Dr. Kirzner is professor of economics at New York University. He is the author of numerous articles and books, the latter including The Economic Point of View, Market Theory and the Price System, and, most recently, Competition and Entrepreneurship.
On December 10, 1975, at what the New York Times described as a glittering Stockholm ceremony, the Nobel Memorial Prize in Economics was awarded jointly to Professor Leonid Vitalyevich Kantorovich, of the Moscow Institute of Economic Management, and to Professor Tjalling Charles Koopmans of Yale University. Their prize was awarded for their contributions to the theory of optimum allocation of resources.
Now concern with the "optimal allocation of resources" has been proclaimed in countless economics classrooms, and in innumerable economics textbooks, to be the very essence of economics. Ever since Lionel (now Lord) Robbins in 1932 defined economic science in terms revolving around men’s allocative decisions, economists have seen efficiency in resource allocation as central to their discipline. It might seem then that Professors Kantorovich and Koopmans have won their Nobel prize for contributions going to the very heart of their science. Nonetheless, it is necessary to point out that, paradoxical though it may seem, in a very important sense the 1975 Nobel Prize in Economics was awarded for work having only peripheral relevance to the central contributions of economic science. What is of even greater concern, the interpretation placed by the Swedish Royal Academy on the contributions of the prize-winning scholars seems to involve implicit denial (if not outright ignorance) of these central contributions of economic science. These may seem surprising assertions; the following pages will attempt to provide the necessary elucidation.
It is to be hoped that, in pointing out these puzzling and disturbing circumstances, the writer will not be understood as seeking in any way to detract from the outstanding merit of the eminent men honored in Stockholm. Both of the laureates are brilliant scholars and dedicated scientists; the quality of their work undoubtedly meets the very highest standards of scientific excellence. Nonetheless, recognition of all this cannot absolve us from recognizing, at the same time, that unfortunate misunderstanding of the nature of the central problems of economic science, which appears to surround the 1975 prize.
The matter might be stated briefly, but far too superficially, in terms of a comment on the role of mathematics in economics. What both laureates — each of whom began his academic career strictly as a mathematician¹ — have devoted their lives to, it might be argued, is not, properly speaking, economics at all, but rather a special genre of applied mathematics. And, while questions of nomenclature might seem to be of only secondary importance, it in fact appears that, in the misunderstanding of the character and significance of these mathematical contributions, there lies embedded not merely semantic confusion, but also substantive unconcern with profoundly economic insights which have (at least up to the present) not proven amenable to mathematical formulation. This statement of the matter, however, while correct in itself, touches only on the surface of the issue.
One Technique — Many Uses
A more thorough discussion may begin by noting that in awarding the prize jointly to a Russian and a (Dutch-born) American, the Royal Academy was intent on more than merely recognizing the international character of the scientific contributions they wished to honor. What it was evidently intended to emphasize was that the techniques of optimal resource allocation contained in modern activity analysis are in principle applicable alike to economic systems reflecting sharply divergent institutional patterns. As the New York Times (October 15, 1975) expressed it in the words of a distinguished colleague of Koopmans: "Activity analysis is used by economists and operations researchers to select the optimum production technique when several competing techniques are available, either at the level of the corporation, as in the United States, or at the national level, as in the planned Communist economies of Eastern Europe… The indifference of these methods to the institutional arrangements of the economic system have permitted a degree of communication and intellectual exchange that could not otherwise have taken place."
This view sees economists as concerned with seeking techniques to solve resource allocation problems. These problems of securing optimum allocation of resources present themselves at a variety of levels. They present themselves, in capitalist societies, at the level of the firm; they present themselves similarly, in socialist societies, to the central planners. The techniques required to solve these allocation problems are, in principle, common to these problems regardless of institutional context. In principle the mathematical techniques employed by activity analysts to assist corporate decision making in the West, are the very same techniques needed for efficient decision making by central planners in the East. Economic science is now visible, then, as consisting of a mathematics of decision making which transcends institutional differences: what is valid for capitalist firms is valid, in principle, for socialist societies.
Missing the Point
Now, we must readily concede several important elements of validity to this view. The abstract character of managerial decision making is, given the sets of ends and means held respectively to be relevant, indeed the same for all levels of decision making. Moreover, within a given ends-means framework, the problem facing the decision maker is indeed a mathematical one. In this context the development of activity analysis, or operations research, has been and will continue to be of extraordinary significance and usefulness. But it is a mistake to see this mathematics of optimal allocation and decision making — enormously valuable though it unquestionably is — as making up essentially the intellectual contribution of economic science. And, perhaps even more important, the uncritical assumption that application of the techniques appropriate to securing resource-allocative efficiency at the level of the firm, to the level of planning for a whole society, can achieve corresponding social "efficiency," — begs entirely those questions which are at the heart of economics.
When Lionel Robbins in 1932 defined economic science as concerned with the implications of man’s resource-allocative decisions, he did not mean that the central task of economics is to provide techniques for efficient allocation. Nor, it should be emphasized, was he referring at all to the concept of the "social" allocation of resources. (In fact the latter concept, while central to so many introductory textbooks and to so much work in theoretical welfare economics, is a highly dubious one.`’-) Robbins was simply defining economics as concerned with the social consequences of the circumstance that decision makers do in fact seek—each within his own framework — to achieve efficiency. Economics, in this view, is concerned not at all with how to achieve individual or social efficiency; but rather with the social forces generated impersonally by the interaction of numerous decision makers each of whom is seeking to allocate his resources optimally. In assuming that the efficiency which firms can achieve by operations analysis, can be achieved for "society" by the use of similar techniques on the part of central planners, one is in fact ignoring the conclusions of Robbinsian economic science. The matter is of course vitally bound up with Mises’ pioneering demonstration in 1920 of the necessary failure of socialist economic calculation. The immediate issue was perhaps most clearly stated by Hayek many years later:
What is the problem we wish to solve when we try to construct a rational economic order? On certain familiar assumptions the answer is simple enough. If we possess all the relevant information, if we can start out from a given system of preferences, and if we command complete knowledge of available means, the problem which remains is purely one of logic….
This, however, is emphatically not the economic problem which society faces….
The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate "given" resources — if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data". It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.3
Here, in this 1945 statement by one of the 1974 Nobel laureates in economics, we have the definitive critique of the confusion we have seen to surround the award of the 1975 prizes.
The Knowledge Is Lacking
To be able to discuss allocative decision making at all, it is necessary to presume that the decision maker has knowledge of the sets of ends and means with respect to which efficient allocation is sought. But absence of such knowledge in centralized form is precisely what in fact constitutes, for Hayek, the economic problem facing society. To assume, therefore, that even the most powerful and sophisticated of mathematical techniques can achieve for society the efficiency they can win for the firm, is to overlook the essence of the economic problem with which society must grapple.
One of the achievements of the market is that it generates impersonal forces which govern the size of firms. Firms which are "too small" find themselves facing opportunities for profitable expansion or merger. Firms which are "too large" find themselves at a disadvantage when facing the competition of smaller, nimbler competitors. What determines whether a firm is "too large" depends on many considerations.} Certainly one consideration of overriding importance has to do with the difficulty, in large organizations, of funneling the information necessary for efficient central decision making, to those entrusted with the organization’s management. The market tends to limit the sizes of its decision making units to permit optimal deployment of planning techniques within these units, while harnessing the "invisible hand" of the market to achieve a tendency towards coordination between these units. All this is very much at the center of economic science, — although it shares little indeed of the mathematical character of the theory of resource allocation techniques.
An Improper Assumption
Simply to assume that society as a whole can be organized as a single firm, run as a centrally planned organization, and thus be able to employ the techniques of activity analysis, is to overlook what Hayek, at least, perceived, in effect, as the core concern of economic science. To be sure, the eminent scholars who pioneered in the development of mathematical al-locative techniques are not, other points of possible vulnerability aside, to be criticized for assuming entirely correctly that these techniques can be useful wherever allocative decisions are in a position to be made. But we do have the obligation to point out that the economic problem facing society concerns precisely those circumstances under which, in fact, allocative decisions are not in a position to be made.
Economics has, ever since Mises, had a very great deal to contribute on why such circumstances are inevitable; and ever since Adam Smith economics has had a great deal to say about how, under such circumstances, the economic problem faced by society comes to be solved. Those who understand the enormous social significance of economic science as it has developed over the past two centuries, cannot therefore but be profoundly disturbed by the continued evidence that the core contributions of the discipline have simply not been noticed by those in the best position to do so. The story of the 1975 Nobel Memorial Prize in Economics suggests indeed that the light shed by economic science continues to fall on an as yet altogether incompletely illuminated intellectual landscape. All these are indeed uncomfortable, but nonetheless apparently inescapable, reflections.
1 In fact Koopmans’ footnote citation of Kantorovich’s work refers to him as "the Russian mathematician", (T. J. Koopmans, Three Essays on The State of Economic Science, McGraw-Hill, 1957, p. 68n.)
2 On this see J. M. Buchanan, "What Should Economists Do?", Southern Economic Journal, January 1964.
3 F. A. Hayek, "The Use of Knowledge in Society", American Economic Review, September, 1945; reprinted in Individualism and Economic Order, pp. 77f.
4 See the classic paper by R. H. Coase, "The Nature of the Firm", Economica, November, 1937; reprinted in G. J. Stigler and K. Boulding, eds., Readings in Price Theory, Irwin, 1952. See also A. A. Alchian and H. Demsetz, "Production, Information Costs, and Economic Organization", American Economic Review, December, 1972.
THE EMPLOYMENT of the means of production can be controlled either by private owners or by the social apparatus of coercion and compulsion. In the first case there is a market, there are market prices for all factors of production, and economic calculation is possible. In the second case all these things are absent. It is vain to comfort oneself with the hope that the organs of the collective economy will be "omnipresent" and "omniscient."
LUDWIG VON MISES, Human Action