[This article originally appeared in “The Unfinished Agenda: Essays on the Political Economy of Government Policy in Honour of Arthur Seldon” (1986). It first appeared online in the Ludwig von Mises Institute. An MP3 audio file of this article, narrated by Nathaniel Foote, is available for download.]
In 1936, the year in which (entirely coincidentally) John Maynard Keynes published The General Theory, I suddenly saw, as I prepared my presidential address to the London Economic Club, that my previous work in different branches of economics had a common root. This insight was that the price system was really an instrument which enabled millions of people to adjust their efforts to events, demands, and conditions of which they had no concrete, direct knowledge, and that the whole coordination of the world economy was due to certain practices and usages which had grown up unconsciously. The problem I had first identified in studying industrial fluctuations — that false price signals misdirected human efforts — I then followed up in various other branches of the discipline.
Inspiration of Ludwig von Mises
Here my thinking was inspired largely by Ludwig von Mises’s conception of the problem of ordering a planned economy. My early investigation into the consequences of rent restriction showed me more clearly than almost anything else how government interference with the price system completely upsets human economic efforts.
But it took me a long time to develop what is basically a simple idea. I was puzzled that Mises’s Socialism,[1] which had been so convincing to me and seemed finally to show why central planning could not work, had not convinced the rest of the world. I asked myself why this was the case.
Prices and Economic Order
I gradually found that the basic function of economics was to explain the process of how human activity adapted itself to data about which it had no information. Thus the whole economic order rested on the fact that by using prices as a guide, or as signals, we were led to serve the demands and enlist the powers and capacities of people of whom we knew nothing. It was because we had relied on a system which we had never understood and which we had never designed that we had been able to produce the wealth to sustain an enormous increase in the world’s population, and to begin to realize our new ambitions of distributing this wealth more justly. Basically, the insight that prices were signals bringing about the unforeseen coordination of the efforts of thousands of individuals was in a sense the modern cybernetics theory, and it became the leading idea behind my work.
It forced me inevitably to investigate the relationship between current political beliefs and the preservation of the system on which the wealth of which we are so inordinately proud depends. Although Adam Smith, like Marshall 150 years later, had basically grasped the point that the success of our economic system was the outcome of an undesigned process coordinating the activities of a myriad of individuals, he never fully convinced the leaders of public opinion of this truth.
This has become my chief task, and it has taken me something like 50 years to be able to put it as briefly and in as few words as I have just attempted; even 10 years ago I could not have put it as succinctly. It seems obvious, once it is stated, that the basic foundation of our civilization and our wealth is a system of signals which informs us, however imperfectly, of the effects of millions of events which occur in the world, to which we have to adapt ourselves and about which we may have no direct information.
Improving the Market System
This insight has extraordinarily important consequences once its truth has been accepted. Either you must confine yourself to creating an institutional framework within which the price system will operate as efficiently as possible, or you are driven to upsetting its function. If it is true that prices are signals which enable us to adapt our activities to unknown events and demands, it is evidently nonsense to believe that we can control prices. You cannot improve a signal if you do not know what it signals.
It is not inconsistent to admit that the price system, even in the theory of a perfectly competitive market, does not take account of all the things that we would like to be taken into account. But if we cannot improve upon the system by directly interfering with prices, we can try to find new methods of feeding information into the market which have not previously been taken into account.
There is still ample room for progress in this direction. Furthermore, beyond what the market already does for us, there is ample opportunity for using deliberate organization to “fill in” what the market cannot provide. Thus we get the best out of the market only if we try to improve the framework within which it operates. We have to go outside the market system to make provision (through government and other organizations) for those people who are not in a position to look after themselves.
Socialism: An Intellectual Error
This line of argument raises some very serious intellectual and moral problems. In the first instance, it seems to me that the ambitions of socialism reflect intellectual error rather than different values. Socialism is based on the lack of understanding of what it is to which we owe the available wealth that socialists hope to redistribute. This objection raises certain other issues which I began to sketch out in a lecture I gave in 1978 at the London School of Economics.[2] The central problem was the conflict between our inborn emotions about laws acquired in a primitive small society, where small groups of people served known fellows for common purposes, and the changes in morals which had to take place to make possible the worldwide division of labor.
Indeed, this small development, which took mankind over 3,000 years gradually to effect, involved very largely a deliberate suppression of very strong emotional feelings which we all have in our bones and of which we cannot entirely rid ourselves. I shall illustrate this briefly with reference to the idea which still prevails about solidarity. Agreement about a common purpose between a group of known people is clearly an idea that cannot be applied to a large society which includes people who do not know one another. The modern society and the modern economy have grown up through the recognition that this idea — which was fundamental to life in a small group — a face-to-face society, is simply inapplicable to large groups. The essential basis of the development of modern civilization is to allow people to pursue their own ends on the basis of their own knowledge and not be bound by the aims of other people.
Mirage of Social Justice
The same dilemma applies to the basic desire of socialism for distribution according to principles of justice. If prices are to serve as an effective guide to what people ought to do, you cannot reward people for what are or were their good intentions. You must allow prices to be determined so as to tell people where they can make the best contribution to the rest of society — and unfortunately the capacity of making good contributions to one’s fellows is not distributed according to any principles of justice.
People are in a very unequal position to make contributions to the requirements of their fellows and have to choose between very different opportunities. In order therefore to enable them to adapt themselves to a structure which they do not know (and the determinants of which they do not know), we have to allow the spontaneous mechanisms of the market to tell them what they ought to do.
It was a sad mistake in the history of economics which prevented economists, particularly the classical economists, from seeing that the essential function of prices was to tell people what they ought to do in the future and that prices could not be based on what they had done in the past. Our modern insight is that prices are signals which inform people of what they ought to do in order to adjust themselves to the rest of the system.
I am now profoundly convinced of what I had only hinted at before, namely, that the struggle between the advocates of a free society and the advocates of the socialist system is not a moral but an intellectual conflict. Thus socialists have been led by a very peculiar development to revive certain primitive instincts and feelings which in the course of hundreds of years had been practically suppressed by commercial or mercantile morals, which by the middle of the last century had come to govern the world economy.
The Decline of Commercial Morality
Until 130 or 150 years ago, everybody in what is now the industrialized part of the Western world grew up acquainted with the rules and necessities of what are called commercial or mercantile morals, because everyone worked in a small enterprise where he was equally concerned with, and exposed to, the conduct of others. Whether as master or servant or member of the family, everybody accepted the unavoidable necessity of having to adapt himself to changes in demand, supply, and prices in the marketplace. A change began to happen in the middle of the last century. Where previously perhaps only the aristocracy and its servants were strangers to the rules of the market, the growth of large organizations in business, commerce, finance, and ultimately in government, increased the number of people who grew up without being taught the morals of the market which had been developed in the course of the preceding 2,000 years.
For probably the first time since classical antiquity, an ever-increasing part of the population of the modern industrial state grew up without learning in childhood that it was indispensable to respond as both producer and consumer to all the unpleasant things which the changing market required. This development coincided with the spreading of a new philosophy, which taught people that they ought not to submit to any principle of morals which could not be rationally justified.
I think it was true that, with the exception of a few men like Adam Smith (and with him to only a limited extent), nobody before the middle of the 19th century could really have answered the question: Why should we obey these moral principles which have never been rationally justified? The failure of a large number of people to accept the moral principles which form the basis of the capitalist system was supported by a new intellectual trend which taught them that these morals had no rational justification.
Ideals versus Survival
This dichotomy explains the increasing opposition to the market system that has expanded far beyond the specifically socialist parties of the last century. In the course of history almost every step in the development of commercial morals had to be contested against the opposition of moral philosophers and religious teachers — a story well enough known in its outlines.
We are now in the extraordinary situation that, while we live in a world with a large and growing population which can be kept alive thanks only to the prevalence of the market system, the vast majority of people (I do not exaggerate) no longer believe in the market. It is a crucial question for the future preservation of civilization and one which must be faced before the arguments of socialism return us to a primitive morality. We must again suppress those innate feelings which have welled up in us once we ceased to learn the taut discipline of the market, before they destroy our capacity to feed the population through the coordinating system of the market. Otherwise, the collapse of capitalism will ensure that a very large part of the world’s population will die because we cannot feed it.
This is a serious problem, and one which has not had to be solved in the past. The world’s population, and not even the leading minds in anyone country, will never be persuaded by theoretical argument that they ought to believe in a certain kind of morality. We can nonetheless demonstrate that unless people are willing to submit to the discipline constituted by commercial morals, our capacity to support any further growth of population other than in the relatively prosperous West, or even to maintain it at its existing numbers, will be destroyed.
People are in a very unequal position to make contributions to the requirements of their fellows and have to choose between very different opportunities. In order therefore to enable them to adapt themselves to a structure which they do not know (and the determinants of which they do not know), we have to allow the spontaneous mechanisms of the market to tell them what they ought to do.
It was a sad mistake in the history of economics which prevented economists, particularly the classical economists, from seeing that the essential function of prices was to tell people what they ought to do in the future and that prices could not be based on what they had done in the past. Our modern insight is that prices are signals which inform people of what they ought to do in order to adjust themselves to the rest of the system.
I am now profoundly convinced of what I had only hinted at before, namely, that the struggle between the advocates of a free society and the advocates of the socialist system is not a moral but an intellectual conflict. Thus socialists have been led by a very peculiar development to revive certain primitive instincts and feelings which in the course of hundreds of years had been practically suppressed by commercial or mercantile morals, which by the middle of the last century had come to govern the world economy.
The Decline of Commercial Morality
Until 130 or 150 years ago, everybody in what is now the industrialized part of the Western world grew up acquainted with the rules and necessities of what are called commercial or mercantile morals, because everyone worked in a small enterprise where he was equally concerned with, and exposed to, the conduct of others. Whether as master or servant or member of the family, everybody accepted the unavoidable necessity of having to adapt himself to changes in demand, supply, and prices in the marketplace. A change began to happen in the middle of the last century. Where previously perhaps only the aristocracy and its servants were strangers to the rules of the market, the growth of large organizations in business, commerce, finance, and ultimately in government, increased the number of people who grew up without being taught the morals of the market which had been developed in the course of the preceding 2,000 years.
For probably the first time since classical antiquity, an ever-increasing part of the population of the modern industrial state grew up without learning in childhood that it was indispensable to respond as both producer and consumer to all the unpleasant things which the changing market required. This development coincided with the spreading of a new philosophy, which taught people that they ought not to submit to any principle of morals which could not be rationally justified.
I think it was true that, with the exception of a few men like Adam Smith (and with him to only a limited extent), nobody before the middle of the 19th century could really have answered the question: Why should we obey these moral principles which have never been rationally justified? The failure of a large number of people to accept the moral principles which form the basis of the capitalist system was supported by a new intellectual trend which taught them that these morals had no rational justification.
Ideals versus Survival
This dichotomy explains the increasing opposition to the market system that has expanded far beyond the specifically socialist parties of the last century. In the course of history almost every step in the development of commercial morals had to be contested against the opposition of moral philosophers and religious teachers — a story well enough known in its outlines.
We are now in the extraordinary situation that, while we live in a world with a large and growing population which can be kept alive thanks only to the prevalence of the market system, the vast majority of people (I do not exaggerate) no longer believe in the market. It is a crucial question for the future preservation of civilization and one which must be faced before the arguments of socialism return us to a primitive morality. We must again suppress those innate feelings which have welled up in us once we ceased to learn the taut discipline of the market, before they destroy our capacity to feed the population through the coordinating system of the market. Otherwise, the collapse of capitalism will ensure that a very large part of the world’s population will die because we cannot feed it.
This is a serious problem, and one which has not had to be solved in the past. The world’s population, and not even the leading minds in anyone country, will never be persuaded by theoretical argument that they ought to believe in a certain kind of morality. We can nonetheless demonstrate that unless people are willing to submit to the discipline constituted by commercial morals, our capacity to support any further growth of population other than in the relatively prosperous West, or even to maintain it at its existing numbers, will be destroyed.
I would not agree that the process of selection by which the morals of capitalism have evolved, producing what a few textbooks acknowledge as its “beneficial effects on society at large,” consists wholly in assisting the growth of population. Many of the world’s peoples would probably be much happier if population growth had not been stimulated to the degree that it has. Nonetheless, the world’s population has grown to a size where it can be fed only by adhering to a market system. Attempts to replace the market demonstrate — most graphically in Ethiopia — the folly of imposing an alternative.
As prosperity has led the more advanced peoples voluntarily to restrict the growth of population, so those peoples who are only very slowly beginning to learn this urgent lesson may come to see that it is not in their interests to grow more rapidly. At this critical juncture for the kind of civilization that we have built up, the most important contribution an economist can make is to insist that we can fulfill our responsibility to sustain our existing population only by continuing to rely on the market system, which brought this enlarged population into existence in the first place.
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Notes:
[1] Ludwig von Mises, Socialism (New Haven: Yale University Press, 1951; reprinted by New York University Press, 1985).
[2] “The Three Sources of Human Values,” published as an Epilogue to Law, Legislation and Liberty, Vol. 3: The Political Order of a Free People (London: Routledge and Kegan Paul, 1979), pp. 153–76.
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Friedrich A. Hayek (1899–1992) was a founding board member of the Ludwig von Mises Institute. He shared the 1974 Nobel Prize in Economics with ideological rival Gunnar Myrdal “for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena.”
