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The Significance of Hayek's Contribution · Free Liberal

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The Significance of Hayek's Contribution

by , Editor in Chief , Free Liberal

Israel Kirzner and Peter Boettke

Last week, the Mercatus Center at George Mason University held a major event, “40 Years After the Nobel” which drew together a Who’s Who of free-market economics. The event reflected on the awarding of the Nobel Prize in Economics to F.A. Hayek, 40 years ago. The award of the prize brought new interest in Hayek’s work as well as that of the Austrian School generally. In the previous thirty years, Hayek and the Austrians had been disregarded by mainstream economics, following their perceived loss in the 1930s of the intellectual battle over central planning to the Keynesians, during the so-called, “Socialist Calculation Debate”.

Israel Kirzner (pictured with Peter Boettke above), in his address, explained that the Austrian School had “virtually disappeared” between 1940 and 1970. In addition to the geographic dispersal from Vienna, some Austrians like Fritz Machlup thought that hallmarks of Austrian thinking: marginalism, opportunity cost, and subjectivism, had been completely embraced by the economics profession. It didn’t behoove Austrian economists to maintain a separate identity. But, as time went on, it became clear that the mainstream economics had analytically moved the locus of decision-making from individuals to the society as a whole.

The human agent, described by Lionel Robbins, given resource limitations, recognizes his goal and tries to maximize utility or profit. “In a market society, the means are definable only in terms of opportunities made available by others. Thus a person’s budget constraint is a function of the market prices of items he might be interested in buying.” This contrasted with the mainstream’s desire to apply such analysis “to the economy as a whole.” In the mainstream’s view, Society allocates “its resources”.

Kirzner argued that it was precisely along this distinction that Hayek and Mises advanced economics in their debate with the Keynesians, rather than merely reiterate older dogmas of the Austrian School. It was precisely the fact that the mainstream had so abandoned that concept of the individual decision-maker in a market process — “the storm of adjustments” — and not “equilibrium”, that they were unable to understand Hayek’s contribution.

The following excerpt is Kirzner’s description of the advance:

Every human actor at the moment of action is an entrepreneur. He faces an open-ended future within which he must determine the range of opportunities available to him. The market process driven by entrepreneurial pursuit of pure profit opportunity consists in all the interacting actions of all the individual agents, all of them acting entrepreneurially, that is, acting with all the alertness they can bring to bear, in the respective situations in which they find themselves.

Pure profit, the element which provides the driving force of the market process, occurs when an alert, prescient entrepreneur senses that a complete package of inputs can be assembled today at a total cost that is below the revenue, that will tomorrow be able to be received by eager consumers… producing an output, without using anything more than is in that package.

In other words, pure profit emerges as an implication of what is in fact the presence of two market prices for the same package. The package can be assembled at a cost of 50 and the revenue from that package is 100. But this, by definition, is a disequilibrium situation. Two prices for the same package is a direct contradiction of the definition of equilibrium What the market process consists of is an endless series of competitive entrepreneurial moves inspired by such arbitrage opportunities.

All this is far, far removed from the Walrasian view of the market as a state of affairs in which all decisions being made are Robbinsian decisions, each of which correctly anticipates the parallel Robbinsian decisions being made by everyone else. This latter equilibrium situation offers no understanding of how it might ever be attained.

Hayek understood the role of interpersonal knowledge in markets. The very definition of equilibrium shows that such an imagined state is the state of complete perfect interpersonal knowledge. Everybody knows every price in the market. Everybody knows every point of every thinkable demand curve and every thinkable supply curve. And everybody knows that everybody knows it.

The market process, on the other hand, consists in the social process in which people come to know that which they have until now, not known.

The market process is a process of discovery and adjustment, creating the need for further discovery, etc., etc., etc.

For both Mises and Hayek, the role of competition is drastically different from the role of perfect competition in mainstream microeconomics, the latter role, starting from its assumption of perfect knowledge is that of ensuring that no disequilibrium elements are present in the theory of price.

Paradoxically, this ensures that we have no theory of equilibration. For Mises and Hayek on the other hand, competition means the dynamic forces which express the entrepreneurial discovery which constitute the market process.

The only requirement for the market to be competitive is that there be freedom of entry, that is, freedom for entrepreneurs to notice what they see as profit opportunities and to act upon their perceptions of available market opportunities. Were the defenders of socialist planning of the 1930s to have understood all this, they would have realized how irrelevant their solutions to Mises’ challenge really were. But, as noted, the entire literature on the socialist calculation debate failed to [grasp] these revolutionary insights contributed by Mises and Hayek

The entire event, including remarks by Nobelists Vernon Smith and Eric Maskin can be viewed here.

Vernon Smith discusses how as a young economist in the 1950s, the concept of markets working outside of the perfect competition model was foreign to him and he only found the market process path through his classroom econ experiments that demonstrated individuals’ willingness to work together through trade, even in imperfect conditions. Eric Maskin’s research, analyzing mechanism design, has lent support to the market as the best mechanism for maximizing social gain that is incentive-compatible for the participants — lending support to the connection between markets and liberty.

To learn more about Hayek’s contribution, I recommend viewing the PBS documentary Commanding Heights: The Battle of Ideas available on YouTube. Also, Gerald O’Driscoll’s Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek, is available free online at the Library of Economics and Liberty.

Please note, in the excerpts from Kirzner’s speech, above, at some points he might be quoting from others. Also, I may have made minor errors in my transcription. Corrections are welcome.


Comrade Führer Kevin Rollins faces the world with an open heart and an open mind.
Kevin Rollins is the founder and editor of Free Liberal and principal of Kevin Rollins Consulting. He was formerly the managing editor of Econ Journal Watch. He holds a master’s in economics from George Mason University.