inadequacy of the price form


Prices, according to Hayek, provide the telecoms system of the economy. But how adequate is this telecoms system and how much information can it really transmit?

Hayek's example of the tin market bears careful examination. Two preliminary points should be made. First, the market system does manage to achieve a reasonable degree of coordination of economic activities. The ``anarchy of the market'' (Marx) is far from total chaos. Second, even in a planned system there will always be scope for the disappointment of expectations, for projects that looked promising ex ante to turn out to be failures and so on. Failures of coordination are not confined to market systems. That said, it is nonetheless clear that Hayek grossly overstates his case. In order to make rational decisions relating to changing one's usage of tin, one has to know whether a rise in price is likely to be permanent or transient, and that requires knowing <#336#>why<#336#> the price has risen. The current price signal is never enough in itself. Has tin become more expensive temporarily, due, say, to a strike by the tin miners? Or are we approaching the exhaustion of readily available reserves? Actions that are rational in the one case will be quite inappropriate in the other.

Prices <#337#>in themselves<#337#> provide adequate knowledge for rational calculation only if they are at their long-run equilibrium levels, but of course for Hayek they never are. On this point it is useful to refer back to Hayek's own theory of the trade cycle (Hayek, 1935; see also Lawlor and Horn, 1992; Cottrell, 1994), in which the `misinformation' conveyed by disequilibrium prices can cause very substantial macroeconomic distortions. In Hayek's cycle theory, the disequilibrium price that can do such damage is the rate of interest, but clearly the same sort of argument applies at the micro level too. Decentralised profit-maximising responses to unsustainable prices for tin or RAM chips are equally capable of generating misinvestment and subsequent chaos.

At minimum, prices may be said to carry information regarding the terms on which various commodities may currently be exchanged, via the mediation of money (so long as markets markets clear, which is not always the case). It does not follow, however, that a knowledge of these exchange ratios enable agents to calculate the profitability, let alone the social usefulness, of producing various commodities. A commodity can be produced at profit if its price exceeds the sum of the prices of the inputs required to produce it, using the production method which yields the least such sum, but the use of current prices in this calculation is legitimate only in a static context: either prices are unchanging or production and sale take zero time. Hayek, of course, stresses constant change as the rule, so he is hardly in a position to entertain this sort of assumption. Whether production of commodity <#338#>x<#338#> will in fact prove profitable or not depends on future prices as well as current prices. And whether production of <#339#>x<#339#> currently appears profitable depends on current expectations of future prices.

If we start from the assumption that prices will almost certainly not remain unchanged in future, how are agents supposed to form their expectations? One possibility is that they are able to gather sufficient relevant information to make a definite forecast of the changes that are likely to occur. This clearly requires that they know much more than just current prices. They must know the process whereby prices are formed, and form forecasts of the evolution of the various factors (at any rate, the more important of them) that bear upon price determination. Hayek's informational minimalism is then substantially breached. A second possibility is that described by Keynes (1936, esp. chapter 12): agents are so much in the dark on the future that, although they are sure that some (unspecified) change will occur, they fall back upon the convention of assuming that tomorrow's prices will equal today's. This enables them to form a conventional assessment of the profitability of producing various commodities, using current price information alone; but the cost of this approach (from the standpoint of a defender of the efficiency of the market) is the recognition that those ex ante assessments will be regularly and perhaps substantially wrong.