November 4, 2014

Knowledge and Government Intervention

It seems quite common in this day and age to hear various individuals and groups promoting government interventions in markets (healthcare, energy, etc.).  The reasons for these government interventions usually vary from group to group (or person to person), but they are generally trying to promote equality, environmental sustainability, welfare of the poor, and so on.  What these promoters of government intervention fail to take into account, however, is that interventionism begets further interventions.  As we learned from Mises, an intervention into one area of the market (lets say on the production side of things) requires further interventions on the factors of production for the product that was the subject of the original intervention.  Austrian economists (especially Mises) would draw the conclusion that interventionism is not a viable system in the long run because the need for further interventions would eventually give rise to central planning (or socialism).

The true economic problem for Austrian economists is not how to efficiently allocate scarce resources, but rather how to make the best use of all knowledge available in society.  For Austrian economists, central planning, of any sort, is an inadequate way of making decisions pertaining to the utilization of the factors of production because they simply lack the necessary knowledge.   Thus, members of a central planning board fail to make the most informed decisions possible.  Because they can't make use of all the knowledge in a society, Austrians hold that planning must be left in the hands of individuals who have direct access to  local knowledge (or stated another way, private ownership of the means of production allows better access to local knowledge).  

Hayek emphasized the importance of this local knowledge, or the knowledge of circumstances pertaining to a particular time and place, because he felt it gave rise to entrepreneurs, who could, in turn, take advantage of this knowledge to organize the factors of production in such a way as to make a profit (or loss if they are unsuccessful).  Entrepreneurs have local knowledge, and can, therefore, make much more informed decisions pertaining to the utilization of the factors of production.  Some of this knowledge is tacit, meaning it is not easily codified or transferable to other individuals.  It is, therefore, of the utmost importance to allow the free market to operate without the government intervening.

If we lived in an evenly rotating economy (as depicted in neo-classical models), central planning could become a viable option because all knowledge would be known (because that's the assumption the model makes).  Because all knowledge is assumed to be known, entrepreneurs have no incentive to try and take advantage of local knowledge.  In such an economy nothing changes, competition has ceased, and the factors of production don't have to be reallocated because they are already at an efficient level (usually equilibrium).  Under these circumstances, one could argue that central planning would be a feasible method for decision making because no new decisions would have to be made.  But since that's not how the world of human action works, decisions regarding the factors of production must be left to individuals who have the knowledge of circumstances pertaining to their particular time and place.

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