How Hayek’s Evolutionary Theory Disproves His Politics
He was arguing with Stalin, not Norway.
As an evolutionist critiquing the field of economics, I felt like a disciplinary outsider until I encountered the work of Friedrich Hayek. The Austrian economist was himself critical of Walrasian general equilibrium theory and proposed a radical alternative: Economic systems are a form of distributed intelligence that evolved by cultural group selection. They work without having been designed by anyone.
That was my area of expertise. I had to admire Hayek as a pioneer, especially since group selection was a heresy and the study of human cultural evolution was in its infancy when he wrote. Nevertheless, both topics have advanced by leaps and bounds since then and do not support his view that economic systems work best in the absence of regulations. Instead, cultural group selection theory points to a middle road between laissez faire and centralized planning that is rich with possibilities.
More recently, three distinguished economists—Samuel Bowles, Alan Kirman, and Rajiv Sethi–have made their own assessment in a retrospective titled Friedrich Hayek and the Market Algorithm published in the Journal of Economic Perspectives. (And their Vox post The Market Algorithm and the Scope of Government: Reflections on Hayek) All three are well read in my discipline of evolutionary science in addition to their economic credentials. Sam recently published The Moral Economy: Why good incentives are no substitute for good citizens, and wrote a piece based on, it for Evonomics. As part of the CORE (Curriculum Open-Access Resources for Economics) he is also co-author of a new free online introduction to economics at www.core-econ.org.
I count Sam as one of my mentors and was proud to work with Alan to edit a MIT Press volume titled Complexity and Evolution: Toward a New Synthesis for Economics, based on a conference that we helped to organize under the auspices of Germany’s Ernst Strungmann Forum, which included Rajiv as a participant. I interviewed Alan on the concept of laissez-faire in 2014, which included a discussion of Hayek. Their jointly authored work, along with a recent op ed by Sam provided a golden opportunity to have a conversation with him.
DSW: Welcome, Sam! I look forward to this conversation. What would you say are the most positive contributions that Hayek made to the field of economics?
SB: Wait! David, before we even start: how can I be your mentor? I learned from you that group selection should be liberated from the dog house, when you were a lone voice against biological orthodoxy at the time.
But to get to your question, I would single out Hayek’s representation of the market as an information processing mechanism that plays an essential role in any economy because information is scarce and local, his critique of perfectly competitive equilibrium thinking in economics, and his dynamic view of the economy.
DSW: Why was his focus on information important for economics?
SB: His 1945 paper – “The use of knowledge in society” — is in my top ten all time contributions to economics. It came in the late innings of the “planning versus the market” debate instigated by Great Depression and the apparent success of the Soviet Union’s first five-year plans. By the end of the thirties the anti-planning side was down by 5 runs at least; even the arch opponent of socialism Joseph Schumpeter had conceded: “Can socialism work? Of course it can. There’s nothing wrong with the pure theory of socialism.” Just in the nick of time: Hayek saved the day, coming up with a clinching argument: central planners could not possibly know enough to plan an economy well.
DSW: But the problem of inadequate information facing the central planner must have been commonplace at the time.
SB: Curiously it was not. The advocates and (still more curiously) the critics of central planning alike had chosen as their terrain the conventional neoclassical (or ‘Walrasian’) model — with its assumption of complete information. Not surprisingly, things had not gone well for the anti-planning side. Some a little closer to the real economics of central planning, however, had seen things differently. Here is an example:
If a universal mind existed, such a mind, of course, could a priori draw up a faultless and exhaustive economic plan, beginning with the number of acres of wheat down to the last button for a vest. The bureaucracy often imagines that just such a mind is at its disposal; that is why it so easily frees itself from the control of the market …
This is straight Hayek – it could easily have been lifted from his 1945 paper –but the author is the Russian revolutionary Leon Trotsky writing in 1932 in light of what had been learned from the First Five Year Plan.
DSW: How did Hayek connect his theory to economic policy, which you call “The Road to Laissez Faire” in your article?
SB: Well that’s just it, David, he did not. Despite his insistence that the two were part of an organic whole, he didn’t connect his economics to his political position. In fact Hayek’s economics gives you good reason to doubt his politics. I hope we can come back to that.
DSW: Definitely. But first, was his argument against central planning, then, his main contribution to economics?
SB: Not at all. The planning versus the market debate was the instigation, but his work both before and after the 1945 paper inaugurated a new way of seeing market economies and has made ‘information economics’ a major theme in contemporary economic research.
DSW: What was Hayek’s main idea about markets and information?
SB: It was simple and profound at the same time. Prices are messages. The devil is in the details of course, but ideally they tell you how much it cost to produce a good, and how valuable that good is to others. These are the facts that the planner could not readily know. So, if there is a drought in the mid-west, and the price of wheat soars, the message is: “think of putting potatoes or pasta on the table this evening.” And as the example shows, prices are more than messages, they are motivation too. The higher price of wheat not only suggests a different menu, it makes the alternative a lower cost option.
DSW: And Hayek used this reasoning to demonstrate that markets should not be regulated by the government because they can on their own produce optimal results?
SB: Not exactly. Hayek advocated the market not on grounds of optimality, but by default. The alternative, central planning, could not work, and moreover any substantial degree of government intervention in the economy, he feared, was bound to be a threat to liberal values. Remember, when he wrote Road to Serfdom, he was not thinking about Nordic social democracy, he was writing under the shadow of Hitler and Stalin.
DSW: It always struck me as curious that Hayek developed a radical alternative to general equilibrium theory, but both were used to justify the same laissez faire economic policies and that Hayek and Friedman were both central figures in the Mont Pelerin Society. This makes me think that the impulse to justify laissez faire policies came first and steered the theorizing in both cases. Is that an unfair thing to say?
SB: Yes, that would be unfair, both to Hayek and to the pioneers of general equilibrium theory. Kenneth Arrow – among those who first proved what is sometimes called “the invisible hand theorem” of general equilibrium theory — was quick to point out its limitations in describing any real economy, and 30 years later advanced what he termed “a cautious case for socialism.”
Hayek’s opposition to most forms of government regulation was not based, as I just said, on claims that the market was in any sense “optimal” He was a severe critic of the concept of perfectly competitive equilibrium on which the ‘invisible hand theorem’ is based. His central economic ideas – the importance of scarce and local information, his alternative notion of equilibrium, his insistence that economics had to be about change, not stasis – these all long predated his use of some of this apparatus to attack central planning.
DSW: But his ideas, nonetheless, became central to the cause of laissez faire?
SB: They did, David, though he didn’t much like the term, but only by a highly selective reading of his work. In the paper you mentioned Alan, Rajiv and I advance the view that Hayek’s economics per se provides good reasons to doubt the superiority of the unregulated market.
DSW: Well, in the volumes written on Hayek pro and con, that’s a new one. How does it go?
SB: I’ll give you two examples. First, prices are indeed messages, and precisely because of that we may have house price bubbles when people correctly infer that when house prices go up they may continue to do so, and hence this may be a good time to buy a house. This is the opposite of the “let’s put potatoes rather than bread on the table” reaction to the price of wheat rising.
Second, the market, as Hayek says, processes information and on that basis, determines, for example, the best way to organize production. But applying this logic shows that hierarchical economic planning may not be such a bad thing at least when combined with markets. The boundary of the firm – how big it will be – is determined by the answer to the question, should this component be produced inhouse or purchased? But this is also the boundary between organizing things according to the market or according to the hierarchical structure of command that has led capitalist firms to be termed (ironically) as ‘mini-planned economies.” The ‘verdict of the market’ in this case is that both markets and hierarchies have a place in the economy!
DSW: That’s a great point, but it can be elaborated along very interesting lines! I’ve been delving into the business literature a lot lately, and “command and control” often doesn’t work at the firm level either. A single firm requires the same protections against disruptive self-serving behaviors that Ostrom demonstrated for common-pool resource groups with her core design principles. Also, for a single firm to adapt to change, it needs carefully orchestrated variation-and-selection processes rather than a centralized plan. However, your larger point is well taken: a firm remains a “mini-planned economy” even if not organized as command and control.
Moving on, these examples of Hayek versus Hayek are not what most economists understand as his take home messages about their discipline, right?
SB: I guess, your economist in the street would draw a blank if asked what Hayek’s contributions to economic theory were. But I think you can draw a line from Hayek to contemporary economists’ concern about information problems in labor and credit markets and other exchanges where there is some important pieces of information not known to one of both of the parties.
DSW: Let’s turn to Hayek the evolutionary thinker who saw economic systems as products of cultural group selection. How new was this against the background of the economic profession at the time?
SB: The language was new, but the fundamental concept really were not. The idea of spontaneous order is at least as old as Adam Smith’s invisible hand. Economists routinely model selection processes by which some firms succeed and others fail with the practices of the winners becoming the norm. What distinguished Hayek was his claim that evolutionary reasoning demonstrated the superiority of substantially unregulated markets.
But this exercise in social Darwinism at the system level need not run along the lines that Hayek chose. Another great conservative thinker, Talcott Parsons, in 1964, had advanced the idea that among ways of organizing society there are “evolutionary universals,” that is, systems that emerge frequently in a variety of environments and persist over long periods once “hit upon” by a population. These are societal analogues to complex biological characteristics such as vision, which are such good ideas that they evolve independently in many species, and are in is seldom abandoned as a result of evolutionary processes.
Parson’s list of the ‘evolutionary universals’ includes markets and money but it also includes “authority of office…backed by coercive force” as “the most effective large scale administrative organization that man has invented, and there is no direct substitute for it.” For Parsons, states as well as markets, pass the test of evolutionary success.
DSW: Can you sum up your critique of Hayek, which I am interested to compare with my own.
SB: I imagine you would focus on shortcomings of his conception of cultural evolution. But to me, he was a great economist whose political agenda did not follow from – even is contradicted by — his contributions to economics. Even more. I think that the liberal values that Hayek espoused would be safer in the world today had he stuck to economics.
DSW: Another remarkable claim, Hayek as a danger to liberal values! How is that?
SB: The union of political liberalism with Hayek’s economic liberalism – laissez faire– has proven to be an unhappy marriage. It is no surprise that some of those who have fared worse during the last quarter century of right wing resurgence are attracted to xenophobic nationalism and intolerance. In the early 21st century it is not ‘big government’ that is the threat to liberal values. Ask yourself: where are they key liberal ideas of tolerance, the rule of law, and defense of the weak against the strong more secure today: the Nordic countries (where governments comprise half of the economy) or the U.S, where Hayek’s political vision has been widely embraced?
Hayek rightly insisted that the question of how best to organize society could not be answered in abstract terms but required instead historical and empirical comparison. I wonder if he might today – on empirical grounds – reconsider his view that a larger government role in the economy is a threat to liberal values?
DSW: As you know, I’m a big fan of Elinor Ostrom and was privileged to work with her to generalize her core design principle approach and polycentric governance from an evolutionary perspective. I think that she points the way toward a middle road between laissez faire and centralized planning more than Hayek. What is your opinion and how do the ideas of Hayek and Ostrom relate to each other?
SB: In opposition to social engineering, Ostrom, like Hayek stressed our human capacity for what might be called bottom up problem solving. She demonstrated that small communities often address problems of environmental degradation such as the tragedy of the commons through a combination of social norms and local rule making. I would place the work of Ronald Coase in the same “bottom up” tradition: he showed how bargaining can often take account of environmental or other ‘external effects’ even where markets fail and governments are either insufficiently informed or motivated to do the job. But Ostrom and Coase differ from Hayek, too. Both gave careful attention to empirical cases – in Ostrom’s case, the result of painstaking fieldwork – and for them the key to solving social problems – communities for Ostrom and bargaining for Coase – was not an unregulated market.
DSW: When we retain Hayek’s positive contribution and add the advances in economics and evolutionary science, what road does it take us on, if not the road to laissez-faire?
SB: The key to my reply is a fact that Hayek stressed: information is scarce, and what one person knows another does not. A result of this situation – called ‘asymmetric information’ – is that it is impossible to write an enforceable contract to cover all of the aspects of the exchange that matter to someone affected. Perhaps surprisingly, what seems a detail – the contract is incomplete – turns the standard economic model on its head. Developments in microeconomic theory over the past 3 decades — I won’t do the heavy lifting here (it is in my Microeconomics: Behavior, Institutions and Evolution) – have shown three paradigm shattering results. First, even competitive markets need not clear in equilibrium; so, for example unemployment, and people without wealth excluded from the credit market are predictions, not anomalies to be explained by ad hoc ‘frictions” or other ‘deviations’ from the standard model. Second, market failures are ubiquitous – they occur in credit and labor markets, for example, not just environmental spillovers — not exceptional. And third, employers, lenders and other “principals” in principal-agent relationships wield power over employees and borrowers.
The irony is, David, that the information revolution in economics that Hayek kicked off well over a half century ago, ended up pointing to a larger public role both in rectifying market failures and in addressing the problem of unaccountable power exercised by employers over employees.
But a new paradigm along these lines is not simply a refurbished Nordic social democracy, or even less centralized planning. It points to an active role for a democratic civil society, and not simply government regulation.
DSW: There are a number of scholars who share your high opinion of Hayek-the-economist, at GMU’s Mercatus center, for example, and around the world. But it is probably fair to say that Hayek is not part of the canon that economists consider essential to their field. Why is this?
SB: True, and economics has been impoverished as a result. Two reasons come to mind. First, Hayek’s vision of the economy as a complex evolving system was less readily rendered in mathematical form than the Walrasian paradigm that dominated economics in the late 20th century. This limited its take-up among economists because we – rightly in my opinion – place a high value on the precise formulation of models using mathematics where this is possible. Second, in the aftermath of the Great Depression, Hayek’s bitter opposition to Keynesian stabilization policies and other forms of highly beneficial government regulation of the economy led many economists – few of whom bothered to read Hayek — to reject his other, more fundamental insights. His reputation has also been tarnished by extreme claims on behalf of laissez faire made by those claiming his mantle. In this he has suffered a fate similar to Marx: his economic insights have been overlooked in part because those who most famously took up his name advocated systems that were rightly opposed by most scholars.