edmund phelps: The Elite Don’t Understand How Capitalism Works

Nobel Prize winner Edmond Phelps channels Friedrich Hayek and re-introduces Frank Knight in a brutal take-down of a failed generation botching up the works because they are fatally ignorant of how a capitalist economy actually works.  What Phelps is too delicate to say is that the elite have been well schooled in their ignorance by professors of economics who have drilled them in mathematical constructions which can do nothing else but create a deep misunderstand of the market process and the inherent economic uncertainty which exists within that process.

In this section, Phelps contrast the inadequate economic vision of Joseph Schumpeter with the deeper insights of Friedrich Hayek:

Well into the 20th century, scholars viewed economic advances as resulting from commercial innovations enabled by the discoveries of scientists – discoveries that come from outside the economy and out of the blue. Why then did capitalist economies benefit more than others? Joseph Schumpeter’s early theory proposed that a capitalist economy is quicker to seize sudden opportunities and thus has higher productivity, thanks to capitalist culture: the zeal of capable entrepreneurs and diligence of expert bankers. But the idea of all-knowing bankers and unerring entrepreneurs is laughable. Scholars now find that most growth in knowledge is not science-driven. Schumpeterian ­economics – Adam Smith plus sociology – captures very little.

Friedrich Hayek offered another view in the 1930s. Any modern economy, capitalist or state-run, is a great soup of private “know-how” dispersed among the specialised participants. No one, he said, not even a state agency, could amass all the knowledge that each participant “on the spot” inevitably acquires. The state would have no idea where to invest. Only capitalism solves this “knowledge problem”.

Later, Hayek fleshed out a theory of how capitalism makes “discoveries” on its own. He had no problem with the concept of an innovative idea, for he understood that, even among experts, knowledge is incomplete about most things not yet tried. So he felt free to suppose that, thanks to the specialised insights each acquires, a manager or employee may one day “imagine” (as Hayek’s hero, David Hume, would have put it) a commercial departure – one that could not be inferred or envisioned by people outside the individual’s line of work. Then he portrays a well-functioning capitalist system as a broad-based, bottom-up organism that gives diverse new ideas opportunities to compete for development and, with luck, adoption in the marketplace. That “discovery procedure” makes it far more innovative than the top-down systems of socialism or corporatism. The latter are too bureaucratic to learn about ideas from below and unlikely to obtain approval from all the social partners of the ideas that do get through ..

UPDATE:  See also this related article by Jerry Muller.  [Ht to Alan Furth.]  Here’s Muller:

From the point of view of top management, the diversity of operations means that executives were managing assets and services with which they have little familiarity. This has led to the spread of pseudo-objectivity: the search for standardized measures of achievement across large and disparate organizations. Its implicit premises were these: that information which is numerically measurable is the only sort of knowledge necessary; that numerical data can substitute for other forms of inquiry; and that numerical acumen can substitute for practical knowledge about the underlying assets and services.

A good deal of our current economic travails can be traced to this increasing valuation of purportedly objective criteria, so denoted because they can be expressed and manipulated in mathematical form by people who may be skilled at such manipulation but who lack “concrete” knowledge or experience of the things being made or traded. As Niall Ferguson has put it, “Those whom the gods want to destroy they first teach math.” …

Read the whole thing.

5 comments to edmund phelps: The Elite Don’t Understand How Capitalism Works

  • David Crookes

    I am pleased to find this comment. Last night I read Phelp’s article and found it very interesting. In the quote above he says: “Scholars now find that most growth in knowledge is not science-driven”

    I wished he’d named some scholars here, because I found this an intriguing statement, and would like to read further. Any idea who he might be referring to?

  • [...] to Greg Ransom at Taking Hayek Seriously.) Comments [...]

  • Jerry Z. Muller

    Greg,
    I’m pleased that my article, “Our Epistemological Depression,” came to your attention. It was inspired, in part, by a Hayekian question, namely, how is knowledge conveyed in society?; supplemented by insights from Oakeshott and Michael Polanyi about abstract versus practical forms of knowledge.
    The question is Hayekian, but the answer — that forces within the capitalist market served to create and disperse fallacious forms of knowledge — is not. That I think corresponds to the difference between a social scientific appropriation of Hayek (which uses his insights heuristically, to generate questions), and an ideological appropriation, that assumes in advance that the market is always right and government wrong.
    Jerry Muller

  • Greg Ransom

    Jerry — I think you misunderstand Hayek’s work. Hayek’s trade cycle theory, for example, does not assume that the market is always right. And that is Hayek’s first and most noteworthy contribution to “technical” economics.

    Frankly, I find the throwing around of the term “ideological” very annoying. The term was coined by Napoleon and used by Marx as an ad hominem to attack without argument and avoid engaging all of the powerful evidence and explanatory frameworks which got in the way of their own agendas.

    And certainly Hayek didn’t use economic theory the way you seem to imply — and I can’t think of any “Hayekians” who use it that way either.

    Perhaps you are confusing the work of Hayek with the work of Eugene Fama. Hayek is explicitly _not_ an “efficient market hypothesis” economist when it comes to finance and the macroeconomy, and he isn’t even that when it comes to explaining individual economic behavior. It’s just a failure to understand Hayek’s work to think the “efficient market hypothesis” represents Hayek’s understanding of things.

    But perhaps you are not making that mistake.

    The Hayekians I know use Hayekian insights to both generate questions and to answer questions — and very often this analysis points to government failures lying behind market failures. (E.g. the current crisis). Nothing inherently “ideological” about it — that’s simply were good explanation giving very often leads us.

    It’s an ad hominem of the Napoleon / Marx sort to suggest otherwise.

    Again, I see nothing “non-Hayekian” about your answer, unless you are insisting on a perverse and false characterizion of “Hayekian”.

    No doubt I’m troubled here mostly about words, but the unfair and false use of words can cause a great deal of damage.

    Jerry writes:

    “The question is Hayekian, but the answer — that forces within the capitalist market served to create and disperse fallacious forms of knowledge — is not. That I think corresponds to the difference between a social scientific appropriation of Hayek (which uses his insights heuristically, to generate questions), and an ideological appropriation, that assumes in advance that the market is always right and government wrong.”

  • Greg Ransom

    “supplemented by insights from Oakeshott and Michael Polanyi about abstract versus practical forms of knowledge.”

    Of course, these same insights are found in Hayek, see for example Hayek’s “Economics and Knowledge” (1937) and “The Use of Knowledge In Society” (1945), etc.

    The mistaken claim is sometimes made that Hayek derived these ideas from Polanyi. As far as I’ve been able to establish, they are original in Hayek’s own work, and Hayek only later found Polanyi using some of the same notions. Whether Polanyi derived some of his account from Hayek is another question (some of Polanyi’s work on these matters was written after he’d read Hayek).

    Similarly, Hayek uses the language of “orders” and order which are “spontaneous” as early as 1932/1933, prior to finding Polanyi’s later use of the expression “spontaneous order”. Again, whether Polanyi derived his language from Hayek is a different question, one I can’t answer. Again, we know that Polanyi was familiar with Hayek’s writing. We also know that Hayek edited and published Polanyi’s work.

    I’d have to go back and look at the details for specifics.

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