Uncertainty, Evolution, and Economic Theory

Based on Wikipedia: Uncertainty, Evolution, and Economic Theory

The Heresy That Changed Economics

What if the most successful businesses in the world have no idea what they're doing?

That's the provocative question at the heart of a 1950 academic paper that quietly revolutionized how economists think about markets, competition, and success. The paper's author, Armen Alchian, made a simple but devastating argument: the firms that dominate our economy might not be there because of brilliant strategy or visionary leadership. They might just be lucky.

This idea sounds almost offensive to our ears. We live in a culture that celebrates entrepreneurial genius. We read biographies of Steve Jobs and Elon Musk, searching for the secret formula that separated them from the pack. Business schools charge hundreds of thousands of dollars to teach the principles of strategic management. The entire consulting industry rests on the premise that success can be engineered through careful analysis and optimal decision-making.

Alchian said: maybe not.

The Sunflower Problem

To understand Alchian's insight, consider a field of sunflowers. Some sunflowers grow tall and healthy. Others wither and die. If you examined only the survivors, you might conclude that they possessed some special quality—perhaps they "chose" to grow toward the sun more effectively, or they "decided" to send their roots deeper into the soil.

But that's not what happened at all. The surviving sunflowers didn't make any choices. They simply happened to land in spots with better soil, more water, or more sunlight. The plants that thrived aren't smarter than the ones that died. They're just luckier.

Alchian's radical move was to apply this same logic to businesses.

Think about it this way: thousands of entrepreneurs start companies every year. Each one makes countless decisions about pricing, products, hiring, marketing, and operations. Some of these decisions are based on careful analysis. Others are gut instincts. Many are essentially random guesses dressed up in business-speak.

A few of these companies will succeed spectacularly. Most will fail. And here's the uncomfortable truth: we have no reliable way to determine, ahead of time, which decisions will prove correct. The future is genuinely uncertain—not just risky in a calculable way, but fundamentally unknowable.

The Difference Between Risk and Uncertainty

This distinction matters enormously. Risk is when you don't know what will happen, but you know the odds. When you roll a die, you don't know whether you'll get a six, but you know there's a one-in-six chance. You can plan around that.

Uncertainty is different. Uncertainty is when you don't even know the odds.

When an entrepreneur launches a new product, they're not rolling dice. They're entering a world where the rules themselves are unclear. Will customers want this? Will competitors respond? Will the economy cooperate? Will some technology emerge that makes the whole thing obsolete? These aren't calculable risks. They're genuine unknowns.

Alchian traced this uncertainty to two sources. First, we simply cannot see the future. No amount of market research or strategic planning can tell you what will happen next year, let alone next decade. Second, even if we could somehow access all relevant information, we couldn't process it. The business environment involves so many variables, interacting in such complex ways, that no human mind—and arguably no computer—can optimize across all of them.

The Death of the Rational Firm

Standard economic theory assumes that firms maximize profits. This assumption is remarkably powerful. It allows economists to predict how businesses will respond to changes in prices, costs, taxes, and regulations. The math works out elegantly. Models can be built. Textbooks can be written.

But Alchian pointed out a fatal flaw: you can't maximize something when you don't know what the outcomes will be.

Profit maximization requires that firms know, or can at least estimate, the consequences of their choices. They need to compare alternatives and pick the best one. But if the future is genuinely uncertain—if the outcomes are probability distributions rather than single values—then "best" becomes meaningless.

Here's why. Suppose you're choosing between two business strategies. Strategy A might yield profits of either $1 million or negative $500,000, depending on how things play out. Strategy B might yield either $200,000 or $100,000. Which is better?

It depends entirely on how you feel about risk. A cautious entrepreneur might prefer the safety of Strategy B. A bold one might swing for the fences with Strategy A. There's no objectively "right" answer. And since attitudes toward risk are subjective—they're matters of preference, not calculation—you can't reduce the decision to pure profit maximization.

Alchian put this more technically: an objective function cannot incorporate a non-objective function and still be an objective function. Your feelings about risk are part of what determines your choice, and feelings aren't objective. Therefore, the choice isn't objective. Therefore, there's no single "maximum" to aim for.

So How Do Markets Work?

If firms aren't rationally maximizing profits, how do we explain the apparent order and efficiency of markets? Why do prices tend toward equilibrium? Why do resources flow to their most productive uses?

Alchian's answer was elegant: natural selection.

Markets don't require rational firms. They only require competition and scarcity. These two forces, operating together, automatically select for firms that happen to behave profitably—regardless of whether those firms intended to behave that way.

The mechanism works like this. Many firms enter the market, each pursuing its own idiosyncratic strategy. Some strategies happen to generate positive profits. Others don't. Firms with negative profits eventually run out of money and disappear. Firms with positive profits survive and potentially grow.

Over time, the population of firms evolves. Not because individual firms are getting smarter, but because unprofitable firms are being culled and profitable ones are being preserved. The result looks like optimization even though no one is optimizing.

This is exactly what happens in biological evolution. Individual organisms don't "try" to be fit. They simply are what they are. But the environment relentlessly eliminates the less fit and preserves the more fit. Over generations, species become remarkably well-adapted to their environments—not through planning or intention, but through differential survival.

The Heliophiliac Plants

Alchian used a vivid botanical example that has become famous in economic literature. Heliophiliac plants are plants that thrive in sunlight. The word comes from the Greek "helios" (sun) and "philos" (loving).

Imagine scattering seeds randomly across a landscape with varying amounts of sunlight. Some seeds land in sunny spots. Others land in shade. The ones in sunny spots grow. The ones in shade don't.

If you later examined the surviving plants, you might conclude that they had somehow "sought out" the sunlight. They seem optimally positioned. But of course they didn't seek anything. They just happened to land where they did. The sun did the selecting.

Markets work the same way. Entrepreneurs scatter their businesses across the economic landscape, each landing on a particular combination of product, price, location, and strategy. Some combinations work. Others don't. The market does the selecting.

The survivors look like geniuses. But many of them are just sunflowers that happened to land in the light.

Imitation as Survival Strategy

Alchian added an important wrinkle to this story: imitation.

In biological evolution, successful traits spread through reproduction. Fit organisms have more offspring, and those offspring inherit their parents' advantageous features. Over time, the population comes to be dominated by those features.

In markets, successful practices spread through imitation. Other firms observe what the survivors are doing and copy it. They don't need to understand why it works. They just need to notice that it does work and replicate it.

This creates a powerful evolutionary dynamic. Firms that quickly imitate successful competitors improve their own survival odds. Firms that fail to adapt, or adapt too slowly, face higher risk of failure. The result is a population of firms that increasingly resembles the successful ones—not because anyone planned it that way, but because competitive pressure rewards imitation and punishes divergence.

There's something almost humbling about this. The apparent rationality of markets doesn't require actual rationality from any of the participants. It only requires competition, scarcity, and enough firms trying different things that some of them stumble onto success.

The Intellectual Origins

Where did Alchian get these ideas? The answer involves a fascinating intellectual genealogy.

Alchian studied statistics at Stanford University under W. Allen Wallis, a distinguished statistician who would later become a prominent economist and government advisor. Wallis introduced Alchian to the work of Ronald Fisher, one of the most influential scientists of the twentieth century.

Fisher was a curious figure—a mathematician who essentially invented modern statistics and then used those statistical tools to transform evolutionary biology. He was one of the architects of what's called the Neo-Darwinian Synthesis, the marriage of Darwin's natural selection with Mendel's genetics that forms the foundation of modern evolutionary theory.

From Fisher, Alchian absorbed two crucial ideas. First, that selection processes operating on variation can produce outcomes that look designed without any designer. Second, that statistical thinking provides powerful tools for understanding systems with inherent randomness and uncertainty.

After Stanford, Alchian worked at the RAND Corporation, the famous Cold War think tank. RAND specialized in systems analysis—using mathematical and statistical methods to analyze complex problems involving weapons systems, military strategy, and resource allocation.

This experience convinced Alchian that uncertainty wasn't just an inconvenience to be assumed away. It was a central feature of economic life that demanded explicit attention. The elegant models of standard economics, with their assumptions of perfect information and rational optimization, simply didn't match the messy reality he observed.

A Controversial Legacy

Alchian's 1950 paper sparked decades of debate that continues to this day.

Some economists saw the paper as a powerful defense of traditional assumptions. Yes, individual firms might not consciously maximize profits. But if market forces ensure that firms behave as if they maximize profits, then economists can continue using profit maximization in their models. The assumption is justified by its results, not its psychological realism.

Economists like Arthur De Vany, Harold Demsetz, and Benjamin Klein took this view. For them, Alchian had provided a deeper foundation for mainstream economics. The market's selection process validates the maximization assumption even when individual actors don't—or can't—maximize.

Other economists drew more radical conclusions. If success is largely a matter of luck and selection, then perhaps we should be more skeptical about the heroic narratives of entrepreneurial genius. Perhaps market outcomes are less efficient than we thought, since selection can only work on available variation—and there's no guarantee that the optimal strategy is among the options being tried.

This latter group gave rise to the field of evolutionary economics, which takes Alchian's insights seriously and builds economic theory around concepts borrowed from biology: variation, selection, inheritance, and adaptation.

The Winter Critique

The most influential criticism came from Sidney Winter, another prominent economist who had thought deeply about evolutionary approaches to economic theory.

Winter raised a crucial question: how exactly do successful behaviors get transmitted from one firm to another?

In biological evolution, inheritance is automatic. Fit organisms reproduce, and their offspring inherit their traits through genetic transmission. But firms don't have DNA. They don't reproduce in the biological sense. So how do successful practices spread through the economy?

Alchian had invoked imitation, but Winter pointed out that imitation is harder than it looks. If a successful firm doesn't consciously know why it's successful—if its profitability is the result of lucky choices rather than deliberate strategy—then what exactly would an imitator copy? How do you replicate something that isn't explicitly understood?

This problem of transmission is serious. Biological evolution works because genes provide a reliable copying mechanism. Economic evolution lacks such a mechanism. Firms can try to copy each other, but without understanding the causal relationships between practices and outcomes, they might copy the wrong things.

Winter also raised the issue of competitive pressure. Alchian's model assumes that competition is fierce enough to quickly eliminate unprofitable firms. But what if competition is weak? What if there are barriers to entry that protect incumbent firms from challengers? In such cases, selection pressure would be limited, and the market might sustain many suboptimal firms indefinitely.

These criticisms didn't refute Alchian's basic insights, but they highlighted important limitations and spurred further research into the mechanisms of economic evolution.

Why This Matters Today

Seven decades after Alchian's paper, his ideas remain surprisingly relevant.

Consider the startup economy. Venture capitalists invest in dozens or hundreds of companies, knowing that most will fail. They're not trying to pick winners—a task that may be impossible given genuine uncertainty. They're trying to create a portfolio with enough variation that some members will stumble onto success. It's an explicitly evolutionary approach to investing.

Or consider the debates about management and leadership. Business schools still teach strategy as if success is largely a matter of making correct decisions. But Alchian's framework suggests that much of what we attribute to brilliant leadership might actually be survivor bias. We study successful companies and their CEOs, then attribute their success to whatever distinctive practices we observe—without checking whether failed companies had similar practices.

The financial crisis of 2008 also carries echoes of Alchian's concerns about uncertainty. The sophisticated risk models used by banks assumed that the future could be described by probability distributions estimated from past data. But Alchian would have recognized this as a fundamental confusion between risk and uncertainty. The future wasn't drawn from a known distribution. It was genuinely unknown.

The Limits of Optimization

Perhaps the deepest implication of Alchian's work is epistemological—it concerns what we can and cannot know.

Modern culture is saturated with optimization. We optimize our diets, our workouts, our morning routines. Companies optimize their supply chains, their algorithms, their organizational structures. Governments try to optimize tax policy, monetary policy, regulatory policy.

But optimization requires knowing what the alternatives are and how they'll play out. In conditions of genuine uncertainty, this knowledge is unavailable. We're not rolling dice with known odds. We're navigating a world where the rules keep changing in unpredictable ways.

Alchian's framework suggests a different approach. Instead of trying to find the optimal solution—which may be impossible—focus on survival and adaptation. Maintain variation. Try different things. Keep what works. Abandon what doesn't. Let selection do the optimizing.

This isn't a counsel of passivity. It requires active experimentation, rapid learning, and willingness to change. But it's a different kind of activity than traditional optimization. It's more like gardening than engineering—creating conditions for good things to emerge rather than designing them from scratch.

A Modest Revolution

Armen Alchian's paper was short—just eleven pages. It appeared in the Journal of Political Economy, a respected but not sensational venue. Its prose was dry and academic. Nothing about its presentation suggested revolutionary intent.

Yet the ideas it contained were genuinely radical. They challenged the core assumptions of economic theory. They drew unexpected connections between economics and biology. They forced economists to think harder about what they really meant by rationality, optimization, and equilibrium.

Most importantly, they offered a different way of understanding markets—not as arenas of perfect calculation, but as evolutionary systems that select for fitness through competition. In this view, the market's intelligence is emergent rather than designed. It arises from the interaction of many imperfect actors, none of whom needs to understand the whole system.

There's something both disturbing and comforting in this picture. Disturbing, because it suggests that success is more contingent than we like to believe, that the line between triumph and failure is thinner than winners typically acknowledge. Comforting, because it suggests that market order doesn't depend on impossible standards of rationality. Even we bumbling humans, making guesses in the dark, can collectively create something that looks remarkably like wisdom.