It’s seminar time folks. I’m going to walk people through many of Hayek’s most significant works over the next weeks and months, most especially those most closely relevant to the current crisis in the economy — and in the economics profession itself. And next year we’ll take up Hayek’s The Constitution of Liberty to mark the 50th anniversary of its publication.
Today I’m going to kick off my seminar series with Hayek’s breakthrough essay, “Economics and Knowledge”, which is chapter II of F. A. Hayek’s Individualism and Economic Order. Read it in pfd format here. Read it in html here. Order it from Amazon here.
The essay was written in the summer and fall of 1936, but a few months after the publications of Keynes’ General Theory. In the immediate years before the publication of Hayek’s famous essay, Hayek had been a very busy man. He’d edited and introduced Carl Menger’s Collected Works, he’d engaged in several major controversies, each of them turning (in Hayek’s mind) on the role of marginalist thinking about production processes and relative price dynamics — and the inability of British and American economists to think in marginalist terms about these production processes in a real world global frame.
These controversies where 1) the “socialist calculation” debates which resulted in the publication in 1935 of Hayek’s Collectivist Economic Planning (read Hayek’s CEP essays in pdf here); 2) the debates over production and interest theory (see for example Hayek’s reply to Frank Knight, “The Mythology of Capital” pdf); and 3) Hayek’s debates with Keynes and the Cambridge economists over how to think about investment / savings, especially in relation to monetary economics and production processes taking more or less time and producing more or less output, esp. when these are put into the context of systematic global dis-coordination (see e.g. F. A. Hayek, Contra Keynes and Cambridge).
Let’s set the table for a discussion Hayek’s “Economics and Knowledge” with Hayek’s recollections of that paper as explained in interviews with James Buchanan, Armen Alchian, Alex Leijonhufvud, and Jack High as part of the UCLA Oral History with Hayek taped in 1978.
Let’s begin with the Alchian – Hayek discussion which explains the practical context behind the writing of the essay:
ALCHIAN: Two things you wrote that had a personal influence on me, after your Prices and Production, were [“Economics and Knowledge”] and “The Use of Knowledge in Society.” These I would regard as your two best articles, best in terms of their influence on me.
HAYEK: “Economics and Knowledge” — the ’37 one — which is reprinted in the volume [Individualism and Economic Order], is the one which marks the new look at things in my way.
ALCHIAN: It was new to you, too, then? Was it a change in your own thinking?
HAYEK: Yes, it was really the beginning of my looking at things in a new light. If you asked me, I would say that up till that moment I was developing conventional ideas. With the [’36] lectures to the Economics Club in London, my presidential address, which is “Economics and Knowledge, “I started my own way of thinking. Sometimes in private I say I have made one discovery and two inventions in the social sciences: the discovery is the approach of the utilization of dispersed knowledge, which is the short formula which I use for it; and the two inventions I have made are denationalization of money and my system of democracy.
ALCHIAN: The first will live. [laughter] How did you happen to get into that topic? When you had to give this lecture, something must have made you start thinking of that.
HAYEK: It was several ideas converging on that subject. It was, as we just discussed, my essays on socialism, the use in my trade-cycle theory of the prices as guides to production, the current discussion of anticipation, particularly in the discussion with the Swedes on that subject, to some extent perhaps Knight’s Risk, Uncertainty and Profit, which contains certain suggestions in that
direction — all that came together. And it was with a feeling of a sudden illumination, sudden enlightenment, that I — I wrote that lecture in a certain excitement. I was aware that I was putting down things which were fairly well known in a new form, and perhaps it was the most exciting moment in my career when I saw it in print.
ALCHIAN: Well, I’m delighted to hear you say that, because I had that copy typed up to mimeograph for my students in the first course I gave here. And Allan Wallace, whom I guess you must know, came through town one day, and I said, “Allan, I’ve got a great article!” He looked at it, started to laugh, and said, “I’ve seen it too; it’s just phenomenal!” I’m just delighted to hear you say that it was exciting, because it was to me, too. But when did the idea hit you? When you started to write this paper, started to think about it, there must have been some moment at which you could just suddenly see you had something here. Was there such a moment at which you said, “Gee, I’ve got a good paper going here”?
HAYEK: It must have been in the few months preceding that, because I know I was very unhappy about having to give the presidential address to the Economics Club. Then I hit on that subject, and I wrote it out for that purpose. How long it was exactly before the date [of the address] I couldn’t say now, but I do know that the idea of articulating things which had been vaguely in my mind in
this form must have occurred to me when I was thinking of a subject for that lecture — the presidential address at the London Economics Club.
ALCHIAN: Well, that was a very influential article, I must say .. I guess I should go back and say one thing on this bit about use of knowledge and individualism. I would have conjectured that your rent control article might have had some carry-over on that. If one perceives that, he can begin to see this broader issue.
HAYEK: Well, I was recently surprised at how much I had forgotten about that article; I hardly knew any longer that it existed. It must have played a very important role in my actual thinking, but I find it very difficult to recall now exactly what role it played. It somehow fitted in with my concern with the direction of investment, and the role which prices and interest rates played in governing the direction of investment ..
As we read the essay, let’s make a note to keep an eye out for the places to think about the implications of Hayek’s arguments when economists discuss such things as “the direction of investment, and the role which prices and interest rates played in governing the direction of investment .. “.
Let’s turn next to the High – Hayek discussion, which seems to pin-point the “ah ha” moment which inspired the insight at the bottom of Hayek’s essay:
HIGH: To what extent do you think that general-equilibrium analysis has contributed to the belief that national economic planning is possible?
HAYEK: It certainly has. To what extent is very difficult to say. Of the direct significance of equilibrium analysis to the explanation of the events we observe, I never had any doubt, I thought it was a very useful concept to explain a type of order towards which the process of economics tends without ever reaching it. I’m now trying to formulate some concept of economics as a stream instead of an equilibrating force, as we ought, quite literally, to think in terms of the factors that determine the movement of the flow of water in a very irregular bed. That would give us a much better conception of what it does.
But ultimately, of course, it goes back to the assumption of what the economists pleonastically call “given data,” this ridiculous concept that, if you assume the fiction that you know all the facts, the conclusion you derive from this assumption can apply directly to the world. My whole thinking on this started with my old friend Freddy Benham joking about economists speaking about “given data” just to reassure themselves that what was given was really given. That led me, in part, to ask to whom were the data really given. To us, it was of course [given] to nobody. The economist assumes [the data] are given to him, but that’s a fiction. In fact, there’s no one who knows all the data or the whole process, and that’s what led me, in the thirties, to the idea that the whole problem was the utilization of information dispersed among thousands of people and not possessed by anyone. Once you see it that way, it’s clear that the concept of equilibrium helps you in no way to plan, because you could plan only if you knew all the facts known to all people; but since you can’t possibly know them, the whole thing is vain and a misconception partly inspired by this concept that there are definite data which are known to anyone.
The heads-up here it to be alert for discussions of “given data” in Hayek’s essay. Could an ongoing seminar gag be the golden nugget behind a landmark essay in economics? Could be.
We turn next to the Buchanan – Hayek discussion:
HAYEK: [The expansion of my work beyond narrow “technical” economics] really began with my doing that volume on collectivist economic planning, which was originally merely caused by the fact that I found that certain new insights which were known on the Continent had not reached the English-speaking world yet. It was largely [Ludwig von] Mises and his school, but also certain discussions by [Enrico] Barone and others, which were then completely unknown to the English-speaking world. Being forced to explain this development on the Continent in the introduction and the conclusion to this volume, which contained translations, I was curiously enough driven not only into political philosophy but into an analysis of the methodological misconceptions of economics. [These misconceptions] seemed to me to lead to these naive conceptions of, “After all, what the market does we can do better intellectually.” My way from there was very largely around methodological considerations, which led me back to — I think the decisive event was that essay I did in about ’37 on … “Economics and Knowledge. ”
BUCHANAN: That was a brilliant essay.
HAYEK: I think that was a decisive point of the change in my outlook. As I would put it now, [it elaborated] the conception that prices serve as guides to action and must be explained in determining what people ought to do — they’re not determined by what people have done in the past. But, of course, psychologically the consequence of the whole model of marginal-utility analysis was perhaps the decisive point which, as I now see the whole thing — market as a system of the utilization of knowledge, which nobody can possess as a whole, which only through the market situation leads people to aim at the needs of people whom they do not know, make use of facilities for which they have no direct information, all this condensed in abstract signals, and that our whole modern wealth and production could arise only thanks to this mechanism — is , I believe, the basis not only of my economic but as much of my political views. It reduces the possible task of authority very much if you realize that the market has in that sense a superiority, because the amount of information the authorities can use is always very limited, and the market uses an infinitely greater amount of information than the authorities can ever do.
I believe it was in that same article on economics and knowledge where I make the point that while the analysis of individual planning is in a way an a priori system of logic, the empirical element enters in people learning about what the other people do. And you can’t claim, as Mises does, that the whole theory of the market is an a priori system, because of the empirical factor which comes in that one person learns about what another person does. That was a gentle attempt to persuade Mises to give up the a priori claim, but I failed in persuading him.
Let’s remind ourselves to compare this casting of Hayek’s insight 40 years on with Hayek’s original explication of 1936. And we are alerted here to grapple with the implications of Hayek’s new way of thinking about how to do economics for traditional conceptions of knowledge and knowing — and especially contemporary ideas about the nature of scientific knowledge and economic knowledge.
And to put a few more bones on this question of how to do science — and the relation of science to the philosophical tradition — let’s conclude with the Leijonhufvud – Hayek discussion:
LEIJONHUFVUD: You have developed your own views on methodology over the years. Did you have a conflict with Mises on methodological matters?
HAYEK: No, no conflict, although I failed in my attempt to make him see my point; but he took it more good-naturedly than in most other instances. [laughter] I believe it was in that same article on economics and knowledge where I make the point that while the analysis of individual planning is in a way an a priori system of logic, the empirical element enters in people learning about what the other people do. And you can’t claim, as Mises does, that the whole theory of the market is an a priori system, because of the empirical factor which comes in that one person learns about what another person does. That was a gentle attempt to persuade Mises to give up the a priori claim, but I failed in persuading him. [laughter]
LEIJONHUFVUD: And you would not share his reliance on introspection?
HAYEK: Well, up to a point, yes, but in a much less intellectual sense. You see, I am neither a utilitarian nor a rationalist in the sense in which Mises was. And his introspection is, of course, essentially a rationalist introspection.
Well, we’re thick in the woods now, aren’t we? Perhaps best to turn to the essay itself, and look at at how Hayek begins:
“Economics and Knowledge”*
THE ambiguity of the title of this paper is not accidental. Its main subject is, of course, the role which assumptions and propositions about the knowledge possessed by the different members of society play in economic analysis. But this is by no means unconnected with the other question which might be discussed under the same title – the question to what extent formal economic analysis conveys any knowledge about what happens in the real world. Indeed, my main contention will be that the tautologies, of which formal equilibrium analysis in economics essentially consists, can be turned into propositions which tell us anything about causation in the real world only in so far as we are able to fill those formal propositions with definite statements about how knowledge is acquired and communicated. In short, I shall contend that the empirical element in economic theory–the only part which is concerned not merely with implications but with causes and effects and which leads therefore to conclusions which, at any rate in principle, are capable of verification — consists of propositions about the acquisition of knowledge.
* Presidential address delivered before the London Economic Club, November 10, 1936. Reprinted from Economica, IV (new ser., 1937), 33-54.
I’ll take up a discussion of this and more in the next seminar posting.
The comments are open. You are invited to participate in the discussion, ask questions, or contribute in any other manner to the seminar.