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“I Prefer A True But Imperfect Knowledge…To A Pretence Of Exact Knowledge That Is Likely To Be False”

March 14, 2012

I was sitting in a meeting at work at the height of the chaos that was the financial sector and housing meltdown in 2008. Banks were failing, huge firms openly wondered if they’d be able to make their next payroll. Some of the most powerful people on earth were basically groping around in the dark hoping their various bailout plans would solve their self-made problems. I was controller of a midsize company, and we were all chatting before the meeting began, and our CEO spoke about a meeting she’d recently been to with some very smart, wealthy people from the financial sector. She related how they said no one had seen this coming, that the smartest financial minds in the world had been fooled. And no one was quite sure what to do now.

The last time the US economy faced such a daunting and depressing economy was the 1970s. Prevailing economic wisdom had gotten us into a mess, and was unequipped to get us out. In 1974 a once famous but now largely forgotten economist was awarded the Nobel prize, and in his acceptance speech he coined the phrase, “Pretence of Knowledge”. In context of today’s economic malaise, it has added significance.

In his speech, Friedrich von Hayek spoke forcefully against the growing belief that through advanced mathematical models the economic profession could steer the economy. He doesn’t completely reject all mathematical method, but rather argues these methods give us general understanding of how the economy works, and what the ingredients are that make a good economy. But it doesn’t, and cannot, tell us what the exact recipe for a good economy is. We know a healthy economy needs flour, but we don’t know how much. And if we don’t know that baseline, then any fiddling with the amount of flour is pure guesswork. It could be too much or too little, we simply don’t know. And not knowing, and acting anyway, can be disastrous.

Hayek used “some ball game” as an example of this. As this is timely, I’ll distill the “ball game” further into March Madness. There are 68 teams from all over the country playing in this basketball tournament. Millions of people are filling out their brackets and entering them into both friendly and competitive competitions testing their predictive abilities. Hayek argues we can know what particular factors make a winning basketball team, but,

“If we knew a few particular facts in addition to our general knowledge of the ability of the individual players, such as their state of attention, their perceptions and the state of their hearts, lungs, muscles etc. at each moment of the game, we could probably predict the outcome. Indeed, if we were familiar both with the game and the teams we should probably have a fairly shrewd idea on what the outcome will depend. But we shall of course not be able to ascertain those facts and in consequence the result of the game will be outside the range of the scientifically predictable, however well we may know what effects particular events would have on the result of the game.”

A simple tournament consisting of 68 teams is much too complicated for anyone to predict with any authority, though many try. Look at the brackets of the professional pundits, who have watched these teams play all year long, are intricately aware of their various strengths, weakness, and tendencies – and yet their picks vary significantly. There is no agreement on who will even win the tournament, let alone who will win every game. I fill out a bracket every year. But even were I to simply copy the bracket of one of these basketball experts, I wouldn’t bet my future on it being right. Yet that’s what we do every time we ask the federal government to “improve the economy”, or pass some sort of stimulus or “jobs bill”.

And that is how we have enabled government actors to harm the economy. We constantly look to them to predict outcomes that are unknowable. We ask them for perfect brackets. We expect them to know if the economy needs more flour or less, when they don’t even have a basic recipe to go off of. In Hayek’s words,

“so long as the public expects more there will always be some who will pretend, and perhaps honestly believe, that they can do more to meet popular demands than is really in their power.”

In the early 2000s the economy ended what had been a boom time, and crept into a recession. In hindsight, the boom had various causes, not the least of which was the internet bubble. Of course, economists of all stripes weighed in on what should be done. One such was Paul Krugman. He was an economist of world renown who would go on to win the Nobel prize in 2008. He said that the recession was caused by too little business investment, the prospects for more of it weren’t good, and the only avenue to avoid a double dip recession was to spur consumer spending. While expressing some doubt it could be done, Krugman said,

“to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”

In actuality, Greenspan was able to create a housing bubble. And when it popped it created the largest recession we’ve known for decades.

This is the very thing Hayek was warning of. Our “pretense of knowledge” of where the economy was and what its ailments were. We poured in more flour, when perhaps it needed less. We bet the farm on our bracket, and we went bust.

And we still haven’t learned our lesson! Barack Obama was swept into office largely on the back of a terrible economy and a hope for change. What we got, in the first part of 2009, was more economic hubris. President Obama and Congress quickly passed a “stimulus” bill, which was designed to quickly stimulate the economy through debt financed government spending in certain sectors. That in itself is contrary to a humble interpretation of what is in the power of the field of economics. But in addition to the vague belief that spending would help somehow, in some way, the administration produced a graph predicting actual unemployment rates, down to a decimal point, of what would happen with and without this stimulus spending. Within a matter of months this graph was proven laughably inaccurate. And now, three and a half years later, we are mired in economic stagnation and huge debt. The economy is growing at a crawl, job growth barely keeps up with population, and our national debt is now as big as the entire US economy.

After the stagflation of the 70s, some of what Hayek talked about was incorporated into the public and government mindset. But clearly not enough. We are too afraid of recession, and think too much of our predictive models, to let the economy manage itself. Hopefully this latest economic running aground will be enough for us to find strength in humility.

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From → Economy, Politics

One Comment
  1. Love “A Pretense of Knowledge” by Hayek. (http://publiusonline.com/2012/02/review-a-free-market-monetary-system-and-a-pretense-of-knowledge-by-friedrich-a-hayak/)

    But really, what I’d like to know is: what do you think about a non-accountant (Dougall) on the line for state auditor? Does it make sense?

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