Positive Feedbacks in the Economy

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Positive Feedbacks

in the Economy
A new economic theory elucidates

mechanisms whereby

small chance events early in the history of an industry
or technology can tilt the competitive balance
by W. Brian Arthur

onventional economic theory is

built on the assumption of diminishing renrrns. Economic
actions engender a negative feedback
that leads to a predictable equilibrium
for prices and market shares. Such
feedback tends to stabilize the economy because any major changes will be offset by the very reactions they generate. The high oil prices of the 1970's

encouraged energy conservation and

increased

oil exploration, precipitat-

ing a predictable drop in prices by the
early 1980's. According to conventional theory the equilibrium marks the 'best" outcome possible under the cir-

natives will be the "best" one. Furthermore, once random economic events select a particular path the choice

may become locked-in regardless of
the advantages of the alternatives. If
one product or nationin a competitive
marke@lace gets ahead by "chance," it
tends to stay ahead and even increase

its lead. hedictable, shared markets
are no longer guaranteed.
During the past few years I and other economic theorists at Stanford University, the Santa Fe Insurute in New Mexico and elsewhere have been developing a view of the economy based

Such a market is initially unstable. Both systems were introduced at about the same time and so began

with roughly equal market shares;
those shares fluctuated early on because of external circumstance, "luclC'

and corporate maneuvering. Increasing returns on early gains eventually tilted the competition toward VHS: it
accumulated enough of an advantage
to take vhrually the entire VCR market.
Yet it would have been impossible at

the outset of the competition to say

which system would win, which of the

two possible equilibria would be

se-

Such an agreeable picture often

on positive feedback. Increasing-returns economics has roots that go back 70 years or more, but its application to the economy as a whole is

does violence to reality. In many parts

largely new. The theory has strong

lected. Furthermore, if the claim that
Beta was technically superior is true,
then the market's choice did not represent the best economic outcome. Conventional economic theory of-

stabilizing forces

parallels with modern nonlinear physics (instead of the pre-ZOth-century physical models that underlie conventional economics), it requires new and challenging mathematical techniques

between two technologies or products
performing the same function. An example is the competition between water and coal to generate electricity. As

cumstances: the most efficient use
and allocation of resources.

of the economy,

appear not to operate. Instead positive feedback magnifies the effects of small economic shifts; the economic
models that describe such effects differ vastly from the conventional ones. Diminishing returns imply a single

equilibrium point for the economy,
but positive feedback-increasing returns-makes for many possible equilibrium points. There is no guarantee that the particular economic outcome
selected from among the many alterW. BRIANARTHUR is Morrison

hofes-

sor of Population Studies and Economics at Stanford University. He obtained his Ph.D. from the University of California, Berkeley, in 1973 and holds graduate degtees in operations research, economics and mathematics. Until recently Arthur was on leave at the Santa Fe Institute, a research insdrute dedicated

to the srudy of complex systems. There
he directed a team of economists, physicists, biologists and others investigating behavior of the economy as an evolving,
complex system.

and

it

appears

lTth" history of the videocassette
I recorder furnishes a simple exI ample of positive feedbaik. the vcR market started out with two competing formats selling...
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