Open, competitive markets have a resilient capacity to successfully coordinate the actions of billions of people around the world. With an amazing adaptability to changing circumstances, the actions and reactions of suppliers and demanders are brought into balance with each other. Yet, none of this requires government planning or control. But how does this all come about?

The key to this coordinating process is often assigned to the pricing mechanism of the market economy. All the minimal information that anyone needs to bring his own actions as supplier or demander into balance with multitudes of others is provided by the changing pattern of relative prices for finished consumer goods and the four factors of production.

Types and uses of knowledge in society

Austrian economist Friedrich A. Hayek explained how this came about almost 75 years ago in his famous article, “The Use of Knowledge in Society,” first published in the American Economic Review in September 1945. He emphasized that matching the division of labour is an inescapable division of knowledge. Specialization necessarily means that each of us knows things that others do not.

Each of us possesses different types of knowledge in different complementary combinations. For instance, all of us, to one degree or another, have acquired what Hayek referred to as scientific or “textbook” knowledge. This is the type of knowledge we learned in school, and while we all learned many of the same things in our classroom experiences, we focused on and acquired far more specific knowledge about some certain subject. Individuals select different majors at the same or different institutions of higher learning. The medical doctor knows many things that the criminal lawyer does not, just as the lawyer has a detailed knowledge of his area of the law that the biologist or the architect does not possess based on their classroom and textbook learning.

Localized knowledge & inarticulate knowledge

But Hayek pointed out that there is also another type of knowledge that we each possess in different ways, what he called “the localized knowledge of time and place.” This is a particular knowledge that is only learned, appreciated, and usable based on an individual working and interacting with others in a specific corner of society and the marketplace.

The recently-graduated young employee shows up for his first day of work in the enterprise that has hired him. There is a period of getting oriented: Meeting the other employees and finding out what, exactly, they do; the nature of the way “things are done” within the firm in terms of rules and procedures; learning who are the individuals and groups of buyers and sellers that company sells to or buys from. The production processes or service activities undertaken and performed may be distinctly different from how things are done in competing firms in the same industry or from those in other markets.

Little or none of this knowledge could be learned in the classroom or read about in any readings assigned to pass a course. Yet, such “intimate” knowledge in all these “mundane” matters are crucial for everything in each corner of the market system to run smoothly and effectively.

The entrepreneur, in particular, needs to know all of these and many other details about his specialised area of the market in which he operates if profits are to be earned and losses avoided. In addition, all of these localised circumstances and situations are subject to continual change in a dynamic market setting in which things today may be different from yesterday, just as tomorrow may vary from the situation today.

Hayek later highlighted a third type of knowledge, what the chemist Michael Polanyi called “tacit” or “inarticulate” knowledge. This is knowledge that each of us possesses in various forms that concern how to do something but which we often find it difficult or “impossible” to easily put into a word form to convey with others.

Think of the auto mechanic who can “just tell” from listening to and looking at an engine that is not functioning properly what is wrong with it, but he cannot easily put it into words for the car owner. Or the master sculptor who knows just the right amount of hand pressure to place upon the watered piece of clay on the wheel whose speed he is controlling with a foot pedal, but he could never precisely put it down on paper so others could readily copy the technique that he uses to produce a pleasing piece of art.

Using all the knowledge no planner can master

These diverse types of knowledge, which are possessed in different combinations in the minds of all the interconnected and interdependent individuals in a modern complex market system and social order, can never be known, Hayek argued, by any one mind or group of minds, no matter how wise and determined they may seem or try to be.

Hayek’s point was that if we are all to benefit from what others know that we do not, but which, when brought to bear, can improve our circumstances in ways we cannot fully imagine ahead of time, then the individuals possessing all this diffused knowledge must have the liberty and market-based latitude to utilize it in ways that they understand best. Otherwise, much that is known and potentially used by many others that could improve our own circumstances will not be taken advantage of or even discovered.

But if not under the commanding instructions of a central planner or government regulator, how will people know how, when, and for what to apply their unique bits of knowledge, which cumulatively add up to all “the knowledge in the world,” but resides in no one mind or group of minds?

 

To be continued…

This article was first published by the Foundation for Economic Education (FEE).