Economics and Knowledge
Freidrich von Hayek
[An address delivered before the London Economic
Club,
10 November 1936; reprinted from Economica IV, 1937]
THE ambiguity of the title of this paper is not accidental. Its
main subject is, of course, the role which assumptions and
propositions about the knowledge possessed by the different members
of society play in economic analysis. But this is by no means
unconnected with the other question which might be discussed under
the same title--the question to what extent formal economic analysis
conveys any knowledge about what happens in the real world. Indeed,
my main contention will be that the tautologies, of which formal
equilibrium analysis in economics essentially consists, can be
turned into propositions which tell us anything about causation in
the real world only in so far as we are able to fill those formal
propositions with definite statements about how knowledge is
acquired and communicated. In short, I shall contend that the
empirical element in economic theory--the only part which is
concerned not merely with implications but with causes and effects
and which leads therefore to conclusions which, at any rate in
principle, are capable of verification -- consists of propositions
about the acquisition of[1].
Perhaps I should begin by reminding you of the interesting fact
that in quite a number of the more recent attempts made in different
fields to push theoretical investigation beyond the limits of
traditional equilibrium analysis, the answer has soon proved to turn
on the assumptions which we make with regard to a point which, if
not identical with mine, is at least part of it, namely, with regard
to foresight. I think that the field in which, as one would expect,
the discussion of the assumptions concerning foresight first
attracted wider attention was the theory of risk[2].
The stimulus which was exercised in this connection by the work of
Frank H. Knight may yet prove to have a profound influence far
beyond its special field. Not much later the assumptions to be made
concerning foresight proved to be of fundamental importance for the
solution of the puzzles of the theory of imperfect competition, the
questions of duopoly and oligopoly. Since then, it has become more
and more obvious that, in the treatment of the more "dynamic"
questions of money and industrial fluctuations, the assumptions to
be made about foresight and "anticipations" play an
equally central role and that in particular the concepts which were
taken over into these fields from pure equilibrium analysis, like
those of an equilibrium rate of interest, could be properly defined
only in terms of assumptions concerning foresight. The situation
seems here to be that, before we can explain why people commit
mistakes, we must first explain why they should ever be right.
In general, It seems that we have come to a point where we all
realize that the concept of equilibrium itself can be made definite
and clear only in terms of assumptions concerning foresight,
although we may not yet all agree what exactly these essential
assumptions are. This question will occupy me later in this essay.
At the moment I am concerned only to show that at the present
juncture, whether we want to define the boundaries of economic
statics or whether we want to go beyond it, we cannot escape the
vexed problem of the exact position which assumptions about
foresight are to have in our reasoning. Can this be merely an
accident?
As I have already suggested, the reason for this seems to me to be
that we have to deal here only with a special aspect of a much wider
question which we ought to have faced at a much earlier stage.
Questions essentially similar to those mentioned arise in fact as
soon as we try to apply the system of tautologies--those series of
propositions which are necessarily true because they are merely
transformations of the assumptions from which we start and which
constitute the main content of equilibrium analysis--to the
situation of a society consisting of several independent persons. I
have long felt that the concept of equilibrium itself and the
methods which we employ in pure analysis have a clear meaning only
when confined to the analysis of the action of a single person and
that we are really passing into a different sphere and silently
introducing a new element of altogether different character when we
apply it to the explanation of the interactions of a number of
different individuals.
I am certain that there are many who regard with impatience and
distrust the whole tendency, which is inherent in all modern
equilibrium analysis, to turn economics into a branch of pure logic,
a set of self-evident propositions which, like mathematics or
geometry, are subject to no other test but internal consistency. But
it seems that, if only this process is carried far enough, it
carries its own remedy with it. In distilling from our reasoning
about the facts of economic life those parts which are truly a
priori, we not only isolate one element of our reasoning as a sort
of Pure Logic of Choice in all its purity but we also isolate, and
emphasize the importance of, another element which has been too much
neglected. My criticism of the recent tendencies to make economic
theory more and more formal is not that they have gone too far but
that they have not yet been carried far enough to complete the
isolation of this branch of logic and to restore to its rightful
place the investigation of causal processes, using formal economic
theory as a tool in the same way as mathematics.
But before I can prove my contention that the tautological
propositions of pure equilibrium analysis as such are not directly
applicable to the explanation of social relations, I must first show
that the concept of equilibrium has a meaning if applied to the
actions of a single individual and what this meaning is. Against my
contention it might be argued that it is precisely here that the
concept of equilibrium is of no significance, because, if one wanted
to apply it, all one could say would be that an isolated person was
always in equilibrium. But this last statement, although a truism,
shows nothing but the way in which the concept of equilibrium is
typically misused. What is relevant is not whether a person as such
is or is not in equilibrium but which or his actions stand in
equilibrium relationships to each other. All propositions of
equilibrium analysis, such as the proposition that relative values
will correspond to relative costs, or that a person will equalize
the marginal returns of any one factor in its different uses, are
propositions about the relations between actions. Actions of a
person can be said to be in equilibrium in so far as they can be
understood as part of one plan. Only if this is the case, only if
all these actions have been decided upon at one and the same moment,
and in consideration of the same set of circumstances, have our
statements about their interconnections, which we deduce from our
assumptions about the knowledge and the preferences of the person,
any application. It is important to remember that the so-called "data,"
from which we set out in this sort of analysis, are (apart from his
tastes) all facts given to the person in question, the things as
they are known to (or believed by) him to exist, and not, strictly
speaking, objective facts. It is only because of this that the
propositions we deduce are necessarily a priori valid and that we
preserve the consistency of the argument[3].
The two main conclusions from these considerations are, first,
that, since equilibrium relations exist between the successive
actions of a person only in so far as they are part of the execution
of the same plan, any change in the relevant knowledge of the
person, that is, any change which leads him to alter his plan,
disrupts the equilibrium relation between his actions taken before
and those taken after the change in his knowledge. In other words,
the equilibrium relationship comprises only his actions during the
period in which his anticipations prove correct. Second, that, since
equilibrium is a relationship between actions, and since the actions
of one person must necessarily take place successively in time, it
is obvious that the passage of time is essential to give the concept
of equilibrium any meaning. This deserves mention, since many
economists appear to have been unable to find a place for time in
equilibrium analysis and consequently have suggested that
equilibrium must be conceived as timeless. This seems to me to be a
meaningless statement.
Now, in spite of what I have said before about the doubtful
meaning of equilibrium analysis in this sense if applied to the
conditions of a competitive society, I do not, of course, want to
deny that the concept was originally introduced precisely to
describe the idea of some sort of balance between the actions of
different individuals. All I have argued so far is that the sense in
which we use the concept of equilibrium to describe the
interdependence of the different actions of one person does not
immediately admit of application to the relations between actions of
different people. The question really is what use we make of it when
we speak of equilibrium with reference to a competitive system.
The first answer which would seem to follow from our approach is
that equilibrium in this connection exists if the actions of all
members of the society over a period are all executions of their
respective individual plans on which each decided at the beginning
of the period. But, when we inquire further what exactly this
implies, it appears that this answer raises more difficulities than
it solves. There is no special difficulty about the concept of an
isolated person (or a group of persons directed by one of them)
acting over a period according to a preconceived plan. In this case,
the plan need not satisfy any special criteria in order that its
execution be conceivable. It may, of course, be based on wrong
assumptions concerning the external facts and on this account may
have to be changed. But there will always be a conceivable set of
external events which would make it possible to execute the plan as
originally conceived. The situation is, however, different with
plans determined upon simultaneously but independently by a number
of persons. In the first instance, in order that all these plans can
be carried out, it is necessary for them to be based on the
expectation of the same set of external events, since, if different
people were to base their plans on conflicting expectations, no set
of external events could make the execution of all these plans
possible. And, second, in a society based on exchange their plans
will to a considerable extent provide for actions which require
corresponding actions on the part of other individuals. This means
that the plans of different individuals must in a special sense be
compatible if it is to be even conceivable that they should be able
to carry all of them out[4]. Or, to put the same thing in different
words, since some of the data on which any one person will base his
plans will be the expectation that other people will act in a
particular way, it is essential for the compatibility of the
different plans that the plans of the one contain exactly those
actions which form the data for the plans of the other.
In the traditional treatment of equilibrium analysis part of this
difficulty is apparently avoided by the assumption that the data, in
the form of demand schedules representing individual tastes and
technical facts, are equally given to all individuals and that their
acting on the same premises will somehow lead to their plans
becoming adapted to each other. That this does not really overcome
the difficulty created by the fact that one person's actions are the
other person's data, and that it involves to some degree circular
reasoning, has often been pointed out. What, however, seems so far
to have escaped notice is that this whole procedure involves a
confusion of a much more general character, of which the point just
mentioned is merely a special instance, and which is due to an
equivocation of the term "datum." The data which here are
supposed to be objective facts and the same for all people are
evidently no longer the same thing as the data which formed the
starting-point for the tautological transformations of the Pure
Logic of Choice. There "data" meant those facts, and only
those facts, which were present in the mind of the acting person,
and only this subjective interpretation of the term "datum"
made those propositions necessary truths. "Datum" meant
given, known, to the person under consideration. But in the
transition from the analysis of the action of an individual to the
analysis of the situation in a society the concept has undergone an
insidious change of meaning.
The confusion about the concept of a datum is at the bottom of so
many of our difficulties in this field that it is necessary to
consider it in somewhat more detail. Datum means, of course,
something given, but the question which is left open, and which in
the social sciences is capable of two different answers, is to whom
the facts are supposed to be given. Economists appear subconsciously
always to have been somewhat uneasy about this point and to have
reassured themselves against the feeling that they did not quite
know to whom the facts were given by underlining the fact that they
were given, even by using such pleonastic expressions as "given
data." But this does not answer the question whether the facts
referred to are supposed to be given to the observing economist or
to the persons whose actions he wants to explain,.and, if to the
latter, whether it is assumed that the same facts are known to all
the different persons in the system or whether the "data"
for the different persons may be different.
There seems to be no possible doubt that these two concepts of "data,"
on the one hand, in the sense of the objective real facts, as the
observing economist is supposed to know them, and, on the other, in
the subjective sense, as things known to the persons whose behavior
we try to explain, are really fundamentally different and ought to
be carefully distinguished. And, as we shall see, the question why
the data in the subjective sense of the term should ever come to
correspond to the objective data is one of the main problems we have
to answer.
The usefulness of the distinction becomes immediately apparent
when we apply it to the question of what we can mean by the concept
of a society being at any one moment in a state of equilibrium.
There are evidently two senses in which it can be said that the
subjective data, given to the different* persons, and the individual
plans, which necessarily follow from them, are in agreement. We may
mean merely that these plans are mutually compatible and that there
is consequently a conceivable set of external events which will
allow all people to carry out their plans and not cause any
disappointments. If this mutual compatibility of intentions were not
given, and if in consequence no set of external events could satisfy
all expectations, we could clearly say that this is not a state of
equilibrium. We have a situation where a revision of the plans on
the part of at least some people is inevitable, or, to use a phrase
which in the past has had a rather vague meaning, but which seems to
fit this case perfectly, where "endogenous" disturbances
are inevitable.
There still remains, however, the other question of whether the
individual sets of subjective data correspond to the objective data
and whether, in consequence, the expectations on which plans were
based are borne out by the facts. If correspondence between data in
this sense were required for equilibrium, it would never be
*possible to decide otherwise than retrospectively, at the end of
the period for which people have planned, whether at the beginning
the society has been in equilibrium. It seems to be more in
conformity with established usage to say in such a case that the
equilibrium, as defined in the first sense, may be disturbed by an
unforeseen development of the (objective) data and to describe this
as an exogenous disturbance. In fact, it seems hardly possible to
attach any definite meaning to the much used concept of a change in
the (objective) data unless we distinguish between external
developments in conformity with, and those different from, what has
been expected, and define as a "change" any divergence of
the actual from the expected development, irrespective of whether it
means a "change" in some absolute sense. If, for example,
the alternations of the seasons suddenly ceased and the weather
remained constant from a certain day onward, this would certainly
represent a change of data in our sense, that is, a change relative
to expectations, although in an absolute sense it would not
represent a change but rather an absence of change. But all this
means that we can speak of a change in data only if equilibrium in
the first sense exists, that is, if expectations coincide. If they
conflicted, any development of the external facts might bear out
somebody's expectations and disappoint those of others, and there
would be no possibility of deciding what was a change in the
objective data[5].
For a society, then, we can speak of a state of equilibrium at a
point of time--but it means only that the different plans which the
individuals composing it have made for action in time are mutually
compatible. And equilibrium will continue, once it exists, so long
as the external data correspond to the common expectations of all
the members of the society. The continuance of a state of
equilibrium in this sense is then not dependent on the objective
data being constant in an absolute sense and is not necessarily
confined to a stationary process. Equilibrium analysis becomes in
principle applicable to a progressive society and to those
intertemporal price relationships which have given us so much
trouble in recent times[6].
These considerations seem to throw considerable light on the
relationship between equilibrium and foresight, which has been
somewhat hotly debated in recent times[7]. It appears that the
concept of equilibrium merely means that the foresight of the
different members of the society is in a special sense correct. It
must be correct in the sense that every person's plan is based on
the expectation of just those actions of other people which those
other people intend to perform and that all these plans are based on
the expectation of the same set of external facts, so that under
certain conditions nobody will have any reason to change his plans.
Correct foresight is then not, as it has sometimes been understood,
a precondition which must exist in order that equilibrium may be
arrived at. It is rather the defining characteristic of a state of
equilibrium. Nor need foresight for this purpose be perfect in the
sense that it need extend into the indefinite future or that
everybody must foresee everything correctly. We should rather say
that equilibrium will last so long as the anticipations prove
correct and that they need to be correct only on those points which
are relevant for the decisions of the individuals. But on this
question of what is relevant foresight or knowledge, more later.
Before I proceed further I should probably stop for a moment to
illustrate by a concrete example what I have just said about the
meaning of a state of equilibrium and how it can be disturbed.
Consider the preparations which will be going on at any moment for
the production of houses. Brickmakers, plumbers, and others will all
be producing materials which in each case will correspond to a
certain quantity of houses for which just this quantity of the
particular material will be required. Similarly we may conceive of
prospective buyers as accumulating savings which will enable them at
certain dates to buy a certain number of houses. If all these
activities represent preparations for the production (and
acquisition) of the same amount of houses, we can say that there is
equilibrium between them in the sense that all the people engaged in
them may find that they can carry out their plans[8]. This need not
be so, because other circumstances which are not part of their plan
of action may turn out to be different from what they expected. Part
of the materials may be destroyed by an accident, weather conditions
may make building impossible, or an invention may alter the
proportions in which the different factors are wanted. This is what
we call a change in the (external) data, which disturbs the
equilibrium which has existed. But if the different plans were from
the beginning incompatible, it is inevitable, whatever happens, that
somebody's plans will be upset and have to be altered and that in
consequence the whole complex of actions over the period will not
show those characteristics which apply if all the actions of each
individual can be understood as part of a single individual plan,
which he has made at the beginning[9].
When in all this I emphazise the distinction between mere
intercompatibility of the individual plans[10] and the
correspondence between them and the actual external facts or
objective data, I do not, of course, mean to suggest that the
subjective interagreement is not in some way brought about by the
external facts. There would, of course, be no reason why the
subjective data of different people should ever correspond unless
they were due to the experience of the same objective facts. But the
point is that pure equilibrium analysis is not concerned with the
way in which this correspondence is brought about. In the
description of an existing state of equilibrium which it provides,
it is simply assumed that the subjective data coincide with the
objective facts. The equilibrium relationships cannot be deduced
merely from the objective facts, since the analysis of what people
will do can start only from what is known to them. Nor can
equilibrium analysis start merely from a given set of subjective
data, since the subjective data of different people would be either
compatible or incompatible, that is, they would already determine
whether equilibrium did or did not exist.
We shall not get much further here unless we ask for the reasons
for our concern with the admittedly fictitious state of equilibrium.
Whatever may occasionally have been said by overpure economists,
there seems to be no possible doubt that the only justification for
this is the supposed existence of a tendency toward equilibrium. It
is only by this assertion that such a tendency exists that economics
ceases to be an exercise in pure logic and becomes an empirical
science; and it is to economics as an empirical science that we must
now turn.
In the light of our analysis of the meaning of a state of
equilibrium it should be easy to say what is the real content of the
assertion that a tendency toward equilibrium exists. It can hardly
mean anything but that, under certain conditions, the knowledge and
intentions of the different members of society are supposed to come
more and more into agreement or, to put the same thing in less
general and less exact but more concrete terms, that the
expectations of the people and particularly of the entrepreneurs
will become more and more correct. In this form the assertion of the
existence of a tendency toward equilibrium is clearly an empirical
proposition, that is, an assertion about what happens in the real
world which ought, at least in principle, to be capable of
verification. And it gives our somewhat abstract statement a rather
plausible common-sense meaning. The only trouble is that we are
still pretty much in the dark about (a) the conditions under which
this tendency is supposed to exist and (b) the nature of the process
by which individual knowledge is changed.
In the usual presentations of equilibrium analysis it is generally
made to appear as if these questions of how the equilibrium comes
about were solved. But, if we look closer, it soon becomes evident
that these apparent demonstrations amount to no more than the
apparent proof of what is already assumed[11]. The device generally
adopted for this purpose is the assumption of a perfect market where
every event becomes known instantaneously to every member. It is
necessary to remember here that the perfect market which is required
to satisfy the assumptions of equilibrium analysis must not be
confined to the particular markets of all the individual
commodities; the whole economic system must be assumed to be one
perfect market in which everybody knows everything. The assumption
of a perfect market, then, means nothing less than that all the
members of the community even if they are not supposed to be
strictly omniscient, are at least supposed to know automatically all
that is relevant for their decisions. It seems that that skeleton in
our cupboard, the "economic man," whom we have exorcised
with prayer and fasting, has returned through the back door in the
form of a quasi-omniscient individual
The statement that, if people know everything, they are in
equilibrium is true simply because that is how we define
equilibrium. The assumption of a perfect market in this sense is
just another way of saying that equilibrium exists but does not get
us any nearer an explanation of when and how such a state will come
about. It is clear that, if we want to make the assertion that,
under certain conditions, people will approach that state, we must
explain by what process they will acquire the necessary knowledge.
Of course, any assumption* about the actual acquisition of knowledge
in the course of this process will also be of a hypothetical
character. But this does not mean that all such assumptions are
equally justified. We have to deal here with assumptions about
causation, so that what we assume must not only be regarded as
possible (which is certainly not the case if we just regard people
as omniscient) but must also be regarded as likely to be true; and
it must be possible, at least in principle, to demonstrate that it
is true in particular cases.
The significant point here is that it is these apparently
subsidiary hypotheses or assumptions that people do learn from
experience, and about how they acquire knowledge, which constitute
the empirical content of our propositions about what happens in the
real world. They usually appear disguised and incomplete as a
description of the type of market to which our proposition refers;
but this is only one, though perhaps the most important, aspect of
the more general problem of how knowledge is acquired and
communicated. The important point of which economists frequently do
not seem to be aware is that the nature of these hypotheses is in
many respects rather different from the more general assumptions
from which the Pure Logic of Choice starts. The main differences
seem to me to be two:
First, the assumptions from which the Pure Logic of Choice starts
are facts which we know to be common to all human thought. They may
be regarded as axioms which define or delimit the field within which
we are able to understand or mentally to reconstruct the processes
of thought of other people. They are therefore universally
applicable to the field in which we are interested--although, of
course, where in concreto the limits of this field are is an
empirical question. They refer to a type of human action (what we
commonly call "rational," or even merely "conscious,"
as distinguished from "instinctive" action) rather than to
the particular conditions under which this action is undertaken. But
the assumptions or hypotheses, which we have to introduce when we
want to explain the social processes, concern the relation of the
thought of an individual to the outside world, the question to what
extent and how his knowledge corresponds to the external facts. And
the hypotheses must necessarily run in terms of assertions about
causal connections, about how experience creates knowledge.
Second, while in the field of the Pure Logic of Choice our
analysis can be made exhaustive, that is, while we can here develop
a formal apparatus which covers all conceivable situations, the
supplementary hypotheses must of necessity be selective, that is, we
must select from the infinite variety of possible situations such
ideal types as for some reason we regard as specially relevant to
conditions in the real world[12]. Of course, we could also develop a
separate science, the subject mattter of which was per definitionem
confined to a "perfect market" or some similarly defined
object, just as the Logic of Choice applies only to persons who have
to allot limited means among a variety of ends. Forthe field so
defined our propositions would again become a priori true, but for
such a procedure we should lack the justification which consists in
the assumption that the situation in the real world is similar to
what we assume it to be.
I must now turn to the question of what are the concrete
hypotheses concerning the conditions under which people are supposed
to acquire the relevant knowledge and the process by which they are
supposed to acquire it. If it were at all clear what the hypotheses
usually employed in this respect were, we should have to scrutinize
them in two respects: we should have to investigate whether they
were necessary and sufficient to explain a movement toward
equilibrium, and we should have to show to what extent they were
borne out by reality. But I am afraid that I am now getting to a
stage where it becomes exceedingly difficult to say what exactly are
the assumptions on the basis of which we assert that there will be a
tendency toward equilibrium and to claim that our analysis has an
application to the real world[13]. I cannot pretend that I have as
yet got much further on this point. Consequently, all I can do is to
ask a number of questions to which we shall have to find an answer
if we want to be clear about the significance of our argument[14].
The only condition about the necessity of which for the
establishment of an equilibrium economists seem to be fairly agreed
is the "constancy of the data." But after what we have
seen about the vagueness of the concept of "datum" we
shall suspect, and rightly, that this does not get us much further.
Even if we assume--as we probably must--that here the term is used
in its objective sense (which includes, it will be remembered, the
preferences of the different individuals), it is by no means clear
that this is either required or sufficient in order that people
shall actually acquire the necessary knowledge or that it was meant
as a statement of the conditions under which they will do so. It is
rather significant that, at any rate, some authors feel it necessary
to add "perfect knowledge" as an additional and separate
condition[15]. Indeed, we shall see that constancy of the objective
data is neither a necessary nor a sufficient condition. That it
cannot be a necessary condition follows from the facts, first, that
nobody would want to interpret it in the absolute sense that nothing
must ever happen in the world, and, second, that, as we have seen,
as soon as we want to include changes which occur periodically or
perhaps even changes which proceed at a constant rate, the only way
in which we can define constancy is with reference to expectations.
All that this condition amounts to, then, is that there must be some
discernible regularity in the world which makes it possible to
predict events correctly. But, while this is clearly not sufficient
to prove that people will learn to foresee events correctly, the
same is true to a hardly less degree even about constancy of data in
an absolute sense. For any one individual, constancy of the data
does in no way mean constancy of all the facts independent of
himself, since, of course, only the tastes and not the actions of
the other people can in this sense be assumed to be constant. As all
those other people will change their decisions as they gain
experience about the external facts and about other people's
actions, there is no reason why these processes of successive
changes should ever come to an end. These difficulties are well
known, and I mention them here only to remind you how little we
actually know about the conditions under which an equilibrium will
ever be reached. But I do not propose to follow this line of
approach further, though not because this question of the empirical
probability that people will learn (that is, that their subjective
data will come to correspond with each other and with the objective
facts) is lacking in unsolved and highly interesting problems. The
reason is rather that there seems to me to be another and more
fruitful way of approach to the central problem.
The questions I have just discussed concerning the conditions
under which people are likely to acquire the necessary knowledge,
and the process by which they will acquire it, have at least
received some attention in past discussions. But there is a further
question which seems to me to be at least equally important but
which appears to have received no attention at all, and that is how
much knowledge and what sort of knowledge the different individuals
must possess in order that we may be able to speak of equilibrium.
It is clear that, if the concept is to have any empirical
significance, it cannot presuppose that everybody knows everything.
I have already had to use the undefined term "relevant
knowledge," that is, the knowledge which is relevant to a
particular person. But what is this relevant knowledge? It can
hardly mean simply the knowledge which actually influenced his
actions, because his decisions might have been different not only
if, for instance, the knowledge he possessed had been correct
instead of incorrect but also if he had possessed knowledge about
altogether different fields.
Clearly there is here a problem of the division of
knowledge[16],which is quite analogous to, and at least as important
as, the problem of the division of labor. But, while the latter has
been one of the main subjects of investigation ever since the
beginning of our science, the former has been as completely
neglected, although it seems to me to be the really central problem
of economics as a social science. The problem which we pretend to
solve is how the spontaneous interaction of a number of people, each
possessing only bits of knowledge, brings about a state of affairs
in which prices correspond to costs, etc., and which could be
brought about by deliberate direction only by somebody who possessed
the combined knowledge of all those individuals. Experience shows us
that something of this sort does happen, since the empirical
observation that prices do tend to correspond to costs was the
beginning of our science. But in our analysis, instead of showing
what bits of information the different persons must possess in order
to bring about that result, we fall in effect back on the assumption
that everybody knows everything and so evade any real solution of
the problem.
Before, however, I can proceed further to consider this division
of knowledge among different persons, it is necessary to become more
specific about the sort of knowledge which is relevant in this
connection. It has become customary among economists to stress only
the need of knowledge of prices, apparently because--as a
consequence of the confusions between objective and subjective
data--the complete knowledge of the objective facts was taken for
granted. In recent times even the knowledge of current prices has
been taken so much for granted that the only connection in which the
question of knowledge has been regarded as problematic has been the
anticipation of future prices. But, as I have already indicated at
the beginning of this essay, price expectations and even the
knowledge of current prices are only a very small section of the
problem of knowledge as I see it. The wider aspect of the problem of
knowledge with which I am concerned is the knowledge of the basic
fact of how the different commodities can be obtained and used[17],
and under what conditions they are actually obtained and used, that
is, the general question of why the subjective data to the different
persons correspond to the objective facts.
Our problem of knowledge here is just the existence of this
correspondence which in much of current equilibrium analysis is
simply assumed to exist, but which we have to explain if we want to
show why the propositions, which are necessarily true about the
attitude of a person toward things which he believes to have certain
properties, should come to be true of the actions of society with
regard to things which either do possess these properties, or which,
for some reason which we shall have to explain, are commonly
believed by the members of society to possess these properties[18].
But, to revert to the special problem I have been discussing, the
amount of knowledge different individuals must possess in order that
equilibrium may prevail (or the "relevant" knowledge they
must possess): we shall get nearer to an answer if we remember how
it can become apparent either that equilibrium did not exist or that
it is being disturbed. We have seen that the equilibrium connections
will be severed if any person changes his plans, either because his
tastes change (which does not concern us here) or because new facts
become known to him. But there are evidently two different ways in
which he may learn of new facts that make him change his plans,
which for our purposes are of altogether different significance. He
may learn of the new facts as it were by accident, that is, in a way
which is not a necessary consequence of his attempt to execute his
original plan, or it may be inevitable that in the course of his
attempt he will find that the facts are different from what he
expected. It is obvious that, in order that he may proceed according
to plan, his knowledge needs to be correct only on the points on
which it will necessarily be confirmed or corrected in the course of
the execution of the plan. But he may have no knowledge of things
which, if he possessed it, would certainly affect his plan.
The conclusion, then, which we must draw is that the relevant
knowledge which he must possess in order that equilibrium may
prevail is the knowledge which he is bound to acquire in view of the
position in which he originally is, and the plans which he then
makes. It is certainly not all the knowledge which, if he acquired
it by accident, would be useful to him and lead to a change in his
plan. We may therefore very well have a position of equilibrium only
because some people have no chance of learning about facts which, if
they knew them, would induce them to alter their plans. Or, in other
words, it is only relative to the knowledge which a person is bound
to acquire in the course of the attempt to carry out his original
plan that an equilibrium is likely to be reached.
While such a position represents in one sense a position of
equilibrium, it is clear that it is not an equilibrium in the
special sense in which equilibrium is regarded as a sort of optimum
position. In order that the results of the combination of individual
bits of knowledge should be comparable to the results of direction
by an omniscient dictator, further conditions must apparently be
introduced[19]. While it should be possible to define the amount of
knowledge which individuals must possess in order that his result
should follow, I know of no real attempt in this direction. One
condition would probably be that each of the alternative uses of any
sort of resources is known to the owner of some such resources
actually used for another purpose and that in this way all the
different uses of these resources are connected, either directly or
indirectly[20]. But I mention this condition only as an instance of
how it will in most cases be sufficient that in each field there is
a certain margin of people who possess among them all the relevant
knowledge. To elaborate this further would be an interesting and a
very important task but a task that would far exceed the limits of
this paper.
Although what I have said on this point has been largely in the
form of a criticism, I do not want to appear unduly despondent about
what we have already achieved. Even if we have jumped over an
essential link in our argument, I still believe that, by what is
implicit in its reasoning, economics has come nearer than any other
social science to an answer to that central question of all social
sciences: How can the combination of fragments of knowledge existing
in different minds bring about results which, if they were to be
brought about deliberately, would require a knowledge on the part of
the directing mind which no single person can possess ? To show that
in this sense the spontaneous actions of individuals will, under
conditions which we can define, bring about a distribution of
resources which can be understood as if it were made according to a
single plan, although nobody has planned it, seems to me indeed an
answer to the problem which has sometimes been metaphorically
described as that of the "social mind." But we must not be
surprised that such claims have usually been rejected, since we have
not based them on the right grounds.
There is only one more point in this connection which I should
like to mention. This is that, if the tendency toward equilibrium,
which on empirical grounds we have reason to believe to exist, is
only toward an equilibrium relative to that knowledge which people
will acquire in the course of their economic activity, and if any
other change of knowledge must be regarded as a "change in the
data" in the usual sense of the term, which falls outside the
sphere of equilibrium analysis, this would mean that equilibrium
analysis can really tell us nothing about the significance of such
changes in knowledge, and it would also go far to account for the
fact that pure analysis seems to have so extraordinarily little to
say about institutions, such as the press, the purpose of which is
to communicate knowledge. It might even explain why the
preoccupation with pure analysis should so frequently create a
peculiar blindness to the role played in real life by such
institutions as advertising.
With these rather desultory remarks on topics which would deserve
much more careful examination I must conclude my survey of these
problems. There are only one or two further remarks which I want to
add.
One is that, in stressing the nature of the empirical propositions
of which we must make use if the formal apparatus of equilibrium
analysis is to serve for an explanation of the real world, and in
emphasizing that the propositions about how people will learn, which
are relevant in this connection, are of a fundamentally different
nature from those of formal analysis, I do not mean to suggest that
there opens here and now a wide field for empirical research. I very
much doubt whether such investigation would teach us anything new.
The important point is rather that we should become aware of what
the questions of fact are on which the applicability of our argument
to the real world depends, or, to put the same thing in other words,
at what point our argument, when it is applied to phenomena of the
real world, becomes subject to verification.
The second point is that I do of course not want to suggest that
the sorts of problems I have been discussing were foreign to the
arguments of the economists of the older generations. The only
objection that can be made against them is that they have so mixed
up the two sorts of propositions, the a priori and the empirical, of
which every realistic economist makes constant use, that it is
frequently quite impossible to see what sort of validity they
claimed for a particular statement. More recent work has been free
from this fault--but only at the price of leaving more and more
obscure what sort of relevance their arguments had to the phenomena
of the real world. All I have tried to do has been to find the way
back to the common-sense meaning of our analysis, of which, I am
afraid, we are likely to lose sight as our analysis becomes more
elaborate. You may even feel that most of what I have said has been
commonplace. But from time to time it is probably necessary to
detach one's self from the technicalities of the argument and to ask
quite naively what it is all about. If I have only shown not only
that in some respects the answer to this question is not obvious but
that occasionally we even do not quite know what it is, I have
succeeded in my purpose.
NOTES AND REFERENCES
- Or rather falsification (cf. K. R. Popper, Log-k det Foschung
[Vienna, 1935], passim).
- A more complete survey of the process by which the significance
of anticipations was gradually introduced into economic analysis
would probably have to begin with Irving Fisher's Appreciation
and Interest (1896).
- Cf., on this point particularly, Ludwig von Mises,
- Grundprobleme der Nationalokonomie (Jena, 1933), pp. 22
ff., 160 fl.
- It has long been a subject of wonder to me why there should, to
my knowledge, have been no systematic attempts in sociology to
analyze social relations in terms of correspondence and
non-correspondence, or compatibility and non-compatibility, of
individual aims and desires.
- Cf. the present author's article, "The Maintenance of
Capital," Economica, 11 (new ser., 1935),
265,'reprinted in Profits, Interest, and Investment (London,
1939).
- This separation of the concept of equilibrium from that of a
stationary state seems to me to be no more than the necessary
outcome of a process which has been going on for a fairly long
time. That this association of the two concepts is not essential
but only due to historical reasons is today probably generally
felt. If complete separation has not yet been effected, it is
apparently only because no alternative definition of a state of
equilibrium has yet been suggested which has made it possible to
state in a general form those propositions of equilibrium analysis
which are essentially independent of the concept of a stationary
state. Yet it is evident that most of the propositions of
equilibrium analysis are not supposed to be applicable only in
that stationary state which will probably never be reached. The
process of separation seems to have begun with Marshall and his
distinction between long- and short-run equilibriums. Cf.
statements like this: "For the nature of equilibrium itself,
and that of the causes by which it is determined, depend on the
length of the period over which the market is taken to extend"
- (Principles [7th ed.], 1, 330). The idea of a state of
equilibrium which was not a stationary state was already inherent
in my "Das intertemporale Gleichgewichts-system der Preise
und die Bewegungen des Geldwerters," Weltwirtschaftlicies
Archiv, Vol. XXVIII (June, 1928), and is, of course, essential
if we want to use the equilibrium apparatus for the explanation of
any of the phenomena connected with "investment." On the
whole matter much historical information will be found in E.
Schams, "Komparative Statik,'Zeitschrift fur
Nationalokonomie, Vol. 11, No. I (1930). See also F. H. Knight,
The Ethics of Competition (London, 1935), p. 175 n.; and
for some further developments since this essay was first
published, the present author's Pure Theory of Capital
(London, 1941), chap. ii.
- Cf. particularly Oshr Morgenstern, "Vollkommene
Voraussicht und wirtschaftliches Gleichgewicht,-' Zeitschrift
fur Nationalokonomic, VI (1934), 3.
- Another example of more general importance would, of course, be
the correspondence between "investment" and "saving"
in the sense of the proportion (in terms of relative cost) in
which entrepreneurs provide producers' goods and consumers' goods
for a particular date,.and the proportion in which consumers in
general will at this date distribute their resources between
producers' goods and consumers' goods (cf. my essays, "Price
Expectations, Monetary Disturbances, and Malinvestment* [1933],
reprinted in
- Profits, Interest, and Investment [London, 1939], pp.
135-56, and "The Maintenance of Capital," in the same
volume, pp. 83-134).1t may be of interest in this connection to
mention that in the course of investigations of the same field,
which led the present author to these speculations, that of the
theory of crises, the great French sociologist G. Tarde stressed
the "contradiction de croyances" or "contradiction
de jugements" or "contradictions de esperances" as
the main cause of these phenomena (Psychologie economique *
Paris, 1902],11, 128-29; cf. also N. Pinkus, Das Problcm *cr
Normalcn in dcr lVationalokonomic [Leipzig, 1906], pp. 252 and
275).
- It is an interesting question, but one which I cannot discuss
here, whether, in order that we can speak of equilibrium, every
single individual must be right, or whether it would not be
sufficient if, in consequence of a compensation of errors in
different directions, quantities of the different commodities
coming on the market were the same as if every individual had been
right. It seems to me as if equilibrium in the strict sense would
require the first condition to be satisfied, but I can conceive
that a wider concept, requiring only the second condition, might
occasionally be useful. A fuller discussion of this problem would
have to consider the whole question of the significance which some
economists (including Pareto) attach to the law of great numbers
in this connection. On the general point see P. N.
Rosenstein-Rodan, "The Coordination of the General Theories
of Money and Price,"Economica, August, 1936.
- Or, since in view of the tautological character of the Pure
Logic of Choice "individual plans" and "subjective
data" can be used interchangeably, the agreement between the
subjective data of the different individuals.
- This seems to be implicitly admitted, although hardly
consciously recognized, when in recent times it is frequently
stressed that equilibrium analysis only describes the conditions
of equilibrium without attempting to derive the position of
equilibrium from the data. Equilibrium analysis in this sense
would, of course, be pure logic and contain no assertions about
the real world.
- The distinction drawn here may help to solve the old difference
between economists and sociologists about the role which "ideal
types" play in the reasoning of economic theory. The
sociologists used to emphasize that the usual procedure of
economic theory involved the assumption of particular ideal types,
while the economic theorist pointed out that his reasoning was of
such generality that he need not make use of any "ideal
types." The truth seems to be that within the field of the
Pure Logic of Choice, in which the economist was largely
interested, he was right in his assertion but that, as soon as he
wanted to use it for the explanation of a social process, he had
to use "ideal types" of one sort or another.
- The older economists were often more explicit on this point
than their successors. See, e.g., Adam Smith ( Wealth of Nations,
ed. Cannan, 1, 116): "In order, however, that this equality
[of wages] may take place in the whole of their advantages or
disadvantages, three things are required even when there is
perfect freedom. First, the employment must be well known and long
established in the neighbourhood ..."; or David Ricardo
(Letters to Malthus, October 22, 1811, p. 18): 'lt would be no
answer to me to say that men were ignorant of the best and
cheapest mode of conducting their business and paying their debts,
because that is a question of fact, not of science, and might be
argued against almost every proposition in Political Economy."
- See N. Kaldor, "A Classificatory Note on the
Determinateness of Equilibrium," Review of Economic
Studies, 1, No. 2 (1934), 123.
- Ibid., passim.
- Cf. L. v. Mises, Gemeinwirtdschaft (2d ed.; Jena, 1932), p. 96:
"Die Verteilung der Verfuigungsgewalt uber die
wirtschaftlichen Guiter der arbeitsteilig wirtschaftenden
Sozialwinschaft auf viele Individuen bewirkt eine Art geistige
Arbeitsteilung, ohne die Produktionsrechnung und Wirtschaft nicht
moglich ware."
- Knowledge in this sense is more than what is usually described
as skill, and the division of knowledge of which we here speak
more than is meant by the division of labor. To put it shortly, "skill"
refers only to the knowledge of which a person makes use in his
trade, while the further knowledge about which we must know
something in order to be able to say anything about the processes
in society is the knowledge of alternative possibilities of action
of which he makes no direct use. It may be added that knowledge,
in the sense in which the term is here used, is identical with
foresight only in the sense in which all knowledge is capacity to
predict.
- That all propositions of economic theory refer to things which
are defined in terms of human attitudes toward them, that is, that
the ' sugar" about which economic theory may occasionally
speak is defined not by its "objective" qualities but by
the fact that people believe that it will sene certain needs of
theirs in a certain way, is the source of all sorts of
difficulties and confusions, particularly in connection with the
problem of "verification." It is, of course, also in
this connection that the contrast between the verstehende social
science and the behaviorist approach becomes so glaring. I am not
certain that the behaviorists in the social sciences are quite
aware of how much of the traditional approach they would have to
abandon if they wanted to be consistent or that they would want to
adhere to it consistently if they were aware of this. It would,
for instance, imply that propositions of the theory of money would
have to refer exclusively to, say, "round disks of metal,
bearing a certain stamp," or some similarly defined physical
object or group of objects.
- These conditions are usually described as absence of "frictions."
In a recently published article ("Quantity of Capital and the
Rate of Interest," /Journal of Political Economy, XLIV,
No. 5 [1936], 638) Frank H. Knight rightly points out that "
'error' is the usual meaning of friction in economic discussion."
- This would be one, but probably not yet a sufficient, condition
to insure that, with a given state of demand, the marginal
productivity of the different factors of production in their
different uses should be equalized and that in this sense an
equilibrium of production should be brought about. That it is not
necessary, as one might think, that every possible alternative use
of any kind of resources should be known to at least one among the
owners of each group of such resources which are used for one
particular purpose is due to the fact that the alternatives known
to the owners of the resources in a particular use are reflected
in the prices of these resources. In this way it may be a
suflicient distribution of knowledge of the alternative uses, m,
n, o, . . . y, z, of a commodity, if A, who uses the quantity of
these resources in his possession for m knows of n, and B, who
uses his for n, knows of m, while C, who uses his for o, knows of
n, etc., until we get to L, who uses his for z, but knows only of
y. I am not clear to what e*tent in addition to this a particular
distribution of the knowledge of the different proportions is
required in which different factors can be combined in the
production of any one commodity. For complete equilibrium
additional assumptions will be required about the knowledge which
consumers possess about the serviceability of the commodities for
the satisfaction of their wants.