May 8 marked the 124th anniversary of the birth of F. A. Hayek, the 1974 Nobel-winning economist of the Austrian school. (He died in 1992.) That makes it a good time to acknowledge one of his many contributions, his epistemic case for the free and competitive market order. It’s well-suited to the information age.
One of Hayek’s best-known articles was published in 1945 in the American Economic Review: “The Use of Knowledge in Society” (reprinted in Individualism and Economic Order). He got right to the point:
What is the problem we wish to solve when we try to construct a rational economic order? On certain familiar assumptions the answer is simple enough. If we possess all the relevant information, if we can start out from a given system of preferences, and if we command complete knowledge of available means, the problem which remains is purely one of logic. That is, the answer to the question of what is the best use of the available means is implicit in our assumptions….
This, however, is emphatically not the economic problem which society faces…. The reason for this is that the “data” from which the economic calculus starts are never for the whole society “given” to a single mind … and can never be so given.
The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is … a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know.
This is an important matter of course. In a world of scarcity and incomplete knowledge, where much vital information is not “data” at all but unarticulated “knowing how,” we don’t want resources and labor services used in just any old way. Rather, we want them put to the best use in the eyes of diverse and fickle consumers — and at the lowest cost possible so can we have more goods and more choices. We also want inevitable errors in production to be readily discovered and corrected. Finally, in a division of labor we want coordination to be as easy as possible.
Can we have all that? Fortunately a solution is available.
Thus Hayek wrote:
Fundamentally, in a system in which the knowledge of the relevant facts is dispersed among many people, prices can act to coördinate the separate actions of different people in the same way as subjective values help the individual to coördinate the parts of his plan….
We must look at the price system as such a mechanism for communicating information if we want to understand its real function…. The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action…. It is more than a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement.
He illustrated the point by describing how consumers and producers tend to economize on a material (he used tin) when the price goes up, even though only a few people know why the price has gone up. The price rise will encourage people to use less and or to use known substitutes and even discover substitutes. Others will be induced to search for new supplies of that material using new technology. Innovation will result. An economy run by politicians cannot approach this process.
What the price system accomplishes when left free is no mean feat. It makes longer and more prosperous lives possible for everyone. In a world of eight billion people, the unsexy price system is literally a lifesaver on a mass scale. Keep that in mind when politicians and activists call for interference with production and commerce.
We can’t acknowledge Hayek’s contribution without also paying tribute to his teacher Ludwig von Mises, which Hayek indeed did in other articles. For example, “Professor Mises’ [1920s critique of socialism] represents the starting point from which all the discussions of the economic problems of socialism, whether constructive or critical, which aspire to be taken seriously, must necessarily proceed.” Hayek, who had favored socialism before he met Mises, also wrote that Mises’s “central thesis could not be refuted.” (Hayek, “Socialist Calculation I: The Nature and History of the Problem,” in Individualism and Economic Order.)
Hayek was referring to Mises’s 1920 pathbreaking paper, “Economic Calculation in the Socialist Commonwealth,” and his 1922 book, Socialism: An Economic and Sociological Analysis. Mises’s fundamental point, which logically precedes Hayek’s later addition, was that without real, honest market prices for all inputs, the economic calculation required for rational and efficient mass production would be impossible. And, he went on, you can’t have honest market prices without private ownership and markets in resources and producer goods. (The Marxists sought the abolition of private property.) Flourishing and even life itself thus depend on prices and their prerequisites — prices that cannot be ascertained or even generated except in the market, where producers and consumers act according to their personal and often improvised preferences, make unpredictable discoveries about what circumstances they prefer, and choose among real, not hypothetical alternatives. Bureaucrats and economists cannot simulate this process, no matter how powerful their supercomputers are.
This critique was devasting to all forms of socialism (including fascism), and history has proved Mises and Hayek correct. Remember, socialism was supposed to be the all-around better way to deliver prosperity to all.
Many people who should know better pretend that Mises and Hayek never found these flaws in socialism. Shame on them. As for others who say they favor socialism, what’s concerning is not that they’ve heard Mises’s and Hayek’s critiques and answered them, but that they have never heard them at all! Enter the libertarians.