They had a healthfully vague understanding that the dynamic competition which is always at work in free markets. It continually inspires market movements, movements in prices, methods of production, and the the array of products being produced. It continually inspires these movements to tend to identify and correct wasteful or inefficient uses of resources. If resources were being used in non-optimal methods of production, this would generate patterns of costs and prices which would “invite” entrepreneurs through opportunities for pure profit, it would invite them to bid away resources from less socially valuable uses toward more valuable uses. That’s basically the healthfully vague insights… the market is a market of dynamic competition.
That was from Israel Kirzner on the Hayek Program Podcast. Here’s some more:
Equilibrium is the state of perfect knowledge… I don’t know which world you grew up in, I grew up in a world without perfect knowledge.
Hayek was able to show how, unlike the textbook models of perfect competition, genuine dynamic competition is the manner in which knowledge is arrived at and disseminated. It is not the state of initial perfect knowledge. One of the conditions of perfect competition is complete knowledge about what everybody else is doing.
For mainstream economics, the market functions as a computer, determining the solution to a set of Walrasian equations. That’s how they perceive the market. For Mises and Hayek, the market functions as a discovery procedure… It discovers the parameters of the relevant equations.
Notice that when we talk about discovery, we are not talking about the economics of search. In the economics of search, it is recognized that knowledge is imperfect. OK, if knowledge is imperfect then what do you do? You buy some knowledge. How much knowledge do you buy? Well as much as it is worth buying. You know in advance how much knowledge is worth buying. And you know in advance what it costs to get the knowledge, what the knowledge will enable you to achieve, and you make a decision as to how much knowledge to buy. In other words, you know what it is you don’t know… It has nothing to do with discovery. Discovery refers to discovering something you didn’t know you didn’t know, which is the world we live in. Gee I never knew this. I never even knew I didn’t know. Now you know. That’s a discovery. And the market is a discovery procedure.
After WWII, the defense acquisition system was built using the framework that the market functioned as a computer. You just need to calculate what the cost, schedule, and benefits were, and then you could optimize the defense portfolio of programs in the PPBS using a systems analysis. Back in the 1960s, the Office of Systems Analysis basically did much the cost-effectiveness analyses themselves, simultaneously. They estimated what future technologies would look like, what they could enable you to do, and how much they would cost.
The systems analysts of old were criticized on this point, because the hard part about weapons choice is discovering the parameters of the problem. This is not something that mathematicians are particularly good at. Alain Enthoven and others explained that a major task of systems analysis was defining objectives and assumptions. E.S. Quade observed that systems analysts are
… likely to be forced to deal with problems in which the difficulty lies in deciding what out to be done, not simply in how to do it… The situation is not like an empirical science, which starts with observed facts, but more like that of mathematics, where the results take any ‘validity’ they might have in the real world from the assumptions… it is important that the assumptions be the ‘right’ assumptions.
Systems analysts were not trusted with that task of defining assumptions. Today, defense programs are mostly built up from agreeable requirements from uniformed officers, which then gets pushed over to cost estimators who try to predict the cost of the thing that hasn’t yet existed. The same problem exists just in a different form.
The purpose of technology development and choice is discovering the parameters of the equations that need to be solved. We need to look at the analogy of the market as a discovery procedure rather than a computer. This means “efficient” actions based on perfect knowledge is impossible. We can only hope to grope toward better allocations of resource. But that requires several means towards the same ends. In other words, we need real competition where teams take different perspectives of weapon systems requirements and technologies. These competitors act like an “experimental method,” which allows us to recognize errors because we have a relevant comparison to see how other concepts worked out.
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