The 1975 Nobel Memorial Prize in Economics; I. Kirzner

Now •concern with the "optimal allocation of resources" has been proclaimed in c'Ountless economic'S classrooms, and in innumerable economics textbooks, to he the Dr. Kirzner is professor of economics at New York University. He is the author of numerous articles and books, the latter including The Economic Point of View, Market Theory and the Price System, and, most recently, Compe tition and Entrepreneurship. 206 very essence of economics. Ever since Lionel (now Lord) Robbins in 1932 defined economic science in terms revolving around men's allocative decisions, economists have seen efficiency in resource allocation as central to their dis cipline. It might seem then that Professors Kantorovich and Koop mans have won their Nobel prize for contributions going to the very heart of their science. Nonetheless, it is necessary to point out that, paradoxical though it may seem, in a very important sense the 1975 Nobel Prize in Economics was awarded for work having only peripheral relevance to the central contributions of economic science.

What is of even ,greater concern, the interpretation placed by the Swedish Royal Academy on the contributions of the prize-winning 1976 THE 1975 NOBEL PRIZE IN ECONOMICS 207 scholars seems to involve implicit denial (if· not outright ignorance ) of these central contributions of economic science. These may seem surprising· assertions; the follow ing pages will attempt to provide the· necessary elucidation. It is to be hoped that, in point ing out these puzzling and dis turbing circum·stances, the writer will not be understood as seeking in any way to detract from the outstanding merit of the eminent men honored in Stockholm. Both of the laureates are brilliant schol ars and dedicated scientists; the quality of their work undoubtedly meets the very· highest standards of scientific excellence. Nonethe less, recognition of all this cannot absolve us from recognizing, at the same time, that unfortunate misunderstanding of the nature of the central problems of eco nomic science, which appears to surround the 1975 prize.

The matter might be stated briefly, hut far too superficially, in terms of a comment on the role of mathematics in economics. What both laureates -each of whom be gan his acad·emic career strictly as a mathematician l - have de voted their lives to, it mi.ght be 1 In fact Koopmans' footnote citation of Kantorovich's work refers to him as "the Russian mathematician", (T. J. Koopmans, Three Essays on The State of Economic Science, McGraw-Hill, 1957, p. 68n.) argued, is not, properly speaking, eoonomics at all, but rather a spe cial genre of applied mathematics. And, while questions of nomen clature might seem to be of only secondary importance, it in fact appears that, in the misunder standing of the character and sig nificance of these mathematical contributions, there lies embedded not merely semantic confusion, but also substantive unconcern with profoundly economic insights which have (at least up to the present) not proven amenable to mathematical formulation. This statement of the matter, however, while correct in itself, touches only on the surface of the issue.

One Technique-Many Uses A more t1horough discussion mlay begin by noting ,that in awarding the prize jointly to a Russian and a (Dutch-born) American, the Royal Academy was intent on more than merely recog nizing the international character of the scientific contributions they wished to honor . What it WHS evi dently intended to emphasize was that the techniques of optimal re source allocation contained in mod ern activity analysis are in prin ciple applicable alike to economic systems reflecting sharply· diver gent institutional patterns. As the N ew York Times (October 15, 1975) expressed it in the words 208 THE FREEMAN April of a distinguished colleague of Koopmans: "Activity analysis is used by economists and operations researchers to select the optimum production technique when several competing techniques are avail able, either at the level of the corporation, as in the Unit'ed States, or at the national level, as in the planned Communist econ omies of Eastern Europe . . . The indifference of these methods to the institutional arrangements of the economic system have per mitted a degree of communica tion and intellectual ex'change that could not otherwise have taken place."

This view sees economists as concerned with seeking techniques to solve resource allocation prob lems. These problems of securing optimum allocation of resources present themselves at a variety of levels. They present themselves, in capitalist societies, at the level of the firm; they present them selves similarly, in socialist socie ties, to the central planners. The techniques requir,ed to solve these allocation problems are, in prin ciple, common to these problems regardless of institutional context. In principle the mathematical techniques employed by activity analysts to assist corporate deci sion making in the West, are the very same t,echniques needed for efficient decision -making by central planners in the East. Eco nomic science is now visible, then, as consisting of a mathematics of decision making which transcends institutional differences: what is valid for capitalist firms is valid, in principle, for socialist societies.

Missing the Point Now, we must readily concede several important elements of va lidity to this view. The abstract character of managerial decision making is, given the sets of ends and means held res'pectively to be relevant, indeed the s,ame for all levels of decision making. More over, within a given ends-means framework, the problem facing the decision maker is indeed a mathe matical one. In this context the development of activity analysis, or operations research, has been and will continue to be of extra ordinary significance and useful ness. But it is a mistake to see this mathematics of optimal allo cation and decision making - enor mously valuable though it unques tionably is - as making up essen tially the intellectual contribution of economic science. And, perhaps even more important, the uncrit ical assumption that application of the techniques appropriate to securing resource-allocative effi ciency at the level of the firm, to the level of planning for a whole society, can achieve corresponding 1976 THE 1975 NOBEL PRIZE IN ECONOMICS 209 social "efficiency," - begs entirely those questions which are at the heart of economics.

When Lionel Robbins in 1932 defined economic science as con cerned with the implications of man's resource-allocative deci sions, he did not mean that the central task of economics is to provide techniques for efficient allocation. Nor, it should be em phasized, was he referring at all to the concept of the "social" allo cation of resources. (In fact the latter concept, while central to so many introductory textbooks and to so much work in theoretical welfare economics, is a highly du bious one.2 ) Robbins was simply defining economics as concerned with the social consequences of the circumstance that decision makers do in fact seek-each with in his own framework - to achieve efficiency. Economics, in this view, is concerned not at all with how to achieve individual or social effi ciency; but rather with the social forces generated impersonally by the interaction of numerous deci sion makers each of whom is seek ing to allocate his resources op timally. In assuming that the effi ciency which firms can achieve by operations analysis, can be achieved for "society" by the use 2 On this see J. M. Buchanan, "What Should Economists Do ?", Southern Eco nomic Journal, January 1964.

of similar techniques on the part of central planners, one is in fact ignoring the conclusions of Rob binsian economic science. The matter is of course vitally bound up with Mises' pioneering demon stration in 1920 of the necessary failure of socialist economic cal culation. The 'immediate issue was perhaps most clearly stated by Hayek many years later: What is the problem we wish to solve when we try to construct a ra tional economic order? On certain familiar assumptions the answer is simple enough. If we possess all the relevant information, if we can start out from a given system of prefer ences, and if we command complete knowledge of available means, the problem which remains is purely one of logic .... This, however, is emphatically not the economic problem which society faces .... The peculiar character of the prob lem of a rational economic order is de termined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contra dictory knowledge which all the sepa rate individuals possess. The eco nomic problem of society is thus not merely a problem of how to allocate "given" resources - if "given" is tak en to mean given to a single mind which deliberately solves the problem set by these "data". It is rather a 210 THE FREEMAN April problem of how to secure the best use of resources known to any of the me'mbers of society, for ends whose relative importance only these indi viduals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to any one in its totality.3 Here, in this 1945 statement by one of the 1974 Nobel laureates in economics,- we have the definitive critique of the confusion we have seen to surround the award of the 1975 prizes.

The Knowledge Is Lacking To be able to discuss allocative decision making at all, it is neces sary to presume that the decision maker has knowledge of the sets of ends and means with respect to which efficient allocation is sought. But absence of such knowledge in centralized form is precisely what in fact constitutes, for Hayek, the economic problem facing society. To assume, therefore, that even the most powerful and sophisticat ed -of mathematical techniques can achieve for society the efficiency they can win for the firm, is to over look the essence of the eco nomic problem with which society must grapple. One of the achievements of the 3 F. A. Hayek, "The Use of Knowledge in Society", American Economic Review, September, 1945; reprinted in Individual ism and Economic Order, pp. 77£. market is that it generates imper sonal forces which govern the size of firms. Firms which are "too small" find themselves facing op portunities for profitable expan sion or merger. Firms which are "too large" find themselves at a disadvantage when facing the com petition of smaller, nimbler com petitors. What determines whether a firm is "too large" depends on many considerations. 4 Certainly one consideration of overriding importance has to do with the dif ficulty, in large organizations, of funneling the information neces sary for efficient central decision making, to those entrusted with the organization's management.

The market tends to limit the sizes of its decision_ making units to permit optimal deployment of planning techniques within these units, while harnessing the "in visible hand" of the market to achieve a tendency towards coor dination between these units. An this is very much at the center of economic science, - although it shares little indeed of the mathe matical character of the theory of resource allocation techniques. 4 See the classic paper by R. H. Coase, "The NatUre of the Firm", Economica, November, 1937; reprinted in G. J. Stig ler and K. Boulding, eds., Readings in Price Theory, Irwin, 1952. See also A. A. Alchian and H. Demsetz, "Production, In formation Costs, and Economic Organiza tion", American Economic Review, De cember, 1972.

1976 THE 1975 NOBEL PRIZE IN ECONOMICS 211 An Improper Assumption Simply to assume that society as a whole can be organized as a single firm, run as a centrally planned organization, and thus be able to employ the techniques of activity analysis, is to overlook what Hayek, at least, perceived, in effect, as the core concern of eco nomic science. To be sure, the emi nent scholars who pioneered in the development of mathematical al locative techniques 'are not, other points of possible vulnerability aside, to be criticized for assum ing entirely correctly that these techniques can be useful wherever allocative decisions are in a posi tion to be made. But we do have the obligation to point out that the economic problem facing soci ety concerns precisely those cir cumstances under which, in fact, allocative decisions are not in a position to be made. Economics has, ever since Mises, Economic Calculation had a very great deal to contrib ute on why such circumstances are inevitable; and ever since Adam Smith economics has had a great deal to say about how, under such circumstances, the economic problem faced by society comes to be solved. Those who understand the enormous social significance of economic science as it has de veloped over the past two cen turies, cannot therefore but be profoundly disturbed by the con tinued evidence that the core con tributions of the discipline have simply not been noticed by those in the best position to do so. The story of the 1975 Nobel Memorial Prize in Economics suggests in deed that the light shed by eco nomic science continues to fall on an as yet altogether incompletely illuminated intellectual landscape.

All these are indeed uncomfort able, but nonetheless apparently inescapable, reflections. , IDEAS ON LIBERTY THE EMPLOYMENT of the means of production can be controlled either by private owners or by the social apparatus of coercion and compulsion. In the first case there is a market, there are market prices for all factors of production, and economic calculation is possible. In the second case all these things are absent. It is vain to comfort oneself with the hope that the organs of the collective economy will be "omnipresent" and "omniscient." LUDWIG VON MISES, Human Action Adam Smith IT HAD NEVER OCCURRED to me that the key to understanding some of the crucial passages of the Decla ration of Independence could be discovered by reading The Wealth of Nations. I had long known, of course, that they were both pub lished in 1776: The Wealth of Nations in Mar,ch, the Declaration of Independence in July. The thought was in my mind, too, that there was something symbolic in the fact that these two great landmarks of liberty had come forth in the same year. It is comDr. Carson has written and taught extensively, specializing in American intellectual history.