Seventy years ago, Austrian economist, F. A. Hayek, published one of the important articles of the twentieth century, “The Use of Knowledge in Society.”
When the Second World War ended in 1945, the future of the world seemed to be moving the direction of socialist planned economies. Some socialists wanted Soviet-style dictatorship, while others believed in “democratic” socialism. But they all wanted the end to capitalism and the establishment of government-directed economic affairs.
In 1944, Hayek had published The Road to Serfdom, arguing that comprehensive government planning threatened to bring with it the end of the free society. “The Use of Knowledge in Society” demonstrated that the planners, even if benevolent and well-intentioned, could never have the necessary knowledge and ability to successfully plan a society due to the fact that the necessary knowledge is dispersed and decentralized among all the minds of all the people in the world.
Either people are at liberty to use their knowledge as they best see fit, or knowledge crucial to the well being of all may go unused. The key to the effective use and coordination of all that dispersed and centralized knowledge is the market price system through which people are able to inform each other about their desires as consumers and abilities as producers.
But for the price system to exist and function, there must be private property, market competition and individual freedom. Now, seventy years later, it is easier to see and appreciate the importance of Hayek’s argument. It explains why full and comprehensive socialist central planning was inevitably going to fail, as it did.
However, is Hayek’s argument against social central planning still valid and relevant in the post-Soviet world of government intervention and the welfare state? That is the next question to answer.
F. A. Hayek and Why Government Can’t Manage Society, Part I
by Richard Ebeling Ph.,D.
This year marks the seventieth anniversary of the end of the Second World War. On May 8th, Nazi Germany surrendered to the Allied Powers in Europe. On September 2nd, Imperial Japan surrendered to the Allies on the deck of the U.S.S. Missouri in Tokyo Bay, thus ending a global conflict that is estimated to have cost the lives of upwards of 50 million people.
In autumn of 1945, everyone was looking forward, finally, to a world at peace that could recover from the destruction of a catastrophic war and move towards a bright new future. But what kind of world was it to be?
Nazism and fascism had been militarily and ideologically pulverized in the conflict. No one wanted to goose-step to Hitler and Mussolini’s grandiose dreams of a world-ruling master race or a war-worshipping aggressive nationalism to which innocent human beings were to be sacrificed.
The Postwar Hope for a Better World Through Soviet Socialism
Instead, many looked East to the Soviet Union that stood as the new colossus that had bore the brunt of the Nazi war machine; Soviet socialism seemed to offer a vision of a “better world” free from economic exploitation or class distinction.
Before the war, under Comrade Stalin’s bigger-than-life leadership, socialist central planning and a spirit of serving the “common good” of humanity seemed to be creating a colossal industrial society in what had been the backwards agricultural nation of Russia a mere handful of years before. This was all being done, Soviet propaganda assured, for the benefit of the mass of the workers, and not a handful of greedy plundering capitalists. A people’s utopia was in the making.
The German invasion had destroyed many of the industrial centers in European Soviet Russia. But beyond the Ural Mountains, Stalin had directed the reconstruction of new industrial centers that had ground out vast amounts of military hardware and equipment that stopped the Nazi onslaught, and had brought the Soviet Army to the central of Europe, with the red flag raised over Warsaw, Budapest, Vienna, Berlin and Prague.
Marxian ideology (and prophecy) asserted the inevitability of the coming socialist society. Communist parties both within the orbit of Stalin’s new empire in Eastern Europe and in the Western democracies outside of Stalin’s grasp were all at work to bring the totalitarian collectivist future to pass.
Western Socialists Wanted Socialism with a Democratic Face
Of course, not all socialists in the West were slavish servants to the Soviet Master in Moscow the way the communist parties were so bound. Many Social Democrats believed that democracy was both compatible with and an essential complement to a humane socialism, a socialism that did not reduce humanity to obedient cogs in a giant collectivist wheel directed by a “dictatorship of the proletariat.” They wanted socialism with traditional civil liberties, personal freedom and democratic politics.
It is important to remember, however, that at a fundamental level the conflict between Western European democratic socialists and Moscow-managed single-party communists on opposite sides of the European divide was a dispute over means and not desired ends.
Soviet Communists and Social Democrats All Wanted Central Planning
In the years before, during, and immediately after the war, the dispute and debate between “communists” and “socialists” was over two things: How shall the collectivist society come about: through ballots or bullets – through democratic elections or violent revolution? And once in power, would collectivist rule and control be maintained through multi-party democratic choice or on the basis of one-party dictatorship with the suppression of civil liberties and political freedom?
But both Western socialists and Soviet-style communists, nonetheless, still agreed about the end or goal to be attained: near or full abolition of private ownership of the means of production and the implementation of government central planning of production and distribution in the place of decentralized and competitive private enterprise.
Capitalism was the enemy for both Soviet-oriented communists and those desiring a hoped for “democratic” socialism. Private enterprise was considered the root of “exploitation” of the workers, “social injustice,” and economic inequality of income and wealth. Both communists and socialists believed in government central planning of a society’s economic activity over virtually all facets of life.
Most American Leftists Pushed for Interventionist-Welfare Statism
The United States, of course, was noticeably different. The socialist ideal of nationalization of the means of production and central planning had never caught the imagination or the political traction the way they did in Europe. In spite of America’s flirtation with economic fascism during FDR’s early New Deal days and the wartime planning under which virtually the entire U.S. economy was put into the straightjacket of government control, the postwar direction was for the freeing of the market from direct and total government planning.
In America, outside of the more consistent and vocal voices on “the left,” the debates focused on the degree to which U.S. industry needed to be regulated by the government to tame tendencies toward supposed monopolistic and oligopolistic inefficiencies and distortions in the market; the extent to which New Deal-introduced welfare state programs should be enlarged and extended; and, of course, the requirements for “activist” fiscal and monetary policies to assure and maintain “full employment” inspired by the virtual monopoly dominance of Keynesian ideas over the thinking of economists and government policy-makers in all matters of macroeconomic theory and policy.
F. A. Hayek was Critic of Keynes and Author of The Road to Serfdom
But in that same September of 1945, now seventy years ago, there appeared a lead article in the American Economic Review, the leading journal of the American economics profession, on “The Use of Knowledge in Society,” by an “Austrian” economist named Friedrich A. Hayek who had been teaching at the London School of Economics for almost a decade and a half.
Born in Austria and having graduated from the University of Vienna, in the 1930s Hayek was recognized as the leading opponent and contender against the ideas of the Cambridge University economist, John Maynard Keynes, and his emerging “Keynesian” economics. Hayek was also acquiring a international name recognition from a book he had published a year earlier in 1944, The Road to Serfdom.
The theme of The Road to Serfdom is that while socialism had been promised as a “new world” of freedom and prosperity for all with an abolition of capitalist exploitation, in reality the inescapable concentration of power and control in the hands of a socialist government so to centrally plan the economic affairs of the society would lead to the threatened loss of not just economic freedom with the end of private property, but the loss of personal and civil liberties as well.
In spite of the dreams and promises of the “democratic” socialists, when the government own all the means of production, then the only books and magazines published, including their content, is what the government wants printed. When the government owns all the resources, factors and machines, the only things produced and made available are those consumer goods the central planners considered “good” and desirable for “the people.” When the government is the monopoly manufacturer, then the only employment opportunities are those the political authorities make available and assign you to fulfill.
You, as an individual, are at the mercy of an all-powerful, single provider of all things from which you have no escape because there is nothing outside of what the government, owns, controls and plans. There is virtually no “private space,” to live in and freedom over outside of the centrally planning hands of the State.
Running through his damning indictment of the political and personal consequences from imposing full socialist planning on society, is a defense of the dignity and sanctity of the individual as a human being. The importance of private property is argued to be essential to secure and protect any and all freedom for the grasping hand of political power.
Hayek also pointed to the crucial role of the existence, practice and respect for an impartial rule of law for any protection from arbitrary government control. Without a delineation and enforcement of the rights of the individual and constitutional limits on the size and scope of government, political tyranny always threatens a society.
Hayek’s “Use of Knowledge in Society” and the Unworkability of Planning
There are several concise and suggestive passages in The Road to Serfdom in which Hayek points out fundamental weaknesses in the practical ability of a central planning system to effectively replace a functioning competitive market order for solving the “economic problems” of society. But it is only in his 1945 article on “The Use of Knowledge in Society” that Hayek details what he considers to be the essential difficulty with any comprehensive system of economic planning.
If central planning were to work, it would be necessary for the central planners to possess complete and comprehensive knowledge of all the relevant “data” to decide how best to use and allocate all the diverse physical resources, human labor skills, and technical possibilities so to produce those goods best serving the wants of the members of society, and in the most efficient manner to get the most out of the scarce means available to satisfy people’s ends.
Hayek’s starting point was to emphasize that all of that meaningfully relevant “data” exists in no one place and in no one mind or group of minds. The “knowledge of the world” is dispersed and divided up in the minds of all the members of society, with each knowing and understanding only a small part relative to all the knowledge that exists in everybody’s minds, combined.
Furthermore, while people often think of knowledge in the textbook or “scientific” sense, there are other types of knowledge no less relevant or important that must be utilized and brought to bear if production is to proceed effectively and efficiently and if what is supplied tends to match what members of society want to demand.
Decentralized Knowledge and Need to Coordinate All That People Know
Hayek called this other type of knowledge the “local knowledge of time and place.” This is the knowledge that is only acquired working and interacting within a particular corner of the social system of division of labor. This knowledge comes from working in a particular trade, in a specific firm or enterprise, working with a distinct group of other people, in which particular machines and tools are used as the means to satisfy specific consumers and demanders in the attempt to gain and keep their business in a competitive market.
But if knowledge is decentralized in a complex system of division of labor in which people are invariably separated from each other by both time and space, how shall information be communicated among people so their choices and actions on the production side of the economy can be tending to match and coordinated with the consumption side of the market?
Hayek forcefully argued that it is not necessary for all the multitudes of millions (now billions) of participants in the division of labor to directly know each other and each other’s planned actions and desires to interpersonally coordinate all that they do. And it is certainly impossible for a handful of central planners to know enough of all that there is to know to successfully perform such an intricate and ever-changing task.
The Role of Market-Based Prices to Solve Society’s Knowledge Problem
The market solves the “economic problem,” which Hayek emphasized was really the problem of how to utilize all the knowledge in the world when all that knowledge can never be coordinated for effective use other than through the competitive price system.
Through the prices they offer to pay, demanders from one corner of the globe to another register their interest and their degree of willingness to pay others to supply them with the various goods, services, and resources they are interested in obtaining from those willing and able to supply.
At the same time, every producer anywhere in the world is saved the necessity of needing to know all the other competing producers and enterprisers who also may have investment goals in mind involving the acquisition and use of various types of labor, capital equipment and raw materials.
It is sufficient that those rival demanders for the means of production on the producer-side of the market indicate and register their interest, willingness and ability to demand those factors of production through the prices they offer to purchase, hire or employ them.
These input prices inform producers anywhere in the world what the relative costs shall be to use those factors of production in their own line of activity, and therefore which combination of them would incur the least monetary expense to employ relative to the anticipated price they think consumers might be willing to pay for the finished product they could assist in producing.
These prices on the demand side of the market enable everyone in their own corner of the society to decide how best to allocate their limited income among alternative consumer goods they might purchase; and those prices on the supply side of the market assist each and every producer in deciding whether production of some product might earn a profit or suffer a loss, and if possibly profitable, with what combination of inputs to minimize expenses given other desired uses for them in other parts of the market.
Markets Enable Both Freedom and Use of Knowledge
The advantage of using a market-generated network of competitively established prices is that they not only inform everyone about the demand and supply potentials of others in society. It also means that every individual may be left free to make his own decisions about how best to use that knowledge of his local time and place in the most effective manner, so all many benefit from what each knows and can do that no central planner could ever know or do better than the decentralized decision-makers themselves.
Thus, individual liberty and social coordination through prices – personal freedom and market order – become not only possible, but can be shown to be indispensable if the “knowledge of the world” is to be brought into play for the mutual benefit and advantage of all.
If personal freedom is considered to be a desirable human condition and if human cooperation for mutual improvement is considered of value for the material and cultural betterment of mankind, then it can be shown, Hayek concluded, that only free markets – competitive capitalism – can solve the “economic problem” of the use of knowledge in society.
Socialist central planning, therefore, with its concentration of control over the means of human existence in the hands of the political authority, is not only a threat to human freedom and dignity – a “road to serfdom” – but also could be shown to be an economic dead end offering neither productive efficiency nor the practical utilization of the division of knowledge that accompanies a system of division of labor.
Abolition of private property in the means of production not only results in the personal loss of the means for existence and betterment outside of the power of government, with its danger of tyranny. It limits mankind’s opportunities and progress to what a small number of finite minds can master and know, who are assigned the task of centrally planning and commanding the productive activities of the society.
Hayek’s argument on the essential limits of the human mind to know enough to reconstruct and plan society according to a crafted central design was and is a powerful critique against the socialist ideal of the last one hundred years.
Which one of us, if we spoke with all honesty and truthfulness, can assert that they know enough to plan the economic and related social activities of the over 320 million distinct individuals living in the United States, or the more than 7.2 billion people who live on our planet?
But it might be said that “socialism” in his older and original form is now dead. It died with the fall of the Berlin Wall in 1989 and the collapse of the Soviet Union in 1991. Except, maybe, in North Korea, the case for and the practice of central planning has become something of the past, a tragic historical curiosity that historians will analyze and try to understand for a long time.
Today around the world practically every country operates with forms of a market economy. Some may be more free and competitive while others a less so, but “the market” as the broad institutional framework in which economic affairs go on in daily life is now virtually universal. Therefore, is Hayek’s message in both The Road to Serfdom and his article on “The Use of Knowledge in Society” still meaningful and relevant in our world today? That question will be addressed in part 2 of this article.
(The text is based on a talk given on a panel session devoted to “Friedrich Hayek as Defender of Liberty” at the Tenth Annual Moral Foundations of Capitalism Conference sponsored by the Clemson Institute for the Study of Capitalism at Clemson University in South Carolina, May 29, 2015)
First published at EPICTiMes, and posted here with the kind permission of the author
Dr. Richard M. Ebeling is the BB & T Professor of Ethics and Free Enterprise Leadership at The Citadel in Charleston, South Carolina, He was formerly professor of Economics at Northwood University. Was formerly president of The Foundation for Economic Education (FEE), was the Ludwig von Mises Professor of Economics at Hillsdale College in Hillsdale, Michigan, and served as president of academic affairs for The Future of Freedom Foundation (FFF).