The reader is suggested to read an article from this site Efficiency of the Market and Imperfect People. [1]

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, etc….

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 this.

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 can design.”

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 them.

Bibliography

Boettke, P. (2018). F.A. Hayek: Economics, Political Economy and Social Philosophy. New York: Palgrave Macmillan.

Boettke, P. J. (2008). Where did economics go wrong? Modern economics as a flight from reality. Critical Review, 11-64.

Hayek , F. A. (1989 [1974]). The Pretence of Knowledge. The American Economic Review, 3-7.

Hayek , F. A. (2016). The Meaning of Competition. Econ Journal Watch, 359-372.

Hayek, F. A. (1937). Economics and Knowledge. Economica, 33-54.

Hayek, F. A. (1945). The Use of Knowledge in Society. American Economic Review, 519-530.

Hayek, F. A. (1960). The Constitution of Liberty. Chicago: The University of Chicago Press.

Hayek, F. A. (1967). The Theory of Complex Phenomena. In Studies in Philosophy, Politics and Economics (pp. 22-42). London: Routledge & Kegan Paul.

Hayek, F. A. (2002). Competition as a Discovery Procedure. The Quarterly Journal of Austrian Economics, 9-23.

Mises, L. v. (1990 [1920]). Economic Calculation in the Socialist Commonwealth. Alabama: Mises Institute.