Friedrich Hayek was Wrong on the Inevitability of Planning 306.0

Friedrich HayekFriedrich Hayek must be twirling in his grave. Like many classical thinkers, his ideas have been selectively harvested to support ideological causes that, as an academic, he would not probably agree with today.

Friedrich Hayek was the 1974 Nobel Laureate for economics specifically on his “penetrating analysis of the interdependence of economic, social and institutional phenomena.”

Note: This post is more about the political than the economic Hayek (and its conclusions are similar to my perspective on Karl Popper to which Hayek agrees with on ‘falsifiability’ criterion for scientific statements).

On the economic Hayek, I share a similar view especially on the importance of sound money and the reality of the microeconomic dynamics over time that the Austrian historical economics school with their fellow Viennese Joseph Schumpeter’s evolutionary economics.

Friedrich Hayek as political philosopher

He is best known for the The Road to Serfdom (1944, University of Chicago).

The phrase “Inevitability of Planning” in the title of this post is also the title of a Chapter of this book where Planning refers to Central Planning in a totalitarian state – his then definition and final state of socialism.

Friedrich Hayek. Road to Serfdom

F.A. Hayek, Road to Serfdom with Milton Friedman introduction. Click image for Amazon link.

New developments in economic theory particularly those on technology, institutions and choice have made his assumptions in the Road anachronisms.

Knowing about the young Hayek and his work makes me think he would have adapted on his deathbed in 1992 when the Berlin Wall had fallen, the totalitarian communist state a failure in the Soviet Union, and his 1944 brand of Socialism only extant in Cuba and North Korea.

Yet milder forms of Planning, i.e. social market economy and dirigiste states, are proving successful in supporting a good society in Western Europe as in Germany, the Scandinavian countries as in Denmark, Japan, South Korea and Taiwan – the last three the case studies for modern industrial policy.

Young Hayek and his work

He was a thorough student of history and economics and a purist for sound methodology.

Hayek was educated in the humanist German-style gymnasium that during his time included strong training in the classics. He would have been very comfortable with this Latin quotation (that I grabbed from a Facebook post on the RH Bill by MS Tensuan) and made sure his premises are solid:

Contra principia negantem non est disputandum. (There can be no debate from unequal premises.)

I think Hayek will hold no truck with those who use his writings today for ideological purposes. He was very uncomfortable that his renown comes more from “The Road to Serfdom,” that he considered a political pamphlet than his work in economics theory that had a revival after he won the Nobel Prize in 1994 and with its relevance to libertarian American wing with the current crisis.

In 1950, the renowned economists at the University of Chicago did not welcome him into their arms when he moved to America and allowed him to teach only in the University’s Committee on Social Thought.

Friedrich Hayek. Prices and Production.Ludwig von Mises Institute

Works on Economics by Friedrich Hayek compiled and available for free at Mises.org. Click image for Mises link.

Note: Like Schumpeter, some scholars think Hayek went through two clear phases. Hayek 1 is thought to have ended by 1941 when he had written his best theoretical work in economics (not other social sciences that I commented on here) and which the Ludwig von Mises Institute has compiled in the book at left. Many of his economics thoughts were revived and Friedrich Hayek quotes became popular after he won the 1974 Nobel Prize and when financial crises erupted that were impervious to Keynesian remedies.

In Vienna, this training implies thinking processes grounded in logic and history. He was a contemporary of Karl Popper in Vienna and agreed with the standard of ‘falsifiability’e (that I wrote about in SYNTHESiST Page and proof against logical positivism) in establishing factual, scientific statements.

His actual worked on real brains a student of psychology led him to reject logical positivism with Popper noting the physical gap between sensing and understanding in his book The Sensory Order (1952, Routledge and Kegan Paul) – thus sensation is not the necessary proof of reality as the positivists aver. This personal experience tracing neurons by staining brains at a young age influenced his economics and philosophy – he concluded from this that since individuals cannot ‘know’ reality then, consequently, groups likewise cannot ‘know’ reality hence his visceral view that [Central] Planning will not work.

In the 1936 Presidential address to the London Economics Club, Economics and Knowledge, he defined the market in psychology terms as below (and calls equilibrium analysis as a system of tautologies):

… a system of the utilization of knowledge, which nobody can possess as a whole, which only through the market situation leads people to aim at the needs of people whom they do not know, make use of facilities for which the have no direct information, all these condensed in abstract signals, and that our whole modern wealth and production could arise only thanks to this mechanism … is I believe, the basis not only of my economic but also much of my political views.

Hayek’s critique of neoclassical macroeconomics above stem directly from the biological disconnect he saw as a psychologist between perception and cognition (and between individual and social action) based on science and technology of the 1930s. This view of the economy extends to his view of the libertarian political systems to which it is consistent.

Hayek died in March 1992 at the age of 93 and three years after the fall of the Berlin Wall.

Hayek adapted with a revised definition of Socialism by 1976

Hayek was a purist academic – while acknowledged as a ‘controversialist’ he was not into polemics. He did adapt when the facts and the science changed much later. He was too old to catch the new theoretical developments in the 1980s that I discuss farther below.

In his Preface to the 1976 edition of The Road to Serfdom for example, he acknowledged that Socialism and Planning had morphed from the original meaning of Totalitarianism and [central] Planning that he used in 1944 to:

Socialism has come to mean chiefly the extensive redistribution of incomes through taxation and the institutions of the welfare stage. (p.xxiii)

Still, he affirmed his original message in that 1976 Preface (when he was 77 years old) that:

… the effects … are brought about more slowly, indirectly, and imperfectly … the ultimate outcome tends to be very much the same …

In the autobiographical dialogue pictured at right and published in 1994, two years after his death, he likewise affirmed the basic truths behind his classic, The Road to Serfdom (1944, University of Chicago).

In conclusion, I find that I disagree with the political Friedrich Hayek and find his ideas already anachronistic.

In economics, I find some agreement on the analysis particularly the dynamic inter-temporal and microeconomic view that the Austrian historical school shares with Joseph Schumpeter, a fellow Viennese, evolutionary economics (More of economic aspect in another post).

His synthesis, I think will not work for emerging markets that have severe factor under-utilization as well as backwardness in technology and institutions. Libertarianism in emerging markets will just cement plutocracy and oligarchy. A rule-based political economy that balances equality in opportunity with incentives for innovation is the fine balance needed going forward.

Interactive Learning forms the core of innovation systems

IFIAS 6. Technical Change and Economic Theory

Neo-Schumpeterians R Nelson, G Dosi, G Silverberg, L Soete and C Freeman in this 1988 book introduce new concepts that overturn Hayek

Evolutionary economists like Bengt Ake Lundvall and the editors of Technical Change and Economic Theory (1988, IFIAS Vol 6) proposed as neo-Schumpeterians that innovations and technology are endogenous to economics.

Friedrich Hayek, with other classical economists in the Austrian school, did not have the methodology to consider technology endogenous. Lionel Robbins and his 1939 paper The Inevitability of Monopoly, whom Hayek cited in The Road to Serfdom, considered technology an externality.

Like the other classical economists, their analysis focused on individual agents because of “given data” issues as Hayek discussed in his self-described 1936 seminal essay Economics and Knowledge that he delivered as a Presidential Address to the London Economics Club already cited above.

Thus, his economics focused on the benefits from transactions and did not consider increasing returns – that would have made monopoly inevitable – that comes from knowledge embedded in technology and from interactions, coming from social media like Facebook. Hayek’s economics cannot handle social media.

Increasing returns from social network effects and learning embedded in products – while originally studied with the railroads (though not referred by Hayek) – needed the work of W Brian Arthur in the 1990s, about the time Hayek died, to be researched and made the basis of such modern wonders as Silicon Valley.

This dynamic (inter-temporal dis-equilibrium as normal) neo-Schumpeterian context of [national] innovation systems is the construct that SYNTHESiST is using as foundation for developing appropriate innovations in the appreciative theory of development that he is working on.

New Institutional Economics makes Hayek’s Sensory Order obsolete

Douglass North. Process of Economic Change

D North (ref R Heiner, 1983) and new institutional economic introduce new concepts that overturn Hayek

In Understanding the Process of Economic Change (2005, Princeton Unversity Press), Douglass North who is the 1993 Nobel laureate for economics wrote a justification for new institutional economics that overturns Hayek’s core idea that supports his libertarian claim based on the gap between perception and cognition.

Note: Interestingly, both North and Hayek take off from Frank Knight and the handling of risk in economics.

Possibly because of the difference of the state-of-the-art (1980s vs 1930s) in the science of perception and cognition, North and Hayek reached different conclusions that determined their choices in political economy.

Referencing a 1983 study by Ronald Heiner on The Origins of Predictable Behavior, North notes that humans bridge the gap coming from uncertainty by “constructing rules to restrict the flexibility of choices in such situations.”

Rules like property rights, sanctity of contracts, and the party system become the bases of institutions over time. Unlike Hayek who concluded that individuals are not capable of handling uncertainty and thus nobody can really know what goes on in a society of individuals, North and the new institutional economists like Oliver Williamson and Elinor Ostrom, who shared the 2009 Nobel laureates in economics, gave new impetus and created institutional economics as a new branch that 1991 Nobel laureate Ronald Coase introduced to the world in 1937.

Note: Friedrich Hayek was associated with Ordoliberalism, the German liberal economics school that advocated individual freedom but specified the presence of rules (and institutions) that facilitate the enjoyment of such freedoms. While accepting the tenets of German Ordnung possibly from its sociological roots say from Max Weber, Hayek’s background in psychology and actual work on brains led him to choose, from the negative – the gap between perception and cognition, that behavior of individuals and, consequently, of groups defy measurement and thus control.

New institutional economics is the construct that SYNTHESiST is using as foundation for social innovation in the appreciative theory of development that I am working on.

In this appreciative theory, the inter-temporal interaction and co-evolution between innovation systems and social innovation is the core dynamic for emerging markets catch-up development.

Modern industrial policy is the next process step in SYNTHESiST appreciative theory of development.

Modern Industrial Policy discovers the economic locomotives for emerging markets catch-up

Dani Rodrik. One economics many recipes. moder industrial policy.

Rodrik's modern industrial policy, while not aptly branded, refutes the 'inevitability of planning' with a discovery process that incentivizes 'new' things. Click image for Amazon link.

It is unfortunate that Dani Rodrik of the Harvard Kennedy School of Governments persist in using modern industrial policy, with all the baggage that it carries from [Central] Planning and Import-Substituting Industrialization (ISI), in describing his new approach.

Still, a careful review of Rodrik’s approach that I summarized in a SYNTHESiST post on modern industrial policy clearly indicates his neoclassical preferences. Compared with Hayek’s opposition to any form of Planning, I emphasize that Rodrik’s ten rules for modern industrial policy – derived from the success of Japan, South Korea and Taiwan – makes ‘modern’ the operative word and highlights the differences versus past versions of industrial policy.

The first four rules below already highlight these differences:

  1. Incentives must be provided only to “new” activities – not to existing ones.
  2. Milestones are necessary – there should be clear benchmarks/criteria for success and failure.
  3. A clear timeline, as well – there must be a built in sunset clause for performance. Maybe, a pre-defined exit strategy for failure can help as well.
  4. Public activities must target activities not sectors – this is a radical departure from current way of giving incentives.
  5. … – 10.

The ten-step outline by Rodrik are used as guideposts in a process of discovery of economic locomotives done in conjunction with industry and academe in a process very dissimilar to the previous ‘picking winners.’

I would venture two more rules – (a) technology forecasting that allows convergence in incentivizing activities across time and (b) the presence of successful innovator-entrepreneurs to drive the locomotives discovered.

Rules to build institutions and to avoid Hayek’s inevitability of Planning

Using Rodrik’s ten-step process and my two as 12 Rules – in the Ordoliberal sense of facilitating and enhancing transactions and interactions and creating spontaneous order in the sectors and meso-economic zone supports the needs for emerging markets for catch-up development.


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2 Responses to “Friedrich Hayek was Wrong on the Inevitability of Planning 306.0”

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  1. Synthesist says:

    [...] a previous post, libertarians including Friedrich Hayek equated industrial policy with Planning to Totalitarianism and Communism. With the rise of the Soviet Union, this started the demonization of industrial policy in modern [...]

  2. Synthesist says:

    [...] ideas flow from those of economists of the Austrian school like Ludwig von Mises and Friedrich Hayek. These days, the ideas are developed, discussed and broadcast in Institutes and websites like that [...]



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