Must-Read: Samuel Bowles, Alan Kirman, and Rajiv Sethi: Friedrich Hayek and the Market Algorithm: “‘[The market is] a system of the utilization of knowledge which nobody can possess as a whole… http://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.31.3.215
…which… leads people to aim at the needs of people whom they do not know, make use of facilities about which they have no direct information; all this condensed in abstract signals…. That our whole modern wealth and production could arise only thanks to this mechanism is, I believe, the basis not only of my economics but also much of my political views” (Hayek 1994, p. 69).
These political views included opposition not only to Soviet-style central planning, but also to monetary and fiscal demand management policies, collective bargaining, wage floors, and significant public expenditures. Such forms of interference with the market, in his view, would compromise its ability to deliver continued prosperity. His hostility to Keynes and Keynesian policies, in particular, was deep and visceral…. Hayek drew a sharp contrast between his approach and Walrasian general equilibrium theory, which itself had been used to make a case for laissez faire on the basis of the two fundamental theorems of welfare economics….
Hayek did not consider the welfare theorems to be compelling arguments for his policy stance. As he put it, the “argument in favor of competition does not rest on the conditions that would exist if it were perfect” (1948, p. 104). Instead, his case for competitive markets rested on the idea that competition was a “procedure for discovering facts which, if the procedure did not exist, would remain unknown or at least would not be used” (Hayek 1968). In this view, the superiority of competition as a procedure for discovering and utilizing knowledge could be established only through a comparative evaluation of economic systems….
We believe that Hayek’s economic vision and critique of equilibrium theory not only remain relevant, but apply with greater force as information has become ever more central to economic activity and the complexity of the information aggregation process has become increasingly apparent. Advances in computational capacity and the growth of online transactions and communication have made the collection and rapid processing of big data feasible and profitable. Many markets now involve algorithmic price-setting and order placement alongside direct human action, raising interesting new questions about the processes by which information is absorbed and transmitted by prices.
Second, we wish to call into question Hayek’s belief that his advocacy of free market policies follows as a matter of logic from his economic vision. The very usefulness of prices (and other economic variables) as informative messages—which is the centerpiece of Hayek’s economics—creates incentives to extract information from signals in ways that can be destabilizing. Markets can promote prosperity but can also generate crises. We will argue, accordingly, that a Hayekian understanding of the economy as an information-processing system does not support the type of policy positions that he favored. Thus, we find considerable lasting value in Hayek’s economic analysis while nonetheless questioning the connection of this analysis to his political philosophy…