Forty years ago, on December 11, 1974, Austrian economist Friedrich A. Hayek formally received that year's Nobel Prize in Economics at the official ceremonies in Stockholm, Sweden. He delivered a lecture called, "The Pretense of Knowledge," which forcefully challenged all those who believe that government has the wisdom or ability to successfully plan the economic affairs of society.

His primary targets were the Keynesian economists at that time who were confident that they could micro-manage the "macro-economy" to assure full employment, economic growth and market stability. His more general antagonists were all those social engineers who wished to redesign and regulate society through the coercive agency of government.

Hayek's Role in Fighting Keynesianism and Socialism

Hayek was awarded the Nobel Prize that year for his contributions over many decades to the understanding of inflations and depressions, and his writings on the nature and workings of society as a "spontaneous order" of evolution and development independent of political control and manipulation.

Born in 1899, Hayek had graduated from the University of Vienna in the early 1920s where he absorbed the ideas of the "Austrian School of Economics." This was especially due to the intellectual influence of one of the leading Austrian economists of the 20th century, Ludwig von Mises, who served as an inspiring mentor for many of Hayek's later works as an economist and social philosopher.

In the 1930s, while teaching at the London School of Economics, Hayek was considered the leading challenger to the ideas of John Maynard Keynes, whose 1936 book, The General Theory of Employment, Interest, and Money, soon became the "bible" of the emerging "Keynesian Revolution" in economic theory and policy.

He also was one of the most prominent opponents of those advocating the transformation of market societies into socialist centrally planned economies. Along with Mises, he demonstrated many of the inherent weaknesses in the socialist scheme, which if fully implemented could lead to both political tyranny and economic stagnation.

The Division of Knowledge in Society

A central feature to all of Hayek's mature conception of the nature of man and society and the workings of the market order was the important insight that matching the system of division of labor is an inescapable and inseparable division of knowledge.

It is not merely that one person is the butcher, another the baker and still one more the candlestick maker, all of whom know various things in the production of good that the others do not.

It is that there are different types and kinds of knowledge that each of us comes to possess that are uniquely our own and which others can never fully know and appreciate the way we each individually do in our respective corners of society.

The Different Types of Knowledge in Society

Firstly, there is what Hayek called "scientific knowledge" that is formally learned through the educational process. This is the kind of special knowledge that the lawyer or the medical doctor or the financial accountant acquires through his years of academic study at institutions of higher learning.

This is a knowledge that in principle any one of us could acquire if we devoted the time, effort and discipline to obtain it through the educational process. Clearly, since each of us has only limited time and interest to give to mastering these kinds of knowledge we rely upon the "purchase" of them through market exchange, as when we hire the lawyer to handle a legal problem for us or employ the trained physician to diagnose and cure a physical ailment.

Secondly, Hayek argued, there is "the knowledge of the particular circumstances of time and place." There are many aspects and elements of useful knowledge that are not learned in the formal educational process without which much in everyday life could not be successfully performed if we did not learn them "on the job," if you will.

For instance, a student graduates from high school or college and starts their entry-level job, and on the first day the "big boss" instructs them to make 30 copies of a company report for a meeting being held later in the day among the firm's executives.

The "new kid" locates the photocopy machine, but when he punches in the number of needed copies and presses the "start" button nothing happens. Frustrated, he turns to one of the long-serving employees for help, who comes over and suddenly kicks the photocopy machine on the side, and the copies start coming out.

There is nothing in that young person's formal education that would have taught him that in that that particular firm, at this particular time there was a "glitch" in the photocopy machine wiring that could be taken care of with a good kick until the repairman arrives to fix it.

This may seem like trivial and "mundane" knowledge, but it is this kind of knowledge that is often essential to know to assure that everyday activities can be kept going.

This young person someday moves up in the company and is now a manager, himself. One of his staff members, "Joe," calls in sick, being down with a bad flu. Who among the rest of remaining the staff can fill in to do "Joe's" job until he is well enough to get back to work?

Or if a supplier fails to deliver a shipment of component parts on time, which alternative wholesale supplier can be called on to make an "emergency" delivery of needed parts, or what in the backroom inventory can be used as an acceptable substitute part so the production line does not have to be stopped when orders to customers have to be fulfilled on time? The manager needs to know the answer to these and many similar kinds of problems, which has little or nothing to do with the formal education he acquired years earlier.

The Importance of Tacit Knowledge

Finally, Hayek emphasized the significance of "tacit" or "inarticulate knowledge," a concept that he adopted from the philosopher of science Michael Polanyi. This refers to the great amount of knowledge that each of us possesses to do many of the everyday things of life, but which we would find difficult to articulate and express in clear detail in any spoken or written form.

Your car is giving you problems, so you take it in to the local mechanic. He has you turn on the engine, and listens under the hood. The mechanic tells you to come back in a couple of hours and he'll have it fixed. When you ask what the problem is, he gives you a general answer, and says he's been working on cars like this for years and he can just tell what the problem is from the sound of the running engine.

It matters little, in fact, if the mechanic can explain in verbal detail the nature of the problem with the engine; for most of us, all that really matters is that he can fix it, and that he can bring to bear his personal knowledge that he just cannot easily put into words, not only not to us but maybe even to himself.

Another instance is the successful businessman who knows how to "read" the market in terms of future consumer demand for his product concerning the qualities demanders might want in the good and the price they might be willing to pay, or a "sense" of what competitive plans his rivals might be weighing to gain more of the consumer business in his sector of the market and to which he'll have to respond.

These, too, are forms of knowledge that the entrepreneur will have accumulated from his everyday experience as a result of interacting with his customers on the "demand-side" and his competitors on the "supply-side" of the market. But this businessman may not be able to explicitly articulate how he "reads" the uncertain possible shape-of-things-to-come in the marketplace upon which his profits and consumer satisfaction will be based.

But, nonetheless, it is upon the use and effective application of these types of knowledge in different ways and combinations in the minds of the respective multitudes of participants in society that assures that supplies tend to match market demands, and that what gets produced is pretty much what turns out to be what consumers want and at prices that they are willing to pay.

More Knowledge Than the Social Engineer Can Know

Hayek's central point in his Nobel lecture on "The Pretense of Knowledge" was to argue that too many in the intellectual world of ideas and in the arenas of government policy decision-making arrogantly believe that they can know enough to centrally plan or heavily regulate the diverse and ever-changing activities of all the people in a developed, complex social system.

It is theoretically and factually impossible for one or a handful of minds, no matter how intelligent and "wise" they may be, to master all of these multi-layered and interconnected different types of knowledge that only resides as dispersed and decentralized bits of information in the minds of the individual members of society.

What is worse, Hayek emphasized, the social engineers and their government policy partners choose to ignore the reality of these multiple types of knowledge and their essentially qualitative characteristics that cannot easily or at all be reduced to measurable and quantitative dimensions.

Instead, the social engineers and policy-makers focus on what they can measure and manipulate for policy purposes: statistical averages and aggregates such as calculated "total output" or "aggregate employment" or general price and wage "levels" for the economy as a whole.

They then proceed to postulate "empirical relationships" between levels of "aggregate demand" spending on all goods and services in the market as a whole with "total employment" of all workers combined in the statistical estimate of the "workforce."

The Fallacy of Macroeconomic Aggregates

Hayek's point was that this is analogous to the man who looked at night only under the lamppost for his missing keys because that is where the light was. Only able to manageably collect and statistically analyze such measured quantitative aggregates, the social engineers and government policy-makers have limited their conception of how and why the market economy works the way it does to what they can quantitatively measure and statistically calculate in making their policy and planning decisions.

But looking only or primarily at this macro-aggregate statistical surface of things results in the reality of all that is going on "below" this statistical macroeconomic surface from being fully understood and appreciated.

The real factors determining what and how much of all the goods produced on the market or which types and how much of employments are available in different sectors of the economy are made up of all the individual decisions by all the participants in the market system, each using his own special and particular combinations of knowledge as he thinks best.

Market Prices Coordinate the Knowledge in Society

What connects and coordinates all of these multitudes of individual decisions and actions is the competitive market price system. The price system combines and integrates all the knowledge of all the people participating in the world of exchange as expressed in peoples' willingness and interest in buying as consumers and their willingness and ability as suppliers to produce all the goods and services that make up the production and employment opportunities of society.

The market system, therefore, incorporates the actions of more people and their individual bits of knowledge in all their detailed complexity than any planner or regulator could ever successfully master, and which can never be captured in all their intricacy in the simplistic macroeconomic statistical aggregates.

Hayek insisted that what resulted from this macroeconomic approach was not merely a serious intellectual error, but a government policy perspective that created most if not all the imbalances, distortions and fluctuations in employment and output that goes under the name of the business cycle.

False Market Signals and the Misdirection of Production

As Hayek explained in "The Pretense of Knowledge":

In fact, in the case discussed, the very measures which the dominant 'macroeconomic' theory has recommended as a remedy for unemployment — namely, the increase of aggregate demand — have become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable.

The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labor and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate — or perhaps even only so long as it continues to accelerate at a given rate.

What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganization of all economic activity.

The fact is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from reappearing; not because, as this view is sometimes misrepresented, this unemployment is deliberately brought about as a means to combat inflation, but because it is now bound to occur as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerate.

The Wider Social Danger from the Pretense of Knowledge

The wider lesson, Hayek also highlighted, was that this false approach of the social engineers and government policy-makers threatened not only the continuing instabilities of inflations and recessions, but the very sustainability of a functioning and prospering free society.

Thus, Hayek concluded his Nobel lecture with this warning:

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails [such as in the modern market economy], he cannot acquire the full knowledge which would make mastery of the events possible . . .

The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men's fatal striving to control society — a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

Forty years after Friedrich A. Hayek spoke these words and twenty-two years since his death in 1992, society continues to be plagued with those suffering from this pretense of knowledge.