Thursday, December 3, 2009

The Pretence of Knowledge

Here is an abstract I wrote for my class on the Hayek article, "The Pretence of Knowledge."

The failure of modern economics to successfully guide policy is due to the tendency to try to imitate the procedures of the physical sciences. This has become to be described as the scientistic attitude. This attitude is unscientific since it involves an application of habits of thought to fields different from those in which they were formed.
Monetary and fiscal policy, which are largely due to the mistaken conception of the proper scientific procedure, consisted in the assertion that there exists a simple positive correlation between total employment and aggregate demand for goods and services. This has lead to the belief that we can maintain full employment permanently by maintaining total money expenditures at an appropriate level. While strong quantitative evidence for this can be brought forward, it is fundamentally false and to act upon it is very harmful.
In the physical sciences, it is generally assumed that any important factor that determines the observed event will itself be observable and measurable. However, in the study of markets, which depends on the actions of many individuals, the factors that determine the outcome will hardly ever be fully known or measurable. We know with markets and other similar social structures a great many facts that we cannot measure and only have some general and imprecise information. Because the effects of these facts cannot be confirmed by quantitative evidence, they are simply ignored by those who only accept scientific evidence who then go on to assume that the factors they can measure are the only ones that are important.
The correct explanation for unemployment would be the discrepancies between the distribution of demand among the various goods and service and the allocation of labor and other resources to the productions of outputs. We have good reason to believe unemployment reflects that the structure of wage and prices has been distorted. To equate the demand and supply of labor, changes will need to be made to relative prices and some labor transfers will be necessary. We can know the general conditions under which the market will be in equilibrium but can never know the correct prices and wages to establish it. We merely say which conditions will allow the market to achieve the prices and wages necessary such that demand and supply are equated.
The social sciences have to deal with structures of essential complexity, structures whose characteristic properties can be exhibited only by models with relatively large numbers of variables.
In the determination of prices and wages will enter the particular information the each market participant possesses. This sum of facts cannot be known by any one observer. Here is the superiority of the market that in the resulting allocation of resources, more of the knowledge of particular facts will be utilized which exists exists dispersed among numerous people and that no individual can possess. Because the observing scientist cannot know all the determinants of such order and cannot know at which particular structure of prices and wages demand equals supply, we cannot measure deviations from that order. We cannot statistically test our theory that it is deviations from this equilibrium price and wages which makes it impossible to sell some products and services.
The great advantage of the mathematical technique is that is allows us to describe by means of algebraic equations the character of a pattern even if we are ignorant of the numeric values which determine the particular manifestation. We have this illusion, however, that this technique can be used for determining and predicting the numerical values of these magnitudes which has lead to a vain search for quantitative constants. Even Vilfredo Pareto, one of the founders of mathematical economics stated that it could not be used to derive a mathematical calculation of prices because we could not ascertain all the data.
Present inflation and employment problems are a very serious example of how much harm can be done by assuming only measurable values are important. The effect has been that the likely cause of extensive unemployment has been disregarded by the scientifically minded economists because it cannot be confirmed by the directly observable relations between measurable magnitudes and an almost exclusive concentration on quantitatively measurable surface phenomenon has made matters worse.
The demand created through injections of additional amounts of money at points in the economic system must cease when the the monetary injection slows down or stops. Together with expectations of a continuous price rise, this draws labor and other resources into employments which last only so long as the rate of increase in the money supply continues or only as long as the it continues to accelerate at a given rate. Due to this mistaken theoretical view, we have gotten ourselves into a position where we cannot prevent substantial unemployment from reappearing.
The key point to be made is that the rapid advance in the physical sciences took place in fields where it proved that explanation and prediction could be based on laws which accounted for the observed phenomenon as functions of only a few variables. To construct a theory of essentially complex phenomenon must refer to a significantly larger number of particular facts. To derive a prediction or to test requires determining all these particular facts.
If we try to act as if we had the knowledge and power to shape the processes of society to our liking, when in fact we do not have the knowledge, is likely to make us do much harm. We are now beginning to understand on how subtle a communication system the functioning of an advanced industrial society is based. This communication system, what we call the market, turns out to be a more efficient mechanism for taking advantage of dispersed information than any that man has designed.
If we are to do more good than harm in our efforts to improve the social order, we will have to learn that in this field, as in other field of essential complexity of organized kind prevails, we cannot acquire the full knowledge which would make mastery of the events possible.

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