Review of Competition, Economic Planning, and the Knowledge Problem

Competition, Economic Planning, and the Knowledge Problem, Israel M. Kirzner, eds. Peter J. Boettke and Frédéric Sautet, Liberty Fund, Indianapolis, 2018, 367 pages, paperback, $12.00.

Israel M. Kirzner is the dean of the "Austrian school" of economics. Over six decades he has produced a stream of papers and books defending and extending the insights into the market process achieved by his mentors Ludwig von Mises and F.A. Hayek. The book under review is part of a 10-volume series collecting Kirznerā€™s works. This volume in particular is a collection of essays centered around the theme of entrepreneurship, and expanding out from there to include other topics such as competition, economic planning, information versus knowledge, and advertising. These secondary themes are connected to entrepreneurship through Kirzner's understanding of entrepreneurship as consisting of alertness to hitherto hidden profit opportunities. The constantly changing "data" of the market again and again render current market prices sub-optimal, offering ever new arbitrage opportunities for entrepreneurs to exploit. And it is the correction of those pricing errors, by alert entrepreneurs, that tends to push the market towards equilibrium. It is this view of the market that leads Kirzner to focus on the process by which these sub-optimal conditions are (partially) corrected, rather than on a mathematical description of the state of affairs which would hold if there were no such errors to correct.

Kirzner contrasts his ("Austrian") process-centered understanding of the market with the mainstream focus on analyzing equilibrium states, in which entrepreneurial activity has ceased, because it has no work left to do. Such hypothetical states, Kirzner contends, are both of little importance for real world markets, and offer no explanation of how such an equilibrium might be achieved, or even approached. Kirzner focuses his critique on one particular equilibrium model, that of perfect competition. In the essay "The Driving Force of the Market," he writes:

"The model [of perfect competition] cannot be used to 'explain' market prices; the model presumes that everyone has, somehow, correctly and self-fulfilling guessed what the market price is going to be. The circumstance that (quite apart from the assumed correctness of the anticipated price) the model treats each market participant as a price-taker further underscores the uselessness of the model as an explanation for the manner in which prices are adjusted. No one in the model ever does change his price bids or offers." (p. 52)

In "Knowledge Problems and Their Solutions," Kirzner makes an interesting distinction between two types of knowledge problems, which I will refer to as type A and type B. Type A problems involve undue optimism, and are self-correcting: if I think I can sell my computer programming services for $1 million per hour, I surely will be disappointed, and then, if wise, I will lower my price. My very attempt to act on my over-optimistic beliefs reveals their falsity.

Type B problems, on the other hand, involve undue pessimism, and, per Kirzner, are not self-correcting. I may believe that my current boss, who is paying me $50 per hour, is the best employer I can find. But, unbeknownst to me, just down the block is someone who would happily pay me $100 per hour, if he knew of my existence. And I would happily go work for him, if I knew of his. For type B problems to be "corrected" requires entrepreneurial action, perhaps, say, a job placement firm that will alert both the potential new employer and me to each other's presence in the market. The agency arbitrages the difference between my current wage and the "correct," market wage, and collects part of that difference (its fee) as an entrepreneurial profit.

The broader theme under discussion in this essay is to what extent Hayek's move from confidence in the error-correcting properties of markets to the error-correcting properties of "social evolution" is justified. Kirzner argues that Hayek is on solid ground in believing that spontaneous social processes will correct type A errors, but on much shakier ground if he wishes to contend that such social processes can correct type B errors. And the reason for this, Kirzner contends, is that the correction of type B errors in the market depend upon the lure of entrepreneurial profit, while no similar attractant exists in non-market contexts.

Hayek cites the evolution of law, language, and money as examples of spontaneous social processes: let us grant, for the moment, that he is correct about this, something Kirzner is willing to do. But, Kirzner contends, such processes exhibit that social agents can spontaneously correct type A problems in non-market settings, and, at the best, that their self-interested actions might accidentally correct a type B problem. (And Kirzner notes the many cases in which spontaneous social processes might create an ever-worsening situation, such as those highlighted in the work of Thomas Schelling.) He offers an analysis of the Mengerian story of the evolution of a medium of exchange as an example: the entrepreneurial alertness to trade for a more liquid commodity, even if it is not that which one ultimately wants to consume, "is never alertness to prospects of further increasing that liquidity... No entrepreneur could, by himself, discover opportunities for pure profit by attempting to move the barter society towards the use of money" (p. 102). But... why couldn't she? Whether or not any such thing ever actually happened, isn't it conceivable that some entrepreneur saw, say, silver being traded more-and-more, and so decided to become a market-maker in silver, in order to facilitate further increases in the liquidity of silver, to his own profit? Nevertheless, Kirzner is correct in stating that there is "no basis for any extension of the welfare theorems relating to markets to the broader field of the theory of institutional evolution. The explanation for such benign tendencies, if indeed they exist, must be sought elsewhere" (p. 103).

However, are Type B problems really as little susceptible to self-correction as Kirzner contends? Consider the example of putting one's house on the market for too low a price: such an error is, I suggest, largley self-correcting: if I put my house on the market for a price significantly below the market price, on the date of the first open house showing, I will be flooded with potential buyers, and it will be obvious to me that I have been overly pessimistic about the price the house can fetch. Similarly, if I own a grocery, and I ask too low a price for my milk, I will run out of milk very fast, and it ought to be obvious to me that I could charge more for my milk.

In the converse case, if I pessimistically believe that I must bid too much for a resource -- for instance, if I have started up a new tech company, and believe I must bid at least $300,000 to attract decent software engineers -- I may be quickly informed of my mistake because I am absolutely overwhelmed with software engineers applying for my open positions.

So it seems to me that Kirzner's analysis of undue pessimism is not universal, but applies only to the cases where there are relatively few buyers or sellers of a commodity, so that an unduly low bid or ask price is not immediately revealed by a flood of sellers or buyers.

But does this analysis perhaps not also undermine Kirzner's analysis of undue optimism? For if there are very few buyers or sellers in a market, could it not be the case that my asking price for, say, my house, is perfectly fine, and that the fact I have not sold it is simply the result of my not having waited long enough for the buyer, for whom mine is the perfect property, to come along?

Some of the essays in this volume, like those discussed above, are largely in the empyrean of "pure theory." Others descend closer to the sphere of economic policy. For instance, in his essay "Knowing about Knowledge," Kirzner contends:

"Since individuals obviously differ in their entrepreneurial alertness, it is clear that opportunities for social improvement will tend to be exploited most fruitfully if institutional arrangements can be patterned so as to translate such opportunities into opportunities that will be encountered by those whose entrepreneurial alertness is the most acute, the most sensitive, and the most accurate." (p. 216)

But what entrepreneurial alertness is alert to, per Kirzner, is profit opportunities, not "opportunities for social improvement." Now, one could protest that those opportunities are the same thing, but then what about an entrepreneur who is alert to the fact that the Internet offers a "better" way to deliver rape-fantasy videos to those who are titillated by the idea of raping women, or alert to the possibility of creating a new, far more addictive form of opiate that will yield huge profits to its creator? A hedonist utilitarian might be able to make a case that these are "social improvements": if these innovations are desired by those who consume them, then all is well! However, Kirzner is not a utilitarian hedonist, and it seems unlikely that he would really see them as such. But if he would not, then what happens to his case for maximally releasing entrepreneurial alertness, given that profit opportunities are not equal to opportunities for social improvement?

In "Advertising in an Open-Ended Universe," Kirzner offers important insights on the difference between economic analysis of a "closed universe" and of an "open-ended universe." In the closed universe, there are only what Donald Rumsfeld would call "known unknowns": an economic agent may be lacking some information, but he knows that he lacks it, and does not act to acquire it only because the "search costs" of doing so are too high. But in Kirzner's "open-ended" universe, there are also "unknown unknowns": not only do economic agents not know everything possibly relevant to their choices, but they also often have no idea of what they do not know. In such a universe, "to choose... is to strike out boldly into a largely unseen world. To act as a producer... is not to fabricate a commodity for a perceived market; it is to create a commodity for a market the extent of which must be imagined... [and in] which any number of competing producers may be introducing novel products at prices that can only be guessed at" (p. 249). The "open-ended" universe is surely a more accurate description of the actual choice situation of economic agents than is the closed one, whether one fully buys into the defense of advertising Kirzner draws from the distinction or not.

There are many more essays in this volume worth reading and pondering, but those discussed above should suffice as a representative sample of the rest of the contents. Hopefully, they are enough to demonstrate that Israel Kirzner is no mere "market ideologue," but a serious theorist of the market process. Kirzner's work contains penetrating insights as to the nature of economic reality, insights that have something to teach even those who do not share his sunny optimism about the outcomes likely to be yielded by a laissez-faire economic policy.