Furthermore, the process of economic growth is never just a simple scaling-up of existing activities and structures, but involves endogenous transformation of the economy from within as new technologies, business plans and suchlike are originated, adopted and retained by the economic system. This creative-destructive process is known as economic evolution (Nelson and Winter 1982, Metcalfe 1998, Loasby 1999, Potts 2000, Beinhocker 2006, Dopfer and Potts 2008). Economic evolution is caused by economic innovation. It results in structural change in the economic system in consequence of new ideas, along with change in the capabilities, organization, connections, boundaries and behaviour of the micro units that compose the economic system and the connections between them.

An economic system in equilibrium (i.e. one that is not evolving) has no need of new policy, for it will be in equilibrium with respect to the extant policy settings and services provided. Also, an economy that is growing in the manner envisaged in neoclassical growth models (in which the economy expands equally and everywhere by some percentage each year) has no need of new policy or services, because the same public services can then be provided at a similarly expanded level. This would happen automatically as the tax base grew proportionately. Public sector innovation is thus unnecessary in an economy in equilibrium or an economy experiencing equilibrium (scaled-up) growth. In such a context, public sector efficiency is the only economic concern.

Yet this is neither necessarily nor even generally true in an evolving economy because evolutionary growth, by definition, implies change in the underlying capabilities and relations between agents changing the structure of the economic order. In an evolving economy, a static (or scaled) structure of policy and services will become increasingly dysfunctional or inappropriate. It will be adapted to an economic world that, by increment, no longer exists. Economic evolution thus renders extant policy settings increasingly dysfunctional. Let us call this policy entropy. Policy entropy does not exist in a static economy, and thus requires no innovation. But an evolving economy requires policy innovation and not just the increased efficiency or scaling-up of existing policy.

The process of innovation and economic evolution continually changes the economic order from within, and hence needs to be met with a continuous flow of novel policy ideas, including the termination of old ideas that no longer work or are devolving into sources of rent. Yet because economic evolution is the product of novelty and the growth of knowledge (Loasby 1999) new policy will need to be experimentally created and tested. Its efficacy cannot be known a priori for the same reason that new private sector enterprises and services cannot be known a priori. Experimentation will be necessary and its costs will be unavoidable. It is these experimental costs associated with policy innovation that directly clash with the goals of static efficiency in policy.

Naturally some and perhaps many policy experiments (Leigh 2003) will fail, and sometimes expensively. Yet this is an essential price to pay for governance and policy to simply keep pace with an evolving economy. Economic evolution implies policy entropy which thus requires policy innovation just to maintain current service (a point we return to below as the 'Red Queen' hypothesis). Policy innovation is not therefore only about 'going forward' in pursuit of better governance as it is often sold, but rather, as a base-line case, is about simply maintaining position. The upshot is that in an evolving economy, the strident pursuit of policy efficiency may actually result in less effective or well-adapted policy.

This sort of dynamic efficiency with respect to policy is necessary in an evolving economy. Yet the governance of a complex evolving system is often stifled by a zero-risk attitude to governance that is incentivized to that position in the short run by the widely perceived need to be efficient: in the sense of being transparent, accountable, precautionary, fair and equitable. Yet for policy to be effective, it must keep pace with ongoing economic change, which means that it must innovate, which then places it in direct contradiction to many of these aspects of efficiency. However, that does not change the underlying fact that an innovative evolving economy requires, indeed mandates, an innovative approach to policy. How, then, might this dilemma be resolved?

4. GOOD WASTE AND BAD WASTE

The upshot is that continuous innovation is required for policy and government services to remain effective in an evolving economy. Yet innovation is by definition wasteful because good policy solutions and service provisions cannot be known in advance. Yet we need more, not less, of this sort of waste.

To be clear, efficiency is indisputably good, but the opposite of efficiency is not always bad. An important distinction thus needs to be made between good waste (the necessary but unknown costs of experimentation) and bad waste (the costs of inefficiency). Bad waste is the consequence of rent-seeking that comes by degrees of corruption and exploitation of power. This is well understood, and the mark of good governance is the absence of such waste, i.e. static efficiency. Good waste, on the other hand is less well understood and indeed often unrecognized, yet it is the natural consequence of experiments in the course of innovation in developing new ideas, technologies or policies. This is the cost of learning that is systematically factored into research and development budgets, for example, or in the amortized costs of learning about new technologies or market opportunities. Many of the most successful and profitable companies produce large quantities of 'good waste', and are often as such precisely because they have learnt how to effectively do so (Dodgson et al 2005). Good governance, in this view, thus involves minimizing bad waste from rent-seeking and maximizing good waste from experimentation.

Waste therefore arises from a failure to organize and use scarce resources efficiently: thus government waste, in this view, is bad governance. This may arise due to information imperfections, organizational slack, rent-seeking and corruption, institutional friction, transaction costs, market failure, government failures, abuse of power, rationality failures and the full complement of potential failures of the competitive market outcome. These are all bad waste in the sense that they are Pareto inefficient, meaning that changes could be made to make some agents better off without making others worse off. Things could be better, yet the natural and artificial limitations of material reality intervene, causing waste. The solution, then, is to remove these imperfections and frictions by promoting efficiency. Bad waste thus always involves rent-seeking and invariably results in sub-optimal resource allocations. Sometimes this is obvious, as in persistent market shortages or artificially high prices, or when dubious or illegal dealings are revealed. The waste from such activities is morally unambiguous and rightfully prosecuted.

Yet there are lesser and more everyday forms of waste that while no less wasteful in proportion are now widely, yet inappropriately from the evolutionary perspective, afforded the mantle of good governance. I refer here to the systematic tendency toward risk aversion that comes to distrust the entrepreneurial gamble or the experimental endeavour because it might fail to meet specific expectations based on knowable extrapolations of extant conditions that would render it unaccountable. In essence, it is the distrust of imagination with public resources. This is the point of much confusion of bad waste and good waste.

This form of distrust is more politely known as transparency and accountability. Yet it leads inexorably to a creeping strangulation of risk that can ossify the governance structures of a company, city, region or nation. When this happens, the cost is the loss of the ability of the governed system to change and grow through imaginative experimental endeavour in order to meet new environmental threats and opportunities. The result is a fragile system (Parsons 2006). This is of course subtle and opaque, but by degrees it is all bad waste. Accountability in this context only ever extends to failures of practice, never to failures of imagination. Yet it is simple arithmetic that large amounts of small corruption are as significant as small amounts of large corruption. Yet only the latter attracts media, civic, shareholder or voter attention. The implication is that the drive to increased transparency and accountability to promote efficiency and to fight egregious corruption has had an unfortunate side-effect by inducing a kind of 'soft corruption'--by which I mean corruption in the sense of increasing dysfunction of a system, not as a moral failing--to favour the known quantity and the sure-thing that works to promote a systematic aversion to uncertainty, risk and experimentation. The present demands of efficiency thus quietly, and with all best intentions, slowly strangle the ongoing possibility of innovation.

This brings us to the other sort of waste--good waste--which is a natural consequence of learning and experimentation. Waste is inevitable, not just because of the second law of thermodynamics, but also because of how economies and societies evolve and progress through differential growth (Metcalfe 1998). All economic growth is a consequence of the ongoing process of variation and selection of the ideas and knowledge of an economy that define what it does and what it can do (Potts 2000, Dopfer et al 2004, Dopfer and Potts 2008). New ideas are the origin of economic growth and are produced through a process of trying many ideas and then learning from what doesn't work and replicating what does (Loasby 1999). Theory and analysis do of course help in this process, but the best way to grow a company, region or economy is still to try lots of things and then select from what works. This can of course be guided by theory and principles, and so will be far from random. But in an open world it will still require experimentation, and experimentation necessarily involves waste (Ormerod 2005).

Print Get the Mag Weekly Updates