Defeating Hayek

     

Peter Boettke's essay provides vital logical and historical context for appreciating Hayek's contribution. Hayek's epistemic project led him to consider the institutional background of economic activity, not to abandon economics. And the project remains incomplete. The most popular contemporary economics textbook, Greg Mankiw's Principles of Microeconomics, only has three index entries for "property rights," each pointing to a brief passage: one arguing that government is necessary to provide them (pp. 10-11), another about patents in industrial policy (p. 209), and the last at the end of his discussion of common-pool resources (p. 237). While Mankiw's textbook is quite good overall, it gives short shrift to the very rules that constitute markets. Until the institutional setting of market activity again occupies the foreground of economics research and education, Hayek's counter-revolution remains incomplete.

Since Boettke's essay is not only correct but also important, I want to examine two argumentative strategies against Hayek's approach that are common in the literature. The particular works I have chosen are exemplary both in that they embody these anti-Hayekian arguments and that they are sophisticated and powerful pieces. Nonetheless, as is clear from the groundwork Boettke lays out in his essay, they both fail in their attempt to defeat Hayek.

First, consider Jack Knight and Samuel Johnson's The Priority of Democracy (2011). The main thrust of their book is that democratic institutions deserve prima facie priority over other types of institutions because they are reflexive. Democratic debate allows us to critically examine the quality of the institutions that shape the various spheres of our social lives and to reform those institutions deliberately. Because of this possibility, there is a presumption in favor of democracy over other institutional forms, including markets. Not everything should be democratic, but democracy should determine its own boundaries. Along they way they offer some compelling arguments. But early in the text, Knight and Johnson recognize that they have to grapple with Hayek (pp. 52-55). Hayek's work seems to create a presumption in favor of decentralized institutions (such as markets and federalism) rather than mass deliberation.

Unfortunately, they don't actually grapple with Hayek. Instead, they grapple with (a caricature of) Kenneth Arrow (pp. 55-61). Their argument against the priority of markets is simply a rehash of the possibility of market failure in standard neoclassical theory. In neoclassical theory, markets "work"—they achieve efficiency—under certain conditions, such as (but not limited to) the perfectly competitive equilibrium that market socialists appealed to. The classic treatment of these conditions is in Arrow's work. And it is easy to imagine deviations from these conditions that generate inefficiency.

Formally, these claims are correct. But they are irrelevant as a critique of Hayek, because his theory of markets is not the same as that of neoclassical economists. In fact, Hayek strongly criticizes using perfect competition as a benchmark for understanding how real markets operate.[1] Though the name comes later, the "market process theory" of Menger, Mises, Hayek, and later Kirzner differs in crucial respects from the standard neoclassical theory. Market-process theorists tend to focus on the dynamic coordination of economic activity through time rather than the static efficiency of snapshot equilibria. And the economic problem is understood as discovering new knowledge and adapting to change rather than allocating given means among given ends. So a critique of Hayek based on the possibility market failure misunderstands both (a) how he thinks markets work and (b) why he thinks they are valuable.

More recently, Samuel Bowles, Alan Kirman, and Rajiv Sethi (2017) have recently taken issue with Hayek's general policy stance in the Journal of Economic Perspectives. They are not wholly critical: they sympathize with and offer additional support for Hayek's critique of equilibrium theory. Bowles et al. are careful to distinguish Hayek's market-process theory from a standard neoclassical approach and relate it to various advances in agent-based modeling and information economics. But they argue that Hayek's theory, while powerful, does not justify his defense of "laissez-faire" policies. Markets operating in an open-ended, dynamic theory can internally generate bubbles and economic crises. Individuals acting on their own peculiar knowledge of time and place may contribute to chaos rather than coordination.

A deeper dive into the particular models and experiments that Bowles et al. cite might reveal some important differences with Hayek's approach. But the general trajectory of their argument in fact provides some Hayekian reasons to doubt the efficacy of markets for securing coordination. It is a strong piece that merits careful reading. Nonetheless, their critique fails because it offers only a cursory nod to the institutional setting of market activity.[2]

Hayek's argument in favor of a strong presumption for market institutions is both epistemic and comparative, as Boettke's essay makes clear. These two features of Hayek's vision go together. "The mind can never foresee its own advance" (Hayek 1960, p. 75). How can a social scientist understand a process of social learning, since by definition learning means uncovering hitherto unknown knowledge? Just as we study choice: by analyzing its institutional antecedents and social consequences. But by refusing to treat human action and imagination as mechanistic, a market-process approach loses the ability to posit a definite optimum outcome against which the real world can be compared.

Instead, we are left only with comparative institutional analysis. We cannot judge whether a market outcome is the best outcome. All we can do is make reasonable guesses—Hayek called them pattern predictions—about how such outcomes stack up against those that would likely occur under alternative rules. Knight and Johnson, to their credit, are thoroughly comparative (see especially chapter 6). Ultimately their comparative analysis does not defeat Hayek, but they have the standard of proof right. They need to show that democracy outperforms markets in some specific and important way. But they only offer a convincing case that deliberation can outperform static models of markets.

Bowles et al. suffer from a different problem. They aim at the right target, but misunderstand what would count as a fatal blow. Dynamic markets are susceptible to the problems they cite. But they do not examine whether (a) alternative institutional arrangements do any better in avoiding crises or (b) whether political agents are more likely than market agents to design rules that avoid the potential crises they are rightly concerned about. Their argument largely amounts to a Nirvana Fallacy, finding markets wanting and calling for government regulation because they are not perfect.[3] Hayek's claim is not that markets are sufficient to avoid bad outcomes, but that in practice they usually do a better job than the alternatives. So while they are right to note that market-process theory does not necessarily lead to a laissez-faire policy prescriptions, they fail to defeat Hayek's strong, comparative presumption in favor of market institutions.

The point of the above is not to immunize Hayek from criticism, but to point out why certain common arguments against his positions fail. Defeating Hayek would require explaining either (a) why his theory of markets is unsatisfactory, (b) why standard market-failure arguments do in fact apply to market-process theory, or (c) why, even according to Hayek's approach, nonmarket institutions can predictably do a better job than market institutions in some definite sphere. When such challenges materialize, they can provide both defenders and detractors of Hayek's ideas with a valuable opportunity to engage in constructive debate.

Bowles, Samuel, Alan Kirman, and Rajiv Sethi. 2017. "Retrospectives: Friedrich Hayek and the Market Algorithm." Journal of Economic Perspectives Vol. 31, No. 3: 215-230.

Demsetz, Harold. 1969. "Information and Efficiency: Another Viewpoint." The Journal of Law and Economics, Vol. 12, No. 1: 1-22.

Hayek, F.A. 1948. Individualism and Economic Order. Chicago: University of Chicago Press.

Hayek, F.A. 1960 [2011]. The Constitution of Liberty: The Definitive Edition. Ed. Ronald Hamowy. Chicago: University of Chicago Press.

Knight, Jack and James Johnson, 2011. The Priority of Democracy: Political Consequences of Pragmatism. Princeton: Princeton University Press.

Mankiw, N. Gregory. 2008. Principles of Microeconomics, 5th ed. Mason, OH: South-Western Cengage Learning.

[1.] See especially "The Meaning of Competition" in Hayek (1948).

[2.] The only evidence they offer in favor of intervention is to (a) point out the relatively strong performance of Nordic social democracies and (b) argue that the mix of state and market institutions probably represents evolutionary fitness. This is a far-too-casual treatment of institutions to merit much response, but (a) it is not obvious that Nordic countries are less market-oriented than the United States (the Doing Business Index ranks Denmark and Norway higher than the United States), and (b) there is no hint in Hayek that evolutionary pressures are strong enough to favor the most effective institutions over a time scale of few decades, especially when the relevant countries are all relatively market-friendly.

[3.] See Demsetz (1969) for a fuller explanation of this point. While his argument is couched in terms of efficiency, the same basic point holds for a market-process approach concerned with coordination.