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{{DES | des = [[Richard Posner]] finds [[Friedrich von Hayek|Hayek]]'s refutation of universal central planning to be useless in real-world mixed economies.  He points out [[Ronald Coase]] has shown that central planning works better than markets for some problems, hence firms (including governments.) | show=}}
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In  an  earlier  essay  in  TransactionalViewpoints, I  showed  the  connection  be-tween John Dewey’s theory of knowledgeand his view of democracy.2In this issuedevoted to Hayek, it should become clearthat Hayek and Dewey have a number ofthings  in  common—despite  their  differ-ences in field, nationality, generation, andpolitics.3 Among these is the derivation ofa comprehensive social, political, and eco-nomic theory from a theory about the struc-ture or operation of the human brain, whatI am calling “cognitive theory.” In the caseof  Dewey,  a  philosopher,  one  would  beinclined  to  substitute  “epistemology”  for“cognitive theory” and in the case of Hayek,who dabbled in biology, one might substi-tute “cognitive science,” but the similarityis considerable and so the choice of a singleterm for both is warranted. Hayek, as wellas  Dewey,  can  be  situated  in  a  traditionthat  begins  with  Plato  founding  politicaltheory  on  cognitive  theory.  My  focus  inthis brief essay however is to show in de-tail how Hayek’s cognitive theory relatesto his notion of “spontaneous order.”The Knowledge Problem andCentral PlanningOn a superficial analysis, Hayek’s cog-nitive theory consists of just two proposi-tions,  and  both  are  empirical  (inductiveor observational) rather than theory-based.The  first  is  that  human  knowledge  is  sowidely distributed throughout the humanpopulation that no single person or agency(“central planner”) could acquire enoughof  it  to  allocate  the  society’s  resourcesefficiently. This is a result of the divisionof labor, which has been carried to an ex-treme  in  modern  society  and  greatly  in-creases efficiency by enabling specializa-tion, but which has brought about, as anunavoidable byproduct of specialization,a narrowing (along with a deepening) ofthe  knowledge  possessed  by  any  singleindividual. He knows more about less.There  is  close  convergence  betweenDewey and Hayek, both emphasizing theradical  dispersion  of  knowledge  acrosspersons  under  the  conditions  of  moder-nity.  But  they  quickly  diverge  becauseHayek,  unlike  Dewey  (who  was  not  aneconomist,  as  Hayek  was),  saw  that  theprice system was a method, probably thebest method and certainly a better methodthan central planning, of aggregating thisdispersed knowledge. An individual mayrealize that a particular input that he needsin his business is likely to become scarce,so he buys up a large quantity and storesit.  His  action  forces  up  the  price  of  theinput, which induces others to economizeon its use and to adjust their own prices.Price  thus  operates  as  a  method  (Hayekwould say the method) by which privateinformation  is  diffused  throughout  theentire market.4The  second  proposition  of  Hayek’scognitive  theory  is  that  private  or  localinformation  (the  sort  of  unsystematizedinformation  possessed  by  an  individualand illustrated in the preceding paragraph,as distinct from information that is codi-fied in general principles stated in booksor articles and thus is readily accessible)is impounded not only in price but also inrules.5A  firm  adopts  a  new  practice—itmight be a new method of compensatingits employees. The firm might have hit onthe new practice by accident or by hunchrather than by explicit cost-benefit analy-sis  or  other  conscious  reflection  on  howbest to fit means to ends. Suppose the prac-tice, whatever brought it about, results inlower costs and higher profits for the firm.That  is  important  information  to  whichthe firm is likely to respond by codifyingthe practice as a rule. The difference be-tween a rule and a standard (“profit maxi-mization,” for example) that requires freshanalysis in every case is that a rule singlesout one or a small number of facts to beoutcome determining. The person apply-ing the rule doesn’t have to know its pur-pose, or the net benefits of applying it in aparticular  case;  all  he  has  to  know  iswhether the fact that triggers applicationof  the  rule  is  present  or  absent.  Eventu-ally the reason for the rule may be forgot-ten (and there may have been no reason,or at least no articulable reason), yet thismay  not  matter;  continued  adherence  tothe  rule  will  be  a  way  of  exploiting  theinformation impounded in the rule with-out need for thought beyond what is nec-essary  to  determine  whether  the  condi-tion for the application of the rule is satis-fied. Complying with a rule, like respond-ing to a change in price, can be a methodof  utilizing  knowledge  without  actually1Judge,  U.S.  Court  of  Appeals  for  the  SeventhCircuit; senior lecturer, University of Chicago LawSchool. This paper is excerpted from the text of atalk given at the Third Annual Symposium on theFoundations of the Behavioral Sciences—entitled“Hayek, Dewey and Embodied Cognition: Experi-ence,  Beliefs  and  Rules”—sponsored  by  the  Be-havioral Research Council of the American Insti-tute for Economic Research and held on July 18–20, 2003. The full talk is entitled “Cognitive Theoryas the Ground of Political Theory in Plato, Popper,Dewey, and Hayek.” I am grateful to Paul Clark,Adele Grignon, and Benjamin Traster for researchassistance  and  Elisabeth  Krecké  and  AnthonySantelli for comments on a previous draft.2See  Richard  A.  Posner,  “Dewey  and  Democ-racy: A Critique,” Transactional Viewpoints, Sum-mer 2003, Vol. 1, no. 3, pp. 1-4.3For  detail,  see  Richard  A.  Posner,  Law,  Prag-matism,  and  Democracy,  Harvard  UniversityPress, 2003.4The  clearest  exposition  of  Hayek’s  theory  ofprice is F. A. Hayek, “The Use of Knowledge inSociety,” American Economic Review, 1945, Vol.35.5See, for example, F. A. Hayek, New Studies inPhilosophy, Politics, Economics and the Historyof Ideas, 1978, pp.3, 7, 10; Hayek, “Rules, Per-ception, and Intelligibility,” in Proceedings of theBritish Academy, 1962, p. 321.
2possessing knowledge.I said that the practice might have beenhit upon by accident or by hunch. The firstpossibility  would  represent  the  operationof trial and error, the Popperian method ofacquiring  useful  knowledge.  The  secondbelongs  to  the  domain  of  “tacit  knowl-edge.”6People know how to do many thingsthat they cannot explain in a communicablefashion. A person who knows how to ridea bicycle cannot convey that knowledge inwords  to  another  person  in  a  way  that  aperson who knows how to bake a cake canconvey  that  knowledge  by  handing  theother person a detailed recipe. Hayek sen-sibly believed that a great deal of knowl-edge, including a great deal of the knowl-edge  utilized  in  business,  is  tacit,inarticulable,  and  therefore  uncom-municable.  (He  believed  this  in  part  be-cause he thought a complex system couldbe understood by only a more complex sys-tem, and hence the mind could never fullyunderstand itself. I don’t know whether thatmakes any sense.) This belief strengthenedhis  challenge  to  the  feasibility  of  centralplanning. If much of the knowledge that isscattered  across  the  millions  of  economi-cally  active  persons  in  a  society  is  tacit,then  no  matter  how  great  the  intellectualcapacity of the central planner is, he (or it,if we speak more realistically of an agencyrather  than  of  an  individual)  will  not  beable  to  obtain  all  the  information  neededbecause   much   of   it   will   be   inuncommunicable form—uncommunicableexcept by pricing. The price system is thealternative to central planning, and to theextent that knowledge is tacit it would be asuperior alternative even if the central plan-ner  had  an  unlimited  capacity  to  absorband analyze data.Hayek—this is his most important con-tribution  to  economics,  and  it  comes  di-rectly from his cognitive theory—thus of-fered a new rationale for the price (or mar-ket)  system.  The  old  rationale  associatedwith  classical  or  neoclassical  economics(as distinct from “Austrian” economics, theeconomics of Hayek, his predecessors KarlMenger  and  Ludwig  von  Mises,  and  hisrelatively  few  successors),  was  that  theprice system was the method of overcom-ing self-interest, of turning private vice intopublic virtue, of leading selfish individualsby  an  invisible  hand  to  serve  the  publicinterest.  People,according  to  this  view,are rational not only in the sense of beingcommitted to means-end reasoning but alsoin the sense of having a clear perception ofthe end, and of the costs and benefits of thealternative means to that end, but they aretoo  self-interested,  too  deficient  in  altru-ism,  to  be  trusted  to  use  their  knowledgefor social ends and so the trick is to inducethem  to  behave  in  a  way  that  will  maxi-mize  social  welfare  as  a  whole;  and  theprice  system  is  the  trick.  Hayek  did  notthink the main problem of which the pricesystem  was  the  solution  was  self-interestand  a  resulting  shortage  of  altruism;  hethought that people needed the price sys-tem  in  order  to  overcome  the  deficits  intheir knowledge. The power of that insightwas that it denied the feasibility of centralplanning, which at the time that Hayek be-gan propounding his thesis, namely in the1930s, the depression decade, was consid-ered  by  most  economists  a  viable  and  bymany a more efficient method of allocat-ing resources than the price system. Hayekwas one of the first to see that, and moreimportant to explain cogently why, this wasincorrect.Hayek’s second proposition, about theimportance of rules as a method for deal-ing with the knowledge deficits that gaverise  to  his  defense  of  the  price  system,belongs to the last part of his career, be-ginning  in  the  1960s.  Whereas  the  firstproposition  undergirds  Hayek’s  defenseof free markets, the second is the key tohis political and legal theory. With knowl-edge dispersed and much of it tacit, thereis  no  way  a  central  authority,  such  as  alegislature or a court, can gather and mar-shal the knowledge necessary for sensibledecisions on issues of law or policy. Thedispersed and tacit knowledge will, how-ever,  be  found  aggregated  in  rules  thatgrow out of the practices of the relevantcommunity. Such rules are customs. Eachcustom  constitutes  what  Hayek  calls  a“spontaneous order,” though spontaneityhas  overtones  of  suddenness  that  are  re-mote  from  Hayek’s  intentions;  for  thesecustom-based rules are the product of evo-lution  rather  than  of  sudden  inspiration.Since  the  relevant  knowledge  is  im-pounded  in  them,  the  proper  function  oflegislatures  and  courts  is  in  the  mainmerely  to  ascertain  and  enforce  them.Hayek acknowledges that legislatures alsohave to pass tax and other laws relating tothe operation of the government and thatthe courts have from time to time to tidyup the customary rules that they enforce.But for the most part law and policy in hisconception of the ideal state are the prod-uct  of  a  decentralized  system  for  aggre-gating  and  impounding  information  thatis  quite  like  the  price  system  itself,  thedifference  being  that  the  information  isimpounded  in  and  conveyed  by  rulesrather than prices. Hayek had no faith indemocracy. He regarded voters as hope-lessly  ignorant  about  political  issues  be-cause such issues are not within the localknowledge  of  the  voter.  It  follows  thatgovernment should, so far as possible, bedecentralized,  since  people  are  moreknowledgeable about local than about re-gional or national affairs.Hayek’s Theory of the MindSo far I have described Hayek’s cog-nitive theory as a matter merely of obser-vations  about  the  locus  (dispersed)  andcharacter   (often   tacit   and   henceuncommunicable in words) of knowledge.But  there  is  more.  There  is  a  theory  ofmind  in  Hayek.  The  theory  regards  per-ceptions as the product of the interactionbetween sensory impressions—the impactof  the  external  world  on  the  organs  ofsense,  such  as  sight  and  hearing—and  aclassificatory apparatus in the brain.7Thisis a Kantian insight. In Kant’s epistemol-ogy, sensory impressions are made intel-ligible by being subjected to mind-gener-ated categories such as causation and time.Hayek’s categories differ in two ways: theindividual’s classificatory apparatus is theproduct of idiosyncratic factors of person-ality and culture rather than just of basichard-wired features of the brain (presum-ably the capacity to perceive two eventsas cause and effect is hard wired) and thusdiffers  across  individuals;  and  the  appa-ratus  is  not  fixed  but  can  be  altered  byexperience. In other words, people see (lit-erally and figuratively) things differently,and  the  way  in  which  they  see  thingschanges in response to changes in the en-vironment. The first point undercores thedispersal of knowledge, scattered as it isas  a  result  of  differences  in  perspectiverather than just differences in raw infor-mation—and  how  is  the  central  plannerto  correct  for  the  possible  distortions  in6The  modern  philosopher  most  responsible  foremphasizing  the  importance  of  tacit  knowledgewas  Michael  Polanyi.  See,  for  example,  “TheLogic  of  Tacit  Inference,”  in  Michael  Polanyi,Knowing and Being: Essays(Marjorie Grene ed.,1969).  The  importance  of  tacit  knowledge  inHayek’s  cognitive  and  economic  theory  is  em-phasized  in  (among  other  places)  Richard  N.Langlois  and  Müfit  M.  Sabooglu,  “Knowledgeand Meliorism in the Evolutionary Theory of F.A. Hayek,” in Evolutionary Economics: Programand Scope(Kurt Dopfer ed., 2001). See also SteveFleetwood, Hayek’s Political Economy: The So-cio-Economics of Order, Routledge, 1995, Ch. 7,for a good discussion of Hayek’s theory of knowl-edge.7The fullest exposition of Hayek’s theory of mindis in F. A. Hayek, The Sensory Order: An Inquiryinto the Foundations of Theoretical Psychology,1952. This is a difficult work. For a helpful sum-mary,  see  G.  R.  Steele,  “Hayek’s  Sensory  Or-der,” Theory and Psychology, 2002, Vol. 12. Thefullest effort that I am aware of to relate Hayek’scognitive  theory  to  his  economic  and  politicaltheories  is  Steven  Horwitz,  “From  The  SensoryOrderto the Liberal Order: Hayek’s Non-Ratio-nalist Liberalism,” Review of Austrian Econom-ics, 2000, Vol. 13. Horwitz’s article also containsa lucid summary of Hayek’s cognitive theory.
3his  own  perspective?  The  second  pointemphasizes the mutability of knowledge,another  obstacle  to  the  central  planner,who  is  bound  to  encounter  a  long  delaybetween  collecting  information  and  act-ing on it.Is Hayek Relevant for a MixedEconomy?Hayek’s analysis of human cognition,both in emphasizing the dispersal and fre-quently the tacit character of knowledgeand in relating these to the way in whichthe mind processes the impressions it re-ceives from the outside world, makes animpressive  theoretical  case,  now  amplyconfirmed by experience, against centralplanning whether confined to the economyor extended across the entire range of pub-lic  issues  in  a  society.  The  limitation  ofhis  approach,  however,  is  that  with  cen-tral planning and other forms of what Pop-per called utopian social engineering nowso  thoroughly  discredited,  it  is  unclearwhat  if  any  significance  Hayek’s  cogni-tive  theory  and  the  political-economictheory that he derived from it retain. Thisproblem is central to the failure of post-Hayekian Austrian economics to enter themainstream  of  economic  and  politicalthought.Hayek is at pains to emphasize that heis comparing the price system to economy-widecentral planning, and that he is com-paring  the  spontaneous  order  created  bycustom  to  a  total(usually  a  totalitarian)political-judicial  system  that  imposes  itsown ideas of what is right on a citizenrythat it does not consult. He is not evaluat-ing  a  mixed  system,  in  which  there  is  adegree of personal freedom but also a de-gree of imposed order. A mixed system iswhat we and our peer nations have, and Ihave not been able to figure out what helpHayek  offers  for  evaluating  such  a  sys-tem.  Consider  an  economist  who  sharesHayek’s  skepticism  about  the  utility  ofthe key concepts in neoclassical econom-ics  of  maximization  and  equilibrium.Hayek is skeptical because both maximi-zation  and  equilibrium  imply  positions,achieved  by  the  firm  or  the  individual,and by a market, respectively, from whichany  change  would  reduce  welfare;  andgiven constantly changing conditions andincomplete  information,  no  one,  and  nomarket,  is  ever  in  such  a  position.  Mar-kets are never in equilibrium (even withcompletely up-to-the-date information, butimperfect  foresight,  the  time  required  totranslate the latest information into a newset  of  prices  would  prevent  the  achieve-ment  of  equilibrium),  and  profit  or  wel-fare  is  never  being  maximized.  RonaldCoase  is  such  an  economist.  He  sharesHayek’s  skepticism  about  maximizationand  equilibrium.  But  he  is  also  famousfor (among other things) his theory of thefirm,  which  proposes  that  economic  ac-tivity will be brought inside a firm ratherthan  conducted  by  means  of  contractswhen the cost of directing economic ac-tivity  by  fiat  (the  employer  telling  hisemployees what to do and paying them asalary rather than buying their output fromthem) is lower than the cost of contracts,that is, of using the market. In other words,sometimes  the  price  system  is  the  moreefficient way of organizing production andsometimes  the  command  and  controlmethod of production within a firm is moreefficient.  But  the  command  and  controlmethod of directing production is just cen-tral planning writ small. A firm that mustdecide whether to buy an input in the mar-ket  or  make  it  itself  is  not  always  mis-taken  when  it  opts  for  the  former,  anymore than families are mistaken when theydo not use prices to direct the householdproduction  of  their  members.  Some-times—in fact rather often—it is more ef-ficient to aggregate information across thepersons  who  possess  it  by  communica-tion  in  the  form  of  words  rather  than  inthe form of prices. The pervasive role ofthe firm in modern economies shows thatthe  price  system  is  not  always  the  mostefficient method of aggregating the infor-mation  that  is  relevant  to  some  produc-tive process.Of  course  the  command  and  controlmethod is not alwaysmore efficient thanthe price system, for if it were, then soci-ety-wide  central  planning  would  be  fea-sible after all, and Hayek had shown thatit is not. But sometimesit is the more effi-cient method, and the important questiononce the extremes are rejected is whenisit  more  efficient;  and  on  that  questionHayek’s analysis casts no light. And simi-larly  with  custom.  Sometimes  it  makessense  for  law  to  follow  custom  becausecustom  may  indeed  impound  the  infor-mation relevant to the activity that the cus-tom concerns. But often it makes no sensefor law to follow custom because a cus-tom  may  reflect  conditions  that  havechanged  (custom,  lacking  central  direc-tion,  tends  to  lag  social  and  economicchange) or may be the product of incen-tives that diverge from the socially desir-able,  as  in  the  case  of  a  custom  of  notcompensating  victims  of  an  industry’snoncost-justified pollution or careless in-juries, or of refraining from price compe-tition. And again, on the crucial questionof whenlaw should reject custom, Hayekcasts no light. What is true is that customscan be tenacious, like habits, and thus bevery costly to change; but that is a differ-ent point from presuming that customs aresocially efficient.Hayek  thus  is  perhaps  best  seen  as  aman  of  his  time,  battling  contemporaryenemies—socialism  in  its  variousguises—with apt and powerful weapons,defeating  them  thoroughly,  and  earningin  consequence  an  honored  place  in  thehistory of political and economic thought,but  not  setting  forth  principles  or  meth-ods that could be used to solve the prob-lems  of  the  next  stage,  the  postsocialiststage, of economic and political ordering.He  has  a  keen  sense  of  how  individualscoordinate their activities through contractand through custom; yet it’s as if he hadnever heard of organizations.Hayek’s LegacyIt  remains  to  consider  briefly  the  sig-nificance of Hayek’s cognitive theory forthree current movements in social science:Austrian economics; the law and econom-ics movement; and behavioral economics.Austrian economics is in part an attempt,considered  by  most  modern  economistsdistinctly  marginal  if  not  indeed  a  com-plete failure and dead end, to tease out theimplications of Hayek’s cognitive theory,and  the  critique  of  central  planning  thatflows from it, for modern political and eco-nomic  issues.  That  is  not  all  there  is  toAustrian  economics;  there  are  theoriesabout the business cycle, the monetary sys-tem, and capital formation, as well, but theyare not relevant to the concerns of this pa-per.  The  endeavor  of  Hayek’s  successorsthat I am concerned with has foundered onhis failure to have bequeathed to them anyguidance on how to extend his approach toproblems other than the problem of centralplanning. With central planning no longeron  the  political  agenda  of  any  major  na-tion, the focus of the Austrian economistswho  follow  in  Hayek’s  footsteps  has  be-come the critique of neoclassical econom-ics,  viewed  as  the  intellectual  underpin-ning of central planning. (I do not regardas distinctive, except in vocabulary, effortsto  extend  the  Austrian  critique  of  centralplanning to government regulation in gen-eral—to “interventionism” as Ikeda calls itin an interesting Austrian-style book8—anextension  that  very  largely  mergesHayekian  critique  into  the  neoclassicists’public-choice theory.) The animating con-cern  is  that  the  belief  in  central  planninghad  its  source  in  the  neoclassical  econo-mists’ concept of man as a rational maxi-mizer,  a  concept  that  implies  such  com-plete knowledge of the costs and benefitsof alternative methods of satisfying humanwants  as  to  make  the  omniscient  centralplanner a realistic aspiration. There was a8Sanford Ikeda, Dynamics of the Mixed Economy:Toward  a  Theory  of  Interventionism,  Routlege,1997.

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