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Extending Hayek's Insights about Local Knowledge: David R. Henderson
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Friedrich Hayek's 1945 article in the American Economic Review, "The Use of Knowledge in Society," has become a classic. It was the last in a series of articles in which Hayek put the final intellectual nail in the coffin of socialism. Hayek argued persuasively that the information that is most valuable in an economy is decentralized; it exists in little pieces in the minds of the billions of people acting in the economy. It is not centrally aggregated by government planners and can't be centrally aggregated except as a happy result of free markets. These facts, argued Hayek, are a sufficient reason for socialism to fail. Economists who write in the Hayekian tradition often refer to people's information about their own circumstances as "local knowledge."


Hayek's conclusion about the importance of local knowledge can be extended far beyond markets into many parts of our lives. In this essay, I summarize Hayek's argument and then apply it to some good things that happened on September 11, 2001, and to two cases after 9/11—the case of the "shoe bomber" and that of the "underpants bomber"—when airline passengers acted together to save themselves from terrorists.


Hayek wrote:

[T]here is beyond question a body of very important but unorganized knowledge which cannot possibly be called scientific in the sense of knowledge of general rules: the knowledge of the particular circumstances of time and place. It is with respect to this that practically every individual has some advantage over all others because he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active coöperation.


Hayek went on to show how letting people act on their own information is not chaotic but, rather, relatively harmonious. What allows each person to act on his or her information and to coordinate with others is the price system, the free market.


Hayek gave the example of tin:

Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes, the supply of all the things made of tin, and their substitutes, and so on; and all this without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes. The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all.


One U.S. newspaper reporter who had never read Hayek1 reached the same conclusion when he observed the centrally planned Soviet economy in the late 1980s. The reporter, Scott Shane, was the Moscow correspondent for the Baltimore Sun from 1988 to 1991. In his book Dismantling Utopia: How Information Ended the Soviet Union, Shane wrote:

My informal survey suggested that some of the longest lines in Moscow were for shoes. At first I assumed that the inefficient Soviet economy did not produce enough shoes, and for that reason, even in the capital, people were forced to line up for hours to buy them.... Then I looked up the statistics.

I was wrong. The Soviet Union was the largest producer of shoes in the world. It was turning out 800 million pairs of shoes a year—twice as many as Italy, three times as many as the United States, four times as many as China. Production amounted to more than three pairs of shoes per year for every Soviet man, woman, and child.

The problem with shoes, it turned out, was not an absolute shortage. It was a far more subtle malfunction. The comfort, the fit, the design, and the size mix of Soviet shoes were so out of sync with what people needed and wanted that they were willing to stand in line for hours to buy the occasional pair, usually imported, that they liked.

At the root of the dysfunction was the state's control of information. Prices are information—the information producers need in order to know what and how much to produce. In a market for a product as varied in material and design as footwear, shifting prices are like sensors taped to the skin of a patient in a medical experiment; they provide a constant flow of information about consumer needs and preferences. When the state controlled information, it deprived producers of information about demand.


Interestingly, noted Levin, after 9/11, FAA officials started to write a set of procedures for getting planes on the ground in case something like 9/11 happened again. But then they stopped. Levin quoted Frank Hatfield, the FAA's eastern region chief: "A lot of things were done intuitively, things that you can't write down in a textbook or you can't train somebody to do." Indeed. Hayek's insight strikes again.


It is difficult to say, a priori, that local knowledge and the actions based on that knowledge will always be superior to centralized information and actions. But what is interesting, and hopeful, is that people acting on their own local knowledge often give better results than centralized government actors do. Hayek's insight is more powerful than even he might have thought.