by Peter Boettke
F. A. Hayek is perhaps best known as the author of The Road to Serfdom (1944), a prophetic work issuing a warning about the totalitarian tendencies of socialist economic planning. Socialism, Hayek argued, was both incompatible with liberal democracy and material progress and well-being. A critical step in his argument was that socialism could not replace the market economy not only in its efficient use of resources, but in stimulating creative innovation and technological change that enhanced the human condition.
To economists, however, Hayek is most appreciated for his article further explaining the argument in the critical step published a year later – “The Use of Knowledge in Society.” In 2011, a group of distinguished professional economists were given the task of selecting the 20 most important articles published in the scientific journal American Economic Review in its 100 years of existence (founded in 1911). Hayek’s article published in the September issue of 1945 was among those selected. This article has been cited close to 25,000 times in the scientific literature, and its core message is often said to be part of the DNA of all modern economics.
But is it? I am not so sure. Certainly, aspects of the argument can be found in mainstream textbooks: prices convey information; prices economize on what information we need to know; prices are sufficient for the establishment of an equilibrium of supply and demand. But is that what Hayek really meant to teach in that essay? I would argue “not really.”
In August of 1944, Hayek had promised Fritz Machlup that he would finish and submit his article “The Utilization of Knowledge in Economics” upon his return from Gibraltar. Hayek worked on the essay and submitted it to Machlup, the editor of the American Economic Review in early 1945 before his tour of the US to promote The Road to Serfdom. Machlup wrote to Hayek in July of 1945 to let him know the article was accepted and would run in the September issue under the title: “The Use of Knowledge in Society.” That was just over 80 years ago, and significant aspects of how that article feeds into our understanding of how markets work have still proven too elusive for many professional economists, let alone regulators, politicians, and pundits. The elusiveness is strange for anyone who has read the original essay, I would argue, because Hayek is quite clear. On the first page he states explicitly that the efficient allocation of resources is not the fundamental economic problem that society must face. “The economic problem of society,” he wrote, “is thus not merely a problem of how to allocate ‘given’ resources – if ‘given’ is taken to mean given to a single mind which deliberately solves the problem set by these ‘data’.” The problem is rather one of “how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.” And, as Hayek would later stress, the economic problems of society “arise always and only in consequence of change.”
The economic problem, Hayek argued, had been obscured rather than illuminated by the development of formal models of the market. The models assume away change and thus fail to capture the dynamics of commercial life. Rather than given, knowledge must be generated, discovered, utilized, and conveyed. Markets are tools for learning, and prices are the conduit through which the vital knowledge for learning is communicated to the various relevant parties. Markets are, as Hayek argued, a form of a telecommunication system that aid in the necessary adaptations and continually adjustments to changing circumstances in which economic actors find themselves having to cope with. Tastes change, technology changes, and resource availability changes, and this necessitates participants in the market to adjust their behavior if they are to continue to pursue productive specialization, and realize peaceful social cooperation through exchange. The coordination of suppliers and demanders is mediated through continuous price adjustments. The price system works based on a system of private property and freedom of contract. Property ownership creates high powered incentives to husband resources efficiently. Relative prices guide economic actors in forming their plans for future economic activity. Profits lure economic actors into potential attractive ventures. And, losses discipline economic actors when their conjectures prove to be mistaken. The price system in this sense gives economic decision makers constant feedback through conveying the ex ante knowledge to plan actions, the ex post knowledge to assess the plans pursued, and the very discrepancy between the ex ante and the ex post sets in motion a continuous process of adaptation and adjustment. “The continuous flow of goods and services,” Hayek wrote, “is maintained by constant deliberate adjustments, by new dispositions made every day in the light of circumstances not known the day before, by B stepping in at once when A fails to deliver.”
The key point Hayek was trying to get across to his scientific peers was that the ability to mobilize the ordinary behavior of individuals in society, and utilize the knowledge scattered throughout society, market competition and the price system was a necessary tool to the human mind. Socialist planning disregards these critical generation, discovery, utilization, and conveyance aspects of markets, and formal models of planning and public administration blinded economists from the necessity of market prices for the achievement of rational economic administration of an economy. The very definition of rational production in this context was that the system would be able to increase the productive capacity of the economy by producing more with less, and the very definition of irrational production is producing less with more. Socialism could not achieve its aspirations of a burst of productivity such that the move from the Kingdom of Necessity to the Kingdom of Freedom would be made because socialist planning is incapable of rationalizing the process of production. In the British context of his time, the promise for a New Jerusalem would produce instead a new hell on earth. As Hayek put it in The Road to Serfdom (1945): “That democratic socialism, the great utopia of the last few generations, is not only unachievable, but that to strive for it produces something so utterly different that few of those who now wish it would be prepared to accept the consequences, many will not believe until the connection has been laid bare in all its aspects.”
Hayek’s argument is institutional – property, contract and consent; and it is scientific – the role of prices in coordinating economic activity through time. The “economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place.” The price system is, in Hayek’s rendering, metaphorically ‘machinery’ for registering change. But it is the farthest thing from a ‘machine’ and its operation is not ‘mechanical’ let alone ‘automatic’. Instead, the market is the by-product of purposive human action and embodies a social process of human interaction. In a market, both sides to exchange walk away saying “thank you,” and as Adam Smith taught us in The Wealth of Nations (which will celebrate its own milestone anniversary next year: 250 years) this set of exchange and production decisions provides for us the meals we consume everyday. The baker, brewer, and butcher do not provide us our dinner out of the kindness of their heart for humanity, but due to their self-interest. Scarcely in our lifetime can we develop deep and intimate relationships with our family and friends, but we require for our survival the cooperation of a great multitude of individuals who we do not know and never will know. Hayek’s concern, and a concern borne out not only in models of socialist planning but also in models of industrial regulation and macroeconomic demand management, was that our theoretical habits as economists “has made us somewhat blind to the true function of the price mechanism and led us to apply rather misleading standards for judging its efficiency.” The market, he went on to tell his peers in professional economics, is a marvel, that is demonstrated by that fact that “a scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; that is, they move in the right direction.”
The spontaneous order of the market is indeed a ‘marvel’ as Hayek put it. But he chose that word, he tells us, deliberately to “shock the reader out of their complacency.” We still, unfortunately need to shock professional economists out of their complacency as the quest to control and design remains strong, and the tools taught to students from high school to PhD are ones more appropriate for the task of social control rather than for cultivating social understanding as the classical political economists from Smith to J. S. Mill provided.
Adam Smith taught us that science progresses through three phases: Wonder, Surprise, Appreciation. He was talking about celestial mechanics when he made this observation, but we can apply his observation to the study of the “marvel” of the market. We first notice the clothes on our back, the food on our table, the cars that we drive, and the iPhones we use daily to stay connected and informed. How did that get into our hands? Isn’t it amazing this cornucopia of goods and services that those of us fortunate enough to live in a market society have at our disposal? When we move this fact of our existence from taken for granted to a subject of inquiry, we are confronted with a sense of wonder and awe in the wake of the mystery of the mundane. As we explore further, and unearth the governing dynamics that brings about this coordination of production and exchange activity and the realization of peaceful social cooperation without central command, we are surprised to learn it is about the marshalling of self-interest and the communication of the relevant knowledge dispersed throughout the economy. We would have thought that if we looked deep enough we would have found a central director, a person behind the curtain pulling and pushing levels. But no such commanding planner exists, instead the array of goods and services and the amazing efficiency with which they are produced and distributed is the result of an infinite number of “planners” each striving to achieve their own goals by pursuing their plans and not society’s. So our sense of wonder is followed by a sense of surprise at how the system works, but once we understand how the system works, we are then led to appreciate the intricacy of that operation and what institutional settings either hinder or promote their operation. Wonder, Surprise, Appreciation.
Hayek’s marvel is still pretty marvelous at 80.
Peter Boettke is Distinguished University Professor of Economics and Philosophy, George Mason University and Director of the F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics, Mercatus Center at George Mason University. Send him mail.
Isonomia Quarterly 