Hayek, Prices and Knowledge
Prior to the mid-20th century, economics focused almost solely on the allocation of scarce resources. Unfortunately, this remains a legacy in undergraduate textbooks. Yet, in 1945 Hayek revolutionised our understanding of the economic problem through an eloquent articulation of the price mechanism. Rather than attempting optimisation in the allocation of scare resources, he suggested that the problem we are really solving is in the coordination of local knowledge. And, the price mechanism is marvellously efficient at coordinating this knowledge.
Hayek segregates knowledge into two forms, each of which possess distinct characteristics; (1) scientific knowledge, and (2) local knowledge. These characteristics were previously unrecognised, and have significant implications in understanding what the discipline of economics is, and the role of the state in the economic order.
The first is ‘scientific’ knowledge. While undoubtedly important, this type of knowledge drew great attention and traction throughout the socialist calculation debate. Flowing from a focus on this ‘scientific’ knowledge, it was hoped that all information could be quantitatively determined – including prices. Fortunately, this ambitious venture did not gain traction, nor bore fruit. Hayek explained why.
The second category is broadly described as ‘local’ knowledge, and I cannot improve on this oft-quoted description: “… knowledge of the particular circumstances of time and place” (Hayek 1945, p 522). This knowledge sits hidden in the minds of individuals. It remains tacit until the individual requires it to make decisions over their individual plans. And, even once revealed, we only observe the outcomes, not the reasons behind the decision. It is this detail that is important. Aggregating heterogeneous tacit knowledge naturally renders the knowledge homogenous, and therefore its value disappears. Local knowledge does not, and cannot, sit in concentrated form. The immense value of this distributed knowledge causes significant problems for economists, particularly those partial to central-planning. The problem we face does not rest purely in scientific knowledge, yet rather in “…the utilization of knowledge not given to anyone in its totality” (p 520). Therefore, we continually face the problem of local knowledge coordination.
For the more pure scientific disciplines (Eg. Physics, Chemistry), it is natural to assume that something that cannot be quantitatively measured is of little value. Yet, a social science such as economics is just that; social. Complex interactions by individuals form the context in which all decisions are made. Without the ability to aggregate this information into statistical reports, many ignored this body of knowledge.
Hayek suggested otherwise – examining the institution of the market mechanism, and more specifically, prices. This system, never designed by any one man, allows the coordination of dispersed local knowledge, without the need of specific information of every other individual. If the market had been of deliberate human design, it would have been “… acclaimed as one of the greatest triumphs of the human mind” (Hayek 1945, p 527).
Crudely summarised, Hayek’s genius is that: the price mechanism (and the emerging prices) are an extremely efficient institution for (almost) instantly coordinating the dispersed local knowledge of the time and of the place. The individual actors do not need to know why prices change, they only need to know that they do. They can then revaluate their own individual plans, in relation to all of the other goods and services of which they are interested. Marvellous, indeed.
Free-market economists continually point to this insight; promoting ways in which this price mechanism may more efficiently allow the continuous updating of individual plans, not known to anyone in its totality. Government intervention that distorts prices, therefore, only distorts the individual plans.
Innovation and Uncertainty
When understanding innovation, the literature pushes towards characterising the individual as boundedly rational; using various adapted heuristics to innovate (See Simon 1955). With boundedly rational individuals, innovation can be framed as a knowledge coordination problem, yet of a different nature to those discussed above. While this knowledge is also local and disperse in a Hayekian sense, it cannot be coordinated through prices. Why? Prices simply do not exist in the early stage of innovation.
Knight (1922) described the inherent differences between risk and uncertainty – where risk is quantifiable and measureable, and where uncertainty cannot be measured. Innovation occurs at the end of the decision spectrum where Knightian uncertainty is greatest. Innovation has long been characterised as making decisions under novelty, a trial-and-error process into the unknown. This is the process of coordinating Shackle’s ‘unknowledge’ of the various innovators, for the production of new knowledge.
Returning to Hayek, he explored the efficiency of the price mechanism as an institution for coordinating local knowledge. How do we go about coordinating ‘unknowledge’? What would be an efficient institution in a theoretical sense? Well, first of all, the process is inherently different. Rather than coordinating local knowledge through prices, we wish to produce new knowledge by coordinating ‘unknowledge’.
It is here where our hypothesis sits. We propose that the ‘innovation commons’ is an institution that efficiently mixes and coordinates this ‘unknowledge’. That is (crudely summarised), the innovation commons are an emergent institution where individuals mix their individual knowledge in the pool; an efficient environment for innovation where sharing is both professed and relied upon.