Monday, May 23, 2011

Knowledge Problem

Governments allocate resources in a fundamentally different way than free individuals behaving cooperatively in voluntary exchange via market capitalism. Individuals acting in their own interest results in a spontanous order guided by prices which reflect tradeoffs based on the knowledge and preferences of millions of individuals. Governments (via democratic processes) allocate resources based on the limited knowledge and preferences of a few voters, elected officials, or appointed bureaucrats. The fundamental problem facing all forms of government including democracies is that centralized decision makers never have enough information or proper incentives to act on the information at hand. As Economist F.A. Hayek (1945) said:

'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 contradictory knowledge which all separate individuals possess'

This is referred to by economists as the 'knowledge problem.'

For more information related to issues regarding democratic decision making, see Public Choice Analysis.  

SOURCES:
The Use of Knowledge in Society
F.A. Hayek
The American Economic Review Vol 35 No 4 (Sept 1945) p. 519-530