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Quotation of the Day…

… is from page 159 of volume III (“The Political Order of a Free People,” 1979) of Hayek’s Law, Legislation, and Liberty (footnote deleted):

In particular, in order to explain the economic aspects of large social systems, we have to account for the course of a flowing stream, constantly adapting itself as a whole to changes in circumstances of which each participant can know only a small fraction, and not for a hypothetical state of equilibrium determined by a set of ascertainable data. And the numerical measurements with which the majority of economists are still occupied today may be of interest as historical facts; but for the theoretical explanation of those patterns which restore themselves, the quantitative data are about as significant as it would be for human biology if it concentrated on explaining the different sizes and shapes of such human organs as stomachs and livers of different individuals which happen to appear in the dissecting room very different from, and to resemble only rarely, the standard size or shapes in the textbooks.

DBx: Modern society and a modern economy are not relatively simple phenomena such as are solar systems and chemical compounds. Observation of solar systems and chemical compounds can yield useful knowledge about how the elements of those phenomena hang together and respond both to each other and to outside (“exogenous”) stimulus. Very little such useful knowledge is available by mere observation of a modern economy.

The claim here is not that observation of a modern economy is unnecessary. Instead, the claim is that the amount of theoretical understanding necessary to make sense of empirically observed phenomena is much greater for complex phenomena such as a modern economy than it is for a solar system and other simpler phenomena.

Here’s only one of the many reasons why it is a grave error to attempt to derive knowledge of the economy using the methods that have proven to be so successful in the physical sciences: the facts of the social sciences are themselves much more the result of theoretical decisions than are the facts of the physical sciences. What, for example, is the meaning of the profit rate of the steel industry? A quantitative figure for such a thing can be found and reported with numerals both to the left and right of a decimal point. Such a figure looks scientific and objective. But on what basis do we reach this conclusion? We can all agree that the person who calculated this figure is perfectly unbiased and honest and enormously competent with numbers. But what is profit? The definition of profit is an artifact of human choice. What is the time span over which the rate of this profit is best calculated? Observation of nature doesn’t reveal an answer to this question.

And what is the steel industry? Does it include only domestically headquartered firms that produce steel? Or does it include all firms, regardless of where headquartered, with factories in operation within the domestic economy? Or does it include all steel-producing firms on the face of the earth? And does “the steel industry” include only firms that produce new steel from iron ore? Why not firms that produce new steel from recycled steel? And what’s so special about the steel industry? Why not theorize instead about the metals-producing industry? Or the construction-materials-producing industry? Many more such questions such as these can be asked.

Like it or not, the reality isn’t going away that for the puny human mind to make sense of the enormous complexity of a modern economy mere observation won’t do. The observer must observe with sound theoretical priors. These priors do not come to the human mind as naturally as do the priors necessary for the human mind to make sense out of the observation of, say, the velocity, mass, and circumference of round object A striking stationary round object B (with its own mass and circumference) on a surface with a certain amount of friction.

As ingenious as is the person who describes the physics of billiards, the amount of information that must be known to the observer to make successful predictions of the detailed outcomes of what happens on each ‘shot’ in a game of billiards is minuscule compared to the amount of information that must be known to the observer to make successful predictions of the detailed outcomes of what happens when, say, a new discovery of iron ore is made or when consumer demand for objects made with metals falls.

The economy is indescribably more complex than it seems to the untrained human eye or that it is made to appear by collections of statistics. This lesson is one that Hayek taught throughout his long life – which, having begun on May 8th, 1899, ended 28 years ago today, on March 23rd, 1992.