Thoughts on economics and liberty

Tag: F.A.Hayek

Hayek’s key arguments, distilled

I recently came across Peter Boettke's article in the Eastern Economic Journal (Winter 1995), entitled, "Hayek's the Road to Serfdom Revisited: Government Failure in the Argument Against Socialism". The article can be downloaded here. In addition to discussing matters of public choice theory, this article is a nice summary of Hayek's key arguments. I've extracted a few key portions below.


The Road to Serfdom is divided into sixteen concise chapters that take us on a tour of intellectual history and abstract logical deduction interspersed with historical observation. 

The theoretical core of Hayek's analysis was Mises's [1922] insight concerning the technical impossibility of economic calculation within a socialist system —socialism traditionally defined as the abolition of private property in the means of production. Hayek's twist on this Misesian argument was to elaborate the precise role that the price system played in providing the information (or knowledge) required for complex plan coordination.6 The Mises-Hayek argument demonstrated that socialism could not replicate what the private property order and the price system provided. No one mind or group of minds could possibly possess the knowledge necessary to coordinate a complex industrial economic system. The private property order and the price system, on the other hand, through the signals of monetary prices and profit and loss accounting engendered the appropriate incentives, economized the information that needed to be processed by economic actors, and not only provided the social context for entrepreneurial discovery that was necessary for the effective use of currently available resources but led to the innovations and technological progress that assured continued prosperity [Mises, 1922, 55-130; Hayek, 1948, 77-91, 119-209].
The Road to Serfdom proceeds under the assumption that this Misesian theoretical proposition has been established in the technical literature.6 Hayek's task in The Road to Serfdom was not to establish that socialist planning could not achieve the efficiency results of capitalism, but rather to demonstrate what would structurally emerge from the failure of socialist planning to achieve its desired results. The detour into intellectual history in the first three chapters was considered necessary to show that despite the Misesian demonstration, the socialist critique of competition had effectively undermined the legitimacy of liberal institutions among the general public and especially among the intellectual elite. Hayek's assessment that one of the great advances of liberal theory was to unmask the special pleading activity of interest groups is significant when demonstrating Hayek's relevance to public choice. Liberalism, Hayek argues, had imparted a "healthy suspicion" of any argument that demanded restrictions on market competition.' With its critique of the competitive system, socialist theory had unfortunately swept away the liberal constraints against special pleading, and opened the door for a flood of interest groups to demand government protection from competition under the flag of socialist planning [Hayek, 1944, 40].

Hayek provides one of the most articulate statements of the liberal proposition that economic freedom and political freedom are linked. This argument has often been misunderstood to suggest that economic development could occur only within a liberal political order. If that were the case, empirical counter examples could be supplied where authoritarian dictatorships produced economic growth. The liberal argument would be refuted, or at least seriously called into question.9 Hayek's argument, of course, was more limited and not so crude as to assert such a tight social causation. He argued that economic control does not control merely "a sector of human life which can be separated from the rest; it is the control of the means for all our ends. And whoever has sole control of the means must also determine which ends are to be served, which values are to be rated higher and which lower —in short, what men should believe and strive for. Central planning means that the economic problem is to be solved by the community instead of by the individual; but this involves that it must also be the community, or rather its representatives, who must decide the relative importance of the different needs" [1944, 92].

Thus, Hayek was examining the organizational logic of central planning and what societal/institutional transforma­tion would occur in response to the failure of planning to achieve its stated purposes.
Obviously, when faced with their failure, government officials could reverse course and move toward the adoption of liberal economic policies. Crucial to Hayek's argument is the public choice wisdom that government decision makers, within a social context where liberalism (and its institutions of governance) has been undermined by the socialist critique, do not face incentives which are likely to produce a choice of reversing course. This is how we get the "slippery slope" argument. 
In examining the organizational logic of planning, Hayek warns the reader that since the economic knowledge necessary to plan the economy rationally will not be available to planners, these decision makers will be forced to rely on the forms of information that are readily available, which in this context comes in the form of incentives to exercise political power. Hayek's argument is an application of the principle of comparative advantage to the selection of leaders within the planning system. In other words, just as we expect the division of labor within a society to reflect the opportunity costs of the various producers, so we should expect those with the requisite skills in exercising political power to advance within the political apparatus of planning. In this regard, Hayek was directly challenging the argument that experiments in real existing planning, say in the former Soviet Union, were tainted by "historical accident" and/or "bad" people, and, therefore, could not be employed to illustrate the difficulties with planning. It simply was not true that if only "good" people controlled the planning bureau, then the results would be harmonious with liberal democratic values." Hayek wrote,

There are strong reasons for believing that what to us appear the worst features of the existing totalitarian systems are not accidental by-products but phenomena which totalitarianism is certain sooner or later to produce. Just as the democratic statesman who sets out to plan economic life will soon be confronted with the alternative of – either assuming dictatorial powers or abandoning his plans, so the totalitarian dictator would soon have to choose between disregard of ordinary morals and failure. [1944, 135]
"Success" in this arena requires a talent for unscrupulous and uninhibited moral behavior with respect to humanity. Totalitarianism is neither a consequence of "corruption" nor "historical accident," but rather a logical consequence of the institutional incentives of the attempt to centrally plan an economy.12
It is not just that a band of "thugs" get control of the coercive apparatus of the state and employ it to oppress the mass of citizens to their own benefit. The desire to organize economic life (or social life in general) in strict accordance to a scientific plan does not spring from a desire to exercise power over people. But, Hayek points out, the arbitrary employment of power is a consequence, and not a cause, of the desire to plan the economy scientifically. In order "to achieve their end, collectivists must create power—power over men wielded by other men— of a magnitude never before known, and … their success will depend on the extent to which they achieve such power" [1944, 144]. Even liberal socialists, as opposed to collectivists, in their desire to plan the economy must establish institutions of discretionary planning and grant authority to the planners to exercise their political power in order to accomplish the task entrusted to them. The complexity of the task implied in rationally planning an economic system would require that planners be granted almost unlimited discretion. And, as a consequence, we should expect that only those that have a comparative advantage in exercising discretionary power will survive.
Frank Knight, in fact, made quite a similar argument when he aptly stated that the planning authorities would have to exercise their power ruthlessly to keep the machinery of organized production and distribution running…. They would have to do these things whether they wanted to or not; and the probability of the people in power being individuals who would dislike the possession and exercise of power is on a level with the probability that an extremely tender-hearted person would get the job of whipping-master on a slave plantation. [1938, 869]

Moreover, Hayek's argument was not limited to an examination of "hot" socialism, but included an analysis of the impottance of rules rather than discretion, the limits of democracy, and the importance of federalism as an institutional constraint on democratic action.

Hayek was above all else an "Austrian" economist. The analytical propositions he worked with, the techniques of analysis utilized, his whole mode of operation was that of an Austrian economist. And, despite his departure from formal economic questions, this analytical apparatus remained intact. Hayek used Mengerian spontaneous order theory and Misesian market process theory to examine the emergence of private property rules, the development of the common law, the growth of commerce, the rules of moral conduct, etc. Liberalism provided Hayek with a set of problems, but the way he went about analyzing these problems was thoroughly Austrian.
The mainstream tenets of economic analysis are: (1) maximizing behavior, (2) stable preferences, and (3) equilibrium. Austrian economists, and Hayek in particular, reject at least two of these tenets, if not all three.23 Hayek, for example, rejects the homo-economicus assumption as part of the rationalist tradition as opposed to the evolutionary tradition in which he places his own work [1960, 61]. Moreover, Hayek was highly critical of the apparatus of perfect competition and the preoccupation of economists with equilibrium analysis [1948, 77- 106].

Public choice analysis in the Austrian tradition would emphasize the structural ignorance actors must confront in situations outside the context of the market economy.26 The Arrow theorem, for example, could be reinterpreted as an application of Mises' impossibility thesis to non-market decision making via democratic voting.

The inability of democracy to ensure agreement means that theorists must recognize the limits of democratic decision making and focus scholarly attention on the governance structures that permit efficient outcomes to result. The political process, just like the market process, should not be expected to generate optimal allocations. Both are imperfect. Unlike the market process, however, democratic politics does not engender the incentives and information for its own error detection and correction. The type of spontaneous adaptations that occur in the market to correct current inefficiencies cannot be expected to emerge in the political process. Instead, conscious direction and rule making are needed. Rather than spontaneous adaptation, politics requires conscious adaptation, and there are epistemological limits to this procedure.

Hayek's The Road to Serfdom is as relevant today as when it was published fifty years ago, perhaps more so. At the time of publication it constituted a warning to the liberal democratic West that the road to totalitarianism was not paved by revolutionary bandits, but instead by high ideals.
In this regard, we are left by Hayek (1) a refined statement of the Misesian proposition concerning the impossibility of economic calculation in the absence of private property, and (2) an examination of the organizational logic of institutions designed to replace the private property system in allocating scarce resources. The strength of Hayek's analysis was to show that this logic was not a function of the form of government which inspired the substitution of collective decision-making for the private choices on the market. Whether democratic or authoritarian in legitimation, the institutional incentives produced a logical pressure toward totalitarianism.

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Hans-Hermann Hoppe’s attack on Hayek doesn’t stick #2

The idea that Hayek is somehow advocating something radically different to Mises has been proposed by Hans-Hermann Hoppe. A couple of days ago I rebutted Hoppe's claim within the limits of my own non-specialist knowledge (I'm not an "Austrian" economist: just a plain vanilla economist and – more importantly – plain vanilla political philosopher).

Fortunately I've now come across an excellent talk by Steve Horwitz – linked below. 

I was a bit sleepy and also in pain (my eyes are still bothering me quite a bit) so I have missed bits of the talk while dozing on the sofa with computer speakers on full blast. But from what I could catch, I notice that Steve actually provides pretty much the same arguments I made to rebut claims of the Hans-Hermann Hoppe sort, albeit with more depth and historical context than I did. Steve also refers to a 2004 paper of his in which he has clarified this issue in detail. 

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Hans-Hermann Hoppe’s attack on Hayek doesn’t stick

Herman Hoppe whom I have discussed here and here, believes that Hayek is misrepresented as a classical liberal when he is, in reality, a social democrat. Also worth reading is Hoppe's interview here.

I've read much of Hayek's political philosophy (but virtually none of his economics). Despite Hoppe's claims, I'm unable to see why Hayek should be seen as a social liberal. Rawls, yes (although Hayek did seem to approve of Rawls). But Hayek, no. 

Hayek (along with many others such as Friedman) comes from the tradition of Locke and Smith. Locke allowed for a modicum of poor laws. Even Mises is not averse to a form of social insurance. This tradition is an investigative, open ended tradition that examines all aspects of liberty. It is not a closed system with its propositions "proven" and agreed by everyone. My take on classical liberalism emphasises, for instance, the importance of accountability. There are many aspects of liberty. 

In my view Hoppe greatly exaggerates Hayek's willingness to allow a government to take over any function for the "common good". The entire goal of his books, The Road to Serfdom and The Fatal Conceit (among others) would be lost if Hayek recommended giving the government a blank cheque. Indeed, at each step, and in great depth, Hayek warns us against government. A few unqualified statements are certain to remain in any work of the magnitude that Hayek wrote. The whole work must be seen as of one piece. A few minor statements here or there do not detract from his main thesis.  

Hoppe also makes false analogy between a firm and government to argue that the information problem that Hayek pointed out is less important than the private property problem that Mises pointed out. Indeed, both these necessarily go hand in hand. It is only private property that provides incentives to seek out the relevant local information (through prices). If you didn't own private property why would you even care to know? All you'd care for is whom you know and how many people you can terrorise. Why would specific information of an investment nature benefit you? Hayek is merely referring to prices as the key relevant information, and prices don't exist without private property. His theory is therefore entirely consistent with Mises's (and with mine, where private property is a function of accountability).

No firm has yet arisen to provide all services that a government generally provides. Some argue that such firms should naturally arise (Nozick wrote about protection associations). But they don't.

What prevents businesses (firms) from becoming governments if firms are so good at managing information? Well, to answer this we need to keep in mind Coase's insights and those of Demsetz, Milgrom and Roberts, and of many others. There are necessary limits on the size and nature of firms. But there are no limits to the size of countries (and hence of governments).

Small countries and large countries both operate with the same informational problems that Hayek pointed out. The SAME informational problems found in a large country government are found in a small country government. Providing border protection, police, and justice services is a different ball game to that of profit maximisation. If Hoppe were correct, then a small village government could successfully manage all its economic, border protection and justice activities as a registered corporation. It can't. That's precisely the point Hayek makes. Unless you make it a commune (even in which case the information problem doesn't disappear). But I trust Hoppes is not suggesting a communist solution. 

Hayek's information approach is therefore persuasive to practical policy makers like me who have seen how easy it is to make poor decisions within governments. That is why Hayek has been more influential with (classical) liberal politicians. 

I probably need to read Hoppe in more detail to understand his points. But from what he has raised, and from my preliminary analysis, I'm afraid the case against Hayek does not stack up.

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Mathematical proof that Hayek was right

Came across a truly complex mathematical paper entitled, "Competitive Markets without Commitment" by Nick Netzer and Florian Scheuer, published in JPE Dec 2010. A PDF copy of an April 2010 version is available here.

A few extracts:

The question whether – and why – markets may perform better than centralized institutions, such as governments, has fascinated economists for a long time, at least since the work of Hayek (1945). However, despite the importance of this question for economics and beyond, it is still hard to find formal arguments for why markets may be able to outperform a benevolent government. Instead, the benchmark result is still provided by standard welfare theorems according to which a benevolent planner can always replicate the market outcome, or even improve upon it if the market is affected by failures such as adverse selection or externalities. In this paper, we compare markets and governments and show that a government, even though benevolent and facing the same constraints as competitive firms, may not be able to replicate the market equilibrium, but instead implements an allocation that is Pareto dominated by the market outcome. 

In particular, the market dominates a central planner even though it is affected by an adverse selection problem, overturning the classic justification for efficiency enhancing government interventions in competitive markets.  

Importantly, this result does not depend on the specifics of Rothschild-Stiglitz contracts, but turns out to be a robust implication of competition. We show that, whenever the outcome of an ex-post market satisfies a weak notion of competitiveness, called minimal contestability (Rothschild 2006), and it sufficiently separates agents who have taken different effort choices, it Pareto-dominates the government outcome. 

On the normative side, our results have implications for market regulation. We emphasize that, for markets to be able to deal with the commitment problem successfully, firms must be allowed to offer separating contracts, some of which involve under insurance and possibly strictly positive profits. These properties of the market equilibrium must not be regarded as a sign of market failure, and they do not provide support on their own for government interventions such as the provision of mandatory social insurance against unemployment or health risk, for instance. 

The paper most closely related to ours is the seminal contribution by Fudenberg and Tirole (1990)

My comment

Nice to know that the simple common sense argument of Hayek (easily verifiable through commonplace experience) can be mathematically proven, as well. For those not familiar with Hayek's argument, please read the simple version provided in chapter 2 of Breaking Free of Nehru.

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