Coping With Ignorance
F. A. Hayek
It is to me not only a great honor but also the discharge of an
intellectual duty and a real pleasure to be allowed to deliver a Ludwig
von Mises memorial lecture. There is no single man to whom I owe more
intellectually, even though he was never my teacher in the institutional
sense of the word.
I came originally from the other of the two original branches of the
Austrian school. While Mises had been an inspired pupil of Eugen Boehm
von Bawerk, who died comparatively early and whom I knew only as a
friend of my grandfather before I knew what the word "economics" meant, I
was personally a pupil of his contemporary, friend and brother-in-law,
Friedrich von Wieser. I was attracted by him, I admit, because unlike
most of the other members of the Austrian school, he had a good deal of
sympathy with a mild Fabian socialism to which I was inclined as a young
man. He in fact prided himself that his theory of marginal utility had
provided the basis of progressive taxation, which then seemed to me one
of the ideals of social justice.
It was he who, just retiring as I graduated, sent me with a letter of
introduction to Ludwig von Mises, who as one of the directors of a new
temporary government office concerned with settling certain problems
arising out of the treaty of St. Germain, was looking for young lawyers
with some understanding of economics and knowledge of foreign languages.
I remember vividly how, almost exactly fifty-six years ago, after
presenting to Mises my letter of introduction by Wieser, in which I was
described as a promising young economist, Mises said, "Well, I've never
seen you at my lectures."
That was almost completely true. I had looked in at one of his lectures
and found that a man so conspicuously antipathetic to the kind of Fabian
views which I then held was not the sort of person to whom I wanted to
go. But of course things changed.
The meeting was the beginning. After a short conversation, Mises asked,
"When can you start work?" This led to a long, close collaboration.
First, for five years, he was my official chief in that government
office and then vice president of an institute of business cycle
research which we had created together. During these ten years he
certainly had more influence on my outlook of economics than any other
man.
It was essentially his second great work,
Die Gemein Wirtscaft
of 1922, which appeared in English translation only fifteen years later
as Socialism, that completely won me over to his views. And then in his
Privatseminar, as we called the little discussion group which met at his office, I became gradually intimately familiar with his thinking.
I do not wish however to claim to be an authoritative interpreter of
Mises' views. Although I do owe him a decisive stimulus at a crucial
point of my intellectual development, and continuous inspiration through
a decade, I have perhaps most profited from his teaching because I was
not initially his student at the university, an innocent young man who
took his word for gospel, but came to him as a trained economist,
trained in a parallel branch of Austrian economics from which he
gradually, but never completely, won me over. Though I learned that he
usually was right in his conclusions, I wasn't always satisfied by his
arguments, and retained to the end a certain critical attitude which
sometimes forced me to build different constructions, which however, to
my great pleasure, usually led to the same conclusions. I am to the
present moment pursuing the questions which he made me see, and that, I
believe is the greatest benefit one scientist can confer on one of the
next generation.
I do not know whether my making our incurable ignorance of most of the
particular circumstances which determine the course of this great
society the central point of the scientific approach would have Mises'
approval. It is probably a development that goes somewhat beyond his
views, because Mises himself was still much more a child of the
rationalist age of enlightenment and of continental rather than of
English liberalism, in the European sense of the word, than I am myself.
But I do flatter myself that he sympathized with my departure in this
direction, which I like to describe briefly as a movement back from
Voltaire to Montesquieu. It is the outcome of this development about
which I am now going to speak.
I've come to believe that both the aim of the market order, and
therefore the object of explanation of the theory of it, is to cope with
the inevitable ignorance of everybody of most of the particular facts
which determine this order. By a process which men did not understand,
their activities have produced an order much more extensive and
comprehensive than anything they could have comprehended, but on the
functioning of which we have become utterly dependent.
Even two hundred years after Adam Smith's
Wealth of Nations, it
is not yet fully understood that it is the great achievement of the
market to have made a far-ranging division of labor possible, that it
brings about a continuous adaptation of economic effect to millions of
particular facts or events which in their totality are not known and
cannot be known to anybody. A real understanding of the process which
brings this about was long blocked by post-Smithian classical economics
which adopted a labor or cost theory of value.
The misconception that costs determined prices prevented economists for a
long time from recognizing that it was prices which operated as the
indispensable signals telling producers what costs it was worth
expending on the production of the various commodities and services, and
not the other way around. It was the costs which they had expended
which determined the prices of things produced.
It was this crucial insight which finally broke through and established
itself about a hundred years ago through the so-called marginal
revolution in economics.
The chief insight gained by modern economists is that the market is
essentially an ordering mechanism, growing up without anybody wholly
understanding it, that enables us to utilize widely dispersed
information about the significance of circumstances of which we are
mostly ignorant. However, the various planners (and not only the
planners in the socialist camp) and dirigists have still not yet grasped
this.
I do not believe that it is merely present ignorance, which we expect
future advance of knowledge will remove, which makes a rational effort
at central planning wholly impossible. I believe such a central
utilization of necessarily widely dispersed knowledge of particular and
temporary circumstances must forever remain impossible. We can have a
far-ranging division of labor only by relying on the impersonal signals
of prices.
That here and now we economists do not know enough to be justified to
undertake such a task as the planning of the whole economic system seems
to me so obvious that I find it increasingly difficult to treat the
contrary belief with any respect.
It is a basic fact that we as scientists have to explain the results of
the actions of men, which produces a sort of order by following signals
inducing them to adapt to facts which they do not know. It creates a
comparable or similar problem of coping with ignorance such as the
people in economics world encounter even more than the people who
undertake to explain this process.
It is a difficulty which all attempts at a theoretical explanation of
the market process face, though it appears that not many economists have
been clearly aware of the source of the difficulties which they
encounter.
If the chief problem of economic decisions is one of coping with the
inevitable ignorance, the task of a science of economics trying to
explain the joint effects of hundreds of thousands of such decisions on
men in many different positions has to deal with an ignorance as it
were, of a second order of magnitude because the explaining economist
does not even know what all the acting people know; he has to provide an
explanation without knowing the determining facts, not even knowing
what the individual members in the economic system know about these
facts.
We are in this respect not in the happy position in which the theorists
of a relatively simple phenomena find themselves. When they have formed a
hypothesis about how two or three variables are interrelated, they can
test such a hypothesis by inserting into their abstract formula,
observing values replacing the blanks, and then see whether the
conclusions are correct.
Our problem is that even if we have thought out a beautiful and possibly
correct theory of the complex phenomena with which we have to deal, we
can never ascertain all the concrete specific data of a particular
position, simply because we do not know all that which the acting people
know. But it is the joint results of those actions which we want to
predict.
If the market really achieves a utilization of more information than any
participant in this market process possesses, the outcome must depend
on more particular facts than the scientific observer can insert into
his tentative hypothesis which is intended to explain the whole process.
There are two possible ways in which economists have endeavored at least partly to overcome this difficulty.
The first, represented by what today we call micro-economics, resignedly
accepts the fact that because of this difficulty we can never achieve a
full explanation, or an exact prediction of the particular outcome of a
given situation, but must instead be content with what I have
occasionally called a "pattern prediction" or, earlier a "prediction of
the principle." All we can achieve is to say what kinds of things will
not happen and what sort of pattern the resulting situation will show,
without being able to predict a particular outcome.
This kind of microeconomics attempts, by the construction of simplified
models in which all the kinds of attitudes and circumstances we meet in
the real life are represented, to simulate the kind of movements and
changes which we observe in the real world.
Such a theory can tell us what sort of changes we can expect in the real
world, the general character of which our model indicates, which
reduces (not so much in scale as in the number of distinct elements),
the facts with which we have to deal, to make its workings still
comprehensible or surveyable.
I still believe that this is the only approach which is entitled to
regard itself as scientific. Being scientific involves in this
connection a frank admission of how limited our powers of prediction
really are. It still does lead to some falsifiable predictions, namely
what sorts of events are possible in a given situation and which are
not.
It is, in this sense, an empirical theory even though it consists
largely, but not entirely, of propositions which are self-evident once
they are stated. Indeed, I doubt whether microeconomic theory has ever
discovered any new facts. Decreasing returns, decreasing marginal
productivity or marginal utility, decreasing marginal rates of
substitution were of course all phenomena familiar to ordinary people
even if these did not call them by that name. In fact, it is only
because ordinary people knew these facts, long before economists
discovered their importance, that they have always been among the
determinants of how the market actually functions. What the economic
theorists found out was merely the relevance of these particular facts
for the decision of individuals in their interactions with other
persons.
It is the obscuring of the empirical fact of people learning what others
do by a process of communication of knowledge which has always made me
reluctant to accept von Mises' claim of an a priori character of the
whole of economic theory, although I agree with him that much of it
consists merely in working out the logical implications of certain
initial facts.
I recognize with him microeconomic theory as the only legitimate
economic theory because, and in so far as, it recognizes the inevitable
limitation of our possible knowledge of the objective facts which
determine any given situation; and we need claim no more that we are
entitled to claim.
I will not deny that we find also in the microeconomic literature a good deal of indefensible pretense of a great deal more.
There is, of course, in the first instance, the frequent abuse of the
convenient conception of "equilibrium" toward which the market process
is said to tend. I will not say that there are not forces at work which
can usefully be described as equilibrating tendencies.
But equilibrating forces are of course at work in any stream of a liquid
and must be taken into account in any attempt to analyze the flow of
such a stream. Such a stream in the physical sense of the word of course
will never reach a state of equilibrium. And the same is true of the
economic efforts of the production and use of goods and services where
every part may all the time tend toward a partial or local equilibrium,
but long before that is reached the circumstances to which the local
efforts adapt themselves will have changed themselves as a result of
similar processes. All we can claim for the achievement of microeconomic
theory is that the signals which the prices constitute will always make
the individuals change their plans in the direction made necessary by
factual charges of which they have no direct knowledge—not that this
process will ever lead to what some economists call an equilibrium.
Not content with this limited insight, which economics can in fact
supply, economists ambitious to make it more precise have often spoiled
microeconomics by a tendency, which we shall encounter in a more
systematic form when I pass on to the second type of approach,
macro-economics. They tried to deal with our inescapable ignorance of
the data required for a full explanation, the macroeconomic one, by
trying measurements I shall discuss later.
I will at this stage make only two further comments on this. The first
is that it is an erroneous belief, characteristic of bad mathematicians,
that mathematics is essentially quantitative and that, therefore, to
build on the great achievements of the founders of mathematical
economics, men like Jevons, Walras and Pareto, one has to introduce
quantitative data obtained by measurements. That was certainly not the
intention of the founders of mathematical economics. They understood
much better than their successors that algebraic mathematical formulae
are the pre-eminent method for describing abstract patterns without
assuming or possessing particular information about the specific
magnitudes involved. One great mathematician has indeed described a
mathematician as a maker of patterns. In this sense mathematics can be
very helpful to us.
The second point which I want to make is that a particular reason which
in the physical sciences make measurements of concrete magnitudes the
hallmark of scientific procedure for a very definite reason do not apply
to the explanation of human action. The true reason why the physical
sciences must rely on measurements is that it has been recognized that
things which appear alike to our senses frequently do not behave in the
same manner, and that sometimes things which appear alike to us behave
very differently if examined.
The physicist, to arrive at valid theories, was often compelled to
substitute for the classification of different objects which our senses
provide to us a different classification which was based solely on the
relations of objective things toward each other.
Now this is really what measurement amounts to: a classification of
objects according to the manner in which they act on other objects. But
to explain human action all that is relevant is how the things appear to
human beings, to acting men. This depends on whether men regard two
things as the same or different kinds of things, not what they really
are, unknown to them. For our purposes the results of measurements (at
least so far as these are not performed by the people whose actions we
want to explain) are wholly uninteresting.
The belief derived from physics that measurement is an essential
foundation of all sciences is very old. There was more than 300 years
ago a German philosopher named Erhard Weigel who strove to construct a
universal science which he proposed to call Pantometria, based as the
name says on measuring everything. Much of economics, and if I may add
in parenthesis much of contemporary psychology, has indeed become
Pantometria in a sense in the principle that if you don't know what
measurements mean, measure anyhow because that is what science does. The
social sciences building at the University of Chicago indeed still
bears since it was built 40 years ago on its outside an inscription
taken from the famous physicist Lord Kelvin: "When you cannot measure,
your knowledge is meager and unsatisfactory." I will admit that that may
be true, but it is certainly not scientific to insist on measurement
where you don't know what your measurements mean. There are cases where
measurements are not relevant. What has done much damage to
microeconomics is striving for a pseudo-exactness by imitating methods
of the physical sciences which have to deal with what are fundamentally
much more simple phenomena. And the assumption that it is possible to
ascertain all the relevant particular facts still completely dominates
the alternative methods of dealing with our constitutional ignorance,
which economists have tried to overcome. This of course, is what has
come to be called macro-economics as distinct from microeconomics.
The. basic idea on which this approach proceeds is fairly simple and
obvious. If we cannot know all the individual facts which determine
individual action and thereby the economic process, we must start from
the most comprehensive information which we can obtain about them, and
that is the statistical figures about aggregates and averages.
Again, the model which is followed is provided by the physical sciences
which, where they have to deal with true mass phenomena such as the
movement of millions of molecules with which thermodynamics has to deal,
where we admittedly know nothing about the movement of any individual
molecule, the law of large numbers enables us to discover statistical
regularities or probabilities which indeed, in this way, provide an
adequate foundation for reliable predictions.
The trouble is, unfortunately, that in the disciplines which endeavor to
explain the structure of society, we do not have to deal with true mass
phenomena.
The events which we must take into account in any attempt to predict the
outcome of particular social processes are never so numerous as to
enable us to substitute ascertained probabilities for information about
the individual events. As a distinguished thinker, the late Warren
Weaver of the Rockefeller Foundation has pointed out, both in the
biological and in the social sciences frequently we cannot rely on
probabilities, or the law of large numbers, because unlike the positions
which exist in the physical sciences, where statistical evidence of
probabilities can be substituted for information on particular facts, we
have to deal with what he calls organized complexity, where we cannot
expect to find permanent constant relations between aggregates or
averages.
Indeed, this intermediate field between the simple phenomena of the
physical sciences, where everything can be explained by theoretical
formulae which contain no more than two or three unknowns, and the
instances where a large enough number of events to be able to deal with
true mass phenomena to rely on probability is our subject. In the social
sciences we have to deal with something which Warren Weaver called
organized complexity, phenomena which are not made up of sufficiently
large numbers of similar events to enable us to ascertain the
probabilities for their occurrence.
In order to provide a full explanation we would have to have information
about every single event which you can never possibly obtain. But while
micro-theorists have resigned themselves to the consequent limitations
of our powers and admit that we must be content with what I've called
mere pattern predictions, many of the more ambitious and impatient
students of these problems refuse to recognize these limitations to out
possible knowledge, and possible power of prediction, and therefore also
of our possible power of control.
What drives people to the pursuit of statistical research is usually the
hope of discovering in this way new facts of general and not merely
historical importance. But this hope is inevitably disappointed. I
certainly do not wish to underrate the importance of historical
information about the particular situation. I doubt, however, whether
the observation and measurement of true mass phenomena has significantly
improved our understanding of the market process. What we can find by
this procedure, as by all observation of particular circumstances, may
possibly be special relations, determined by the particular
circumstances of the moment and the place, which indeed, perhaps for
some time may enable us to make correct predictions. But with general
laws which help to explain how at different places the course of
economic affairs is determined, these quantitative relations between
measurable magnitudes have precious little to do. Indeed, even the very
moderate hopes which I myself had at one time concerning the usefulness
of such economic forecasts based on observed statistical regularities
has mostly been disappointed. The concrete course of the process of
adaptation to unknown circumstances cannot be predicted. All we can
predict is certain abstract features of the process, not its concrete
manifestations.
It is now frequently assumed that at least the theory of money, in the
nature of that subject, must be macro-theory. I can see no reason
whatever for this. The cause for this belief is apparently the fact that
the value of money is usually conceived as corresponding to an average
of prices. But that is no more true than it is of the value of any other
commodity. I do not see for instance, that our habitual use of index
numbers of prices, although undoubtedly very convenient for many
purposes, has in any way assisted our understanding of the effect of
monetary changes, or to draw relevant conclusions, except, perhaps about
the behavior of index numbers.
The interesting problems are those of the effect of monetary changes on
particular prices, and about these index numbers or changes of general
price levels, tell us nothing.
It seems to me more and more that the immense efforts which during the
great popularity of macroeconomics over the last thirty or forty years
have been devoted to it, were largely misspent, and that if we want to
be useful in the future we shall have to be content to improve and
spread the admittedly limited insights which micro-economics conveys.
I believe it is only microeconomics which enables us to understand the
crucial functions of the market process: that it enables us to make
effective use of information about thousands of facts of which nobody
can have full knowledge.
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