Friedrich Hayek – The Use of Knowledge in Society

Friedrich Hayek – The Use of Knowledge in Society. The American Economic Review, Vol. 35, Issue 4 (September 1945), 519-530.

NOTES:

  • Using rational economic order has a problem:
    • We use all relevant info
    • We use a coherent system of preferences
    • We use complete knowledge of relevant means
      • Problem becomes just using logic to solve the mathematics
    • Question becomes what is the best use of available means
      • Answer is implicit in the assumptions
        • Marginal rate of substitution between commodities must be the same for all user
    • NOT IN THE REAL WORLD!!
      • Our tools give us no answers b/c our data is never “given” to one single person to work out the implications
      • Knowledge is dispersed in incomplete bits & often contradictory
  • Problem is really – How to secure best use of resources known to any individual
    • USE OF KNOWLEDGE – isn’t given to any 1 individual entirely
    • Problem is obscured by development of Economic Theory & Math
    • Leads to dispute between theory & policy due to misconception of Economics Problem
  • “PLANNING” = complex interrelated decisions about available resources
    • All economic activity is planning & need knowledge to plan but it must be given to the planner
    • Knowledge is dispersed – main stumbling black to designing efficient system
  • Q – Who is planning? A Central authority? Individuals?
    • “Planning” usually means Central Planning according to a unified plan
    • “Competition” usually means decentralized planning by individuals
    • Half-way is planning by organized industries (monopolies or cartels)
  • Q – Which is most efficient?
    • A – The one that can use fuller existing knowledge & have better success
  • The answer will vary based on what kind of knowledge will be available, to whom & relevant importance
    • We tend to think that Scientific knowledge is the only kind of knowledge – NOT SO
    • A body of experts may be the wisest about a subject
      • But who will choose the body?
  • Economic Problem of Knowledge – Particulars of time & place
    • Individual has an advantage b/c of his unique information which is beneficial to others
      • It’s only useful if his information & decision based on information are made with his cooperation
    • Our individual training in theory & practice is valuable in all walks of life
      • Use of machines, management decisions to be efficient requires use of individual’s unique knowledge
    • Somehow this view isn’t popular – seen as dishonest
      • We’re “supposed to share” all knowledge amongst everyone
      • But it is beneficial to society, often commercially b/c it is most efficient
  • If the economy can be centrally planned, why is it so hard to do?
    • New problems arise in the day-to-day running of a factory/business
    • Central planners are removed from this
    • Are economic decisions only necessary in the long-term planning?
      • Once a factory is built, is planning over?
    • Manager’s job includes constant need to minimize costs
      • An unknowledgeable manager does this inefficiently
  • Economists often forget about small changes b/c they’re preoccupied with aggregated statistic which appear more stable by the law of large numbers
    • Individuals don’t have robust data/orders like that
      • Flow of goods/services maintained by constant, deliberate adjustments
      • If 1 company fails, another will step in to fulfill demand
      • Factories need to be maintained & depreciation occurs randomly or unseen
        • Doesn’t show up in Central Planner’s stats
  • If the problem is how to adjust quickly to changes in particular circumstance of time & place
    • Decisions must be left to those familiar w/ circumstance & can directly meet them
    • Central planning requires 1000s of communications to central planner & him integrating all knowledge & then doing something about it
      • Easily solved by de-centralizing
        • Communication is easier w/ knowledge of circumstances of time & place
  • Q – How much knowledge is needed to fulfill demand?
    • All information & occurrences have some effect on supply & demand
      • But we don’t need to know why they’ve happened
      • Just need to know, time, place, quantity & PRICE
        • Not interested in more than that
  • Economic Calculus
    • Solved by the price system
      • Small adjustments in resource allocation is signaled by prices
      • Allows us to attach a value on scare resources to allow people/managers to adjust budgets, use of factors & resources
  • Prices coordinate separate actions of different people
    • If a new source of raw resources arises or an old one is eliminated
      • (Why is not very important)
      • All that users really need to know is if that resource is more abundant or scarcer
    • When prices rise high enough, new entrants arrive or if they drop low enough, some producers will leave market
    • 1 price for a commodity guides the market to a solution that would have been arrived at by a central planner w/o actually involving him
  • Price system is a mechanism for communicating information
    • System economizes knowledge w/ which is operates
    • Individuals need to know very little to take the efficient/right action
    • Price is a symbol – most essential information is passed on to those concerned
  • Adjustments are never perfect like economists imagine b/c they assume all knowledge is available to everyone
    • Amazing that 1 scarcity w/ only a few people knowing about it can be conveyed to so many & orders adjust w/o any central planning
    • Not out of deliberate design
    • Those who want conscious direction:
      • Think how best to use knowledge beyond capacity to collate, process & issue resource allocation with respect to scarcity as efficiently as possible
  • Major problem is w/ language
    • We are told to think about what we are doing in the big picture
    • But all advances in technology & production happen when we increase the number of activities where we don’t think very much
    • Price system represents a large system w/ use of knowledge w/o fully understanding what we are doing
    • Usually derided as expecting a miracle that the system arises spontaneously
      • Nobody’s been able to do any better
  • Economic critiques of Price system
    • Some believe that production can be efficient w/o price mechanism
      • Prices don’t only apply to end markets
        • Intermediary markets function to allocate resources efficiently between supply & demand
        • Information is never given completely to a single name
      • Practical problems’ solutions come from dispersed knowledge
        • Signs are in the price system!

 

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