The Uses and Limits of Local Knowledge: A Cautionary Note on Hayek
One of Hayek’s great intellectual achievements stems from his appreciation of the quiet virtues of the price system. At a time when everyone was clamoring for central planning, Hayek, writing in his classic article, The Use of Knowledge in Society, understood the unsurpassed ability of the price system to coordinate the activities of myriads of separate individuals. Each person, in Hayek’s view, possesses local knowledge of his own situation, which gives him a clear sense of the costs of his factor inputs and the prices that he hopes to obtain by selling the out-puts of their deployment. The strength of the individual’s convictions can be communicated to the world by a single number―the price that is bid or asked for certain commodities. These prices are, of course, not randomly generated but depend on accurate estimates of both benefits and costs. Yet no market participant has any incentive to inflate or deflate the relevant figures, because the only person who will be deceived by this action is himself. The system, moreover, is easily expandable across different markets, even when their participants operate in different languages and under different cultural norms. The thicker the market, and the greater the apparent disorder, the fuller the range of options from which everyone may choose.
