Saturday, March 30, 2013

Hayek on the “Use of Knowledge in Society”

The “knowledge problem” according to Hayek consists in explaining how a market economy overcomes the problem of dispersed, decentralised knowledge of supply and demand and the many individual plans and preferences of both consumers and producers. His classic article on the subject was published in 1945 in the American Economic Review (35.4 [1945]: 519–530).

But, curiously, various Austrians – mainly Misesians and Rothbardians – are unsatisfied with Hayek’s paper. Even Kirzner complains that in the “Use of Knowledge in Society” Hayek made “it appear that the function of prices in communicating knowledge was a function that is filled, in principle, also in the state of equilibrium” (Kirzner 2000: 157).

Salerno argues that Hayek’s “knowledge problem” is different from Mises’s “socialist economic calculation” problem, and even Kirzner concedes that Mises did not formulate the “calculation problem” in terms of knowledge (Kirzner 2000: 158).

What is Hayek’s argument?

The economic data for a whole society are never given to a single mind (Hayek 1945: 519) or given to any person “in its totality” (Hayek 1945: 520). A rational economic order is characterised by a state of affairs in which the relevant information exists “solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess” (Hayek 1945: 519). Planning is obviously done by very many individuals in a decentralised manner (Hayek 1945: 521).

Therefore the “various ways in which the knowledge on which people base their plans is communicated to them is the crucial problem for any theory explaining the economic process” (Hayek 1945: 520). At the same time, specific knowledge of “particular circumstances of time and place” is also very important (Hayek 1945: 521): that is, the knowledge that individual business people have of their markets, stocks, trades and capital goods, and so on.

In dealing with economic change, the best people to make the decisions are those who know their businesses, resources and markets: the “man on the spot,” as it were (Hayek 1945: 524).

Yet business people need to fit their decisions into the “whole pattern of changes of the larger economic system” (Hayek 1945: 525).

For Hayek, the price system communicates this knowledge (Hayek 1945: 526). As an example, Hayek thinks of an increase in demand for tin. The price of tin rises: buyers of tin now know they must economise tin.

What are the problems with Hayek’s theory?

We can set the problems out below:
(1) the implied assumption of Hayek’s argument (so his Misesian critics argue, perhaps not unfairly) is an economy near equilibrium, or (that is to say) in a “proximal equilibrium” state.

(2) the failure of Hayek to understand the role of Knightian uncertainty;

(3) the role of fixprice markets and administered prices, and

(4) the destabilising role of speculation in prices.
First, the role of “proximal equilibrium.” Hayek briefly nods his head at the reality that price adjustments in the real world are never “perfect” as in equilibrium analysis (Hayek 1945: 527), but his actual theory does require reasonably flexible – if not perfect – price adjustments in all markets. It is no surprise that even Austrian critics of Hayek complained that his theory treats the world as if it is in a state of “proximal equilibrium.”

Salerno contends that:
“as Hayek points out, in order for prices to fulfill their knowledge-disseminating and plan-coordinating functions, the economy must subsist in a state of what I will call ‘proximal equilibrium,’ wherein realized prices are always fairly accurate indicators of future prices.” (Salerno 1993: 128; cf. Horwitz 2004: 314–315).
That is a wholly unrealistic idea.

Secondly, more serious difficulties emerge in Hayek’s neglect of Knightian uncertainty:
“Uncertainty for Hayek means that each individual decision maker only has a small piece of the puzzle. However, as a whole, the aggregated set of all decision makers have a complete set of all relevant knowledge. There are no pieces missing, lacking or unavailable from the puzzle. Market prices organize and synthesize the aggregate amount of knowledge so that market price signals, understood only by savvy, knowledgeable entrepreneurs, [eliminate] … any uncertainty.” (Brady 2011: 14).

“Keynes, Knight and Schumpeter deny Hayek’s claim that the market generates price vectors which concentrate the knowledge so that savvy, knowledgeable entrepreneurs can act on this information and solve the problem of uncertainty. Uncertainty means vital important information is missing. Pieces from the puzzle are missing and will not turn up in the future” (Brady 2011: 14).

“Hayek could not accept the standard concept of uncertainty as defined by Keynes, Knight and Schumpeter because it would then be impossible for market prices to concentrate knowledge that did not exist. In conclusion, nowhere in any of Hayek’s three articles on Knowledge in Economics in 1937, 1945 and 1947 does Hayek deal with the standard view that uncertainty means knowledge that is not there.” (Brady 2011: 15).
Thirdly, factor (3) above – the extensive role of fixprice markets – means Hayek’s vision is deeply flawed.

Prices that remain essentially rigid in response to demand changes (quite frequent in the real world) cannot have the knowledge-communicating role of Hayek’s theory.

And finally Hayek’s theory never considers the destabilising role of commodity speculation. How can relevant information be communicated if prices are distorted by speculative activity, and therefore are not related to underlying supply and demand?

Finally, there is one statement in the paper that Hayek never develops:
“We must look at the price system as such a mechanism for communicating information if we want to understand its real function—a function which, of course, it fulfils less perfectly as prices grow more rigid. (Even when quoted prices have become quite rigid, however, the forces which would operate through changes in price still operate to a considerable extent through changes in the other terms of the contract.)” (Hayek 1945: 526).
It never occurs to Hayek that, in the advanced capitalist economies of his day, prices had already grown rigid in many markets because of administered prices. Yet economic coordination continued to occur, and economic growth and markets continued to function, and after 1945 far better than in previous periods.

And what other forms of the business contract allow economic coordination without flexible prices? Hayek never tells us, but in reality it is “quantity signals” that are the fundamental factor in fixprice markets that equate supply and demand, but Hayek never understood that.

Probably he never properly understood it at any point in his life.

In short, the price system mostly has a secondary coordination role in modern markets: “in actual adjustment of supply and demand, prices play only a very subordinate role, if any” (Kaldor 1985: 25).


Brady, Michael Emmett. 2011. “Comparing J.M. Keynes’s and F. von Hayek’s Differing Definitions of Uncertainty as it Relates to Knowledge,” January 30.

Hayek, F. A. von. 1945. “The Use of Knowledge in Society,” American Economic Review 35.4: 519–530.

Horwitz, S. 2004. “Monetary Calculation and the Unintended Extended Order: The Misesian Microfoundations of the Hayekian Great Society,” Review of Austrian Economics 17.4: 307–321.

Kaldor, Nicholas. 1985. Economics Without Equilibrium. M.E. Sharpe, Armonk, N.Y.

Kirzner, Israel M. 2000. The Driving Force of the Market: Essays in Austrian Economics. Routledge, London and New York.

Salerno, Joseph T. 1993. “Mises and Hayek Dehomogenized,” Review of Austrian Economics 6.2: 113–146.


  1. I just started reading Will Hutton's "The Revolution That Never Was - An Assessment of Keynesian Economics".

    Really worth a look.

  2. Thanks for your post and the bibliography.

    I am actually surprised by the claim of Brady (2011) (but I will read the paper) that "Hayek could not accept the standard concept of uncertainty as defined by Keynes, Knight and Schumpeter".

    Indeed, Knight's notion of uncertainty describes situations where the future cannot be foreseen with measurable probability. It is "impossible to form a group of instances because the situation dealt with is in a high degree unique". "The best example of uncertainty is in connection with the exercise of judgment or the formation of those opinions as to the future course of events, which opinions (and not scientific knowledge) actually guide most of our conduct."

    And this is, I think, actually what Hayek had in mind in "The use of knowledge in society" when he wrote:

    "I should briefly mention the fact that the sort of knowledge with which I have been concerned is knowledge of the kind which by its nature cannot enter into statistics and therefore cannot be conveyed to any central authority in statistical form. The statistics which such a central authority would have to use would have to be arrived at precisely by abstracting from minor differences between the things, by lumping together, as resources of one kind, items which differ as regards location, quality, and other particulars, in a way which may be very significant for the specific decision. It follows from this that central planning based on statistical information by its nature cannot take direct account of these circumstances of time and place".

    "The continuous flow of goods and services is maintained by constant deliberate adjustments, by new dispositions made every day in the light of circumstances not known the day before."

    Not known the day before, precisely because it is true future uncertainty in Knight' sense.

    Regis Servant.

    1. Thanks for your comments.

      I have looked at the Hayek quotation again, but I do not think he is really thinking of Knightian uncertainty there.

      His chief point is that statistical aggregates (p. 523-24) do not convey to central planners the needed day to day information required for production plans. That is, local information is needed.

      But the investment decisions require information about medium to long-term future variables, information that is not communicated by current prices.

      The "information" does not exist and you can't have quantifiable risk here.

      Yet Hayek is implying that the current price system communicates the relevant information.

  3. Sorry for the off topic link, LK, but have you read Wall Street by Doug Henwood? (available for download at As it pitches itself as more of an introductory text into the workings of the financial markets you probably know a lot about what it's talking about already, and it's a bit outdated now but there's a lot of good, interesting data about the real functions of the stock markets (it seems that the supposed key function of raising capital appears to be a very small part of what the stock market does, for instance)

    1. I have actually read parts of that book but quite a few years ago now.

  4. Has modern information technology invalidated some aspects of Hayek's argument any way? I can just imagine "Hayekian" parcel delivery tracking. You call the delivery company to find the status of something you ordered from across the country, and the clerk says, "I'm sorry, but the knowledge of your parcel's location is dispersed and localized, and beyond the ability of any one mind here at headquarters to know."

    Yet in 2013, you can go online and track every stage of your parcel's journey from vendor to doorstep.

    For another example, on several occasions a clerk at my bank has called me on my cell phone because the bank's software detected what it considered unusual purchases with my debit card, and the clerk wanted to confirm that i had, in fact, authorized those transactions. I doubt that Hayek anticipated that this kind of fine-grained remote information gathering and analysis of an individual's economic activities would ever become possible.

    1. I think you are on to something here. Yes, Hayek probably never dreamed of such things.

      But, of course, even with all this technology, the business person still faces incalculable risk (Knightian uncertainty).