Fermat's Library | Competition as a Discovery Procedure annotated/explained version.

#### TL;DR This is a lecture given by Hayek in 1968. It is one o...

Friedrich A. Hayek was an Austrian-British economist and philosophe...

This is Hayek's core idea for this lecture. **According to Hayek co...

>***"The curious fact that the merits of competition cannot be empi...

Competition is important because it helps us uncover and use knowle...

Traditional economic theories often make the mistake of assuming th...

**Catallaxy** refers to the spontaneous order brought about by the ...

Equilibrium suggests that everything there is to know is already kn...

In this section Hayek emphasizes that the market should be allowed ...

Competition seems to be even more important in less developed count...

Hayek discusses the problem of wage rigidity and its negative impac...

COMPETITION AS A

DISCOVERY PROCEDURE

F.A. H

AYEK

TRANSLATED BY MARCELLUS S. SNOW

t would not be easy to defend macroeconomists against the charge that for

40 or 50 years they have investigated competition primarily under

assumptions which, if they were actually true, would make competition

completely useless and uninteresting. If anyone actually knew everything that

economic theory designated as “data,” competition would indeed be a highly

wasteful method of securing adjustment to these facts. Hence it is also not sur-

prising that some authors have concluded that we can either completely

renounce the market, or that its outcomes are to be considered at most a first

step toward creating a social product that we can then manipulate, correct, or

redistribute in any way we please. Others, who apparently have taken their

notion of competition exclusively from modern textbooks, have concluded

that such competition does not exist at all.

By contrast, it is useful to recall that

wherever

we make use of competi-

tion, this can only be justified by our

not

knowing the essential circumstances

that determine the behavior of the competitors. In sporting events, examina-

tions, the awarding of government contracts, or the bestowal of prizes for

poems, not to mention science, it would be patently absurd to sponsor a con-

test if we knew in advance who the winner would be. Therefore, as the title of

this lecture suggests, I wish now to consider competition systematically as a

procedure for discovering facts which, if the procedure did not exist, would

remain unknown or at least would not be used.

THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 5, NO. 3 (FALL 2002): 9–23

Marcellus S. Snow is professor emeritus at the University of Hawaii at Manoa;

snow@hawaii.edu. This is a translation from German of F.A. Hayek’s “Der Wettbewerb als

Entdeckungsverfahren,” a 1968 lecture sponsored by the Institut für Weltwirtschaft at the

University of Kiel. It was published as No. 56 in the series Kieler Vorträge.

It might at first appear so obvious that competition always involves such

a discovery procedure that this is hardly worth emphasizing. When this is

explicitly underscored, however, conclusions are immediately obtained that

are in no way so obvious. The first is that competition is important

only

because and insofar as its outcomes are unpredictable and on the whole dif-

ferent from those that anyone would have been able to consciously strive for;

and that its salutary effects must manifest themselves by frustrating certain

intentions and disappointing certain expectations.

The second conclusion, closely associated with the first, is methodologi-

cal in nature. It is of particular interest in that it has reference to the princi-

pal reason why, during the last 20 or 30 years, microeconomic theory—the

analysis of the fine details of the economy’s structure which alone can teach

us to understand the role of competition—has lost so much of its reputation,

and indeed as a result appears not at all to be understood anymore by those

calling themselves economic theorists. For this reason I would like to begin

here with a few words about the methodological particularity of every theory

of competition that makes the conclusions drawn from it appear suspicious

to all those who habitually decide, on the basis of an excessively simplified

criterion, what they are prepared to recognize as scientific.

The only reason we use competition at all has as its necessary consequence

the fact that the validity of the theory of competition can never be empirically

verified

for those cases in which it is of interest

. It is of course possible to ver-

ify the theory on preconceived theoretical models; and in principle we could

also conceivably verify the theory in artificially created situations in which all

the facts that competition is to discover are known to the observer in advance.

In such a situation, however, the outcome of the experiment would be of little

interest, and it would probably not be worth the cost of conducting it. When,

however, we do not know in advance the facts we wish to discover with the help

of competition, we are also unable to determine how effectively competition

leads to the discovery of all the relevant circumstances that could have been dis-

covered. All that can be empirically verified is that societies making use of com-

petition for this purpose realize this outcome to a greater extent than do oth-

ers—a question which, it seems to me, the history of civilization answers

emphatically in the affirmative.

The curious fact that the merits of competition cannot be empirically ver-

ified in precisely those cases in which it is of interest is also shared by the dis-

covery procedures of science in general. The advantages of established scien-

tific procedures cannot themselves be scientifically demonstrated; they are

recognized only because they have actually provided better results than alter-

native procedures.

10 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 5, NO. 3 (SUMMER 2002)

See the interesting discussion of these problems in M. Polyani,

The Logic of Liberty

(

London, 1951), in which the author is led from a study of the methods of scientific

research to that of economic competition. See also K.R. Popper,

Logik der Forschung

, 2d.

ed. (Tübingen, 1966), p. 16.

The difference between economic competition and the successful proce-

dure of science is that the former exhibits a method of discovering particular

temporary circumstances, while science seeks to discover something often

known as “general facts,” i.e., regularities in events, and is concerned with

unique, particular facts only to the extent that they tend to refute or confirm

its theories. Since this is a matter of general and permanent features of our

world, scientific discoveries have ample time to demonstrate their value,

whereas the usefulness of particular circumstances disclosed by economic

competition is to a considerable extent transitory. It would be as easy to dis-

credit the theory of scientific method by noting that it does not lead to verifi-

able predictions regarding what science will discover, as it has been to dis-

credit the theory of the market by noting that it does not lead to predictions

about particular outcomes of the market process. By the nature of things,

however, the theory of the market is unable to accomplish this in all those

cases in which it is reasonable to make use of competition. As we shall see,

the predictive power of this theory is necessarily constrained to a prediction

of the type of structure or abstract order that will result; it does not, however,

extend to a prediction of particular events.

II.

Although this will lead me even further from my main topic, I should like to

add a few words about the consequences of the disappointment in microeco-

nomic theory caused by using fallacious methodological criteria of scientism.

Most of all, this disappointment was probably the major reason why a great

number of economists rejected it in favor of so-called macroeconomic theory,

which, since it aims to predict concrete events, appears to correspond better

with the criteria of scientism. In reality, however, it seems to me much less sci-

entific—indeed, in the strictest sense, it can make no claim to the name of a

theoretical science.

The basis for this point of view is the conviction that the coarse structure

of the economy can exhibit no regularities that are not results of the fine struc-

ture, and that those aggregates or mean values, which alone can be grasped

statistically, give us no information about what takes place in the fine struc-

ture. The notion that we must formulate our theories so that they can be

imme-

diately

applied to observable statistical or other measurable quantities seems

to me to be a methodological error which, had the natural sciences followed it,

would have greatly obstructed their progress. All we can require of theories is

that, after an input of relevant data, conclusions can be derived from them that

can be checked against reality. The fact that these concrete data are so diverse

COMPETITION AS A DISCOVERY PROCEDURE 11

See my essay “The Theory of Complex Phenomena” in

The Critical Approach in

Science and Philosophy

, M. Bunge, ed. (London and New York, 1964). Reprinted in my

Studies in Philosophy, Politics, and Economics

(Chicago and London, 1967).

12 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 5, NO. 3 (SUMMER 2002)

and complex in our area of inquiry that we can never take them all into

account is an unchangeable fact, but not a shortcoming of the theory. A result

of this fact is that we can derive from our theories only very general state-

ments, or “pattern predictions,” as I have called them elsewhere;

we cannot,

however, derive any specific predictions of individual events from them.

Certainly, however, this does not justify insisting that we derive unambiguous

relationships among the immediately observable variables, or that this is the

only way of obtaining scientific knowledge—particularly not if we know that,

in that obscure image of reality we call statistics, in aggregates and averages

we unavoidably summarize many things whose causal meaning is very

diverse. It is a false epistemological principle to adapt the theory to the avail-

able information, so that the observed variables appear directly in the theory.

Statistical variables such as national income, investment, price levels, and

production are variables that play no role in the process of their determina-

tion itself. We might be able to notice certain regularities (“empirical laws” in

the specific sense in which Carl Menger contrasted them to theoretical laws)

in the observed behavior of these variables. Often these regularities apply, but

sometimes they do not. Yet using the means of macrotheory, we can never for-

mulate the conditions under which they apply.

This should not mean that I regard so-called macrotheory as completely

useless. About many important conditions we have only statistical informa-

tion rather than data regarding changes in the fine structure. Macrotheory

then often affords approximate values or, probably, predictions that we are

unable to obtain in any other way. It might often be worthwhile, for example,

to base our reasoning on the assumption that an increase of aggregate

demand will in general lead to a greater increase in investment, although we

know that under certain circumstances the opposite will be the case. These

theorems of macrotheory are certainly valuable as rules of thumb for gener-

ating predictions in the presence of insufficient information. But they are not

only not more scientific than is microtheory; in a strict sense they do not have

the character of scientific theories at all.

In this regard I must confess that I still sympathize more with the views of

the young Schumpeter than with those of the elder, the latter being responsi-

ble to so great an extent for the rise of macrotheory. Exactly 60 years ago, in

his brilliant first publication,

a few pages after having introduced the concept

of “methodological individualism” to designate the method of economic the-

ory, he wrote:

If one erects the edifice of our theory uninfluenced by prejudices and out-

side demands, one does not encounter these concepts [namely “national

income,” “national wealth,” “social capital”] at all. Thus we will not be fur-

ther concerned with them. If we wanted to do so, however, we would see

See my above-cited essay, “The Theory of Complex Phenomena.”

J. Schumpeter,

Das Wesen und der Hauptinhalt der theoretischen Nationalökonomie

(Leipzig, 1908), p. 97.

COMPETITION AS A DISCOVERY PROCEDURE 13

how greatly they are afflicted with obscurities and difficulties, and how

closely they are associated with numerous false notions, without yielding

single

truly valuable theorem.

III.

Returning now to my actual topic after having shared my concerns with you

on this matter, I should like to begin with the observation that market theory

often prevents access to a true understanding of competition by proceeding

from the assumption of a “given” quantity of scarce goods. Which goods are

scarce, however, or which things are goods, or how scarce or valuable they are,

is precisely one of the conditions that competition should discover: in each

case it is the preliminary outcomes of the market process that inform indi-

viduals where it is worthwhile to search. Utilizing the widely diffused knowl-

edge in a society with an advanced division of labor cannot be based on the

condition that individuals know all the concrete uses that can be made of the

objects in their environment. Their attention will be directed by the prices the

market offers for various goods and services. This means, among other

things, that each individual’s particular combination of skills and abilities—

which in many regards is always unique—will not only (and not even prima-

rily) be skills that the person in question can recite in detail or report to a gov-

ernment agency. Rather, the knowledge of which I am speaking consists to a

great extent of the ability to detect certain conditions—an ability that individ-

uals can use effectively only when the market tells them what kinds of goods

and services are demanded, and how urgently.

This suggestion must suffice here to clarify the kind of knowledge I am

speaking of when I call competition a discovery procedure. Much more would

have to be added if I wanted to formulate this outline so concretely that the

meaning of this process emerged clearly. What I have said, however, should

be sufficient to point out the absurdity of the conventional approach pro-

ceeding from a state in which all essential conditions are assumed to be

known—a

state

that theory curiously designates as perfect competition, even

though the opportunity for the

activity

we call competition no longer exists.

Indeed, it is assumed that such activity has already performed its function.

Nonetheless, I must now turn to another question about which even more

confusion still exists, namely the meaning of the claim that the market spon-

taneously

adjusts

the plans of individuals to the facts thus discovered; in other

words, the question of the purpose for which the information thus discovered

is used.

The confusion that prevails here can be ascribed above all to the false idea

that the order which the market brings about can be regarded as an

economy

in the strict sense of the word, and that the outcome must therefore be judged

according to criteria that in reality are appropriate only for such an individ-

ual economy. But these criteria, which hold for a true economy in which all

effort is directed toward a uniform order of objectives, are to an extent com-

pletely irrelevant for the complex structure consisting of the many individual

economies that we unfortunately designate with the same word “economy.”

An economy in the strong sense of the word is an organization or an arrange-

ment in which someone consciously uses means in the service of a uniform

hierarchy of ends. The spontaneous order brought about by the market is

something entirely different. But the fact that this market order does not in

many ways behave like an economy in the proper sense of the word—in par-

ticular, the fact that it does not in general ensure that what most people regard

as more important ends are always satisfied before less important ones—is one

of the major reasons people rebel against it. It can be said, indeed, that all

socialism has no other aim than to transform catallaxy (as I am pleased to call

market order, to avoid using the expression “economy”) into a true economy

in which a uniform scale of values determines which needs are satisfied and

which are not.

This widely shared wish raises two problems, though. First, as far as the

management decisions of a genuine economy or of any other organization are

concerned, it is only the knowledge of the organizers or managers alone that

can have any impact. Second, all members of such a genuine economy—con-

ceived of as a consciously managed organization—must serve the uniform

hierarchy of objectives in all their actions. Contrast this with the two advan-

tages of a spontaneous market order or catallaxy: it can use the knowledge of

all participants, and the objectives it serves are the particular objectives of all

its participants in all their diversity and polarity.

The fact that catallaxy serves no uniform system of objectives gives rise to

all the familiar difficulties that disturb not only socialists, but all economists

endeavoring to evaluate the performance of the market order. For if the mar-

ket order does not serve a particular rank ordering of objectives, and indeed

if, like any spontaneously created order, it cannot legitimately be said to have

definite objectives, neither is it then possible to represent the value of its out-

come as a sum of individual outputs. What do we mean, then, when we claim

that the market order in some sense produces a maximum or an optimum?

The point of departure for an answer must be the insight that, although

the spontaneous order was not created for any particular individual objective,

and in this sense cannot be said to serve a particular concrete objective, it can

nonetheless contribute to the realization of a number of individual objectives

which no one knows in their totality. Rational, successful action by an indi-

vidual is possible only in a world that is to some extent orderly; and it obvi-

ously makes sense to try to create conditions under which any randomly

selected individual has prospects of pursuing his goals as effectively as pos-

sible, even if we cannot predict which particular individuals will benefit

thereby and which will not. As we have seen, the results of a discovery pro-

cedure are necessarily unpredictable, and all we can expect by employing an

appropriate discovery procedure is that it will increase the prospects of

unspecified persons, but not the prospects of any particular outcome for any

14 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 5, NO. 3 (SUMMER 2002)

particular persons. The only common objective we can pursue in choosing

this technique for the ordering of social reality is the abstract structure or

order that will be created as a consequence.

IV.

We are accustomed to calling the order brought about by competition an equi-

librium—a none-too-felicitous expression, since a true equilibrium presup-

poses that the relevant facts have already been discovered and that the process

of competition has thus come to an end. The concept of order, which I prefer

to that of equilibrium, at least in discussions of economic policy, has the

advantage of allowing us to speak meaningfully about the fact that order can

be realized to a greater or lesser degree, and that order can also be preserved

as things change. Whereas an equilibrium never really exists, one can

nonetheless justifiably claim that the kind of order of which the “equilibrium”

of theory represents a sort of ideal type is realized to a great extent.

This order manifests itself first of all by virtue of the fact that the expec-

tations of particular transactions with other persons, upon which the plans of

all the economy’s participants are based, are to a considerable extent realized.

This mutual adjustment of individual plans is brought about by a process that

we have learned to call negative feedback ever since the natural sciences have

also begun to concern themselves with spontaneous orders or “self-organizing

systems.” Indeed, as even well-informed biologists are now aware,

long before Claude Bernard, Clark Maxwell, Walter B. Cannon or Norbert

Wiener developed cybernetics, Adam Smith perceived the idea just as

clearly in his

Wealth of Nations

. The “invisible hand” that regulates prices

appears to express this idea. Smith says in essence that in a free market,

prices are determined by negative feedback.

It is precisely through the disappointment of expectations that a high

degree of agreement of expectations is brought about. This fact, as we shall

see later, is of fundamental importance in understanding the functioning of

the market order. But the market’s accomplishments are not exhausted in

bringing about a mutual adjustment of individual plans. It also provides that

every product is produced by those who can produce it more cheaply (or at

least as cheaply) as anyone who does not in fact produce it, and that goods

are sold at prices that are lower than those at which anyone could offer the

goods who does not offer them. This does not of course prevent some people

from extracting large profits above their costs, as long as these costs are con-

siderably lower than those of the next best potential producer of the good. It

COMPETITION AS A DISCOVERY PROCEDURE 15

G. Hardin,

Nature and Man’s Fate

(New York and London, 1959). Mentor Edition,

1961, p. 54.

means, however, that of the combination of different goods that is actually

being produced, as much is produced as we can manufacture by any method

that is known to us. That is of course not as much as we could produce if in

fact all the knowledge that anyone possessed or could acquire were available

at a central point and from there could be entered into a computer. The cost

of the discovery procedure that we use is considerable. But it is unfair to judge

the performance of the market in a certain sense “from the top down,” namely

by comparing it with an ideal standard that we are unable to attain in any

known way. If we judge the market’s performance “from the bottom up”

(which seems to be the only permissible way), i.e., by comparison with what

we could attain by means of any other method available to us, and in partic-

ular by comparison with what would be produced if competition were pre-

vented—for example, if a good could be produced only by those the authori-

ties allowed to do so—the market’s performance must be judged as most

considerable. We need only recall how difficult it is in an economy with effec-

tive competition to discover ways of providing consumers with better or

cheaper goods than is presently the case. If, for a moment, we believe we have

discovered such unrealized opportunities, we generally find that government

authority or a highly undesirable exercise of private power have hitherto pre-

vented their exploitation.

Of course, we must also not forget that the market can provide no more

than an approximation of any point on the n-dimensional surface by which

pure theory describes the range of possibilities that could conceivably be

attained in the production of any combination of goods and services; but the

market allows the particular combination of various goods and their distri-

bution among individuals to be decided essentially by unforeseeable circum-

stances and in this sense by chance. As Adam Smith realized,

the situation is

somewhat like agreeing to play a game based partly on skill and partly on

luck. The rules of the game ensure that at the price such that each individual’s

share is left more or less to chance, the real equivalent of each individual’s

share, depending partly on chance, becomes as large as possible. In modern

terminology we can say that we are playing a non-zero-sum game whose rules

have the objective of increasing the payoff but leave the share of the individuals

partly to chance. A mind endowed with full information could of course choose

every point on the n-dimensional surface that appeared desirable to him and

then distribute as he saw fit the product of the combination he chose. But the

only point on (or at least somewhere near) that surface we can reach using a

procedure known to us is the one we reach when we leave its determination up

to the market. The so-called “maximum” we achieve in this manner cannot of

course be defined as a sum of certain quantities of goods, but only by the

opportunity it affords unspecified persons to receive as large an equivalent as

16 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 5, NO. 3 (SUMMER 2002)

See A. Smith,

Theorie der ethischen Gefühle

, W. Eckstein, trans. (Leipzig,, 1926), vol. 2,

pp. 396, 467.

possible for a share determined partly by chance. The fact that this outcome

cannot be evaluated on the basis of a uniform value scale of desired concrete

objectives is one of the main reasons it seems so misleading to me to consider

the outcome of the market order or catallaxy as if it had anything to do with

an economy in the proper sense.

The consequences of this erroneous interpretation of the market order as an

economy whose task is to satisfy the various needs according to a given rank

ordering are reflected in political efforts to correct prices and income in the

service of so-called “social justice.” Notwithstanding the various meanings

with which social philosophers attempted to invest this concept, in practice it

has had virtually only one: protecting some groups of people from having to

descend from the absolute or relative lifestyle they have heretofore enjoyed. Yet

this is a principle that cannot be implemented in general without destroying

the foundations of the market order. Not only continuous growth, but under

certain circumstances even the preservation of the average income level

attained depends on processes of adjustment that require a change not only

of the relative shares but also of the absolute shares of individual persons and

groups, even though such persons and groups are not responsible for the

necessity of that change.

It is useful to recall at this point that all economic decisions are made nec-

essary by unanticipated changes, and that the justification for using the price

mechanism is solely that it shows individuals that what they have previously

done, or can do now, has become more or less important, for reasons with

which they have nothing to do. The adaptation of the total order of human

action to changing circumstances is based on the fact that the compensation

of the various services changes without taking into account of the merits or

defects of those involved.

In this connection the term “incentives” is often used in a way that easily

lends itself to misunderstanding, namely as though their primary purpose

were to induce individuals to exert themselves sufficiently. The most impor-

tant function of prices, however, is that they tell us

what

we should accom-

plish,

not how much

. In a constantly changing world, merely maintaining a

given level of welfare requires constant adjustments in how the efforts of many

individuals are directed; and these will only occur when the relative compen-

sation of these activities changes. Under relatively stationary conditions,

however, these adjustments—which are needed simply to maintain the income

stream at its previous level—will not generate a surplus that could be used to

compensate those who are disadvantaged by the price changes. Only in a rap-

idly growing economy can we hope to prevent an absolute decline in the mate-

rial level of particular groups.

Today, customary treatments of these problems often overlook the fact that

even the relative stability of the various aggregates that macroeconomics treats

COMPETITION AS A DISCOVERY PROCEDURE 17

as data is the result of microeconomic processes in which relative price

changes play a decisive role. It is an outcome of the market mechanism that

someone is induced to fill the gap that arises when someone else does not ful-

fill the expectations on the basis of which a third party has made plans. In

this sense all the collective supply and demand curves that we use so happily

are not really data, but rather outcomes of the constantly ongoing process of

competition. Thus, statistical information can never disclose to us what price

or income changes will be needed to bring about the necessary adjustment to

an unavoidable change of the data.

The decisive point, however, is that in a democratic society it would be

completely impossible, using commands that could not be regarded as just, to

bring about those changes that are undoubtedly necessary, but the necessity

of which could not be strictly demonstrated in a particular case. In such a sys-

tem, a conscious direction of the economy would always have to aim for prices

that are considered fair, and in practice that can only mean preservation of

the existing price and income structure. An economic system in which every-

one received what others felt he deserved could not help but be a highly inef-

ficient system, quite apart from the fact that it would also be an unbearably

tyrannical one. For the same reason, it is also to be feared that any “incomes

policy” would tend more to prevent than to facilitate those adjustments in the

price and income structure required by the adaptation to unanticipated

changes in conditions.

It is one of the paradoxes of our age that the communist countries, in this

regard, are probably less burdened by ideas of “social justice” than are the

“capitalistic” and democratic countries, and are thereby more prone to allow

those who are disadvantaged by development to suffer. In at least some of the

Western countries the situation is as hopeless as it is precisely because the

ideology that determines policy renders impossible those changes that would

be necessary to improve the situation of the working class quickly enough to

make that ideology disappear.

VI.

If even in highly developed economies competition is important primarily as a

discovery procedure whereby entrepreneurs constantly search for unexploited

opportunities that can also be taken advantage of by others, then this is true of

course to an even greater extent as far as underdeveloped societies are con-

cerned. I have intentionally begun by considering the problems of maintain-

ing an order in societies in which most techniques and productive forces are

generally known, but also an order that requires continuous adjustment of

activities to unavoidable small changes simply to maintain the previously

attained level. At this point I do not wish to inquire into the role played by

competition in the progress of available technology. I would like to emphasize,

however, how much more important competition must be wherever the pri-

mary objective is to discover the still unknown possibilities in a society where

18 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 5, NO. 3 (SUMMER 2002)

COMPETITION AS A DISCOVERY PROCEDURE 19

competition was previously limited. While for the most part false, it might not

be completely absurd to expect that we can predict and control the develop-

ment of the structure of a society that is already highly developed. But it

seems incredible to me to hold that we can determine in advance the future

structure of a society in which the major problem is still to find out what

kinds of material and human productive forces are present, or that we should

be in a position, in such a country, to predict the particular consequences of

a given measure.

Quite apart from the fact that there is still so much more to discover in

such a country, it seems to me that there is another consideration making the

greatest possible freedom of competition much more important here than in

more highly developed countries. The fact I have in mind is that the necessary

changes in habits and customs will occur only when those who are ready and

able to experiment with new procedures can make it necessary for the others

to imitate them, with the former thereby showing the way; but if the majority

is in a position to prevent the few from conducting experiments, the necessary

discovery procedure will be frustrated. The fact that competition not only

shows how things can be improved, but also forces all those whose income

depends on the market to imitate the improvements, is of course one of the

major reasons for the disinclination to compete. Competition represents a

kind of impersonal coercion that will cause many individuals to change their

behavior in a way that could not be brought about by any kind of instructions

or commands. Central planning in the service of any some “social justice”

may be a luxury that rich countries can afford, but it is certainly no method

for poor countries to bring about the adjustment to rapidly changing circum-

stances on which growth depends.

It might also be worth mentioning in this connection that the more the

available opportunities of a country remain unexploited, the greater its oppor-

tunities for growth; this often means that a high growth rate is more a sign of

bad policies in the past than of good policies in the present. It also seems that

one cannot in general expect a country that is already highly developed to

have as high a growth rate as a country whose full use of its resources has long

been rendered impossible by legal and institutional barriers.

Having seen what I have of the world, it appears to me that the proportion

of people who are prepared to try out new possibilities that promise to

improve their situation—as long as others do not prevent them from doing so—

is more or less the same everywhere. It seems to me that the much-lamented

lack of entrepreneurial spirit in many young countries is not an unchangeable

attribute of individuals, but the consequence of limitations placed on indi-

viduals by the prevailing point of view. For precisely this reason, the effect

would be fatal if, in such countries, the collective will of the majority were to

control the efforts of individuals, rather than that public power limits itself to

protecting the individual from the pressure of society—and only the institution

of private property, and all the liberal institutions of the rule of law associated

with it, can bring about the latter.

20 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 5, NO. 3 (SUMMER 2002)

VII.

Although competition is by and large a quite resilient specimen as far as pri-

vate firms are concerned—one that continues to resurface in the most unex-

pected manner after efforts to suppress it—its usefulness with respect to the

one omnipresent factor of production, namely human labor, has been ren-

dered more or less ineffective throughout the entire Western world. It is a gen-

erally known fact that the most difficult and indeed the apparently insoluble

problems of present-day economic policy, which have occupied economists

more than all other problems, are the result of the so-called rigidity of wages.

This means in essence that the wage structure as well as the wage level has

become increasingly independent of market conditions. Most economists con-

sider this situation as an irrevocable development that we cannot change and

to which we must adapt our policies. It is hardly an exaggeration to say that

for the past 30 years, discussions of monetary policy in particular have dealt

almost exclusively with problems of circumventing the difficulties created by

inflexible wages. I have long since had the impression that this was a mere

treatment of symptoms. For the moment, we might thereby cover up the fun-

damental difficulties, but this is not only a mere postponement of the moment

at which we must directly confront the primary problem, but it also makes the

eventual solution of the latter increasingly difficult. This is because accepting

these rigidities as unavoidable facts not only results in increasing them, but

also confers an aura of legitimacy on the antisocial and destructive practices

that they cause. I must confess that as a result, I myself have lost all interest

in the ongoing discussions of monetary policy, which was once one of my

major areas of research, because this avoidance of the central issue seems to

me to load the burden onto the shoulders of our successors in a most irre-

sponsible manner. In a certain sense, of course, we are harvesting here only

what the founder of this fashion has sown, since we are naturally already in

that “long run” in which he knew he would be dead.

It was a great misfortune for the world that these theories arose from the

very unusual and, indeed, perhaps unique situation of Great Britain in the

1920s—a situation in which it appeared obvious that unemployment was the

result of too high a real wage

level

, and that the problem of rigidity of the wage

structure thus had limited significance. As a result of Great Britain’s return to

the gold standard after years of war inflation at the parity of 1914, it could be

claimed with some justification that all real wages in that country were too

high relative to the rest of the world to achieve the necessary volume of

exports. I am not convinced that this was really true even then. Even at that

time, to be sure, Great Britain had the oldest, most deeply rooted, and most

all-encompassing trade union movement, which through its wage policy had

succeeded in conserving a wage structure that was determined much more by

considerations of “justice” than of economic appropriateness. This meant by

and large that the time-honored relationships between the different wages

were maintained, and that any such change in the relative wages of the vari-

ous groups as was required by changed circumstances had become effectively

COMPETITION AS A DISCOVERY PROCEDURE 21

impossible. As things stood then, full employment could doubtless have been

attained only by bringing some real wages—possibly those of numerous

groups of workers—down from the level they had reached as a result of defla-

tion. It is not certain, however, that this would necessarily have meant a

decrease in the average level of real wages. Perhaps the adjustment of the

structure of the entire economy brought about by the wage changes would

have made this unnecessary. In any event, the emphasis that was customary,

then as now, on the average real wage

level

of all a country’s workers pre-

vented this possibility from even being considered seriously.

It is perhaps useful to consider the problem from a broader perspective. It

seems to me impossible to doubt that the productivity of a country’s labor,

and thereby the wage level at which full employment is possible, depend on

the distribution of workers among the various branches of industry, and that

this distribution is in turn determined by the wage structure. But if this wage

structure has become more or less rigid, this will prevent or delay the econ-

omy’s adjustment to altered circumstances. It is thus to be assumed that, in a

country where the relationships between the various wages have been kept

rigid for a long period of time, the real wage level at which full employment

can be attained will be considerably below what it would be if wages were

flexible.

It appears to me that a completely rigid wage structure would prevent

adjustment to changes in other conditions, particularly without the rapid

technological progress we are used to today. This also concerns especially the

adjustment to those changes that must occur simply in order to keep the

income level constant. A completely rigid wage structure is therefore liable to

lead to a gradual decrease in the level of real wages at which full employment

can be realized. Unfortunately, I am not familiar with any empirical investiga-

tions of the relationship between wage flexibility and growth. I would expect

such investigations to disclose a high positive correlation between these two

variables—not so much because growth leads to changes in relative wages, but

above all because such changes are the necessary preconditions for that

adjustment to changed conditions that is required by growth.

But the main point, I believe, is that if it is correct that the real wage level

at which full employment is possible depends on the wage structure, and if

the ratios among the various wages remain unchanged as conditions change,

then the real wage level at which full employment comes into existence will

either fall continuously or will not rise as rapidly as would otherwise be pos-

sible. This means that manipulating the real wage level by monetary policy

offers no way out of the difficulties caused by the rigidity of the wage

struc-

ture.

Nor can a way out be offered by any practically possible “incomes pol-

icy.” Rather, as things turn out, it is precisely the rigidity of the wage struc-

ture brought about by the wage policy of the trade unions in the supposed

interest of their members (or of any notion of “social justice”) that has become

one of the greatest obstacles to an increase in the real income of workers as a

whole; in other words, if the real wages of individuals are prevented from

22 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 5, NO. 3 (SUMMER 2002)

falling absolutely or at least relatively, the real wage level of workers as a whole

will not rise as quickly as would otherwise be possible.

The classical ideal that John Stuart Mill described in his autobiography as

“full employment at high wages to the whole labouring population” can be

realized only by an economic use of labor, which in turn presupposes freely

fluctuating relative wages. In the place of this ideal, the great man whose

name will probably go down in history as the gravedigger of the British econ-

omy has popularized decreasing the level of real wages through a decrease of

the value of money as a method of attaining full employment while recogniz-

ing the rigidity of the nominal wage structure. In my view, however, the expe-

rience of recent years clearly shows that this method offers only temporary

relief. I believe we should no longer delay attacking the root cause of the prob-

lem. We cannot go on much longer closing our eyes to the fact that the inter-

est of labor as a whole demands that the power of individual trade unions to

maintain the relative position of their members against other workers be

removed. The most important task at present appears to be convincing labor

as a whole that removing the protection of the relative position of individual

groups not only does not threaten the prospects for a rapid increase in the real

wages of labor as a whole, but in fact enhances those prospects.

I will certainly not dispute here that for the foreseeable future it will

remain politically impossible to restore a truly free labor market. Any such

attempt would probably lead to such great conflicts that it could not be seri-

ously considered—at least as long as employers do not collectively guarantee

to maintain their employees’ average real income. But precisely such a guar-

antee, I believe, is the only way of restoring the market to its function of deter-

mining the relative wages of the various groups. Only in this way, it seems to

me, could we hope to induce individual groups of workers to give up the secu-

rity of their particular wage rates, which has become the main obstacle to a

flexible wage structure. Such a collective agreement between employers as a

whole and employees as a whole seems to me a transitional measure deserv-

ing serious consideration, because the outcome would probably show work-

ers how much they could gain from a truly functioning labor market. This

would in turn create the prospect of subsequently eliminating the tedious and

complicated apparatus that would initially have to be created.

What I have in mind is a general contract in which employers as a whole

would promise workers as a whole, initially for a year, their previous real wage

total plus a share of increased profits. Each individual group or individual

worker, however, would receive in his monthly paycheck only a certain part,

say five-sixths, of his previous wage. The rest (together with the agreed-upon

share of the increased total profits of all enterprises) would be distributed in

two additional monthly payments—at the end of the year and after the books

are closed—to the employees of the various firms and branches of the econ-

omy, in proportion to the change in profits that results on the basis on the five-

sixths of wages distributed. I have proposed five-sixths as the share of contin-

uous payments, since this would make possible the payment of a Christmas

COMPETITION AS A DISCOVERY PROCEDURE 23

bonus at the average level of a month’s income on the basis of a preliminary

estimate of profits, and of a second vacation bonus of approximately the same

amount when the books are closed for the calendar year. For the subsequent

year the average wages of the first year would again be guaranteed, but by the

end of the year every group would be paid only five-sixths of the total amount

paid in the previous year, plus a supplement at the end of the year for each

group based on profits realized in the corresponding industry or firm, and so

on.

Such a procedure would have somewhat the same effect as a restoration

of the free labor market, except that labor would know that its average real

wages could not decrease, but only increase. I would expect that such an indi-

rect re-introduction of the market mechanism for determining the distribution

of workers among industries and firms would bring with it a considerable

acceleration of the increase of the level of average real wages, along with a

stepwise decrease in the real wages of individual groups.

You will believe me when I say that I do not make so unusual a proposal

lightly. But some measure of this kind, I believe, is today the only remaining

way out of the increasing rigidity of the wage structure. This rigidity seems to

me not only the major cause of the increasing economic difficulties of coun-

tries like Great Britain. It also drives such countries deeper and deeper into a

planned and thereby still more rigid economic structure by misleading them

into dabbling with the symptoms through “incomes policies” and the like. It

seems that labor can only gain from such a solution, but I realize of course

that trade union officials would lose through it a large part of their power and

would therefore reject it completely.

Discussion

#### TL;DR This is a lecture given by Hayek in 1968. It is one of Hayek’s most important pieces of work that would influence economic policies in the late 20th century. In this lecture, Hayek emphasizes that free markets, through price signals and dynamic adjustments, are more effective at allocating resources and fostering economic growth than central planning and government interventions. The main takeaways: - Competition is valuable because it helps discover unknown information and opportunities. This leads to better economic adjustments and efficient resource allocation. Unlike static models, real competition reveals unpredictable facts that drive progress. - Markets create a dynamic order through the adjustment of individual plans based on price signals. This dynamic process ensures that the economy remains flexible and responsive to changes. - Hayek warns against political efforts to enforce "social justice" through income redistribution and fixed wages, as these can disrupt the competitive process and lead to inefficiencies. The market should function freely to enable diverse individual goals and economic growth. This is Hayek's core idea for this lecture. **According to Hayek competition should be understood as a process that helps uncover information. If competition did not exist some market information and facts would remain undiscovered.** >***"The curious fact that the merits of competition cannot be empirically verified in precisely those cases in which it is of interest is also shared by the discovery procedures of science in general. The advantages of established scientific procedures cannot themselves be scientifically demonstrated; they are recognized only because they have actually provided better results than alternative procedures"*** Competition is important because it helps us uncover and use knowledge spread out among many different people. Competition reveals **unpredictable information**, we can’t always test it in a straightforward way but we can see its positive effects in the real world. Competition seems to be even more important in less developed countries because it helps discover new growth opportunities. Developing countries need competition to experiment with new methods and ideas which can yield significant improvements. Central planning often fails because it hinders the process of discovery and slows down economic growth. **Catallaxy** refers to the spontaneous order brought about by the market. It's different from a centrally planned economy. Hayek argues that the market order does not serve a hierarchy of objectives but rather accommodates diverse individual goals. Hayek discusses the problem of wage rigidity and its negative impact on the economy. When wages are fixed and do not change according to market conditions, it can create significant economic issues. This rigidity prevents wages from adjusting to changes in supply and demand. As a result the labor market cannot respond flexibly to economic changes, leading to inefficiencies and unemployment. Hayek suggests a more flexible wage system is necessary to improve economic performance - ex: linking wages to company profits as a way to make them more adaptable. Equilibrium suggests that everything there is to know is already known. Hayek prefers to use "order" in order to acknowledge that the economy is always evolving and adjusting. Market prices help people coordinate their actions, leading to a more efficient economy. This constant adjustment process is what keeps the economy organized and functioning well. Friedrich A. Hayek was an Austrian-British economist and philosopher best known for his defense of classical liberalism and free-market capitalism. Hayek made important contributions to the fields of macroeconomics, political economy, and the study of complex systems. He was awarded the Nobel Prize in Economic Sciences in 1974 for his work on the theory of money and economic fluctuations. His ideas on the limits of central planning and the benefits of decentralized decision-making significantly influenced the shift towards free-market policies in the late 20th century. Learn more here: [Friedrich A. Hayek](https://mises.org/profile/friedrich-hayek) !["hayek"](https://www.libertarianism.org/sites/libertarianism.org/files/styles/featured_image_md_2x/public/2024-03/Hayek%20Image.jpg?itok=oxq7v3MT) Traditional economic theories often make the mistake of assuming that the quantities of goods are already known and fixed. Hayek argues that this assumption overlooks the crucial role of competition in discovering what goods are actually scarce and valuable. Market prices signal which goods and services are in demand, helping decide what to produce and how to use resources effectively. Competition is not static; it is a dynamic process that constantly changes based on new information and circumstances. Real competition involves continuous discovery and adaptation. This process helps the economy to respond to new opportunities and challenges, making it more efficient and resilient. Hayek highlights how competition works in practice to allocate resources and drive economic progress. In this section Hayek emphasizes that the market should be allowed to function without excessive interference because. The market enables individuals to pursue their goals and adapt to changing circumstances. According to Hayek, policies aimed at achieving social justice lead to inefficiencies and slower economic growth. If we try to control the market too much undermines its ability to function effectively and ultimately harms society as a whole.

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