The reader is suggested to read an article from
this site Efficiency of the Market and Imperfect People. 
F.A. Hayek’s Nobel Prize lecture “Pretence of Knowledge” is
one of the most popular Nobel Prize lectures in economics. After his “Economics
and Knowledge” (1937) points flaws in the priori approach and explains the empirical
phenomena of economics and “The Use of Knowledge in Society” (1945) attacks the
market socialist ideology, he then goes on to target the neoclassical economics
(to the early development of which he greatly contributed).
Hayek was critical of the new approach adopted by the field.
Many see him as anti-mathematical too. But, Hayek said something worth
importance in the speech,
It seems like Hayek wasn’t against the mathematical approach
to economics but was more against econometrics and statistics attempting to
make hopeless predictions. Hayek wasn’t a supporter of positive economics
either (that included names like Milton Friedman and George Stigler) and he
didn’t only have a problem with the mathematical approach of positivists but the
whole methodology. He considered that the science of economics just like
Biology and Linguistics deals with “Complex Phenomena” unlike those of Physics,
Mathematics and more specifically Algebra are useful to
economics as they can explain relationships between many variables that
economics deals with and also take those data into consideration that are
difficult to observe or can’t be recorded easily. But Econometrics can have its
use in economics too just like mathematics. It’s all about how these tools are
being used. Hayek’s critique on econometrics just after the fall Philips curve
makes sense very well, he mainly criticized the econometricians’ claim to
predict the market.
Economics is an empirical science as Hayek explained in his
“Economics and Knowledge” (1937) but empirical and statistical aren’t the same.
Economics is empirical in the sense that individuals with heterogeneous
subjective knowledge also interpret objective facts differently in front of them.
They have expectations and knowledge which they improve on trial and error. So
individuals make decisions or more accurately improve their decision-making
empirically in an economy and thus economics in its theories must consider
Today’s empirical science is different; it can be simply seen
in the way that Hayek was talking on a micro level whereas modern research is
more at a macro level aiming to give policy suggestions. Also, Hayek talks in
the context of the concept of the “market process”. In his “The Use of
Knowledge in Society” he said knowledge is dispersed and tacit due to which it
can’t be recorded and possessed by a single mind to make crucial decisions
about the society.
Importantly, knowledge isn’t static but goes through a
process. New data is generated in the competition over time. Even if all data
is collected somehow then also it is of no use as new data will be generated by
the competition. The real world competition isn’t like how “perfect
competition” is, we don’t have perfect knowledge, and the facts aren’t “given”.
Rather we discover new opportunities in competition. Tacit knowledge is
difficult to record in words or numbers and is also personal, cognitive, and evolutionary.
This is the reason why Hayek was anti towards the mainstream
phenomenon of assuming a market variable to be “given”. Economics students are
given questions where prices are “given” but it isn’t a given variable. It is
the result of market and competition. Econometricians’ predictions were seen as
giving dangerous signals to Hayek as then economists would claim to allocate
resources just like central planners in the past.
But, the prices or wages aren’t known and the fact is nobody
can claim simply what is supposed to be a rational price or wage level. I will
argue in this way. If it is known to experts what should be price level,
unemployment level, or output level then why there is even a need for a market
in the first place?! If anyone claims that government intervention is justified
in “filling the gaps that the market couldn’t” then they should simply go with
allocating at the efficient level that they claim. If the government can reduce
the unemployment level, then why don’t they give everyone employment without
the need for the market system (this also reminds me of the “natural rate of
unemployment” concept)? They don’t and they can’t because they simply don’t
know! That’s what economics is truly about, “The curious task of economics is
to demonstrate to men how little they really know about what they imagine they
For example, there are two demand functions: Marshallian and
Hicksian. Marshallian demand function finds optimal allocation with the help of
prices and income level whereas Hicksian demand function finds it with the help
of prices and utility of individual. In both functions, prices are commonly taken
as the independent variable. This briefly portrays the importance of the price
mechanism. Both demand functions exhibit the need for market and price systems
for more efficient allocation. The income of consumers is a known variable and
utility could be too as per models but prices are determined by the market.
This can be better understood by Austrian Legend Ludwig von
Mises who started the “Socialist Calculation Debate”. When the popularity of
socialism and central planning was on the rise, Mises asked a simple question.
How are you going to make calculations? How will planners be able to choose
between substitutes if there are no prices and hence no knowledge about the
scarcity? If there are no market and private property, then there wouldn’t be
prices and money and hence calculation simply becomes “impossible”.
Mises emphasized the importance of price systems that are
crucial for allocation just like explained by Hicksian and Marshallian Demand
functions too. Instead of finding the optimal allocation by putting values on
the formula, if the students are taught about the Mises Calculation Problem
then their understanding of the market and economy would be better. Economics
must make economists and students humbler on how little they know and how
capable each one in the society is in their ways.
Hayek even though sympathetic to neoclassical (he is a
neoclassical economist too) was still not in support of the positivist approach
and ignorance towards the evolutionary aspect of the economy. Assumptions are
needed in theories and models but certain facts cannot be ignored! He had confidence
in the decentralization that many didn’t have in his time. In the rising fame
of Keynesianism, Market Socialism, and Marxism, he never doubted his defense of
the market system. All those fell but Hayek still stands relevant today.
Whenever economics academia forgot his name, nature made us remember it again.
Econometricians shall not easily forget Hayek too.
Econometrics in an informal way is economic theory + mathematical economics +
statistics. The statistics part is seen as the most important but rather it is
the economic theory. What separates econometrics from statistics is the
economic theory helping in making interpretations. Statistics simply by putting
values in mathematical formulas can show correlation but not causation. By
significant correlation, it confirms the first criterion that there exists a relationship
in a particular direction but there is more needed to get causal inference.
Econometrics can explain the relationship between the
variables from the data of the past. But, more than science this is history.
Econometrics is indeed a kind of historical study. As discussed earlier, the
market generates new data, the regression analysis can be useful for historical
studies but cannot claim to give precise predictions. The predictions will be
based on data from the past and ignorance about the forthcoming data will still
prevail. It might help to test a hypothesis or can also help in giving new
ideas (anything helps in that though). It has its uses but while using it as a
tool there is a need for proper understanding by scholars on what they are
using and what phenomena (complex) they are dealing with.
Also, economics is possible very much and with great scope
without the adoption of mathematics and statistics. There are other fields too
whether it be philosophy, law, political science, etc… that can be adopted for
analysis. Great economists like Ronald Coase, James M. Buchanan, Israel
Kirzner, etc… didn’t need mathematics and statistics. But that doesn’t mean the
two are useless as there have been those who made good use of it. Simply, there
mustn’t be any such criteria made on what economists need as a basis point. Economics
deals with complex phenomena, it is way more complicated than has been
understood by many (especially by the economics professors and students).
Scholars need more than 3-4 ways to find answers to important questions in this
field. Making any criteria will restrict that.
Econometrics is part of economics but not only part of the
field. Mistakes must not be made by only taking it seriously and also by
depriving those minds that can do well in economics but aren’t able to fulfill
the made-up criteria. Economics isn’t yet as fully established as the scholars
today portray. There are many unanswered questions and many scopes left in this
field. Rather than ignoring or avoiding them, we need to take more interest in
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