Modern Economics As a Flight from Reality
||books + ideas + provocations
BY PETER J. BOETTKE
discuss this article
AS STUDENTS PROGRESS BEYOND ECONOMICS 101, THEY
find themselves ascending to the ever more rarefied
world of formal mathematical models, where theory has
only a tenuous relationship to reality. In the clear-cut
equations of economic theory, the flaws of everyday life – such as ignorance and uncertainty – disappear.
Although they are famously quarrelsome, modern
economists all reach their widely varying conclusions
through the same process: building abstract models on
Of course, to reject economic theory because it is
too abstract would be inimical to satisfactory economics.
We have no choice but to think in terms of models
and simplifying assumptions. Otherwise, the world
would be too complex to understand. However, some
theories are better than others, because even though
they’re abstract, they’re relatively realistic.
Too much concreteness drowns analysis in the sea
of detail that economists are trying to distill. But too
little realism is unscientific; and for all its mathematical
precision, it is in this unscientific direction, untethered
to reality, that economics has gone.
If theoretical coherence alone were all that mattered,
then the main constraint on theoretical exercises
would be the human imagination. Interesting puzzles
would replace pragmatic solutions to problems encountered
in actual economies. Arguably, that is an accurate
characterization of most contemporary economic theory.
In classrooms and academic journals, the false precision
of economic formalism has obscured the messy
nature of the real world, where individuals cannot simply
assume away issues like the passage of time, the limits of
our knowledge, and the uncertainty of the future.
I. WHERE ECONOMICS WENT WRONG
On March 1, 1933, Austrian émigré F. A. Hayek delivered
his inaugural lecture at the London School of
Economics and Political Science. For reasons I will try
to make clear, Hayek was a convinced free marketeer.
So his lecture warned against the popular trend toward
economic interventionism that had been touched off
by the Great Depression. Laissez faire, critics argued,
was both unjust and chaotic. Business cycles were
seen as manifestations of the inherent contradictions
of capitalism. This message possessed a very practical
appeal during the crisis, and Hayek warned that public
ignorance of basic economic principles might prompt
disastrous legislative responses.
But like other members of the Austrian school
of economics, Hayek was about to be blindsided by
the direction from which interventionist tendencies
would come: not only from the public and its political
tribunes, but from the very heart of the academic economic
tradition of which the Austrians formed one of
the main branches.
Hayek would spend the rest of his long life criticizing
the unrealistic assumptions that separated the new,
interventionist economists from him and his Austrian
colleagues. But at first, he was taken by surprise. It was
only in retrospect that he came to see that, even in 1933,
Austrian economists were different from the neoclassical
Austrians emphasized the role of knowledge and
ignorance, time and uncertainty, change and disequilibrium
in economic processes. Non-Austrian economists
recognized the existence of such factors as time and
ignorance, but soft-pedalled them as market “imperfections.”
This innocent shift of emphasis grew into
the neoclassical interventionism that caught Hayek
unawares. If, as non-Austrians came to see it, the market
allowed imperfections, then perhaps the market should
be regulated, or replaced.
In the 1930s, the socialist economist Oskar Lange
even used neoclassical equilibrium analysis to demonstrate
that a planned economy could be as efficient
as a market economy — if one assumed that perfect
knowledge was available to the central planners. For
in that case, the planners could calculate the prices of
alternative uses of resources just as the competitive
market supposedly does. Socialist planners could draw
on knowledge of supply and demand conditions just like
economic agents do in the neoclassical, perfectly competitive
model. If the orthodox neoclassical model was
theoretically coherent, then Lange’s model of market
socialism was equally coherent.
In response to Lange’s arguments, both Hayek and
his mentor, Ludwig von Mises, started to articulate
more clearly and precisely the differences between
Austrian economics and the neoclassical orthodoxy.
But by this time they were already too far outside of
the mainstream to command its attention. Mises and
Hayek came increasingly to be viewed as politically
motivated pundits of the right, not as serious economists.
By 1950 at the latest, the Austrian school of economics
was marginalized — to the extent that it became
questionable whether it should be considered part of
the discipline of economics any more.
II. THE FORMALIST REVOLUTION
In the eyes of professional economists, Austrian economics
was soundly defeated by both neoclassical
socialism like Lange’s, and by neoclassical macroeconomics
like that of John Maynard Keynes. Whereas
Keynesianism challenged the ability of capitalism to
avoid catastrophes like the Depression, neoclassical
socialism challenged capitalism’s efficiency at producing
goods and services even under the best of conditions.
Either way, markets were deficient, and government
correctives seemed to be called for.
What made mainstream economics receptive to
these arguments was that it paid only lip service to ignorance,
uncertainty, the passage of time, and changes in
economic conditions. Meanwhile, Austrians continued
to reject government interventionism because, if one
does take these factors seriously, interventionism premised
upon perfect knowledge in a timeless, changeless
equilibrium seems utterly fantastic, hence irrelevant.
In 1947, the gap between the Austrians and the
mainstream of neoclassical economics was widened
by the publication of Paul Samuelson’s Foundations of
Economic Analysis. Samuelson pioneered a synthesis
of neoclassical and Keynesian economics, as well as
endorsing the neoclassical argument for market socialism.
Samuelson also furthered the neoclassical case
against the free market in the 1950s, with his development
of the theory of market failure.
Samuelson’s tremendous influence can be explained
on two levels. First, economists suffer from physics
envy. Samuelson’s mathematization of economics promised
to complete the transformation of economics into
social physics. Second, Samuelson was not only smart,
but strategic. Shortly after his Foundations of Economic
Analysis became the major textbook in graduate education,
his Economics became the leading undergraduate
text. Samuelson influenced students on their way in and
on their way out.
Within a decade, Samuelson became synonymous
with economics, and his hold over the style — if no
longer the substance — of economic reasoning has not
Before Samuelson came along, the model of a
perfectly competitive market was primarily used in
thought experiments that were supposed to present
contrasts to the real world of actual market institutions.
Such counterfactual thought experiments illuminated
the positive function of those institutions.
For example, why do we need profits? In a world
of perfect information, profits would not exist, since
producers would know exactly what consumers would be
willing to pay for their products, and any producer who
charged more than that amount, in order to make a profit,
would be put out of business by a producer who charged
a little bit less. Given an endless supply of perfectly
informed producers, they will compete prices down to
the cost of production, leaving no room for any of them
to keep any income for herself as profit. This is “perfect
competition.” When perfect competition prevails across
the economy, an equilibrium is reached from which any
change would represent harm to the consumer.
The contrast between this imaginary world and
the real world, in which competition and profit coexist,
suggests that profits may have some functional
significance in coping with imperfect knowledge and
The functional significance is this: profits guide
producers toward the areas of unmet consumer demand.
If one producer is making huge profits by selling people
product X, then other producers, lured by the prospect
of taking some of those profits for themselves, may
be induced to start the process of competition that
would — given enough time — eventually bid the price
down to the cost of production, leaving zero profit. But
the zero profit point is rarely reached in a world in which,
as time passes, circumstances change. Moreover, the first
producer of product X would not have made a profit to
begin with unless, beforehand, other potential producers
of X had been ignorant of consumer demand for it.
The counterfactual of a perfectly competitive, perfectly
informed, zero-profits world therefore suggests
that profits are not a useless burden on consumers, one
that can be taxed or regulated away without harmful consequences.
In the factual world of imperfect information
about consumer demand, profits stimulate and guide the
competitive process that meets people’s needs.
On the other hand, once profit opportunities are
established, competition to seize them can be vicious.
Far from holding consumers in a viselike grip, profit-seeking
corporations are in a ceaseless race against real
and potential competitors to meet consumer demand
before it shifts from product X to some new entrepreneur’s
invention, product Y.
As counterintuitive as it seems, the corporation
is at the mercy of the consumer, not the other way
around. And the result of what might first seem like the
parasitic profits of the corporation is what we in the
real world of capitalism take for granted every day: that
the stores are full of things that people want to buy.
This use of perfect competition in thought experiments
that, like laboratory experiments, isolate important
aspects of a complex reality was reversed by the
formalist revolution that Samuelson pioneered. To
him, departures of reality from the model of perfect
competition highlighted the need for politics to set
things straight. Formal models of perfectly competitive
equilibrium have represented the hard core of the mainstream
economics research program ever since.
This formalist revolution has led economists to
focus on building theoretical models, for one of two
reasons: either to vindicate the market economy when
it approximates the model, justifying laissez faire; or to
vilify the market when it deviates from the model, justifying
government intervention. Both types of formalism
are utopian. Either capitalism is idealized, so that
it approximates the model; or capitalism is demonized,
and utopian properties are attributed to political processes
intended to make reality match the model.
Absent from both types of formalism is the recognition
of any possibility but all or nothing. Either the
real world exemplifies perfect equilibrium, or it could
not even approach that condition without a push from
To see how much idealization is required to reach
laissez-faire conclusions using such models, consider the
requirements of perfectly competitive equilibrium: not
only perfect information, but an infinite number of buyers
and sellers, and the costless mobility of resources.
These constraints require each market participant to treat
prices as given, because prices equal the cost of production
— with no profit left over. But with no profit, there is
no incentive for anyone to do the things that would push
the market in this optimal direction, and no guidance, in
any case, as to where that optimum might lie.
The new role played by competitive equilibrium
models was fostered by Samuelson’s methodological
innovations. Samuelson sought to eliminate the vague
assumptions that underlay debates among the “literary
economists” of previous generations. Restating
economics in the axiomatic language of mathematics,
Samuelson argued, would force economists to make
explicit what they had previously thought only implicitly.
But the techniques of mathematics available to
Samuelson required well-behaved and linear functions;
otherwise, results would be indeterminate and the
promised precision would not be achieved. In order to
fit economic behavior into mathematical language, the
real world had to be deprived of its complexity. The
problem situation of economic actors had to be simplified
drastically so as to yield the precise formulations
that Samuelson sought.
Samuelson drained economic theory of institutional
context and historical detail. Parsimony won out
over thoroughness. Economics moved from one side
of the cultural divide (the liberal arts) to the other side
(the sciences) — or at least that was the self-image of
economists, who equated science more with precision
than with accuracy.
The physicist does not let the impossibility of making
accurate predictions in many real-world contexts,
such as meteorology, interfere with her pursuit of the
precise formal laws that interact, with unfathomable
complexity, in a real-world thunderstorm. Because of
the complexities of real-world interaction, it would take
a foolish physicist to say that we can abolish imprecise
meteorology and use physics to forecast the weather.
III. GIVING LAISSEZ FAIRE A BAD NAME
Almost simultaneously with Samuelson’s use of equilibrium
as a harsh indictment of reality, University of
Chicago economists such as Milton Friedman, George
Stigler, Gary Becker, and Robert Lucas began to use it
as a laudatory description of reality. In their view, real
markets come breathtakingly close to approximating
the efficiency properties of general competitive equilibrium.
And even if a real-world market deviates from the
ideal, the predictions of the model approximate behavior
in the real world better than alternative models do.
Real-world markets, in other words, act “as if” they are
in competitive equilibrium.
By collapsing the gap between the perfectionist
model and reality, the Chicago school in its purest form
does away with the need for intervention of the sort
advocated by Samuelson et al. Hence the current reputation
of laissez faire as a wildly unrealistic economist’s
dogma. In comparison with the implausible assumptions
of Chicago-school laissez faire, government regulation
has come to be seen as hard-headed realism. But
in fact, neoclassical interventionists couple a dystopian
misunderstanding of market institutions with a utopian
faith in government to improve on such institutions.
The contest between the Chicago school and its
interventionist enemies poses a Hobson’s choice. The
Chicago school’s use of equilibrium to describe reality
conflates the mental and empirical worlds. By contrast,
those who use equilibrium models to indict capitalist
realities at least recognize that reality isn’t perfect. But
they neglect the ways imperfect market institutions
approach competitive ideals, so they have an unduly
pessimistic view of capitalism — even while they are
wildly optimistic about the ability of politics to bring
reality up to par.
By ignoring the dynamics of disequilibrium, both
traditions obscure the possibility that real-world market
institutions may set in motion dynamic processes that
help economic agents cope with the human condition:
pervasive ignorance, the irreversibility of time, and the
inevitability of change.
The Chicagoans’ endorsement of markets raises
false hopes that are bound to be dashed. The Chicago
school lacks a theory explaining how markets achieve
whatever degree of success they do; all the important
work, as critics never tire of pointing out, is done
by their model’s perfect-knowledge, perfect-competition
assumptions. If the Chicagoans could explain
something as simple as the dynamic by which profits
inspire and guide competition, they could teach their
interventionist colleagues that market “imperfections”
may actually serve to alleviate scarcity in the real world.
But Chicagoans can’t do so, because they adhere to the
same static assumptions that interventionists use. This
gives them the weaker position in the debate with interventionists,
since members of the observing audience
are bound to notice that the world isn’t perfect. If politicians
can devise interventions that merely promise to
solve problems the existence of which Chicagoans deny
as impossible, then just establishing the existence of
those problems will seem to license intervention, and
the Chicago school will be doctrinaire in opposing it.
IV. HAYEK AS A BRIDGE TO REALITY
Pondering the unexpected use of perfectionist formal
models to justify intervention in markets, Hayek was
moved to produce his seminal contributions to economic
theory: “Economics and Knowledge” (1937) and
“The Use of Knowledge in Society” (1945).
In these essays, Hayek suggested that the central
concern of economics is to explain “how the spontaneous
interaction of a number of people, each possessing
only bits of knowledge, brings about a state of affairs
in which prices correspond to costs, etc., and which
could be brought about by deliberate direction only by
somebody who possessed the combined knowledge of
all those individuals.”
Economic theory, in other words, should explain
For instance, the empirical observation that prices
tend to correspond to costs is the starting point
of economic science. But Hayek notes that formal
neoclassical theory is static, so it cannot discern the
dynamic process by which prices allow diffuse cost
information to be processed and used by imperfect economic
actors — for instance, in their pursuit of profit.
Thus, to explain the correspondence of prices and
costs, formal theory falls “back on the assumption that
everybody knows everything,” and so evades “any real
solution of the problem” of how it is that prices tend to
be competed down to costs.
Likewise, the economic problem, as stated by
Hayek, was not the one posed by standard welfare
economics, namely the allocation of scarce resources
among competing ends. This way of stating the
problem — which leads the neoclassical mainstream to
regard general equilibrium as a solution — “habitually
disregards” essential elements of the phenomena under
investigation, according to Hayek, by ignoring “the
unavoidable imperfection of man’s knowledge and the
consequent need for a process by which knowledge is
constantly communicated and acquired.” To be able to
allocate scarce resources among competing ends, we
would have to know how scarce they were, how dire
were the competing demands, and how best to combine
the available resources to meet the demands. But
real-world economic actors know none of these things
beforehand; they are constantly in the process of learning
them, and the question is how they go about it.
V. FROM STIGLER TO STIGLITZ:
A BRIDGE TO NOWHERE
To answer such questions about market dynamics,
which can be addressed by counterfactual thought
experiments but are inexpressible in the language of
mathematics, the orthodox model’s assumptions would
have to be relaxed. But then it would get overly complex
and lose its formal elegance.
This dilemma has dogged a significant strand within
orthodox economic thought that, since about 1960,
has tried to take up Hayek’s challenge and examine the
informational aspect of markets. This research program
attempts to grapple with the main feature of economic
reality that, in the Austrian view, is obscured by economic
formalism: incomplete knowledge. But because the
new economics of information is itself formalist in its
use of equilibrium models, it has been fated to oscillate
between utopianism about the informational properties
of real markets and utopianism about the alternatives.
Classical economists of the early and middle nineteenth
centuries had focused exclusively upon how
prices provided the incentive to purchase more or less of
a particular good. The new economists of information
recognize that prices serve a communicative function
as well. They see that prices transmit vital knowledge
about (for instance) relative scarcities.
Chicago’s George Stigler is usually credited with
being the first economist to develop an informational
model consistent with standard neoclassical price theory.
Stigler argued that individuals will search for the
information necessary to accomplish their goals in the
market, but unlike Hayek, he assumed that they will do
so in an optimal manner, by comparing the marginal
cost of information with the marginal benefit of continuing
to search for it.
In other words, Stigler joined the informational
content of markets with the assumption that equilibrium
models should be seen as describing actual behavior.
In Stigler’s view, there was economic ignorance in
the real world, but it was the optimal level of ignorance.
The attempt to eliminate the remaining ignorance
would entail searches for information that were more
costly than the benefits they could produce. Following
Stigler, Chicago-school economists such as Armen
Alchian and Jack Hirshleifer developed information-search
models in which various aspects of the economic
system such as advertising, middlemen, unemployment,
queues, and rationing take on a new meaning and functional
At the same time, economists who treated equilibrium
as a critical norm rather than a reality, such
as Kenneth Arrow, Leonid Hurwicz, and Roy Radner,
also sought to develop models that accounted for
informational imperfections. Where Stigler’s approach
extended the assumption of maximizing behavior to the
information-search process, predicting that markets
would see various practices emerge to economize on the
search process and generate an optimal flow of information,
the Arrow/Hurwicz/Radner approach argued
that in the face of incomplete information, maximizing
agents would be unable to coordinate their behavior
with others in an optimal manner unless an appropriate
mechanism could be designed anterior to the market.
The first approach presupposed the efficiency of
market allocations. The second presupposed their
inefficiency and the prevalence of market failure. Neither
approach adequately dealt with the components of
market processes that help economic actors adjust to
and learn from real-world disequilibrium.
Among contemporary economists, Joseph Stiglitz
and Sanford Grossman have elaborated the second
approach more systematically than anyone else. Their
research on the informational role of prices has led
to a fundamental recasting of many basic questions in
orthodox economic theory.
Grossman and Stiglitz understand Hayek to be
arguing that prices are “sufficient statistics” for economic
coordination, and they conclude that this argument
is flawed. In situations where privately held
information is important, they contend, market prices
will be informationally inefficient, for the market will
not provide the appropriate incentives for information
acquisition; because of “information asymmetries,” the
case for economic decentralization is not as strong as
Grossman and Stiglitz’s reasoning, however, begs
the question against Hayek by starting from the unrealistic
assumption of rational-expectations equilibrium.
(Rational-expectations theory is another development
of neoclassical orthodoxy, this time from the Chicago
direction, which I criticize in the longer version of
this article. Given this
assumption, they maintain, prices will reveal information
so efficiently that no one could gain from the revelation
of privately held information. Individual agents
can simply look at prices and obtain free what would be
costly to acquire privately. This free riding leads to an
underproduction of information by the market. Prices,
as a result, will necessarily fail to reflect all the available
information. Grossman states the supposed paradox as
“In an economy with complete markets,
the price system does act in such a way that
individuals, observing only prices, and acting
in self interest, generate allocations which are
efficient. However, such economies need not
be stable because prices are revealing so much
information that incentives for the collection
of information are removed. The price system
can be maintained only when it is noisy enough
so that traders who collect information can
hide that information from other traders.”
This paradox does challenge Stigler’s (Chicago)
model of information searching. But Grossman and
Stiglitz’s analysis translates Hayek’s view of dispersed
knowledge into the language of formal information
theory. This leaves out questions of the context and the
tacit dimension of knowledge.
In reality, Hayek argued, the kind of “knowledge”
that is dispersed among market participants is “knowledge
of the kind which by its nature cannot enter into
statistics.” The determinants of market prices are not
the sort of data that can be treated as a commodity.
It is not, therefore, the costliness of information that
is essential to Hayek’s story, but rather its dispersal.
Its dispersal makes economic knowledge inaccessible
except under special, institutionally fragile circumstances.
The relevant economic knowledge, as Hayek
put it, is knowledge of “particular time and place.” It can
be used and discovered only in particular institutional
contexts — contexts that are abstracted away in the
timeless, placeless formalism of equilibrium modeling.
The fundamental purpose of economic analysis,
according to Hayek, is to determine how a dynamic
system of production uses dispersed knowledge in a
manner that aligns production plans with consumption
demands. The price system, an unintentional outgrowth
of an institutional environment of well-defined private
property rights, serves this aligning function in at least
First, ex ante, prices transmit knowledge about the
relative scarcities of goods to various market participants
so they may adjust their behavior accordingly. If
the price of a good goes up because it has become more
scarce, the effect is to impel consumers to economize in
Second, the price system serves the ex post function
of revealing the ultimate profitability or unprofitability
of economic actions. Prescient entrepreneurship is
rewarded with profits; errors are penalized by losses.
Market prices, therefore, not only guide future decisions
by conveying information about changing market
conditions, but also help market participants evaluate
the appropriateness of past market decisions and correct
Seen in this light, the market process is a matter
of dynamic adjustment. What is it an adjustment to?
It is, in effect, an adjustment to the gaps between a
static equilibrium of universal satisfaction and the many
departures from this model that are present in the real
world. Each of these gaps between the counterfactual
and the factual represent a profit opportunity.
While the assumption of perfect knowledge was
essential for modeling the state of competitive equilibrium,
it precluded an examination of the path by which
adjustment toward equilibrium could be achieved. If
the system were not already in equilibrium, one could
not explain how it would get there. Omniscience logically
results in non-action.
A profit opportunity that is known to all can be
realized by none. The knowledge that economic agents
rely on to make decisions is not universal and abstract,
as it must be if it is to be replicated through either
bureaucratic planning or political deliberation. Nor is
it magically revealed to market participants through
prices, the import of which must, after all, be interpreted,
based on the context and the tacit knowledge of the
interpreter. It can be interpreted in different ways by
different entrepreneurs, drawing on different contexts
The essence of the price system lies not in its ability
to convey perfectly correct and transparently clear
information about resource scarcity and technological
possibilities, but in “its ability to communicate information
about its own faulty information-communication
properties,” in the paradoxical words of Israel M. Kirzner.
Disequilibrium prices, imperfect as they are, nevertheless
provide some guidance in error correction and avoidance,
when interpreted correctly. Entrepreneurs who interpret
them correctly will tend to profit; those who don’t will
tend to go bankrupt. The entire process of entrepreneurial
error detection and correction, however, is absent
from Stiglerian and Stiglitzian formal models of economic
“information,” premised on static equilibrium.
VI. REPLACING SCIENTISM WITH SCIENCE
Much economic information is “private” and is held
“asymmetrically.” But that doesn’t stop market prices from
using this information effectively — albeit not perfectly.
Entrepreneurs act on their competing interpretations
of the “meaning” of market prices, which come
from the entrepreneurs’ private perceptions of prices in
the context of their local “time and place.” The resulting
interpretations of how to make a profit don’t need to be
explicit or self-aware, and they probably can’t be — any
more than literary or historical interpretations can be
reduced to articulate formulae that precisely state every
tacit assumption. The dynamics of profit and loss select
among entrepreneurs’ competing “interpretations” not
by rigorously debating them, but by subjecting to an
acid test the actions to which the interpretations lead.
By making a profit, an entrepreneur whose actions benefit
consumers is rewarded, ex post. By incurring a loss,
an entrepreneur who produces things consumers don’t
want is penalized, and his underlying, tacit interpretation
of what prices “mean” is falsified.
The fact that there are losses means that contrary to
Stigler, the right level of “information” — or, rather, the
perfect overall interpretation of the available information
— has not been achieved. But the effect of profits
and losses is nonetheless to push markets in consumer-satisfying
directions. Contrary to Stiglitz, the “informational”
function of prices isn’t to create an accurate
synoptic picture of where resources should be “allocated.”
In order to be effective, such a picture would have
to be accessible to some imagined “public” — whether
that public consists of fully informed market participants;
or fully informed voters, legislators, or bureaucrats,
acting through politics to correct deviations from
the ideal allocation. Real-world market prices induce
entrepreneurs to serve consumers despite the asymmetry
of their information and the subjectivity of it. Trial
by fire replaces conscious thought.
By conferring profits and losses, consumers unconsciously
reward the effective use of privately held
information without anyone having to articulate it.
There is no analogue in markets to the political need for
transparent deliberation. The error in formal economic
modeling is to depict markets as if they are — or should
be — an arena of clear reasoning about good data: perfect
knowledge of all the necessary information. The
reality of imperfect markets is that they work even
when they don’t draw on information that is articulate
enough to enlighten actors in the public sphere about
how to correct “market failures.”
When one grasps the effectiveness of imperfect
market processes in helping fallible economic actors
discover how to meet changing needs, one will probably
start questioning the ability of fallible political
actors to duplicate these achievements. Where is there
an analogue, in politics, to the price system? — some
method of testing regulators’ interpretations of how
to meet unmet needs, without requiring well-informed
abstract theorizing about a complicated world that is
rich with surprising detail? When one interpretation is
imposed on everyone through public policy, the scope
for inarticulate local innovation enabled by markets is
dramatically reduced; and testing the effects of innovation
becomes a purely intellectual exercise, one that
demands absurdly competent synoptic powers from
imperfect people. The “marketplaces” of ideas and of
electoral competition are no substitute for real markets.
It is democracy, not capitalism, that needs an unrealistic
level of “information” if it is to work well.
Economists’ oscillation between perfect-market
theory and market-failure theory, both of which take as
the terms of debate the formal model of general competitive
equilibrium, will inevitably be won by theorists
of market failure. It is obvious that the economic world
is not perfectly competitive (or even near that state of
affairs). Hence the triumph of the interventionism that
Hayek forecast in 1933 — not, as he feared at the time,
because economic theory had been rejected, but, as he
came to realize later, because it had been misconceived.
To address Hayek’s argument seriously, economists
would have to drop the false precision of equilibrium
models and engage in careful reasoning about imprecise
phenomena, such as the passage of time, the limits of
our knowledge, the uncertainty of the future, and the
discovery of opportunities. Perhaps Hayek’s argument
cannot be sustained when confronted in this manner,
but we will not know this until eight decades’ worth
of formalization is abandoned, and the realities of
economic life amoung fallible, ignorant people are reengaged.
discuss this article
Peter J. Boettke is a professor of economics at George Mason University. A longer version of this article originally appeared in Critical Review, vol. 11, no. 1.