Over the course of this afternoon, you will hear a series of presentations that put Hayek's thinking in the context of contemporary developments and that offer a variety of perspectives on his intellectual legacy.
Hayek was a prolific—some might even say profligate—thinker. He was at various times, and in various modes, an early neuropsychologist, an epistemologist, a theoretical economist, a political philosopher, a moral philosopher, a philosopher of science, a historian of ideas, a public intellectual, and a social polemicist. This vast range has caused some to undervalue his contributions as an economist, notwithstanding his eventual Nobel Prize—when Hayek moved to the United States in , the University of Chicago Economics Department would not hire him because, as Milton Friedman said, "At that stage, he really wasn't doing any economics," and Paul Krugman famously said that "the Hayek thing is almost entirely about politics, not economics.
In my contribution to the discussion today, I want to examine a particular example of the lasting effect that Hayek has had on economic thinking—one pertaining to the importance of freely determined prices for producing efficient economic outcomes—and consider how Hayek's insights in this area can, in fact, tie together the various strands of his larger philosophy. So as not to appear entirely out of touch with more immediate developments, I will end by descending from the empyrean to the terrestrial with a discussion of the economic outlook and the Federal Open Market Committee's FOMC policy decision from earlier this week.
Hayek and Economics Hayek's contributions to economics ranged widely, and many were important and of lasting influence. Among them were his studies of the relationship between the economic and political arrangements of a society. That body of work included, of course, his celebrated book The Road to Serfdom, which was published 75 years ago this year and is a focus of this event, as well as his later monograph, The Constitution of Liberty.
His work in this area included the theory of the business cycle that was part of the thinking of the Austrian school of economics. Today, however, I will be concerned instead with still another key contribution that Hayek made to economic analysis: understanding the operation of the price system. This contribution was formalized in his most famous paper in the economic-research literature: his article "The Use of Knowledge in Society," which was published in the American Economic Review in September Hayek Revisited It is worth outlining the basis for the high esteem in which economists hold Hayek's contribution.
In , the press release by the Royal Swedish Academy of Sciences that announced Hayek's Nobel Prize in Economics stated: "The Academy is of the opinion that von Hayek's analysis of the functional efficiency of different economic systems is one of his most significant contributions to economic research in the broader sense.
His guiding principle when comparing various systems is to study how efficiently all the knowledge and all the information dispersed among individuals and enterprises [are] utilized. His conclusion is that only by far-reaching decentralization in a market system with competition and free price-fixing is it possible to make full use of knowledge and information. In the research that the academy described, Hayek's paper was the key article. More recently, this paper received further prominent acclaim when it was categorized by an expert panel as being one of the top 20 articles ever published in the American Economic Review.
With regard to the paper's contribution to the understanding of economic processes, an illuminating discussion was provided in by Oliver Williamson—himself later a Nobel laureate in economics. Williamson cited Hayek's paper, along with Adam Smith's The Wealth of Nations from the eighteenth century, as forming the core of a "venerated tradition in economics" of studying the notion of "spontaneous order" arising from a freely operating market system.
How does Hayek's case for the price system fit in alongside the other work that Williamson mentioned? As Paul Samuelson—yet another Nobel Prize winner—had occasion to note, the argument for the price system that Hayek articulated in was complementary with, but distinct from, the argument that Adam Smith espoused in The Wealth of Nations.
Hayek instead stressed how the market mechanism makes, as he put it, "fuller use Hayek emphasized that the signals transmitted by the various individual prices in the economy could, together, serve as a useful means of guiding overall resource allocation. The reason is that prices convey messages to consumers and producers even when the information that drives prices is not aggregated or directly observed.
As a related matter, Hayek recognized that prices transmit information even in a situation in which much of that information is not explicitly disclosed by one market participant to another, or even consciously articulable by any market participant at all.
Hayek believed that all of us "know" many things that we cannot articulate but that we nevertheless act on in practical situations, and the price system can therefore aggregate and transmit that knowledge which we could not otherwise convey. Hayek's analysis had implications for the viability of different economic systems. With regard to centrally planned economic systems—which had considerable support in the West in , in light of the increased use of government economic controls in many countries during World War II and the dismal performance of market economies during the Great Depression—Hayek's analysis suggested that these systems would likely exhibit great inefficiency.
To Hayek, it was totally unrealistic to expect an economy to operate efficiently if it was based on the "direction of the whole economic system according to one unified plan," as such a plan lacked the valuable information embedded in market-determined prices. The economist Gregory Mankiw has elegantly summed up Hayek's insight here: "Information is very, very dispersed among the population.
Nobody can possibly know all the information you need to run a centrally planned economy. Again, it is important to recognize that this is not a contingent or technological problem. It is not only that the dispersion of knowledge makes it hard to gather, although that is certainly true—but if that were the only issue, then perhaps future advances in technology such as quantum computing would remove that obstacle.
Rather, as already mentioned, we all know many important things that we cannot articulate; and many of these things we come to know precisely through our participation in trade and exchange through the market. This type of knowledge a is by its nature not conveyable to a central planner because we are not fully aware of all we know, and b would not even exist apart from the social interactions facilitated by the market which a central planner would replace.
The flip side of Hayek's analysis was that, while there are insurmountable obstacles to economic efficiency via a central plan, an efficient economy may still be obtainable by letting the price system work. To quote Mankiw again, Hayek's analysis implies that "markets figure out a way to aggregate, in a decentralized way, dispersed information into desirable outcomes. It is, instead, sufficient for the proper operation of the price mechanism that the relevant information be embodied implicitly in the economy's multiplicity of prices of individual goods and factors of production.
This information is recorded in such prices because they respond to the behavior of individual buyers and sellers in the economy. It is [in Hayek's description] nothing short of a 'marvel. How Hayek Has Influenced Economics Hayek's paper has had a great influence on subsequent economic research. It has been found to be highly relevant to a variety of areas of economic inquiry.
For example, Hayek's analysis has proved valuable in the development of standard microeconomics, since his contribution deepened economists' understanding of the working of the price system and promoted further investigation of the question of how decentralized information is transmitted by markets.
Hayek's ideas on prices influenced Joseph Stiglitz in his analysis of markets with asymmetric information and Roger Myerson's insights on mechanism design theory. Each of these bodies of work earned a Nobel Prize. Qualifications and Extensions I do not want to leave the impression, however, that all of the conclusions in Hayek's paper have become unchallenged principles chiseled into the economic consensus.
On the contrary, one of the reasons why the paper has been so influential is that it remains a benchmark reference for understanding the case for relying primarily on a market system, based on freely determined prices, for determining the production and allocation of resources. The paper has therefore set a high bar for preempting the price system or for other interventions in the market: When economists point to cases in which market mechanisms can be improved on by regulation or other public-sector intervention, or to instances in which price signals do not appear to be operating effectively, they need to identify a specific market failure as the source of the inefficiency.
Essentially, they need to establish instances in which the price system can be improved on as a means of processing information. There is yet another link with positivism.
There is much to suggest that, when Hayek denies any ultimate dualism in the nature of things, he is not lapsing into an idiom of essences or natural kinds, but simply observing—much in the fashion of the American pragmatist philosopher, W. Quine—that nothing in our experience compels us to adopt ideas of mental or physical substance.
In his skeptical and pragmatist attitude to ultimate questions in metaphysics and ontology, Hayek lines up with many positivists rather than with Kantian critical philosophy—though positivists themselves sometimes claim, with some justification, to be treading a Kantian path.
But this is not what I have in mind. In his later writings, Hayek is explicit that the human mind is itself an evolutionary product and that its structure is therefore variable and not constant. The structural principles or fundamental categories which our minds contain ought not, then, to be interpreted in Cartesian fashion as universal and necessary axioms, reflecting the natural necessities of the world, but rather as constituting evolutionary adaptations of the human organism to the world that it inhabits.
We shall suppose the animal senses to have evolved from primitive beginnings; and we shall look therefore on our own senses, essentially, as part of a decoding mechanism—a mechanism which decodes, more or less successfully, the encoded information about the world which manages to reach us by sensory means. In the sense that we must exercise this faculty of judgment even before we can apply a rule, it is action which is at the root of our very knowledge itself.
Our perceptual processes, indeed all our processes of thought, are governed by rules which we do not normally articulate, which in some cases are necessarily beyond articulation by us, but which we rely upon for the efficiency of all our action in the world. Indeed, it is not too much to say that, for Hayek notwithstanding his stress on the abstract or conceptual character of our sensory knowledge all our knowledge is at bottom practical or tacit knowledge: it consists, not in propositions or theories, but in habits and dispositions to act in a rule-governed fashion.
It is in this sense—in holding the stuff of knowledge to be at bottom practical—that Hayek may be said to subscribe to a thesis of the primacy of practice in the constitution of human knowledge. It is not indeed that Hayek disparages the enterprise of theory-building, but he sees the theoretical reconstruction of our practical knowledge as necessarily incomplete in its achievements.
Why is this? Hayek argues that, not only human social life, but the life of the mind itself is governed by rules, some of which cannot be specified at all. Note that Hayek does not contend merely that we cannot in fact specify all the rules which govern both social and intellectual life: he argues that there must of necessity be an insuperable limit beyond which we are unable to specify the rules by which our lives are governed. As he puts it:. So far our argument has rested solely on the uncontestable assumption that we are not in fact able to specify all the rules which govern our perceptions and actions.
We still have to consider the question whether it is conceivable that we should ever be in a position discursively to describe all or at least any one we like of these rules, or whether mental activity must always be guided by some rules which we are in principle not able to specify.
If it should turn out that it is basically impossible to state or communicate all the rules which govern our actions, including our communications and explicit statements, this would imply an inherent limitation of our possible explicit knowledge and, in particular, the impossibility of ever fully explaining a mind of the complexity of our own.
Nothing is said in Ryle or Polanyi thus far about rule-governedness as a distinctive mark of human and, it may well be, not only human but also animal intelligent behavior. It is for the insight that practical knowledge is transmitted mimetically through the absorption of social rules that we need to turn to Wittgenstein, from whom Hayek may have taken it.
But secondly, all of these rules, including even the most fundamental of them are products of a process of evolutionary selection, by which they may be further altered or eliminated.
Systems of rules conferring successful behavior are adopted by others without conscious reflection. It is this disposition to emulate or copy successful behaviors which explains the cultural evolution of which Hayek speaks, and which though he recognizes its primitive beginnings in the social lives of animals Hayek regards as the distinguishing mark of human life.
His Kantian view is distinctive in that it anticipates Popper in affirming that our mental frameworks by which we categorize the world are neither universal nor invariant, but alterable in an evolutionary fashion; his Kantian view also follows Wittgenstein in grasping the role of social rules in the transmission of practical knowledge. Hayek himself is emphatic that these insights in the theories of mind and knowledge have the largest consequences for social theory.
The inaccessability to reflexive inquiry of the rules that govern conscious thought entails the bankruptcy of the Cartesian rationalist project and implies that the human mind can never fully understand itself, still less can it ever be governed by any process of conscious thought. It is the chief burden of the latter, let us recall, that no external or transcendental standpoint on human thought is achievable, in terms of which it may be supported or reformed. In social theory, this Kantian perspective implies the impossibility of any Archimedean point from which a synoptic view can be gained of society as a whole and in terms of which social life may be understood and, it may be, redesigned.
We can never reduce a system of rules or all values as a whole to a purposive construction, but must always stop with our criticism of something that has no better grounds for existence than that it is the accepted basis of the particular tradition. Hayek goes beyond Kantianism, however, in his recognition that, just as in the theory of mind we must break off when we come to the region of unknowable ultimate rules, so in social theory we come to a stop with the basic constitutive traditions of social life.
But this is not to say that these traditions are unchanging, nor that we cannot understand how it is that they do change. It is not just that too many concrete details of social life would always escape such an intelligence, which could never, therefore, know enough.
Nor though we are nearer the nub of the matter here is it that society is not a static object of knowledge which could survive unchanged the investigations of such an intelligence. No, the impossibility of total social planning does not rest for Hayek on such Popperian considerations, [28] or, at any rate, not primarily on them.
Such an impossibility of central social planning rests, firstly, on the primordially practical character of most of the knowledge on which social life depends. Such knowledge cannot be concentrated in a single brain, natural or mechanical, not because it is very complicated, but rather because it is embodied in habits and dispositions and governs our conduct via rules which are often inarticulable.
But, secondly, the impossibility of total social planning arises from the fact that, since we are all of us governed by rules of which we have no knowledge, even the directing intelligence itself would be subject to such government.
It is naive and almost incoherent [29] to suppose that a society could lift itself up by its bootstraps and reconstruct itself, in part at least because the idea that any individual mind—or any collectivity of selected minds—could do that, is no less absurd. If the order we discover in society is in no important respect the product of a directing intelligence, and if the human mind itself is a product of cultural evolution, then it follows that social order cannot be the product of anything resembling conscious control or rational design.
As Hayek puts it:. Crony capitalism shouldn't be confused with the real thing. The fourth timely idea of Hayek's is that order can emerge not just from the top down but from the bottom up. The American people are suffering from top-down fatigue. President Obama has expanded federal control of health care. He'd like to do the same with the energy market.
Through Fannie and Freddie, the government is running the mortgage market. It now also owns shares in flagship American companies. The president flouts the rule of law by extracting promises from BP rather than letting the courts do their job. By increasing the size of government, he has left fewer resources for the rest of us to direct through our own decisions.
Hayek understood that the opposite of top-down collectivism was not selfishness and egotism. A free modern society is all about cooperation.
We join with others to produce the goods and services we enjoy, all without top-down direction. The same is true in every sphere of activity that makes life meaningful—when we sing and when we dance, when we play and when we pray.
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