Because this is the 50th anniversary of the announcement that Friedrich Hayek won the Nobel Prize in economics (who shared it with Gunnar Myrdal), it is a good time to take a closer look at his 1945 article in the book. American Economic Review“The Use of Information in Society.”
When I often covered this topic in my classes over 30 years ago, the students had trouble following his argument. Part of it, I think, was Hayek’s German writing style: lots of long sentences. So for a few years, I stopped covering this topic. But that was not enough. So instead, I sent students detailed ideas and questions in various sections to guide them through the topic. That worked well.
Every time I look at my notes, I update. So this morning I updated again.
Here are my notes.
Lecture Notes on Hayek, “The Use of Knowledge in Society”
David R. Henderson
October 9, 2024
I think this article is one of the ten most important articles published in economics in the last 80 years. So, it’s worth the effort.
The most important paragraph in this article is the third paragraph and the most important sentence in the article is the first sentence of this paragraph:
The peculiar character of the problem of rational economic organization is determined precisely by the fact that the knowledge of the conditions we must use never exists in a concentrated or integrated form but as scattered fragments of incomplete and often contradictory knowledge. different people have them. So the economic problem of society is not just a problem of allocating resources that are “given”—when they are “given” they are considered to be given by a single mind that deliberately solves the problem posed by this “data.” Rather, it is a problem of how to secure the best use of resources known to any member of society, for whose purposes their value is estimated only by these people. Or, to put it more succinctly, it is the problem of the use of information that no one can provide completely.
Economists today who use Hayek’s insight often refer to this point about dispersed information as “local knowledge.” Think about the kinds of local information you have about your work or other parts of your economic life, information that would not be available to the average planner. Now ask yourself how things would work if you had to get the approval of a central editor every time you wanted to do this information. Think about your work and other parts of your financial life.
In Part II, the second paragraph, Hayek writes:
The answer to this question is closely related to the other question that appears here, that of WHO to do planning. It is about this question that the whole argument about “economic planning” institutions. This is not an argument about whether planning should be done or not. It is an argument about whether planning should be done in one place, by one authority of the entire economic system, or if it should be decentralized.
When economists stared criticizing the idea of central planning in the early 20sth century, the response from some of those who wanted central planning was, “Don’t you think we need planning?” That is why Hayek has this section.
Read and re-read Section III, section two. There’s a lot there. One example: Consider someone who graduates at the top of their class at Stanford, Yale, or Harvard Law School. On a scale of 1 to 10, what does he know on the first day at work that will help him do the job? My guess is that it is no more than 4 and could be 2 or 3.
In Part III, paragraph three, Hayek writes:
Even economists consider themselves immune to the crude lies of materialism [i.e., thinking in terms of material wealth] they always make the same mistake as far as activities aimed at gaining such practical knowledge are concerned—apparently because in their systems all such knowledge must be ‘given.’
About 15 years ago, the dishwasher was leaving our dishes fragile so we called an appliance repairman. He came out—small charge of $69.95—and within 5 minutes he assessed the situation and told us we should use powder instead of liquid dish detergent. I was angry for a few minutes. Then I remembered Hayek. Explain. What did I find contained in this quote?
Read Section IV, paragraph five. Some economists who studied the Soviet Union and other middle-class economies have said that the major failure of such economies is not in manufacturing but in agriculture. Given Hayek’s opinion in this section, explain why.
In Part IV, paragraph six, Hayek writes:
It follows from this that central planning based on statistical knowledge by its very nature cannot directly take into account these conditions of time and place and that the central planner will have to find some way or another in which the decisions that depend on them can be left to “someone there.”
There is no question about it: Just think about it.
In Section V, the first paragraph, Hayek poses this problem:
We need decentralization because this is the only way we can ensure that knowledge of specific time and place conditions will be used quickly. But “man on the spot” cannot decide only on the basis of his limited but deep knowledge of the facts of the immediate area. There is still the problem of communicating with him more information as he needs to be consistent with his decisions in the whole pattern of changes in the big economic system.
This is the problem. So far, Hayek has explained why central planning does not work. Things seem hopeless. Knowledge is always changing and each person only has their own limited knowledge. It looks like things will end in chaos. Is there hope? Yes, that’s why I’m calling this next section, “Free markets that help.”
Let’s see what solves it.
Carefully read Section V, paragraph five, another key paragraph. Hayek writes:
It does not matter to our purpose—and it is very remarkable that it does not matter—which of these two causes made tin more scarce.
Why is it so important that it doesn’t matter?
In Section VI, the first paragraph, Hayek gives an analogy between the price system and machinery. What is that analogy?
In Section VI, the second section, Hayek uses the word “miracle” to describe the value system and then explains in the third section why he uses that word. Why?
See the reading I’m attaching from that famous economic analyst, Howard Stern, for a funny example of local knowledge.
Source link