Hayek, Equilibrium and Complexity

By Paul Ormerod

I have been interested in this for some years, and here is a paper I published on Keynes, Hayek and complexity.

Both Keynes and Hayek retained the concept of equilibrium in their models.  But their theories describe what happens when – which is most of the time – the economy is out of equilibrium, possibly a considerable distance, as happened in the Great Depression of the 1930s.

Complex systems have several key features:

 

  • Emergence
  • Low level of predictability at a point in time
  • Limited cognition of individual agents
  • Multiple possible histories at any point in time

Emergence means that observable properties of a complex system at the aggregate, overall level emerge from the interactions of its constituent parts.  So the theory of any complex system requires a theory of how the individual component parts behave.

Hayek’s major general contribution to social science was to emphasise the limits to knowledge in social and economic systems – the limits to knowledge of all agents, including finance ministries and central banks.

His 1974 Nobel lecture, for example, is entitled ‘The Pretence of Knowledge’.  In it he writes, along with much else, that ‘the social sciences, like much of biology but unlike most fields of the physical sciences, have to deal with structures of essential complexity, i.e. with structures whose characteristic properties can be exhibited only by models made up of relatively large numbers of variables’.

In essence Hayek’s view as to why the business cycle exists is first, that agents have different expectations about the future; and, second (partly in consequence of the first) agents find that outcomes differ from their expectations, and revise their actions as a result.

So in his 1937 article ‘Economics and Knowledge’, for example, Hayek writes that ‘It appears that the concept of equilibrium merely means that the foresight of the different members of the society is in a special sense correct. It must be correct in the sense that every person’s plan is based on the expectation of just those actions of other people which those other people intend to perform and that all these plans are based on the expectation of the same set of external facts, so that under certain conditions nobody will have any reason to change his plans’.

He argued that such individual plans might indeed have to be revised by external shocks.  But, more importantly, the individual plans may not have been, indeed are unlikely to have been, compatible from the outset, so that revisions are inevitable.  This relates to the concept of reflexivity and the inherent inability of agents to co-ordinate their actions and expectations.

It is the interactions between agents, this time in terms of the incompatibility of their individual plans, which brings about the particular macroscopic outcome for the system as a whole – the business cycle and recessions.

Hayek was a true precursor of modern complex systems theory.

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5 Responses to “Hayek, Equilibrium and Complexity”

  1. tom says:

    “It is the interactions between agents, this time in terms of the incompatibility of their individual plans”

    this seems like a strangely individualistic conception of what is happening at a macro level in society for a complex systems advocate? i thought one of the features of a complex system (as you also seem to allude to) – is that the agents in them are interacting with one another? what happens when they interact then – is it simply a case of different plans butting up against one another – which are usually pretty similar because of our/their expectations of the future?

    As you suggest, things/expectations change because of external shocks – perhaps you can define shocks better? Do you mean inanimate shocks, like hurricanes, or the price of gold, or are you also referring to social shocks, i.e. when meaning changes, or understanding? If you are, as I think you are, then what does that tell us about the animated interaction between the agents, or plans??

    I think you are on to something with expectations and intuition, but I’m interested to see where these blogs are heading, what ‘plan’ are you devising?

  2. tom says:

    and I should add – that plans off-course have meaning which has been generated somewhere, so how does that meaning emerge, independently, or how?

  3. David Hales says:

    I think Paul is spot on in pointing out the links between complexity approaches and Hayek’s perspective on economic order. As someone from a computer science background coming to Hayek for the first time I find his ideas clear, provocative and highly relevant to self-organising distributed information systems. The key insight, for me, is that markets are information aggregation and communication mechanisms that allow for autonomous agents to coordinate while sharing very limited information (price signals). Also that these mechanisms emerged – they were not designed – and that other kinds of information aggregation system could exist that would lead to different social structures if we chanced upon those.

    For example, in his 1945 essay “the use of knowledge in society” he states:

    “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 activities to changes of which they may never know more than is reflected in the price movement.”

    And later he states:

    “The price system is just one of those formations which man has learned to use.. after he had stumbled upon it without understanding it. Through it not only a division of labor but also a coordinated utilization of resources based on an equally divided knowledge has become possible. The people who like to deride any suggestion that this may be so usually distort the argument by insinuating that it asserts that by some miracle just that sort of system has spontaneously grown up which is best suited to modern civilization. It is the other way round: man has been able to develop that division of labor on which our civilization is based because he happened to stumble upon a method which made it possible. Had he not done so, he might still have developed some other, altogether different, type of civilization, something like the “state” of the termite ants, or some other altogether unimaginable type. All that we can say is that nobody has yet succeeded in designing an alternative system in which certain features of the existing one can be preserved which are dear even to those who most violently assail it—such as particularly the extent to which the individual can choose his pursuits and consequently freely use his own knowledge and skill.”

    I contend that new information systems supply some of these new mechanisms but that they can co-exist with markets. i.e. the market itself, as an information aggregation mechanism, now has competition. I consider commons based peer production – e.g. such things as wikipeadia or open source projects – as one kind of alternative.

    It seems to me that many of Hayek’s ideas still work when applied to these kinds of non-market approaches – consider modified forms of Catallaxy (which might look a bit like neo-group selection). Hayek was focused on defending the market against central state planning since these were the major options on the table in his time. We now see new options emerging. Options that allow for even higher levels of individual freedom and competition. 21st Century Hayek?

  4. Paul Lewis says:

    People interested in Hayek’s reliance, both in his theoretical psychology and also in his account of social order, on one aspect of complexity, namely emergence, might be interested in the article found here:
    http://www.sciencedirect.com/science/article/pii/S0167268111001144

  5. Unfortunately Hayek, like Keynes, was wrong about equilibrium. There are no possible “special conditions” in which any individual would have “no reason to change their plan”. Such statements are contradictory in nature when you merely reflect on the concept of action. Action means change. Therefore, building further arguments based on this faulty notion and incorrect method cannot render any more useful information.

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