I Misunderstood Hayek

Market information isn't only distributed locally. It is generated locally too.

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Because I'm in the middle of a move and teaching a business ethics class — it is a hoot, happy to share the syllabus — I was too swamped to post something original. So this is a piece from a few years ago that is one of my favorites. Enjoy!

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When I first discovered Friedrich A. Hayek’s work on information and markets, it struck me as brilliant. The simple observation that practical information is often widely distributed across societies and markets seemed not only brilliant, but also underappreciated in philosophy. Just consider the specialized knowledge and expertise it takes to make a peanut butter and jelly sandwich—not merely by assembling a few premade ingredients from the supermarket, but by making the sandwich from scratch. Each individual simply lacks the information and expertise to make a peanut butter and jelly sandwich from scratch. As I wrote in a past Substack post:

There are many ingredients to a peanut butter and jelly sandwich, not to mention the components needed to process, pack, and ship those ingredients. Start with the bread: to make the bread one would need to know things like how to domesticate wheat, how to produce farm equipment to grow and harvest the wheat, how to produce fertilizer—along with the equipment required to manufacture farm equipment and tools. Just think about the many inputs needed to produce the rubber that makes up the tires on the tractor one may use to harvest wheat. And that’s just some aspects of producing wheat, not to mention the processes needed to produce the bread, the machinery needed to bake it, the energy needed to run the machine(s), and so on and so forth. The same point applies to the peanut butter and the jelly too. So, really, in a fundamental sense, no individual knows how to make a peanut butter and jelly sandwich. And that is a relatively simple object.

As Hayek himself writes:

[It] is almost heresy to suggest that scientific knowledge is not the sum of all knowledge. But a little reflection will show that there is beyond question a body of very important but unorganized knowledge which cannot possibly be called scientific in the sense of knowledge of general rules: the knowledge of the particular circumstances of time and place. It is with respect to this that practically every individual has some advantage over all others because he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active cooperation.

And that’s right—to a point. Hayek does hold that a great deal of practical information is widely dispersed throughout the population, such that no individual knows how to do much of anything by themselves. In modern societies, it’s often better for people to specialize in producing or offering goods or services, as a means of increasing worker productivity and improving overall prosperity.

However, this isn’t the deep insight for which Hayek deserves the most credit. Hayek’s real target is the centralized planning of the economy. And here, his argument is often misunderstood. It’s commonly taken to be a claim that the problem of widely dispersed information simply makes central planning too difficult for a committee of people to pull off. At this point, critics will often respond: well, fine—but if that’s the issue, then we just need more computing power. If only we had a sufficiently powerful supercomputer or AI, then we could design the economy, having solved the problem of gathering widely dispersed information with the aid of a very powerful machine.

But appealing to supercomputers and AI won’t solve the Hayekian challenge to the feasibility of a centrally planned economy. The reason is that the problem Hayek diagnosed isn’t simply that the relevant information is dispersed across society and the economy—though that’s a problem too. The deeper issue is that markets generate the information that central planners would need in order to plan a prosperous economy. No supercomputer or AI could solve the problem of generating information in the form of prices. As economist Michael Munger explains:

Suppose that our society has perfect information about the amount, quality, and location of all the resources available in every barn, closet, nook, and cranny of the economy. All this information is stored in an infinitely fast computer, meaning that computations are all performed instantly, with zero lag. One thing we have to decide is how to produce a widget. There are two production processes, one that requires ten pounds of iron, and the other requires an ounce of gold. Which should we select? … The limiting factor is not calculating power, it is the capacity of a system to generate information.

Why? Munger continues:

There’s the problem. Prices are not given; they are not inputs to allocation decisions. Prices are the result of millions of people, all over the world, simultaneously choosing and reacting to the feedback that dynamically adjusting prices reveal about the consequences of choices by others […] Having the amounts of resources in a database tells you very little. Only the fact that an ounce of gold costs more, in terms of value foregone, answers the question. But that information is not calculated by markets—it is generated by markets.

My own misunderstanding of Hayek was this: I thought the issue with centralized planning was just that the salient information is often (though not always) widely distributed across society. But it’s not just that. The key insight is that market interactions between consumers and producers, buyers and sellers, are what generate the price information necessary to coordinate economic activity. And if that’s right, then the problem of planning a prosperous economy—without the aid of markets—is even deeper than I first appreciated.