Commentary on Political Economy

Monday 26 September 2011

THE STATE OF EQUILIBRIUM: Historical Antecedents of ‘Supply-Side Economics’ in the Austrian School – Part 2

THE STATE OF EQUILIBRIUM: Historical Antecedents of ‘Supply-Side Economics’ in the Austrian School – Part 2
As Hayek established in his critique of Walras, the economic notion of “equilibrium” is tautologous in that it makes a number of aporetic assumptions (“apory” is intended here as “historico-logical contradiction”). The assumption that Hayek demolished was that market participants had full and immutable information about the endowments and preferences of all other participants. The effect of this assumption was that “Walrasian equilibrium” was transformed into a totalitarian “social brain” simultaneously holding and clearing all the information socially available about the desired allocation of resources. This “impossible” assumption Hayek dubbed “the Pure Logic of Choice”, and it summarised his objection to socialism. Tersely put, a socialist state’s economic system would not be able to reach its goal of “administratively” knowing the preferences of its citizens without removing their “political independence” – thus turning into a totalitarian state – simply because, in order to do so, these preferences would have to be “co-ordinated” simultaneously without the possibility of “intertemporal” change between their notification and their execution.
Hayek extended this critique also to the neoclassical notion of “pure competition” which he easily disposed of along the same line of attack he adopted for Walrasian equilibrium. Accordingly, Hayek went on to outline his notion of “intertemporal equilibrium” where market participants are allowed to change their preferences and communicate these through free market-pricing mechanisms. The reason why “co-ordination” is needed in a society is that its citizens specialise in different inter-dependent activities, that there is a “division of labour”. Indeed, this is why in Walrasian equilibrium there is exchange at all! But although there is a “need” for individuals to exchange, this exchange must be “free”, that is, it must be according to their spontaneous preferences. As Brian Loasby remarked, given the propensity of individuals to collude for personal gain, “a world of [“enforced”, my addition] universal perfect competition is almost as repellent as a world of perfect slavery; indeed the two are not easily distinguished” (in ‘Equilibrium and Evolution’, p.16).
This is precisely Hayek’s position also. The neoclassical notion of “equilibrium” represents a “closed system”. Perfect simultaneous information and pure competition would turn the market society into a totalitarian state where individuals would not be able to change their choices from beginning to end. Socialism would not have a “co-ordination problem” because its government would be omniscient. The socialist State is “theo-logical” because in seeking to abolish the market and the State of Law it must necessarily postulate the abolition of personal choice, of private property, and individual rights. (There is a striking similarity with Max Weber’s critique of Marx’s vision of a stateless socialism in that its “freedom” was inconsistent with the iron necessity of socialism’s advent pursuant to the “laws of motion” of capitalist society.)
Furthermore, the “closed system” of equilibrium analysis, whilst theoretically resulting in the optimal or “perfect” allocation of resources, also leads inexorably to a stationary state in which there can be neither quantitative-horizontal “growth” (Wachstum) nor innovation-induced industrial and commercial “development” (Entwicklung). Rather than theorise the economy as a stationary state with simultaneous a priori “tautologous” equilibrium where resources were allocated “optimally”, what was needed was an “empirical”, “verifiable” approach that focussed on the central problem of economics – “the co-ordination problem”:
“The problem which we pretend to solve is how the spontaneous interaction of a number of people, each possessing only bits of knowledge, brings about a state of affairs in which prices correspond to costs, etc., and which could be brought about by deliberate direction only by somebody who possessed the combined knowledge of all those individuals.*82 (ibid.)
Hayek’s preferred “empirical” approach consisted in treating the “price mechanism” of the market as the exchange of ‘information’ about individuals’ plans and expectations. Thus, the gravitational centre of the “price mechanism” constituted an “intertemporal equilibrium” where there might be “sub-optimality” in the sense that some resources remained unemployed or underutilised but where at least the consequent “division of information” left individuals free to decide for themselves. As Hayek explained,
“While such a position represents in one sense a position of equilibrium, it is clear that it is not an equilibrium in the special sense in which equilibrium is regarded as a sort of optimum position. In order that the results of the combination of individual bits of knowledge should be comparable to the results of direction by an omniscient dictator, further conditions must apparently be introduced.19 (Individualism and Economic Order, pp.45-46)
The greater this “division of information”, the more freely “competitive” the market, the greater will be the degree of economic freedom, and consequently the legal and political liberty of individuals in society. It follows that any “political” interference on the part of the State through fiscal or monetary policy will distort the “co-ordination mechanism” in ways that will impede the freely-determined “division of information” of individuals and its “co-ordination” through the market “price mechanism”.
Hayek’s attempt is quite obviously circuitous – and therefore tautologous, a posteriori, ex post facto, a petition principii – because it requires us to accept that “the price mechanism”, however “imperfect” or “suboptimal”, constitutes the “best” available form of economic “co-ordination” consistent with “freedom”. But this conclusion is entirely “unfounded” because it assumes what it wishes to prove. The most notable feature of Hayek’s approach is that it substitutes the notion of “the division of labour” which sociologically and economically highlights the “physical interdependence” of the process of production…with “the division of information”, which subtly but decisively shifts the emphasis to the “independence” and subjective “separation” of individuals in society.
From Hayek’s “Ind&EconOrd”: ‘The Pure Logic of Choice’: As I have suggested elsewhere in this volume,2 the tautological method which is appropriate and indispensable for the analysis of individual action seems in this instance to have been illegitimately extended to problems in which we have to deal with a social process in which the decisions of many individuals influence one another and necessarily succeed one another in time. The economic calculus (or the Pure Logic of Choice) which deals with the first kind of problem consist of an apparatus of classification of possible human attitudes and provides us with a technique for describing the interrelations of the different parts of a single plan. Its conclusions are implicit in its assumptions: the desires and the knowledge of the facts, which are assumed to be simultaneously present to a single mind, determine a unique solution. The relations discussed in this type of analysis are logical relations, concerned solely with the conclusions which follow for the mind of the planning individual from the given premises. When we deal, however, with a situation in which a number of persons are attempting to work out their separate plans, we can no longer assume that the data are the same for all the planning minds. (93)

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