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Thursday, September 20, 2012

On Individualism and Economic Order

Great Austrian works of the twentieth century

In the first of my three columns on foundational texts in twentieth-century Austrian economics, I explored Ludwig von Mises’s Human Action, published in English in 1949. Less than a year before that, the second of our three books hit the shelves. Individualism and Economic Order is a collection of Friedrich Hayek’s papers from the 1930s and ’40s, most of which were first published in economics journals. Though not intended for collection in such a volume, these papers lay out a clear and consistent vision of the distinctive contribution of Austrian economics.

The papers roughly divide into three groups. First are the ones on the nature of economics, then comes those generally known as the “knowledge” papers, and finally we have Hayek’s three contributions to the socialist calculation debate. Nearly absent from this collection, interestingly enough, are any papers directly taking on Keynes and the macroeconomic debates of the 1930s. Most of those papers were collected in Profits, Interest, and Investment, published in 1939.

The first group includes “Individualism: True and False” and “The Facts of the Social Sciences,” which provide important introductions to the ideas of spontaneous order and subjectivism. The first paper distinguishes the individualism of thinkers like Adam Smith and David Hume, with its more modest and less rationalistic understanding of individualism, from the more rationalist tradition of Rousseau and others, which ascribes to individuals inordinate power to create and control the social world. Hayek argues that the Smith-Hume tradition understands that because human beings have limited knowledge, freedom is necessary to make that knowledge available to others. In contrast, the rationalists’ overestimation of human rationality ended up destroying individual freedom.

Facts of the Social World

The second paper is a reminder to economists, and social scientists more generally, that the facts of the social world are the beliefs and perceptions of individuals. Any good explanation of social phenomena, such as those in the market, has to begin with how individuals perceive the world. This does not mean that only individuals exist, but that explaining organizations and economic outcomes must start with individuals.

The knowledge essays are the core of the book’s importance for modern Austrian economics. In “Economics and Knowledge,” Hayek argues that markets are best understood as social learning processes. In the market people try to coordinate their expectations with one another, which means they try to know as much as possible about how others see the world. “The Use of Knowledge in Society” explains how prices work to solve this coordination problem by serving as knowledge surrogates that guide our behavior. And in “The Meaning of Competition,” Hayek pushes this another step by showing how the standard model of “perfectly competitive equilibrium” assumes away the whole problem by treating people as having perfect knowledge. He argues that the Austrian conception of competition as a process, rather than an equilibrium state, sheds light on how it drives the price system to facilitate the discovery of knowledge.

These insights are also present in the three essays on rational calculation under socialism. Here, especially in the third and last of them, Hayek argues that the equilibrium orientation of economics has misled economists into thinking that a central planning board’s task–setting prices for and allocating capital goods –is no harder than that faced by the market. The “market socialist” models of thinkers like Oscar Lange presumed that the task was to find the equilibrium set of prices just like the market was thought to do. So why not apply the conditions of the perfectly competitive model to socialist firms?

No Curves Out There

Hayek insists that the cost and demand curves that we use in economic theory, and that Lange assumes the planning board will have access to, do not have an objective existence and thus are not known to real-world actors; rather, they must be discovered day to day. That discovery process can only happen when entrepreneurs face real competition, using and risking their own resources. Socialism, whether comprehensive planning or “market socialism,” is incapable of matching the market because it lacks true money prices and this discovery process. The task is not to reach equilibrium but to adjust, moment to moment, to the constant change in human knowledge and the availability of resources. Moving away from equilibrium thinking makes the superiority of the market clearer.

Many of the themes that characterize Austrian economics since its revival in the mid-1970s emerged from these essays. More accurately, post-revival Austrian economics is defined by the combination of Hayek’s focus on knowledge, discovery, and spontaneous order and Mises’s emphasis on purposive action, monetary calculation, and entrepreneurship.

That set of issues is the bedrock of the modern Austrian approach, and it was in the third key book of the twentieth century that the merging of the Misesian and Hayekian themes came to its first real fruition. We will turn to that book next week.

  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.