Since this is the fiftieth anniversary of the announcement that Friedrich Hayek was co-winner of the Nobel Prize in Economics (the person who shared it was Gunnar Myrdal), it is a good time to review his 1945 article in the American economics magazine‘The use of knowledge in society.’
When I taught the article in my classes about thirty years ago, students had difficulty following his argument. Part of that, I think, was Hayek’s Germanic writing style: lots of long sentences. So for a few years I stopped covering the article. But that was not satisfactory. So instead, I sent the students detailed comments and questions on several paragraphs to guide them through the article. That worked well.
Every time I look at my notes I update. So this morning I did another update.
Here are my notes.
Teaching notes on Hayek, ‘The use of knowledge in society’
http://www.econlib.org/library/Essays/hykKnw1.html
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 it.
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 a rational economic order is precisely determined by the fact that the knowledge of the circumstances that we have to make use of never exists in concentrated or integrated form, but only as the scattered bits of incomplete and often contradictory knowledge that all separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate ‘given’ resources – if ‘given’ is understood as given to a single mind that deliberately solves the problem posed by these ‘data’. Rather, it is a problem of how to best use the resources known to all members of society, for purposes whose relative importance is known only to these individuals. Or, to put it briefly: it is a problem of utilizing knowledge that is not given to anyone in its entirety.
Today, economists who draw on Hayek’s insights often call this point about dispersed information “local knowledge.” Think about the types of local knowledge you have about your job or other parts of your economic life, knowledge that would not be available to a central planner. Now ask yourself how it would work if you had to get permission from a central planner every time you wanted to act on this knowledge. Think about your job and other parts of your economic life.
In Part II, second paragraph, Hayek writes:
The answer to this question is closely related to the other question that arises here, namely that of WHO is to make the planning. It is this question that all discussion of ‘economic planning’ revolves around. This is not a discussion about whether or not plans should be made. It is a discussion about whether planning should be done centrally, by one authority for the entire economic system, or whether it should be distributed among many individuals.
When economists criticized the idea of central planning in the early 1920se century was the comeback of some who wanted central planning: “Don’t you think we should plan?” That’s why Hayek has this paragraph.
Read and reread Part III, second paragraph. There’s so much in it. An example: think of someone who graduates at the top of his/her class from Stanford, Yale, or Harvard Law School. On a scale of 1 to 10, what does he/she know on the first day of work that will help him/her complete the job? My guess is that there are no more than 4, but it could also be 2 or 3.
In Section III, third paragraph, Hayek writes:
Even economists who consider themselves absolutely immune to the gross materialist fallacies [i.e., thinking in terms of material wealth] continually commit the same mistake when it comes to activities aimed at acquiring such practical knowledge – apparently because in their system of things all such knowledge is assumed to be ‘given’.
About 15 years ago, our dishwasher was leaving our dishes streaky, so we called the appliance repairman. He came out (minimum €69.95) and assessed the situation within five minutes and told us to use powder instead of liquid dish soap. For a few minutes I was angry. Then I remembered Hayek. Explain. What did I discover that this quote says?
Read Chapter IV, fifth paragraph. Some economists who have studied the Soviet Union and other centrally planned economies have argued that the greatest failure of such economies was not in manufacturing, but in agriculture. Given Hayek’s reasoning in this paragraph, explain why.
In Section IV, sixth paragraph, Hayek writes:
It follows that central planning, based on statistical information, cannot by its nature take direct account of these circumstances of time and place and that the central planner will have to find some way of leaving the resulting decisions to the “man on the spot.” ”
No question about this: just think about it.
In Part V, first paragraph, Hayek poses the dilemma:
We need decentralization because this is the only way to guarantee that knowledge of the specific circumstances of time and place will be put to immediate use. But the “man on the spot” cannot decide solely on the basis of his limited but thorough knowledge of the facts of his immediate environment. There still remains the problem of providing him with the further information he needs to fit his decisions into the whole pattern of changes of the larger economic system.
This is the dilemma. So far, Hayek has explained why central planning cannot work. Things seem hopeless. Information is constantly changing and everyone only has his or her little bit of information. It seems that everything will end in chaos. Is there hope? Yes, that’s why I call this next part: “Free Markets to the Rescue.”
Let’s see what it solves.
Carefully read Section V, fifth paragraph, another important paragraph. Hayek writes:
For our purposes it does not matter – and significantly it does not matter – which of these two causes has made tin scarcer.
Why is it so important that it doesn’t matter?
In Part VI, first paragraph, Hayek gives an analogy between the price system and machinery. What is that analogy?
In Part VI, second paragraph, Hayek uses the word “miracle” to describe the price system and then explains why he uses that word in the third paragraph. Why?
See the lecture I am attaching from noted economic analyst Howard Stern for a humorous example of local knowledge.