Aggregate demand, Aggregation problem, Conscious Design, David Kreps, F.A. Hayek, Interventionism, Library of Economics and Liberty, Norman Barry, Spontaneous Social Order, The Counter-Revolution of Science
The great gains in human welfare over the past few hundred years are not the result of some conscious design by a central authority. They are due instead to the emergence of conditions under which a “spontaneous social order” could bear fruit. Yet most people toil under the illusion that the progress of humanity and civilization are impossible without the imposition of some conscious design and intervention by human planners. In “The Counter-Revolution of Science“, F.A. Hayek noted that conscious direction was unnecessary to the development of such fundamental institutions as language, markets, money, the legal system and morals:
“We flatter ourselves undeservedly if we represent human civilization as entirely the product of conscious reason or as the product of human design, or when we assume that it is necessarily in our power deliberately to re-create or to maintain what we have built without knowing what we were doing.“
A liberal, spontaneous social order arose against a backdrop of secure rights that encouraged voluntary exchange. Individuals, free to act on their preferences, capabilities and personal resources forged their own trade relationships and contractual arrangements. In this sort of environment, the prices established by free exchange not only direct goods and resources in the present, but also direct their availability over time by balancing the time preferences of savers and investors. Again, it was this set of unplanned but voluntary private arrangements that brought such dramatic material progress to humanity. The chief contributions of central authority were the provision of a reasonably stable legal environment and, ironically, the constitutional framework in the U.S. that imposed limits on government power.
On the other hand, there is a long history of attempts to impose “conscious” designs by edict. They have met with consistent failure, and for good reason: human authorities cannot possess the dispersed knowledge needed to balance the diverse needs and preferences of millions of economic agents with the abilities of others to produce and provide for those demands. Nor would human authorities have the correct incentives to properly direct resources to their most valued uses, even if they possessed the requisite knowledge. In fact, the imposition of a “collective” plan implies a degree of coercion. The plan, no matter how well meaning, will necessarily conflict with the objectives of some individuals. Efforts to work around the plan will lead to additional coercive steps to bring all parties into compliance.
Still, there seems to be a deeply ingrained belief that advances can only be a product of conscious design and central direction. The idea dovetails with the tendency to view policies and objectives as things that must be achieved by “society” as a collective. But the details of deliberate social policies must be promulgated by relatively few policymakers and then executed by technocrats, even if the policies themselves are the product of representative democracy.
The elites who administer central plans must rely on aggregate measures of economic activity and broad categories or class groupings, which grossly over-simplify and misrepresent the complexities of human activity. This aggregation problem afflicts a wide variety of measurements and attempts to analyze behavior. Gary Galles discusses various aggregation problems in “How Economic Aggregation Hides The Problems of Interventionism“.
By analyzing things at aggregate levels, we may deceive ourselves by thinking that the aggregates can represent meaningful outcomes, or even worse, policy levers. The aggregates become constructs to which theories of “behavior” are applied, often rationalized by so-called “micro-foundations” of “representative agent behavior”. This effectively elides the fundamental reasons for engaging in voluntary market exchanges in the first place: differences in preferences, abilities, knowledge, and endowments of resources create opportunities for gain through trade. David Kreps is quoted at a link above on a prominent example of this phenomenon, the weak foundations of “aggregate demand”:
“… total demand will shift about as a function of how individual incomes are distributed even holding total (societal) income fixed. So it makes no sense to speak of aggregate demand as a function of price and societal income ….“
In short, the theoretical relationships between aggregates do not describe real economic behavior. Hayek noted that relying on aggregates fosters the all-too common but mistaken view among policymakers, pundits and the public that the economy can be shaped and managed much as an engineer designs a machine, or as a manager runs his factory. That is an incorrect but insidious viewpoint. Hayek explains that engineers or factory managers are able to perform their functions with relative precision because they are able to take so much for granted: prices or the availability of certain materials and resource flows, and reliable, technical relationships between inputs and outputs. Again, the economy and society encompass too many complex relationships and details that are unknowable to any central authority to manage effectively from the top down.
Some kinds of differences between individuals are recognized by planners and collectivists. Policies divide the population into groups subject to disparate treatments in an effort to meet social goals deemed worthwhile by the collective conscience. As my friend John Crawford said in a recent email: “… to have public policy the individual must be subjugated to the group simply for ease of understanding.” These disparate treatments imply that:
“… the simple act of generating public policy requires racism, ageism, sexism, classism, whatever-ism. Some ‘-ism’ must be conceived of simply so individuals can be grouped into bins, measured so a public policy action can be justified.“
These sorts of policies do not encourage a productive society. Instead, they promote political competition rather than economic competition, division rather than unity, and rent seeking and cronyism instead of productive effort, saving and economic growth. Norman Barry discusses the negative consequences of this shift in orientation in his essay “The Tradition of Spontaneous Order“:
“Hayek is no doubt correct in identifying the main disruptive threat to the preservation of a spontaneous order as the inevitable formation, under present democratic rules, of coalitions of interests which divert the stream of income in a catallaxy to politically-favored groups—to the ultimate harm of all.“