Coordination Through Prices

1. 1. What If There Were No Prices? Railroad Thought Experiment (video): 
   2. “The Use of Knowledge in Society” (essay): Friedrich Hayek argues that central planning can never be successful because the knowledge needed for economic planning is too vast, dispersed, and ever-changing for any one person or group to know. 
   3. “I, Pencil” (essay): In this essay, referenced in the video, Leonard Reed illustrates how much knowledge is required to produce even the simplest of objects.

Dan Russell: Coordination through prices. The challenge of achieving good use of our resources is the challenge of making use of knowledge that exists only in dispersed form. That is Friedrich Hayek’s message in his essay, The Use of Knowledge in Society. Now, if you’ve read Leonard Read’s classic essay, “I, Pencil,” then you’ve actually come across this concept of dispersed knowledge before, because the knowledge of how to make a pencil is knowledge that couldn’t exist in any human mind. Instead, it’s spread out in little pieces across a vast array of different people. That concept is the focus of Hayek’s essay, as well, and he proposes that dispersed knowledge is the single most important factor in understanding the emergence of human civilization.
The human ability to coordinate our individual plans makes it possible for networks of humans to know how to do things that are impossible for any individual human, or even any committee of humans to know how to do. That is a surprising claim. When something orderly arises from human action, such as the creation of pencils, it seems natural to assume that someone must have planned for that order to arise that way, and that assumption causes us to think that how well we make use of our resources has to depend on how good our central planners are. Hayek’s surprising claim is that paradoxically, creating such efficient orders is something that central planning could never do. The reason why not is that such central planning could be effective only if the knowledge the central planners would require could be made available in a centralized form, but not all knowledge is centralized. Some knowledge is really just fragments of knowledge possessed by lots of different individuals who are all networked together.
If the knowledge required to make efficient use of resources is like that, then creating an economic order, like the coordination of all the activities that go into making a pencil, could never be the job of any central planner. Efficient planning could only be carried out at ground level by lots and lots of local planners, and Hayek argues that that is exactly what the knowledge it takes to create orderly coordination is like. It is not centralized knowledge, it’s dispersed knowledge. Dispersed knowledge is not scientific, it’s not abstract, and it’s not general. Instead, it’s just this person’s knowledge, and that person’s knowledge, of how to adjust constantly, moment by moment, so that they can keep doing their work productively, given the inevitable constant changes in the particular circumstances of time and place.
So, the knowledge that’s actually available to humans for efficient economic planning is knowledge that is available only in localized dispersed form, but if the only knowledge available for economic planning is dispersed knowledge, then how do people ever manage to coordinate with each other to do things like, well, create pencils? This is one of Hayek’s most powerful observations. The thing that enables people to plan how to use resources and to dovetail their plans with each other, and therefor the thing that hold the whole network together, is the price system. The price system is the language in which localized planners send and receive their messages about which resources have what value in what places, and those messages are all they need in order to know how to adjust their plans. Prices are the conduits of information that run between all the nodes and create a network out of people who would otherwise have no idea what to do next.
Hayek describes the coordination of dispersed knowledge as the greatest marvel of human civilization, but it’s also the most likely to be taken for granted, and for that reason, of all the marvels of civilization, it’s probably the least understood.