Niall Ferguson on an evolutionary approach to financial history

Niall Ferguson gave the Gresham annual special lecture yesterday in the grand surroundings of the Guildhall, which marked the publication in paperback of his latest book, “The Ascent of Money”. (It was also the title of a Channel4 series earlier in the year.)

This was the title of his talk, too; it was subtitled “an evolutionary approach to financial history”, which means it covered two of my interests – evolution, and finance and economics. Indeed, I have just finished reading a comparison of the evolutionary ideas of Richard Dawkins and Stephen Jay Gould – both of whom Ferguson name-checked in the first couple of minutes. This year is the 200th anniversary of Darwin’s birth, and the 150th anniversary of the publication of The Origin of Species, so it was an apposite subject.

Ferguson said that he took a Darwinian view of economics, and he admitted this wasn’t necessarily an original stance: US Assistant Secretary for Financial Markets Tony Ryan said to the Congress in September 2007 “Just as some species become extinct in nature, some new financing techniques may prove to be less successful than others”; the Economist recently described the “Darwinian world” of hedge funds and business start ups.

Ferguson described how Darwin was influenced by the economists of the industrial revolution, notably Malthus, whose ideas of resource constraints lead Darwin to develop his ideas on natural selection through competition. (Competition remains a constant metaphor in business.) Darwin in turn influenced economists. Thorstein Veblen asked “Why Is Economics Not An Evolutionary Science?” in 1898; Joseph Schumpeter envisaged an evolutionary quality to economic life [PDF], using the term “industrial mutation” to describe innovation; and Nelson and Winter wrote An Evolutionary Theory of Economic Change in 1982. More recently, Andrew Lo of MIT published “ The Adaptive Markets Hypothesis: Market Efficiency from an Evolutionary Perspective [PDF]” in 2004.

Evolution through natural selection is of course only an analogy for the changes in the economy, industry and finance; but it is one that fits quite well. Ferguson was able to identify

  • mutation, as financial companies innovate and create new products and business processes
  • competition for customers and staff – the innovators – in a crowded market place
  • selection of financial companies, and their products, as they merge or fail, producing differential survival
  • speciation, as new business models are created (such as internet banks)
  • extinction, as other business models disappear disappear.

Ferguson went further, suggesting that the employees of financial firms acts as the genes or (in Dawkin’s definition) memes, the agents of cultural inheritance in organisation.

Whilst he didn’t use the phrase, he also described one of the drivers of Gould’s theories, mass extinction: the number of hedge funds has been greatly reduced in the past couple of years, as a result of the credit crunch – Reuters anticipates a reduction of 50% in the number of funds this year alone.

I think one can take the metaphor too far though. Companies are neither species or organisms, but institutions comprised of individuals. Ferguson accepted that innovation isn’t mutation – it is a directed process. The ideas that come out of innovation can be copied freely, without sex between institutions (copyright allowing). The intervention by governments, regulators and central bankers can stop businesses going bust (RBS, HBoS and Northern Rock in the UK) and force others into the arms of competitors (Bradford & Bingley, Alliance & Leicester, Dunfermline BS, and others) – Ferguson thought this was akin to very un-Darwinian intelligent design (although he questioned its intelligence!).

He was sceptical about sense of keeping ailing institutions going, worrying about the trouble that keeping these dinosaurs going would lock into the financial system. Better, he thought, to allow them to go bust, opening up new niches for more competitive institutions – more diverse, smaller, more nimble, and perhaps more innovative. We won’t know if he’s right until the credit crunch, and its long term effects as a result of the vast sums spent throughout the world on fiscal stimulus and capital injected into banks, insurance companies and other institutions, have worked their way through the economy and the business cycle: more boom and bust, perhaps.

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