Bowles, Kirman, and Sethi have a new paper out in which they reconsider Hayek.
Bowles is an interesting neo-Marxist thinker. I was first introduced to his research a few years ago when he released a study claiming that inefficiencies result from inequality on a free market, because resources are wasted when they are channeled into the protection of private property. He calls this kind of waste “guard labor.”
In a certain sense his theory is sound; the protection of private property is a cost. If no one ever stole anything, we could devote more resources into productive enterprises, but as long as some are willing to steal, the cost of defense against theft is necessary. It would be far costlier to forgo effective protection of property rights. Without widespread adherence to property rights, there are too many externalities, and maintaining an advanced economy isn’t feasible.
Bowles makes a different argument though, that it would actually be more efficient to institutionalize redistribution instead of devoting as many resources as we currently do to protect against theft. This seems like pretty standard Marxist conflict theory. His radical empirical claims, that one in four are employed to guard the wealth of the rich, and that we could expand the production-possibility frontier by institutionalizing redistribution, are pretty suspicious. Won’t redistribution be plagued by the local knowledge problem?
The new paper on Hayek directly challenges the local knowledge problem, on three fronts:
- The instability of price adjustments
- Speculation, which erodes the integrity of the price signal’s information about consumer preferences, relative scarcity, etc.
- Hierarchical organizations failing to make decisions as individuals would
I’m glad that some leftists are taking Hayek seriously. Let’s break down each claim.
A contrived model
The paper elaborates on a glaringly contrived model of a simple economy. The model suggests:
- An economy of wine and bread producers who are perfectly specialized in their production, but consume both goods in fixed amounts, as perfectly complementary goods
- A wine producer, mistakenly expecting a weak bread harvest, lowers his wine prices to stock up on bread
- Bread producers mistake the lower wine prices as a signal for an increased wine supply, and increase their consumption of both wine and bread
- The bread producers’ increased bread consumption increases the scarcity of bread
- Wine producers are forced to lower prices even more to obtain bread for their complementary preferences
- The wine market collapses and the wine producers are left languishing in poverty while the bread producers gorge themselves
The patently absurd underlying assumptions of this model are:
- The original wine producer who was mistaken about the bread harvest can’t correct his mistake and adjust prices
- The economy consists only of perfect complementary goods
- Beliefs among bread producers about the abundance of wine are given only from the price
This model is so unbelievably disconnected from reality. Seriously, is there any person in the universe who would be convinced by this?
The paper concedes that at equilibrium, information coordinates resources quite efficiently, but questions how a price could be stable, and therefore useful, after being wildly disrupted, such as in the instance of Walrasian tatônnement. I don’t know what this means. Prices are sometimes volatile? Who cares? This just seems pedantic.
The paper explains that Hayek’s ideas about the price mechanism apply to fundamental analysis, but don’t apply to technical analysis. Maybe Hayek didn’t have technical analysis in mind, but perhaps given the right conditions, technical analysis could provide innovative and useful information. I don’t have a strong opinion on this.
In describing the 2008 financial crisis though, they seem unaware of the narrative that the central planning of governments obfuscated important signals, thereby preventing sustainable growth in the financial sector. Sure, the bubble was indeed a sort of “dark” spontaneous order, “the result of human action but not of human design,” but Hayek never asserted that the business cycle could be eliminated. The paper is attacking a straw man. Hayek was just wary that central planning could make business cycles much more painful.
The paper discusses how the local knowledge problem doesn’t just affect government on the societal level, but also affects management within an organization. Hayek was well aware of this as well. It’s a straw man to claim that he thought firms were perfectly rational. On the contrary, Hayek was concerned with human ignorance in all contexts.
The paper also touches on Coase’s insight that firms exist to minimize transaction costs, and Ostrom’s insight that social norms can function as a substitute for coordination when markets aren’t feasible, which are both good and important concepts that are complementary to Hayek’s corpus.