Optimization of Knowledge in a System

Optimization of Knowledge in a System:

A Look at Frederich Hayek's THE USE OF KNOWLEDGE IN SOCIETY

by 

Timothy Cole Wanless

    Knowledge is a funny thing. Too little and we can’t make informed decisions. Too much and we can’t find the relevant information amid the background noise. In reading THE USE OF KNOWLEDGE IN SOCIETY by F.A. Hayek, I realized what I assumed to be an outdated application of economics knowledge for a less efficient, steam-powered time still held great value for our current system. Despite technological advances, it still maintains its relevance by analyzing how knowledge should be spread in society.

Friedrich Hayek: Austrian-British Economist
    So what did this article hold that still had relevance for modern times? If I were to summarize the article’s main point it is this. 

The price system generated by a decentralized system better assigns value to goods than a centralized planning body due to the inherent nature of knowledge in society and the adaptability to change in the system. 

Now I know this sounds like long verbose technical jargon... and it is. But it is my goal to unpack the article’s true brilliance and message as easily and simply as possible so that you can take away a better understanding that economic thought can provide in solving problems.

    To better understand Hayek’s argument, it is important to understand what a centralized system and decentralized system are. In a centralized system, a government or organization would oversee and take all the knowledge in a system and calculate the best use of those goods and services to maximize the benefit for everyone in the society. In a decentralized system, individuals drive the value of goods and services by placing demands on goods and services where knowledge of a good's value spreads throughout the industries in a system.

    Hayek believed that sudden rapid changes in multiple industries of an economy were responsible for a lack of useful accurate knowledge. He argued that a decentralized price system where people influence the price through demand was faster to react to industry changes than a centralized government system where people would have to consult with the government in order to know the value of a good or service. He says no centralized government is going to be able to take into account the value systems of all individuals as rapidly as the price systems' ripple effect through the economy has. 

    According to Hayek, the decentralized system is superior in taking into account all the people's wants and needs thus resulting in an accurate price in an economy. This is due to innate knowledge of needs of an industry or company known immediately and specifically by people who work there. It is also due to scientific knowledge using aggregates of data that over-generalize topics. He emphasizes that people are people and we are not just scientific numbers in a spreadsheet but something more complex that cannot be factored entirely into mathematical models.  

    He staunchly believed that the reason many economists of his time refused to accept it as superior was it was not consciously designed by man. Naturally occurring social phenomena are sometimes superior than any man-made scheme, but credit for these concepts is very rarely attributed as people take them for granted like "division of labor" or "the price system". 

He recommends a decentralized system in conjunction with information given to the actors in the economy with "boots on the ground" knowledge, but he does state that he is unsure what level of information may be necessary to give in order to optimize a society.

    Throughout this article, I was blown away by the genius simplicity in his ideas, and  it reminded me of why economics differs from just statistical analysis. It is the human factor. We don't just take into account the aggregates of data but instead use it in conjunction with the decisions people make and ask why. It shows that even though mathematically something may be efficient in an economy and the numbers are optimized, human emotions, contentment, and utility vary and are not as easily taken into account, and sometimes it is better for people to step aside, provide relevant information, and not try and dispatch with a naturally occurring economic construct.

TLDR: Hayek argues that a decentralized price system of people dictating value is better than a centralized government body assigning value to goods and services. This is because the price system considers sudden changes in production, individual desires, and the maximization of societal well-being quickly through supply and demand.

Source:

Friedrich August von Hayek, “The Use of Knowledge in Society,” American Economic Review, XXXV, No. 4;     q        September, 1945, pp. 519–30. 

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