Edmund Phelps explains “knowledge problem”

Michael Giberson

Occasionally we hear from readers curious about the blog name, “knowledge problem.” Edmund Phelps explains the knowledge problem in an excellent essay that appeared in the Financial Times. (Registration may be required for FT.com; the essay is also posted in full at the FT‘s Capitalism blog.)

Joseph Schumpeter’s early theory proposed that a capitalist economy is quicker to seize sudden opportunities and thus has higher productivity, thanks to capitalist culture: the zeal of capable entrepreneurs and diligence of expert bankers. But … most growth in knowledge is not science-driven. Schumpeterian ­economics – Adam Smith plus sociology – captures very little.

Friedrich Hayek offered another view in the 1930s. Any modern economy, capitalist or state-run, is a great soup of private “know-how” dispersed among the specialised participants. No one, he said, not even a state agency, could amass all the knowledge that each participant “on the spot” inevitably acquires. The state would have no idea where to invest. Only capitalism solves this “knowledge problem”.

There is much more in the essay than this brief clip reveals. In fact, the very next paragraph provides the one of the best brief explanations of Hayek’s central insight into capitalism. In addition to a little Schumpeter and a lot of Hayek, Phelps nods to David Hume and invokes some Frank Knight on uncertainty.

The whole thing is worth reading.

(HT to Greg Ransom at Taking Hayek Seriously.)