On the Relevance of Hayek and Bastiat

Me on twitter:

I am primarily referring to their two well-known (on the internet, anyway) essays, The Use of Knowledge in Society, and What Is Seen and What Is Not Seen. Libertarians and conservatives consider them seminal, perhaps even irrefutable rationales for a private market economy, while leftists generally don’t consider them that important.

I shouldn’t be interpreted as saying people who aren’t impressed by Hayek and Bastiat’s essays are smarter or more perceptive; I just think one’s attitude towards these two essays reflects the libertarian-left divide. I’ll try to explain why as a leftist, I found them underwhelming – perhaps good starting points, but little more.

Bastiat’s essay made a good point at the time: when we look at government spending, we need to remember that it comes from somewhere, and consider the ‘unseen’ effects of taxing. The story he uses to demonstrate this is one where a window is broken and the community observes that the money paid to fix it generates income. This, however, ignores that the money paid to fix it could have been used to, say, buy shoes from a shoemaker, and a result the community could have had it all: the window, shoes and the income. The broken window was therefore a net loss, even though it appeared to generate income.

Bastiat is right within the confines of his own examples, but really the real world throws up so many confounding factors that there is no need to invoke him in contemporary debate. Even when ‘Broken Window’ effects take place, Bastiat himself is not necessary.

People consider Bastiat relevant when discussing tax and spend – if you take money from one place and put it into another, you cannot only observe the positives of where you spend it; you must look at the negatives at the source of tax. But generally these things are considered separately anyway, and negative effects are incorporated into the analysis.

Taxation can have a negative impact on output, but it can also have a positive impact: if the taxed were going to save their money; if an activity is tax-deductible; if we are taxing economic rents, and so forth. If there are going to be negative effects, we can discuss them, too, but this generally revolves around elasticities, dead weight loss income versus substitution effects, and so on. I am not here to debate which of these effects is stronger: the point is that we have moved beyond Bastiat.

Similarly, arguments about stimulus/spending generally revolve around the claim that there are unemployed resources. The ‘crowding out‘ argument – that government spending will displace private sector spending that would have happened otherwise – retains Bastiat in some sense, but really it too has moved beyond him. What we need to discuss – sometimes empirically – are liquidity preference, multipliers, unemployment and the like. Again, there is no need to invoke Bastiat’s essay.

Hayek’s essay centres around the point that, since knowledge in society is highly dispersed among individuals and groups, the best way to coordinate this is through a price system. Individuals buy and sell at certain prices which reflects their knowledge of demand, supply, technology and whatever else. Thus the market system helps to coordinate and bring together dispersed knowledge in a way a single central planner or group of central planners could not do.

The essay does have something of an unsupported feel to it – Hayek’s idea that prices reflect knowledge (and not, say power) is never really justified. Having said that, it is overall a good rationale for a market economy, specialisation and the division of labour as a way to distribute resources.

My major problem is how one-sided his essay is. It would have been greatly strengthened if he’d acknowledged the limits of markets in coordinating dispersed knowledge – for example, that people have disparate knowledge opens the door to fraud, which is pervasive in both small and large quantities. That most people do not know the conditions, location or process by which their goods were produced is actually a justification for a lot of regulation: ensuring people have information about their products, or feel safe that somebody else has ensured they are not being deceived. Hayek does not mention fraud at all.

Furthermore, Hayek retains the phony markets versus governments dichotomy. In his essay there are basically two entities: private folk with dispersed knowledge, who are good, and ‘the government’ – apparently a massive leviathan with its own homogenous set of knowledge – that interferes with this process. But the government, too, is fragmented: the local policeman in a small town shares roughly the same knowledge as its inhabitants; similarly, a regulator will probably know something about the field they are regulating. Note that this is not necessarily an ideological point: that regulators have similar knowledge to the regulated opens the door to regulatory capture. But again, Hayek and his followers do not explore this issue.

Finally, Hayek completely disregards the democratic process in his arguments (if you think saying ‘Public Choice Theory‘ refutes democracy please do not comment). It is far to say that private individuals have a degree of influence over the actions of public enterprise, whether through voting, petitions, protests or what have you. In some ways, democracy brings together dispersed knowledge and wants too, even if it may be, as with markets, imperfect. (Incidentally, local knowledge is actually a good argument for worker democracy, something Chris Dillow is fond of pointing out.) Hayek explores none of this, but if he did his essay would be stronger no matter the conclusions.

In fairness, I may be commenting more on how Hayek’s essay is used rather than his original intent, as it was written during the rise of central communism. But my points apply to many of his modern followers. Perhaps something similar could be said for Bastiat, who did at one point offer limited support to public works programs during recession.

In summary, my problem with these essays is not that they are ‘wrong;’ Bastiat is right, but no longer relevant, and Hayek is roughly right, but incomplete. In the case of Bastiat I see no further need to invoke him, even though we may remember the essence of his point; with Hayek, I feel his essay would be far more respectable had he explored the implications of local knowledge a little more. At any rate, this is something that his proponents should be doing, rather than holding his essay up as pure truth.

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  1. #1 by Donald Last on October 16, 2012 - 5:30 pm

    You are simply going off into highways and byways that YOU consider relevant and/or important and which others might consider either fallacious or unsubstantiated. It is intellectual adventurism of this sort which at the end of the day points to the guiding hand of government and its profoundly wise bureaucracy employing economists like you pulling the Big Levers that has landed us in the mess we are in now. And I have absolutely no doubt that you are not sort to get us out of it.

    • #2 by Unlearningecon on October 16, 2012 - 6:26 pm

      If you could substantiate your comment, that would be great. Why aren’t my musings relevant? What’s wrong with ‘highways and byways?’ Isn’t that called ‘exploring an issue?’

      Why do you read this and assume I am a communist trying to rationalise reasons I should control you? As I note, it’s not necessarily an ideological issue.

    • #3 by Roman P. on October 16, 2012 - 7:54 pm

      First of all, you are unfair to the host who has disclosed that he is just an undergrad student recently. Not everyone are into those topics for personal gain or mass opinion manipulation.

      Second, your comment could be flipped on its head: one could dismiss neoclassical theory in much the same way by calling it ‘intellectual adventurism’. But that is not conductive for finding out how the world works.

  2. #4 by David Glasner on October 16, 2012 - 6:18 pm

    You make a fair point about Hayek, but leave out an equally strong or possibly even stronger point made by Jack Hirshleiffer (one of the great figures of the golden age of economics at UCLA when I was a student there) in his paper “The Private and Social Value of Information and the Reward to Inventive Activity,” in which he explained that there is an overincentive to invest in gaining information because the private value of information exceeds the social value because information advantages allow people to gain at the expense of others, for example by anticipating future price movements and making trades with others based on that knowledge. I explored some possible implications of this idea in a post on my blog several months ago: “Soak the Rich?”

    • #5 by Unlearningecon on October 17, 2012 - 4:55 pm

      That is a great point, and there are plenty more that could be made (for example, prices in big corporations are generally set by administrators and can be quite arbitrary).

      I feel like ‘pure’ libertarianism has the rational, perfectly informed agent at its heart, even though many would probably deny it. Once you take into account systemic behavioural biases, the cost of information etc.markets begin to look very different.

  3. #6 by Tom Hickey on October 16, 2012 - 11:12 pm

    Bastiat is assuming a convertible fixed rate monetary system, which no longer applies. The contemporary monetary system is non-convertible, floating rate. They are operationally different and under the latter, currency sovereigns have no need to tax to fund themselves or borrow to finance themselves. Taxation is used operationally to control inflation, and issuance of Tsy securities acts as a reserve drain assisting the central bank to hit its target overnight rate. See Warren Mosler, “Soft Currency Economics” (Jan 1994).

    Hayek ignores the role of institutions, which greatly weakens his argument. His price theory is also questionable in light of Post Keynesian analysis, for example. So while the essay has merit, it is incomplete as it stands.

  4. #7 by Julia on October 17, 2012 - 3:01 am

    First of all, I want to mention that I’m a mutualist anarchist, so I have an extremely negative view of people who apologize for the exploitative and authoritarian nature of capitalism.

    I was talking about Bastiat’s broken window with a friend-of-a-friend the other day, and we came up with several responses to it. For starters, let’s say the glazier in the story created a much more durable window for the shopkeeper; the shopkeeper would be *saving* money in the long-run as this new window would be resistant to any potential damage in the future (this one of the reasons why *actual* businesspeople love state spending) . Or let’s say an artisan took the broken glass and turned it into a vase. Or if creating a new window was the start of work for the glazier who went through a long period without work – would that opportunity not be helping him polish or regain his skills? (Compare that to universities that pay professors to engage in “useless” research projects solely for the sake of keeping their skills sharp.) I’m not a keynesian at all, and I don’t find the state to be legitimate in the least bit, but I find the broken window parable to be full of holes. I would argue that the main reason why libertarians love that story so much is because it’s simple to understand.

    • #8 by Unlearningecon on October 17, 2012 - 8:36 am

      You are correct that there are many nuances that could make the story more complex. I have mentioned as much here.

      • #9 by Julia on October 19, 2012 - 7:46 am

        I guess it all depends on the context. I’ve seen left-libertarians use Bastiat’s parable as an argument against globalization and Walmart of all things: namely, that the reason big corporations seem to “help” the poor is because the corporation caused the poor to lose their jobs or not be able to compete in the market in the first place and is now there to offer the poor jobs and consumer goods. Of course, this is an entirely different reading of the story, that one doesn’t “gain” anything by deliberately breaking a hundred legs and then providing a hundred crutches. Then again, that assertion could be dubious as well in certain situations.

      • #10 by Unlearningecon on October 19, 2012 - 3:54 pm

        That’s an interesting point, and really captures what I’m trying to say perhaps better than I have: these stories, which demonstrate a certain principle, need to be explored fully rather than from an ideological perspective. But it seems libertarians don’t really want to do this – that’s why I was so amused when Krugman used Bastiat when talking about a private company.

  5. #11 by Shenpen on October 17, 2012 - 8:43 am

    >Taxation can have a negative impact on output, but it can also have a positive impact: if the taxed were going to save their money;

    Huge and horrible Keynesian fallacy. Please unlearn Keynesian econ first… Nobody puts money in a pillow. They put it in a bank, banks lend, those who get it, spend it. Sometimes they do not, but then that is an entirely different problem than saving itself. Not-lending is not a savings problem, it is the normal purpose and operation of a bank to lend, so not-lending is an abnormal situation. Normally people want interest on it, which means someone else must spend that money.

    • #12 by Unlearningecon on October 17, 2012 - 8:59 am

      Nobody puts money in a pillow.

      Oh really?

      The people who want more money than commodities have a name: they are called capitalists. Pursuit of profit is how capitalism functions.

      They put it in a bank, banks lend, those who get it, spend it.

      No, that is not how banking works.

      I suggest you do your research before throwing the words ‘fallacy’ and ‘Keynesian’ around as if they discredit your opponent instantly.

  6. #13 by joey2times on October 17, 2012 - 11:13 am

    This appears to be The Bottom LIne:

    “All managed markets—whether managed by
    government allocation as under Communism or by
    government sponsored central bank credit as in
    Capitalism—are doomed to failure.” –Darryl Schoon

    Begs the question: What’s left?

    • #14 by Unlearningecon on October 17, 2012 - 2:33 pm

      I’m not sure how that follows from any of this as I haven’t talked about ‘managed’ markets (markets are always managed in reality, both privately and publicly). The comment just seems to be loaded with paving the way for Austrian solutions.

  7. #15 by Metatone on October 17, 2012 - 6:46 pm

    Nice piece. I go further than this personally – I think the way Hayek’s article is usually used is toxic and it’s only the age of the article that suggests this is not all the author’s fault.

    1) Collapsing local knowledge (presumably of several dimensions) into a single unit – price – can be useful, but it should never be mistaken for preserving local knowledge. It’s very purpose is universal exchange – and as such it creates many distortions in just the same way that Hayek’s straw man government does.

    2) You’ve already said it, but few organisations (including governments) actually operate the way he describes. Many large firms are larger than governments and the whole class of these organisations devolves power in some ways and trades information in some ways. It needs a lot more justification than Hayek (or his followers) put in to state that the price mechanism is more accurate.

    3) Most toxic is the way Hayek’s article is used in these days as an excuse for inaction. By pretending dispersed knowledge is critical, some Hayekians basically rule out any action larger than a certain scale, on the grounds that “too much is unknowable.” What irks most about this (beyond the inaccuracies noted above) is that most of time human civilisation advances by finding a way forward despite unknowability. We improved medicine and engineering steadily ahead of “complete scientific explanations” and we’ve managed to achieve many things in other complex systems where knowability does not exist. We have methods for dealing with unknowability – and those methods are far more extensive than just “make a market out of it” (although sometimes that is the correct solution) – but for far too many Hayek’s basic ignorance about knowledge has become the last word on the subject.

    • #16 by Unlearningecon on October 18, 2012 - 1:31 pm

      Great comment. I hadn’t really explicitly thought about prices as an imperfect signal before.

      • #17 by Blue Aurora on October 18, 2012 - 2:08 pm

        There’s also Dr. Michael Emmett Brady’s criticism of Hayek’s essay.

        http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1751569

      • #18 by Unlearningecon on October 18, 2012 - 2:16 pm

        Yes, that is a good one.

      • #19 by Metatone on October 19, 2012 - 10:13 pm

        Great find, Blue Aurora. Thanks for pointing that one out. Knightian uncertainty is a great (and well established) frame for illustrating the oddities in Hayek’s conception of uncertainty and knowledge.

  8. #20 by Aziz on October 17, 2012 - 7:48 pm

    I am not sure my reaction Hayek and Bastiat was “wow”, but I think they (as well as more recently Taleb and myself) have made a strong enough case to make central planning technically unviable as a system of economic organisation.

    On the other hand, while I believe that all non-market organisation is by definition inefficient, I think that respect for democracy is important too. While central planning may be inefficient, if a society legitimately wants to run its economy based on any form of central planning, be it the more extreme Soviet form, or the softer European socialism, or the American corporatism, then I don’t think that the reality of inefficiency should stop that society from running itself however it sees fit. The most that an Austrian (-ish) economist like myself can do is point out the huge problems of inefficiency inherent to central planning.

    • #21 by Unlearningecon on October 18, 2012 - 1:27 pm

      Absolutely. If more Austrians were like you then I wouldn’t write posts like this.

    • #22 by Draco T Bastard (@DracoTBastard) on October 19, 2012 - 2:06 pm

      There’s more than two ways to run an economy. It’s not a dichotomy of market or central planning. You should also note the similarities between capitalist free-market and central planning – both are dictatorial and both demand loyalty (one to the state, the other to the company).

      There’s also the fact that a competitive market itself is also highly inefficient (I think it may be more inefficient than central planning actually, what brings central planning down is it’s dictatorial bent). There’s the increased duplication brought about by groups of people working on the same product, the non-sharing of information and thus the increased use of scarce resources.

      What we need is a democratic economy. One where the resources that the society has is known and where everyone has the same say in how those resources are used. One which encourages cooperation so that excessive duplication is minimised if not completely eliminated. Cooperation would also help deal with the fraud that is endemic to a market system.

      This democratic system would have the benefits of dispersed knowledge that the market systems claim but doesn’t actually have due to the hierarchy that they produce while also being completely free of any dictatorial bent.

      • #23 by Unlearningecon on October 19, 2012 - 3:56 pm

        Exactly. What we have right now is a corrupted democracy at the governmental level, a democracy skewed by unequal votes (the market) and outright dictatorship inside firms. All 3 can be improved greatly, without any need for talking about ‘markets versus governments’ and central planning.

  9. #24 by Ben Bacque on November 7, 2012 - 3:38 pm

    All interesting, but I am concerned about your having judged these two icebergs by what we see above the water only in these two essays. IMHO Bastiat’s great contribution is the dichotomous statement “All legitimate interests are in harmony” (From his “Harmonies of Political Economy”) because in either agreeing or disagreeing one must come down on the side of freedom or coercion, respectively, as one’s primary tool for guiding public policy towards social good. As Leonard Read pointed out in “I, Pencil”, it is freedom that is the pencil’s only known and true primary antecedent.

    The neuron will never understand what the brain collectively knows.

    The “wow”/”meh” split is explored by Thomas Sowell in his “Conflict of Visions”. Those of the “constrained” vision know that there is much they cannot know, and that these unknowable truths can only be discovered and/or remembered systemically, while the “unconstrained” believe we just have not yet perfected our individual knowledge. The unconstrained thus see social benefit in coercion, to guide those whose knowledge is “less perfect”, an idea abhorrent to the constrained.

    It is (I think) easy to imagine socio-economic systems that might work better than what we have now. In fact, the founders of the US did a decent job of thinking it all through, and it can be summarized in two words: “bottoms-up”. The problem with most other countries is that they lack the strong constitutional basis of the ‘States. The problem with the ‘States is that they have forgotten they have rights, forgotten the constitution. The conditions to require a Constitutional Congress were met over twenty years ago (44 states have formally requested, only two-thirds, or 34 are required). How many Americans know that their federal government has been operating outside of its mandate for two decades?

    If we do not even abide by rules we make of our own free will, do the rules really matter? The first step needed is to re-establish the rule of law, starting with enforcing the constitution, which was designed to create an environment in which socio-economic complexity could develop through freedom from coercion.

    Nothing happens until the foundation is shored-up. I’ll believe something positive is happening when I see the Patriot Act repealed.

    At least Americans have a solid foundation to build upon. In Canada, our rights are punctuated everywhere by “notwithstanding” clauses… as clear as mud and about as solid a foundation.

    • #25 by Unlearningecon on November 8, 2012 - 10:33 am

      because in either agreeing or disagreeing one must come down on the side of freedom or coercion, respectively, as one’s primary tool for guiding public policy towards social good.

      This is the problem. Libertarians (even clearly reasonable ones such as yourself) instantly define their opponents as having totalitarian tendencies, compared to some implicit laissez-faire baseline which is supposedly ‘neutral’ and free of coercion. But property rights and other laws libertarians approve of are also coercive. For example, a poor man who will starve is ultimately being stopped from eating by the law, as if he went into a store and tried to eat something, he would be kicked out/arrested.

      Having said that, I see what you are getting at. But a revolutionary would argue to you that our current system is built on institutionalised coercion, and while there may be some casualties in a revolution (even though there wouldn’t have to be), we live in an imperfect world and the alternative is to let all the war, famine and quasi-slavery to continue. I always think about whether you would tell slaves or feudal peasants not to have a revolution because they might hurt somebody.

      Btw, I am not from the U.S. so I don’t know so much about its laws/constitution.

  10. #26 by Ben Bacque on November 8, 2012 - 4:47 pm

    I thank you for publishing and responding to my comment, but there is sad irony in your statement “this is the problem”. We have many problems, primary amongst them that most people (if they engage in reasoning about society at all) now debate about labels instead of ideas, about people instead of their principles. Truth is not a popularity or categorization contest. I a [capitalization yours, sir] Libertarian? We have hardly met! Beware being blinded to truth by false symbols and labels!

    There will always be coercion. If we have no law, then the strong coerce the weak. If we have enforced law, then we have granted to the few the right to coerce the many, for our greater good. The most important social question is who should hold coercive authority, and under what conditions should they be allowed to (legitimately) use it? I assert that the society that employs the least coercion is superior to all others, as it represents the greatest expression of free will. Perhaps that makes me a “Libertarian” in some people’s eyes, but I find most people who apply that label to themselves have distasteful characters lacking in compassion, and they fail to understand Man’s inherently communal nature, and inherent sense of fairness.

    There is another split in Sowell’s conflict of visions, and it is between the focus on process versus focus on outcome. Some see that a result that is achieved by a fair process cannot be unfair in its result. Some think that we must focus on predetermining fair outcomes, then adjust the process to achieve them. I should add here that “fairness” has never been possible in my lifetime, as my entire adult life has been lived under a fiat currency regime, and inequity is inherent under such monetary tyranny.

    The poor man starves not solely because of property rights. There was an environment and a history of individual action that brought the man to the store to steal in order to survive. If we do not hold Man to account as Nature does herself, if we do not define and enforce the rules under which Man shall operate, as physics does for Nature, we cannot benefit from the same processes that created us, ie competition, cooperation, evolution and natural selection, from the Big Bang on. Every person who saw and understood the poor man’s plight yet did not help him is guilty of his starvation. Every person who assisted in the creation of the system in which he starves (despite, I am assuming, his best efforts to sustain his own existence) shares in the guilt. The blame does not lie solely at the feet of the store-owner, nor at the right we grant him to his property, nor at the policeman’s who enforces this right. It is a complex system.

    I think it very important that we “unlearn” (re-learn?) much of our economics, and that is what brought me to your site. The first thing we need to re-learn is that quantitative study of phenomena based on qualitative and changing units of measure is pointless. While a small few still control the nature and value of the basic unit of measurement of debt and savings and trade, we cannot possibly know the truth.

    Central banking is a recent development, its ubiquity only a hundred years old. Fiat currency is an even more recent experiment, only forty years old (this incarnation). Until we address some basics, arguing about unfair outcomes is shuffling deck-chairs, as fair processes are impossible in such systems.

    Are you familiar with “I, Pencil”, written in 1958 by Leonard E. Read? I would be interested in your thoughts after a reading of it. A copy can be found at:

    http://www.econlib.org/library/Essays/rdPncl1.html

    best regards,
    ben

    • #27 by Unlearningecon on November 9, 2012 - 11:40 am

      Fair enough, I didn’t mean to shoehorn you into a label but even if you take ‘libertarian’ out of my comment I think my point stands on its own. I mostly agree with you, btw.

      Not too much to disagree with in your coercion paragraph, although in a society that already has an incredibly coercive elite I feel as if all bets are off with regards to moving forward. But perhaps that’s another issue.

      Again, I completely see where you’re coming from in your property paragraph. My point was only that, functionally, the man experiences a property right as a constraint on his ability to eat. It’s not the store owner’s fault; it’s not that particular property right that is wrong. It is the system.

      I have read I, Pencil – perhaps you’d be interested in this rebuttal? I Pencil: A product of the mixed economy

  11. #28 by Ben Bacque on November 9, 2012 - 7:06 pm

    Thanks for the link to Quiggin’s rebuttal. Perusing the comments was interesting. I think most people seem to miss the essential epistemic point Read makes (perhaps more succinctly and eloquently than Hayek in the paper you link): we *cannot* know what we are doing, economically speaking, so we shouldn’t pretend we do and try to “guide” the economy, but should instead largely rely on freedom of human action to produce social benefit. I think it was in Jack Nicklaus’ book on golf that I read (in his description of the gentle grip and free motion one must use in a good golf swing): “Abandon control to gain control”. The same strategy is necessary in the control of all complex systems.

    Many people are uncomfortable with this notion, and I think it results from having done some, but not enough, physics, math etc. The vast majority of society – including most economists – still have a very linear view of things, in which prediction is possible, as is knowledge of causation. This is the Newtonian world-view, and it still dominates. The stunning results (both for accuracy of prediction, and the result that prediction is impossible!) of quantum, chaos, and complexity theory that tell us more about what we cannot know than about what we do know remain largely unappreciated.

    Or perhaps intentionally suppressed? If it were widely known that the latest irrefutable science and mathematics points to the fact that the outcomes of policy choices in complex systems cannot be predicted, wouldn’t a lot of experts and policymakers and policy implementers be out of work?

    Stuart Kauffman of the Santa Fe Institute wrote a wonderful book called “At Home in the Universe”. It should be required reading in every undergrad economics program. Courses in non-linear dynamics, control theory, quantum theory and so on would also be a good idea. You can’t know that you can’t know stuff unless you truly understand why you can’t know it.

    Hayek and Bastiat both saw and tried to describe something that only later became formalized: “complexity”. Metatone above refers to Hayek’s views on the limits of knowability as “dangerous” but nothing could be further from the truth. The danger lies in thinking we are, or could ever be, in control.

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