The Epistemology of Economics

Hayek on Knowledge: The Epistemology of Economics

by Ramon Lopez

As with many of the social sciences, modern economic thinking has become seduced by the allure and successes of the natural sciences. In particular, physics has given man power over the world in a way once reserved for the gods. Knowledge of the physical laws of the universe allows the physicist to predict the effects of any cause that is governed by those laws. In a sense, the physicist can predict the future. This capacity has been the foundation upon which the technological and material successes of the modern era have been built, and has helped to give way to an age of previously unimaginable prosperity.

It is no wonder, then, that in the study of those things which relate to mankind, we have seen fit to apply those same principles which have proven so successful in the natural sciences. If that success could be replicated, the stark ideological divisions within the social sciences may be reduced, and perhaps even eliminated. But even more enticingly, the same sorts of benefits that have emerged from our knowledge of physical laws and processes may also be found in the social sciences. In particular, scientific knowledge in the field of economics could provide us with substantial material and social benefits. “If we possess all the relevant information, if we can start out from a given system of preferences, and if we command complete knowledge of the available means, the problem which remains is purely one of logic.” Just as the mechanisms of the universe are revealed to us through the application of the scientific method, so too may the mechanisms of social life be unraveled and laid bare. And, as in the physical sciences, we will gain full predictive power over economic effects, making use of that knowledge to improve the welfare and condition of society. Economics would become radically technocratic, with ideologically neutral predictions and analyses being provided by those experts who, like physicists, have knowledge over cause and effect within their field.

While this approach was more conspicuously prevalent in the middle of the 20th century, such social positivism lies at the heart of most planned economic systems. And none have more successfully and more convincingly argued against these assumptions than Friedrich Hayek. Throughout his corpus exists a robust line of reasoning, extending from the philosophy of science into economics, which outlines the limits of our capacity to gain predictive knowledge. His call for epistemic humility in regards to the study of the social sciences, as well as his analysis of how knowledge is distributed within the market, is invaluable for those interested in better understanding the nature of social and economic relations. In this piece, I aim to outline Hayek’s epistemic argument against economic planning and defend its reasoning.

The Social and Natural Sciences

In investigating the nature of the sciences, Hayek notes the necessity of making use of different methodologies when investigating different kinds of phenomena. Physics and chemistry are able to make due with relatively few variables. Within these fields of study, the scientists are able to directly observe complex phenomena, and from their relations derive simple principles which govern those interactions. In contrast, the social sciences must begin with the dispositions and attitudes of the individual, aggregating from the isolated case to the complex phenomena that result from the multitude of social relations. Rather than dealing with the relatively limited number of variables of the natural sciences – which can be observed in repeated and controlled interactions – the social sciences must concern themselves with a “number of separate variables which in any particular social phenomenon will determine the result of a given change” which “will as a rule be far too large for any human mind to master and manipulate.”

The physical sciences have the benefit of direct observation of the complex phenomena, of which the social sciences can only study in aggregation, and can also make use of repeated and controlled experimentation, with the social sciences being limited in this regard and always subject to innumerable variables. The complexity of the situation which faces the social scientist is therefore of a different order than that which is faced by the natural scientist. The capacity for the natural sciences to analyze the whole is the reason Hayek defines its method as “analytic,” while the social sciences, which must reconstruct the existence of the whole through its interconnected parts while hoping that such a reconstruction is accurate, is forced to make use of a “compositive” or “synthetic” method. We must make a concerted effort to reconfigure the pieces of the social puzzle, to reconstruct the actions of numerous actors in combination with one another. It is through this manner that “we ‘understand’ the way in which the result we observe can be produced, although we may never be in a position to watch the whole process or to predict its precise course and result.”

Furthering these challenges, we see that the physical sciences are purely concerned with external phenomenal facts, while the social sciences deal with the phenomenal result of internal opinions and values. In economics, the economist does not directly study the subjective state of individual actors, but only what results from their interaction with the world. Thus, the direct cause of what is being studied must be treated as a “black box,” with the statistical aggregation of psychological states simplifying the complexities of human psychology to a simple universal attitude. While this method may be perfectly appropriate and useful in making general pattern predictions, it in no way allows for the direct cause-and-effect predictions of the natural sciences. Planners presuppose such an epistemic capacity—since only through this sort of intensive understanding could one rationally construct a new economic order—whether in a particular segment of the economy, as in modern liberalism, or throughout the entire economy, as in socialism.

Essential Complexity

Beyond these practical and methodological challenges, the natural sciences, and in particular the physical sciences, cannot serve as an adequate model for the social sciences due to the nature of the phenomena each observes. There is a fundamental difference in kind, with the social sciences observing essentially complex phenomena. Phenomena of essential complexity are “structures whose characteristic properties can be exhibited only by models made up of relatively large numbers of variables.” Physical phenomena discovered by physics and chemistry can be reduced to a relatively small number of distinct variables, with the micro-level properties reflecting all those properties expressed in the whole. When the simple phenomenal parts are expressed as a whole in the form of complex phenomena, these structures are understood as “phenomena of unorganized complexity.” This stands in contrast to phenomena of organized complexity, such as social relations, which is the whole that emerges from the relationship of essentially complex phenomena.

What distinguishes organized complexity from unorganized complexity is that organized complex structures “depend not on the properties of the individual elements of which they are composed, and the relative frequency with which they occur, but also on the manner in which the individual elements are connected with each other.” The heightened number of variables, as well as the phenomenal importance of the ways in which they relate, causes the emergence of aggregate attributes in wholes made up of essentially complex structures, attributes whose properties exist independently of their component parts. This new layer of complexity, in addition to the practical and methodological challenges, means that a complete understanding of social phenomena is fundamentally impossible.

Within the natural sciences, biology finds itself grappling with similar challenges. Decades before these issues became the foci of a complicated debate within biology, Hayek already noted that biology is fundamentally different from physics and chemistry due to the fact that it also deals with essentially complex phenomena. Biological properties can only be expressed through relatively large numbers of variables, they are reflective of the relations of those variables, and, perhaps most significantly, biology generates emergent phenomena that are irreducible to its composite parts. For example, homeostatic and metabolic systems are used to maintain the actualization of genetic and somatic programs in light of the information encoded in those programs, adjusting for deviations in growth or environmental conditions. Living organisms are then unique in their negative entropy, being physically open and self-maintaining systems. This biological functionality is irreducible to the organism’s physio-chemical parts, as it cannot be conceptually understood by wholly relying on the lower-order phenomena. In light of these developments, leading scientists and philosophers in the field have called for a stark division between the biological and non-biological natural sciences, as well as persuasively arguing that there are no such things as laws within biology.

The importance of these developments is that Hayek’s categorizations have seen renewed significance as biologists recognize the necessity of differentiating the kinds of phenomena they study from those dealt with by the physical sciences. Additionally, the kinds of predictions that can be made about a structure depend upon whether its constituent parts are simple or complex. Observed patterns allow us to make predictions about simple phenomena, but when observing essentially complex phenomena the situation becomes much different. In simple phenomena, the pattern is instrumental to the prediction, while in complex phenomena the pattern itself is what we hope to determine. Rather than discovering universal laws from a pattern of observed occurrences, the goal is to predict abstract patterns given a set of particular circumstances. Pattern predictions are then “predictions of some general attributes of the structures that will form themselves, but not containing specific statements about the individual elements of which the structures will be made up.”

An example of this sort of pattern prediction would be evolution, which is understood when the elements of its pattern are recognized. It is not assumed that through studying the pattern of evolution man will acquire the capacity to predict how different creatures will evolve. Instead, we say that given certain conditions (natural selection, random drift), a particular kind of pattern will emerge. Predicting patterns in essentially complex phenomena is possible because we only need to know that “the data possess[es] certain general properties,” and thus do not need to know anything about the micro-attributes of the structure itself. Statistics then deals with essential complexity by acting as if the individual elements of the broader variables it is making use of are not systemically connected. “The statistical method is therefore of use only where we either deliberately ignore, or are ignorant of, the relations between the individual elements with different attributes.”

Modern Economic Scientism

What then, is the full economic significance of Hayek’s foray into the philosophy of science? According to Hayek, it is to discredit the “naïve superstition that the world must be so organized that it is possible by direct observation to discover simple regularities between all phenomena”—a concept which lies at the heart of the planner’s fatal conceit. Therefore, planners think in “terms of limited causal processes they had learnt to interpret in areas such as physics.” In philosophically engaging the nature of essentially complex phenomena, Hayek warns against the attempt to expand methodology appropriate for the natural sciences beyond its borders into the social sciences.

The progress of the natural sciences in modern times has of course so much exceeded all expectations that any suggestion that there may be some limits to it is bound to arouse suspicion. Especially all those will resist such an insight who have hoped that our increasing power of prediction and control, generally regarded as the characteristic result of scientific advance, applied to the processes of society, would soon enable us to mould society entirely to our liking.

All forms of planning—most notably socialism—depend upon the premise that Cartesian rationalism can be applied to social systems just as it was to natural systems. The predictive power and robust understanding of phenomena in physics, if applied to society, would give the planners the capacity to “build a new world, a new morality, a new law, and even a new purified language, from itself alone.” The difficulty planning has always faced is its inability to accurately predict the full effects of its policies, and so “the application of engineering techniques to the whole of society requires indeed that the director possess the same complete knowledge of the whole society that the engineer possesses of his limited world.” Through his development of the concepts of essentially complex phenomena and organized complexity, as well as his methodological distinction between analytic and synthetic methods, Hayek demonstrates the infeasibility of the attempt to fully scientize economics.

Rather, economics must content itself with pattern predictions, which excludes the capacity for planning. While mathematical and statistical principles in economics may be useful, we must be wary of using them as quantifiable constants with which we can make fully predictive statements. Economic theories should, “make only very general predictions of the kind of events which we must expect in a given situation.” Thus, economics can help us understand the general conditions within which economic growth and material welfare are maximized, but cannot give us the capacity to make particular predictions and plans within a given industry or the market as a whole. On the need for epistemic humility, Hayek writes, “I prefer true but imperfect knowledge, even if it leaves much indetermined and unpredictable, to a pretence of exact knowledge that is likely to be false.”

The Problem of Knowledge

Even if it were possible to make more than basic pattern predictions about social phenomena, such predictions would require the collection of information that “never exists in concentrated or integrated form, but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.” An economic system must be constructed in such a way that it is able to make efficient use of “knowledge not given to anyone in its totality.” In studying the relations and phenomenal results of the opinions and values of individual agents, economics is epistemically limited due to the subjective cause of its object of study. Thus, the aim of economic organization is to provide the structure that best distributes the relevant information so that actors can quickly adapt and base their values according to the changing information. The indeterminate nature of economic change is often deemphasized by economic statisticians, who, in making use of large aggregations of data, are deceived by “the ‘law of large numbers’ or the mutual compensation of random changes” into overemphasizing stability in the market.

If economics is aimed at properly organizing economic decision-making so as to allow for the most effective and rapid dissemination of information, then the organizing power must be decentralized, as “the ultimate decisions must be left to the people who are familiar with these circumstances, [and] who know directly of the relevant changes and of the resources immediately available to meet them.” This makes expertise in economics of a different sort than the expertise found in a number of other disciplines, and analogizing prototypical scientific expertise with economic expertise misunderstands the nature of economic knowledge. Experts in economics are only capable of making pattern predictions; by virtue of the fact that they study aggregate data, these experts lack “the knowledge of the particular circumstance of time and place,” which is essential to gaining a full understanding of any given economic situation. There is no collection of objectively existing economic facts, as exist in physics and chemistry, and so government intervention requires the collection and aggregation of economic data. But while economic experts can use aggregate data to make pattern predictions, they are unable to generate plans superior to those made by actors within the particular industries, since these actors and their positions have special, yet constantly changing, relationships with the goods and services in question. And because particular subjective knowledge can never be generalized, the only way to effectively harness this economic information is through the decentralization of planning into the hands of those on the micro-level: “decentralization has become necessary because nobody can consciously balance all the considerations bearing on the decisions of so many individuals.” In advocating planned intervention into the market, liberalism and socialism fail to “comprehend that the coordination of the multifarious individual efforts in a complex society must account for facts that no individual can completely survey.”

The Extended Order

Colloquially called the free market, this decentralized system in which individual agents make independent decisions is referred to by Hayek as the “extended order.” The extended order is a kind of “spontaneous order,” which is a phenomenon that is “the result of human action but not of human design.” The extended order is a stable, tacit order of rules and values which are not consciously constructed, and instead form as a natural consequence of peaceful and mutually-beneficial human interaction. It is then through the price system that information is naturally disseminated to the relevant actors, without the need for a consciously directing authority. Within the extended order, “the whole structure of activities tends to adapt, through these partial and fragmentary signals, to conditions foreseen by and known to no individual.” The price system is the means by which the entire order is able to naturally adjust to changing values and material constrains.

The market is the only known method of providing information enabling individuals to judge comparative advantages of different uses of resources of which they have immediate knowledge and through whose use, whether they so intend or not, they serve the needs of distant and unknown individuals. This dispersed knowledge is essentially dispersed, and cannot possibly be gathered together and conveyed to an authority charged with the task of deliberately creating order.

Individuals have the capacity to plan for themselves because they have access to the information which is relevant to their interests through the price system. The importance of the price system comes from its ability to coordinate the actions of many different actors who have no relation to or knowledge of the motivations or characteristics of other actors. The whole of economic activity is capable of acting as a 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.” The price system allows for that overlap, but only through the free choices of individuals can the price system continue to operate effectively. Government intrusion into the price of goods and services only distorts their natural value, as the government is not capable of possessing the particular knowledge of the differing values possessed by actors in the various sectors of the economy and instead must act as if it is capable of surveying the whole field. This distortion then prevents the price system from reliably transmitting accurate information, which in turn causes economic dislocations and stagnation.

Hayek’s economic outlook is not only shaped by his philosophy of science, but his conception of the nature of social knowledge in general. Hayek believed knowledge to be widely dispersed, subjective, and often tacit. Being widely dispersed, knowledge of different categories of things exists in different ratios and orderings across society. Because of this dispersal, the collection and centralization of social information is deemed as being fundamentally impossible. As has been noted, the mechanism which allows for some overlap in shared information is the price system, and without such a system the subjective values that are applied to goods and services would have no effective means of being expressed. Values are subjective in that they are always related to individual dispositions and preferences, which are ever in flux. Social study is thus tasked with investigating these values, even though their subjectivity, as has been previously noted, prevents them from being centralized or universally known.

Much of human knowledge is “tacit,” in that it is intuitive, unreflective, and cannot be meaningfully articulated. Hayek observes that humans are situated with particular norms and customs, which guide action and judgment through “movement patterns” and “ordering principles” which are categorized as “rules.” Tacit knowledge is knowledge regarding the conduct of an actor who follows certain rules but does not need to reflectively recognize the rules while acting within their limits (e.g. language). As Hayek notes, “Most knowledge…is obtained not from immediate experience or observation, but in the continuous process of sifting a learnt tradition.” Those who favor government intrusion into the market presume that empirical knowledge, as is made use of in the natural sciences, is equally as effective in developing causal relationships in the social sciences. However, the particular tacit knowledge gained by actors existing within a small part of the market is incapable of being transferred to that higher authority, as it is both unrecognized and unable to be articulated. Tacit knowledge is “knowledge of the kind which by its nature cannot enter into statistics and therefore cannot be conveyed to any central authority.” Tacit knowledge merely relies upon “the habit of following rules of conduct,” which is “utterly different from the knowledge that one’s actions will have certain kinds of effects,” which is required by planners at the aggregate level. Without the full scope of relevant information, and without the capacity to gain an understanding of the underlying relations of properties which make up the market, government intervention is often blind and incapable of accurately predicting the consequences of its actions.

The Problem of Pluralism

Perhaps, most importantly, in reflecting individual and subjective evaluations; the market takes into account the judgments and dispositions of each agent. Different people have different value structures, and by decentralizing planning to the individual actors, each person is able to make decisions in the market based on their own private ordering of values. This poses an additional problem for the centralization of planning, as “an order arising from the separate decisions of many individuals on the basis of different information cannot be determined by a common scale of the relative importance of different ends” (italics in original). There is no common scale of values that can be appealed to, except in the broadest and least definite circumstances, and so any government action will invariably promote certain interests and certain values above others. “[S]cales of value can only exist in individual minds,” with these scales of value being only “partial scales of values,” as each scale is the result of the limited and particularized value structure of that individual. While the market as a whole is naturally capable of incorporating these values through the acts of individuals relating to one another, because no individual mind can grasp the numerous relations in the market and have a complete understanding of the whole, whatever central plan emerges will be a register of partial values, excluding the values of some and privileging those of others.

Human welfare and happiness cannot be quantified into a universal constant, which can then be maximized through specific government plans and procedures. Each individual has his or her own goals and aspirations, an ordering of values which is ever changing and dependent upon subjective alterations and experiences, with the ordering of values existing in an “infinite number of combinations.” All people plan based on the information available to them, and the question Hayek asks us to consider is whether individuals or a central authority have a greater capacity to make those plans, and which has greater access to the knowledge necessary to evaluate between different outcomes. “Who plans for whom, who directs and dominates whom, who assigns to other people their station in life, and who is to have his due allotted by others?” The planner must privilege his ends over the ends of others, making use of the coercive hand of government to impose a particular ordering of values upon the general population. Only on those things in which there is broad agreement can government act, but in the case of economic planning there rarely exists such agreement – and, even if such agreement existed, the government would still be unable to adequately account for the effects of its plans.

The Limits of Competition

While Hayek is opposed to government planning due to its epistemic challenges and dependence upon the coercive imposition of a partial value structure, he states: “It is important not to confuse opposition against this kind of planning with a dogmatic laissez faire attitude.” Hayek recognizes that limited government involvement is needed in certain instances, and that competition is not always applicable, though when the government does intervene it must do so within the epistemic bounds set for it by the nature of social knowledge. Individuals are the agents best suited for planning, as the value structure that determines the plan is subjective and the information most important for a plan to come into being can only be accessed at the level of the individual. Thus, agents must always have the capacity to buy and sell goods and services at levels mutually agreed upon by all relevant parties, with the legal framework sanctifying such activity applying equally to all parties. This excludes the possibility of price caps, mandates, or regulatory measures that are aimed at targeting a particular company or industry within a larger sector of the economy.

However, regulations regarding public safety, or which obligate producers to supply relevant information to consumers, are allowed to standardize production. In these sorts of cases, the government is not intervening into the market through planning, but is instead setting general measures that do not interfere with the actual competition between different agents in the market. Thus, the government may “prohibit the use of certain poisonous substances,” “limit working hours or…require certain sanitary arrangements,” which are regulations that are “perfectly compatible with the preservation of competition.” The kind of government intervention that is epistemically limited is particular intervention, such as government subsidies, industry or product specific tax breaks, or direct government control of specific sectors of the economy. However, general legal rules are legitimate government functions, and are even necessary in a functioning market economy, as “in order that competition should work beneficially, a carefully thought-out legal framework is required.” The extended order naturally emerges from individual choices and relationships, but that order must then by codified in a general manner through the creation of property and contract laws. And, beyond even that, in order to maximize the benefits of competition, the government is tasked with the creation of “certain institutions like money, markets, and channels of information – some of which can never be adequately provided by private enterprise.” Making use of its capacity for pattern prediction, the government is tasked with setting the proper conditions for competition, though it is prohibited from actively engaging in market-specific planning of its own.

In certain specific instances, it is also true that competition may be unable to maximize the general welfare and subjective conceptions of happiness due to a structural component of that case. If, Hayek says, “it is impracticable to make the enjoyment of certain services dependent on the payment of a price,” or “when the damage caused to others by certain uses of property cannot be effectively charged to the owner of that property,” there is a “divergence between the items which enter into private calculation and those which affect social welfare.” In these cases a system other than market competition must be utilized, as market competition is not good in itself, but, due to the epistemic and pluralistic value considerations, is the most effective way of promoting human welfare.


Without the capacity to predict the effects of its interventions, government planning invariably causes unforeseen distortions and side effects. Well-meaning technocrats, whose plans may have seen limited successes in private application, must remain epistemically humble when dealing with an object as complex and unassailable as the extended order. Often those investments and regulations that are meant to promote human welfare detract from it, reducing the creative freedom and flexibility of undetermined market relations. When attempting to engineer social and economic relations for the betterment of all, planners implicitly assume the rationalism that underlies investigations in physics without recognizing that other kinds of knowledge are needed, and by the nature of social knowledge it is incapable of being used in the same manner. Thus, economic experts are incapable of relating to economic facts in the same way that physicists may relate to physical facts, and are thus constrained to making pattern predictions. “[W]e can never predict from which of the many forms in which a good or service can be provided something better may develop…the argument for freedom is precisely that we ought to leave room for the unforeseeable free growth.” And by leaving room for growth, we will give each individual both the capacity to seek their own ends and, through the maximization of material welfare through competition, the means by which to do it.

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