Coordination Problem

Hayek's "The Use of Knowledge in Society" - A Summary

Steve Horwitz

I have been thinking a lot about the misunderstandings of Hayek's "The Use of Knowledge in Society" essay. Below I offer what I think is a quick summary of his argument that stresses both the importance of private property and the price system as jointly necessary for economic coordiation.

1. Knowledge IS decentralized in that each of us has our own personal knowledge of time and place (and that is often tacit).
2. Therefore, planning and control over resources SHOULD BE decentralized so that people can take advantage of those forms of knowledge.
3. HOWEVER, decentralization of control over resources (what Hayek calls "several property") is necessary BUT NOT SUFFICIENT for social coordination.
4. Effective decentralized planning also requires that people have access, in some form, to the bits of knowledge that other people have so that they can form better plans and have better feedback as to the success and failure of those plans.
5. Providing that knowledge is the primary function of the price system. Prices serve as knowledge surrogates to enable people's individual knowledge and "fields of vision" to sufficiently overlap so that our plans get COORDINATED.
6. In other words: decentralized control over resources is NECESSARY BUT NOT SUFFICIENT for a functioning economy. Such decentralization requires some process that actually ensures that separately made decisions are, to a signifcant degree, based on as much knowledge as possible so that economic coordination can be achieved. That is what the price system enables us to do. [EDIT: and the prices in question are not, and need not be, equilibrium prices.]

Decentralized decision making without a price system will produce very little coordination and prosperity. Centralized decision making will render a price system useless for economic coordination.

The fact of decentralized knowledge requires that an economy capable of producing increased prosperity for all has both decentralized decision-making (private/several property) and a price system to coordinate those decisions.

Same questions, new models?

So, I have been reading a lot of stuff about complexity, emergence, agent-based –modeling (ABM), and the like – getting by with a little help from my friends, HT: Roger Koppl. It’s all very intriguing. My underlying agenda is policy relevance, particularly in this crisis environment.

In my last post I raise the question: Can we be certain, as a logical matter, that if certain conditions obtain, certain definite types of outcomes will result from the free-market process? As I understand it, much of effort in ABM-type investigations is into this type of issue. Not so much into the “logic” as we usually understand it, as into the necessary outcomes of certain kinds of processes, such processes being modeled by the behavior of the virtual agents of the model. By investigating these process-outcome variations one hopes to get traction onto the kind of economic-policy one feels appropriate – for example, supporting less intervention, support for property-rights, etc. – or the opposite.

There are some things I find very attractive about ABM (understanding that this may sound naïve, being the reactions of an outsider to the methodology and someone arriving late to the party). In particular, I like two things:

One, the ability to handle large numbers of interactions (variables) without the need to for closure (equilibrium), save for sufficient information to compute the next iteration. The system is open-ended, in disequilibrium.

Second, it makes me think about the uncertainty conundrum/paradox – the problem of how to model uncertainty that is shared by the agent and the modeler. I think it leverages the distinction between real/radical uncertainty (which is of a categorical, open-ended, inarticulabe nature – things will happen that could not have been foreseen or even imagined) and the effects of this uncertainty, which are arguably limited to a set of known categories. The AB model models the effects of the uncertainty – not the uncertainty itself, right?

But I have some concerns that  I am struggling to think through. The exercise seems to start from the conclusion. We observe a particular reality. So we wonder what kind of world might be producing this outcome and we try and put the essentials into a computer model. How do we know we are right? We see what comes out. If it is close, we are happy. If it is not, we tweak it until it is close, then we are happy. Where does this really get us? There are probably a very large number of agent-institution-profiles that will produce outcomes close enough to make us happy.

Of course, this is not so different, maybe not different at all, from what really goes on with business-as-usual empirical work in economics, based on classical probability theory and the estimation of structural parameters. There is the pretense of randomness, but, in reality, the researchers select for desirable results, which they report, and discard the undesirable ones. The upshot is a competition of models – often based on the same, or very similar data, and certainly on the same reality. Model choice then becomes a matter of credibility, prior inclination or something else; the “facts” never speak for themselves, and they don’t speak with one voice. In this regard ABM is really no different. The model choice here will depend on the plausibility of the model setup – the realism of the agent-behavior and institutional-framework modeled. I can see some potential for progress, as long as the number of outcomes from a particular setup-type is not too varied (as it is with the standard macro-empirical story). I guess time will tell.

In my next post I want to consider the question of action in disequilibrium and plausible Keynesian stories (ABMs and others) built around that. My punchline is that it all comes down to the burden of proof. 

Here is a riddle. Who said this?

"It has been more than four years since the US economy first entered recession—and although the recession may have ended, the depression has not. Unemployment may be trending down a bit in the United States (though it’s rising in Europe), but it remains at levels that would have been inconceivable not long ago—and are unconscionable now. Tens of millions of our fellow citizens are suffering vast hardship, the future prospects of today’s young people are being eroded with each passing month—and all of it is unnecessary.

For the fact is that we have both the knowledge and the tools to get out of this depression. Indeed, by applying time-honored economic principles whose validity has only been reinforced by recent events, we could be back to more or less full employment very fast, probably in less than two years. All that is blocking recovery is a lack of intellectual clarity and political will."

Housing Policy, Labor Mobility, and Unemployment Duration

Steven Horwitz

One of the distinguishing features of this recession is that the duration of unemployment has been notably longer than in other recessions.  See this graph:

This weekend, I've seen a couple of online pieces (second one gated) arguing that one possible explanation for these data is that unemployed folks are less mobile than they used to be thanks to having homes that they cannot sell for a price that comes close to breaking even. [UPDATE:  to be clear, I'm not, nor are they, arguing that this is the only explanation for the increased duration of unemployment.  Surely benefits extensions matter as well as other factors, but this is one that we perhaps haven't seen before.] Housing policy that subsidized low- or no-equity loans have left a fair number of people in situations where they would like to move to greener pastures in search of employment, but are unable to make the move because they are stuck with houses they can't sell, which in turn prevents them from affording a new home or even a rental in the new location.  It's worth noting that the same argument would apply to currently employed people looking for better work elsewhere, opening up their own job for others.

A comparison to Canada is interesting as they did not have the perverse housing policies we had and still have a home ownership rate similar to ours, yet they have not had the fall in housing prices that would limit labor mobility the way that is being hypothesized for the US.  The latest Canadian data that I could find has their current unemployment rate at 7.9%, lower than the US, and although their median duration of unemployment in 2009 was 17 weeks, which was slightly higher than the US one was on average, that number was actually just a bit higher than their 2007 and 2008 numbers and the same as 2005.  That 17 weeks was also notably lower than their average for the last 15 years.  Canadians have always had longer unemployment duration thanks to differing unemployment policies and a weaker economy, but what they have not seen is anything near a comparable jump in duration during this recession.  That would appear to be some evidence for the "can't sell the house" explanation for labor immobility and unemployment duration in the US.  But I'd love to hear alternative hypotheses.

If this argument is right, it's an interesting unintended consequences story in the way that housing policy interacts with labor market mobility.  One can also tell a Lachmann type story here:  housing and a job are complementary goods in a household production function.  In the face of dynamic change that changes the value of one of the goods, substitution will be called for.  Unemployment requires a revaluation of one's human capital.  And changes in one's human capital that might make a new job attractive may require rethinking the housing side by moving.  But substituting a new job for the old one means that it has to be complementary to the housing piece of the puzzle.  In a healthy housing market, swapping out the housing component is not as difficult, which makes it easier for the household to make the necessary shifts in employment/human capital in the face of dynamic change.  Where households are stuck with the housing capital, they are also stuck with the range of jobs available in that area.  The result is, apparently, longer spells of unemployment and a higher unemployment rate.

I also think this poses some interesting questions for the whole "recalculation" process.  Much like the Hoover high-wage policy (though much less dramatic), one of the effects of the housing debacle has been to reduce labor mobility.  In the Hoover case, it was a matter of being unaffordable to hire, and in today's case, it's that people can't sell their houses to move to where opportunities might be.  In both cases, interventions prevent human capital from finding the places where it is complementary to the new post-crash structure of production. If we want households to recalculate effectively in the face of economic change (e.g., adjust their labor supply when the structure of production changes), we cannot distort the various markets and prices that inform that recalculation process.

If all of this is correct, it would suggest that we're in for a long period of fairly high unemployment until the housing market settles.  It may well be the case that some folks who would like to find a (new) job elsewhere will have to wait until they have sufficient equity in their homes to afford to sell.  This is yet another reason to get rid of the policies that created this mess so that we don't exacerbate or repeat it in the long run.  As for what, if anything, can be done through policy (including, of course, eliminating bad policies) to alleviate this situation in the short run, I have no brilliant ideas.  Feel free to suggest some below.  The answer, of course, may be "nothing, let the process play out and heal itself."