Austrian Economics Forum Fall 2010 #2

It seems as though I am running a little behind in my updates for our discussion group.  At the last meeting we discussed Chapters 2 & 4 of Hayek's Individualism and Economic Order. 

The first article we covered was "Economics and Knowledge."  The article comes from a Presidential address before the London Economic Club in November 1936.  It was reprinted in Economica in 1937.  This article is significant because it is the first attempt he makes in describing the role and importance that prices play in our economy.  He addresses the question, "With the absence of a central planner, how is it that people cooperate?"  How do we coordinate our actions?  And more fundamentally, how do economists view and model this process?

Hayek focuses on what the economist assumes, and particularly, what the economist assumes the people in the economy know.  There is knowledge, data, which needs to be conveyed from one corner of the economy to the other.  Can knowledge be assumed to be "perfect" and known by all?  Hayek answers that knowledge is limited and divided.  This article sets him on the path of developing his concept of "spontaneous ordering."

There is one aside that I'd like to point out with regard to this article.  Hayek is questioning whether markets tend to equilibrate.  At the end of section 9, I think that we can see that Hayek agrees with market equilibration.  However during these years 1936-37, Ludwig Lachmann was Hayek's student at LSE.  I think that it is clear that he was influenced by this thinking and led him down the path of rejecting market equilibration.

The second article is one of Hayek's most famous articles, "The Use of Knowledge in Society."  It was published in the American Economic Review in 1945.  Here Hayek expands on his earlier question by asking,

"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."

Then he forcefully argues,

"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 which could work out the implications and can never be so given."

In this article, Hayek argues that knowledge is dispersed and must be that way.  He refers to the knowledge of "time and place."  There is no manner to communicate to a central planner all the knowledge that is necessary to have an efficient economy. 

There is no substitute for simply reading this very short article.  It is found here.  Nevertheless,...

The first thing that Hayek discusses is the different types of knowledge.  He says that there are scientific knowledge and the knowledge of the particular circumstances of time and place.  He argues that not all knowledge is something that can be communicated to a central planning board.  While Hayek is absolutely correct and he is not saying that he has a complete taxonomy of knowledge categories, I think that the category of tacit knowledge should also have been included in his discussion.  Tacit knowledge is the "learning-by-doing" knowledge that is easily seen in the world of art and music.

The next big thing that Hayek demonstrates is the economy of knowledge that is found in a price and that this information moves the economy.  Hayek uses an example of a Tin Mine.  Suppose that you use tin in your production process and the price of tin increases.  What do you do?  You cut back on your use of tin and look for substitutes.  But not only does the price tell the entrepreneur in which way to move, but it also tells him the magnitude.  If the price of tine goes up 3-cents, it's no big deal.  If the price of tin goes up 300%, then it is a big deal.  All of these actions are done without evening knowing what the root cause was.  The only thing that is known is that tin is relatively more scarce and the economy needs to adjust.

The next point that Hayek makes is that prices allow the individual to link himself into the greater economic order.  The price system sends to him enough information to make decisions and those decisions have effects on present and future price formation.  It is through this process that prices lead to coordination.  Paris gets fed!  How?  Through each individual, acting in his own self-interest, making decisions on what and how much to buy, and what and how much to sell, we get food to major population centers.  The best short story that illustrates this point is "I, Pencil" by Leonard Read of FEE.


Finally, I think that one of the most neglected points that Hayek makes is the fact that without prices, civilization could not exist.  Paris would starve without prices.  There is no other substitute for prices.  The Russians, under Lenin, tried it and it was a disaster.

There is no substitute for reading this article.  It's short--only 11 pages in the AER.  So get reading!