The economic lessons Hayek taught us are as relevant today as they were 50 years ago.
Fifty years ago, Friedrich Hayek and Karl Gunnar Myrdal won the Nobel prize “for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena.” Hayek’s Nobel is notable for several reasons, and each relates to the importance of intellectual humility.
First, his Nobel address—delivered 50 years ago today—was an exercise in humility, as highlighted by FEE’s own Larry Reed. Hayek even went so far as to argue that there really shouldn’t be a Nobel prize for economists due to the disproportionate intellectual authority the prize bestows.
Second, Hayek’s work, including much of the work he won his Nobel for, is based on recognizing the limits of the intelligentsia to plan society and, in particular, the economy.
To understand Hayek’s work, we must understand two key contributions of his mentor Ludwig von Mises. It’s no surprise that Hayek’s Nobel would be connected to Mises. Nobel-winner Paul Samuelson, who departs from the work of Hayek and Mises on many points, has previously argued that Mises himself would have won the Nobel had it been awarded earlier in history.
Economic Fluctuations
First, Hayek’s prize was linked to his work on money and economic fluctuations. There’s no doubt that this work is placed under the umbrella of Austrian Business Cycle Theory (ABCT). ABCT is by no means an invention of Hayek. Rather, he developed the theory which has its foundations at the beginning of the Austrian school with elements in Carl Menger, Eugen von Böhm-Bawerk, and finally Mises.
Hayek, in particular, focused on how capital goods transform over the various stages of production. As capital goods advance in time toward the customer, they fundamentally change in kind. So, when a central government monetary policy (such as an increase in the supply of money) causes an increase in long-term loans, these-long term loans change the structure of capital goods in society.
However, if this increase in money is not accompanied by an increase in consumer savings, the borrowers of the government money will compete with consumers for production inputs, raising their prices and ultimately leading to projects which fail systemically.
Hayek’s contribution here is to highlight how prices, like the interest rate, communicate important information about consumer preferences. If economic experts decide to tinker with prices, they distort this communication mechanism, which can lead to widespread failure.
Calculation and Knowledge
Hayek’s next contribution related to this topic is his most famous work: The Use of Knowledge in Society.
In this work, Hayek points out how sudden changes in price are indicative of real increases or decreases in the relative scarcity of goods. For example, if a major coal mine collapses, the attendant reduction in supply will lead to higher prices. These higher prices will cause the users of coal to engage in rationing to cut down on expenditures.
Notice, this is exactly how we would want society to respond. If something becomes more scarce, it makes sense to use it more sparingly. The increase in prices for coal caused by the mine collapse communicates the increase in scarcity without the end user of the coal even needing to know about the mine collapse.
Hayek goes on to highlight how some information, like mine collapses, may be easily communicable. However, some knowledge cannot be easily codified and, as such, is incommunicable. This is called tacit knowledge.
If some knowledge is difficult or even impossible to codify with words, but it can be communicated by prices, then this highlights a major drawback to central economic planning.
Central economic planning, by its very nature, requires planners to acquire knowledge and make decisions based on that knowledge. However, central planners cannot use prices by definition because allocating according to a central plan means that allocation decisions don’t use markets and therefore no prices arise.
This creates an irreconcilable contradiction. Central planners need the tacit knowledge captured by prices, but their means of planning are incompatible with the price system itself.
This argument is integrally linked to Mises’s argument that economic calculation is impossible within the institutional context of socialism (read more about why here).
In response to Mises’s devastating argument, socialist economists gave many answers including trial-and-error solutions, supercomputer solutions, and equation-based solutions. It is in the context of this argument that Hayek wrote The Use of Knowledge in Society. As economist Peter Boettke highlights, Hayek’s essay brilliantly refutes these counter-arguments by pointing out:
The “knowledge of the particular circumstances of time and place” and the fact that we are dealing with data which “by its nature cannot enter into statistics” does not just challenge the practicability of socialism (see Hayek 1945, pp. 80, 83). Rather, socialism is impossible precisely because the institutional configuration of socialism precludes economic calculation by eliminating the emergence of the very economic knowledge that is required for these calculations to be made by economic actors.
Hayek’s argument again centers on humility. Regular people on the ground have a more intimate familiarity with the relevant knowledge than any planner can have. This knowledge is embodied by the market system in prices. When you abolish markets, you abolish prices, and you abolish the very knowledge needed for calculation.
Fifty years later, Hayek’s argument remains relevant. As evidenced by an ever-expanding debt-to-GDP ratio, the political system in the US continues its slow march to take over the market system. As the domain of the political planner expands, the domain of planning for the ordinary person contracts.
We can only hope that this anniversary will remind us and our political leaders that the economy is not a simple machine to be tinkered with. Instead, it is a complex arrangement of human institutions with no single language, leader, or mind in control. In the words of Hayek:
To assume all the knowledge to be given to a single mind in the same manner in which we assume it to be given to us as the explaining economists is to assume the problem away and to disregard everything that is important and significant in the real world.
