Caldwell: Hayek's Intellectual Journey

Come along on a journey through the corridors of economic history and methodology with our esteemed guest, Bruce Caldwell from the Center for History of Political Economy at Duke University.  Caldwell's personal voyage, from the nuances of economic methodology to his deep dive into Austrian economics, sets the stage for an enthralling discussion on the workings of institutions, transaction costs, and the profound impact of Friedrich Hayek's theories on modern economics. Get ready to unlock the secret meaning behind the unique TIPS acronym within Austrian economics.

We follow Hayek's intellectual transition from his focus on business cycles to the intricate challenges of economic calculation and knowledge distribution. The conversation illuminates the value of information in economic decision-making and highlights the importance of markets in reconciling diverse plans and purposes. Discover how Hayek's 1945 paper reshaped economic thinking, extending its influence beyond the Austrian school and into the realms of neoclassical economics.

Our exploration culminates with an examination of the very fabric holding our economic systems together – institutions. Delve into the evolution of economic institutions with insights from Doug North's intellectual quest and the relevance of Austrian capital theories in understanding economic flexibility.

Links:

Bruce Caldwell, Beyond Positivism  https://www.amazon.com/Beyond-Positivism-Bruce-Caldwell/dp/1138834238

Bruce Caldwell and Hansjoerg Klausinger, Hayek: A Life, 1899-1950  https://www.amazon.com/Hayek-Life-1899-1950-Bruce-Caldwell/dp/0226816826/

F.A. Hayek, 1945: The Use of Knowledge in Society, American Economic Review. https://www.econlib.org/library/Essays/hykKnw.html

Michael Munger,  "The Socialist Generation Debate" https://www.aier.org/article/the-socialist-generation-debate/

Surge Pricing, NPR.  https://www.vox.com/money/24105250/fast-food-restaurants-dynamic-pricing-algorithm-wendys

Hope Center at Duke. https://today.duke.edu/2018/08/duke-center-expands-commitment-history-economics

If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !

You can follow Mike Munger on Twitter at @mungowitz

Transcript

Speaker 1: 0:01

This is Mike Munger of Duke University, the knower of important things Information, transaction costs, time and the main precepts of Austrian economics. Fa Hayek and his intellectual journey from business psychotherapist to broad commentator on society and institutions. Today's interview takes up these topics with an internationally recognized expert and author, bruce Caldwell of the Hope Center at Duke University. Four new twedges, plus this month's letter and more Straight out of Creedmoor this is Tidy C.

Speaker 2: 0:40

I thought they'd talk about a system where there were no transaction costs. It's an imaginary system. There always are transaction costs. When it is costly to transact, institutions matter and it is costly to transact.

Speaker 1: 1:00

Bruce Caldwell has lived in North Carolina for much of his life but spent some postdoctoral time at New York University working with Ludwig Lachmann and Israel Kersner. He's one of the world's foremost experts on the work of Nobelist Friedrich Hayek. Caldwell has also made important contributions to the study of economic methodology, including his first 1982 book Beyond Positivism, which has nearly 2,000 citations in the professional literature. We spoke about Hayek, austrian economics, neoclassical economics and, of course, transaction costs.

Speaker 1: 1:36

Well, my guest today is Bruce Caldwell from the Center for History of Political Economy at Duke University the Center for History of Political Economy at Duke University and I always ask that the guests introduce themselves and say something about how they came to be here. In Bruce's case, he is one of the world's foremost experts on the work of Friedrich Hayek and a number of other topics in history of political economy. Also. Bruce, welcome to Tidy C. Could you say something about how you came to be interested in the study of economic history and history of political economy, how those things are different and how you came to be interested in studying Friedrich Hayek?

Speaker 2: 2:20

I went to UNC, which is my dirty little secret as a faculty member here at Duke. Wouldn't know if anyone else would have such secrets, but anyway, I studied the history of economic and saw how insightful some of the things that I got out of my economics classes were for understanding how the world worked. I went on to do graduate work in economics and suddenly was perplexed by the sort of stuff we were studying at UNC at the graduate level, were studying at UNC at the graduate level. So I didn't know why economics looked so different at the undergraduate versus the graduate in the 1970s, which is when this was, and the 70s, by the way, economics education, graduate education in the 70s, I think, quite different from the way it is now. That was the point of when theory was king, and if you weren't a particularly effective student, you'd go on and do empirical work instead. Ok, so all the best people did theory, everybody else did something else. Now it's quite different and empirical work is king. So I mean, these trends that take place in economics are pretty funny. I actually think that Hayek has some insights as to why some of these things happen, but anyway, that's besides the point.

Speaker 2: 3:54

So I took history of economic thought as a field because I was interested in understanding better the development of economics through time, and it turned out that the dissertation advisor I had, vincent Tarazio, was also someone who's interested in economic methodology. So I took the first course in history of thought. The second course in the field was one on methodology, and I ended up doing a dissertation that was ultimately published as a book called Beyond Positivism, which looked at economic methodology, various debates that took place in economics in the 20th century from a philosophy of science perspective or background, looking at changes that took place in the philosophy of science and trying to kind of fit together the ideas that economists had versus those that philosophers who studied all sciences had. And I didn't really understand what was going on in economics so much. But it did lead me to an interest in methodological issues and it turns out that Hayek was someone who wrote extensively about the methodology of economics.

Speaker 2: 5:03

So at some point I went out to a summer school out in Boulder, colorado, for three weeks. It was my first exposure to Austrian economics in air quotes, and I was fascinated. I tell people that I learned more or had more intellectual stimulation in three weeks in Colorado than I had had in four years in grad school and then I went, as a result of that, went on a postdoc to NYU Israel Kirsner was there at the time, larry White, ludwig Lachmann came in in the spring. So I got introduced to a large number of people who ended up either at the time were influential in the Austrian movement or later on were peers who were influential in that movement.

Speaker 2: 5:50

So that's how I got into studying Austrian economics and, as I said, hayek had some particularly interesting methodological insights. So that was the draw there. Subsequently I went on to do a couple of volumes. I was invited to do a couple of volumes in the Hayek Collected Works by Stephen Kresge, who was the general editor in the 90s. He then stepped down as general editor in early 2000,. So I took in the 90s and the early 2000s.

Speaker 1: 6:34

But you also have come then to do work on the intellectual history of Hayek, the intellectual history of Hayek. So your description is certainly interesting, how you came to be interested in the Austrian method, the conclusions, the approaches that Austrians take that are different from maybe we might call it mainstream. As opposed to what Pete Betke calls mainline economics, he thinks that Austrian economics is really the main line. It's consistent with the way economics was developing. And then there was this diversion into what you've been calling theory. For those outside of economics, what that means is math. It looks like to an outsider that these are mathematical models that are being used to generate propositions which then don't need to be tested because the proof strategy is deductive. We show that they are true, and the job of theorists is to accumulate a set of propositions known for certain to be true because we have proved that they are correct, given their premises. Empirical work is a bit different and I'm hoping we can talk some more about that is a bit different and I'm hoping we can talk some more about that.

Speaker 1: 7:48

A number of Austrians are skeptical about our ability to do empirical work, particularly at the macro level, because of problems of aggregation. But you have come to be an expert not just on Austrian economics but on the development of the intellectual perspective of Friedrich Hayek, and it happens that Duke has a significant number of Hayek's papers, or all of Hayek's papers, so that's a pretty big resource. You have recently co-written the first volume of one of my favorite books of the last five years, which was Hayek A Life. It's supposed to say volume one, but the publisher wouldn't allow that. It says 1899 through 1950. So in principle there could be four more volumes. That is a work of intellectual history that is such a significant contribution to the study of Hayek. Just parenthetically, could you say a little bit about how you came to work on that aspect of Hayek's life?

Speaker 2: 8:55

Oh sure, well, thank you for the plug of the book. It is a book that Hans-Jörg and I worked on for a decade, a book that Hans-Jörg and I worked on for a decade. So I became general editor in the early 2000s of Hayek's collected writings. This ended up being a 20-year project for me and it was a project that had started in the 80s under Bill Bartley, but it was always the plan that whoever was the general editor would also be a good person to do a biography, a full biography, of Hayek. So in becoming general editor of the Collected Works, I got to meet the Hayek family, which at that time was Larry Hayek, his son, and Christine Hayek, his daughter. Both have now since died, because this was in the 2000s that I met them. But in meeting them I got to know a lot about the family. I saw that they had a lot of really interesting artifacts.

Speaker 2: 9:57

When I visited Larry Hayek in his home in Devon, we had a nice conversation. I had a conversation with Christine, I had dinner there, I spent the night. The next day I went up to Larry's study and saw all these wonderful things that were contained there, and I realized that in agreeing to become the general editor of the Collected Works, I would have access to things that nobody had access to before as biographers. So that was when I decided that I would like to do that, and it was about a decade ago that I approached Hans Sjord, who had done two of the volumes in the collected works. One of the requirements that Hayek always said for the biographer was that they be able to read German, and I studied French in school, so that was not me, but Hans Jorg had done such a wonderful job on the volumes and the collected works that he had edited that I thought it was a natural team, and indeed we had a very smooth relationship. I thought it was a natural team and indeed we had a very smooth relationship.

Speaker 2: 11:10

It took so long because we had to figure out exactly what we had to work with, so that meant going through the archives. I do have a microfilm version of Hayek's papers here at Duke, but the actual holdings for his papers are at the Hoover Institution. But the actual holdings for his papers are at the Hoover Institution, so that's the mothership for all of Hayek's actual writings that are not on microfilm, and so we had to figure out what was there. We had to visit other archives. I did interviews of Christine, of Larry, of Lionel Robbins' daughter, various people who had known Hayek at various points in his career, and it was once we have all of that together, which we now do, that we ended up starting to do the writing and, as you said, it's the first volume. There will not be four, there will be two and I'm working on the second one now.

Speaker 1: 12:00

You're talking big. We'll see. It is a monumental effort and in fact, those of you who have ever anyone who's received an email from you there's a hilarious quote at the bottom of your emails that someone who does intellectual history constantly confronts that it can take hours to find a reference and it can take days to fail to find one. So the hardest thing is always when you're looking for references and it's not there. It's not there, you're not sure when to stop. So finding one, okay, I'm done, I can go on to the next. There's a lot of references in this book. The sources of it are it just it's a marvelous resource, and it is. It sounds like you were right near the end of the time when it was still possible to get personal recollections that would help guide at least some of the writing. It's not from Hayek himself, but from people who knew Hayek, and that makes a big difference in the quality of the intellectual history. So congratulations.

Speaker 2: 13:06

Thank you. The person that I thought was along those lines that I was most fond of was Hayek's daughter, Christine. She was just an absolutely lovely woman, had a great sense of humor, was expressive, was honest about personal family details, but also just so full of life and enjoyed life so much. Every time I would go to London, I would go down to Cheswick and visit her and we would sit in her rat's nest of an apartment because it made your office look like pristine. Rat's nest of an apartment because it made your office look like pristine, Let me tell you, it was just piles and piles of books and papers all over the place. And then we would, after we'd talked for a while, we'd go to the pub right down the road and have a pub lunch, and it was just.

Speaker 2: 13:58

I really enjoyed meeting her and finding out about her family from her perspective. It was just very, very rich. One of the things that we did on one of my trips there was to visit their neighborhood where she had grown up and she had not been there in 50 years and it was just so wonderful to watch her face as she was pointing out things and says this is where we'd play here and here's where I'd ride my bike and, yes, there's the clock that we would check to know what time it was to come in from playing and all the rest. So it was. It was really nice.

Speaker 1: 14:36

Well, as I said, congratulations. I recommend that book most heartily and we all look forward to the second volume. We'll see if that really is the last one, because I said you're talking big, so let's switch now a bit. I wanted to give a very brief and so, with a warning that brevity and summary leave out a lot of important details. I think a lot of people don't really know what Austrian economics is. The way that I usually describe it is I try to give tips, and that's an acronym T-I-P-S. So the four things that make up tips are first, the importance of time, and a lot of economics work outside of Austrian economics is pretty static in terms of time. Attempts at dynamics might be a couple of generations, but Austrians are interested in things that are durable, that things that we might invest in because they last over multiple periods, and I'm a student of Douglas North.

Speaker 1: 15:37

Much of Douglas North's work was the problem of economic development in institutions through time, so in some ways he was sympathetic. The second is I, which is either information or ignorance, and so the importance of ignorance and information is something that we're going to come back to in a minute, so I'll not say much more. The third P is plans and purposes, and so any kind of institution has to have some means of reconciling the conflicting plans and purposes that many different individuals have, and we need some means of coordinating that. Now, centrally planning means that we give orders and direction, but any decentralized solution will have to have a mechanism for letting people update their plans and purposes. For Austrian economists in commercial settings, that is the price mechanism. Hayek later in his life became interested in non-market institutions and actually came to some of the public choice meetings In non-market institutions. You have a problem of what is the source of information if you don't have prices for having people update their plans and purposes and then reconcile these in a way that doesn't involve fighting. I want a resource, you want a resource. Can politics answer that question? And so Hayek went in that direction later in his life.

Speaker 1: 16:59

And then S the last letter in tips is subjectivity. Last letter in tips is subjectivity, and the problem of subjectivity is one that was not unique to Austrians. I have tried to find some family connection to Karl Menger. It's pretty close to Munger. I think it's vain. They come from different roots. But Karl Menger in his work on marginalism and subjectivity is kind of a fork because a lot of classical economics, neoclassical economics, took up the marginal part and Austrian economics took up the subjective part. It's not that they're not worried about marginalism, but the subjectivity is much more important.

Speaker 1: 17:39

So for Hayek, much of his early work, and in fact some of what's mentioned in the Nobel Prize announcement, was on the problem of business cycles, and some of that is because at the time that he was working, the period after World War I and then of course what we call the Great Depression, business cycles were a very significant topic. But he had switched, and arguably by 1937, in his paper in Economica, economics and Knowledge. Let me just quote from the first paragraph, because this is something you make a fair amount of in the book, and I think rightly, and it's not a very well-known paper. So let me just read the first paragraph. This is from 1937, economics and Knowledge by Friedrich Hayek.

Speaker 1: 18:30

The ambiguity of the title of this paper is not accidental. The main subject, of course, is the role which assumptions and propositions about the knowledge possessed by the different members of society play in economic analysis. But this is by no means unconnected with the other question which might be discussed under the same title, the question to what extent formal economic analysis conveys any knowledge about what happens will be that the tautologies of which formal equilibrium analysis and economic essentially consists can be turned into propositions which tell us anything about causation in the real world only so far as we're able to fill these formal propositions with definite statements about how knowledge is acquired and communicated. Now that sentence should be taken out and shot. It should be three sentences. It's pure hyek, it just, it can't stop. But when you parse it that's really an amazing sentence. So the extent to which formal economic analysis conveys any knowledge about what happens in the real world, it can only be because we can say something about information. And so by 1937, he had started working in that direction, that, as far as I know, there aren't many other people who had taken up that view.

Speaker 1: 19:50

And then by 1945, he wrote the piece for the American Economic Review, one that he, as I found out from your book, maybe didn't have all that big hopes for. He had written it as sort of a general description, and because it was written what's like Paul's letter to the Romans, paul's letter to the Romans in the New Testament was the only letter that Paul wrote to people he didn't know. So he's sending this is what we believe to some other group, hoping it will catch on like a virus. So Hayek sent the 1945 paper across the Atlantic to the Americans. They're going to publish it in their AER and he's describing an overview of his thought. And it became it's probably the single thing that he is most known for.

Speaker 1: 20:38

So forgive the length of that introduction, but my question is actually relatively simple. Hayek was working on business cycles. He became interested in the calculation problem as early as 1937, he was saying economics should be about information to the extent that it's not, we're wasting our time. And then in 1945, he nails it in a way that actually changed not the entire course of economics but brought it outside of just Austrian and into a subject that a neoclassical might plausibly study. So can you say something about how Hayek made that transformation and why the 1945 paper is so significant?

Speaker 2: 21:19

Okay, so that's a great introduction to the changes that took place in Hayek's intellectual path from the 30s to 1945. So he starts out, as you say, interested in business cycle theory. He lived through a hyperinflation. He realizes that money is an important part of all this. So he was working on a theory of a money-using, capital-using economy. He was really trying to be a theorist and this is in the days before there's extensive mathematization of economics. So it's all verbal, very tough stuff to read, as is Keynes' alternative theory, if you read the pure theory of money, or indeed the general theory, very difficult stuff to get through.

Speaker 2: 22:16

But he gets to England and, in addition to concern about the Great Depression, in terms of what we would think today, stabilization of the economy, a lot of people are saying well, the Great Depression indicates that capitalism is well and truly dead and we need to figure out what we should adopt instead as an economic system.

Speaker 2: 22:39

Fascism didn't look that cool, communism not so great Socialism Socialism is the way to go. So there was great enthusiasm for socialist planning among the British intelligentsia in the 1930s and so Hayek wanted to take up this argument because he disagreed with these claims that were being made. He publishes a collection of translations of readings that had been written in the papers, that had been written in the 1920s and earlier. It comes out as collectivist economic planning. He has an introduction and a conclusion, and among the pieces are Ludwig von Mises' critique of socialist planning that had been written in 1920. So he's starting to engage in all this. At the same time, he's getting other socialist voices, someone like Oskar Lange, saying well, yes, we are thankful for Mises for saying how important it is to have prices, but prices are just datum.

Speaker 1: 23:43

Yeah, we're going to put a statue of him up in the Socialist Planning Institute.

Speaker 2: 23:49

Yeah, the Great Hall of Planning. That's right for giving us these insights, but we can handle all this and it was in the process of these and other conversations. He is, by the way, at the London School of Economics. Hayek is working there and that school was founded by Fabian Socialist, so he has lots of colleagues who think that planning is just going to be able to work fine. They have courses in how to plan the economy and this is what he's kind of pushing up against in conversations in the senior commons room, et cetera.

Speaker 2: 24:23

So the question that he's trying to ask or that he's asking not trying to, but asking in economics and knowledge, as you put it in that first very, very, very long sentence is what assumptions do we make about agents in our models, and particularly those concerning what they know? Concerning what they know and basically, if you think about, even today, mainstream economic theory that's taught in your second course in microeconomics, you're assuming that agents have the full information and that the information that they have is correct. And he said well, in the real world, neither of those are true. What we have are each person has bits of information, so information is localized and some of the things that you think are true, particularly if you're planning for action through time as you point out, a very important Austrian insight action in the future. Some of the plans that we make are going to be wrong.

Speaker 2: 25:28

So the real question he says if we had all of the information that we're assumed to have in these models, everything would always work out. There's no problem. The real question is these models are trying to reproduce something in the world, a certain amount of coordination that we see in the world. We see that coordination in the world, but the model doesn't explain it. So that's what that whole long first. It's not really helpful in letting us know how this coordination that we sometimes observe Don't always observe it. During a hyperinflation, you don't have a price mechanism working very well because we don't know what the real prices are because you've got rampant inflation.

Speaker 2: 26:07

But in a well-functioning market system you get the coordination of economic activity. As Bastiat put it, paris gets fed. Nobody's planning to feed Paris. You've got millions of people just operating in their own particular sphere and yet we have massive coordination. So how does that happen? That's the question he asks in 1937. And, as you put it, he answers the question in 1945 in an article that was published in the American Economic Review, which even then was considered the major outlet for publishing things. He was lucky because his buddy, fritz Mocklup, someone he had known from university days in Vienna, was acting editor of the American Economic Review and actually sent Hayek a letter saying, hey, send me something. And Hayek's like I'm not sure. And then he just puts this together really quickly, really quickly, this most important article which really engaged the rest of the economics profession in asking questions about information and its importance. He put it together very quickly, sent it off and it got published and, yeah, it was really even then really quickly appreciated by other writers who were more mainstream economists. So yeah, that was the story of how he came to write that very important and influential article. It's certainly often listed in the top 100, if not the top 10 articles in economics in terms of people citing it as an important part.

Speaker 2: 27:49

You mentioned Doug North, by the way. I had the pleasure of having him visit me when I worked at UNC Greensboro in the 90s and he was very interested in Hayek's work. Part of it was Hayek's later turn towards the importance of institutions as conveying information, not just a market mechanism, but also there's lots of information in institutions. I know that sounds strange, but that is kind of an insight of his and I think that North appreciated Hayek's work and on this particular visit he was very interested in Hayek's sensory order and I think he was trying to figure out how is it that humans come to decide things in the way that they do? I think Doug was talking. He used the word ideology how do individuals come up with their individual ideologies and I really wasn't sure what he was talking about then I kind of later understood better what he was trying to do. I think, like Hayek, he was trying to come up with the theory of everything towards the end of his life, which is a typical Doug. I mean great guy, he was your advisor, right.

Speaker 1: 29:03

He and Barry Weingast were my advisors and I for a long time wrote things about how North was wrong and then I realized he was right. I think I didn't really understand it North was interested in and he was. It was very frustrating in class. He would say the big explanatory problem of economic institutions is that they never change until they do, and so you need a theory. That both, because if you have a theory that just says economic institutions never change, that actually does pretty well in terms of classification, but it doesn't explain any of the great turning points of history. And he wanted an evolutionary theory and that was why works like law, legislation and liberty from Hayek later became of such interest to him.

Speaker 1: 29:49

Although he had started out, north had been interested in measurement and economic history, had been working in cleometrics, had actually worked in the national income and product accounts with Simon Kuznets in trying to define the size of the transaction cost sector. So what they were interested in since this podcast is about transaction costs the idea of productive and nonproductive assets, some of which may be necessary as a sort of foundation, was something that North was interested in and it related, I think he realized later, to the Austrian idea of capital structure, because the capital structure is something that is contingent and time bound. It doesn't matter how much capital you have. A lot of it may not be appropriate. It's difficult to change it around. And so the availability of liquidity and how could, did you have institutions that allowed you to convert capital into liquid capital that could then be used for something else is a big part of generating information.

Speaker 1: 30:52

How much is this asset worth? Well, it has to have a fairly thick market. It has to have people buying and selling something like that asset. If everything is unique, you can't say much about it. Well, one of my treasured possessions you may have seen this, I bet you have at least seen it referred to it's a book called the Planned Society and it is edited by Findley McKenzie. And it was the Planned Society Yesterday, today and Tomorrow, a Symposium of 35 Economists, sociologists and Statesmen.

Speaker 2: 31:27

And.

Speaker 1: 31:27

Mussolini and Stalin. Yeah right, mussolini and Stalin. Yeah right, mussolini and Stalin. It starts out fairly okay. So, margaret Mead and Wesley Mitchell.

Speaker 1: 31:39

I had wanted to ask you about Hayek's encounter with Wesley Mitchell, where he was surprised at how backwards the American economic, because Wesley Mitchell was a pretty big deal but he was just committing the fallacies of the German historical school. We'll look at this information. We don't really need theory. The data will tell us how things work. But yes, towards the end, the real big delivery of this book is essays, how-to essays on planning by Mussolini and Stalin, and by 1937, you probably should have known better, but it was maybe 32, 33, okay, but by 37,.

Speaker 1: 32:20

So the reason I quote this is that it is this was published the same year that Hayek's Economic and Knowledge paper was published, and I think it may be hard for modern people to realize the depth of the faith and it was a faith by this time that planning was the way to go. Whether it was socialism or not, it certainly is planning. It is central planning. Maybe planning need not take the form of state ownership of the means of production, which is the usual definition of socialism, but it could just be that the direction will be. Here's what prices are going to be. We'll calculate what the price will say where the resources should go. We don't need to own them, but of course we will direct them for the good of society. So when Hayek talks about planning, it's not hypothetical and it's not paranoia. That was by far the established way of thinking about. To such an extent he said, his voice rising in incredulity, to such an extent that Hayek and Stalin and Mussolini are seriously quoted and consulted as being authorities about how we should proceed.

Speaker 2: 33:32

Yeah, I mean, it is really hard, I think, for modern readers to have any sense of what was going on then In doing the book. Also in doing my editor's introduction for the Road to Serfdom, which was something that I had done that was published in 2007, I think. So I was working on that in the early mid-2000s and I had always thought well, the Road to Serfdom is a popular piece, it wasn't going to be too challenging to do. I wasn't sure if I understood what Hayek's claims were, and it was a transformative experience for me because I realized, boy, he's making an awful lot of sense.

Speaker 2: 34:18

And in reading the people that he was responding to, I was appalled.

Speaker 2: 34:23

I was appalled at the arguments that were being made because, from a modern perspective, well, on the other hand, if, in fact, it's true that something like 50% of college students in America today, when asked which would you prefer, a capitalist society or a socialist society, say socialism, so this is not a this sort of kind of easy acquiescence in the idea that, well, socialism just means social democracy, just means social justice, just means trying to help poor people, and so therefore, it must be good, and capitalism is something where you have greedy people and that hurts people. So it is in responding to those sorts of casual arguments, in addition to the arguments that were being made by, you know, the intelligentsia that Hayek, you know, wrote the Road to Serfdom. I mean that was why it kind of shifted from doing the sort of work he usually does, which was either theoretical or a major piece of intellectual history, which was what he was working on in the 40s A big, two-volume work on the abuse and decline of reason, typical Hayekian sort of project. Huge, huge set of volumes. Instead does something quite popular in the Road to Serfdom, because he recognized that it's not just the academic socialists that need to be answered, it's the general arguments that are being made out in the streets about these things that people were buying into. So Pence's that aspect of his career path.

Speaker 1: 36:00

Well, so let's drill down a little bit into the actual transaction cost argument that he's making in the night pretty explicitly in the 1945 paper. There's some of this in the Road to Serfdom, but the 1945 paper in particular is talking about the way that a commercial system generates information about the relative scarcity of resources. So what we have is in economics we mostly focus on equilibrium prices, and there's two problems with that. One is that it's static, and the other is that price misses the fact that any voluntary exchange requires a disagreement about value. So the only way you and I can agree on a price is if we disagree about the value. If I sell you a car, I must value it less than the price you offer. If I sell you a car, I must value it less than the price you offer and you must value it more than the price that you pay. And so there's all this disagreement about value, about resources, products, services, and as a result we're able to negotiate a price and to the extent that these commodities are real commodities, they're homogeneous. We probably could talk about a single price, or at least a tendency towards single price because of arbitrage, because I, as a middleman, I can buy and resell. So price tells me something about the opportunity cost of the resource.

Speaker 1: 37:24

Where does that information come from? Why is it that we couldn't approximate it in Hayek's view, if we just had all the information about the amounts of resources and then we can use particulars? Maybe in 1945 he was right about input-output matrices. We have a form for calculating ratios. We have computers that can make and then update these calculations very quickly. So maybe Hayek was once correct. But that was before computers. Now we have computers. Why is it that people like you still claim that socialism won't work?

Speaker 2: 38:07

Let's unpack some of the things that's going on there. So one of the things that he said, first of all, why a market does solve what he called the knowledge problem. He's saying well, you know, each of us has our own little bits of knowledge, right, knowledge is dispersed and we know what we want to do. We have plans that we're trying to achieve and we do have subjective evaluations that differ across people, just as you say. I mean, that was a Mangarian insight when he talked about how trade emerges. He says it's because people value the marginal unit differently, and the marginal unit is what everybody jumps on, but it's really the subjectivism, just as you say, just as you say. So he's saying we have all these bits of information, so how do we coordinate it with everybody else's bits of information? And he points out that, in a market system that is functioning, property rights that are established and enforced and all the rest established and enforced and all the rest, that I take this array of prices that are relevant to my decisions as more or less given and then I make my decisions, but millions upon millions of people are doing the same thing and it is the millions and millions of decisions that those people are making as consumers and producers that generate the array of prices that each person is dealing with, and this is constant. This is like a pulsating mechanism because people are constantly adjusting as those prices change, and they change according to what people are doing in terms of their decisions in the market on a day-to-day basis. So it is a complex, adaptive system. It is probably the best example of one, and it certainly is the one that got Hayek thinking about complex systems or what he calls spontaneous orders In looking at that and saying, okay, this is what is coordinating all of this activity and it's doing it on an ongoing basis. The whole problem that he had with static equilibrium analysis is not so much that he liked the fact that it showed the interdependence General equilibrium theory or static theory of his day said boy, this is useful because it shows that we're all interacting together, but it's not useful because it does have this equilibrium thing that a lot of people focused on. Indeed, general equilibrium theory in the 50s and 60s that kind of gave rise to that period of high theory that I talked about when I was in grad school. That was what they were examining the stability of the variety of mathematical characteristics of what an equilibrium would be and modifying various aspects of it to get different models. That was a lot of where the game was back in that period, and Hayek has this wonderful quote. Let me find it here yeah, this was in one of the essays that he wrote on socialism. He's saying a lot of the mistakes that we're making here are due to an excessive preoccupation with the problems of the pure theory of stationary equilibrium, that it's always emphasizing the equilibrium part that gets you in trouble. He, by the way, said the same thing about perfect competition as being a misleading thing, that a rivalry is a much better that what was described in the mainline tradition that you mentioned, that Pete Betke, the phrase he uses to describe economics, from Adam Smith through Marshall, through Manger, these sorts of insights about the rivalriness of the competition is rivalry and a discovery procedure. These are the sorts of ideas that I think the Austrians had on that.

Speaker 2: 42:09

So Did I get to your question? Well, yes, oh, about the computers, yeah, why now, now that we have computers, can't we do? And I think you know it is. You can never say never, I suppose, and I think that's right. But I mean this argument was being made by Lange himself in the late 60s. They had planification sorts of experiments in the 70s in Chile, or at least they were attempting to do that. I ran into the same sorts of arguments through my career when computable general equilibrium theory started to be. You know. That lasted for about six years maybe or something, but that was a big thing. And now we've got supercomputers and then AI and all the rest.

Speaker 2: 42:58

So I guess there's a couple of things. One of the things is I'd like to see a proof of concept. I mean, take a township, take Lichtenstein or something and have them run it. Let's run a planned economy that's run by a computer. I'd like to see it on the small level, just to have some evidence that it could possibly work. Because every attempt at doing this ends up often in things like the Soviet Union not a big success North Korea, cuba these are not systems that are doing particularly well.

Speaker 2: 43:36

But in addition, I think it is making the static mistake again, because one of the things that Hayek emphasized about a competitive market system in his book the Constitution of Liberty. He talked about the creative power of a free civilization and he says freedom is really important to allow people to make mistakes, because by trying out things, lots of which don't work. Some of them do we get new inventions? So if you've not only got, you know, if you've got a set of goods, you know, these big planning models, the Ant, ontf, input, output sorts of models, or if you've got a fixed set of resources that you're trying to allocate, the whole point is growth and change, and that's something that is missed. And I don't know, maybe IEI is going to be able to take care of all of that too. What do you think, mike? I find it hard to conceive, but then maybe I've just got very limited conceptual abilities.

Speaker 1: 44:43

Obviously I agree with you, and so we're not in a position to debate it. I do have a quibble and I'd be interested to know what you think of it, and in some ways it's a semantic quibble. Think of it and in some ways it's a semantic quibble. I think we got off on the wrong foot in 1920. So I can't read the German but the original title of Mises' 1920, and then his 22 book on socialism. But in 1920, mises wrote an article called Economic Calculation in the Socialist Commonwealth, but the word is actually Wirtschaftsrechnung and that, literally translated, means the economic arithmetic. We translate that as calculation. I think it should be generation.

Speaker 1: 45:30

So what happens is that people interacting, and Adam Smith said we have this propensity to trade and exchange and barter. The fact is that it's not right that the information already exists but is dispersed. It's actually generated by the process of us trying to accomplish our contradictory plans and purposes, and so the example that I use is I want to put a new roof on my house. I have some wood and I have some gold. Now gold is a way better roofing substance. It doesn't tarnish, doesn't rot and it can be pounded out quite thin. So I think about I'm going to put gold on my roof. In a system without prices, I probably do that Now. If I want gold, I can't acquire it, but if I have it I use it. But in a system where other people are allowed to say well, I can think of other uses of that. I will offer you a lot of money. I have both the information that other people need it more than I do and I have an incentive to give it to them because they pay me for it, whereas in a socialist system I have neither the price nor the incentive. So I think instead of the socialist calculation debate, we should call it the socialist generation debate.

Speaker 1: 46:50

Where does socialism generate this information which does not now exist? You have to have a process by which the information itself is generated by all of these widely decentralized little acts and you get some aggregate, sufficient statistic, what econometricians call a sufficient statistic. I can look at this one thing price. Do I know and Hayek is great in this in the 1945 paper the price of tin goes up. Why, I don't know. I don't need to know. What I do know is that I should economize on tin. Now if a planner were to whisper in my ear and say it would be socially better if you economize on tin because someone else, somewhere else, needs it. It would be hard to communicate that, but I just look at the price and I know, and so I do what an omniscient social planner would tell me to do, except that that thing doesn't exist. So I would. I think we got it wrong in 1920. That word should have been translated as generation instead of calculation, because the economic arithmetic is a way of generating information, not calculating it.

Speaker 2: 47:59

I'm not sure where the word calculation came from, because I sometimes heard appraisement too, but certainly by the time it got to the 30s, everyone was referring to it as the socialist calculation debate.

Speaker 1: 48:11

I think socialists called it that Rhetorically. You can win if it's just a calculation problem.

Speaker 2: 48:21

I take your point and I'd like to investigate it because as an intellectual historian I'm interested in that. But I think you might be right. But certainly by the time we get to the people writing about it in the 70s and the 80s, from Karen Vaughan to Kirzner to Don LaVoy they're calling it a calculation debate. So there we go. Yeah, at a moment in time you're making an appraisement or a calculation, but you're basing it on this information which is constantly being generated by the market. So it could be called the appraisement calculation generation debate perhaps. But you're getting at a point that is a crucial one for sure.

Speaker 1: 49:02

Where does the information come from and it is contained in Hayek's article. I'm not adding anything. I'm just saying that when we hear calculation, that's what we should understand. But I can't blame someone who wants to advocate for socialists, because if it's calculation, that's what we should understand. But I can't blame someone who wants to advocate for socialists, because if it's calculation, we're way better at that.

Speaker 1: 49:19

Calculators used to be human beings with a pencil and now they're supercomputers, and so the problem, the big problem of transaction cost in a social system, is that we need to have accurate measures of the opportunity cost of resources so that people have both an information and an incentive to take account of the needs of others, and that it was better if that is transmitted directly rather than up through some bureaucracy and back, because by the time it makes that trip and it's been approved and has gotten the stamps and signatures of all the people that have to sign off on it, conditions have changed and it's no longer accurate about what the opportunity cost of the resource is. So what you want for a social system is a way of getting people to want to take account of the needs of others for their own self-interest.

Speaker 2: 50:13

So I Adam Smith. You're sounding more and more like Adam Smith.

Speaker 1: 50:17

Because it is the main line that I understand Hayek's contributions as being an illustration of how Adam Smith's commercial world could be realized, and you can say it's implicit in Adam Smith. I think that's anachronistic. I think it was not understood until Mises and Hayek started to work in this, and a few other people also. Now there's a problem and I would be interested in your thoughts on this. You actually met Ludwig Lachmann. If you believe enough in subjectivity and you believe in a collided commercial universe, then there's not even information in prices, at least not for very long. There may not even really be a tendency towards equilibrium. How could social systems work if Lachman, shackle and the sort of I don't want to call it extreme but the people who really wanted to take subjectivity seriously? How could a social system work in that setting?

Speaker 2: 51:17

I don't want to call it extreme but the people who really wanted to take subjectivity seriously. How could a social system work in that setting? Radical subjectivism was the big debate taking place around the time that I was up there at NYU. So it's associated, as you say, with the work of George Shackle, who was a fellow student at the London School of Economics with Ludwig Lachmann in the 1930s. They knew each other well, they were great friends, and so, yeah, if it's a world of constant change, you know what is what keeps it from not just exploding like a kaleidoscope vision. And Lachmann's answer was, and it will be, one that you will like very much, and I imagine that you already know the answer and this is why you asked the question is institutions.

Speaker 2: 52:08

Institutions help us navigate this kaleidic world. So prices are an important part of it, but there's all other sorts of institutions having to do with property rights yeah, a long list of them. Morals, yeah, all sorts of things that are important in allowing people to coordinate their actions and their ideas. So, yeah, and political institutions obviously are some of the ones that Hayek started to deal with in the Constitution of Liberty and law, legislation and liberty, but certainly by the end of his life. Yeah, he's writing about the family. It's going all over the place, so right institutions.

Speaker 1: 52:50

Let me just raise this to foreshadow it for future episodes, because it's important. Douglas North defined markets as a set of institutions for reducing the transaction cost of impersonal exchange. John R Commons had views of institutions. Torstein Veblen had views of institutions. So the institutional economics, this view of the importance of institutional economics, especially the old style. So douglas north and others had tried to create a new institutional economics that's mostly focused on commerce, but the the old institutionalism. There were marxists who were institutionalists. So the idea of institutions is that this is something in which markets and commercial society are embedded, and it means that you don't just get constant movement of prices that are unpredictable, because there's other considerations that limit the amplitude of those fluctuations. So I guess we do have to think in terms of the context. What's interesting is that Marxists and socialists tend to accept the neoclassical assumptions about markets and division of labor. Their view of institutions for the most part accepts neoclassical economics. It's just that socialism is going to solve the calculation problem better than markets do because we can take a broader view. And so what? The last topic that I had wanted to take up? And I've never really understood the answer. What is the line? Let me give the preface a different way.

Speaker 1: 54:30

Another hero of mine and someone that I do a summer camp every year, is James Buchanan, who's not just an institutionalist but a contractarian, and he laughingly accused Hayek of mysticism in ignorance. And he's interested in institutions that take ignorance and turn it into usable knowledge In a market setting we have prices to do that. Somehow Hayek wanted the ignorance of good institutions to be translated into some kind of knowledge in a setting where we don't have prices. So why was Hayek optimistic about the evolution of institutions? So you can say, the institutions that come down to us from the past. They embody information because tradition tells us this has worked in the past.

Speaker 1: 55:23

We may not understand why, but then that means it's going to be really hard to defend it because you sound like a conservative. Hayek said he was not a conservative, that he was a liberal. So there seems to be a contradiction and, as I said, buchanan was sort of gleeful about this that there was a mysticism in Hayek. If you're not a conservative, it means somehow you know which institutions are good and what the direction of positive change is. How do you know that? Without prices, what is Hayek doing?

Speaker 2: 55:53

He doesn't. It is a tension in Hayek.

Speaker 1: 55:58

but I think that Buchanan's unfair. Of course he was laughing about it.

Speaker 2: 56:01

He meant to be unfair, Right right. My take on this is that Hayek was interested in how the great society that we observe all around us emerged without anyone planning it and came to an evolutionary view that certain things get tried and they're successful, and other people copy them. Other things get tried and they're not successful, so people know not to copy them. We don't really know. So the idea that Hayek was optimistic because he somehow knew which were the right institutions and which were the wrong is a misreading of him.

Speaker 1: 56:39

He said he's a liberal.

Speaker 2: 56:41

Liberal institutions are better. He knows that, he does know that, but he doesn't know that they're going to be able to survive, because he's also pointing out in the fatal conceit that they go against our reason and our instinct and it's actually kind of a miracle. He was marveling at how they have managed to survive through time. So when he's offering that kind of advice, I mean I think he's saying, yes, if we do have liberal institutions in place, those societies are probably going to be able to do pretty well in this competitive game of alternative societal forms. But we don't know that they're going to be able to do pretty well in this competitive game of alternative societal forms. But we don't know that they're going to be able to because, as we see around the world that we look around just look around you people don't like them, people don't like liberal institutions. They say, okay, liberty, ha, let's celebrate, you know, celebrate these cultures that have no liberty because they're pure. Somehow you know just the truth of so much of what he describes.

Speaker 2: 57:41

I do find myself increasingly incredulous that other people can't see it. But I think Hayek felt the same way. You know, lots of people can't see this and indeed, as I said, towards the end of his life. He's trying to explain why. So yeah, I don't think Buchanan's right. I mean, I don't think Hayek was saying that he knew that this particular path was going to be followed, but he had a sense of which ones would work and which not. One way that he put it towards the end too was well, you know, maybe it's all going to go away, but then it's going to be an awful lot of people starving to death because our population has grown so much because of the plenty that has been created by these various sorts of institutions.

Speaker 1: 58:41

So one of the concepts that Hayek had that I thought was really interesting was moral atavisms, that we have a sense of moral intuitions that were basically evolved, and maybe they're physiological, maybe they're just customs that have been handed down for a different social setting. So the question is and I thought I would end with this if you could say a little bit about where this thought comes from In the intellectuals and socialism, socialism. In his 1945 piece he has this kind of call to arms which is pretty stirring. We must make the building of a free society once more an intellectual adventure, a deed of courage. What we lack is a liberal utopia, a program which seems neither a mere defense of things as they are nor a diluted kind of socialism, but a truly liberal radicalism. We need intellectual leaders who are willing to work for an ideal, however small may be the prospects of its early realization. Free trade and freedom of opportunity are ideals which still may arouse the imagination of large numbers, but a mere reasonable freedom of trade or a mere relaxation of controls is neither intellectually respectable nor likely to inspire any enthusiasm. Now. He wrote that in 1949, when in England there was little hope for liberalism. They were just rapidly going in a socialist direction. And so there was a kind of and I was part of this, I'm guilty of it there was a kind of neoliberal, classical liberal triumphalism.

Speaker 1: 1:00:17

In the 90s and 2000s we see the collapse of the Soviet Union. George Will says that the Cold War is over and it was won by the University of Chicago. We're all done. But the argument that was made for the most part was prosperity. You people are all rich. Now why are you complaining? And Hayek, in 49, recognized that that would not be enough, that we need to make it an intellectual program that appeals to people's sense of right and wrong, not just to their self-interest. Now and so it seems to me in 2024, there's a question about the renewed relevance of Hayek and Hayek's call for free trade and freedom of opportunity, not just well, if we let prices move. Most wonderful pieces that he has written, because in 1947, he founds the Mont Pelerin Society.

Speaker 2: 1:01:19

This is a society of liberals gathered together in Switzerland for a 10-day conference, and his vision was let's see if we can articulate the principles by which a liberal society might work for the 20th century, because liberalism was associated with the 19th century and laissez-faire the 20th century. It's a brand new world. It's a world that has much of it had been destroyed, at least in Western Europe. It was at a very low point when this meeting took place. It was before the Marshall Plan had started. Europe was still broken up into four zones. It was under a command and control system that had existed from 1945 through 1947 and further Rationing, as you point out, still going on in England.

Speaker 2: 1:02:10

It was a horrible time. So he founds this society and they didn't know which direction they wanted to go in. There was debates in the early first two meetings about whether it should be a society that looked at liberal principles and tried to articulate them, or one that would be more of a think tank and do studies and propagandize. And he firmly stood for we need to get the ideas right and that 1949 piece was meant to be that articulation. There's something he distributed to some of the members at. He was trying to get it distributed at one of those early meetings so as to say this is what we believe, just like Margaret Thatcher. Gentlemen, this is what we believe.

Speaker 1: 1:02:54

Well, this is what Hayek's view was on the intellectuals and socialism, and I think it is a wonderful piece, and I'm so glad you read that final paragraph, that excerpt from that unfortunately relevant today, because the collapse of the Soviet Union should have been a chance to make the moral case for commercial society and capitalism, and instead we just said well, it's the end of history, we're done. We no longer have to know the exact numbers, but 50% or more of educated young people in the United States would say at least socialism is an acceptable alternative. They may or may not prefer it to capitalism, but it's viable. It's neither viable in the sense that it can do the job being assigned to it, nor is it morally desirable. So we have a lot of work to do, but it does seem to me that Hayek does help show us the way. I want to thank you for your work on giving us the background on Hayek and I want to thank you for having been on. The Answer is Transaction Cost. Thank you so much.

Speaker 2: 1:04:10

Thanks for having me, Mike. I really enjoyed it.

Speaker 1: 1:04:13

Whoa. That sound means it's time for the twedges. These weeks economics jokes First. How many Austrian economists does it take to screw in a light bulb? Well, all of them. First, ludwig von Mises screws in the bulb with apodictic certainty, and then the rest of the Austrian economists spend the next century writing quotes from Mises and claiming that every other economist was just copying Mises without attribution.

Speaker 1: 1:04:42

I think, that's the worst thing I've ever heard. How marvelous that's. A little snarky, I admit, but a number of times I have been told that anything that I was saying was either something Mises had already said or it was wrong because Mises hadn't said it. So that's where the snark comes from. Second joke there are three kinds of Austrian economists those who make quantitative predictions and those who don't. That's a good one. That one comes from Mario Rizzo. Thanks, mario Third. Who don't? That's a good one. That one comes from Mario Rizzo. Thanks, mario Third. Did you hear about the Broadway play about Austrian capital theory? It closed after one night, turned out, the production was roundabout and no one really understood it. That's an Arnold Kling joke. I don't really understand it. That's what the money is for. Fourth the optimist thinks the glass is half full. The pessimist thinks the glass is half empty. The Austrian economist thinks that price distortions cause capital malinvestment in oversized glassware.

Speaker 1: 1:05:47

Time now for this month's letter from JR Mike. Is the Wendy's surge pricing hysteria driving you as insane as it is me? The best I can interpret from the initial earnings call comment about investing in digital screens for menu board to allow for dynamic not really surge but dynamic pricing Wendy's communication team clarification is this nothing more than a sophisticated way of lowering prices to meet demand on off-peak hours to maximize revenue? Seems like econ 101 level stuff here. That used to be done with chalkboards and printed signs above the bar. The media's characterization of this and the outrage in social media seems entirely bad faith and not actually stopping to think about the fact that restaurants in particular have been applying this kind of pricing strategy for years. They have happy hour drink specials, half-priced appetizers before four, early bird specials. I cannot buy into the idea that this is a price gouging situation. I cannot buy into the idea that this is a price gouging situation. Am I nuts? End of letter. Well, thanks, jr. In fact, all restaurants use surge pricing.

Speaker 1: 1:07:01

As I've argued a number of times, the price of something is the sum of the monetary cost and the queuing cost the amount of time that you have to wait in order to be served and receive what you came in to buy. So Starbucks has surge pricing. Now they don't change the monetary price of their lattes. They're always $11. But different times of day you might have to stand in line and there's times when almost no one is going to Starbucks. Where they might if Starbucks had a discount at off-peak hours. For some reason, though, using actual price as a rationing mechanism rather than queuing drives people nuts. I wonder if it is one of Hayek's moral atavisms.

Speaker 1: 1:07:48

It's time for Book in a Month Now. The main book that I wanted to talk about was one that was mentioned in the podcast Bruce Caldwell and Hans-Jörg Klausinger Hayek A Life 1899-1950, university of Chicago Press, but also a book I was very impressed with and haven't mentioned before on this podcast is by Deirdre McCloskey, almost three years ago now Bettering Humanomics A new and old approach to economic science, also from University of Chicago Press. Well, the next episode will be released on Tuesday, april 30th, the last Tuesday of the month. We'll have a new interview and another book in a month. Plus, we'll have four more hilarious twedges and more next month on Tidy C.