Knowledge Problem

Michael Giberson

The knowledge problem made the newspaper today – that’s Hayek’s concept of the knowledge problem, not the KP blog that Lynne and I operate.  But since we appreciate the significance of Hayek’s insight on the mobilization of knowledge, it seems appropriate to draw attention to Glenn Reynold’s op-ed, “Progressives can’t get past the Knowledge Problem,” appearing today in the Washington Examiner.

In his “The Use of Knowledge In Society,” Hayek explained that information about supply and demand, scarcity and abundance, wants and needs exists in no single place in any economy. The economy is simply too large and complicated for such information to be gathered together.

Any economic planner who attempts to do so will wind up hopelessly uninformed and behind the times, reacting to economic changes in a clumsy, too-late fashion and then being forced to react again to fix the problems that the previous mistakes created, leading to new problems, and so on.

Market mechanisms, like pricing, do a better job than planners because they incorporate what everyone knows indirectly through signals like price, without central planning.
Thus, no matter how deceptively simple and appealing command economy programs are, they are sure to trip up their operators, because the operators can’t possibly be smart enough to make them work.

Hayek’s insight into economics and regulation is often called “The Knowledge Problem” ….

Reynolds is giving us a simplified version of Hayek’s view (which isn’t surprising since he’s writing an op-ed for a newspaper), but mostly avoids the cartoon version that sometimes shows up in editorializing about government and the economy.  Hayek is clear in the article that his point is a comparative one: decentralized economic activity does a better job than centrally managed economic activity because it does a better job of mobilizing the knowledge relevant to the decisions that need to be made.  Reynolds gets the point right, “Market mechanisms … do a better job.”  Not perfect, just better.

Hayek says that the issue isn’t one of planning vs. not planning, but rather a question of who does the planning: “whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals.”  Both central planners and de-central planners (i.e., individual business people) will make mistakes, but there is very good reason to believe that the aggregated errors of decentralized decision makers will be smaller than the errors of a centralized decision maker.

Hayek allows that there are different kinds of knowledge and likely different kinds of organizations or processes that would be appropriate to putting the different kinds of knowledge to best use.  Hayek’s main point in his article is that the most important knowledge with respect to economic activity is the knowledge of particular circumstances of time and place (that is to say, what resources can be found to address particular needs, what terms govern access to those resources, and which combination of resources is likely to bring about the most desired outcome).  This kind of knowledge exists in a widely dispersed and fragmented state and may not even be revealed except in cases in which people are placed in a position in which they must choose between alternatives.  As such, this kind of information is not readily rolled up into statistical summaries for easy and appropriate centralized decision making.

While Reynolds does a pretty good job of simplifying Hayek without being too simple-minded, I cringe a bit to see the knowledge problem wielded as a rhetorical club to beat upon policy proposals that the editorialist doesn’t like. Relative to, say, outright nationalization of health care services, I’d conclude that “Obamacare” preserves a lot of decentralized decision making.  Reynolds doesn’t seem to notice this not-so-subtle point.

Certainly relative to the status quo, the health care law centralizes decision making and is appropriately made subject to this Hayekian critique.  But I don’t think Hayek’s insights can quite do all of the anti-big government work that Reynolds wants. While political and intellectual elites have mostly given up the enthusiasm for outright socialism that was common when Hayek wrote his article in 1945, government is bigger and more intrusive now then it was then.  Nonetheless, big government has not collapsed under the burden of these knowledge problems; it grows, mostly with public support or at least apathy.

Opponents of Obamacare don’t need a theory that says centralized decision making always fails (and by the end of Reynold’s article we are to this cartoon version of Hayek).  Rather, such opponents need a theory that explains when government action works and when it doesn’t, and then make the case that Obamacare falls into this latter category.  Hayek’s insights into the fundamental value of decentralized economic decision making are obviously useful but not sufficient to make this case.

NOTE: Hayek’s “The Use of Knowledge in Society,” published in the American Economic Review in 1945, is available online at the Library of Economics and Liberty.