#### TL;DR This is a lecture given by Hayek in 1968. It is one o...
Friedrich A. Hayek was an Austrian-British economist and philosophe...
This is Hayek's core idea for this lecture. **According to Hayek co...
>***"The curious fact that the merits of competition cannot be empi...
Competition is important because it helps us uncover and use knowle...
Traditional economic theories often make the mistake of assuming th...
**Catallaxy** refers to the spontaneous order brought about by the ...
Equilibrium suggests that everything there is to know is already kn...
In this section Hayek emphasizes that the market should be allowed ...
Competition seems to be even more important in less developed count...
Hayek discusses the problem of wage rigidity and its negative impac...
F.A. H
t would not be easy to defend macroeconomists against the charge that for
40 or 50 years they have investigated competition primarily under
assumptions which, if they were actually true, would make competition
completely useless and uninteresting. If anyone actually knew everything that
economic theory designated as “data,” competition would indeed be a highly
wasteful method of securing adjustment to these facts. Hence it is also not sur-
prising that some authors have concluded that we can either completely
renounce the market, or that its outcomes are to be considered at most a first
step toward creating a social product that we can then manipulate, correct, or
redistribute in any way we please. Others, who apparently have taken their
notion of competition exclusively from modern textbooks, have concluded
that such competition does not exist at all.
By contrast, it is useful to recall that
we make use of competi-
tion, this can only be justified by our
knowing the essential circumstances
that determine the behavior of the competitors. In sporting events, examina-
tions, the awarding of government contracts, or the bestowal of prizes for
poems, not to mention science, it would be patently absurd to sponsor a con-
test if we knew in advance who the winner would be. Therefore, as the title of
this lecture suggests, I wish now to consider competition systematically as a
procedure for discovering facts which, if the procedure did not exist, would
remain unknown or at least would not be used.
Marcellus S. Snow is professor emeritus at the University of Hawaii at Manoa;
snow@hawaii.edu. This is a translation from German of F.A. Hayek’s “Der Wettbewerb als
Entdeckungsverfahren,” a 1968 lecture sponsored by the Institut für Weltwirtschaft at the
University of Kiel. It was published as No. 56 in the series Kieler Vorträge.
It might at first appear so obvious that competition always involves such
a discovery procedure that this is hardly worth emphasizing. When this is
explicitly underscored, however, conclusions are immediately obtained that
are in no way so obvious. The first is that competition is important
because and insofar as its outcomes are unpredictable and on the whole dif-
ferent from those that anyone would have been able to consciously strive for;
and that its salutary effects must manifest themselves by frustrating certain
intentions and disappointing certain expectations.
The second conclusion, closely associated with the first, is methodologi-
cal in nature. It is of particular interest in that it has reference to the princi-
pal reason why, during the last 20 or 30 years, microeconomic theory—the
analysis of the fine details of the economy’s structure which alone can teach
us to understand the role of competition—has lost so much of its reputation,
and indeed as a result appears not at all to be understood anymore by those
calling themselves economic theorists. For this reason I would like to begin
here with a few words about the methodological particularity of every theory
of competition that makes the conclusions drawn from it appear suspicious
to all those who habitually decide, on the basis of an excessively simplified
criterion, what they are prepared to recognize as scientific.
The only reason we use competition at all has as its necessary consequence
the fact that the validity of the theory of competition can never be empirically
for those cases in which it is of interest
. It is of course possible to ver-
ify the theory on preconceived theoretical models; and in principle we could
also conceivably verify the theory in artificially created situations in which all
the facts that competition is to discover are known to the observer in advance.
In such a situation, however, the outcome of the experiment would be of little
interest, and it would probably not be worth the cost of conducting it. When,
however, we do not know in advance the facts we wish to discover with the help
of competition, we are also unable to determine how effectively competition
leads to the discovery of all the relevant circumstances that could have been dis-
covered. All that can be empirically verified is that societies making use of com-
petition for this purpose realize this outcome to a greater extent than do oth-
ers—a question which, it seems to me, the history of civilization answers
emphatically in the affirmative.
The curious fact that the merits of competition cannot be empirically ver-
ified in precisely those cases in which it is of interest is also shared by the dis-
covery procedures of science in general. The advantages of established scien-
tific procedures cannot themselves be scientifically demonstrated; they are
recognized only because they have actually provided better results than alter-
native procedures.
See the interesting discussion of these problems in M. Polyani,
The Logic of Liberty
London, 1951), in which the author is led from a study of the methods of scientific
research to that of economic competition. See also K.R. Popper,
Logik der Forschung
, 2d.
ed. (Tübingen, 1966), p. 16.
The difference between economic competition and the successful proce-
dure of science is that the former exhibits a method of discovering particular
temporary circumstances, while science seeks to discover something often
known as “general facts,” i.e., regularities in events, and is concerned with
unique, particular facts only to the extent that they tend to refute or confirm
its theories. Since this is a matter of general and permanent features of our
world, scientific discoveries have ample time to demonstrate their value,
whereas the usefulness of particular circumstances disclosed by economic
competition is to a considerable extent transitory. It would be as easy to dis-
credit the theory of scientific method by noting that it does not lead to verifi-
able predictions regarding what science will discover, as it has been to dis-
credit the theory of the market by noting that it does not lead to predictions
about particular outcomes of the market process. By the nature of things,
however, the theory of the market is unable to accomplish this in all those
cases in which it is reasonable to make use of competition. As we shall see,
the predictive power of this theory is necessarily constrained to a prediction
of the type of structure or abstract order that will result; it does not, however,
extend to a prediction of particular events.
Although this will lead me even further from my main topic, I should like to
add a few words about the consequences of the disappointment in microeco-
nomic theory caused by using fallacious methodological criteria of scientism.
Most of all, this disappointment was probably the major reason why a great
number of economists rejected it in favor of so-called macroeconomic theory,
which, since it aims to predict concrete events, appears to correspond better
with the criteria of scientism. In reality, however, it seems to me much less sci-
entific—indeed, in the strictest sense, it can make no claim to the name of a
theoretical science.
The basis for this point of view is the conviction that the coarse structure
of the economy can exhibit no regularities that are not results of the fine struc-
ture, and that those aggregates or mean values, which alone can be grasped
statistically, give us no information about what takes place in the fine struc-
ture. The notion that we must formulate our theories so that they can be
applied to observable statistical or other measurable quantities seems
to me to be a methodological error which, had the natural sciences followed it,
would have greatly obstructed their progress. All we can require of theories is
that, after an input of relevant data, conclusions can be derived from them that
can be checked against reality. The fact that these concrete data are so diverse
See my essay “The Theory of Complex Phenomena” in
The Critical Approach in
Science and Philosophy
, M. Bunge, ed. (London and New York, 1964). Reprinted in my
Studies in Philosophy, Politics, and Economics
(Chicago and London, 1967).
and complex in our area of inquiry that we can never take them all into
account is an unchangeable fact, but not a shortcoming of the theory. A result
of this fact is that we can derive from our theories only very general state-
ments, or “pattern predictions,” as I have called them elsewhere;
we cannot,
however, derive any specific predictions of individual events from them.
Certainly, however, this does not justify insisting that we derive unambiguous
relationships among the immediately observable variables, or that this is the
only way of obtaining scientific knowledge—particularly not if we know that,
in that obscure image of reality we call statistics, in aggregates and averages
we unavoidably summarize many things whose causal meaning is very
diverse. It is a false epistemological principle to adapt the theory to the avail-
able information, so that the observed variables appear directly in the theory.
Statistical variables such as national income, investment, price levels, and
production are variables that play no role in the process of their determina-
tion itself. We might be able to notice certain regularities (“empirical laws” in
the specific sense in which Carl Menger contrasted them to theoretical laws)
in the observed behavior of these variables. Often these regularities apply, but
sometimes they do not. Yet using the means of macrotheory, we can never for-
mulate the conditions under which they apply.
This should not mean that I regard so-called macrotheory as completely
useless. About many important conditions we have only statistical informa-
tion rather than data regarding changes in the fine structure. Macrotheory
then often affords approximate values or, probably, predictions that we are
unable to obtain in any other way. It might often be worthwhile, for example,
to base our reasoning on the assumption that an increase of aggregate
demand will in general lead to a greater increase in investment, although we
know that under certain circumstances the opposite will be the case. These
theorems of macrotheory are certainly valuable as rules of thumb for gener-
ating predictions in the presence of insufficient information. But they are not
only not more scientific than is microtheory; in a strict sense they do not have
the character of scientific theories at all.
In this regard I must confess that I still sympathize more with the views of
the young Schumpeter than with those of the elder, the latter being responsi-
ble to so great an extent for the rise of macrotheory. Exactly 60 years ago, in
his brilliant first publication,
a few pages after having introduced the concept
of “methodological individualism” to designate the method of economic the-
ory, he wrote:
If one erects the edifice of our theory uninfluenced by prejudices and out-
side demands, one does not encounter these concepts [namely “national
income,” “national wealth,” “social capital”] at all. Thus we will not be fur-
ther concerned with them. If we wanted to do so, however, we would see
See my above-cited essay, “The Theory of Complex Phenomena.”
J. Schumpeter,
Das Wesen und der Hauptinhalt der theoretischen Nationalökonomie
(Leipzig, 1908), p. 97.
how greatly they are afflicted with obscurities and difficulties, and how
closely they are associated with numerous false notions, without yielding
truly valuable theorem.
Returning now to my actual topic after having shared my concerns with you
on this matter, I should like to begin with the observation that market theory
often prevents access to a true understanding of competition by proceeding
from the assumption of a “given” quantity of scarce goods. Which goods are
scarce, however, or which things are goods, or how scarce or valuable they are,
is precisely one of the conditions that competition should discover: in each
case it is the preliminary outcomes of the market process that inform indi-
viduals where it is worthwhile to search. Utilizing the widely diffused knowl-
edge in a society with an advanced division of labor cannot be based on the
condition that individuals know all the concrete uses that can be made of the
objects in their environment. Their attention will be directed by the prices the
market offers for various goods and services. This means, among other
things, that each individual’s particular combination of skills and abilities—
which in many regards is always unique—will not only (and not even prima-
rily) be skills that the person in question can recite in detail or report to a gov-
ernment agency. Rather, the knowledge of which I am speaking consists to a
great extent of the ability to detect certain conditions—an ability that individ-
uals can use effectively only when the market tells them what kinds of goods
and services are demanded, and how urgently.
This suggestion must suffice here to clarify the kind of knowledge I am
speaking of when I call competition a discovery procedure. Much more would
have to be added if I wanted to formulate this outline so concretely that the
meaning of this process emerged clearly. What I have said, however, should
be sufficient to point out the absurdity of the conventional approach pro-
ceeding from a state in which all essential conditions are assumed to be
that theory curiously designates as perfect competition, even
though the opportunity for the
we call competition no longer exists.
Indeed, it is assumed that such activity has already performed its function.
Nonetheless, I must now turn to another question about which even more
confusion still exists, namely the meaning of the claim that the market spon-
the plans of individuals to the facts thus discovered; in other
words, the question of the purpose for which the information thus discovered
is used.
The confusion that prevails here can be ascribed above all to the false idea
that the order which the market brings about can be regarded as an
in the strict sense of the word, and that the outcome must therefore be judged
according to criteria that in reality are appropriate only for such an individ-
ual economy. But these criteria, which hold for a true economy in which all
effort is directed toward a uniform order of objectives, are to an extent com-
pletely irrelevant for the complex structure consisting of the many individual
economies that we unfortunately designate with the same word “economy.”
An economy in the strong sense of the word is an organization or an arrange-
ment in which someone consciously uses means in the service of a uniform
hierarchy of ends. The spontaneous order brought about by the market is
something entirely different. But the fact that this market order does not in
many ways behave like an economy in the proper sense of the word—in par-
ticular, the fact that it does not in general ensure that what most people regard
as more important ends are always satisfied before less important ones—is one
of the major reasons people rebel against it. It can be said, indeed, that all
socialism has no other aim than to transform catallaxy (as I am pleased to call
market order, to avoid using the expression “economy”) into a true economy
in which a uniform scale of values determines which needs are satisfied and
which are not.
This widely shared wish raises two problems, though. First, as far as the
management decisions of a genuine economy or of any other organization are
concerned, it is only the knowledge of the organizers or managers alone that
can have any impact. Second, all members of such a genuine economy—con-
ceived of as a consciously managed organization—must serve the uniform
hierarchy of objectives in all their actions. Contrast this with the two advan-
tages of a spontaneous market order or catallaxy: it can use the knowledge of
all participants, and the objectives it serves are the particular objectives of all
its participants in all their diversity and polarity.
The fact that catallaxy serves no uniform system of objectives gives rise to
all the familiar difficulties that disturb not only socialists, but all economists
endeavoring to evaluate the performance of the market order. For if the mar-
ket order does not serve a particular rank ordering of objectives, and indeed
if, like any spontaneously created order, it cannot legitimately be said to have
definite objectives, neither is it then possible to represent the value of its out-
come as a sum of individual outputs. What do we mean, then, when we claim
that the market order in some sense produces a maximum or an optimum?
The point of departure for an answer must be the insight that, although
the spontaneous order was not created for any particular individual objective,
and in this sense cannot be said to serve a particular concrete objective, it can
nonetheless contribute to the realization of a number of individual objectives
which no one knows in their totality. Rational, successful action by an indi-
vidual is possible only in a world that is to some extent orderly; and it obvi-
ously makes sense to try to create conditions under which any randomly
selected individual has prospects of pursuing his goals as effectively as pos-
sible, even if we cannot predict which particular individuals will benefit
thereby and which will not. As we have seen, the results of a discovery pro-
cedure are necessarily unpredictable, and all we can expect by employing an
appropriate discovery procedure is that it will increase the prospects of
unspecified persons, but not the prospects of any particular outcome for any
particular persons. The only common objective we can pursue in choosing
this technique for the ordering of social reality is the abstract structure or
order that will be created as a consequence.
We are accustomed to calling the order brought about by competition an equi-
librium—a none-too-felicitous expression, since a true equilibrium presup-
poses that the relevant facts have already been discovered and that the process
of competition has thus come to an end. The concept of order, which I prefer
to that of equilibrium, at least in discussions of economic policy, has the
advantage of allowing us to speak meaningfully about the fact that order can
be realized to a greater or lesser degree, and that order can also be preserved
as things change. Whereas an equilibrium never really exists, one can
nonetheless justifiably claim that the kind of order of which the “equilibrium”
of theory represents a sort of ideal type is realized to a great extent.
This order manifests itself first of all by virtue of the fact that the expec-
tations of particular transactions with other persons, upon which the plans of
all the economy’s participants are based, are to a considerable extent realized.
This mutual adjustment of individual plans is brought about by a process that
we have learned to call negative feedback ever since the natural sciences have
also begun to concern themselves with spontaneous orders or “self-organizing
systems.” Indeed, as even well-informed biologists are now aware,
long before Claude Bernard, Clark Maxwell, Walter B. Cannon or Norbert
Wiener developed cybernetics, Adam Smith perceived the idea just as
clearly in his
Wealth of Nations
. The “invisible hand” that regulates prices
appears to express this idea. Smith says in essence that in a free market,
prices are determined by negative feedback.
It is precisely through the disappointment of expectations that a high
degree of agreement of expectations is brought about. This fact, as we shall
see later, is of fundamental importance in understanding the functioning of
the market order. But the market’s accomplishments are not exhausted in
bringing about a mutual adjustment of individual plans. It also provides that
every product is produced by those who can produce it more cheaply (or at
least as cheaply) as anyone who does not in fact produce it, and that goods
are sold at prices that are lower than those at which anyone could offer the
goods who does not offer them. This does not of course prevent some people
from extracting large profits above their costs, as long as these costs are con-
siderably lower than those of the next best potential producer of the good. It
G. Hardin,
Nature and Man’s Fate
(New York and London, 1959). Mentor Edition,
1961, p. 54.
means, however, that of the combination of different goods that is actually
being produced, as much is produced as we can manufacture by any method
that is known to us. That is of course not as much as we could produce if in
fact all the knowledge that anyone possessed or could acquire were available
at a central point and from there could be entered into a computer. The cost
of the discovery procedure that we use is considerable. But it is unfair to judge
the performance of the market in a certain sense “from the top down,” namely
by comparing it with an ideal standard that we are unable to attain in any
known way. If we judge the market’s performance “from the bottom up”
(which seems to be the only permissible way), i.e., by comparison with what
we could attain by means of any other method available to us, and in partic-
ular by comparison with what would be produced if competition were pre-
vented—for example, if a good could be produced only by those the authori-
ties allowed to do so—the market’s performance must be judged as most
considerable. We need only recall how difficult it is in an economy with effec-
tive competition to discover ways of providing consumers with better or
cheaper goods than is presently the case. If, for a moment, we believe we have
discovered such unrealized opportunities, we generally find that government
authority or a highly undesirable exercise of private power have hitherto pre-
vented their exploitation.
Of course, we must also not forget that the market can provide no more
than an approximation of any point on the n-dimensional surface by which
pure theory describes the range of possibilities that could conceivably be
attained in the production of any combination of goods and services; but the
market allows the particular combination of various goods and their distri-
bution among individuals to be decided essentially by unforeseeable circum-
stances and in this sense by chance. As Adam Smith realized,
the situation is
somewhat like agreeing to play a game based partly on skill and partly on
luck. The rules of the game ensure that at the price such that each individual’s
share is left more or less to chance, the real equivalent of each individual’s
share, depending partly on chance, becomes as large as possible. In modern
terminology we can say that we are playing a non-zero-sum game whose rules
have the objective of increasing the payoff but leave the share of the individuals
partly to chance. A mind endowed with full information could of course choose
every point on the n-dimensional surface that appeared desirable to him and
then distribute as he saw fit the product of the combination he chose. But the
only point on (or at least somewhere near) that surface we can reach using a
procedure known to us is the one we reach when we leave its determination up
to the market. The so-called “maximum” we achieve in this manner cannot of
course be defined as a sum of certain quantities of goods, but only by the
opportunity it affords unspecified persons to receive as large an equivalent as
See A. Smith,
Theorie der ethischen Gefühle
, W. Eckstein, trans. (Leipzig,, 1926), vol. 2,
pp. 396, 467.
possible for a share determined partly by chance. The fact that this outcome
cannot be evaluated on the basis of a uniform value scale of desired concrete
objectives is one of the main reasons it seems so misleading to me to consider
the outcome of the market order or catallaxy as if it had anything to do with
an economy in the proper sense.
The consequences of this erroneous interpretation of the market order as an
economy whose task is to satisfy the various needs according to a given rank
ordering are reflected in political efforts to correct prices and income in the
service of so-called “social justice.” Notwithstanding the various meanings
with which social philosophers attempted to invest this concept, in practice it
has had virtually only one: protecting some groups of people from having to
descend from the absolute or relative lifestyle they have heretofore enjoyed. Yet
this is a principle that cannot be implemented in general without destroying
the foundations of the market order. Not only continuous growth, but under
certain circumstances even the preservation of the average income level
attained depends on processes of adjustment that require a change not only
of the relative shares but also of the absolute shares of individual persons and
groups, even though such persons and groups are not responsible for the
necessity of that change.
It is useful to recall at this point that all economic decisions are made nec-
essary by unanticipated changes, and that the justification for using the price
mechanism is solely that it shows individuals that what they have previously
done, or can do now, has become more or less important, for reasons with
which they have nothing to do. The adaptation of the total order of human
action to changing circumstances is based on the fact that the compensation
of the various services changes without taking into account of the merits or
defects of those involved.
In this connection the term “incentives” is often used in a way that easily
lends itself to misunderstanding, namely as though their primary purpose
were to induce individuals to exert themselves sufficiently. The most impor-
tant function of prices, however, is that they tell us
we should accom-
not how much
. In a constantly changing world, merely maintaining a
given level of welfare requires constant adjustments in how the efforts of many
individuals are directed; and these will only occur when the relative compen-
sation of these activities changes. Under relatively stationary conditions,
however, these adjustments—which are needed simply to maintain the income
stream at its previous level—will not generate a surplus that could be used to
compensate those who are disadvantaged by the price changes. Only in a rap-
idly growing economy can we hope to prevent an absolute decline in the mate-
rial level of particular groups.
Today, customary treatments of these problems often overlook the fact that
even the relative stability of the various aggregates that macroeconomics treats
as data is the result of microeconomic processes in which relative price
changes play a decisive role. It is an outcome of the market mechanism that
someone is induced to fill the gap that arises when someone else does not ful-
fill the expectations on the basis of which a third party has made plans. In
this sense all the collective supply and demand curves that we use so happily
are not really data, but rather outcomes of the constantly ongoing process of
competition. Thus, statistical information can never disclose to us what price
or income changes will be needed to bring about the necessary adjustment to
an unavoidable change of the data.
The decisive point, however, is that in a democratic society it would be
completely impossible, using commands that could not be regarded as just, to
bring about those changes that are undoubtedly necessary, but the necessity
of which could not be strictly demonstrated in a particular case. In such a sys-
tem, a conscious direction of the economy would always have to aim for prices
that are considered fair, and in practice that can only mean preservation of
the existing price and income structure. An economic system in which every-
one received what others felt he deserved could not help but be a highly inef-
ficient system, quite apart from the fact that it would also be an unbearably
tyrannical one. For the same reason, it is also to be feared that any “incomes
policy” would tend more to prevent than to facilitate those adjustments in the
price and income structure required by the adaptation to unanticipated
changes in conditions.
It is one of the paradoxes of our age that the communist countries, in this
regard, are probably less burdened by ideas of “social justice” than are the
“capitalistic” and democratic countries, and are thereby more prone to allow
those who are disadvantaged by development to suffer. In at least some of the
Western countries the situation is as hopeless as it is precisely because the
ideology that determines policy renders impossible those changes that would
be necessary to improve the situation of the working class quickly enough to
make that ideology disappear.
If even in highly developed economies competition is important primarily as a
discovery procedure whereby entrepreneurs constantly search for unexploited
opportunities that can also be taken advantage of by others, then this is true of
course to an even greater extent as far as underdeveloped societies are con-
cerned. I have intentionally begun by considering the problems of maintain-
ing an order in societies in which most techniques and productive forces are
generally known, but also an order that requires continuous adjustment of
activities to unavoidable small changes simply to maintain the previously
attained level. At this point I do not wish to inquire into the role played by
competition in the progress of available technology. I would like to emphasize,
however, how much more important competition must be wherever the pri-
mary objective is to discover the still unknown possibilities in a society where
competition was previously limited. While for the most part false, it might not
be completely absurd to expect that we can predict and control the develop-
ment of the structure of a society that is already highly developed. But it
seems incredible to me to hold that we can determine in advance the future
structure of a society in which the major problem is still to find out what
kinds of material and human productive forces are present, or that we should
be in a position, in such a country, to predict the particular consequences of
a given measure.
Quite apart from the fact that there is still so much more to discover in
such a country, it seems to me that there is another consideration making the
greatest possible freedom of competition much more important here than in
more highly developed countries. The fact I have in mind is that the necessary
changes in habits and customs will occur only when those who are ready and
able to experiment with new procedures can make it necessary for the others
to imitate them, with the former thereby showing the way; but if the majority
is in a position to prevent the few from conducting experiments, the necessary
discovery procedure will be frustrated. The fact that competition not only
shows how things can be improved, but also forces all those whose income
depends on the market to imitate the improvements, is of course one of the
major reasons for the disinclination to compete. Competition represents a
kind of impersonal coercion that will cause many individuals to change their
behavior in a way that could not be brought about by any kind of instructions
or commands. Central planning in the service of any some “social justice”
may be a luxury that rich countries can afford, but it is certainly no method
for poor countries to bring about the adjustment to rapidly changing circum-
stances on which growth depends.
It might also be worth mentioning in this connection that the more the
available opportunities of a country remain unexploited, the greater its oppor-
tunities for growth; this often means that a high growth rate is more a sign of
bad policies in the past than of good policies in the present. It also seems that
one cannot in general expect a country that is already highly developed to
have as high a growth rate as a country whose full use of its resources has long
been rendered impossible by legal and institutional barriers.
Having seen what I have of the world, it appears to me that the proportion
of people who are prepared to try out new possibilities that promise to
improve their situation—as long as others do not prevent them from doing so—
is more or less the same everywhere. It seems to me that the much-lamented
lack of entrepreneurial spirit in many young countries is not an unchangeable
attribute of individuals, but the consequence of limitations placed on indi-
viduals by the prevailing point of view. For precisely this reason, the effect
would be fatal if, in such countries, the collective will of the majority were to
control the efforts of individuals, rather than that public power limits itself to
protecting the individual from the pressure of society—and only the institution
of private property, and all the liberal institutions of the rule of law associated
with it, can bring about the latter.
Although competition is by and large a quite resilient specimen as far as pri-
vate firms are concerned—one that continues to resurface in the most unex-
pected manner after efforts to suppress it—its usefulness with respect to the
one omnipresent factor of production, namely human labor, has been ren-
dered more or less ineffective throughout the entire Western world. It is a gen-
erally known fact that the most difficult and indeed the apparently insoluble
problems of present-day economic policy, which have occupied economists
more than all other problems, are the result of the so-called rigidity of wages.
This means in essence that the wage structure as well as the wage level has
become increasingly independent of market conditions. Most economists con-
sider this situation as an irrevocable development that we cannot change and
to which we must adapt our policies. It is hardly an exaggeration to say that
for the past 30 years, discussions of monetary policy in particular have dealt
almost exclusively with problems of circumventing the difficulties created by
inflexible wages. I have long since had the impression that this was a mere
treatment of symptoms. For the moment, we might thereby cover up the fun-
damental difficulties, but this is not only a mere postponement of the moment
at which we must directly confront the primary problem, but it also makes the
eventual solution of the latter increasingly difficult. This is because accepting
these rigidities as unavoidable facts not only results in increasing them, but
also confers an aura of legitimacy on the antisocial and destructive practices
that they cause. I must confess that as a result, I myself have lost all interest
in the ongoing discussions of monetary policy, which was once one of my
major areas of research, because this avoidance of the central issue seems to
me to load the burden onto the shoulders of our successors in a most irre-
sponsible manner. In a certain sense, of course, we are harvesting here only
what the founder of this fashion has sown, since we are naturally already in
that “long run” in which he knew he would be dead.
It was a great misfortune for the world that these theories arose from the
very unusual and, indeed, perhaps unique situation of Great Britain in the
1920s—a situation in which it appeared obvious that unemployment was the
result of too high a real wage
, and that the problem of rigidity of the wage
structure thus had limited significance. As a result of Great Britain’s return to
the gold standard after years of war inflation at the parity of 1914, it could be
claimed with some justification that all real wages in that country were too
high relative to the rest of the world to achieve the necessary volume of
exports. I am not convinced that this was really true even then. Even at that
time, to be sure, Great Britain had the oldest, most deeply rooted, and most
all-encompassing trade union movement, which through its wage policy had
succeeded in conserving a wage structure that was determined much more by
considerations of “justice” than of economic appropriateness. This meant by
and large that the time-honored relationships between the different wages
were maintained, and that any such change in the relative wages of the vari-
ous groups as was required by changed circumstances had become effectively
impossible. As things stood then, full employment could doubtless have been
attained only by bringing some real wages—possibly those of numerous
groups of workers—down from the level they had reached as a result of defla-
tion. It is not certain, however, that this would necessarily have meant a
decrease in the average level of real wages. Perhaps the adjustment of the
structure of the entire economy brought about by the wage changes would
have made this unnecessary. In any event, the emphasis that was customary,
then as now, on the average real wage
of all a country’s workers pre-
vented this possibility from even being considered seriously.
It is perhaps useful to consider the problem from a broader perspective. It
seems to me impossible to doubt that the productivity of a country’s labor,
and thereby the wage level at which full employment is possible, depend on
the distribution of workers among the various branches of industry, and that
this distribution is in turn determined by the wage structure. But if this wage
structure has become more or less rigid, this will prevent or delay the econ-
omy’s adjustment to altered circumstances. It is thus to be assumed that, in a
country where the relationships between the various wages have been kept
rigid for a long period of time, the real wage level at which full employment
can be attained will be considerably below what it would be if wages were
It appears to me that a completely rigid wage structure would prevent
adjustment to changes in other conditions, particularly without the rapid
technological progress we are used to today. This also concerns especially the
adjustment to those changes that must occur simply in order to keep the
income level constant. A completely rigid wage structure is therefore liable to
lead to a gradual decrease in the level of real wages at which full employment
can be realized. Unfortunately, I am not familiar with any empirical investiga-
tions of the relationship between wage flexibility and growth. I would expect
such investigations to disclose a high positive correlation between these two
variables—not so much because growth leads to changes in relative wages, but
above all because such changes are the necessary preconditions for that
adjustment to changed conditions that is required by growth.
But the main point, I believe, is that if it is correct that the real wage level
at which full employment is possible depends on the wage structure, and if
the ratios among the various wages remain unchanged as conditions change,
then the real wage level at which full employment comes into existence will
either fall continuously or will not rise as rapidly as would otherwise be pos-
sible. This means that manipulating the real wage level by monetary policy
offers no way out of the difficulties caused by the rigidity of the wage
Nor can a way out be offered by any practically possible “incomes pol-
icy.” Rather, as things turn out, it is precisely the rigidity of the wage struc-
ture brought about by the wage policy of the trade unions in the supposed
interest of their members (or of any notion of “social justice”) that has become
one of the greatest obstacles to an increase in the real income of workers as a
whole; in other words, if the real wages of individuals are prevented from
falling absolutely or at least relatively, the real wage level of workers as a whole
will not rise as quickly as would otherwise be possible.
The classical ideal that John Stuart Mill described in his autobiography as
“full employment at high wages to the whole labouring population” can be
realized only by an economic use of labor, which in turn presupposes freely
fluctuating relative wages. In the place of this ideal, the great man whose
name will probably go down in history as the gravedigger of the British econ-
omy has popularized decreasing the level of real wages through a decrease of
the value of money as a method of attaining full employment while recogniz-
ing the rigidity of the nominal wage structure. In my view, however, the expe-
rience of recent years clearly shows that this method offers only temporary
relief. I believe we should no longer delay attacking the root cause of the prob-
lem. We cannot go on much longer closing our eyes to the fact that the inter-
est of labor as a whole demands that the power of individual trade unions to
maintain the relative position of their members against other workers be
removed. The most important task at present appears to be convincing labor
as a whole that removing the protection of the relative position of individual
groups not only does not threaten the prospects for a rapid increase in the real
wages of labor as a whole, but in fact enhances those prospects.
I will certainly not dispute here that for the foreseeable future it will
remain politically impossible to restore a truly free labor market. Any such
attempt would probably lead to such great conflicts that it could not be seri-
ously considered—at least as long as employers do not collectively guarantee
to maintain their employees’ average real income. But precisely such a guar-
antee, I believe, is the only way of restoring the market to its function of deter-
mining the relative wages of the various groups. Only in this way, it seems to
me, could we hope to induce individual groups of workers to give up the secu-
rity of their particular wage rates, which has become the main obstacle to a
flexible wage structure. Such a collective agreement between employers as a
whole and employees as a whole seems to me a transitional measure deserv-
ing serious consideration, because the outcome would probably show work-
ers how much they could gain from a truly functioning labor market. This
would in turn create the prospect of subsequently eliminating the tedious and
complicated apparatus that would initially have to be created.
What I have in mind is a general contract in which employers as a whole
would promise workers as a whole, initially for a year, their previous real wage
total plus a share of increased profits. Each individual group or individual
worker, however, would receive in his monthly paycheck only a certain part,
say five-sixths, of his previous wage. The rest (together with the agreed-upon
share of the increased total profits of all enterprises) would be distributed in
two additional monthly payments—at the end of the year and after the books
are closed—to the employees of the various firms and branches of the econ-
omy, in proportion to the change in profits that results on the basis on the five-
sixths of wages distributed. I have proposed five-sixths as the share of contin-
uous payments, since this would make possible the payment of a Christmas
bonus at the average level of a month’s income on the basis of a preliminary
estimate of profits, and of a second vacation bonus of approximately the same
amount when the books are closed for the calendar year. For the subsequent
year the average wages of the first year would again be guaranteed, but by the
end of the year every group would be paid only five-sixths of the total amount
paid in the previous year, plus a supplement at the end of the year for each
group based on profits realized in the corresponding industry or firm, and so
Such a procedure would have somewhat the same effect as a restoration
of the free labor market, except that labor would know that its average real
wages could not decrease, but only increase. I would expect that such an indi-
rect re-introduction of the market mechanism for determining the distribution
of workers among industries and firms would bring with it a considerable
acceleration of the increase of the level of average real wages, along with a
stepwise decrease in the real wages of individual groups.
You will believe me when I say that I do not make so unusual a proposal
lightly. But some measure of this kind, I believe, is today the only remaining
way out of the increasing rigidity of the wage structure. This rigidity seems to
me not only the major cause of the increasing economic difficulties of coun-
tries like Great Britain. It also drives such countries deeper and deeper into a
planned and thereby still more rigid economic structure by misleading them
into dabbling with the symptoms through “incomes policies” and the like. It
seems that labor can only gain from such a solution, but I realize of course
that trade union officials would lose through it a large part of their power and
would therefore reject it completely.


This is Hayek's core idea for this lecture. **According to Hayek competition should be understood as a process that helps uncover information. If competition did not exist some market information and facts would remain undiscovered.** >***"The curious fact that the merits of competition cannot be empirically verified in precisely those cases in which it is of interest is also shared by the discovery procedures of science in general. The advantages of established scientific procedures cannot themselves be scientifically demonstrated; they are recognized only because they have actually provided better results than alternative procedures"*** Competition is important because it helps us uncover and use knowledge spread out among many different people. Competition reveals **unpredictable information**, we can’t always test it in a straightforward way but we can see its positive effects in the real world. Competition seems to be even more important in less developed countries because it helps discover new growth opportunities. Developing countries need competition to experiment with new methods and ideas which can yield significant improvements. Central planning often fails because it hinders the process of discovery and slows down economic growth. Equilibrium suggests that everything there is to know is already known. Hayek prefers to use "order" in order to acknowledge that the economy is always evolving and adjusting. Market prices help people coordinate their actions, leading to a more efficient economy. This constant adjustment process is what keeps the economy organized and functioning well. Hayek discusses the problem of wage rigidity and its negative impact on the economy. When wages are fixed and do not change according to market conditions, it can create significant economic issues. This rigidity prevents wages from adjusting to changes in supply and demand. As a result the labor market cannot respond flexibly to economic changes, leading to inefficiencies and unemployment. Hayek suggests a more flexible wage system is necessary to improve economic performance - ex: linking wages to company profits as a way to make them more adaptable. **Catallaxy** refers to the spontaneous order brought about by the market. It's different from a centrally planned economy. Hayek argues that the market order does not serve a hierarchy of objectives but rather accommodates diverse individual goals. Friedrich A. Hayek was an Austrian-British economist and philosopher best known for his defense of classical liberalism and free-market capitalism. Hayek made important contributions to the fields of macroeconomics, political economy, and the study of complex systems. He was awarded the Nobel Prize in Economic Sciences in 1974 for his work on the theory of money and economic fluctuations. His ideas on the limits of central planning and the benefits of decentralized decision-making significantly influenced the shift towards free-market policies in the late 20th century. Learn more here: [Friedrich A. Hayek](https://mises.org/profile/friedrich-hayek) !["hayek"](https://www.libertarianism.org/sites/libertarianism.org/files/styles/featured_image_md_2x/public/2024-03/Hayek%20Image.jpg?itok=oxq7v3MT) In this section Hayek emphasizes that the market should be allowed to function without excessive interference because. The market enables individuals to pursue their goals and adapt to changing circumstances. According to Hayek, policies aimed at achieving social justice lead to inefficiencies and slower economic growth. If we try to control the market too much undermines its ability to function effectively and ultimately harms society as a whole. Traditional economic theories often make the mistake of assuming that the quantities of goods are already known and fixed. Hayek argues that this assumption overlooks the crucial role of competition in discovering what goods are actually scarce and valuable. Market prices signal which goods and services are in demand, helping decide what to produce and how to use resources effectively. Competition is not static; it is a dynamic process that constantly changes based on new information and circumstances. Real competition involves continuous discovery and adaptation. This process helps the economy to respond to new opportunities and challenges, making it more efficient and resilient. Hayek highlights how competition works in practice to allocate resources and drive economic progress. #### TL;DR This is a lecture given by Hayek in 1968. It is one of Hayek’s most important pieces of work that would influence economic policies in the late 20th century. In this lecture, Hayek emphasizes that free markets, through price signals and dynamic adjustments, are more effective at allocating resources and fostering economic growth than central planning and government interventions. The main takeaways: - Competition is valuable because it helps discover unknown information and opportunities. This leads to better economic adjustments and efficient resource allocation. Unlike static models, real competition reveals unpredictable facts that drive progress. - Markets create a dynamic order through the adjustment of individual plans based on price signals. This dynamic process ensures that the economy remains flexible and responsive to changes. - Hayek warns against political efforts to enforce "social justice" through income redistribution and fixed wages, as these can disrupt the competitive process and lead to inefficiencies. The market should function freely to enable diverse individual goals and economic growth.