Knowledge Lost in Information

     

My title is a play on the title of a new book by Philip Mirowski and Edward Nik-Khah, The Knowledge We Have Lost in Information (2017).  Their book is a social history of the concept of information in the evolution of modern economics, and, of course, Hayek plays a central role in their narrative.  But a subtle reading of Hayek both drives their narrative and complicates it.  There should be little doubt that the challenge Mises and Hayek put forth in the socialist-calculation debate inspired much of the original research on information economics as seen in Leonid Hurwicz's mechanism design theory, Joseph Stiglitz's comparative institutional analysis, and all the technical work in between.  For tractability reasons, though, when Mises's and Hayek's ideas were translated into modern models of the communicative properties of decentralized markets, the "Hayek hypothesis" was understood as positing prices as sufficient statistics to ensure a competitive equilibrium outcome.

This is not the right place to work through the problems with this argument with the analytical rigor required, but suffice it to say it is precisely with this intellectual move that the knowledge Hayek talked about was lost in the models of information. Our professional understanding of the price system has been significantly distorted ever since.  In Hayek's "The Use of Knowledge in Society" (1945) he described as a "marvel" the continuous adaptation and adjustments in the market due to changing circumstances guided by price movements.  As he says, "I have deliberately used the word 'marvel' to shock the reader out of the complacency with which we often take the working of this mechanism for granted." (101) It is important to remember this paper wasn't published in the New York Times or Reader's Digest, but in one of the leading specialized journal in the scientific field of economics – The American Economic Review.  In other words, the readers were his peers.  Yet he had to shock them out of complacency so they would appreciate the price system's role in coordinating plans of demanders and suppliers, enabling the gains from trade and innovation to be realized.  As he not-so-subtlety concluded, an approach to economic theory "such as that of much of mathematical economics with its simultaneous equations" (104) systematically distorts our understanding of the basic task of economic science.  It does so by assuming that the knowledge people hold corresponds perfectly with the objective facts and that the unique price and quantity vector that clears the market already has been determined.

What's lost are the learning by economic actors, the multiple margins of adaptation and adjustment guided by relative prices, and the market process.  By squeezing out the social process of learning, mid-20th-century equilibrium economics misled economic thinkers and policymakers into falsely believing the equilibrium model could serve as a normative benchmark and planning guide for practical affairs – from comprehensive central planning to regulation of industry to price controls.  From Adam Smith to Hayek, it was understood that political economy and economics studied exchange relationships and the institutions within which those exchange relationships are formed and transactions take place. This emphasis was also lost in the system of simultaneous equations, where pre-reconciliation of all plans was required by model construction.  Not only the market process, but also the institutions that framed the market process, were lost.  So the knowledge lost in information was significant and, I would argue, devastating for science.

Hayek argued in his Nobel Prize address, "The Pretense of Knowledge" (1974) that in the study of man, the approaches that appear to be the most scientific are in fact the least scientific and that to demand of a science more than it is capable of achieving leads to "charlatanism and worse." (371) The student of society, Hayek argued, must resist the urge to commit the error of scientism and instead adopt a more humble stance, eschewing the social-engineering mindset.  If not, the student runs the risk of "becoming an accomplice in men's fatal striving to control society," a "tyrant" over fellow citizens, and a "destroyer" of civilization. (372)

The stakes, as Hayek saw it, involved in the knowledge lost in information are not trivial scientifically or socially.

Steve Horwitz, Adam Martin, Roger Koppl, and I are all in essential agreement with Hayek on these arguments.  We each have our own unique points of emphasis, but if we keep the conversation at an abstract level we are in agreement. 

Horwitz's calling our attention to The Sensory Order is both expected and critically correct.  Hayek's challenge to central planning is often taken to be merely one of computational complexity – that the objective information was "out there" but too difficult to collect and marshall effectively.  This is precisely not Hayek's argument.  The Sensory Order describes the operation of the mind, but from a social-science perspective we learn much about human decision-making.  Hayek can be read as making an argument that aligns with ideas later developed by thinkers such as Gerd Gigerenzer (2008), the rules of thumb or heuristics in decision-making, and what has been dubbed "ecological rationality."  As Hayek stressed in a variety of his writings, man has reason because he followed rules; he has not designed rules because he has reason.  What this implies for decision-making is that our choices are best understood as the play between our cognitive capabilities and the circumstances in which we choose.  We rely on evolved rules to enable us to cope with our cognitive limitations and our ignorance as well as to navigate the vagaries of changing circumstances.  Again, the link between Hayek's "knowledge problem" and the institutional ecology within which we act and learn permeates his work, from theoretical psychology to philosophical anthropology, and it reflects his economics as well.  Perhaps one of the discussions we can have is whether -- given the nature of Hayek's enterprise in the social sciences and the humanities, and the way economics evolved in the 20th century and now in the 21st century --  economics is the right scientific community for Hayekians.

Adam Martin insightfully raises the spectre of "defeating Hayek" that permeates the literature and is reflected in two areas --- democratic theory and economic theory. He concisely argues that the arguments in neither democratic theory nor economic theory effectively meet Hayek on his own terms and thus ultimately miss their target.  I agree with Martin that, to effectively critique Hayek, this literature needs to address his epistemic arguments about the limits of agreement in democratic decision-making and the nature of the price system and market economy on his own terms.  Hopefully, a conversation that addresses Hayek's epistemic institutionalism can take place in the leading political science and economics journals. Until that happens, the knowledge lost in information will again be illustrated.

Roger Koppl makes the important distinction between learning by individuals -- the cognitive processes going on in their own heads -- and the sort of social learning on which epistemic institutionalism strives to focus analytical attention.  Of course, as I just discussed with respect to Horwitz's comments, I believe one can see a connection between these two aspects of social ordering, but Koppl is right to stress their distinctiveness.  A promising direction for research that follows from Koppl's comment is a more-detailed articulation of the knowledge assumptions used in economic theory.  In The Counter-Revolution of Science (1952, 99) Hayek distinguished between the knowledge used within a system and the knowledge we develop about a system.  Knowledge within the system is constitutive of the phenomena, while our theoretical exercises result in our knowledge about the system. 

Consider what I would argue is the subtle but important difference between Hayek and Robert Lucas, who revolutionized economic theory in the 1970s and 1980s with his demand for a shift in economists' assumptions about knowledge.  Lucas in effect argued that economic actors within a system had to be assumed to have knowledge of the theories that economists were deploying to explain the operation of the system (and its control).  The Keynesian policy agenda had assumed that the economic-policy expert could stand outside of the system and know how actors within the system would behave if they had the theorists' knowledge, and thus the expert could manipulate policy variables to get the passive actors to behave in ways that would improve the operation of the system.  Lucas countered that the actors within the system are neither passive nor ignorant, that they were instead rational actors who could anticipate the consequences of policy changes and act strategically to position themselves for the best response.  This was a particularly powerful corrective with respect to policies that were directed at addressing unemployment through inflation.  Lucas's rational-expectations revolution transformed the discipline, even after the initial invariance proposition in public policy was no longer widely accepted.  (This is the proposition that rational actors fully anticipate the effects of public policy and orient their behavior accordingly in such a way that policy becomes ineffective.  <https://en.wikipedia.org/wiki/Policy-ineffectiveness_proposition>) From the 1970s onward, economic modeling insisted on rational-actor microfoundations and equilibrium theorizing in macroeconomics.  For our purpose, the key issue is how Lucas used the knowledge assumptions to constrain the modeling exercise.

A generation earlier Hayek had sought to get his fellow economist to also accept a constraint on their theorizing about knowledge within and about systems.  The theorist could never be assumed to be in possession of the contextual knowledge of time and place that actors within the system were using in their decisions, discovering in their interactions, and learning from in their competitive experimentation to improve their lot in life.  The theorist can obtain abstract knowledge of the patterns about the system and can cultivate in others an appreciation of the spontaneous order that emerges in the market as individuals strive for productive specialization and peaceful social cooperation.  But a theorist is never in the position of the entrepreneur within the system.  Mises made a significant point along these lines when in his original article on the problems of socialist economic calculation he stated: "It is not a knowledge of bookkeeping, of business organization, or of the style of commercial correspondence, or even a dispensation from a commercial high-school, which makes the merchant, but his characteristic position in the production process, which allows of the identification of the firm's and his own interests." (1920, 121)

The Mises-Hayek knowledge problem is characterized, as Koppl points out, by SELECT knowledge, and is grounded in the recognition that alternative institutional arrangements not only structure incentives differently, but also generate different types of knowledge, lead to different discoveries, and shape the environment of learning.  The question that I hope we can explore with Koppl is what forms of empirical investigation are appropriate to the discovery and use of SELECT knowledge.

Gigerenzer, Gerd. Rationality for Mortals. New York: Oxford University Press, 2008.

Friedrich August von Hayek, "The Use of Knowledge in Society," American Economic Review, XXXV, No. 4; September, 1945, pp. 519–30. </titles/92>.

Hayek, F.A. 1974. "The Pretense of Knowledge," reprinted in The Collected Works of F. A. Hayek. Vol. 15: The Market and Other Orders, ed. by Bruce Caldwell. Chicago: University of Chicago Press, 2014, 362-72. <https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1974/hayek-lecture.html>.

Mirowski, Philip and Edward Nik-Khah. 2017. The Knowledge We Have Lost Lost in Information. New York: Oxford University Press.

[Wikipedia], "Policy-ineffectiveness proposition," Wikipedia, <https://en.wikipedia.org/wiki/Policy-ineffectiveness_proposition>.