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Global lockdown shows again that business success owes much to chance

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“Everything existing in the universe is the fruit of chance and necessity.” – Democritus, 5th-4th century B.C.

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Paleontologist Stephen Jay Gould repeatedly warned against practising Darwinism outside the field of biological evolution. He considered that the theory was useless to understand History, culture or society. One field that blatantly ignored his advice is economics.

Ever since, in the 18th century, Adam Smith came up with the idea of a wholesome ‘invisible hand’, industrialists have tried to underline the benefits of capitalism. When Darwin came up with the concept of natural selection a century later, Victorian political theorist Herbert Spencer jumped at the opportunity of applying the theory to economic models and coined the phrase ‘survival of the fittest.’

Despite the compelling need for state intervention both during the 2008 financial crisis and the ongoing coronavirus outbreak, we are frequently assured that market liberalization is the best answer to all economic woes. Capitalism, we are told, is Darwinist. To some degree, this is true, though not in the sense that free-market advocates understand it.

Shortcomings Of Economic Darwinism

Darwinism is the acknowledgment that evolution is accidental. As such, it does not equate perfection but experimentation. According to Charles Darwin, species selected in this struggle for life are not the best or even superior to the rest; they are simply those whose capacity to adapt gave them the right to survive. Bacteria or viruses that thrive are not those that are the most beneficial to their environment; they are those that can withstand antibiotics or vaccines.

Likewise, if we were to employ - against Gould’s advice - the libertarian doctrine of the ‘survival of the fittest’ to the economy, firms that prosper are not necessarily the most valuable to society; they could be market participants best able to bypass protective or restrictive regulations. Capitalism, like Darwinism, has no ethical finality. Today’s global technology platforms and financial institutions are not per se the most trustworthy and respectful corporations. They are the ones that skillfully skirt or fudge privacy, licensing, employment and tax laws.

Although few would dare question Darwin’s findings about the process of natural selection and his theory of evolution, some researchers offered an intriguingly distinct explanation for survival. The late Japanese geneticist Motoo Kimura argued in the 1960s that a criteria to demonstrate evolution might not be resilience but chance.

Another geneticist, Bernard Kettlewell, studied the population of moths that lived in the British city of Manchester during the 19th century. Before Manchester became heavily industrialized, in 1848, green moths represented 98% of the species due to their ability to blend with their natural habitat and hide from birds. But by 1898, dark moths accounted for 95% of the entire moth population in that city. Their color protected them from predators in surroundings blackened by pollution, essentially soot discharged by factories.

Fortune, rather than adaptability, explains the dark moths’ staying power. According to Kimura, all members of a species have the same capabilities, but random variations in the environment decide which representatives flourish.

When applied to the corporate world, this view forces us to reconsider the deterministic penchant so prevalent in present business circles. Luck might best define which firm will pull through the next crisis provoked by technological revolution, speculative euphoria, regulatory onslaught or the current worldwide pandemic.

Evolution of Financial Markets

If American investment banks have become the undisputed leaders in global financial markets, is it because they were better equipped to adapt than their Canadian, Asian or European peers, or is it because they were located in the country that, in its obsessive search for economic expansion, was most determined to introduce deregulation and the widespread propagation of credit?

What happened in the private markets since the turn of the millennium also proves that chance plays a big part in our economies. Private capital has experienced much brisker growth than the traditional banking and public markets. The primary reason for this success is not the superior flexibility of buyout specialists, non-bank lenders and venture capitalists. It is not the result of a fight to the death. In a true market economy, commercial banks and public equity would win that battle as, without regulation, the winners are participants with the broadest capital base.

Instead, the progress of private capital derived from the introduction of tighter regulations by US and European governments to bring the global banking sector, bond and stock markets under control. Investment groups like Apollo and Blackstone - with assets under management up sevenfold and fivefold, respectively, over the past decade - found themselves in the right place at the right time.

To apply Kimura’s argumentation, private capital already held dormant capabilities and pre-existing features, such as tax-avoidance deal structures and limited accountability, which proved handy when governments introduced the Dodd-Frank Act to restrict speculative activities from financial institutions that presented a systemic risk.

When the Volcker Rule was enacted in 2010 and finally implemented in 2015, preventing banks from taking high-risk positions with their clients’ money, it opened the door for non-systemic asset managers. Fortuity boosted demand for notoriously opaque and under-regulated products. No longer “exposed to severe competition” (to adopt Darwin’s terminology), alternative fund managers captured the niche left vacant by closely monitored banking institutions.

That would explain why the evolution of private markets went through a momentous leap in the wake of the financial crisis rather than gradual progression, as an intricate process of natural selection would entail. As Darwin stated, while “man does not actually produce variability…he does select the variations given to him by nature.”

Determinism vs. Probabilism

The coronavirus outbreak will put many start-ups and small enterprises out of business. Those that make it through the global lockdown and economic recession will not necessarily have the most compelling business models. They might merely be the ones with the longest cash runway, perhaps because they raised fresh funds in the weeks preceding the sanitary crisis. As chronicled in Brad Stone’s book The Everything Store, Amazon was able to handle the 2000-02 dotcom crash better than most essentially because it had raised $672 million through a convertible bond in February 2000, just before the Nasdaq started its vertiginous, two-year-long drop. Providence played a big part in Amazon’s destiny. Some of today’s start-ups will similarly experience the ‘survival of the luckiest.’

Until a month ago, meal-kit service provider Blue Apron had seen its stock price drop 98% since its IPO in June 2017. The former unicorn was considering desperate strategic options: a distressed sale followed by a delisting. Five weeks later, its stock is up 400% due to the government-enforced confinement, encouraging people to stay home and order food online. In the struggle for existence, the company is going through its own ‘dark moth moment’, if only temporarily. Loss-making Blue Apron did not have to adapt; the environment unexpectedly changed in its favor.

Naturally, businesses can wield tools to improve their survival rate. Many market participants have long suspected that luck rather than talent was behind their ascendancy. Some decided to shape their own fate. Rigging LIBOR, falsifying accounts, trading on inside information, lobbying, colluding, creating cartels and monopolies, defrauding the mortgage loan industry are ways to ‘survive’ in a ruthless and random competitive landscape.

Just like modern medicine helped humans cheat death - or at least alleviate the worst effects of natural selection - in a deregulated economy, market manipulation helps skew the statistical odds in one’s favor.

Resolving whether chance (probabilism) or ability (determinism) is the key factor behind the evolution process is best left in the hands of scientists. But if business success is haphazard, the Darwinian view adopted by fervent market economists (a.k.a. economic Darwinists) is based on a fallacy. That would not be so surprising. As Nassim Nicholas Taleb put it: “In science you need to understand the world; in business you need others to misunderstand it.”