Friedrich August von Hayek published The Use of Knowledge in Society in the American Economic Review in 1945. With the world turning towards central economic controls, Hayek set out to describe what he called “the problem of a rational economic order.” Hayek’s emphasis here is how a system of economic order is to overcome the problem that much of the information relevant to decision-making is dispersed among many individuals; often among those not in direct communication with the decision maker. However, a decision about the use of resources will inevitably be made by a decision maker. Hayek describes planning as “the complex of interrelated decisions about the allocation of our available resources.” This planning is to be done by decision makers in society. The question then becomes: Who will do the planning for society, and how will knowledge about specific events, individuals’ plans, and preferences be communicated?
In response to these posed questions, Hayek elaborates that the dispute in economics is not whether planning is to be done or not, but rather “as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals.” Hayek’s dichotomy here (he offers a third alternative; half-way point between central planning and competition, which he calls fascism, characterized by monopolies to organized industries) contrasts the organizations of economic systems of state control, or central planning, with those of free markets, or decentralized planning.
Extrapolating from this, Hayek goes on to show that knowledge is not, and cannot, be known, let alone used, by a central economic planner. The idiosyncratic information necessary to plan an economy is unavailable to a central planner. Enter the free market system. The market achieves what the central planner cannot. Through the use of prices, the market is capable of transmitting relevant information from those individuals privy to that knowledge to planners. A planner may not know for what reasons prices move, but he is sure to feel the impact of those reasons as they are reflected in the prices he plans with.
In application, this knowledge problem means that it is necessary, assuming one wants as much information as possible to be used in the planning in an economy, to allow individuals and firms to exchange goods and services freely, and to allow prices to arise from the spontaneous order of this social cohesion.
The Left-Libertarian Interpretation
In their interpretation of the knowledge problem, left-libertarians assert that hierarchical firms suffer from the knowledge problem as well, due to the fact that management is removed from the production process, and so cannot make decisions as well as workers who are directly involved. This interpretation is a far leap from the original conception of the knowledge problem and suffers a fundamental misunderstanding of its key points. The issue is that the knowledge problem deals with central planning by The State of entire industries. This problem does not hold for decentralized firms; even hierarchical ones. While the state seeks to dictate the quantities, methods, and prices to be used in the production of goods and services, firms take their orders from market prices and, ultimately, consumers. While large firms can indeed suffer problems from diseconomies of scale, including principle-agent problems, worker incentive and payment structuring issues, coordination, etc., this does not constitute a problem of central planning or of the knowledge problem.
In other words, it’s a problem of supply and demand and not about hierarchy. Should society produce more corn, more coffee, more steel, or more beer? No one individual or group of individuals will ever possess enough knowledge of the desires of all of the members of society to ever come up with the correct answer. Prices, however, balance supply with demand, so no one ever needs to know the whole equation. Companies and organizations are different. Their main objective is not to determine how to balance competing goods and services to meet the demands of society. Their objective is to make a profit producing their good or service. All employees of a company are working towards a common goal which is for the betterment of the organization. They want to increase their supply to the point of what the market is willing to bear. Organizations with hierarchies do not suffer the consequences of Hayek’s knowledge problem; rather, they are subjected to it. Their production is subject to the demands of society. The work the employees do is in demand by the company and restricted to a certain supply of qualified people and therefore commands a certain wage for each position. This means that the company must balance the supply with their demand by paying a certain wage. The point is that hierarchical organizations do not attempt to increase or decrease the supply of resources in a manner that is misaligned with demand. Everything they do is in reaction to the forces of society’s demands.
Left-libertarians have a number of questionable positions, and they often invoke Austrian theory in an effort to vindicate these positions. Hayek’s knowledge problem is no exception. Per their interpretation of the knowledge problem, it is their belief that smaller, flatter firms could be expected to out-compete larger, more hierarchical firms due to the knowledge problem impacting those larger firms.
As Carson argues in Why Self-Organized Networks Will Destroy Hierarchies — A Credo:
“Hierarchies are systematically stupid and inefficient, for the following reasons.
1. Hayekian information problems: The people in authority who make the rules interfere with the people who know how to do the job and are in direct contact with the situation. The people who make the rules know nothing about the work they’re interfering with. The people who make the rules are unaccountable to the people who do know how to do the work. Consequently, all authority-based rules create suboptimal results and irrationality when they interfere with the judgment of those in direct contact with the situation.”
First, Hayek is specifically referring to state authority, a specific type of hierarchy. Kevin Carson is using the word “hierarchy” broadly, but is backing it up with an example that presumes a narrowly defined concept in a different context in order to equivocate. Hayek’s information problem does not apply equally to workplace hierarchies, in other words. Now, left-libertarians could argue that although it doesn’t apply equally to workplace hierarchies that it does apply to some extent. However, this interpretation deviates greatly from the original conception of Hayek’s Knowledge Problem, as laid out in his essay “The Use of Knowledge in Society.” In espousing this interpretation, left-libertarians make fundamental errors regarding what the market is. Left-libertarians are making the common mistake of holding the market up as an incorporeal concept when in reality the market consists of individuals making plans and acting, rather than governments. This is exactly what Hayek was talking about in Use of Knowledge in Society when he says, “It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals”. “It” being the use of knowledge and its economic implications. Hayek is very clear what he meant in regards to planning and the Knowledge Problem.
Furthermore, Carson is twisting Hayek to justify his ideology by arguing that due to the knowledge problem with larger firms, flatter firms will be prevailing in a stateless society. Economic theory though shows that profit will tend towards firms which are organized efficiently and who limit the “stupidity” of their managers.
In Beyond Bossism, Chartier continues this line of thinking:
“Large, hierarchical firms seem likely to be beset by the incentive and knowledge problems that complicate the lives of state central planners.
The larger an organization, the more likely it is that managers will lack crucial information. This is both because there will be multiple layers separating various actors with relevant information (with institutional pressures impeding accuracy) and because there will be no system of prices encoding the information and usable for calculation. In addition, the principal-agent problem besets large firms at multiple levels, fostering inefficiencies as workers—whether senior managers or front-line employees—seek their own goals rather than firm profitability.
Thus, it seems fairly clear that, all other things being equal, the smaller and flatter a firm is, the better the information available to participants will be.”
A big matter of contention here being overlooked is that all interpersonal relationships are subject to numerous problems such as incentive issues, coordination issues, etc. However, it does not follow that we should avoid all relationships, which would be the libertarian left’s position taken to its logical conclusion.
For instance, I will never know as much about plumbing as a professional plumber. We can even assume that his knowledge is tacit and inarticulable in Hayek’s sense. The plumber can use this knowledge to his own advantage (say, making an unnecessary repair). Does it follow that I should do all my own plumbing repairs? Not at all. It means that I (as a typical homeowner) weigh the benefits and costs of alternative organizational arrangements in deciding how to accomplish tasks. If I choose to hire the plumber, I’m saying that the advantages of delegation – allowing the plumber to work on my bathroom, in my house, to exploit his expertise and to free me up to do other things – outweigh the costs that he might take advantage of me, might perform the wrong repairs, might damage my property, and so on. Every employment relationship is like this, whether I employ one person or a thousand, whether I deal directly with each employee or put them into a nested hierarchy and deal only with the middle managers.
Left-libertarians don’t seem to grasp that all feasible forms of organization are flawed. As Peter Klein points out (see here and here), their preferred networks of decentralized contractors, cottage production, cooperatives, and the like all suffer from various information, incentive, and coordination problems, just different ones from those affecting hierarchical corporations. The libertarian left are guilty of what Harold Demsetz called the “Nirvana fallacy” by comparing real-world hierarchies against some hypothetical ideal, finding them lacking, and concluding that their own favorite methods of organizing are better. It’s a huge non-sequitur and special pleading as well implying their own organization is exempt from the same criticism).
Another issue worth noting is that Chartier is talking about size and organizational structure at the same time. Most of what he’s talking about affects large firms regardless of organizational structure as pointed out above, and a hierarchical organization mitigates some of these problems, which would be even worse in a large, flat organization. If you’ve ever worked for a large firm you’re familiar with the communication issues among managers and departments, etc. Try to imagine how an organization the same size without managers would move information throughout the firm. It would be an absolute nightmare. And in the meantime, other firms would be competing over not just quality and price, but in organizational structure too.
In some large firms with deep hierarchies, creating knowledge problems by separating the order-giver from the action itself may indeed be the case. But any firm suffering from this “diseconomy of scale” is also enjoying the advantages of economies of scale, and you as an observer are unlikely to accurately determine whether its size is a net advantage or disadvantage – certainly less likely than its owners, who will take steps to mitigate it once discovered. Carson makes the same mistake in his article “Economic Calculation in the Corporate Common Wealth”. In this piece, Carson correctly identified a diseconomy of scale and compared it to the impossibility of calculation under socialism. In large organizations, for various reasons, calculation can become more and more difficult, and the firm will suffer from diseconomies accordingly, but that only changes quantitatively as a firm “grows” (and the analysis is different depending on the nature of that growth) but doesn’t become entirely impossible as it does in the absence of prices, except in certain situations that Rothbard has already addressed, and for the same reasons. And even in those cases, a firm operating in a free market will have access to the same workaround as the Soviet Union had in theirs: the availability of real prices in real markets elsewhere to fill the gaps, but also with the advantage that they’re much more flexible and innovative, and actually respond to consumer preferences. For any firm, there is an optimal size. It’s hard to guess where that is, even for its owners, who will tend to err on the side of overgrowth, but it’s a lot more common than left-libertarians probably think for those owners to realize the error after the fact and start downsizing, spinning off divisions, unwinding acts of vertical integration, etc.
Firms being impacted by the knowledge problem as left-libertarians assert is a contrived problem: that economic analysis shows that hierarchy per se isn’t a problem for firms as left-libertarians claim. Entrepreneurship necessarily entails a hierarchy and entrepreneurship is fundamental for market processes. The entrepreneur is a decision maker who creates profit opportunities, steers flows of capital and means of production, and forecasts future market conditions.“Entrepreneurship, as decisive action under uncertain conditions, is at the very heart of a market economy”, writes Peter Klein. Indeed. “Economic and growth”, as he says, “cannot happen without entrepreneurship”. Left-libertarians love to go on about how much decision makers don’t know how to produce X or Y, but then completely ignore the division of labor in which they do know how to make decisions about investment, capital management, and so on. Meanwhile, the workers know next to nothing about these aspects. The entire point of the entrepreneur is specifically to coordinate production and forecast market conditions. If a firm was to simply allow workers to collectively do that, they’d soon find themselves bankrupt. So the Hayekian knowledge problem goes both ways, but I fail to see them address how blue collar workers are going to manage multi-million dollars lines of production and take over for entrepreneurs. Joe Shmoe the blue-collar worker doesn’t know jack about accounting or finance and so would be pretty poorly off if he and his union buddies were left in charge of acquiring equity for their firm.
Left-libertarians may claim this as a misconception that they don’t have problems with entrepreneurs, but with managers, yet this is inconsistent. Managers are too far removed, they say, but the entrepreneur is even more removed from the process. Usually, the entrepreneur uses management as an intermediary to the workers while making the biggest decisions. Their criticism must be applied to both to be logically consistent. If left-libertarians want to be consistent, they also have to decry entrepreneurs.
Firms have adapted to large sizes and particular structures through the development of accounting principles, finance, management techniques, and so forth. The hierarchical structure is an adaptation to the large size. Or it was – many small firms start out hierarchical because it’s the structure their founders are familiar with, and/or they’ve discovered or assumed it works well for them. The small flat firms get a lot of attention for having “discovered” that it may not be the only way for the firm to organize, or even the most optimal. Left-libertarians could answer that the hierarchical structure precludes any of the supposed state interventions that create and enable it. As Chartier states in Beyond Bossism,
It might seem, then, that smaller, flatter firms could be expected to out-compete larger, more hierarchical ones. But we don’t see lots of smaller, flatter firms in the marketplace. Does this mean that, contrary to expectations, larger firms really are more efficient?
Whether this is so will depend in significant part on empirical questions that can’t be sorted out a priori. But it does seem as if several factors in our economy might tend to help large firms ignore the diseconomies of scale that would otherwise render them unsustainably inefficient. Tax rules and regulations tend to encourage capital concentration and thus increased firm size.
Chartier is not entirely wrong, but prevalence of hierarchical firms before, say, writing interest payments off on taxes defeats that argument. Left-libertarians focus on interventions of the state for hierarchical firms, but those interventions haven’t always been around and yet hierarchical firms have been for much longer.
Left-Libertarian Perversion of Austrian Economics
Left-libertarians have a complete misunderstanding of Austrian Economics and of Hayek in this case. If their analysis is wrong, their near entire worldview goes with it, so they desperately want it to be true by their standards. With a coherent understanding of Austrian Economics, it’s quite a bit more difficult to arrive at justifications for workers seizing the means of production. That’s a big part of this assessment anyway, but it’s very pervasive throughout leftist thought, particularly when they make claims that hierarchies are “often morally objectionable”, which seems to be what their conclusions are arriving at. Many who identify as left-libertarians often misinterpret Austrian Economics to arrive at conclusions to rationalize quasi-agrarian, anti-modernist, anti-division of labor views of anti-private property leftists. I have a constant suspicion when talking to the libertarian left that when they seem to be talking about economics, and even if they are talking about it, they’re not so much doing analysis as justifying their ideology.