Monday, October 15, 2012

Some Current Economic Considerations Base on Hayek's "The Use of Knowledge in Society"

Friedrich Hayek's "The Use of Knowledge in Society" is one of the most cited and read pieces of economics of all time. The piece was advanced as a defense of free markets against centralized planning and,while Hayek has been tentatively adopted by some parts of the political right, it has a depth of thinking that means he cannot be reduced to a "wooden insistence" on the free market above all else. Times have changed and the free market is here to stay. But I wish to revisit his discussion of "special knowledge" in light of income inequality and the environment. I see the key bit of the piece revolving around "special knowledge of circumstances of the fleeting moment not known to others." This is also expressed as "knowledge of the particular circumstances of time and place." Examples Hayek points to are knowing that a machine is not fully employed and can be put to better use, or that some person has skills that can be better utilized, or knowledge of tramp-steamers that are only partially filled so a few extra goods can be shipped at a good price. Hayek sees this kind of special knowledge as generally held in disrepute, and seen as slightly unfair or crass. Thus the value of markets, which do a good job of communicating this kind of information to individuals engaged in non-coordinated or decentralized planning, are also disparaged. Now for my points. Herbert Simon has noted that ever since Adam Smith (who disparaged all institutions, including Oxford), we have in fact seen a rise in the amount of economic activity that occurs within organizations. 80% of current economic activity occurs within organizations and only 20% outside in what can properly be considered markets. This means a large portion of economic activity is coordinated, organized, and standardized. I suggest that this means all special knowledge is not of the same value. A special knowledge of how a particular machine works will only be of great value if there is something special about that machine. The machine may very likely be replaced, or moved to China. A special knowledge of particular tax codes, and how to use them with your business strategy if you're head of a major corporation, however, may be very valuable. As may a special knowledge of the personalities and bottom lines of a few other CEOs. Thus the relative availability of valuable special knowledge could explain inequality. This would also suggest that it will be very hard to root out such inequality. Broad based simplifying the rules of the game might be a start which Hayek would approve of. Environmental externalities are well known to not be communicated through markets. They can be dealt with through "command and control" or economic policy instruments, but in both cases intervention of a centralized planner is generally called for to set up the policy regime. Standard setting is an engineering (command and control) task and one that the U.S. EPA has been able to do generally well. But as the costs of meeting standards has risen, interests in economic policy instruments has risen. One solution is to start pricing ecosystem services, i.e. the market value of goods people receive from nature. While I support this effort, I am skeptical that it will yield the rational policy instrument many of its backers hope for. In many cases the value of a particular environmental feature is tied up in special knowledge. The value of that stream may be partly tied to sediment and nitrogen reduction and flood control. But whether it is valued by someone because it is far away and pristine, or whether it is next to houses and a group of children particularly enjoy wading in it, is very much a case of special knowledge. One with apparently identical characteristics may be viewed as a nuisance. Thus, I would suggest that the ecosystem services work will generally be more useful for educational purposes rather than yielding any strong rational planning framework.