Thursday, October 7, 2010

Austrian Economics Forum Fall 2010 #3

The last readings group covered Hayek's articles "The Meaning of Competition" and "'Free' Enterprise and Competitive Order."  In my opinion the first is brilliant and the second, well, maybe it should not have been published.  The group also seemed to be of the same opinion--the second article made too many concessions. 

The first article, "The Meaning of Competition," was originally a lecture presented in 1946 at Princeton University.  If I am recalling correctly, in the late 1940s, Hayek was on a lecture tour of the United States for two reasons.  First, he was very popular due to his book The Road to Serfdom.  Based on the popularity of this book, he was asked to go on a speaking tour to promote it.  Also at this time, his home life was becoming increasingly unhappy.  He was moving towards a divorce and, as a result, he was looking for a new position outside of the LSE.  (He eventually moved to the University of Chicago, 1950-1962.)

"The Meaning of Competition" takes the model of perfect competition to task.  In fact, he completely trashes it.  He starts by examining the perfectly competitive model's assumptions.  He, of course, focuses his attention on the assumption of perfect or "complete" knowledge.  Hayek argues that by making this assumption, the economist has assumed away the very problem that he is to answer.  It is only through the competitive order that relative scarcities can be discovered.  It is only through a market price system that this knowledge can be communicated.  It is the price system that economizes on what and how much needs to be communicated to create a efficient economic system.

Hayek argues,
"The function of competition is here precisely to teach us who will serve us well: which grocer or travel agency, which department store or hotel, which doctor or solicitor, we can expect to provide the most satisfactory solution for whatever particular personal problem we may have to face."

During the group discussion, I presented the following argument.  For the economist, the relevant cost of any decision is always the opportunity cost.  In a world of perfect knowledge, the marginal cost is the opportunity cost of the resource.  When we remove the idea of perfect knowledge, opportunity cost and marginal cost are no longer the same.  In fact, the entrepreneur should completely set aside the Average Variable Cost curve, the Average Fixed Cost curve and the Marginal Cost curve, because they are not the relevant basis of decision. 

For example, suppose an entrepreneur is faced with the choice of project A and project B.  Suppose further that the expenditures for both projects are $100.  The revenue for project A is $150 and the revenue for project B is $120.  Since the rate of profit for A is higher (50% versus 20%), the entrepreneur will obviously pick project A.  What is the cost of this decision?  It's not the $100.  The cost, the opportunity cost, of his decision is not being able to get the 20% return from project B.  Now suppose that the expenses for project A climbs from $100 to $110.  The rate of profit falls to about 36%.  Now even though the entrepreneur's expenses have risen, the cost of the project (the opportunity cost) has remained exactly the same!  The cost is still the 20% that the entrepreneur is unable to get when he chooses project A.

(I'm not sure if everyone agreed with this line of thought or not, because they were fairly quiet.  I suppose that it might be something that people need to sit with and think through.)

Hayek then drops the assumption of homogeneous goods and states the obvious--we live in a world with a spectrum of unalike products.  For Austrians, products are substitutes or complements not because they look a certain way or have a certain physical similarities.  For example, helicopters and closed-circuit cameras can be substitutes.  How so?  When a news station wants traffic updates, it can either send out a helicopter to monitor the traffic or it can use the cameras that now watch traffic flow.  They are substitutes, not because cameras and helicopters look like each other, but because they are able to yield the same result.  In a world where goods are not homogeneous, in a world where cameras and helicopters can be substitutes, the perfectly competitive model is completely inadequate.

Hayek concludes the article with:
"Competition is essentially a process of the formation of opinion: by spreading information, it creates that unity and coherence of the economic system which we presuppose when we think of it as one market.  It creates the views that people have about what is best and cheapest, and it is because of it that people know at least as much about possibilities and opportunities as they in fact do.  It is thus a process which involves a continuous change in the data and whose significance must therefore be completely missed by any theory which treats these data as constant."

The second article was the last one written for this book.  It was written for the 1947 Mont-Pélerin conference and it was presented as the beginning of a discussion group.  As a result, it raises many questions and answers very few.  The conference was the first for what is now called the Mont-Pélerin Society.  The purpose of the group was to gather the few remaining classical liberals, draw a line in the sand and determine the best course of action to promote liberty and oppose collectivism.

I confess that I like the beginning of the article.  Hayek illustrates how there is this tendency for popular governments to cater to special interest groups, take over certain "responsibilities" of the citizens, gather power and control the masses.  Hayek argues that we need to take a long-term perspective.  A free society cannot be built overnight; people must be educated about liberty, responsibility and the importance of private property.  Hayek then argues that we cannot simply chant mantras of private property and liberty.  There needs to be more. 

It is after this point that the wheels fall off.

Hayek argues that we need to think about the extension of the traditional concept of property to areas such as patents, copyright, trade-marks "and the like."  Hayek then argues that maybe we shouldn't have patents and trade-marks.  At first, I thought that this is similar to today's controversy in Austrian circles on the topic of Intellectual Property (IP) Rights.  However, Hayek continues further along this line of reasoning.  By questioning the "blind" extension of property rights to areas such as IP, we should further question the "blind" extension of property rights and "freedom of contract" to other areas such as corporations and limited liability organizations.  Hayek then argues that it is the proper role of government to step in and limit corporations.  In fact, it is "the duty of government to protect the individual against organized groups [corporations]."  Hayek further states, "There may be valid arguments for so designing corporation law as to impede the indefinite growth of individual corporations....Hayek then argues that we should also scrutinize labor unions and their collective power.

In the final section, Hayek opens the discussion to taxation.  While he warns against the negative incentives that taxes cause, he also says, "I ought to add that inheritance taxes could, of course, be made an instrument toward greater social mobility and greater dispersion of property and, consequently, may have to be regarded as important tools of a truly liberal policy which ought not to stand condemned by the abuse which has been made of it."

I find these passages astonishing.  Maybe Hayek is attempting to be thought provoking to generate a discussion for a panel, but I doubt it.  Hayek is making these claims in front of the first Mont-Pélerin meeting, a meeting to stem the tide of collectivism, a meeting attended by the leading classical liberal thinkers.  I wonder what Mises thought of this paper.  I think that passages such as these may have been the cause for some to split Hayek into Hayek I (the good one) and Hayek II (the not-so-good one).

There is no question that Hayek was a champion for liberty.  His writings have done much for the promotion of free markets.  However, Hayek was only human and could make mistakes.  He regretted not reviewing Keynes' General Theory.  I suspect that he wouldn't place this article on a pedestal either.


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