the systems of innovation literature, pioneered by Chris Freeman (1987, 1988) at the University of Sussex and developed further by Lundvall (1992), Nelson (1993) and, more recently, Timothy Foxton (2011) at the University of Leeds. It is also informed by Herbert Simon’s (1991) organisational theory of decision-making, Gigerenzer’s (2002) work on heuristics, Carlotta Perez’s (2002) work on the role of financial and production capital in the process of technological change and Donald Schön’s (1967, 1973) work on the ‘stable state’ and the importance of a flexible ‘learning society’.

First, consider the famous passage from Herbert Simon’s (1991:27-28) article in the Journal of Economic Perspectives describing how a Martian might describe social organisation if looking at the earth from outerspace:

The firms reveal themselves, say, as solid green areas with faint interior contours marking out divisions and departments. Market transactions show as red lines connecting firms, forming a network in the spaces between them. Within firms (and perhaps even between them) the approaching visitor also sees pale blue lines, the lines of authority connecting bosses with various levels of workers. No matter whether our visitor approached the United States or the Soviet Union, urban China or the European Community, the greater part of the space below it would be within the green areas, for almost all of the inhabitants would be employees, hence inside the firm boundaries. Organisations would be the dominant feature of the landscape. A message sent back home, describing the scene, would speak of “large green areas interconnected by red lines.” … When our visitor came to know the green masses were organisations and the red lines connecting them were market transactions, it might be surprised to hear the structure called a market economy. “Wouldn’t ‘organisational’ economy’ be the more appropriate term?” it might ask.

We can consider Figure 1.2 in the same way a geographical map is a stylised overlay against which the reality of the world can be viewed. On this map we can model institutions and organisations that have evolved in response to the problems of collective action that people in a given society have felt worth solving. For example, such problems may include: the provision of electricity to the home, of food and water, of communications, of protection from violence, the maintenance of social cohesion, the provision of education, and, regarding the subject of this thesis, the reduction of greenhouse gases.

These organisations provide the ability for people to deal with more information than the individual can handle on their own and can help solve coordination problems. Organisations move up from families and households, through to schools and universities, to firms, banks and various governmental bodies. In this sense, organisations provide the link between the individual and social systems. In the actual world, the evolution of these organisations is a process which depends upon the continual exercise of rigorous selectivity – a complex adaptive process. This process may be either guided or unguided, but need not necessarily be a change that anyone particularly wants – take for example the economic collapse associated with the transition to a market economy in Russia discussed in Chapter 7. The nature of change is strongly influenced by the nature of institutions that support or hinder one type of change over another.

Significantly, this logic also allows for the case where institutions and organisations might not even exist to control the elements of the system necessary to achieve a social objective – in which case they must be incubated before a social objective can be successfully achieved. It is argued that this incubation process requires a different set of policy tools than the eventual diffusion process which can be led by demand-pull forces of the market.

As observed by Schön (1970) the structure of governance in the economy is most often a series of memorials to the solutions of old problems rather than targeted structures to deal with contemporary issues. Indeed, he argues that this very success often gives existing institutional and organisational regimes problems in adapting to new sets of social desires. The suggested solution, he argues, lies in a flexible learning society, able to adapt and reconfigure its organisational map to a changing set of environmental and social pressures. However, there is always the pressure to attempt to re-impose an established order onto the world which results in an inherent conservatism or stability in the system.

We can view the actors in this network – individuals and organisations – as positioned within the institutional structure of the system – what Douglas North (1990:4-5) describes as ‘players’ within the rules of the game. Meric Gertler (2004:7- 9) elaborates to define institutions as:

Formal regulations, legislation, and economic systems as well as informal societal norms that regulate the behaviour of economic actors: firms, managers, investors, workers. They govern the workings of labour markets, education and training systems, industrial relations regimes, corporate governance, capital markets, the strength and nature of domestic competition, and associative behaviour… Collectively, they define the system of rules that shape the attitudes, values, and expectations of individual economic actors. Institutions are also responsible for producing and reproducing the conventions, routines, habits, and ‘settled habits of thought’ that, together with attitudes, values, and expectations, influence actors’ economic decisions… Although these institutionally shaped attitudes, values, and conventions influence choices and constrain decisions regarding practices, they do not wholly determine them. There is still a major role here for individual agency to produce a variety of responses within the same sector, region, and nation-state.

Unlike the canonical form of path-dependency theory (Arthur, 1988, 1989, 1994a, 1994b, 1994c, 1994d, 1999; David, 1985, 1986, 1988, 1992, 1993a, 1993b, 2005, 2007), this view emphasises the role of individual agency to express itself within a guiding institutional framework. The continual exercise of agency is thus a crucial driver of change within this model, insofar as while economic activity may be shaped by institutions, it is not wholly determined by it. Rather, niches populated by ‘mutant’ actors (to borrow the biological terminology) come into being to challenge the dominant set of actors, technologies and historical institutions. In this conception of the economy, the dominant institutions of society make up ‘the market’, but unlike the neoclassical model, what constitutes ‘the market’ has taken on a historical and normative dimension, evolving over time. As North (1990:52) writes:

The rules descend from polities to property rights to individual contracts. Contracts will reflect the incentive-disincentive structure imbedded in the property rights structure (and the enforcement characteristics); thus the opportunity set of the players, and the forms of the organisation they devise in specific contracts, will be derived from the property rights structure.

One of the important implications of this work is that the process by which each jurisdiction’s institutional setting is derived – in other words, the construction of ‘each jurisdiction’s ‘market’ – can take geographically differentiated forms. These forms, especially in authoritarian or quasi- authoritarian regimes outside the values of liberal democracy, may not have as their basis the objective of the maximisation of social welfare at all – a conception of ‘the market’ which neoclassical economics takes for granted. For example, a market may exist, but the institutions have evolved in a way to encourage a certain allocation of resources among those with political power – an observation that might help explain the difference in income distribution across nations.

The point that Gertler and others make is that there is no such thing as “free market exchange” that exists in some sort of “natural state of capitalism” the attainment of which should be the default objective of government policy. Market interactions are shaped by institutions, which are formed through the historical process of politics, culture and the evolving nature of what Veblen called the ‘settled habits of thought common to the generality of men’ (Veblen, 1919:239).

‘The market’ is thus not merely a place of exchange but is formed by the normative actions of agents through the political process. Due to the fact that the government writes the rules, while the players play the game:

…the government has strong incentives to behave opportunistically to maximize the rents for those with access to the government decision-making process… the government will [thus] cartelize economic activity in favour of politically influential parties (North, 1990:67).

In this area Mancur Olson’s work has been influential. He observes that, in developed societies, organisations and institutions tend to evolve together where competing organisations are engaged in constant a distributional struggle for their own existence with income and wealth as the objective. In this context, organisations can grow large enough to influence the institutional environment (for example through securing a favourable legislative environment) and this can lead to widespread diffusion of their good or service and promote system stability.

However this stability may result in undesirable lock-in if organisations seek to preserve their own markets over the interests of serving the consumer. For example, marketing departments will try to manipulate the marketplace by projecting certain products or ideas onto consumers, whether this is the market for software for computer components, sim cards in mobile phones, vacuum cleaners and filterbags, or shavers and their blades (David, 1985; Arthur, 1989; Larkin, 2008). Whether this vision helps address the underlying demands of society (for example, Fair Trade), or merely acts to entrench a commercial position (for example, the highstatus fashion industry) is an empirical question. As Olson (1982:165) writes:

The dense network of distributional coalitions that eventually emerges in stable societies is harmful to economic efficiency and growth, but so is instability. There is no inconsistency in this; just as special interest groups lead to misallocations of resources and divert attention from production to distributional struggle, so instability diverts resources that would have otherwise gone into productive long-term investments into forms of wealth that are more easily protected, or even into capital flights to more stable environments. On the whole stable countries are more prosperous than 53 instable ones and this is no surprise. But, other things being equal, the most rapid growth will occur in societies that have lately experienced upheaval, but are expected nonetheless to be stable for the foreseeable future.

Figure 1.2 also highlights the critical role the separation of financial capital (for example agents such as banks, pension funds and venture capitalists) and production capital (companies or governments engaged directly in the production process) play in propelling this process forward (Perez, 2002). Here it is the investment strategy when brought to ground through new projects that play a vital role in challenging the status quo of the stable state. Whereas the production capital of established organisations is often focused on supporting new but similar supportive investments, financial capital is more likely to be focused on organisations and technologies which provide good and services to meet the demands of the day. This is not out of altruism, but out of the financial gain to be made from opening up a new market and the associated wave of investment opportunities.

Perez argues that financial capital may take technological gestation into a period of ‘frenzied exuberance’ of financial activity leading to a bubble economy. Here the ‘blue sky’ forward-looking world financial agents and new technologies become detached from the real economy. For example, in the case of solar photovoltaic panels, the cost of production has fallen significantly, which combined with the gradual winding down of government subsidies, has led some to argue there will be an oversupply of solar panels (Clark, 2011). Eventually, the existing socio-technical system reaches a crisis or turning point as the imagined world of the future is forced to reconcile with the realities in the production-side of the economy (the time between points c and d or e in Figure 1.1).

This conflict over alternative visions of the future – in our case between a high carbon and different varieties of low carbon energy systems – may lead to crisis as a ‘clean-tech bubble economy’ bursts in the face of pressure from the extant institutional world. Such a crisis may provide the motivation for change and can fuel an intense debate over what the future world should look like – either with reformed institutions to support the mutant agents, or a reassertion of existing institutions.

In the case of successful institutional change, pressure eventually accumulates to the point where the old institutional reality rapidly unwinds to be replaced by the new – often populated by a new set of winners and losers. The more obvious that the outcome of the institutional tension between mutant and established agents is collapse, the more convincing the focal point is for a transition (Schelling, 1960).

An important implication of this analytical logic is that policy timing has a significant influence on economic outcomes. This means in the early stage development of a technology, public subsidies for research and development and technology policy should be focused on supply push support. Only after a low-carbon technology has matured and becomes ‘market ready’, will demand pull policies be effective. Otherwise, in the absence of credible alternative technologies ready for adoption, undesirable energy price inflation may result. Related to this is the notion that it is just as important to dismantle previous regimes of support inherent in high carbon pathways. This support is often quite subtle, for example through university and government sponsorship of education and research; or more direct through sponsoring the exploration and production of fossil fuels directly. Non-price support such as streamlined planning approval processes should also be reviewed in light of this logic.

The integrated approach to economic and political change articulated in this section seeks to provide a synthesis between neoclassical and evolutionary theories. It attempts to show that not only that institutions matter, but also to prompt the researcher to ask what sort of institutions work best in which environments? The relevance of this approach to current research in the social sciences was recently highlighted in the Nobel Committee’s note on the 2009 prize to Eleanor Ostrom and Oliver Williamson (Kungl Vetenskaps-Akademien, 2009):

Institutions are sets of rules that govern human interactions… One important class of institutions is the legal rules and enforcement mechanisms that protect property rights and enable the trade of property, that is, the rules of the market. Another class of institutions supports production and exchange outside markets. For example, many transactions take place inside business firms. Likewise, governments frequently play a major role in funding pure public goods, such as national defence and maintenance of public spaces. Key questions are therefore: which mode of governance is best suited for what type of transaction, and to what extent can the modes of governance that we observe be explained by their relative efficiency?

It is to such an agenda that this thesis aims to contribute – focusing in the area of humanity’s efforts to reduce and control anthropogenic greenhouse gas emissions.

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