5.1.5 Historical context: an argument about knowledge in markets

Back to 5.1.4

Unit 5 Contents

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

But before we turn to the documents of CST, it will be helpful to add one more element into this description of the historical context of the current debate.

I mentioned Friedrich Hayek above.  He was an Austrian who spent most of his life as a professor in Britain and the USA.  More than anyone, he was the figure whose work inspired the growth of neoliberalism.  If you have time, take a look at the Wikipedia entry about him.

—————————————————————

Optional reading (c.14pp)

Wikipedia entry: Friedrich Hayek

——————————————————————

I am referring to Hayek because one argument he made is especially significant and it is not inherently connected with capitalism in the narrow sense of this term.  Think of a local market selling, for example, fruit and vegetables, clothes, household goods and CDs and DVDs.  In writing this, I have in mind one market near where I live – see East_Street_Market.  No doubt you’re familiar with similar local markets.  While they comprise a range of stalls, each such local market is unique and, to some degree, incorporates local customs and practices.  Hundreds or perhaps thousands of people come to buy different things each day, each purchasing a unique set of goods.

Hayek made an argument about knowledge in markets.  He pointed out that each seller brings a lot of specific knowledge about their products – where they are sourced, their good and bad points, how they can be best used, etc.  Likewise, buyers bring a huge amount of knowledge simply of what they need and want, which informs whether they buy bananas or plantains, size 9 or size 8 shoes, or food for just two people or for a family of six.  Just think how much knowledge is brought to bear during a single day’s trading at such a market – an incalculable quantity of knowledge about products for sale and what people need and want to buy.

Hayek contrasted this dispersed knowledge in markets with such knowledge as it is possible for state officials to have in a system of state control of economic activity.  He argued that a group of bureaucrats in an office block can never accumulate anything close to the amount of knowledge that exists in a market.  The consequence of this, he argued, is that it would be impossible for state administrators to determine the distribution of goods and services in anything like as effective a way as the diverse knowledge that people bring to markets makes possible.

For Hayek, this argument about knowledge was a very powerful reason why decisions about distribution of most goods and services are best made by a multitude of people in markets and not by administrators in a state bureaucracy.  He regarded this argument as relevant for economic decision-making across the economy, not just in local retail markets.1

Many people, on both the right and left in politics, have found this to be a very powerful argument.  In the final years of the Cold War, recognition of how badly the state-administered economies of the Communist countries had done, relative to the market economies of the West, appeared to give clear evidence of its force.  The problem was that state socialism had simply bitten off more than it could chew.  Public administrators can never acquire the quantity of relevant knowledge necessary for making decisions about the quantity and price of products on behalf of a large numbers of people.  It is far better for these people to bring their own knowledge to market places and to make use of it directly.  Bureaucrats who lack such knowledge are bound to do a worse job.

While this is certainly a compelling argument, it is important to recognize immediately that it doesn’t apply equally to all kinds of goods.  As all economists recognize, there are some goods that, if they are supplied at all, are supplied to everyone – such as street-lighting or defence forces that protect a country from attack.  Nobody can be excluded from benefiting from these goods.  This means that they simply can’t be supplied in markets at all, i.e. by being offered for sale by individuals, but have to be supplied by public authorities.  Economists call them ‘public goods’.

There are other goods that could be supplied through markets, but the very nature of the goods means that this could not be done in a way consistent with human dignity and justice.  An obvious example, most people agree, is health care.  The reason why markets are not good at supplying health care is two-fold.  Unlike in Hayek’s argument, the ‘buyers’ often don’t know what they need – because only the ‘supplier’, the doctor, has the expertise to tell them what treatment they should have.  So the suppliers hold most of the knowledge – it is not dispersed across the marketplace.  Second, what people need is dramatically unrelated to their ability to pay – they might be very poor but happen to have an illness that requires expensive medication.  If their treatment were left to market exchanges, they would remain ill or die.

Another example, one which has emerged clearly in recent years, some of the financial products offered by banks.  In the UK, one huge scandal has been to do with something called “payment protection insurance”.  During the years after 2000, all the major banks sold this to a large number of people for whom it could have negligible benefit or none at all.  It is now recognized that, as an article in The Times put it, a basic problem here was “the asymmetry of financial knowledge that exists between [banks] and their customers”.2. In other words, given the products’ complexity, the banks had vastly more knowledge about them than the customers could possibly have, giving the banks great power to abuse their position.  They were in this respect like doctors, but with the difference that in general the banks saw their customers as means from which to make profit – and so sold them products that were basically useless to them.

In these examples, the doctor and banker have far too much knowledge, relative to the ‘customer’, whereas economic planning bureaucrats have far too little knowledge, relative to both suppliers and customers.  These examples show that Hayek’s case depends on suppliers and purchasers in markets having at least roughly equivalent access to relevant knowledge.

Nevertheless, Hayek’s argument has proved a very powerful one in favour of supply of most goods – primary products, manufactured goods, and services – being through markets, rather than on the basis of bureaucratic decisions about quantity and price.

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

Reflection

What do you make of this argument about knowledge in markets?  Can you relate it to your own experience of buying and, perhaps, selling?

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

It was this argument made by Hayek, the philosopher of neoliberalism, that contributed probably more than any other economic argument to ending the Cold War contest between ‘capitalism’ and ‘state socialism’.

Despite this, however, we need to notice one very important point for the on-going, twenty-first century debate about economics, and especially about capitalism. That argument of Hayek’s is about knowledge in markets, not about ‘capitalism’ in the narrow sense.  It is not about whether people acting in markets are or should be driven by the objective of maximizing return to capital.

At the end of the Cold War, ‘capitalism’ seemed to win.  But strictly speaking, the main economic argument that won was for the advantages of markets over state control, not for ‘capitalism’ in the strict sense of the term.

I end this outline of the historical context of current debate about economics and business with that point because we find in CST a position which rejects ‘capitalism’ in the strict sense, but which strongly affirms the benefits of markets, and so is consistent with the insight in that particular argument of Hayek’s. Since the recent financial crisis, the credibility of neoliberal capitalism has been vulnerable to serious challenge, which gives a new opportunity for advocacy of what we find in Catholic Social Teaching.

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

Reflection

No doubt you have been aware of the severe crisis in finance and banking of recent years, whether you have closely followed it or have only heard a few news bulletins about it.

What are your reactions to it?  Are you generally resigned to the view that profit-making is what drives the world and there’s nothing that realistically can be done to change it, even though there might be crises and recessions from time to time?  Or do you think that private business, including the banks and other financial companies, really could do things differently?

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

End of 5.1.5

Go to 5.1.6 McCarthy on ‘Modern Economy’, and a lacuna: ‘social capitalism’

Copyright © Newman University.  If you wish to quote from this page, see Citation Information. N.B. If you are a student and make use of material on this page in an assignment, you are obliged to reference the source in line with the citation information.


  1. An early and definitive statement of this argument is F.A. Hayek, ‘The Use of Knowledge in Society’, American Economic Review, 35.4 (1945), 519-530.  A pdf of the original article can be accessed (Apr. 2014) at: http://home.uchicago.edu/~vlima/courses/econ200/spring01/hayek.pdf

  2. A. Ellson, ‘Analysis: Pragmatism not contrition from the banks’, The Times, 10 May 2011 

Go to Top