Because this is the 50th anniversary of the announcement that Friedrich Hayek was co-winner of the Nobel Prize in economics (the person who shared it was Gunnar Myrdal), it’s a good time to look closely at his 1945 article in the American Economic Review, “The Use of Knowledge in Society.”

When I used to cover the article in my classes about 30 years ago, the students had trouble following his argument. Part of it, I think, was Hayek’s Germanic writing style: lots of long sentences. So for a few years, I quit covering the article. But that wasn’t satisfactory. So instead, I sent the students detailed comments and questions on various paragraphs to guide them through the article. That worked well.

Each time I look at my notes, I update. So this morning I updated yet again.

Here are my notes.

 

Teaching Notes on Hayek, “The Use of Knowledge in Society”

http://www.econlib.org/library/Essays/hykKnw1.html

David R. Henderson

October 9, 2024

I think this article is one of the ten most important articles published in economics in the last 80 years. So, it’s worth the effort.

The most important paragraph in this article is the third paragraph and the most important sentence in the article is the first sentence of this paragraph:

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate “given” resources—if “given” is taken to mean given to a single mind which deliberately solves the problem set by these “data.” It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.

Economists today who draw on Hayek’s insight often refer to this point about dispersed information as “local knowledge.”  Think about kinds of local knowledge you have about your job or other parts of your economic life, knowledge that would be unavailable to a central planner.  Now ask yourself how things would work if you had to get a central planner’s permission each time you wanted to act on this knowledge.  Think about your job and about other parts of your economic life.

In Section II, second paragraph, Hayek writes:

The answer to this question is closely connected with that other question which arises here, that of who is to do the planning. It is about this question that all the dispute about “economic planning” centers. This is not a dispute about whether planning is to be done or not. It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals.

When economists stared criticizing the idea of central planning early in the 20th century, the comeback from some of those who wanted central planning was, “Don’t you think we need to plan?” That’s why Hayek has this paragraph.

Read and reread Section III, second paragraph. There’s so much in there. One example: Think of someone who graduates at the top of his/her class at Stanford, Yale, or Harvard Law School. On a scale of 1 to 10, what does he/she know on the first day at the job that will help him/her do the job? My guess is that’s no more than 4 and could well be 2 or 3.

 

In Section III, third paragraph, Hayek writes:

Even economists who regard themselves as definitely immune to the crude materialist fallacies [i.e., thinking in terms of material wealth] constantly commit the same mistake where activities directed toward the acquisition of such practical knowledge are concerned—apparently because in their scheme of things all such knowledge is supposed to be “given.”

About 15 years ago, our dishwasher was leaving our dishes streaky and so we called the appliance repairman. He came out—minimum charge $69.95—and in 5 minutes assessed the situation and told us we should use powder instead of liquid dishwasher detergent. For a few minutes I was angry. Then I remembered Hayek.  Explain.  What did I figure out that is contained in this quote?

Read Section IV, fifth paragraph. Some economists who studied the Soviet Union and other centrally planned economies have claimed that the biggest failure of such economies was not in manufacturing but in agriculture.  Given Hayek’s reasoning in this paragraph, explain why.

In Section IV, sixth paragraph, Hayek writes:

It follows from this that central planning based on statistical information by its nature cannot take direct account of these circumstances of time and place and that the central planner will have to find some way or other in which the decisions depending on them can be left to the “man on the spot.”

No question on this: Just think about it.

In Section V, first paragraph, Hayek states the dilemma:

We need decentralization because only thus can we insure that the knowledge of the particular circumstances of time and place will be promptly used. But the “man on the spot” cannot decide solely on the basis of his limited but intimate knowledge of the facts of his immediate surroundings. There still remains the problem of communicating to him such further information as he needs to fit his decisions into the whole pattern of changes of the larger economic system.

This is the dilemma. So far, Hayek has explained why central planning can’t work. Things seem hopeless. Information constantly changes and each person has only his or her little bit of information. It seems as if things would end in chaos. Is there hope? Yes, which is why I call this next part, “Free markets to the rescue.”

Let’s see what solves it.

Carefully read Section V, fifth paragraph, another key paragraph. Hayek writes:

It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce.

Why is it very significant that it does not matter?

In Section VI, first paragraph, Hayek gives an analogy between the price system and machinery. What is that analogy?

In Section VI, second paragraph, Hayek uses the word “marvel” to describe the price system and then explains in the third paragraph why he uses that word. Why?

See the reading I’m attaching from that noted economic analyst, Howard Stern, for a humorous example of local knowledge.

http://www.theloonies.co.uk/1998.02/0012.html

 

Editor’s Note: Readers may wish to join us in a weeklong online discussion of this article later this month in the Liberty Fund Portal. Readers may also be interested in Don Boudreaux’s recent appearance on The Great Antidote podcast on this same topic.