This article will discuss the Problem of Knowledge, in particular as discussed by Hayek. This discussion necessarily relates to the Economic Calculation Problem as discussed by Mises and Hayek. I will argue that the these problems are not simply economic issues, but first policy issues writ large and secondly fundamental human conditions. I will argue that this implies that centralized policy making, or policy making at all for that matter, is an inherently flawed endeavor. Lastly, I will claim that although policy making is technically flawed it is sufficiently functional as a practical matter for small scale organizations.

In his article The Use of Knowledge in Society, Hayek criticizes the rational model of economics. As he mentions, the rational model of economics describes how an economy operates under certain given conditions . In order for an economy to be rationally described there are 4 conditions, 3 of which Hayek mentions and 1 of which is implicit.

The system is rational according to the conventional usage at the time in economics. This requirement he made implicitly. A rational system is one in which every social actor chooses to maximize its own utility to the greatest extent possible.

The system possess all the relevant information. That was Hayek’s phrasing, but I would assert that the system must have perfect information. Hayek’s phrasing requires that every agent have sufficient information. I would agree, but rather than distinguishing sufficient information from complete information, I would assert that the two values are equal. Regardless, we both mean the same thing: Every agent must have all the information necessary to do whatever they want. Think about this a while because this value is huge. Not only does each person need the information to do what they would do ceteris paribus, but they must have all the information to do what they would absolutely want to do, that is, given any potential combination of conditions.

The system has particular preferences and it is aware of its own preferences. This means that every actor is aware of their own personal preferences as well as the collective preferences of the rest of the group. I would say that this is redundant because it is part of all of the relevant information, as is the means, but I suppose Hayek wanted to emphasize these points.

The system has known methods of transaction, interaction, production, operation and systemic control. This is called means. We may know that a bread factory produces bread, but only if we know how it produces bread do we have knowledge of the means of production.

The essential implication of the rational model is that for a society to act in optimal fashion it must desire to maximize its own utility and must also have perfect information. I think the first assumption is garbage and I have talked about this before. Not only is rational action not a requirement, it is in fact impossible, not observed in practice and antithetical to what it means to be human.

Hayek takes my complaints about the rationality assumption, but applies them to the other assumption. Hayek shows that perfect information can never be centralized. Criticizing Shumpeter, who claimed that the rational model implies central planning is hypothetically tenable, Hayek says:

“The problem is thus in no way solved if we can show that all the facts, if they were known to a single mind (as we hypothetically assume them to be given to the observing economist), would uniquely determine the solution; instead we must show how a solution is produced by the interactions of people each of whom possesses only partial knowledge.”

In summary, Hayek shows that a decentralized system, namely a market, is the most conducive instrument we have for optimizing information and stimulating rational choice. While he may not have proven that the market is perfect, he certainly demonstrated that central planning is worse.

News flash: This is old news. Hayek isn’t even around anymore. The article was published in NINETEEN FORTY FIVE (1945).

Over HALF A CENTURY LATER, Here is my questions: Why do we insist that economic systems should be constructed to optimize accurate information and rational choice making, but we don’t insist on the development of political and other systems which operate on the same standard? Note:

All decisions, not only financial or economic decisions, are superior under perfect information.

All decisions, not only financial or economic decisions, are superior under rational choice.

All information, not only financial or economic information, is disbursed, resulting in some variant of the Hayekian problem of knowledge.

Political systems, laws and so on can be viewed as economic products themselves. Taxes in, service out. Being monopolies, these are inefficient structures. On the other hand, economics can be viewed through a political lens. Every economic action has sociopolitical repercussions. As a result, the dichotomy between politics and economics is a false dichotomy. In fact nearly all systems exhibit this kind of false distinction. I am calling for three kinds of generalized systems theories (and work has already begun on them, but the mainstream is out of the loop): A generalized social systems theory, a generalized naturalistic systems theory, and a super-generalized systems theory, consisting only of those insights which apply to both previously mentioned sub-fields.

I think there are at least five answers for different kinds of people or groups of people to the aforementioned question. I find it likely that people have multiple contributing reasons. The list is substantial not exhaustive:

We don’t. The problem is not demand it is supply. The expected ROI of going out and starting a new country in the past has been less than the expected ROI of maintaining the current, albeit decaying, system. Maybe if it turns into Nazi Germany we will run away, if that’s still an available option at that time, but for now we are content to take it. Because the structural flaws benefit me! Credit to Patri Friedman for this insight. If a bill passes that taxes every person $1 and benefits a few elites by a few million a year it will pass every time. This is because the opportunity costs of organization far outweigh the benefits for the average person, yet the elites are highly motivated to organize. I really think this basic insight from Petri immediately explains the major reason for the accumulation of corruption of political systems over time. Apathy. False beliefs or lack of true beliefs: They never knew about Hayek’s insights or consider the insights false. Rational ignorance plays a role here. Emotional response rather than logical response. (Patri Friedman thinks this is a major driver.)

I also think two smaller groups of people would be the people who just plain never thought about that before (or never thought about it like that), as well as the people who actually agree and are trying to start new countries. Patri Friedman, as in the link previous, thinks that another large degree of resistance is emotional.

In conclusion we have shown that the belief that the problem of knowledge applies only to economic phenomenon is unjustified and theoretically plausibly wrong, although there is a severe lack of data which might prove that assertion outside of theory. We have also uncovered several of the reasons which preclude development of alternatives. In another post I will discuss how we might overcome those preclusion.