The work of Bruce Caldwell and others on nature and significance of Hayek’s solution to the explanatory problem of economics outlined in his 1936 paper “Economics and Knowledge” and developed thereafter has been deeply flawed because because these account grasp neither Hayek original problem situation nor the nature and scope of Hayek’s revolutionary solution to that problem.
Here I’d like to outline Hayek’s original problem situation and the roots of Hayek’s solution to that problem in the work of Friedrich Wieser, Ludwig Wittgenstein, and others. And then I will explain the nature and content of Hayek’s solution, and explain how Caldwell and others have failed to accurately grasp the character of that solution.
Hayek’s original problem has a double source in two different academic literatures — economics and philosophy — and multiple roots within each of these two literatures, as I will explain.
The background of Hayek’s problem situation and revolutionary solution can be found in the collision between old and new ways of conceiving such fundamental problems as how knowledge is gained and how economic goods get their value. The first problem involves the collision between Kantian and empiricist conceptions of how knowledge is produced and what Hayek was learning in the brain lab of Constantin von Monakow, thinking about how the brain and its neurological cell structure could produce knowledge. The second problem involves the collision between the old problem of distribution theory conceived by Ricardo and the new way of explaining the determination of prices conceived by Menger, Walras and Jevons.
These two separate trains of problems and ideas had been knocking heads for decades but fortuitously managed to collide together in the 1920s and 1930s in the economic literature on business cycles and socialist planning in way which to Hayek’s breakthrough of 1936, which Hayek always identifies as among the greatest of his career.
The problem of the epistemic or logical character of economic science had been brewing for decades when Hayek first began butting heads with it in the 1920s. Menger, Wieser, Bohm-Bawer, Schumpeter, Mises and others had all attempted address the problem in the period between 1870 and 1925 under the challenge of German economists and philosophers who disputed the very conception of social science outside of mere history.
The neo-Kantians, Hegelians, and British empiricists by the end of the 19th century had convinced everyone that knowledge of the world came either in the form of nomological laws or via the growth of national cultures and ways of interpreting the world. The relation of pure logic and phenomenal experience to all this was disputed, but the basic division was part of the background understanding of the age. The task of economists developing the new economics of Jevons, Menger and Walras was to explain the place of economics in this framework.
The ongoing task within economics generated by the new theory of valuation conceived by Walras, Jevons and Menger was to use that new conception to address old problems, including the problem of the determination of the different classes of income stipulated by Ricardo. What did the explanation of price determination using the new theory of valuation have to tell us about the explanation of interest, wages, profit, or rent on land and capital?
Hayek came at each of these problems with a very special background — a background in biological research, neo-Kantian philosophy, theoretical psychology, the new analytical philosophy of Wittgenstein, and the economic research program of Menger, Bohm-Bawerk and Friedrich Wieser.
What we will discover as we proceed is how the conceptual framework developed by Wieser for understanding the elements of economic valuation and their relations runs in parallel with the framework developed by Wittgenstein for understanding the elements of semantic significance and their relations — and how both lead to constructions in which purely logical relations are separated from the world of the causal and the empirical. Hayek will combine these insights to separate out the world of the God’s Eye View and the world of empirical problems and contingent causal explanations.
Hayek began working on the problem of fitting the new findings of biology to dominant post-Kantian conceptions of knowledge in 1920. Hayek’s work staining brain cells convinced him that knowledge was a bottom-up product of neurological connections, rather than a top-down construct of a God’s Eye View mind combining phenomenal ‘givens’ according to purely formal logical rules or in line with a priori nomological structures.
Hayek began working on the problem of fitting the new findings of marginal valuation theory to the dominant conceptions of distribution theory in 1923. Hayek’s work under the influence of Wieser convinced him that the problem was one of pure logic conceived from a God’s Eye View, and conceptually could not be conceived mixing the empirical world of exchange and the logical realm of individual valuation. Hayek began to tackle the problem of attributing income shares to the factors of production using Wieser’s pure logic approach.
Hayek’s problem of the nature and source of knowledge began to collide with Hayek’s problem of the explanation of the distribution of the factors of income when he started thinking about the problem of business cycles as a research assistant collecting data on the Federal Reserve and the American economy. The problem became: (1) What is the relation of economic data to economic theory, and, (2) How do neo-Kantian and empiricist conceptions of how science works apply in the case of explaining business cycles using the new economic of marginal valuation? The problem became one of making sense the relation between empirical patterns and theoretical constructions. The idea that for economics to be properly ‘scientific’ according to the stipulations of the neo-Kantians and the empiricists is must be at once both nomological and grounded upon empirical experience. But how does that work in economics? Hayek would attempt to work out the solution within the domain of explaining the problem of business cycles.
The first hints at Hayek’s revolutionary solution come in his 1929 book Monetary Theory and the Trade Cycle. In that book, two central but conflicting ideas come crashing together, creating an explanatory anomaly at the heart of Hayek’s program of economic science. Hayek is attempting to address the problem of establishing economics as a theoretical science, while at the same time confronting the difficulty of addressing unruly economic phenomena like business cycle which are recalcitrant to being crammed into the confides of the pure logic of coordinated choice, what economists were calling the static theory of market equilibrium.
Germans under the influence of Kant and Hegel insisted that the economists in Britain, France and Austria could not possibly produce science because scientific knowledge took the form of nomological necessity and the world of human life was a world of cultural growth and individual will ungoverned by any law except that imposed by the self or the state. Economists outside of Germany tried to answer these objections through a whole host of strategies, almost all of them attempting to locate scientific law somewhere in the theory or the phenomena, for example, in lawful patterns of the unfolding of cultural history or in lawful patterns in the unfolding of strings of economic or demographic data, or some other stratagem. Because they were most directly pressured by the Germans, economists in Vienna struggled hardest to sort out the connection between the theoretical concepts and logical relations worked out in basic value theory and the Kantian and empiricist demand that the formal constructions limning the nomological structure of reality be connected to empirical experience. Wieser, Bohm-Bawerk, Schumpeter and Mises among others all took different tacks, borrowing largely from alternatives already found in the neo-Kantian heritage, grounding theoretical science and its empirical or explanatory character in psychologism, Kantian formalism, or predictive Machian phenomenalism, among other alternatives.
Hayek’s original background was in brain science, botany, evolutionary biology, experimental psychology, neo-Kantian epistemology and the new logic of Frege as presented by Hayek’s cousin Ludwig Wittgenstein. Hayek was an instinctive empiricist with a conception of theoretical science as a formal system, as prescribed by the neo-Kantian consensus and as suggested by the growing logical empiricist movement inspired by Frege and Wittgenstein. Hayek’s mentor Friedrich Wieser conceived of economics as an empirical discipline, but Hayek was far to sophisticated in the literatures of experimental psychology, neo-Kantian epistemology and the work of Wittgenstein to be satisfied with Wieser’s crude psychologistic account of the empirical content of economic science. Hayek’s own approach was to assume that the scientific status of economics was assured by the fact of its theoretical structure i.e. adherence to neo-Kantian dictates for scientific status, with its empirical status merely assumed rather than explained or shown.
So in the 1920s we have the young scientist Friedrich Hayek working on several difficult but rather well defined normal science puzzles, as Thomas Kuhn would describe them.
1. Hayek is working on extending the new logic of marginal valuation from consumer goods at a simple moment in time to production goods across time.
2. Hayek is working on extending the new logic of marginal valuation from the problem of explaining of the determination of relative prices to the old Ricardian problem of explaining the distribution of income shares between land, labor and capital goods, e.g. rent, wages, and profits.
3. Hayek is working to square the new logic of marginal valuation with the old problem of characterizing of the overall coordination of production plans and market trades as an perfectly balanced equilibrium system.
4. Hayek is working to square the new logic of marginal valuation with the old problem of explaining the phenomena of interest income on production goods.
5. Hayek is working on using the new logic of marginal valuation and its formalization into an equilibrium system to explain the old problem of systematic business cycle disruptions.
6. Hayek is working on showing how the new logic of marginal valuation can be used in a fashion which meets the dictates of science as pressumed in the wake of the neo-Kantian revolution in epistemology, which was sweeping all before it, especially as its core precepts were taken up by the logical empiricists using the work of Frege and Wittgenstein.
Hayek’s 1936 Copernican Revolution in economics can be shown to be the outcome of specific intractable anomalies which Hayek uncovered in the course of attempting to solve the normal science puzzles identified above. But it also came in the midst of a clash of competing ideas between rival approaches to resolving the outstanding normal science problem confronting economics.
These clashes of ideas include the following.
1. The clash between Hayek, Joseph Schumpeter, Frank Knight, Ludwig Mises, A. C. Pigou and others an how to square the new marginalist valuation construction with the problems of making sense of equilibrium theory and production valuation.
2. The clash between Hayek and John M. Keynes on how to make sense of the relation savings, investment, interest rates, the demand for consumer goods, and the demand for production goods, when explaining the business cycle.
3. The clash between Hayek and Fred Taylor, Maurice Dobb, Oskar Lange, and Henry Dickinson on the possibility of economic calculation in a socialist society.
And there is one final element we should note, whose significance will be explained later. All during this period when Hayek was clashing with British and American economists over how to proceed with the 1870 marginalist revolution, Hayek was editing the collected works of one of the founders of that revolution, Carl Menger.
Hayek’s various normal science puzzles and Hayek’s clashes with economists on how to think about production goods, interest, socialist calculation, business cycles, interest, and market discoordination all turned in various ways on the proper way to make use of the logic of valuation when moving beyond the simple case of consumption choice over the uses to be made of a given basket of apples — and how to think about continuing to use the logic of marginalist choice when turning to economic categories which violate the basic logical demands of marginalist thinking.
What Hayek repeatedly ran into were economists using the pre-marginalist categories of pre-marginalist Ricardian or classical economics, categories which had no foundation whatever in the logic of marginal choice, and who were then tying these categories to the logic of marginal choice in ways that made an illogical, incoherent hash of the logic marginalist choice. Hayek also found economists assuming as “given” elements which could never be given to anyone adjusting their affairs within an economy. And Hayek found economists assuming causal relations between presumed economic categories and entities which could never possibly interact in any economic system.
What is interesting here is that the model for thinking about a coordinated economic community which Hayek had inherited from Wieser come together with what Hayek had learned from Wittgenstein and the logical empiricists about logic to focus Hayek’s attention and what could be assumed to be “given” to a single mind in a formal construct versus what could not be given to any single mind in a great and extended global community.
The other thing which Hayek had which distinguished him from most other economists was a firm grasp on an crucial element of choice theory found in the pioneering work of Bohm-Bawerk on production goods, the insight that no one would ever choose extend the length of an individual production process unless that extension across time promised a superior output over the choice of a shorter production process (consider aging grape juice to make wine).
Wieser gave Hayek the model for a Dictator economy, where all supplies and demands within an economy are “given” to one mind. This model focused Hayek’s attention on the fact that this construct is indeed made up of assumed informational “givens”. But when thinking about the business cycle and when thinking about the problem of calculation in a socialist economic, Hayek was acutely aware that the information needed by folks in the economy to coordinate the lengthening and shortening of the structure of production to adapt to changing productivity advances, monetary changes, consumer preferences, time preference changes, and credit price and supply changes was information that simply was not given to anyone and could not be given to any one mind.
What other economists were doing in the case of the normal science problem Hayek was attempting to address was simply assuming “given” information which could never be given to anyone in the real world, and they were also assuming “given” relations between economic categories which did not and could not exist in any real community of individuals coordinating their individual plans in an extended global economic system. Most importantly, economists were leaving out the whole realm of choice over alternative production plans, including crucially the choice at any given moment in time between longer production plans which promised superior output versus shorter production processes which offered inferior output later yet a bit better consumption in the mean time.
Hayek’s great Copernican Revolution come just here when Mises’ work on the impossibility of socialist calculation comes together with the editorial work Hayek was doing on Carl Menger’s Collected Works.
What Carl Menger gave Hayek was a new vision of what explanatory science could be, one that fit with Hayek’s prior background in the biological sciences. Menger did this by giving Hayek as explanatory paradigm, an explanatory problem paired with a causal mechanism to account for problem. After producing his breakthrough paper of 1936 Hayek would spend decades fleshing out various aspects of this Menger explanatory paradigm, and fitting it in with the findings of the philosophy of science, the history of social science, the advances in neurosciences, complexity theory, and other branches of science and human thought.
Menger’s explanatory paradigm was this. Menger identified an empirical phenomena, the origin of money and money exchange, and he asked for a causal process which could account for that empirical phenomena. And Menger identified a possible causal mechanism to account for that origin in the learning by individuals about the ever increasing exchangeablility of a good, a good which over time would be universally demanded simply because of its ease of use as a widely demanded good that could substituted as an easily traded means of exchange. Hayek in his work had always been looking for problems, here Hayek has in Menger an empirical problem, one that describes a coordination problem across time and one that requires an empirical causal process of learning in order to effectuate.
Hayek had already been thinking about the problem-raising empirical patterns in our experience when working on the problem of business cycles. The boom and bust cycle of business fluctuations presented a set of patterns across time and across sectors of the economy that demanded explanation. The great question was how to account for them and what elements when into such an explanation. What Hayek ran into was in inadequacy of the logic of marginal valuation to account for these patterns, and what Hayek’s work exposed was the importance of false price signals in systematically misdirecting production in patterns which were unsustainable, generating patterns of boom and bust, and implicating systematic discoordination in the markets for money and credit.
Hayek could see this were others could not because of Hayek’s grasp of the central Bohm-Bawerkian insight into choice concerning production goods, the fact that no one would chose a longer production process unless in promised superior output, and the fact than when confronted with a new choice between rival production processes choices between longer and shorter production processes was always a part of the deliberative choice process.