Liberty Matters

Is a Market Process Theory Purely Based on the Logic of Choice Really Impossible?


In order to provide some comments on the discussion between Mario and Pete, I went back to Hayek’s paper, “Economics and Knowledge” (a presidential address to the London Economic Club, November 10, 1936; first published in Economica, February 1937).[28] My proposition is as follows: Hayek saw individual learning and the tendency towards equilibrium as empirical problems because he did not care enough about the role of the entrepreneur in pure theory.
It is known that Hayek has only a few direct references to the entrepreneur in his entire work. I only know of two (but I am sure there are others). One of them is in The Constitution of Liberty (chapter 5, section 7). The other one is in “Economics and Knowledge”on page 44 (more on this below).
In “Economics and Knowledge” Hayek states several times that the hypothesis of a tendency towards equilibrium and that of learning (which are two sides of the same coin) are empirical propositions. For instance: “the assertion of the existence of a tendency towards equilibrium is clearly an empirical proposition” (p. 44).
The issue of learning is the crux of the matter in Hayek’s paper. He states: “If we want to make the assertion that, under certain conditions, people will approach [the equilibrium state], we must explain by what process they will acquire the necessary knowledge” (p. 45). We need to know “how experience creates knowledge” (p. 46).
According to Hayek, two issues are unresolved in equilibrium analysis: “(a) the conditions under which this tendency is supposed to exist, and (b) the nature of the process by which individual knowledge is changed” (p. 44, italics in the original).
Following Mario and Pete, I propose two solutions: (a) institutions and their enforcement mechanisms (i.e., the epistemic role of institutions in learning), and (b) the entrepreneurial process (i.e., the role of discovery in the existence of a tendency). Hayek doesn’t really propose either of these two solutions in his 1937 paper. (He briefly mentions “institutions” on page 53 but in the sense of the media, the press, advertising, etc.) But we must note that Hayek’s questions call for exactly the answers that Kirzner provides.
Hayek explains on page 44, however, that the tendency towards equilibrium means that “the expectations of the people and particularly of the entrepreneurs will become more and more correct” over time. That point is very similar to Kirzner’s view about how entrepreneurs discover new opportunities that imply a learning process of mutual discovery.
Overall, Hayek’s own response to the issue of learning is disappointing. Pages 48-54 are filled with theoretical insights but not many clues as to how to put empirical content in the learning process. More surprisingly perhaps, he even states on page 53 that he “very much doubt[s] whether such [empirical] investigation would teach us anything new.”
We can conclude from a closer examination of Hayek’s paper that he perhaps identified an interesting problem, but he realized that the solution was elsewhere. Hence, I see my proposition as valid, i.e., that Hayek saw individual learning and the tendency towards equilibrium as empirical problems because he did not care enough about the role of the entrepreneur in pure theory — and, I would add, the role of institutions (as in the rules of the game and their enforcement) -- in his 1937 paper (although he studies the role of institutions elsewhere in his work).
Now let’s turn to Kirzner’s view. First, he makes the following statement in Competition and Entrepreneurship:
There is nothing in the picture of a market of purely Robbinsian decision-makers, even with the injection of liberal doses of ignorance concerning the ends and means believed to be relevant, which can explain how yesterday’s market experiences can account for changes in plans that might generate alterations in prices, in outputs, or in the use of inputs. For this is it necessary to introduce the insight that men learn from their experiences in the market. It is necessary to postulate that out of the mistakes which led market participants to choose less-than-optimal courses of action yesterday, there can be expected to develop systematic changes in expectations concerning ends and means that can generate corresponding alterations in plans.[29]
Kirzner associates any learning capability with the “entrepreneurial element” of human action. Only homo agens is capable of learning, not the Robbinsian maximizer.
In “Hayek, Knowledge, and Market Processes”[30] Kirzner offers an analysis of Hayek’s work on knowledge, including his 1937 paper, and discusses Hayek’s contention that learning is an empirical proposition and cannot be part of the logic of choice. Kirzner’s criticism consists in saying that Hayek erroneously equates the logical proposition concerning learning and the revision of expectations that individuals may engage in, on the one hand, and the particulars of that process, on the other. As Kirzner puts it: “It is one thing to postulate an equilibrating tendency on the basis of the general character of human action; it is quite another to account for the concrete pattern of events in which this tendency happens to manifest itself”.[31]
Hayek, Kirzner contends, is concerned with the “empirical accidents of the learning process,” as opposed to the pure logic of entrepreneurial discovery, as he probably overlooks the “difference between learning facts and discovering opportunities” (1979, p. 29).
As I see it, the logic of Kirzner’s analysis is:
Errors exist (price gaps) —> May lead to their discovery —> Formulate purpose —> May lead to positive learning
What I mean by “may lead to positive learning” is that learning something that improves one’s own situation may not always follow from discovery and purpose. Indeed, “insights into the entrepreneurial element in human action does not by itself assure us that people necessarily learn the correct facts of their situations from their market experiences” (1979, p. 29). Kirzner explains further: “Can we be sure that, confronted with a surplus, would-be sellers will realize that they must accept lower prices in the future? Can we be sure that, when more than one price prevails for the same item, entrepreneurs will indeed learn of this and move toward the elimination of the price differential?” (1979, p. 29). The answer is no. Individuals may fail to discover errors and they may also fail to learn the correct facts.
But the fact that learning can be faulty (that price bubbles exist, that herd behavior is common, etc.),[32] does not imply that man cannot learn anything. This goes back to Pete’s point about the nature of man’s action: “fallible but capable.” Alertness and the entrepreneurial element in human action guarantee man’s capacity to learn, even though it can be imperfect. As Kirzner puts it:
The entrepreneurial alertness with which the individual is endowed does not refer to a passive vulnerability to the impressions impinging on his consciousness during experience in the manner of a piece of film exposed to the light; it refers to the human propensity to sniff out opportunities lurking around the corner…. We have no assurance that a man walking down the street will, after his walk, have absorbed knowledge of all the facts to which he has been exposed; we do, in talking of human action, assume at least a tendency for man to notice those that constitute possible opportunities for gainful action on his part. [1979, p. 29]
Could purposeful action (driven by the entrepreneurial element) rest on something other than the noticing of opportunities for gainful action? I don’t see how it could. Kirzner’s proposition that we can assume “a tendency for man to notice those [facts] that constitute possible opportunities for gainful action” is on par with Adam Smith’s propensity to trade and barter. It is that important. “It is enough,” writes Kirzner, “to recognize this propensity [to discover opportunities] as inseparable from our insight that human beings act purposefully” (1979, p. 30). Purpose and discovery of opportunities (and hence positive learning as the case may be) are two sides of the same coin.
Moreover, “Our insight that opportunities tend to be discovered assures us that a process is set in motion by disequilibrium conditions as these opportunities are gradually noticed and exploited” (1979, p. 30). Kirzner sees entrepreneurially generated events in the marketplace as related to earlier or future events in a systematic way. Human beings are capable of sheer novelty, and their actions can be originative, as G.L.S. Shackle explains, but as far as entrepreneurship is concerned, these actions are not unrelated (as they would be in the case of Shacklean originative choice) to the environment in which they take place. In that sense, Kirzner links discovery to learning (of the correct facts of the environment). If choice were truly always Shacklean, then it would not lead to learning. Instead, discovery may lead to learning because it is related to the environment in which the discovery takes place. This is why Kirzner insists on talking of “discovery” and not “imagination.” As Kirzner puts it: “The genuine novelty I attribute to the entrepreneur consists in his spontaneous discovery of the opportunities marked out by earlier market conditions (or by future market conditions as they would be in the absence of his own actions)” (2015, 147).[33]
In conclusion, a market process resting entirely on the Logic of Choice is possible!
[28.] Friedrich Hayek, “Economics and Knowledge” (a presidential address to the London Economic Club, November 10, 1936; first published in Economica, February 1937).
[29.] Israel Kirzner, Competition and Entrepreneurship (2013), p. 56.
[30.] Kirzner, “Hayek, Knowledge, and Market Processes” in Perception, Opportunity, and Profit, (Chicago: Chicago University Press, 1979), pp. 13-33.
[31.] Ibid., (1979), p. 31. See also Kirzner (1979, p. 25) for a more detailed explanation.
[32.] Note that most of these phenomena are induced by government’s manipulation of money and credit.
[33.] Israel M. Kirzner, “Entrepreneurship, Economics, and Economists,” in The Collected Works of Israel M. Kirzner, Austrian Subjectivism and the Emergence of Entrepreneurship Theory, Peter J. Boettke and Frederic Sautet, eds., (Indianapolis, IN: Liberty Fund, 2015 [1979]), pp. 139-50.