In a fresh look at 20th-century philosopher-economist Friedrich Hayek, three authors note how the Nobel laureate’s work exemplifies complexity economics. They also show how his political support of laissez faire economic policies needn’t necessarily follow.

Hayek was among the first to view the perpetually adaptive nature of an economy as counterpoint to the notion of equilibrium. He took a dim view of conventional equilibrium theory and its disregard for the dynamic processes through which interlocking markets might reach a state of balance.

Best known for his book The Road to Serfdom and his advocacy of free market policies, he was awarded the 1974 Nobel Prize in Economics in part for his vision of the market economy as an information processing system.

“Hayek’s critique of general equilibrium theory and his conceptions of markets and how they work to diffuse through the economy is an enormous contribution, and we can now model many of the mechanisms he postulated using the tools of complexity science,” says Alan Kirman (University of Aix-Marseille), who with SFI Professor Samuel Bowles and SFI External Professor Rajiv Sethi co-authored a paper on Hayek to be published this summer in the American Economic Association’s Journal of Economic Perspectives.

In Hayek’s view, prices encapsulate information about the scarcity of goods and services through adaptive, decentralized adjustment by market participants, each acting on incomplete and mostly local information.

This information processing framework, formalized in two influential papers published in 1937 and 1944, formed the basis of Hayek’s own political view that price setting should proceed without artificial or exogenous influence. As a witness to the 20th century’s authoritarian experiments in centralized economic planning — Stalin in the Soviet Union and Hitler in Germany — Hayek aligned himself with the proponents of laissez faire economic policies and in opposition to price ceilings, wage floors, policies to smooth out the business cycle, collective bargaining, and redistributive taxation.

“Hayek got a lot of things right,” says Bowles. “But we show in our paper that he got some things wrong. Most important: if, as Hayek taught us, people treat prices as bits of information, this does not always guide the economy in socially desirable directions. For instance, it can lead to bubbles and crashes.”

In the six-plus decades since Hayek formed his political views, Bowles added, “we’ve learned that the choice is not Stalin’s central planning or laissez faire. Many countries in which governments adopt just the policies that Hayek opposed – the Nordic social democratic economies, for example – are exemplars of personal liberty and also of economic dynamism.”

 “Fortunately,” the authors write, “Hayek’s economics and his political philosophy do not have to be taken as a package. It is possible to appreciate his insights into the functioning of a market economy without following him down the road to laissez faire.”

Read the paper, "Friedrich Hayek and the Market Algorithm," in the Journal of Economic Perspectives (July 26, 2017)

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