The headlines blare that President Obama will “restructure the financial services industry” and “fix the health care crisis.” A 31-yearold with no experience in the business world, but a lot of experience in politics, has been put in charge of dismantling General Motors.
Members of Congress lecture car manufacturers and mortgage lenders on how to do their jobs. Politicians keep taking on more and more responsibility for the U.S. economy, as each industry appears to be getting its own “czar.” Unfortunately, more czars will not produce better cars, or health care, or mortgages, or much of anything else.
The belief that one person or group, no matter how smart, can know how best to allocate resources is a classic example of what the Nobel Laureate economist F. A. Hayek called “the fatal conceit.”
In Hayek’s view, what enables businesspeople to make good decisions about the allocation of resources is not that they are smarter than other people. Instead, two other factors are key.
First, businesspeople have very detailed knowledge of their particular corners of the world. They know where resources are, where their customers are and what they want, and have the experience of knowing how to deliver it. This is not about being “smarter,” but about having local and contextual knowledge that others don’t have.
Second, entrepreneurs develop this knowledge by making use of the signals provided by prices, profits, and losses. Prices guide entrepreneurial decision-making by enabling them to formulate budgets and estimate the profitability of the various choices they might make.
Profits and losses provide information after the fact about how well they chose. Profits signal them to continue, while losses tell them that resources need to be reallocated. By acting on the basis of that information, each entrepreneur contributes to the overall improved allocation of resources.
The lesson from Hayek is that when the rules are right, markets are collectively much smarter than any individual or group within them. This is the lesson that the Obama administration has utterly missed.