The Invisible Hand or the Heavy Hand? J. Montgomery

John Montgomery The "Invisible Hand" or the Heavy Hand? IT WILL COME as no surprise to read ers of the Freeman that the national debate over inflation, recession and unemployment rests on a more fun damental issue-what kind of economic system will work best for America? Should it be a continua tion of the free-market, capitalistic system which meant unparalleled growth and wealth in the past, or a centrally planned economy directed by government? There is a superficial plausibility to the argument for central plan ning. The public is generally in clined to leave problems of national scope to government and to assume that centralized authority is either desirable or inevitable. Looking on the surface of things, people generMr. Montgomery is a newspaperman and writer on socioeconomic issues who lives in Closter, N.J. ally think no further than the im mediate effects and short-term bene fits of government action. Beset and buffeted by· the workings of the marketplace, they are taken in by the promise of ideal government ac tion to correct the shortcomings of the market, and they forget that government promises often exceed the results.

In contrast, economic thinking shows that there is good reason to believe that government action can be counterproductive. Economic thinking goes beyond the im mediate, visible impact of a policy to foresee the longer-range, secondary effects. And it can recognize the real as opposed to the promised results of a government policy which is based on a misunderstanding of the work ings of the market economy. For example, government711 712 THE FREEMAN December imposed price controls would seem to offer protection against inflation. But powerful economic forces come into play and cause widespread shortages. Then, government must intervene again. Rationing is im posed. The result of that is the rapid growth of black markets. What's more, there is a conflict between successful politics and sound economic policy. Politics can work to serve the interests of power ful pressure groups rather than the general public.

An Invisible Hand Two centuries ago the first great economist, Adam Smith, explained the operation of the free market by saying it was as though there were an invisible hand directing the ef forts of everyone-even though each was pursuing his own gain-in a way that promoted the interests of soci ety as a whole. And that is essen tially what the advocates of a free market are saying today, leaving themselves open to the charge that they are clinging to an archaic no tion which no longer applies in mod ern times. Smith's great work, The Wealth of Nations, came out in the watershed year of 1776. The industrial revolu tion was just under way and it was a time of pervasive regulation of pro duction and trade by the king and Parliament. Smith was arguing for a laissezfaire, hands-off policy by government. But it wasn't that he thought the invisible hand was tug ging on puppet strings to guide each producer, merchant and trader.

Smith believed that economic affairs were self-regulating, that internal order was inherent in the competi tive market process to the extent that it was free of government in tervention. He saw an order which, in the words of his contemporary Scottish philosopher, Adam Fergu son, was the Hresult of human action but not of human design." In the two hundred years since Adam Smith, economics has de veloped in many directions. But for our own time only the economists of the so-called Austrian school, named for the place of its beginnings a century ago, have contributed much to that concept of Smith's. In particular, Friedrich Hayek, Nobel Prize winner and dean of the Aus trian economists of today, has drawn on the work of his great teacher, Ludwig von Mises, to address the idea repeatedly over the past 40 years or more. Mises, Hayek and younger ~~Austrians," mostly in the English-speaking world, have built on Smith's concept in fundamental ways to show how it can apply to the vastly more complex economy of to day.

In attempting to describe some of those ideas here, largely from Hayek's writings, only the essence of the market process will be focused 1978 THE ~~INVISIBLE HAND" OR THE HEAVY HAND? 713 on. Major forces and mechanisms will go unmentioned and the picture will be somewhat abstract and idealized. But if the advocates of central planning can rhapsodize over the economic utopia to be realized if their designs are carried out, then there would appear to be good reason to portray the workings of a truly competitive market econ omy, free of the distortions and con straints imposed in these times of big business, big labor and, most of all, big government. Hayek restates Smith's concept by saying that the coordination of indi vidual efforts in society is the result of an immensely complicated mechanism which exists, works and solves problems but is not the result of deliberate regulation. Or, as he puts it, ~~The spontaneous interplay of the actions of individuals may produce something which is not the deliberate object of their actions but an organism in which every part performs a necessary function for the continuance of the whole, with out any human mind having devised it."l General Rules of Order The ~~ordering forces" in such so cial formations are the general rules for the behavior of individuals in a society. Not that these rules are laid down by the architect of a master plan, or that the rules dictate what each person must do. Rather, the rules are largely negative, prohibi tions against certain forms of be havior. Each person knows what he must not do but is left free to choose what he will do from all the remain ing alternatives. What these com mon rules give rise to are patterns of human behavior, a certain range of actions and an overall order in so ciety.

Such common rules have come down through the ages, passed on in the cultural traditions of human societies, and represent the accumu lated experience of mankind. They have shaped the spontaneous order in human affairs which is now widely recognized in such social in stitutions as language, law, morals, writing and the use of money. In these cases it is no longer argued that they are the work of inventors, legislators or bodies of wise men. 2 In certain ways the idea of central economic planning dates back to Mercantilism, which was dominant in the 17th Century and then went on the decline as capitalism began to take shape. Its economic assump tions were finally put to rout by Adam Smith, but not before Eng land's Mercantilist policies had goaded the American colonies to re volt. Mercantilism held that the purpose of economic life in a nation was to serve and advance national power; accordingly, it was the right of government to control economic affairs. Throughout that period, the 714 THE FREEMAN December trading nations of western Europe were engaged in commercial war fare with each other, in the struggle drawing on the resources of their colonial possessions without regard to the interests of the colonists and native inhabitants. The most in tense international rivalry was in foreign trade, which yielded gold the source of national wealth and power.

In mobilizing its assets and people in the international struggle, each nation tried to promote a forced growth of its domestic economy, par ticularly in the small-scale man ufacturing of the time and the pro duction of goods and commodities for export. Despite the embryonic state of economic knowledge, each nation resorted to a planned economy, which gave rise to an overgrown thicket of regulations, trade re straints, currency manipulation, impoverishing controls over wages and the movement of labor, grants of monopoly privileges, and subsidies to favored industries. The similarity of the extensive intervention in the economy by the modern welfare state in pursuit of its social goals has suggested the name of neo Mercantilism. Utopian Socialism But it is not so much that today's advocates of central planning want a return to Mercantilism. Their sus taining vision came along a bit later, early in the 19th Century. And it was a vision which has had enor mous influence, inspiring genera tions of social scientists, writers and intellectuals to this day. Its patron saint was an impoverished French nobleman, the Comte de Saint Si mon. His followers and successors generated the major part of what came to be known as Utopian socialism. Observing the great ac complishments of the physical sci ences in 18th Century France, they sought to develop a social science of society in which everyone in it would be directed by an elite group of philosophers and scientists using their know ledge for the common good.

Then, not long after and building at least in part on their ideas, came Marx and Engels who foresaw the downfall of capitalism in the revolt of the workers of the world to take over the means of production from the capitalists who had exploited their labor. But Marx was far from a mere social visionary. Starting with certain flaws in the classical eco nomics of the time, he built his own system which continues· to exert a powerful influence on many economists. This influence can be seen in the insistence by many that cen tral planning is necessary to compensate for «inherent" and (structural" weaknesses in the capi talistic system. There are other reasons for the 1978 THE ((INVISIBLE HAND" OR THE HEAVY HAND? 715 continuing resistance to the idea of a self-regulating economy. For one thing, it took a long time for man to concede that any system with order, function and apparent purpose was not of human design; the belief in central planning may be the last vestige of that reluctance. But, most important for politics and policy to day, Keynesian economic theory which has been so dominant since the Thirties plus the development of mathematical models and statis tical data which can be fed into a computer seem to offer ways that the economy can be managed.

Too Complex for Planners Ina recent article, Hayek re sponded to that idea by saying that ((the very complexity which the structure of modern economic sys tems has assumed provides the strongest argument against central planning. It is becoming progres sively less and less imaginable that anyone mind or planning authority could picture or survey the millions of connections between the ever more numerous interlocking sepa rate activities which have become indispensable for the efficient use of modern technology and even the maintenance of the standard of life Western man has achieved."3 But, then, if central planning cannot cope with such complexity, how would the free market do any better? It would, of course, have to serve such basic economic functions as the allocation of resources, the organization of production, and the distribution of goods and services. But these things cannot occur in a vacuum. Information is required: about the availability of resources, about how production is progressing and whether adjustments are called for, and about what goods and ser vices people want, and how much, of each.

The crux of the matter, as Hayek puts it, is that the necessary knowl edge and information does not exist in concentrated or integrated form but solely as dispersed bits of in complete and frequently contradic tory know ledge possessed by differ ent individuals throughout the economic system. Market Pricing So, how is this dispersed informa tion to be conveyed to the decision makers, who are also scattered about the system? And how are the decision makers to know what in formation of potential use to them is out there somewhere, beyond their purview but available for the ask ing? In this connection, Hayek has another observation: knowledge comes in two kinds. First, there is the scientific knowledge vital to an advanced technological society. That knowledge would be easily commanded by the experts, and 716 THE FREEMAN December would even be manageable by the central planners. But then there is the second kind, that important but unorganized knowledge which has to do with the particular circum stances of time and place. Of this latter kind, nearly every participant in the market system possesses knowledge which is unique to his job and location. And, in view of this expertise, who better should make the decisions that that knowledge mandates?

To illustrate the difference be tween these two kinds of informa tion, Hayek points out how much there is to learn on a new job even after completion of scientific or technical schooling, and how impor tant to any job is the knowledge of the people involved, of local condi tions and special circumstances. Response to Change And then there is the problem of change. The market must respond with dispatch to change which can occur anywhere in the economic sys tem: a transportation tie-up in and out of Chicago, a craze for sky blue jeans on the East Coast, and so on. Again, decisions are required where the change has occurred and where the knowledge of possible responses is to be found. It is the man on the spot who must decide and take action. But he needs to know more than the facts of his immediate surroundings. He must know something of the big picture, what is going on out there in the rest of the economic system-so that he can dovetail with the other decision makers and fit in with the workings of the whole system. 4 If there were no change, at least one of the insoluble problems con fronting the central planners would be done away with. They could draw up long-range plans with precise and detailed instructions for the un derlings throughout the system to carry out. There would be no need for adjustment to unforeseen events, for adjustments to eventualities which had not entered into their calculations. But, among other things, there would still be the prac tical impossiblityof obtaining and distilling the enormous quantity of information reflecting local condi tions in all the interacting sectors of the economy.

Returning to the market economy, it is not enough that know ledge and the ability to act on it be dispersed throughout the economic system. A mechanism for communicating that knowledge is needed. And there is such a mechanism: the price system. Prices are a numerical index which determines the value of each thing considered for purchase rela tive to all other things available to each potential buyer, whether pro ducer, consumer or middleman. Thus he can rank the urgency of his needs as a basis for his decisions 1978 THE ((INVISIBLE HAND" OR THE HEAVY HAND? 717 without being overwhelmed by all of the information which might con ceivably be brought to bear on his choices. Price fluctuations reflect change wherever it has occurred in the market system. The numerical index of prices communicates suf ficient information in condensed and distilled form for the market as a whole to be coordinated.

Guidelines to Follow Hayek illustrates how the price system works as follows: ((Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply has been eliminated. It does not matter for our purpose-and it is significant that it does not matter-which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more prof itably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the result will rapidly spread throughout the whole economic system. This influences not only all the uses of tin but also those of its substitutes and the sub stitutes of these substitutes, and so on. . . . The whole acts as one mar ket, not because any of its members surveys the whole field, but because their limited individual fields of vi sion sufficiently overlap so that through many intermediaries the relevant information is communi cated to all. The mere fact that there is one price for any commodity-or rather that local prices are con nected in a manner determined by the cost of transport, etc.-brings about the solution. . . .

((We must look at the price system as .such a mechanism for com municating information. . . . The most significant fact about this sys tem is the economy of know ledge with which it operates, or how little the individual participants need to know in order to take the right ac tion. In abbreviated form, by a kind of symbol, only the most essential information is passed on, and this is passed on only to those concerned. It is more than a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their acti vities to changes of which they may never 718 THE FREEMAN December know more than their reflection in the price movement. ~~ ... The marvel is that in a case like that of a scarcity of one raw material, without an order being is sued, without more than a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more spar ingly; that is, they move in the right direction. . . ."5 The Entrepreneur's Role Austrian economist Israel Kirz ner, citing the work of Mises, fills in another part of the picture of the market process. He describes three types of market participants: con sumers, entrepreneur-producers and the providers of productive re sources, including labor. Again, the key to the process is information, with the market participants start ing out in ignorance of each other's intentions and thus unable to join in exchanges as buyers and sellers.

Prices estimated and offered are far apart but move closer together as the market process goes on. From the information derived in the pro cess about each other's expectations, the market participants change plans and set new courses. The entrepreneur is the driving force in the process. It is he who is on the alert for places in the economy where conditions for exchange exist and who seeks profit in the creation of new business, new production methods and new products. And in his activities he conveys informa tion in the form of successive price offers and estimates, nudging the plans of the market participants into closer and closer alignment until an exchange is achieved. In so doing, he exploits and creates change in the discovery of new re source sources, new technical oppor tunities and new consumer tastes and preferences. And he exploits such possi bili ties by changing prices, product specifications and selling effort. Impelled by the goad of competition, he seeks to close a deal, secure a resource or penetrate a market sector before his rivals.

The result is growth in business activity, in income and employment, and in the supply of new goods and services. 6 StUltifying Bureaucracy There is no place in the centrally planned economy for the entrepre neur in search of profit. Bureaucrats are after job security and power in the hierarchy. The search for profits is risky and the bureaucrat must play it safe. Besides, he knows the profits are not for him to keep. Thus, another signal required by the self regulating economy, profit as indi cator of the viability of a business enterprise and guide to the use of resources, is forgone.