Sunday, March 27, 2011

Towards a Critique of Hayek's "Economics and Knowledge"

Interestingly, it was Bruce Caldwell's excellent "Hayek's Challenge" book that got me thinking about this important article of Hayek's.

I am referring, of course, to pages 211-212 of Caldwell's book where he quotes Hayek arguing that the concept of equilibrium implies essentially that everybody foresees the future correctly, this information consisting of both objective data and the behavior of other people.

This definition prompted a response by Oskar Morgenstern claiming that "perfect expectation and movements toward equilibrium are logically incompatible." Here is Caldwell on Morgensterm's criticism of Hayek's initial definition of equilibrium:

"If one assumes perfect foresight, one assumes, not only that one knows what all other people will do, now and in the future, but also that all other people know what you will do. This suggests either an infinite regress or that the world is always in equilibrium; either way, the concept of tatonnement ... is rendered superfluous."

Hayek, in response to this criticism by Morgensterm, promptly redefined equilibrium in terms of the compatibility of plans and by emphasizing correct foresight instead of perfect expectation.


This is completely wrong, and I think the reasons stem from a lack of understanding with respect to what equilibrium implies in terms of omniscience.

1.) We can begin by arguing that with omniscience (equilibrium) there no longer is scarcity.

2.) Scarcity ceases to exist because there no longer is scarcity of information in equilibrium.

3.) This follows from Leibniz's principle of identity of indiscernibles, namely, that the greater knowledge you have of something, the closer you approximate it, rather than the representation of it.

4.) A thing is only a compilation of information, a complex of forms; therefore, anything of structure is a body of information. If knowledge has no limits (equilibrium), then the distinction between "thing" and "representation" collapses. You no longer have information about the thing; you have it directly.

5.) The logical implication of this argument is that it is incoherent to speak of multiple omniscient agents, i.e. Morgenstern's criticism is mistaken and confused.

These musings led me to arrive at another fundamental insight:

In Equilibrium, economics is destroyed. There would no longer be any social cooperation and specialization under the division of labor if we posit the existence of equilibrium (omniscience).

I am convinced that Hayek and Morgenstern had equilibrium completely wrong. Incidentally, these reflections are part of a larger project on the economics of Ludwig von Mises, which can be found here:

Take away point:

Q1: Of what does economics consist?

A1: Rationality.

Q2: What does rationality imply?

A2: The destruction of economics.

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