Thursday, 19 April 2007

How a beautiful illusion is born from a fatal conceit

At his inaugural lecture, Professor G.L.S. Shackle gave a brief outline of what was required to be a “complete economist”:

“To be a complete economist, a man need only be a mathematician, a philosopher,
a psychologist, an anthropologist, a historian, a geographer, and a student of
politics; a master of prose exposition; a man of the world with the experience
of practical business and finance, an understanding of the problems of
administration, and a good knowledge of four or five languages. All this in
addition, of course, to familiarity with the economics literature itself.”
Few, understandably, live up to this demanding standard. One of those who came closest to doing so was Friedrich Hayek, at least according to G. R. Steele, Lecturer in Economics at Lancaster University Management School. Steele was launching his new book, The Economics of Friedrich Hayek, at Policy Exchange.

In fact, as Steele freely admitted, the book was about far more than economics, as Hayek was far more than an economist: indeed, he is recognised and taught in politics, sociology, philosophy and psychology, but economics courses usually ignore him; an essay on him by Steele was rejected by one (unnamed) economics journal on the grounds that their readers would not be interested in the history of economics (if only the same excluded tracts on Keynes!).

Hayek took a dim view of both Micro- and Macro-economics: the former a mathematical extraction that ignores social and institutional contexts, assumes perfect knowledge and rational behaviour, and sees no value in entrepreneurship; the latter a rationale for intervention based on broad measures which politicians could then seek to influence ( a view which the politicians were surprisingly keen to embrace!). For him, economics was a subset of a broad theory of human action founded upon social theory and psychology, and needed to reflect the fallible, partial and dispersed nature of knowledge.

This was the basis for Hayek’s defence of freedom and the market economy. No policy maker, no bank of civil servants, no computer in the basement, can ever capture the extent and subtlety of the knowledge that resides within each individual actor, and so can never improve upon the judgements of individuals exercising “particular knowledge [in a specific] time and place”. Steele might have added Lionel Robbins’ observation that economics is the interaction of scarcity and desire, so that individuals must assess for themselves what a commodity (car, medicine, an hour of one’s time) is worth. Thus Hayek realised that central planning – the second guessing of millions of citizens operating independently – was both a “beautiful illusion” and a “fatal conceit” that would destroy productivity, efficiency, liberal institutions, the rule of law, and ultimately civilisation itself. It is a big claim, and was the subject of Hayek’s most famous book.

Why, then, was (and, even more surprisingly, is) socialism so popular, particularly among the educated middle-classes. Hayek’s explanation was acerbic: “One’s initial surprise at finding that intelligent people tend to be socialists diminishes when one realises that, of course, intelligent people will tend to overvalue intelligence …” It flatters us to believe that we can exercise a guiding hand over something as vast and chaotic as the economy – itself nothing more than the expression of our wishes and our capabilities. It lets us play at being Olympians, shaping the lives and fortunes of mortal men far below. In fact there is only one hand that can truly guide the economy, an invisible hand subject to no single will.

Socialists have no “understanding of economic processes”: the price system and the mechanisms of the market leave them cold. Socialists fail to allow the vast amount of dispersed and tacit information to express itself, and so the economies they guide underperform. This in turn encourages them to seek to break through the torpor with ever more authoritarian measures: in Britain it was price controls, which destroyed industry; in China it was a concentration on the production of steel to the exclusion of food, which destroyed lives.

In 1974 Hayek was awarded (half) the Nobel Prize for economics. In his acceptance speech, he noted that he would have advised against creating such a prize, which would “tend to accentuate the swings of scientific fashion”, though in his case “the selection committee has brilliantly refuted [this fear] by awarding the prize to one whose views are as unfashionable as mine are.”

He was more worried, however, by the effect it may have on the recipients themselves, and their impact upon public policy: “the Nobel Prize confers on an individual an authority which in economics no man ought to possess… I am not sure that it is desirable to strengthen the influence of a few individual economists by such a ceremonial and eye-catching recognition of achievements… [The committee should,] on conferring the prize, remind the recipient of the sage counsel of one of the great men in our subject, Alfred Marshall, who wrote: ‘Students of social science, must fear popular approval: Evil is with them when all men speak well of them’.” Such acclaim was never granted to Hayek himself.

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