Governing Dynamics Refutes Adam Smith?

A Beautiful Mind has been one of my favorite movies for years. However, I have a criticism to offer, after watching it again recently. Below is one of the most famous scenes from the movie:

This is the scene where John Nash finally discovers the revolutionary idea he's been searching for, Governing Dynamics (or what is now known as Nash Equilibrium). However, the movie completely misrepresents the concept.

"Adam Smith needs revision. If we all go for the blonde, we block each other - not a single one of us is going to get her... What if no one goes for the blonde? We don't get in each other's way... It's the only way we win. 

The best result will come from everyone in the group doing what's best for himself... and the group. Adam Smith was wrong."

So there we have it. The theory of the Invisible Hand has been demolished. Well, at least that's what some bloggers across the web have claimed, based on this clip.

In reality, Nash's theory of Governing Dynamics was not meant to be a critique of Adam Smith, nor was it a recommendation for social organization. It's simply a theory that can be used to predict the outcomes of certain situations.

In other words, Nash wasn't saying, "We need to consider the group, not just self-interest." Nash was saying that human action *IS* influenced by the actions of others. In the clip, it is in everyone's self interest to not go for the blonde. It has nothing to do with concern for the overall group. An individual from the group must simply take into accord the actions of the others in the group, in order to make the correct, self-interested decision.

Nash was not concerned with how society should function. His theory deals with the reality of self-interested human action.

I just needed to get that off my chest. Carry on.

In Defense of Free Banking

One area of disagreement within Austrian Economics is on the subject of the proper role of banks. Specifically, many Austrians disagree on whether or not banks should be required to maintain full reserves on savings. This divergence goes back to Mises (a defender of free banking) and Rothbard (a proponent of full reserve banking). It is important to recognize that both positions are very different from, and preferable to, the status quo. However, I believe free banking is both the most economically beneficial position, and the position that stands on free market principles.

I will attempt to simplify the issue:

Assume there exists an island on which only two people, Fred and George, make up the population. Fred  spends his time picking apples, while George spends his time on bananas. Both depend entirely upon the consumption of apples or bananas for survival. Trade exists between apples and bananas, so it is possible for  both Fred and George to consume a combination of apples and bananas, instead of relying completely on one or the other.

One day, Fred decides to leave some of his apples with George, in exchange for protection of his apple supplies while Fred goes out picking for more apples. George decides to consume the apples in order to maintain the energy levels for one day's banana picking.

Clearly, George expects to receive a higher value in banana picking for the day than the value he consumed in apples. If this were not the case, George would have not touched Fred's stock of apples. (This is assuming that George receives utility from Fred's "banking" with him. George wants Fred to continue to leave his apples with him in the future, so that he may use the apple resources to generate more bananas.) So, George wants Fred's initially banked value to be returned to him when he demands it. George is able to meet Fred's demands because his apple resources were used to generate an equal or higher value in bananas (if things go as expected).

This is precisely what is going on in a free market, fractional reserve banking system, except rather than using banked funds themselves, banks loan out the funds for others to use on investments. There is no false credit expansion as we have currency debasement. The credit expansion is real because the loanable funds are true sources of wealth that are being used to generate returns on investments. Thus, I reject the Rothbardian case for full-reserve banking as a means to prevent a Misesian boom-bust cycle.

There is an objection that may be raised. What if things do not go as expected in the world of Fred and George? What if George uses Fred's apples but fails to gain the necessary return on investment? Fred would not be able to collect his full demand.

This is certainly a concern, but hardly one that is not inherent to a market economy. Suppose instead Fred had invested his apples in George's firm, Bananas Inc. There is clearly a possibility that Bananas Inc. will fail and Fred's initial investment will not be returned. Fred implicitly accepted that risk when he invested the money.

The same is true for Fred, or any person, who puts their money in a bank. There is a natural risk (albeit small) that the banked money will not be returned in full. Fred was compensated for this risk by the security George provided in watching over his stock of apples. In our world, bank savers are compensated in a similar manner.

I seriously doubt any Austrian economist would demand an S&P 500 company maintain full reserves on money invested by a stockholder. When a company uses the unused resources of savers to invest in current and future production, we see it as the eloquent functioning of the market. But when this same activity is organized through a banking system, it is called credit manipulation or fraud.

Paul Krugman Outdoes Himself

Nobel laureate and New York Times journalist Paul Krugman has once again lived up to his legacy of being a Keynesian simpleton. His most recent blog post that has left me open-mouthed is titled What You Add Is What You Get. Krugman writes on the effects of raising taxes on the rich:


So, imagine a Romney supporter named John Q. Wheelerdealer, who works 3000 hours a year and makes $30 million. And let’s suppose that he really does contribute that much to the economy, that his marginal product per hour — the amount he adds to national income by working an extra hour — really is $10,000.

Now suppose that President Obama has reduced Mr. Wheelerdealer to despair . . . Wheelerdealer decides to go Galt. Well, actually just one-third Galt, reducing his working time to just 2000 hours a year so he can spend more time with his wife and mistress.

Wheelerdealer adds $10,000 worth of production for every hour he works, so his semi-withdrawal reduces GDP by $10 million. Bad! But what is the impact on the incomes of Americans other than Wheelerdealer? GDP is down by $10 million — but payments to Wheelerdealer are also down by $10 million. So the impact on the incomes of non-Wheelerdealer America is … zero.


Clearly, Dr. Krugman sees the economy as a simple numbers game to be manipulated at the whims of the elite. Can he truly not see that the economic consequences go beyond immediate GDP statistics? By his logic, the government could raise taxes to 100% on every single person, distribute the funds arbitrarily, and the economy would still be perfectly fine. There's still the same amount of money in the economy, right Paul?

No, something that cannot be measured in GDP is the incentive to invest in future production. Communism fails because the incentives to produce are absent. Capitalism leads to prosperity because members of the society receive a reward equal to value in what they produce. Mises eloquently sums up one of the necessary conditions for action:


A . . . condition [for human action] is required: the expectation that purposeful behavior has the power to remove or at least alleviate the felt uneasiness. In the absence of this condition, no action is feasible. Man must yield to the inevitable. He must submit to destiny.


When income is distributed, not by what an individual produces and earns, but by the determination of need according to the government, the power to affect one's own condition is lessened. Thus, individuals are incentivized to show need (or establish political pull) instead of benefiting the economy through producing goods or providing services. There is no way to manipulate GDP that will make a man productive. Krugman, being an excellent mathematician, lacks the capability to use simple economic reasoning.

Now, Krugman allows income to be equal to a person's marginal product for the purposes of this particular writing. However, he strongly implies that it is not actually so. I must agree on this. But it is not due to the flaws of the free market, as Krugman would have us believe. To the contrary, the reason that the top income earners are able to receive incomes which exceed their marginal product is that people like Krugman prop up the corporate welfare system through Keynesian bailouts and central banking. Through bailouts, large companies are able to receive benefits from the government while the market is trying to oust them. Similarly, central banks are capable of providing loans with low interest rates to companies that are going through financial difficulties.

In a free market, choices are made voluntarily. Every monetary transaction is made with the consent of both the purchaser and the provider. It is inconceivable that a consumer would purchase a good or service at a price higher than its worth to them. Thus, it is implausible that anyone, in a purely free market, could earn an income larger than their marginal product. Only through theft could such an outcome be possible.

Applying Austrian Business Cycle Theory to Higher Education

Uncle Sam is currently subsidizing higher education like there is no tomorrow (self-fulfilling prophecy?) . Practically anyone attending a university or community college is eligible to receive a Pell Grant throughout their academic career. The Pell Grant is essentially free money, with eligibility being based on nothing more than "need." In addition, the federal government is also supporting need-based loans for college students. These loans feature lower-than-market interest rates and extended payment options. Like the Pell Grant, almost everyone is eligible for a government backed loan.

The result of this subsidization is more students attending college than they otherwise would have. I'm sure affordable education sounds great to many people - just as many lauded the government's efforts to make housing affordable. The housing bubble's burst should be a history lesson. Unfortunately, many Americans chalked it up to capitalism and decided the answer was more government interference in the market. On the other hand, some, predicted that the Federal Reserve's credit creation, coupled with the Community Reinvestment Act, would create a housing bubble that would inevitably bust. They couldn't have been more right.

How were these economists able to predict such events, and how might we predict the consequences of other market manipulations? For the answer, we must look to Ludwig von Mises, who originally developed Austrian Business Cycle Theory, and F.A. Hayek who would expand upon the theory in 1967. Mises and Hayek asserted that interest rates are important signals to investors throughout the economy, and that interest rates are not arbitrary numbers that can be manipulated without consequence. 

Under natural market conditions, interest rates will be lower during times of economic prosperity. This is because there will be an abundance of wealth, much of which will be saved in banking institutions. With more money in hand, banks will be willing to make more loans and loan at lower interest rates. These lower rates send a signal to potential investors. Entrepreneurs are encouraged to initiate expensive projects that require funding through loans, like building homes. Under natural economic conditions, this activity is magnificent. These interactions display the beauty of the free market. Entrepreneurs would be investing in projects precisely when consumers have high demand for them (i.e., when the economy is booming). 

Conversely, if the economy is in a recession or slower growth period, money and savings will be scarce. The result would be higher interest rates, which encourage the savings required to rebuild the economy, and discourage investment spending. 

This is contra-logical to mainstream economics, which is heavily influenced by John Maynard Keynes, a contemporary of Mises and Hayek. Keynes believed that during recessions the central bank should encourage spending, and the government itself should engage in spending. However, Keynes failed to understand that when investment slows in a free market system, it does so for a very good reason. Encouraging or engaging in investment during a contraction will result in mal-investment, that is, investment in projects which are not worth the cost. 

Now, let's return to the main issue, the subsidization of higher education. Interest rates for educational purposes work similarly to interest rates for investments. After all, education could be considered a personal investment. Just as is the case throughout the entire economy, interest rates for education will naturally be low during periods of prosperity. These low rates encourage students to invest in their education or professional training. Again, this is a truly magnificent market interaction. More students are receiving training and education, at just the time when wealth is abundant. During time, there is a strong demand for high quality labor. For one, people can afford to pay more for improved labor. Secondly, the abundant wealth makes it possible for entrepreneurs to open businesses, which will require different types of specialized labor. 

Personally, I wouldn't describe our current economic condition as prosperous (not by U.S. standards, at least). Yet, we are faced with low interest rates for higher education as a result of government interference. Indeed, college education is being encouraged, and we are seeing higher enrollment figures across the country. However, this is not the time that the free market would encourage investment in education. Wealth is not abundant. Unemployment is high. The demand for high quality labor is not sufficient for the excess amount of degree-earners. This does not mean a college degree will be worthless, but it does mean that, for many, their degrees will not be as valuable as they expect them to be. Therefore, it is highly likely that many people are spending more time, effort, and money on their education than it will actually be worth. This is mal-investment. 

There is another aspect of the issue that may be unique to education. With the price of attending college being artificially lowered, many students whom would not have enrolled otherwise, are now enrolled. The very best students would have most likely went on to further their education, with or without government subsidization. The students at the margin are those that did not preform as well in high school, on the SAT, or  on the ACT. Generally, these students are less likely to be prepared for college. In order for a college degree to maintain its value overtime, a degree must only be given to the students that meet a certain quality standard. Maintaining this quality standard, with an influx or less-prepared students, would mean failing a higher percentage of students. However, professors may be unwilling to do this. Failing a large amount of students could result in complaints or poor student evaluations, which in turn could affect a professor's pay or job security. For this reason, I believe the mal-investment in higher education is coinciding with grade inflation, which will make college degrees less prestigious.  

If I am correct in my analysis of the higher education bubble, then much damage has already been done. As Mises wrote in Human Action: 

There is no means of avoiding the final collapse of a boom brought about by credit expansion.

However, the damage can be minimized if the government would cease to manipulate the market. In a wildly popular episode, President Obama recently appeared on Jimmy Kimmel Live. The President pleads the case for maintaining low interest rates for college education. While this is clearly a popular political move, it is immoral and foolish to continue to mislead people as to the value of a college degree. Manipulation of interest rates effectively steers people away from their best interests, and towards the ends that the politically elite desire. 

Mises and Hayek did not develop Austrian Business Cycle Theory in an attempt to discourage government-backed student loans. The theory is most concerned with the entire monetary system and the economy as a whole. With that said, the same logical tools that were applied to ABCT, can be applied to the higher education bubble. I can't see a reason to not use the methods provided by such great economists.

Abraham Lincoln: Hero Or Tyrant?

For most people, the name Abraham Lincoln will conjure images of a tall, principled, and noble top-hatted man. We have dedicated our largest presidential memorial to him. His nicknames range from "Honest Abe" to "The Great Emancipator." Clearly, he has become much more than a man, in the minds of most Americans. Does this make Lincoln a legend or a myth? 

Lincoln's most touted accomplishment is the abolition of slavery. For this feat, Lincoln is viewed as the antithesis of tyranny, the champion of liberty and equality, and one of the most courageous men in history. I will attempt to refute this view, proving our 16th President to be mythical. 

First, I do not deny that slavery was, and is, an evil institution. Any true libertarian will tell you this. Second, I do not deny that bringing about equality and freedom is, indeed, an accomplishment to be praised. What I will argue is as follows:

1) Lincoln had no desire bring about equality for blacks, and he was not concerned with abolishing slavery before the Civil War began.

2) The Civil War was not fought solely over the issue of slavery.

3) The Emancipation Proclamation did not end slavery; it only diminished the area in which it was legal. 

4) Lincoln did not diminish slavery with the goal of bringing about freedom. It was simply a war strategy.

While Point 1 is possibly the easiest statement to prove, it seems to be point that people believe most strongly to be incorrect. Lincoln's aura is largely built on the belief that he was a 19th Century Martin Luther King Jr., of sorts. With words coming straight from the horses mouth, this can easily be refuted. In Lincoln's First Inaugural Address, he states, “I have no purpose, directly or indirectly, to interfere with the institution of slavery in the States where it exists. I believe I have no lawful right to do so, and I have no inclination to do so."

Either Lincoln was a liar, or he had no intention to end slavery. In either case, he was clearly not the champion of equality that he is made out to be. Oh, it gets better. The following is a statement from Lincoln, made in Lincoln-Douglas debate:

I will say, then, that I am not, nor ever have been, in favor of bringing about in any way the social and political equality of the white and black races; that I am not, nor ever have been, in favor of making voters or jurors of negroes, nor of qualifying them to hold office, nor to intermarry with white people; and I will say, in addition to this, that there is a physical difference between the white and black races which I believe will forever forbid the two races living together on terms of social and political equality. And in as much as they cannot so live, while they do remain together there must be the position of superior and inferior, and I as much as any other man am in favor of having the superior position assigned to the white race.

Since Lincoln was clearly not concerned with slavery or equality, why then, we must ask, was the Civil War fought. First, allow me to refer to the Tariff of 1828, coined "The Tariff of Abominations" in the South. This was the highlight (or lowlight) of a series of tariffs, designed to limit trade between the southern states and Britain and protect manufacturers in the North. Taxing exports and imports was also the main source of income for the federal government, during this time period. At the time, the South produced a large majority of U.S. exports. Well, in response to the Tariff of 1828, South Carolina attempted to simply refuse (through nullification). Andrew Jackson, the president at the time, threatened to collect the taxes from the state by force. Eventually, they reached a compromise, in which South Carolina agreed to a smaller tariff. However, the tensions between the southern states and the federal government were apparent, as was the dividing issue - tariffs, not slavery. 

In a strange turn of events, it happens that Lincoln was a major proponent of tariffs. His entire economic platform was based upon "protecting home industry." While this rhetoric may sound appealing, protectionist trade policies are extremely anti-consumer. Tariffs limit competition, allow monopolies to form, and cause prices to rise. Not only this, but as international trade was heavily concentrated in the southern states, tariffs of the time benefited some states at the expense of others. 

Fort Sumter, for most, marks the place where the Civil War would begin. However, many are unaware of its true significance. The Fort was located at the tip of Charleston Harbor. Charleston was home to a major trading port - Do you see where this is going? Fort Sumter enabled the federal government to collect tariffs on imports and exports at Charleston. Indeed, Sumter was not chosen at random as a starting place for war.

On to Points 3 and 4. If you're still convinced that Lincoln was concerned with slavery, let's consider the Emancipation Proclamation. It is widely known that the Proclamation did not end slavery in the border states - Kentucky, Missouri, West Virginia, and Maryland. It only applied to the Southern states. As the South did not recognize the United States government at the time, the Emancipation Proclamation did not free a single slave. What it did do was revoke the Fugitive Slave Act, which required runaway slaves to be returned to their owners. This was clearly an attempt to hurt the Confederate agricultural industry, as well as allow runaway slaves to join the Union army. 

Again, I do not argue that the Emancipation Proclamation was not a good thing. I am simply looking at the motives of Lincoln, a man commonly viewed as a saint. I find it very un-saint-like to willingly preside over, implying approval of, the ownership of one person by another. Lincoln did exactly that when he chose not to end slavery in the border states. His reasoning? He did not wish to anger any neutral state, which could result in further secession. In the end, the Emancipation Proclamation was simply a war strategy, and clearly not the principled, humanitarian act that it is believed to have been. 

In American Bastille: A History of the Illegal Arrests and Imprisonment of American Citizens in the Northern and Border States on Account of Their Political Opinions During the Late Civil War, John A. Marshall compiles over 100 incidents of wrongful seizures, authorized by Lincoln. In total, Lincoln imprisoned over 30,000 Northern citizens without trial for voicing opposition to the war.

The Abraham Lincoln we have been told of since childhood is no more than a myth. In actuality, the man was more of a tyrant than a hero.

References

Lincoln's Inaugural Address quotation:

http://avalon.law.yale.edu/19th_century/lincoln1.asp

Lincoln-Douglas debate quotation:

http://www.classic-literature.co.uk/american-authors/19th-century/abraham-lincoln/the-writings-of-abraham-lincoln-04/

The Impact of the Housing Market

No matter which theory you follow to understand the latest recession, the housing market seems to always be the crux. One might wonder why one market is so important for the entire economy. After all, there are literally hundreds of thousands of markets in a complex economy like the U.S. has. Labor, transportation, food, and metals markets are some large ones. Smaller items, like radios, chairs, and t-shirts, also are traded in markets with fluid supplies and demands of their own. Why is it that no one talks about market failures in the food industry? 

Failures in the food market certainly exist (thanks, government subsidies), and food is certainly a necessity. But the housing market possesses a longer reach than most other markets. To understand the extensive influence of this market, it helps to imagine one's self in the position of the producers and buyers. To produce a house, the producer will need materials, or factors of production. Some possible production factors include: concrete, brick, wood/lumber, plumbing/pipes, wiring, insulation, carpeting, light fixtures, windows/glass, tile flooring, drywall, and many, many more. These factors of production also have their own factors of production. For example, wiring may rely on materials like copper. The producer must also rely on the transportation market, which relies on the energy market. And let's not forget the massive amounts of labor hours required to build a house. Throw in the labor market. From the consumers perspective, a new house will often be accompanied by new products to be used in the house. This could include appliances, electronics, furniture, cookware, curtains, or beds. It is hard to think of another market that draws from so many other materials and products. If we think of the economy as a pyramid, the housing market would be near the top. Since housing is naturally a large market (everyone wants a place to live), many of its underlying markets are pegged with it. This is how the housing market crisis was able to put our entire economy into a recession. A crash in the housing market means a crash for the economy.

Now that we have established its importance, how did the housing market crash play out? Let's start with the Community Reinvestment Act. The CRA, initiated in 1977 and strengthened in the 90s, created incentives for banks to give out loans to low-income families. This meant more credit available for taking out loans and buying houses. As more houses were built and bought, prices were rising, and the economy was thriving. When the Federal Reserve, in response to short recession in 2001, increased the money supply multiple times, investors saw the rising home prices as a signal to invest more in the market. The housing bubble continued to grow.

This may sound great, but the story obviously didn't end happily.  However, it's important to realize that many of these loans for houses wouldn't have been given without interference in the market, and for good reason.  These were not secure loans, and the economy wasn't as thriving as the low interest rate suggested. As a result, many defaulted on their loans, the houses were repossessed, and we were left with a colossal surplus in the housing market. As logic follows, with so many empty houses, there is no need to build new ones. Thus, the housing market came to a halt, bringing all of its underlying markets with it. 

So there you have it - the tale of how the housing market, along with some help from the U.S. government and the Federal Reserve, was able to bring down the entire world economy on its own.

Hayekian Brilliance

I recently discovered a magnificent paper titled “The Use of Knowledge in Society,” by the great economist, F.A. Hayek. This paper looks at the most basic economic question of how resources can be used in their most effective manner. Hayek begins by critiquing the popular method of approaching this problem. Commonly, in economics, the belief is that one can find a mathematical solution in resource management problems. But to find this solution, one must assume full information of all individual preferences within the market. Hayek explains why this is not realistic, and therefore, finding a solution based on the assumption of full information is no solution at all.

He states that the problem, in reality, is to make use of resources in the best possible way with only individuals knowing their respective preferences. This means that we face the problem of making the best possible use of what individual knowledge exists. He believes this has been hidden through use of mathematics in economic problem solving. Interestingly, Hayek relates this failure to see the real problem to issues in public policy. Many policymakers believe that we can find economic answers through mathematical analysis, but in doing so, oversimplify a complex system of individuals in which we do not have full knowledge of individual preferences.

I find this particular point to be extremely important. It seems that for the last century or so, the world has been run by scientists. Many of these scientists, while well-intentioned, believe the world to be made up of physical problems. They are quick to blame problems like the low supply of water in some countries on simply not having enough water. In reality, physical water shortages are uncommon, and economic water shortages are all too common. The scientists who do realize this seem to believe the solution lies in changing people minds or coercing people into managing the water supply more effectively. Either way, they believe that governments or people in power can directly manage the water supply efficiently. But these scientists must have never heard of Hayek. The only way that a resource can be managed effectively is through free markets and a pricing system.

Hayek goes on to explain why free markets are most efficient. There are three possible systems that can address the question of how we make the best use of resources, he states. The first is central planning, which he defines as, “direction of the whole economic system according to a unified plan.” Another option is competition, or “decentralized planning by separate persons.” The final possibility is through “delegation of planning to organized industries,” or monopolies.

The question of which system should be used depends on which makes the best use of knowledge. The answer depends on the type of knowledge we seek. Hayek clearly differentiates between two types of knowledge- scientific and specialized individual knowledge. He concedes that if scientific knowledge is the most important, a centrally planned economy may make the best use of it. However, he refutes the popular claim that science is the most important knowledge available. This is because of the power that lies in knowledge gained from individual specialization. The latter sort of knowledge tends to be more unique, as it often comes from years of training, education, or experience in a particular field. For this reason, individual knowledge is extremely important.

Hayek emphasizes how frictional the economy is. There are numerous changes that occur in the day-to-day economy, which must be dealt with through the use of individual knowledge. While some claim to account for these changes in aggregate statistics, Hayek discredits this. He does not believe such statistics can effectively consider the constant changes in the economy. A centrally planned economic system must take into account these numerous, daily changes. But since they cannot account for them in numbers, even a centrally planned economy will be forced to leave some decisions to the discretion of “man on the spot.” But to accept this is to admit the need of at least some decentralization.

Hayek more closely examines the aforementioned “man on the spot.” He asks, what and how much knowledge does this person need? Sufficient knowledge is passed to this person through the price system. Pricing is what allows individuals to neglect all outside factors of a decision. It also eliminates the need for individuals to make complicated mathematical calculations to determine the correct course of action for every decision. One must only examine prices.

This is explained further by Hayek through an example of a realistic resource – tin. The example asks us to assume tin has become more valuable in another part of the world. The effect this would have, assuming all else remains constant, is an increase in the price of tin. This acts as a signal to people everywhere that tin is now more valuable. The price forces people to consider their use of tin and realize it is now more expensive. Hayek sees beauty in this, as the individuals do not need to know why or where tin has become more valuable. It also takes no central decision maker to force people to economize their use of tin. The pricing system allows people to act rationally in managing world resources, while only considering their own options.

Considering the magnificence of the price system, Hayek is very critical of the desire for central planning in society. While many people are concerned with solving the world’s problems by themselves or from a central authority, Hayek does not believe this should be the goal. Instead, he believes the goal should be “extending the number of important operations which we can perform without thinking about them.” In the competitive price system, there is no significant thought or decision making required by any planner. People must only consider prices. Therefore, this system makes the most sense in working toward Hayek’s goal of limiting difficult decision making.

He also discusses another benefit to the price system. It is highly compatible with freedom. It is a system that not only allows for economic efficiency, but also maintains the rights of individuals to their choice of pursuits and use of knowledge and skills. A centrally planned economy would often conflict with individual freedoms, with individual decisions being made by a single planner.

In concluding, Hayek states that to assume a certain entity can have full knowledge is to assume away the true problem in economics of resource management. To truly address this problem, one must consider how this knowledge can be gained and communicated. The system that solves the problem of gaining and communicating knowledge is the price system.

While reading this paper, it is easy to see the relevance of Hayek’s argument to the traditional study of economics. One thing that came to mind was how most economic students study utility. In a typical utility problem, we are given a budget constraint and a utility function for two goods. Given this, we must solve the problem of what choice the individual will make. As a practice problem, this is fine. But I believe Hayek would argue that to use this sort of analysis related to policy making, would be erroneous. If we assume that we have full knowledge of individual utility functions, the problem becomes one of mathematics. However, it seems unlikely, not only to gain specific knowledge of preferences, but to be able to represent them easily in a function. Many topics in modern economics deal with similar assumptions. Could this possibly be why our economic leaders have failed us so terribly as of late? Gaining the knowledge portrayed by these assumptions, in reality, is much more difficult than solving the problems with the given assumptions.

I hope that our policymakers will begin to see that they do not have, and never will attain, full knowledge of individuals or resources. Markets cannot function properly when dictated by a central planner. Both the theoretical and empirical evidence lie on the free market’s side. Hayek views economics as the study of individual interactions, rather than the study of how to control these interactions. He was ahead of his time, and almost surely an outcast in 1940s Austria for his beliefs. Luckily, Hayek has found a great appreciation for his work in a new generation of economics students, including myself.