Minds and Markets

     

Perhaps unsurprisingly, I find little to disagree with in Pete Boettke's summary of Hayek's "epistemic liberalism." I think Pete is correct to emphasize the role of knowledge in Hayek's version of liberalism, especially as it contrasts with the centrality of incentives in many other discussions of the advantages of the market and the liberal order more broadly. How Hayekians talk about prices and profits differs from many other economists' and liberals' emphasis on the role of prices and profits as surrogates for knowledge that enable us to coordinate our behavior. Prices and profits don't just serve as incentives to elicit the "right" choices. Moreover, prices are not valuable because they capture all of the relevant information that enables market actors to maximize utility or profits. Rather, prices are important because they serve as surrogates for the imperfect, contextual, and often unarticulated knowledge of other market actors. Prices are necessary not because they solve coordination problems by enabling everyone to know everything, but because they make possible more economic coordination than would take place in their absence. That is, rather than enabling us to reach the state of being in which we are able to access everyone else's knowledge, prices enable us to engage in the process of learning through their ability to both inform our choices ex ante and provide us feedback about those choices ex post.

This emphasis on learning in Hayek is a theme that permeates his whole career. He grew up in a family of scientists, and one of his first, and eventually lifelong, fascinations was with psychology and the human brain. That interest was fully realized in The Sensory Order, his 1952 book on theoretical psychology (or the theory of cognition). However, that book's roots were in a 1920 paper in which he outlined many of the ideas that would form the core of his book 32 years later. And even after the publication of The Sensory Order (hereafter, TSO), Hayek continued to write about the issues it raised and their relevance for the liberal order. The lasting importance for Hayek of these questions about the brain, the mind, and how humans learn can help us see why his liberalism would have a distinct epistemic flavor.

There is much that could be said about the role of TSO in Hayek's system. Viktor Vanberg's long introductory essay (2017) to the Collected Works edition of the book does a masterful job in covering that ground. I want to focus on two points here that relate to Pete's argument, especially what he has elsewhere called Hayek's "epistemic institutionalism." The question concerns the role TSO might play in understanding how Hayek's social theory came to differ from the direction mainstream economics began to take between the world wars. The growing focus on equilibrium rather than market processes, and the increasingly behavioristic and positivistic method that came to define mainstream economics, were strongly at odds with Hayek's thought. His cognitive theory can help us understand the particular positions he took on both the substance of economics and the appropriate method for studying human action.

Summarizing the contribution of TSO is a challenging task. In short, Hayek argued that what we call mind is a system for classifying the external world in such a way that we are able to construct a model of that world which enables us to form reasonably reliable expectations about the way in which the world actually works. Although all human beings are born with some common biological features and dispositions from our evolutionary past, much of the structure of our brains comes from our specific interactions with the world. The people we interact with, the languages we speak, and the situations we find ourselves in all contribute to forming the neural connections that determine how the brain classifies incoming sensory data and creates the model of the world that guides our expectations and actions. Hayek is clear to argue that those connections are contingent and therefore can change as we learn from experience what works and what does not. In this way, Hayek's theory of mind is a spontaneous order story: our minds are the unintended outcome of our interactions in the world, guided by the "profit and loss" signals of success and failure in accomplishing our goals. Importantly, Hayek argues that the mind can never fully understand itself, as understanding any classifying system requires a classifying system more complex than the one being understood. Therefore we are limited in our ability to understand the mind. At best we can offer an "explanation of the principles" by which mind operates, much in the same way that we cannot make specific predictions about events in the market, but only broad causal statements of the underlying laws by which it functions.

As Pete notes in his opening piece, it is in Hayek's 1937 article "Economics and Knowledge" that he first truly describes the market as a learning process. He asks the empirical question about how humans come to learn what others want and how best to provide it for them such that our expectations can become more consistent with each other. He also notes that this consistency of expectations includes not just our knowledge of "external events" but also of other actors' expectations.

Within economics, this Hayekian question has been answered by Israel Kirzner's theory of the entrepreneur. Kirzner took the theory of the entrepreneur developed by Ludwig von Mises and demonstrated how it could answer this Hayekian question. The entrepreneur is alert to opportunities for profit and acts to exploit them. Having noticed that apples are selling for $2 on one side of the street and $4 on the other, the entrepreneur expects she can profit by buying them for $2.50 and selling them for $3.50. Trying out this set of expectations informs the $2 sellers that their expectations about much they could get for their apples were mistaken, and it informs those buying at $4 of their mistaken expectations about how little they had to spend to get apples. Entrepreneurs spread knowledge and, when they are successful, thereby correct errors and enable people to have more accurate expectations about the actions of others. This is how economics can describe the learning process of the market.

Within that emergent order of the marketplace is the emergent order of the minds that are engaged in this learning process. Hayek's cognitive theory (2017 [1952]: 240) stresses that we "live as much in a world of expectation as in a world of 'fact,' and most responses to a given stimulus are probably determined only via fairly complex processes of 'trying out' on the model the effects to be expected from alternative courses of action." Note the parallel to what the entrepreneur does. For Hayek, it's learning and expectation formation and correction all the way down. His view that markets are learning processes rests on a foundation about how humans learn in all of the situations in which we find ourselves.

Where the liberal order comes in, as Pete rightly notes, is with respect to what sorts of institutions best facilitate the formation of these emergent orders in such as way as to promote human progress. That is, what sorts of economic, political, and social institutions give maximum scope to entrepreneurial alertness to discovery and error-correction?  What sorts of institutions ensure that errors are knowable and that actors have at least partial information to correct them?  What sorts of institutions reward error-correction that better coordinates expectations? What sorts of institutions give humans the ability to deploy their own knowledge in ways that are accessible to others? The institutional context matters for learning, and therefore for economic coordination and social progress. From minds to markets, epistemic questions are central for Hayek.

But there's a second element to his cognitive theory that's relevant for his epistemic liberalism. Hayek's theory of mind also provides, as Bruce Caldwell (1994) has noted, a scientific foundation for his subjectivism. In the last chapter of TSO, Hayek discusses the philosophical implications of his theory. There he says (2017 [1952]: 303), in response to the behaviorists, "The recognition of the fact that for our understanding of human action familiar mental entities must always remain the last determinants to which we can penetrate, and that we cannot hope to replace them by physical facts, is, of course, of the greatest importance for all of the disciplines which aim at an  understanding and interpretation of human action." We cannot understand the social world without making use of concepts of perception, intention, goals, and preferences. That is, we must start our analysis with the subject's perceptions of the world. As Hayek says in The Counter-Revolution of Science, also published in 1952 (44, emphasis in the original): "So far as human action is concerned the things are what the acting people think they are."

It is not mere coincidence that Hayek published a book on theoretical psychology and a book on the method of the social sciences in the same year and in the wake of his perceived defeat in the debates with the market socialists and Keynes. In both debates it became clear to Hayek that his differences with his interlocutors were primarily epistemological and methodological. They had a different view of the nature of knowledge and how to engage in social science. TSO and Counter-Revolution constitute a two-pronged epistemic response to those debates. As Hayek reported in his 1977 retrospective on TSO (2017 [1977]: 384-5), it was during his work in the early 1940s on the essays that eventually became Counter-Revolution that he "had been driven both to rely in some measure on the results of my unpublished work in psychology and to think further about some of the problems with which I had dealt in it." That in turn led him to revisit those issues while writing TSO. The importance of TSO is that it provided a scientific response to those, such as the behaviorists and positivists, who said subjectivist approaches to the social sciences were unscientific. A correct understanding of human cognition indicates that we must make use of the "familiar mental entities" and take human perceptions and intentions as the starting point of our analysis.

To get people to grasp that markets are a learning process and that understanding markets requires a subjectivist economics, Hayek had to make this stronger epistemic turn in the 1940s. "The Use of Knowledge in Society" (1945) was the first step, as he made the case that key function of prices was epistemic. But that was not enough. TSO, along with Counter-Revolution, enabled him to make a more comprehensive argument for the nature of human learning and what that means for the doing of economics. Those projects also led to the institutional questions that are at the heart of Pete's opening essay.

If the twin processes of evolution and spontaneous order are learning processes, and if they are at work at every level, from the molecular to the mental to the market to large-scale biological evolution, then it is incumbent upon us to understand the conditions under which the evolutionary processes at work in the social world are best able to contribute to human progress. That requires we recognize that these are, in fact, epistemic processes and that we must study them through the lens of social theories that start from the perceptions of individuals and how the institutional contexts in which humans choose determine the consequences of those choices. As Pete rightly notes, this is what pushed Hayek towards his study of the liberal order in his work in the 1960s and 70s. If human society is an emergent order of learning that rests on the emergent order we call mind, and if human progress depends upon maximizing that capacity to learn, under what institutional conditions will that potential best be realized? The answer to that epistemic question is the set of institutions that comprise the liberal order.

Caldwell, Bruce. 1994. "Hayek's Scientific Subjectivism," Economics and Philosophy 10: 305-13.

Hayek, F. A. 1937. "Economics and Knowledge," in Individualism and Economic Order, Chicago: University of Chicago Press.

__________. 1945. F. A. Hayek. "The Use of Knowledge in Society," American Economic Review, 35(4): 519–30. Reprinted in Individualism and Economic Order,(Chicago: University of Chicago Press, 1948).

__________. 1952.  The Counter-Revolution of Science, Indianapolis, IN: Liberty Press.

__________. 2017 [1952]. The Sensory Order, reprinted in The Collected Works of F. A. Hayek Volume 14: The Sensory Order and other Writings on the Foundations of Theoretical Psychology, Viktor J. Vanberg, ed., Chicago: University of Chicago Press, 2017.

__________. 2017 [1977]. "The Sensory Order after 25 Years," reprinted in The Collected Works of F. A. Hayek Volume 14: The Sensory Order and other Writings on the Foundations of Theoretical Psychology, Viktor J. Vanberg, ed., Chicago: University of Chicago Press, 2017.

Vanberg, Viktor J. 2017. "The 'Knowledge Problem' as the Integrating Theme of F. A. Hayek's Oeuvre: An Introduction to The Sensory Order," editor's introduction to The Collected Works of F. A. Hayek Volume 14: The Sensory Order and other Writings on the Foundations of Theoretical Psychology, Viktor J. Vanberg, ed., Chicago: University of Chicago Press, 2017.