In a speech delivered to the Centre for Independent Studies’ annual conference Consilium in early August, Prime Minister Kevin Rudd took free-market economics to task by claiming that the ideas of one of its leading twentieth-century proponents, Friedrich von Hayek, have been superseded. ‘The solutions to today’s challenges … will come,’ he said, ‘from people willing to challenge the false choices of the old paradigms that our only options are heavy-handed regulation or unrestrained market forces. We simply don’t have to choose between Friedrich von Hayek and Leonid Brezhnev.’ (‘Moving Beyond Brezhnev or Hayek,’ The Australian, 4 August 2008).
Few would disagree with Rudd in believing that governments play an essential role in underpinning market institutions and correcting market failures. But that entirely misses the point of Hayek’s work. His central contribution to political economy was to identify the reasons for government failure. This continuing and largely intractable problem is far more damaging to contemporary societies than market failure is.
Contrary to academic ‘consensus’ at the time, history has confirmed Hayek’s 1940s prediction that central planning would fail. Closer to home, pervasive and chronic problems in government-provided health care, education, family support, and public transport, and the costs of excessive and poorly conceived regulation, are just some of the many familiar contemporary manifestations of Hayekian government failure. In a review of Yale political scientist James C. Scott’s 1998 book, Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed, leading US economist Brad DeLong, who describes himself as a ‘liberal Keynesian’ and ‘profoundly hostile to many of Hayek’s arguments’, says this of Hayek’s insight into the causes of government failure:
Today all economists … agree that Hayek and company hit this particular nail squarely on the head. Looking back at the seventy-year trajectory of communism, it seems very clear that Hayek … [is] … right: that its principal flaw is its attempt to concentrate knowledge, authority, and decision-making power at the center rather than pushing the power to act, the freedom to do so, and the incentive to act productively out to the periphery where the people-on-the-spot have the local knowledge to act effectively. (emphasis added)
Hayek’s arguments in this area are most succinctly expressed in his 1945 essay ‘The Use of Knowledge in Society.’ There, he contends for an economy and most other social processes to function effectively, what we need is not what is commonly considered ‘knowledge’—the ideas and facts to be found in books—nor what we consider ‘information’—details of events, weather forecasts, prices, quantities. What is really essential is that purely personal knowledge we all possess about what is best for us to make, do, and sell, and what is best for us to buy and consume.
This includes such basic things as how willing we are to devote physical and mental effort to particular jobs, and our attitudes to cooperating with others in organising activities and coordinating production. An economic system’s effective use of resources to satisfy people’s demands for material goods depends largely on its capacity to mobilise, interpret, and make effective use of this widely dispersed and inarticulate knowledge.
Hayek saw that the fundamental reason market-based economies have delivered massive improvements in human welfare over the past two centuries is that they have a unique capacity to mobilise and use this kind of information. He saw that each time we spend a dollar, we are voting in favour of continued production of that good or service we purchase. As importantly, we are creating an incentive for it to be produced. Crucially, markets drive people to discover better and more efficient ways to satisfy others’ needs and wants, and give them opportunities to implement their discoveries.
Compare this with our political processes. At intervals of about three years, we have one vote each to choose between four or five extremely complex and vaguely defined packages of goods and services offered by parties contesting an election. We have little subsequent control over the government we and our fellow citizens elect, because the winning package is financed by compulsory taxes.
The fundamental weakness of bureaucracies is that they lack the capacity to discover and mobilise precise information about the quantities and qualities of services that people need according to their individual circumstances. Moreover, they fail to create effective opportunities and incentives for public-sector service suppliers to use their skills and knowledge in ever more effective and efficient ways, to better fulfil the needs of those they ostensibly serve.
Hayek’s insights into the reasons for government failure remain as relevant to economic and social policymaking today as they were to exposing the catastrophic defects inherent in socialist central planning more than half a century ago. His ideas do not provide ready-made solutions for economic and social problems. But they do offer basic principles to help us set realistic policies and to cope with the difficulties inherent in creating institutions and regulations that will achieve their objectives.
As an example, we could look at how Hayek’s insistence on the importance of the price mechanism in communicating information about consumption preferences can help us understand the chronic problems in our public schools and public hospitals. These problems are, to some extent, a consequence of the fact that they are provided free of direct charge. Hayek shows us why possible market-based solutions should be considered. For instance, would an education voucher system, similar to that now operating in Sweden, help parents tell teachers and the education bureaucracy about what sort of education they want for their children, while also creating incentives for schools and government to respond to these demands? Does shared ward hospital accommodation satisfy adequately the preferences of sick people, when we also know that most travellers choose to pay for private rooms rather than saving money by staying in backpacker dorms?
The other major and perennially relevant strand in Hayek’s thinking is on the importance of institutions that evolve spontaneously outside of government and outside of the market. For example, manners and customs are essential to people’s welfare. And most people would recognise the benefits many of us derive from the existence of institutions such as the Australian Football League, the Wayside Chapel, the Surf Life Saving Association, Rotary, and an endless list of other organizations that have all evolved spontaneously.
Indeed, during his attendance at Consilium, Prime Minister Rudd witnessed first-hand the birth of a ‘spontaneous institution’ devised by Andrew Forrest (presumably with contributions from other attendees, such as Warren Mundine and Noel Pearson) with the monumental aim of creating 50,000 jobs for people of Aboriginal descent. This initiative is surely largely attributed to government failure in the admittedly very complex problem of Aboriginal welfare. The outcome of Forrest’s initiative far from certain, but it will create strong incentives to devise and implement effective solutions to the massive problem of Aboriginal unemployment.
In spite of all these signals of his continued relevance, Rudd contends that Hayek’s ideas are over the hill. Is he aware that the research projects of the most recent Nobel laureates in economics, Leonid Hurwicz, Eric Maskin, and Roger Myerson, into the design of mechanisms for achieving social objectives (such as increasing organ donation) derive directly from Hayek’s insights into the use of information and the creation of incentives?
But far from passing into irrelevance, Hayek’s insights should be regarded as essential analytical tools for all senior public-sector managers. When devising solutions to the challenges Rudd identifies as facing us today— productivity improvement, welfare reform, Indigenous policy, and so on—politicians on all sides, and public servants, would benefit from taking a few hours to read the roughly fifteen pages of Hayek’s seminal essay, ‘The Use of Knowledge in Society,’ and to reflect on its insights into social and economic processes. They won’t find easy solutions, but it will offer them an essential framework, compatible with common sense, for thinking about how to tackle perceived problems and devise workable solutions.
Parts of Hayek’s incredibly wide-ranging thinking, which runs the gamut from political economy to neuroscience, may well be forgettable. There may be a cult out there that foolishly regards his every word as gospel. But it will be a very long time before we move on from Hayek’s timeless insights on the reasons for government failure, because we are a very long way from finding effective solutions to the myriad examples of it that bedevil contemporary societies.
Geoff Hogbin is a senior fellow at the Centre for Independent Studies.