The Competitiveness of Nations in a Global Knowledge-Based Economy

Brian J. Loasby

The Innovative Mind

DRUID  Summer Conference 2003 on

Creating, Sharing and Transferring Knowledge.

The role of Geography, Institutions and Organizations.

Copenhagen June 12-14, 2003.




Hayek’s Sensory Order

NeoDarwinism and neoconstructivism

Some Implications




The foundation of this paper is the cognitive theory presented by Hayek in The Sensory Order.  Hayek’s account of the creation of mental orders is related to Smith, Marshall, evolutionary psychology and some recent work in neuropsychology, with particular emphasis on the distinction between development of the species and development at the level of the individual.  The applications of pattern-making for the creation and use of knowledge are discussed in terms of domain specificity, with reference to the division of labour and imperfect specification, and attention is drawn to the problems of co-ordination.



Adam Smith, Alfred Marshall and Friedrich Hayek were all confronted with the uncertain basis of knowledge before they began their study of economics; and what their responses have in common is not only a theoretical focus on the process by which people develop what we call ‘knowledge’ but also a reliance on similar kinds of process, which result in the formation of connections within particular domains.  Each author recognises the impossibility of demonstrating that any such process can deliver proven truth; instead each envisages sequences of trial and error within particular contexts, leading to the preservation of what seems to work - until it no longer does, when a new sequence of trial and error begins.  In other words, they all offer evolutionary theories, Marshall and Hayek explicitly so, while Smith, directly and indirectly, had a major influence on the development of Darwin’s ideas.

Raffaelli (2003), who was the first to emphasise the significance of Marshall’s theory of human cognition, has now demonstrated the pervasiveness of its influence in Marshall’s economics.  A comparison between Marshall and Hayek is therefore on the agenda; however in this paper it is appropriate to concentrate on Hayek, because he offers the most elaborate account by an economist of the neurological basis of thought and action.  Reference will be made to Smith and Marshall either when the resemblances are particularly striking or when they offer particularly valuable complements, but these will be indications rather than explorations.


Hayek’s Sensory Order

The problem which attracted Hayek’s attention was this. “In order to be able to give a satisfactory account of the regularities existing in the physical world the physical sciences have been forced to define the objects of which this world exists increasingly in terms of the observed relations between these objects, and at the same time more and more to disregard the way in which these objects appear to us” (Hayek 1952, pp. 2-3).  Not only have sensory qualities been progressively discarded from this scientific account; they have not been replaced in a way that allows them to be mapped onto the new categories, but by a distinctive ordering.  Thus “objects which appear alike to us do not always prove to behave in the same way towards other objects,... objects which phenomenally resemble each other need not be physically similar to each other, and... sometimes objects which appear to be altogether different may prove to be physically very similar” (Hayek 1952, pp. 5-6).  Hayek’s formulation accepts the superiority of the physical order as a representation of relationships within the physical world, including the physical properties of humans, but he does not raise the question why the human species should have first developed an apparently inferior classification system; instead he asks how this sensory order came into existence.  ‘How’ may be thought a more ‘scientific’ question than ‘why’, and in this instance it may also be thought to have logical priority: indeed Hayek’s analysis provides a basis for explaining why, though that will not be the primary concern of this paper.  That concern is the value of Hayek’s analysis as a general theory of the creation of mental orders - an explanation of how the mind works.

Since the disparity to be explained is that between a classification that is based on the effects produced by external events on other external events and a classification based on their effects on our senses, the focus of inquiry is on systems


of relationships, and the key to Hayek’s analysis is the hypothesis that ‘causal connexions’ in either classification are linked to ‘structural connexions’ within the human brain.  It follows that the sensory and physical orders are linked to different neurological networks, and that networks of the latter kind are of relatively recent origin.  The essential point to note here is that connections within the brain are selective, and so connections between human perceptions and the physical world (including the physical world of the brain) are also selective; moreover, being selected within the human brain, which as a physical system is capable of sustaining alternative connections, they are ‘subjective’ rather than ‘objective’  The characteristic Austrian emphasis on subjectivity therefore has a psychological, indeed biological, basis.  This allows great scope for error (connections may be false or incomplete) and for sheer ignorance as defined by Israel Kirzner (connections may never have been made); it also allows great scope for imagination and novelty (through the making of new connections).  The influences on the formation of connections, and on the possibilities of aligning them with the external world, then become an important field of study, the results of which may be significant for policy.  We shall return to these implications later.

Since connections are formed within the brain, it might be supposed that individuals could develop patterns of connections which are so diverse that they fail to understand each other; and this is not a possibility that we should ignore.  However, Hayek argues that similarities of experience promote similarities of patterns and perceptions, at the level of the individual or the species - as we shall see, there are important differences between the evolutionary processes at these two levels; Smith’s (1976a [1759]) Theory of Moral Sentiments also rests on such similarities of patterns and perceptions.  Because of the normal connotations of the word ‘experience’ it might be more appropriate to use Kelly’s (1963) terminology of ‘construing the replication of events’.  This is indeed an accurate definition of the process that is analysed in Hayek’s neuropsychological theory, for what events are deemed to constitute a replication is determined by the interpretative framework that is applied to them.  In what circumstances people are likely to use similar constructions is an issue that we shall have to consider later, as is the issue - perhaps of greater importance - of the possibility of understanding substantially different constructions which are used by other people, and of using such different constructions within a single coherent economic or social system.  Any discussion of such issues must be based on some account of how these interpretative frameworks are formed; and that is the problem that Hayek explores.

Because its conceptual basis is that of a selectively-connected system, Hayek’s theory is to be sharply distinguished from general equilibrium models, in which every element is connected to every other - indeed the completeness of the connections (the equivalent of a ‘field theory’) is the basis both for analyses of the existence and stability of general equilibrium allocations and for claims about their welfare properties.  (For an incisive argument that the incompleteness of their connections is the crucial fact about all economic systems, see Potts 2000; the incompleteness of all cognitive systems is also the foundation of Simon’s work on human decision-making and organisational design).  Hayek’s hypothesis of connectivity also naturally, almost inevitably, suggests the need for a process-theoretic explanation of the development of connections, and this is what Hayek provides.  Suggesting a topological isomorphism between the neural and phenomenological orders (Hayek 1952, p. 40),


he argues that instead of direct connections between particular stimuli and particular sensory qualities, the effect that is produced by any stimulus depends, first, on how (or indeed whether) it is translated into an impulse in some nerve fibre (Hayek 1952, p. 10) and, second, on the location of this impulse in relation to other impulses within the network of connections (Hayek 1952, p. 53).  De Vecchi explores the influence on Hayek’s thinking of gestalt psychology, which insisted on the importance of perceptions which derived not from the parts but from the relationships between them; these relationships are “the result of a process of organization... performed by the nervous system” (De Vecchi 2003, p. 144.)

Any impulse, which is itself not a carrier of the initial stimulus but a ‘representation’, perhaps with some different properties, is interpreted in terms of the relationships which have already been established within the brain: thus “the qualities which we attribute to the experienced objects are strictly speaking not properties of that object at all, but a set of relations by which our nervous system classifies them” (Hayek 1952, p. 143).  Hayek immediately and explicitly draws on Popper’s language to emphasise that “all we know about the world is of the nature of theories and all ‘experience’ can do is to change these theories”; in other words, we create a different set of connections.  All knowledge, including ‘knowledge how’ as well as ‘knowledge that’ (Ryle 1949), is constituted by connections; it is a particular set of relationships among many other sets which are technically possible, and which is always potentially subject to replacement - though major changes are not easily achieved, as we shall see.

These theories are themselves the outcome of a trial and error process in which theories, and the patterns of neural connections which embody them, are tested by the effectiveness of the actions to which they lead - or, as we shall see almost immediately, of their success in interpreting phenomena.  The test, of course, is of sufficiency, not optimality; the perceived inadequacy of a theory, as a basis for action or understanding, stimulates a search for better theories.  Indeed, it is such a process, Hayek argues, that has gradually led to the supersession, for some important purposes, of sensory theories by physical theories.  As Hayek points out, this gives us some reason to expect a closer fit between these physical theories and the environment, provided that the environment does not change at a faster rate than the revision of theories - a point to which we shall return when we come to consider alternative versions of this evolutionary process.  However, because we must always use theories to interpret experience before we can use experience to modify theories, existing theories provide both the conditions which stimulate, or fail to stimulate, the revision of theories and the starting point for any such revision; thus history matters, though we need not assume that it determines unique paths or unique outcomes.  Moreover, since all of these theories “are generalisations about certain kinds of events, and since no number of particular instances can ever prove such a generalization, knowledge based entirely on experience may yet be entirely false” (Hayek 1952, p. 168).  This, we should note, is a restatement of David Hume’s objection to induction as a means of demonstrating empirical truth.

It is worth pausing at this point to observe the similarities between Hayek’s analysis and the psychological theories that, as noted in the introduction, were developed early in their careers by two other economists who were also concerned about the nature and foundations of human knowledge.  It was the sensory order that


Hayek set out to explain; in his exposition of “the principles which lead and direct philosophical enquiries” Adam Smith (1980 [1795]) had sought to account for the development of mental representations of the physical order.  Smith responded to Hume’s scepticism by explaining how science emerged from the attempt to achieve comfort by the invention of “connecting principles” that could be satisfactorily imposed on events; the discomfort occasioned by the failure to accommodate some new phenomenon within an established pattern then provided the stimulus to create a new interpretative system by a rearrangement of connections.  That Smith, like Hayek, had a conception of knowledge as a set of replaceable theories is most strikingly demonstrated by his insistence that Newton’s theories were the product of Newton’s imagination, not a direct perception of the truth.  Smith (1980 [1795], p. 77) even noticed that the desire for theoretical comfort could be powerful enough to override the evidence of the senses (such as the overwhelming sensory evidence of a stationary earth), in a process that had advanced much further by the time that Hayek began to consider his problem.

Smith did not attempt to provide a physiological underpinning for what we may now call his evolutionary theory of cognition, but used it to introduce in this particular context the argument that the division of labour promotes the growth of knowledge.  First, science emerges as an identifiable category of knowledge, and then, as scientific knowledge expands, specialisation between the sciences simultaneously increases the range of study within the scientific community and the attention to detail within each sector; and this attention to detail accelerates the perception of anomalies which, by causing intellectual discomfort even when they appear to have no practical significance, stimulate the invention of new ‘connecting principles’ that may accommodate them.  This argument was subsequently broadened into Smith’s (1976b [1776]) fundamental proposition that the division of labour, because of its powerful effects on the growth of knowledge, is the primary instrument of economic growth.  (For an extended account, see Loasby 2002).

It was this application, not Smith’s underlying psychological theory, that attracted Marshall’s attention; however Marshall had already recognised the possibility of a conjunction between contemporary associationist psychology and Darwin’s ideas (which, as we shall see later, owed much to Smith’s emphasis on the advantages of differentiation), and in the process provided a physical equivalent of Smith’s cognitive theory.  He did not think of connections between neurons (which was a later pattern of thought), but wondered how far these psychological processes could be represented by a mechanical system, and devised the most elaborate model of his whole life in order to investigate this question (Marshall 1994).  In doing so he was consciously following the example of Charles Babbage, who in turn had been inspired by the decision of the French mathematician Prony to organise the production of mathematical tables on Smith’s principles of the division of labour (see Raffaelli 2003, pp. 52-3).  The possibility of reducing biology to physics is not a recent idea, and the problematic relationship between mechanical and biological concepts which pervades Marshall’s economic analysis seems to have its origin here.

Smith, Marshall and Hayek all built their systems on the fundamental economic principle of scarcity; but what is scarce in their systems is human cognitive capacity and the energy that is necessary to drive it.  These are precisely the only resources that are assumed to be freely available in most formal models in present-day


economics, which thus ignore the most fundamental of all allocation problems that human beings face.  The Chicago objection to regulation rests on the assumed abundance of entrepreneurship, while the Austrian objection is based on the importance of incentives to expand the supply (Audretsch, Baumol and Burke 1999, p. 620).  Smith, Marshall and Hayek also effectively, if unintentionally, provide the basis for explaining why the assumption that cognition alone has no opportunity costs is maintained by most economists; it is essential to underpin the concept of rational choice equilibrium (as Herbert Simon often pointed out), and thus, in Smith’s (1980, p. 77) words, “to preserve the coherence of the ideas of their imagination”.  Smith’s, Marshall’s and Hayek’s psychological systems rely on routines and institutions which economise on cognition, and so do the economic systems that they later considered and which are populated by human beings who are equipped with such systems.  The preservation of established structures is an important economising principle.  (The practice of mainstream economists naturally exemplifies these features rather than the principles which are apparently embodied in their models.)

These routines and institutions have the additional merit of focussing attention on the issues for which they are inadequate at any particular time; consequently they are systems in which the evolutionary sequence of variety generation, selection, and the preservation of selected variants in the form of modified or novel routines and institutions is a natural occurrence.  Indeed, one can say that there can be no evolution without routines.  This evolutionary sequence may be handled, in somewhat different ways, at several levels; these may include, for example, genetic and neurophysiological structures, ideas, and organisations, formal and informal, which link together clusters of routines and institutions and provide both the framework and the problems for continuing innovation.


NeoDarwinism and neoconstructivism

Hayek’s theory of the formation and modification of mental orders is explicitly designed to encompass two distinct processes, one of which “takes place in the course of the development of the single individual” and one “in the course of the development of the species and the results of which will be embedded in the structure of the individual organism when it commences its independent life (or when it reaches maturity” (Hayek 1952, p. 102).  The idea of an embedded framework of the human mind which (correctly) controlled human knowledge of such basic and universal concepts as space and time was developed, in a non-evolutionary fashion, by Kant in response to Hume, and it was Herbert Spencer (now so out of favour) who proposed an evolutionary interpretation of such embedding which would preserve Kant’s conception of the mind’s power of structuring perceptions against the claims of extreme empiricists (Raffaelli 2003, pp. 31-4), thus preparing the way for Hayek’s two processes.  Smith had already gone further in observing how “the ideas of the imagination” could overthrow “the evidence of the senses”, which we might now interpret as the ability of ‘the development of the single individual’ to override the results of ‘the development of the species’.  The significance of this development will become a major theme of this paper.

Since Hayek’s specific objective was to explain how the sensory order could differ from the physical order, it was reasonable for him to leave open the application of his unifying principle to the distinctive systems of individual and species


development - as Smith left open the application of his unifying principle of the division of labour to the distinctive systems of firms and markets; but it is now difficult to ignore the important differences between them.  Hayek’s presentation in terms of individual development, which was - and for many of us still is - easier to connect with our own established schemes of ordering, avoids any discussion of these differences, and this presumably explains why Hayek’s theory of species development is so often overlooked.  The neoDarwinians, however, are very sensitive to the implications of proposing two distinctive evolutionary processes.  They would argue that Hayek’s theory of development within the lifetime of an individual gives no reason why any such developed order should be transmitted across generations, whereas the neoDarwinian transmission mechanism of genetic inheritance can be comfortably fitted to a theory of the development of species-specific patterns of behaviour.

Hayek’s account of development within the individual may be interpreted as driven by experience (in Kelly’s sense of the constructions that are imposed on a sequence of events), both in providing the stimulus to experiment with new connections and in supplying the criteria for choosing among these new connections; but in species development the role of ‘experience’ is not to stimulate experimental changes in mental ordering but to select among changes which have occurred by random mutations.  The double helix is a device for accurate reproduction, and so all mutations must be technically regarded as mistakes in copying; and although environmental factors may be allowed to influence the frequency of mistakes it is a fundamental principle of neoDarwinism that it cannot influence the kind of mistakes that are made.  There is thus no role for adaptations that are prompted by experience; instead a very small fraction of these mistakes turn out to enhance fitness, and these are preserved by accurate copying to succeeding generations.  Experience-led learning by individuals is regarded with suspicion by neoDarwinians, and it cannot be inherited; our mental orders are genetically adapted to some past environment, with the era of hunter-gatherers being a current favourite (see Cosmides and Tooby 1994).

Indeed we may now observe an emerging conflict for supremacy in the social sciences between the rival unifying theories of rational choice equilibrium and neoDarwinian evolution.  The two stand in a curious relationship.  Both are theories about selection between alternatives and the preservation of what is selected; and in both, selection is based on the consequences of those alternatives which are presented for selection.  However, rational choosers, being equipped with rational expectations, know these consequences in advance, and having made the correct choices they naturally have no wish to change them, but remain in their equilibrium state until there is some shock to the economic system.  (Their cognitive system, being already fully connected and therefore perfect, never changes.)  In the neoDarwinian model, by contrast, no-one knows the consequences of the available alternatives, and any attempt to design alternatives in order to produce desirable consequences is a pretence that is unworthy of science; but if neoDarwinian processes can discover the best answer that is currently available only after trying all existing (though not all possible) alternatives, nevertheless the best currently available answer will be discovered, and once discovered it will be conserved in the genetic code, which may then be indistinguishable from an equilibrium allocation.  By appropriate allowance for the costs of this process, which is claimed to be the only process possible, one may even be able to make claims for optimality along similar lines to the claims for


optimality, subject to information and transaction costs, that are sometimes put forward in economics.  Thus assumptions which appear to be polar opposites can, with a little sleight of thought, support identical outcomes.

Now deriving equilibria from the initial data is analytically simpler than tracing processes, because the stages of these processes are not full equilibria and are therefore difficult for the modeller to control in a non-arbitrary fashion.  Partial equilibria can be devised, but any particular partial equilibrium is always open to objection - particularly by those who believe either in rationality or in the long-term power of neoDarwinian processes.  (The standard isolation of game-theoretic models from the wider environment raises dual questions about the appropriateness of this assumption of environmental irrelevance and their applicability in a wider domain, which modellers do not always address.)  So we should not be surprised that some evolutionary theorists are attracted to equilibrium modelling ; and one particularly attractive application is the attribution of particular medical conditions or behaviour to specific genes.  The explanation of performance by structure is a favourite theoretical principle across the disciplines, and a direct link between final outcomes and the initial data has the dual appeal of simplicity and plausibility, especially when the initial data can be identified as a specific gene sequence.

However, there is some resistance to the dominance of this strategy among neuropsychologists; and the combination of argument and evidence which they have produced should have particular resonance among social scientists of an evolutionary inclination, especially those who are impressed with Hayek’s reasoning.  The following account is based on a series of papers, some jointly-authored, by Professor Annette Karmiloff-Smith, Head of the Neurocognitive Development Unit at University College London.  In a lecture to mark the Centenary of the British Psychological Society (Karmiloff-Smith 2002), her starting-point is the use by neoDarwinian geneticists of evidence from adult neuropsychological patients and children with genetic disorders to support claims that the human brain is organised into specialised modules which are directed by specialised genes.  She offers a fundamental methodological criticism that will appeal to all Austrians: an exclusive focus on the relationship between initial conditions and end-states may lead us astray, and a better understanding of causation requires attention to the processes by which these end-states are produced.

Her central example is of a genetic disorder, the Williams Syndrome, which is clearly associated both with the deletion of 17 specific genes and with a specific set of physical consequences in adults, including a smaller brain volume, an abnormal size, orientation and density of neurons, and atypical proportions of several regions of the brain, together with psychological consequences of low IQ, and low spatial skills, with the notable exception of proficiency in facial recognition.  This combination appears to supply strong prima facie evidence for an exclusively genetic explanation, and has been cited (e.g. by Pinker 1997, 1999) in support of a theory of the direct determination of behaviour, including altriuism, aggression, intelligence, spatial cognition and language, by specific genes or specific sets of genes (Karmiloff-Smith 2002, p. 526).

Such an exclusive explanation is then confronted with further evidence.  First, patients who lack a subset of these 17 genes do not exhibit corresponding subsets of


the symptoms.  (Though the sample size is small, universal claims, such as that for exclusive and specific genetic determination of end-states, may logically be refuted by a single counter-example; questions about the sample must be questions about the experimental procedure which has generated an apparent counter-example, not about the logical implications of its results.)  Second, the claim that the apparently unimpaired proficiency in facial recognition of people with Williams Syndrome demonstrates an intact face-processing module is undermined by careful experimentation which revealed that these people were processing faces feature by feature, whereas the supposed ‘face-processing module’ relies on configuration.  (Of particular interest is the observation that control subjects are equally reliant on featural processing when presented with inverted faces; the implications of this will be considered later.)  Differences were also found in the production of some other supposedly-intact skills; thus the “pattern of intact versus impaired modules formed from intact versus mutated genes”, which the theory of purely genetic determination requires, is removed by “[d]ifferentiating between superficial behavioural scores and underlying cognitive processes” (Karmiloff-Smith 2002, p. 536).  Third, experimentation with infants revealed substantial differences from the results with adults, while the use of infants with Down’s Syndrome as controls had the incidental effect of demonstrating notable differences between the infant and adult states of those affected by this syndrome also; such changes in response during the course of development, implying a reconfiguration of neural networks, is not what one would expect from genetic programming.

These results do not, of course, overthrow the conception of a genetically driven evolutionary process, or indeed the argument that many human physical and behavioural characteristics are genetically determined; but the modified theory that is offered by Professor Karmiloff-Smith, in conjunction with other cognitive neuropsychologists, allows scope for “complex pathways from gene-to-brain-to-cognitive-processes-to-behaviour” (Karmiloff-Smith 2002, p. 526).  Even here, genetics and the neoDarwinian model of which they are the focus retain a major role; but there is nevertheless considerable space for social scientists to develop evolutionary explanations of a somewhat different kind, for which genetic constraints may provide an appropriate baseline, such as all evolutionary explanations need.  This kind of permissive linkage between disciplines appears to correspond to Ziman’s view of science.  Though commending ‘weak’ reductionism - the search for underlying commonalities - as a research strategy, Ziman (2000, pp. 323, 326) objects to ‘strong’ reductionism - the unification of knowledge by the universal application of fundamental principles, precisely because no such principles can explain “the spontaneous emergence of novel modes of order in complex systems”; and these selective connections produce “a simplification of nature, and of human cognition as naturally evolved, that actually makes scientific research possible”.

Explanations of the emergence of order, in human brains and in human societies, are not confined to random mutations and natural selection, though neither is excluded, but can incorporate the search for novelty, through making new connections, and choices that are made for what appear to be good reasons, because they embody plausible connections.  They may go beyond this to suggest why particular reasons may be thought to be good and why searches may be undertaken in particular circumstances and may proceed in particular directions.  Thus they are not restricted to explaining how people may get things right, but may also help to


understand how they may go astray - and an understanding of the reasons for failure may have practical uses.  The drastic simplifications of assuming all economic agents to be hard-wired optimisers who are extremely well-informed (and if confronted with asymmetric information know precisely what are the implications of what they do not know), which excludes the need for any process other than Bayesian updating, will, however, not suffice.  The kind of psychology-based social science developed by Hayek, and also by Smith and Marshall, on the other hand, is highly congenial.

In fact, the final sentence of Karmiloff-Smith’s lecture would serve as a present-day introduction to Hayek’s Sensory Order: “The contrasting view [to the static model of genetic determination of adult states] presented in this lecture is that our aim should be to understand how genes are expressed through development, because the major clue to genotype-phenotype relations is not simply in the genes, or simply in the interaction between genes and environment, but in the very process of development itself” (Karmiloff-Smith 2002, p. 540).  In other papers she argues that “on the gene side, the interaction lies in the outcome of the interacting, cascading effects of interacting genes and their environments and, on the environment side, the interaction comes from the infant’s progressive selection and processing of different kinds of input... The child’s way of processing environmental stimuli is likely to change repeatedly as a function of development, leading to the progressive formation of domain-specific representations” (Karmiloff-Smith 1998, p. 390).

In a jointly-written paper advocating “an emergentist solution to the Nature-Nurture controversy”, she and her colleagues emphasise “the extraordinarily plastic and activity-dependent nature of cortical specialization”.  Because “cortical regions are likely to differ from the outset in style of computation, which means that they will also differ in the variety of tasks they can perform best”, there may be widespread dispositions to convert domain-relevance into domain-specificity; nevertheless any particular pattern of domain-specificity is a consequence of development (Bates et al. 1998).  (The argument that localisation of mental functions does not imply localisation in any particular part of the cortex, and that alternative pathways may be developed in response to specific damage, had already been made by Hayek (1952, pp. 147-8), citing Lashley’s (1929) account of “vicarious functioning”andequipotentiality”.)  Though much is genetically determined and the remainder is genetically constrained, nevertheless in important respects “the brain progressively sculpts itself, slowly becoming specialised over developmental time” (Karmiloff-Smith 2002, p. 527).

“The expression of genes through development”, rather than entirely by programming, may itself be given an evolutionary explanation, as Karmiloff-Smith (1998, p. 390) notes: “although evolution has pre-specified many constraints on development, it has made the human neocortex increasingly flexible and open to learning during postnatal development.  In other words, evolution is argued to have selected for adaptive outcomes and a strong capacity to learn, rather than prior knowledge.  Within such a perspective, it is more plausible to think in terms of what one might call domain-relevant mechanisms that might gradually become domain-specific as a result of processing different kinds of input.”  There has been some evolution away from genetically specified domain-specificity towards a genetically-enabled multi-specific capability for creating domain-specific skills through development, in a Smithian evolutionary process.  Present-day humans therefore embody a partial shift from “evolution in the course of the development of the


species” towards “evolution in the course of the development of the single individual” - a shift which has been confirmed by natural selection, but which entails other forms of selection (for a discussion of some of these, see Loasby 2001).  This process of learning works through the creation and modification of connections within the brain, for selective connections are the key to human cognition.  If two stimuli are experienced differently, “this difference must be reflected somewhere in the brain.  Every new piece of learning changes the structure of the brain in some fashion, however minor” (Bates et al., 1998).  This is precisely how learning is modelled by Hayek, and also by Marshall (1994).  The development of a new system of connections that constitutes a physical order, and which at first supplements and then increasingly supersedes our sensory order in many contexts, may be seen as a consequence of this major trend in selection within the human species.  This deserves some further consideration.

That specialisation on a particular range of activities would result in a progressive movement from relatively undifferentiated potential to domain-specific knowledge and capabilities, which could confer distinctive advantages, was Adam Smith’s great idea.  It was applied to the world of nature by Milne-Edwards (1827, p. 534) to explain the great variety of species, and this gave Darwin the principle which governed the direction of evolution.  We may now draw on our knowledge of genetics to argue that the detailed specification of a limited range of behaviour for each species provided evolutionary space for very many different species to demonstrate that their evolved domain-specific behavioural regularities conferred sufficient comparative advantage within their specific environment to allow them to survive, though any comparative advantage may be extinguished by changes in this environment, including the evolution of other species.  Only in the human species is this specialisation associated with exchange, though the principle of complementary specialisation is manifest in social insects and in many specific inter-species relationships - plants and pollinating insects provide the largest class of examples - and in a broader sense in ecology.

The growth of the pre-human brain allowed for an increasing range of behaviour within each individual; but what appears to have been a crucial change resulted from a very rapid increase in brain size between 500,000 and 100,000 years ago.  Because it followed the change to an upright stance, which inhibited enlargement of the birth canal, this increase could be accommodated only by the birth of infants at a very early stage of brain development; this made them extremely vulnerable to both accident and predation for an exceptionally long period, and could therefore have been selected for only if it was associated with some great advantage.  This advantage, we may now conjecture, seems to have been precisely the ability to direct this new genetically-guided cognitive capacity to form better representations of the environment as it was experienced, and to develop more appropriate skills to deal with it - which is the kind of adaptation cited by Karmiloff-Smith.  For this purpose “the unusually slow period of human postnatal brain development” (Karmiloff-Smith 1998, p. 394) is actually an advantage, for the connections in the brain are being formed while the child is interacting with the environment.  With an appropriate genetic endowment of programmable rather than programmed capacity, domain-specific skills can be developed within individuals as well as through the evolution of species; and this has some advantages.  This developmental process of theory-revision can cope with faster environmental change than reliance on the selection and diffusion


of fortuitous genetic mutations, and also with movement into an environment that has not previously been experienced by that individual.  Hayek’s model of development at the individual level applies.

This interaction between the growing brain and the environment could not have happened if the development of this larger brain were strictly genetically determined; but the extraordinary increase in the size of the brain entailed a far greater proportionate increase in the number of potential connections, and it is very hard for a non-specialist to see how the programming capacity of the genome could have increased sufficiently to cope with this increase.  Specialists appear to share this view.  “On mathematical grounds, it is difficult to understand how 1014 synaptic connections in the human brain could be controlled by a genome with approximately 108 genes, particularly when... humans share approximately 98% of their genes with their nearest primate neighbours” (Bates et al. 1998).  (We may immediately recall Hayek’s (1952, p. 185) proposition that “the capacity of any explaining agent must be limited to objects with a structure possessing a degree of complexity lower than its own”.)  Instead, “brain development in the higher vertebrates appears to involve massive overproduction of elements early in life (neurons, axons and synapses), followed by a competitive process through which successful elements are kept and those that fail are eliminated” (Bates et al. 1998) - a non-genetic application of neoDarwinian evolution to introduce a different evolutionary process.

The loss of genetic control has allowed cognitive development to be shaped by interaction with particular environments at the level of the individual, on evolutionary principles of variation and selective preservation.  Thus the evolutionary process has itself evolved, as genetic determination has been supplemented by genetically-enabled capabilities, in a way that increases adaptation - at least in the short term, in relation to the time scale of genetic evolution (though even within a human lifetime, as Adam Smith realised, the development of domain-specific skills and habits of thought may lead to dangerous reductions of adaptability).  The evolution of the evolutionary process (though not precisely so expressed) is also a feature of Adam Smith’s psychological theory of the growth of knowledge, in which specialisation between individuals, in both knowledge and capabilities, is a later development that enhances the effectiveness of the powerful motivation to create mental models of puzzling phenomena (Loasby 2002).  The principle that greater diversity requires a relaxation of central control is familiar in studies of organisational design and innovation; and it is, of course, a central principle of Austrian economics.  (It is not good news for economists who rely on general equilibrium modelling.)  That this diversity within the human species should apparently be an unintended consequence of the increase in brain size (even though to a neoDarwinian all consequences are unintended) should also appeal to an Austrian mindset.


Some implications

Let us now consider some of the implications of Hayek’s psychological theory of the development both of general cognitive powers and of individual knowledge and capabilities, in the light of the general corroboration and specific refinements of this theory by neuroconstructivists.  We shall also exploit the similarities with the constructivist (and fallibilist) views of the growth of knowledge and capabilities developed by Smith and Marshall, and with George Kelly’s (1963) theory of


personality, which focuses particularly on the problem of preserving the internal coherence of an individual’s ‘interpretative system’ while simultaneously maintaining a satisfactory correspondence with the events encountered by that individual or precipitated by her actions, and in doing so provides a powerful line of enquiry into biases in and obstructions to learning.  Apparently-relevant evidence may be ignored, and locally-effective explanations may be dismissed, because they appear incompatible with ways of making sense that have become indispensable - even in the hardest of sciences, as Ziman (1978) observes.

Hayek’s principal application of his proposition about the limits of any apparatus of classification is to show that “no explaining agent can ever explain objects of its own kind, or of its own degree of complexity, and, therefore, that the human brain can never fully explain its own operations” (Hayek 1952, p. 185); thus, although we can hope to understand the principles underlying our own mental processes, “mind must remain forever a realm of its own which we can know only through directly experiencing it, but which we shall never be able fully to explain or to ‘reduce to something else” (Hayek 1952, p. 194).  This is his conclusion to his investigation into the problem of psychological explanation; human cognition is inevitably bounded, as Simon also insisted.  Hayek also, naturally, draws attention to the impossibility of achieving a full explanation of the world around us, while simultaneously supplying a principle of organisation for the human brain and for human societies; and this is the starting-point for the following discussion.

Hayek’s impossibility theorem warns us that our knowledge is necessarily fallible and incomplete, but it also suggests how it may be improved and tested, and what kinds of opportunity costs are likely to be incurred along different pathways of attempted improvement.  Knowledge is created by selecting connections which will constitute domain-specific modules; and we may identify two general principles on which to base this selection, which apply both to everyday cognitive operations and to those special cases - which are not so very special - in which we are consciously attempting to construct interpretative frameworks, some of which we may choose to call theories.  One directs us towards fine discrimination in our definition of categories, at the expense of reducing the breadth of our view and ignoring interactions with the rest of the universe, thus restricting our pattern-making to a narrow domain which we may be able to explore in some depth.  The second principle points towards the strategy of aggregating the elements of our universe into invented categories on the basis of similarities that we suppose are significant for our particular purpose, while ignoring the differences which we assume to be of little relevance for that purpose - or which we simply fail to notice, thus creating a domain which is broad but almost empty.  Though each has a physical counterpart in the human brain, all categories are located in the space of representations, and may be manipulated without further reference to what they are deemed to represent.  Such manipulations may be enlightening, or misleading; much depends on how they are used (Loasby 2003).

Normally, there is some accommodation between these two principles, and all our representations are sub-systems which include both a few external connections and a few subdivisions within their components.  To illustrate from formal economics, near one extreme we find theories in which everything of interest is bundled into a few composite categories, as when a whole economy is represented by the


combination of undifferentiated labour and capital to produce undifferentiated output, with a unit price for each category; near the other extreme we find models of precisely-specified games which are isolated from all external influences - though in a wider scientific perspective, the agents within a game represent a high degree of aggregation by comparison with the attempt to identify fundamental particles.  Even this supposedly-ultimate objective, we may note, retains the principle of aggregation within each category of particle; but since, as Herbert Simon (1982, 2, p. 142) observed, the purpose of theory is to economise on fact, some aggregation is unavoidable.

Indeed, as Hayek (1952, p. 176) pointed out, nothing can be recognised unless it can be assigned to some existing category.  Perhaps the clearest, and prior, statement of this necessary principle of contextual similarity, and the implicit dangers of ignoring apparently irrelevant differences in favour of salient resemblances, was provided by Frank Knight (1921, p. 206); Hayek (1952, pp. 145-6) also emphasises that all classification must be based on selected elements, so that the resulting “system of acquired connexions... will give only a very distorted reproduction of the relationships” which it purports to represent, and “will often prove to be false”, generating misleading expectations.  (Simon (1982, 2, pp. 306-7) similarly observes that because of the active filtering involved in both direct perception and the handling of information “the perceived world is fantastically different from the ‘real’ world”.)  Hence the importance of a procedure for revising, or even replacing, classifications which no longer seem to work, and of a strong intrinsic (and therefore genetic) motivation for doing so; such revisions are of course the means by which the physical order began to emerge from the sensory order.

The possibility of revision implies the ability to conceive of alternative principles of classification on which to construct representations.  What is distinctive, at least in degree, about the human species is that the multifarious forms of the division of labour among its members have produced such an unprecedented variety of these representations and so have enormously increased the total of human knowledge.  Hayek’s account of the functioning of the human brain and neurocognitive theory both lead to the conclusion that human knowledge is dispersed and incomplete; furthermore, the particular potential and limitations of the human brain imply that knowledge can be less incomplete only if it is more dispersed.  The division of labour exploits the ability of individuals to create domain-specific networks - if they are given the freedom to so.  In currently-fashionable terminology that implies delegation and empowerment, or in economic language imperfectly-specified contracts; but the obverse of such discretion is loss of control, which to those concerned with the overall efficiency of allocation, either as analysts or policy-makers, is a serious deficiency.  The fundamental reason for this negative perception is the illusion that the system can be safely treated as if it were fully connected (Potts 2000); this is comparable to the illusion that the connective structures of the greatly-enlarged human brain can be fully specified genetically though this is a very different specification, not of a fully connected system but of disjoint modules.  Both illusions exclude uncertainty; but in doing so they also exclude endogenous innovation.

The incentive problems of dispersed knowledge, under the title of asymmetric information, have become a major focus of attention in economics, and that in itself is no bad thing; but because full specification (at least of all contingencies and their


implications) is necessary for the calculation of system optima it is inevitable, though unfortunate, that such problems are treated as some kind of ‘organisational failure’, rather than being part of the pathology of success.  (Kirzner, by contrast, has rightly insisted on differential alertness to opportunities as an essential contributor to economic progress.)  One important consequence of this prevalent attitude is an implicit assumption that the co-ordination of dispersed knowledge is simple if incentives are entirely compatible, whereas there is abundant evidence of the major contribution of well-intentioned misunderstandings to many failures: for those of a generous disposition, economists’ recommendations to the transition economies of eastern Europe may be so classified.  The apparently analysable problems of information have diverted attention from the more fundamental issue of interpretation; asymmetric interpretation is at once a threat to co-ordination, a basis for opportunism and a route to innovation.  The recent growth of interest in ‘knowledge management’ may provide an opportunity for a balanced analysis of the costs and benefits of the growth of knowledge, related to an understanding of the processes of this growth -but not if the management of knowledge is treated as primarily a problem of information technology.

It is no accident that the principles and compromises that are inherent in the use of human mental capabilities are to be found in the organisation of social, economic and political systems, for the operation of these systems entails equivalent cognitive problems, which cause us to rely on abstract systems of rules for the selection and classification of relevant phenomena.  As De Vecchi (2003) points out, Hayek used this equivalence in his later work, and advocated the dispersion of both political power and economic decision-making; Kirzner has pursued the theme of domain-specific entrepreneurial alertness; and Marshall (1919, pp. 647-8), though describing the state as “the most precious of human possessions”, insisted on the importance of confining it to “its special work”, and applied his cognitive model of conjectured linkages to industrial organisation (Raffaelli 2003).  For example, a cluster of small firms has greater potential for variety than a large firm, especially if the advantages of large-scale are believed to require conformity to routine, and therefore inhibit the changes in administrative and cognitive organisation that generate increasing returns.  As Quéré (2003, p. 198) points out, “Increasing returns do not pre-exist.  They are the result of an economic process; that is, a result of the way co-ordination problems are managed overtime”.  Marshall recognised the connection between the management of co-ordination problems in the economy and the management of co-ordination problems within the brain: both require combinations of routines and novelty, and these combinations are themselves modified by evolutionary processes of trial and error.

Economic growth and the growth of knowledge both entail the division of labour in order to achieve an effective allocation of resources to the development of domain-specific cognitive modules within the economy and within society - indeed within many kinds of ‘space’.  As Darwin learnt from Smith, perhaps indirectly through Milne-Edwards, these are the advantages of the division of labour that have led biological evolution towards the variety of species; they have led human societies towards the variety of knowledge.  The genetic specification of life forms has created many short-lived inefficient allocations of resources along the way, for only a very small proportion of all possible genetically-induced specialisations produce any advantages; but as Smith saw, the most important advantage of the division of labour


is not its effective application of the differentiated knowledge and capabilities that are already available but the effects of specialisation on the generation of new knowledge and new capabilities, which also create many short-lived inefficient allocations of resources to unsuccessful novelties along the way.  The economy is an evolving system which is continually creating and modifying domain-specific modules of knowledge, and of productive organisations that are based on particular combinations of knowledge.

The realisation of this potential would be very severely restricted if domain-specific modules could be created only by genetic mutations and natural selection among the variants that they produce.  Much more can be achieved once genetic mutations (which cannot, of course, be contrived) begin to supplement the programming of behaviour with the potential to develop domain-specific programmes of behaviour within the individual brain; for this allows the division of labour to be extended and knowledge to be improved within a human lifetime - especially when an increase in brain size expands the range of possible connections.  As in the economy, the realisation of this potential requires a relaxation of control; and it was therefore fortunate that the genome did not grow enough to permit an increase in genetic instructions to match the increase in brain size.  The imperfectly-specified brain structure has similar merits to the imperfectly-specified contract of the Coasean firm and the imperfectly-specified activities of a Hayekian economy.

It is important that the resulting knowledge-domains should also be imperfectly specified: indeed ‘domain-specificity’, though adequate to mark the contrast with notions of general applicability, is a misleading label (compare the relationship between ‘bounded rationality’ and ‘rational choice’).  In Nelson and Winter’s (1982) evolutionary theory, the primary units of evolution are skills, including skills of organisation, which are treated as cognitive programmes of limited scope; but Nelson and Winter take care to emphasise and to illustrate how ambiguous this scope may be, and use this ambiguity within their theory.  Imperfect specification is also a condition of those experiments at the margin, inspired by differences of temperament and interpreted experience, on which Marshall relied for the variations that were “a chief cause of progress” (Marshall 1920, p. 355), and it is essential for Penrose’s (1959, 1995) central notion of the imagination of new services to be obtained from resources and of new productive opportunities to which these services may be directed.  Since increasing attention is being paid to the knowledge content of capital (of which Marshall was very well aware), it may be helpful to apply to structures of knowledge Lachmmm’s (1978) analysis of capital goods: they are substitutable between uses but within each use they are complementary to a particular set of other capital goods when combined in a specific way; in other words they are multi-specific.  Lachmann’s warning also applies: just as the value of capital cannot be maintained simply by maintaining the current set of combinations, so the value of knowledge cannot be maintained simply by perpetuating its current uses.  It is indeed a most important characteristic of knowledge that it can be reused, but in a way that is not simply deducible from current uses - a consideration which is not prominent in endogenous growth theory, because it is not easily accommodated within the system of thought to which it belongs.  Imagination (which Lachmann rated almost as highly as Shackle) is the genetically-derived device by which genetic evolution allows the humans species to exceed the limits of genetic evolution.


The exploitation of our cognitive capabilities may be enhanced by a (genetically-programmed) motivation to search, which is cnucial to Smith’s account of the growth of knowledge; this increases the rate of ‘mutation’ among networks in what is likely to be the appropriate neighbourhood, though we should not lightly assume that it will improve the success rate within this neighbourhood.  Incentives (broadly defined) replace instructions as the search space is increased.  Since these are fundamental principles of human behaviour we should not be surprised that they apply to organisational design and management.  However, although we may welcome the present interest in incentives among economists, we should note that this interest is heavily concentrated on the delivery of what is already specified, at the expense of the search for new possibilities, let alone the search for unrecognised problems.  In addition it is generally restricted to a very narrow view of human motivation (Frey 2002); here the contrast with Smith is especially striking.

Discretion is important in two ways: it allows the development of substantially different cognitive structures for different specialisms, and it also allows local variation, and therefore localised progress within each specialism.  Both major and minor differences in the environment make their distinctive contributions; and these environments include the size and structure of organisations, which were of especial interest to Marshall.  (This is the context in which he introduced his ‘law of increasing return’; and that is why he was not prepared to attenuate it in order to conform to a particular concept of equilibrium.)  At neither level is it possible to prescribe the ‘best’ direction in which to seek improved knowledge; human consciousness and human purpose may lead to a faster rate of variety generation, and may even raise the average quality, but the growth of knowledge remains a process of trial and error, as Hayek continued to argue throughout his life.  Despite the waste generated in this process, that is so obvious in retrospect, the necessary superiority of a centrally directed search for knowledge is no less an illusion than the necessary superiority of central planning.

The digital revolution in information processing has diverted attention from the structural nature of knowledge.  The evidence on facial recognition presented earlier is particularly relevant at this point.  The motivation to recognise faces is, we may presume, a shared genetic endowment - its advantages in the formation of human society (including its importance in controlling opportunism) are obvious; but it is not linked to a unique facial module.  Recalling that recognition by feature is always employed by those affected by the Williams Syndrome, but also by those not so affected when they are presented with inverted faces, we may identify recognition by feature as the default mode; configural recognition is employed by those who have both the capability to do so and have also been presented with the material that is necessary to build patterns.  Pattern-making is an inherited capability, which may therefore be impaired by a genetic disorder; how that capacity is used depends on the environment and individual attempts to make sense of it.  The use of different procedures for upright and inverted faces is also a demonstration that domains may become very specific through development few people encounter inverted faces frequently enough to build appropriate patterns by which to identify them, but experiments with inverting spectacles have shown that it can be done.  (There is also a familiar economic principle at work here; investment in developing the skill of configural recognition within a specific domain, such as inverted faces, is not justified if this skill is very rarely used.)  Developed capabilities are configurations that economise on cognition; Marshall (1920, p. 251) explains how someone who has


learnt to skate can employ that knowledge as a unit in constructing more elaborate figures.  Ziman (2000, p. 120) points out that “pattern recognition is deeply embedded in scientific practice”, and that the construction, use and modification of such patterns within each scientific field is a particular (we may say domain-specific) application of a universal and inter-subjective human capability.

Patterns provide a basis for extending similarities by physical and mental experimentation at the margin; and since cognitive patterns differ somewhat between people there will be different margins at which to experiment.  Marshall’s recognition that these differences in cognitive patterns and in their corresponding experimental margins are substantially influenced by interactions with particular environments explains his profound interest in the “linkage between what people do and how they are changed by doing it”, which Becattini (1991, p. 16) forecast would justify “a radical repositioning of Marshall from theorist of price and equilibrium to theorist of industrialization and development”.  (Raffaelli (2003) presents such a radical repositioning.)  There will also be different margins at which knowledge may be most readily absorbed from other people or from written or electronic sources, for absorption requires incorporation into or amendment of some configuration; and what is absorbed is likely to differ slightly even between those who have undergone standardised training.  Creative and absorptive capacity both depend on the ability to make new connections, and are therefore limited by the connections that already exist; this ability and its potential domain, we may suppose, are genetically determined, but its use is not.  That use, however, follows the broad evolutionary principles of variation, selection, and retention.

Language allows us to experiment with simile and metaphor; and it is surely no accident that abstract thought is so reliant on metaphor.  Many English metaphors are derived from classical languages, and these are commonly used without recognition of their original meaning, but others, though very tired, are not yet dead: for example, we are invited to ‘draw a line under’ the past and ‘move ahead, bringing others with us towards new horizons’, perhaps through ‘leaps of faith’.  Though metaphors may often suppress thought, yet they occasionally have the power to make a connection between previously distant domains and thereby produce a significant innovation in thought or practice.  As in genetic evolution, even mistakes in copying may occasionally turn out to be productive.

A characteristic of this cognitive theory, as of all evolutionary theories, that is often overlooked is the intimate dependence of change on the absence of change.  Systematic development is impossible unless there is a stable baseline from which to begin and a stable environment against which options may be assessed - and which, in theories such as Hayek’s that allow for deliberate attempts to generate conjectures, may give direction to these attempts.  Smith’s (1980) psychological theory was identified in its title as an explanation and illustration of “the principles which lead and direct philosophical inquiries”.  The heavens provided a stable environment, which was subject to improving techniques of observation, and the sequence of robust interpretative systems examined by Smith was used, two centuries later, to illustrate Kuhn’s (1962, 1970) theory of scientific development, which is remarkably close to Smith’s.  Routines stabilise evolved patterns, thus releasing mental energy and providing a basis for experiment; this interplay between routine and innovation, within an individual, a firm, an industry, and an economy, is a pervasive theme in


Marshall’s economics (Raffaelli 2003).  Thus a sensible use of the concept of equilibrium is to enquire which elements of a system stand in an equilibrium relationship to each other; for these equilibrium relationships provide the foundations of change.  A natural consequence of this dependence of innovation on stability (which is also essential to neoDarwinian theory) is a substantial degree of path-dependency within each cognitive domain - including that of a whole economy, as is indicated by Marshall’s (1919) surveys of national systems; but this tendency is partially offset by the variety and the quasi-independence of domains - another consequence of the combined effects of cognitive limitations and the division of labour.

The counterpart of this quasi-independence is the problem of co-ordination, which arises in two forms: the compatability of separately-produced knowledge, and its comprehensibility to those who have not participated in its production.  The division of labour offers to the innovator the protection of cognitive distance; the integration of what has been divided requires cognitive proximity.  We should not overlook the effects of our shared genetic inheritance, which extends beyond the substantial component of programmed behaviour to the shared procedures by which our interpretative frameworks are formed (Ziman 2000, p. 121).  Smith’s (1976a) hopes for a civil society rested substantially on his argument that most people could both understand and appraise the behaviour of others in situations that were different from their own.  Since then, social and economic evolution, based on an inherited capacity to create differentiated patterns, has increased the variety of situations and increased the possibilities of juxtaposing interpretative frameworks that have few elements or connections in common.  Development within the individual dilutes the shared genetic inheritance of domain-specific behaviours.  Cultural evolution, in particular, may serve either to reinforce or to override the similarities of attitudes and behaviour embedded in humans on which both Smith and Hayek relied.

Kelly (1963) construes human personality in terms of the interpretative frameworks which guide each person’s understanding and behaviour; and the failure to achieve an acceptable coherence between interpretative frameworks in a changing environment thus becomes Kelly’s construction of a personal breakdown.  In an organisational context, this analysis can easily be extended to include problems of incompatability between the frameworks which seem to apply in the work environment and those with which each worker is comfortable in other parts of life, and also to problems of incompatability between the changes of framework that seem to be required in different parts of the organisation to cope with major changes in the organisation’s environment.  ‘A breakdown of corporate personality’ may be an appropriate way to describe what has happened to many organisations (including the Soviet Union).

We should remember, however, that compatability may be necessary in only a few dimensions, and systems may be connected along the dimensions where it is most readily achieved (Ziman 2002, pp. 302-6).  Success may depend both on bringing some people together and keeping others apart; and this may sometimes require the redefinition of organisational boundaries, as Allyn Young (1928) argued.  Richardson’s (1972) analysis of capabilities along the dimensions of similarity and complementarity provides a basis for such redefinition.  Adaptability - the capacity to modify connections - is preserved, and sometimes enhanced, by rearranging the


connections between units or between levels.  Such rearrangements may increase independence or exploit complementarities, thus redefining the cognitive unit, though not without creating new problems.  Organisational design is always an option of difficulties.

Although the division of labour is usually associated with the separation of activities, Smith (1976b, p. 21) recognised not only the benefits of recombination but also that the selectivity of connections provides scope for those who “are often capable of combining together the powers of the most distant and dissimilar objects”; thus integration, he observes, is itself a specialised activity.  It is a particularly important exemplar of the advantages of the division of labour, because it encourages novel extensions of the results of more narrowly-focussed specialisation through the development of new configurations.  The skills of integration across domains are themselves domain-specific, and for each individual, as the careers of ‘Schumpeterian’ entrepreneurs have shown, they are normally restricted to particular categories of “distant and dissimilar objects”.  Witt (1999) has also pointed to the entrepreneurial role in creating and maintaining compatible interpretations within a firm; because we all need plausible interpretative schemes, entrepreneurs may thereby crowd out opportunism.  These interpretations must also be, in some degree, differentiated from those which frame the activities of other firms, and sometimes differentiated from the shared assumptions of an industrial community; Schumpeter and Marshall both recognised the importance of the outsider as a source of novelty, though it was Schumpeter who drew attention to the major co-ordination failures that may result from the destruction of established knowledge.



As Potts (2000) has reminded us, a system consists of elements (which may themselves be systems) and the connections between them; changes in systems may therefore be traced to changes in either elements or connections, or to interactions between these two kinds of change.  It is an essential feature of general equilibrium modelling that any model should be fiully connected; consequently any differences between equilibrium models must be attributed exclusively to differences in their elements.  There is an apparent exception: the effects of imperfect information appear to depend on missing connections.  However, this appearance is deceptive, because the standard modelling strategy is to explain why the system works ‘as if’ it were completely connected.  It is because Williamson leaves some connections to be handled by governance structures, which are left outside his model, that this explanation of the firm is not quite admissible into the choice-theoretic core.

Unfortunately, complete connections within these models require significant omissions from the elements of which they are composed, even in the supposedly complete Arrow-Debreu system.  What is excluded is nothing less than what Arrow called ‘the costs of running the system’ - everything from the energy costs of cognition to the creation and operation of markets and organisations.  Not only does this make these models incompetent to handle externalities and institutions (Coase 1988, p. 15) - both of which are the consequences of incompletable connections; economising on these costs requires a high degree of selectivity among connections.  The elements and the connections in a model cannot, in general, be independently chosen by the modeller.


Structures matter.  Marshall’s (1920, p. 139) suggestion that organisation should be reckoned as a distinct agent of production is not an idiosyncratic idea, especially as he defined organisation very broadly (almost as the equivalent of ‘the costs of running the system’.  The idea is particularly appropriate if we are interested, as Marshall certainly was, in the process of economic development.  Just as perfect reproduction excludes genetic evolution, so does perfect organisation (and, of course, perfect competition) exclude novelty.  Hayek’s theory of the mind is a theory of connection-building: at the level of the species, it is part of a general theory of genetic evolution; at the level of the individual it is a theory of the innovative mind; and if one combines the two we have a theory of the evolution of the evolutionary process itself, along the lines suggested by Karmiloff-Smith and her co-authors.

Domain-specificity (in contrast to general equilibrium) is a key concept.  The genome appears to be inherently a method of constructing a system of domain-specific elements, embodying Smith’s principle of the division of labour; but with the remarkable enlargement of the human brain we seem to have a partial but significant movement away from genetically-determined domain-specificity (which seems likely to include at least a major part of the sensory order) towards a genetically-enabled development towards domain-specificity at the level of the individual.  As Hayek argues, this requires novel - and additional - patterns of connections within the brain; and these patterns are produced, as Smith and Shackle notably emphasised, by the human imagination.  Though the results of genetic evolution are still pervasive, there are now significant possibilities for development at the level of the individual to modify, and even sometimes to override, development at the level of the human species.

This is by no means all.  The mental orders created by our imagination and tested in specific domains are themselves forms of organisation, for all knowledge is a structure of selected connections.  Now although much of our “life-world knowledge is coded organically into our behaviour, genetic make-up and bodily form” (Ziman 2000, p. 299), these created mental orders vary greatly across individuals.  Consequently the knowledge available in any human society depends on organization - which means on particular patterns of connections - of the kinds listed by Marshall, which exploit the advantages of similarity (these depend not on total homogeneity but on local variation within imperfectly-specified patterns, as in genetic modifications) and of differentiation, which can produce new species of knowledge incomparably faster than genetic evolution.  The distribution and selective connection of domain-specific modules within the economy is a central issue for explaining economic development and for effective policy at the level of firms and governments.

However, economists should never forget opportunity costs.  There are important disadvantages of domain-specificity at all levels.  Though it is perhaps somewhat easier to escape from internally-generated patterns of thought and action than from those that are genetically determined, it is nevertheless true (as the studies reported by Karmiloff-Smith confirm) that patterns resulting from development become increasingly rigid.  The reconstruction of a personality to match a changed environment is a formidable challenge.  (As a problem for clinical psychologists, it stimulated Kelly’s (1963) Theory of Personality).  Changing the patterns of all the members of a group in a way that preserves intra-group compatability while adjusting


to a different environment is even more difficult reconstructing an organisation, formal or formal, of any size seems to be impossible without changing the membership.  Penrosian firms, like individual entrepreneurs, may find that nothing fails like success, because success may entrench belief in the patterns that appear to have produced it.  The coherence of larger societies may depend on moderating the demands for compatability; for although, as Ziman (2000, p. 121) observes, the world-wide appeal of some soap operas indicates the similarity of evolved mental and emotional mechanisms, the power of genetics is being continually attenuated by individual and social developments which, though genetically enabled, are not genetically controlled.

In the end, there is no escape from Knightian uncertainty; no procedures for expanding either theoretical knowledge or practical skills can be proved to be correct in relation to the total system to which they are to be applied, because our best representations of this system are necessarily incomplete, and likely to be erroneous in some unrecognised respects.  However, Knightian uncertainty is also a precondition for novelty, as Shackle kept reminding us; and human cognitive systems have a distinct, if limited, capacity for creating novelty as an integral part of their cognitive operations.  They may well also have a genetically-based need to search for novelty, and so a degree of uncertainty (balanced with some perceived stability) may be a necessity for the survival of the human species, as well as a potential threat to that survival.



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