Thoughts on Hayek's essay on the use of knowledge

Economics Economics Questions
1

“The Use of Knowledge in Society”

I read it and it was wonderful. I believe that I might not have been able to appreciate the full impact of the essay had I not studied various bits of AE before that.

Many of the passages are amazing, but what struck me especially was the fact that economic actors only need to be privy to a tiny amount of information for the structure of production to adjust:

the “man on the spot” cannot decide solely on the basis of his limited but intimate knowledge of the facts of his immediate surroundings. There still remains the problem of communicating to him such further information as he needs to fit his decisions into the whole pattern of changes of the larger economic system.

H.18

How much knowledge does he need to do so successfully? Which of the events which happen beyond the horizon of his immediate knowledge are of relevance to his immediate decision, and how much of them need he know?

H.19

There is hardly anything that happens anywhere in the world that mightnot have an effect on the decision he ought to make. But he need not know of these events as such, nor of all their effects. It does not matter for himwhy at the particular moment more screws of one size than of another are wanted, why paper bags are more readily available than canvas bags, or whyskilled labor, or particular machine tools, have for the moment become more difficult to obtain. All that is significant for him is how much more or lessdifficult to procure they have become compared with other things with which he is also concerned, or how much more or less urgently wanted are the alternative things he produces or uses. It is always a question of the relative importance of the particular things with which he is concerned, and the causes which alter their relative importance are of no interest to him beyond the effect on those concrete things of his own environment.

Then the realization struck me. Consider this market scenario:

Tin is an integral part of the production of a certain product (say, cans) in a certain industry. Tin is also used in many other industries. One day, the price of tin increases due to a demand shock in another part of the world. Since the price is higher, the marginal buyers of tin before will be priced out. This means that the marginal producers of cans will also be priced out (perhaps shift into other lines of production). The combination of these effects leads to an increase in the price of tin cans due to a supply shift to the left. This means that marginal consumers of foods in tin cans will be priced out and will decide in accordance with their individual value preferences to buy less canned food relative to other kinds of foods.

What happens when central planners have to do this?

Tin is used to make cans and many other things. Tin demand in another part of the world jumps and the price of tin increases. The central planners have to decide on the realtive imporatances of the uses of tin and which production lines to decrease. They then also have to decide to whom to distribute the smaller amount of tin cans (which will probably not be in line with their subjective preferences).

Wow! The market has automatic, built-in mechanisms to solve this quickly and efficiently. Plus, the final consumption decisions based on relative subjective valuations informed by price are completely inaccessible to the government.

This is insane!

2

It is an excellent essay. I still find it amusing when some textbooks claim things like what Hayek says here is “fully expressed” by the Pareto Welfare theorems.

3

I feel that the whole of economic science is just a “proof” of said conclusion. Namely, that prices are not arbitrary but are a necessary requirement in creating what society most wants with what society has access to.

If only people understood this we would never again have stupid arguments about minimum wage laws, price gouging, CEO salaries etc.

It’s not even that the “proof” (that is: economics) is very difficult, at least not compared to other sciences. Anyone with a little time can understand the basics of it. Rather, people don’t want to accept it, because it is at times critical of themselves. Because surely their salary would be higher were it not for the evil and completely arbitrary judgements of capitalists. There is after all, no chance in hell that it can be representative of society’s valuation of their productivity as absolutely appalling. I mean, they are after all the most important people on this planet (at least, according to their mothers, and later their surrogate the state).

4

Hans-Hermann Hoppe on why Hayek’s knowledge prolem is fallacious and very different from Mises’ calculation problem.

I perosnally have always found the “knowledge prolem” to be quite inferior to Mises’ calculation problem when trying to argue why central planning is not only impossible, but that only private property of the means of production allows for any sort of rational economic planning. It took me a while to realize also that Hayek’s argument is simply wrong.

5

I agree that the Calcuation Problem provides the superior arguments not only against central planning and in my mind the Knowledge Problem can be mostly solved through communications. Clearly prices are a superior way to communicate information, but not the only. On the otherhand there is no communications system that can resolve the Calculation Problem resulting from the lack of free market prices. Producers encounter a vast array of methods to accomplish their plans and without prices there is no measuring system that the producers can use to evaluate the best use of resources to best satisfy consumers.

I would also agree with Rothbard conjecture that any use of force on actors in the economy creates instances of the Calculation Problem in what he called Islands of Chaos.

6

DD5 - I was thinking about that. If I recall correctly, Mises argued that even if there were no information problem, the government still couldn’t solve the economic problem. Is this correct?

Even so, the fact that the market can distribute information like this is phenomenal.

7

It’s all wrong, and adds nothing of value to the debate.

http://mises.org/daily/2401 & http://archive.mises.org/5306/knowledge-vs-calculation/

For some other interesting views on this:

  • Rothbard (p. 66): “the entire Hayekian emphasis on ‘knowledge’ is misplaced and misconceived”
  • Hülsmann (p. 39): discussing “the irrelevance of knowledge problems”
  • Salerno (p. 44): “[t]he price system is not–and praxeologically cannot be–a mechanism for economizing and communicating the knowledge relevant to production plans. The realized prices of history are an accessory of appraisement”
  • Hoppe (p. 146): “Hayek’s contribution to the socialism debate must be thrown out as false, confusing, and irrelevant.”
  • Kinsella: “The encoding metaphor seems to be a pseudoscientific and scientistic attempt to give this kind of economic theorizing a patina of scientific respectability by borrowing engineering terminology. It is scientistic because, in vainly trying to borrow natural science terminology, there is an assumption that only the “hard” or natural sciences have true validity. It is akin to using such inapt phrases as the “momentum” of the leading team in a basketball game, the “energy” of crystals and astral forms, or, even worse, “revving the engine” of the economy. Both economics and ethics can be sciences, but not in the same way as the causal, natural sciences.”
8

In that piece, Hoppe says:

But that seems to contradict what Peter Klein writes here (page 2):

Firms (and clubs and families) do “face the very same problems as socialism” sometimes. Indeed, that is one of the diseconomies of scale that prevents firms from growing very large. Rothbard recognised this:

For this reason, I struggle to see how Hoppe’s criticism of Hayek holds. Just as a firm gets bigger and bigger and begins to suffer Hayek’s knowledge problem, so too does it begin to suffer Mises’ calculation problem. Hoppe is right that the problem Hayek raises is not unique to socialism, but then neither is the problem that Mises was talking about.

I’m not saying I disagree with Hoppe’s conclusion (which Conza posted) but I don’t see how that particular point of his is a valid criticism.

9

I agree. I think Mises’ statement about a calculation problem was the fundamental one to socialism as strictly concieved in the Marxian sense as world socialism. I entirely agree with Salerno, Hoppe et al on this point, as well as the fact that what Hayek and Mises are talking about are really quite distinct things.

Where I disagree and where I think the zeal of their criticism takes them too far is when they assert what Hayek was talking about in essays like that linked above was entirely unimportant and even completely wrong. I think it can reasonably be understood why the pricing system to a certain extent can economise knowledge, and why this is an advantage.

I think this could be understood in 2 simple ways to begin with. Prices first of all reflect a composite of the current situation regarding scarcity for an array of commodities, and current prices are at least direct relevant for production planning to the extent they constitute one half of all profit-loss calculations on the cost side, while it is entirely the case that the expected prices are entirely consist of what we say is based on appraisement and understanding. Of course one might retort that really what is being balanced against expected revenue is perceived opportunity cost (again based on an appraisement and understanding of the future), yet even that is a percentage proportion of current costs and therefore current prices.

Another sense in which Hayek’s argument is important is the extent to which it extends and relates the kind of Smithian notion regarding how through a market dispersed decision making of unrelated actors utilising dispersed knowledge can nevertheless allow for an overall efficient coordination of resources unplanned by anybody (and this gos beyond the trivial relation between producers and consuimers). Changes in the tin supply and the political situation affecting it may be of little concern to producers in other businesses, yet they still benefit from the chain of effects induced along the capital structure produced by the actions of successful speculators in the commodity market who pay attention predominantly to the former two problems yet heed little attention to those particular factors affecting the other businesses. This division of analysis and dispersed decision making can only take place via the use of a market price system.

10

I think Hoppe is way off on this. First, as noted above, he doesn’t realise that families and firms do have the same problem as socialism since they do not have a common unit of calculation. Has he not heard of diseconomy of scale?

Second, I think that Mises’ calculation problem is primarily about knowledge, specifically the lack of knowledge about the efficient use of resources that results from the lack of a common unit with which to compare those uses. And what does Mises argue facilitates that comparison on the free market? Prices - the very same thing that Hayek argues transmits knowledge!!

So really Hoppe’s contribution to the socialism debate must be thrown out as false, confusing, and irrelevant.

11

Graham, you say

Firms (and clubs and families) do “face the very same problems as socialism” sometimes. Indeed, that is one of the diseconomies of scale that prevents firms from growing very large.

Yet this paper on Mises disputes this:

http://mises.org/journals/scholar/mackenzie13.pdf

This paper argues that economic calculation does not
require division of capital between separate organizations. Capital in an all encompassing
global firm can be priced indirectly through the pricing of securities issued by that firm, in its
stock exchange. Competition in the stock market can determine the pattern of investment
with a reasonable degree of efficiency, even if this market has only one corporation listed.
While a centralized system of monopoly capitalism allows for rational planning of capital
investment in dynamic conditions, neither centralized nor decentralized socialism allows for
the reconciliation of capital investment plans with changing economic conditions

I haven’t read any of the relevant arguments, so I just throw this out there.

12

Here is Jeff Tucker on the matter, commenting on a copy of Hayek’s essay:

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13

Here is Yeager on the matter:

http://www.mises.org/journals/rae/pdf/RAE7_2_5.pdf

And here is an information theory critique of Hayek:

http://reality.gn.apc.org/econ/hayek.htm

14

I agree with Yeager on this, as much as I like Salerno, Herbener and Hoppe. I’ll probably do a post on the Voluntaryist Reader about this eventually.

15

“Here is Yeager on the matter”

… And here is Salerno’s reply to Yeager; Reply to Leland B. Yeager on “Mises and Hayek on Calculation and Knowledge”, Ludwig von Mises as Social Rationalist

16

There is a fundamental difference between Mises and Hayek that you (and others) are over looking.

Mises argues: Private property of the means of production → formation of prices for factors → economic calculation

We can conclude: That the problem of economic calculation is one of private property, not one of knowledge!

That’s not to say that Socialism doesn’t suffer from a lack of knowledge, but this is an effect and not a cause. Without property and prices, the division of labor/knowledge would not emerge in the first place, and we wouldn’t have a “knowledge problem” to talk about either.

Let me put it another way. Without private property and prices, no people who know how to build iphones (all thousands or millions of them) would exist in the first place. So then what is the problem of Socialism? That there is no private property of the means of production(Mises), or is it simply a knowledge problem (Hayek - how to coordinate all those people who know how to build iphones)?

I think it becomes obvious that the knowledge problem confuses cause and effect.

17

Prices are information. Not knowledge. We apply knowledge to interpret information. it is precisely why mathematical algorithms cannot be developed to tell you where and how to invest.

Are you going to tell me that there was a “knowledge problem” in NJ and NY after Sandy? Are you going to tell me that because prices of gasoline were not allowed to rise, that entrepreneurs did not know that NJ and NY had gasoline shortages and therefore did not divert any shipments of gasoline from other places into that region? If you subscribe to the “knowledge problem” (recall the tin example), then you have to argue that yes, there was a knowledge problem.

In fact, entrepreneurs had the knowledge about gasoline shortages. Everyone did! What they lacked was a functional price system due to sabotage by government. They lacked true property rights! But if prices and knowledge are the same thing (or 2 sides of the same coin), then how can they posses one and not the other?

18

I’m really enjoying this thread. Thanks for all the links. I agree with Salerno that Mises and Hayek are talking about different things. I continue to think Hoppe’s criticism is wrong.

MacKenzie conflates Mises and Hayek in this paper, but I don’t think that is the main problem with it. The main problem is definitional. The all-encompassing global firm that he describes is so decentralised that it is really no longer a single firm. He talks about a stock market existing in such a scenario, where the stocks and shares being traded are divisions or branches of the single firm. But if you have stocks and shares being traded separately for each division, then how is it still just one firm?

As I see it, an all-encompassing firm and an all-encompassing government would face precisely the same fundamental problem. In neither scenario would there be a stock market, which Mises says (and MacKenzie agrees) is the essential thing for allowing economic calculation. The existence of a stock market implies the existence of multiple firms.