Posts tagged Knowledge
A Hayekian Walk Down Wall Street

The always enjoyable Candace Smith, Etiquette Advisor to the Stars (my description), has a great short post on the etiquette of going for a stroll. Candace’s post is full of excellent nuggets of general polite rules of walking in public. These rules are not legislation; for the most part, they are convention. People, even those new to the society, quickly pick them up and obey; to not do so would be against their self-interest. These rules developed over time and, as Candace notes, have connections to similar activities we partake in (“The general rule here in the United States: keep to the right and pass on the left, exactly as if one were driving”). These rules, in other words, emerged from human interaction with one another in out society and they exist outside those members (in other words, the rules are not just the reflection of the current members of the society but have power over newcomers as well). In that sense, they are more like laws.

But there is another aspect of Candace’s post I wish to draw attention to: namely, the unarticulated rules. Candace is articulating many of the unspoken rules of walking, but there are things she leaves out, not because of incompleteness on her part but simply because those things are inarticulatable.; they are very loose, vague, indeterminante, and subjective.

Consider her common-sense rule: “Stay mindful and off your phone as you will be moving in and out among others, gauging their movement without bumping into them or pushing up against them.” This rule is simple enough, but what it fully means is not captured in this short sentence. The actual steps needed to be taken will vary from situation to situation, from person to person, from moment to moment. No one could explain all the lightning-quick decisions made while on a walk. Don’t believe me? Try to guide someone who is blindfolded down a street only by your words (articulation). I bet it would be impossible.

These inarticulate rules still influence us despite their inarticulate nature. We try to articulate them as much as we can, like Candace, but even that is incomplete. There is so much background knowledge we need in order to make our actions coherent, to make them in concert with other people.

And that is the fundamental insight of FA Hayek.

Jon MurphyPrice Theory, Knowledge
Market Failure, Epiphany, and $20 Bills on Sidewalks

There’s a joke economists like to tell:

Two economists are walking down the street. One spots a $20 bill on the sidewalk in front of them. He bends down to pick it up. “What are you doing?” says the other. “I am picking up this $20 bill,” says the first. “Nonsense! If that were a real $20 bill, it would have already been picked up!”

Economists like to tell this joke as an effort to demonstrate that profit opportunities tend to be quickly accounted for in a market: if there was indeed a $20 bill on the sidewalk, then the “market” is “out of equilibrium” and someone would have recognized this, picked up the bill, and the “equilibrium” would have been restored.

But there is a subtle assumption in this joke, namely that the two economists would have been aware of an opportunity to pick up the $20 bill. There is some behavior they are doing (such as paying attention to the sidewalk) that allows them to be susceptible to notice this profit opportunity. Perhaps everyone else walking down the street had their eyes upward doing window shopping.

Perhaps a literary tale will better tell this story: “The Verger” by W. Somerset Maugham. In the Verger, the verger of St. Peter’s was sacked for being illiterate. In his sadness, we wandered the neighborhood and fancied a cigarette. He noticed no tobacco store existed and alighted upon the idea to open his own store in the neighborhood. It was a roaring success (this story is recounted in Dan Klein’s book Knowledge and Coordination, and much of this blog post is inspired by that book).

Many people walked the streets the verger did. Why was the verger able to notice the metaphorical $20 bill on the sidewalk and not the many others who were walking? It appears it was because he was in a position to notice this particular $20 bill. He was in a certain frame of mind that allowed him to notice this particular “market failure,” this profit opportunity.

Dan Klein, in the aforementioned book, calls this form of discovery “epiphany.” This has an interesting implication for regulatory economics in that market failure needs to be “discovered.” The “market failure” in the verger (that the quantity supplied of tobacco products was less than the quantity demanded) was discovered only when the verger was in the right frame of mind to notice it and in a position to reduce transaction costs (he made have had passing thoughts in the past on the lack of a tobacconist, but given his job as a verger, did not possess the resources, such as time, to act on this market failure). Thus, market failures are something that arises from the market process. But likewise, the solution to this market failure had itself to be discovered. It was discovered in an alert mind: this street needs a tobacconist!

That both the failure and solution need to be discovered gives us great pause when considering law & economics. Mere welfare analysis does not capture this discovery process. Indeed, your standard economic analysis assumes all knowledge is known by all actors. Once we realize that such knowledge is dispersed and cannot easily be obtained, the whole concept of activist government to “fix” market failures becomes extremely shaky to say the least.