Hayek: Economic models in the context of a pandemic and the information society
Phuah Eng Chye (24 October 2020)
During the 1940s when scientific planning, conscious organization of industry and socialism were fashionable, Friedrich A. Hayek argued it was a fallacy to believe a whole economic system could be directed “according to one unified plan”. He warned central planning could lead towards totalitarianism and that socialism and individual freedom were at odds with each other as “individual freedom cannot be reconciled with the supremacy of one single purpose to which the whole of society is permanently subordinated”. Friedrich A. Hayek’s seminal work The road to serfdom espoused economic and political beliefs remains influential in economic thinking.
Friedrich A. Hayek’s advocacy of a liberal democracy underpinned by individual freedoms and a free market supported by competition, private property rights and the rule of law represents the core principles of the Western model. “The guiding principle in any attempt to create a world of free men must be this: A policy of freedom for the individual is the only truly progressive policy”. He concludes that “who does not see this has not yet grasped the full width of the gulf which separates totalitarianism from the essentially individualist Western civilization”.
Hayek’s thesis drew the battle line between the Western and centrally planned models. His economic insights proved prescient. Noah Smith notes “the 20th century represented the triumph of mixed economies over central planning…Communist states…suffered various degrees of economic failure amid rigid central control of the economy. Meanwhile, countries that relied on government regulation and fiscal redistribution simply to smooth out capitalism’s rough edges…experienced political stability and rising living standards. Democratic countries that experimented with extensive nationalization of industry or pervasive regulation…struggled until they implemented market reforms. Meanwhile, the spectacular results of China’s own market liberalization are well known”.
Noah Smith argues markets work because of “three big advantages over Soviet-style central planning. The first is information. Market prices tell companies what consumers want, preventing them from wasting resources on useless stuff. Prices also tell producers how to be more efficient and hold down costs. All of that tends to increase the productivity of an economy. The second benefit of markets is competition. This pushes down consumer prices, and it also drives companies to innovate, develop new products and find better ways of making things. The third benefit is trade. Different regions can specialize in making different products, allowing greater efficiency and more variety”. In this regard, “information, competition and trade were all sorely lacking in the insular, centrally planned economies of the communist bloc during the Cold War”.
Economic models in the pandemic
The pandemic can be regarded as a litmus test of the coordination abilities of the different economic models. The Western economies were regarded as more advanced and their inability to contain the pandemic came very much as a surprise. Joseph E. Stiglitz noted mystification “at the apparent shortages of N95 masks, protective gear, ventilators…After all, aren’t markets supposed to respond quickly and efficiently to changes in demand?” He explains “markets work well, when everything is going smoothly, when things are normal. But markets don’t work well in crises…The 2008 financial crisis was a quintessential example. No country in times of serious war turns to markets…We needed immediate action, with complex coordination and changing demands; markets just don’t work well in these circumstances”. “Moreover, markets are short-sighted and risk averse – and the market mechanisms for looking into the future and managing risks are very deficient. And that private risk aversion and that extreme short sightedness gives rise a large discrepancy between social and private returns. Society would like to have an excess supply of masks or ventilators just in case…The cost of storage is infinitesimal compared to the costs of not having these supplies on hand, and a well-functioning government would have recognized this and planned accordingly. On the other hand, a private firm producing these just in case they might be needed could well go bankrupt…Even now that the demand is so clear, companies may be slow to step forward. They know that if they charge much more than the normal prices, they’ll be accused of price gouging…Can they recover the large costs of quickly expanding capacity for a rush of production now at normal prices? Many will judge that the answer is no…Hopefully, enough firms will step forward to meet our urgent supplies. But if not, we shouldn’t hesitate to use the war-time powers of the government to commandeer the necessary resources”.
Some argue the pandemic exposed the frailties of capitalism. They criticised privatisation (and private equity), share buybacks, outsourcing, temp employment, and fiscal, welfare and pension cuts as having eroded the public and private buffers that would have worked to mitigate the social stress. Philippe Aghion, Helene Maghin and André Sapir argue the pandemic thus served “as a wake-up call for reforming capitalism…In the US, the epidemic has brought into focus the tragedy of all those individuals who are not insured – or only badly insured – against job losses and health problems. In Europe, the crisis has shed light on the rigidities and lack of coordination in the innovation response to the Covid shock. Unavoidably, the crisis has prompted existential debates on how to think about the after-Covid world.” In this regard, the US model is “good for innovation but generates inequality not only in income but also in employment and health protection” while the Western European models are “better at redistributing income and at protecting employment and health but worse at producing frontier innovation”.
The Western models were also subject to the existential from economic maturity such as aging, stagnation, deindustrialisation and inequality. In relation to this, high costs and litigation risks were major factors impeding coordination. So far, Western governments have responded to the pandemic by literally throwing money and fiscal spending. Longer-term, Western governments need to face up to difficult policy reality of unwinding interventions, getting markets to work again and adjusting to economies that are likely to be smaller and less vibrant than before.
But the most troubling phenomenon in the Western countries were the displays of inept leadership and administration, the lack of accountability, the politicization of public health measures (how does mask wearing even become an issue) and the denial of science and data. The Western political system seemed to have gone astray and this has damaged their ability to coordinate effectively against the pandemic.
In contrast, China’s strengths at coordination were on display. But the credit may not belong to central planning. First, the difference is more geographical than ideological. Andrew Salmon notes “East Asia has been far more adept at pandemic management than the West. This runs across all key metrics and by massive differentials”; particularly on fatality rates. This was attributed to the disease containment experience which “granted East Asia an edge in its response”. East Asia also enjoys the advantage of its manufacturing and digital capabilities and stricter control on cross-border movements as compared to the EU and US.
Andrew Salmon suggest “East Asian nations share a Sinic-influenced, Confucian culture of collectivism and group identity, bolstered by greater levels of ethnic homogeneity than exist in the West. While politics may override culture in authoritarian Asian states, cultural factors may contribute to civic consciousness in democratic Asian states. Such attitudes are visible in low rates of street crime and in widespread acceptance of nanny state governance and of dirigiste economic management. Broadly, these various factors point to the trend of East Asians being more responsive to rules than individualistic Westerners”. In addition, “the leadership, in general, has been less politicized and more effective in the East than in the West…Indeed, there have been policy shifts, clashes with experts and inconsistent messaging by Western leaders”. Andrew Salmon however cautions jumping to conclusions as “the East-West disparity combines a bewildering multiplicity of facets”.
This was the case for Africa as well. Maru Mormina and Ifeanyi M Nsofor notes “as industrialised countries have struggled, much of the developing world has quietly shown remarkable levels of preparedness and creativity during the pandemic”. They highlight several factors: “different approaches to recording deaths, Africa’s young demographic profile, greater use of outdoor spaces, or possibly even high levels of potentially protective antibodies gained from other infections”. Most of all, African countries benefitted from prior experience managing other infectious diseases. They cooperated on testing and established “a continent-wide platform for procuring laboratory and medical supplies”.
Second, China has nurtured a vibrant private sector and is no longer a “pure” centrally planned economy. It is interesting to observe the coordination between the government and private sector. Chen Kang notes it is taken “for granted that the government should be responsible for governing the country and managing all matters of public interest. However, governance issues are becoming more complex and the needs and interests of the people more diverse…Since the 1990s, public management theories have emphasised the importance of mobilisation beyond that of the government. Governance in recent years requires the government, private enterprises and social organisations to cooperate with each other and leverage on their respective strengths. Comparable to a three-legged stool, each and every leg is indispensable”.
Chen Kang describes how China’s central government mobilised resources quickly to manage the lockdown of Wuhan city – dispatching medical personnel and supplies and expanding hospital capacity. “Although the Wuhan lockdown was meticulously planned, there were inevitable oversights in its implementation due to different perceptions on goals and information asymmetry in the process”. Gaps emerged. “When donated supplies suddenly came in from all parts of the country, it created a logistic bottleneck…government ordered that all donated supplies had to be centrally managed…had insufficient manpower and lacked experience. As a result, logistics was paralysed, and the donated supplies were stranded in warehouses and remained undistributed…Eventually, the government had to ask a private pharmaceutical logistics company to take over the processing of the donated supplies and their distribution…the private enterprise professionally processed and distributed the emergency supplies within two hours of their arrival”. Donated vegetables were handed “to three major commercial supermarkets for sale at a fair price, with the collected revenue turned over to the Wuhan Municipal Bureau of Finance Affairs as funds for epidemic control. In addition to avoiding complicated distribution schemes, this innovative model also reduced unnecessary wastage and transaction costs”. Other examples include organising “volunteer drivers to pick up doctors and nurses to and from work, while other companies provided shared bicycles and electric cars”. Similar efforts were made to distribute donated supply of meals, sanitary panties and disposable underwear to medical personnel; the purchase and delivery of medication to chronic disease patients; support to assist migrant workers; and the provision of counselling services.
However, he notes social efforts can be “uncoordinated, and their ability to verify information and organise resources was also lacking. For example, some volunteers who wanted to help stranded people expended considerable effort to coordinate the transport and distribution of supplies, only to discover upon arrival that the intended recipients were no longer at the destination”. Chen Kang argues “evidently, it is impossible for the government to spearhead and implement everything”. “Social organisations have the advantages of their proximity to the people, timely problem detection and operational flexibility, which enable them to play an indispensable role in public governance”. “In fact, as contributing to society becomes more commonplace, many companies are setting up corporate social responsibility departments to deal with matters of public interest”.
Third, coordination with the government can be replaced by self-organisation even when the public’s relationships with the government are antagonistic. Zeynep Tufekci highlights that “seared with the memory of SARS, and already mobilized for the past year against their unpopular government, the city’s citizens acted swiftly, collectively, and efficiently, in effect saving themselves. The organizational capacity and the civic infrastructure built by the protest movement played a central role in Hong Kong’s grassroots response”. “On the very day the first known coronavirus case in Hong Kong was announced, the same protest team behind the candidate information sites immediately created a new website – this time to track cases of COVID-19, monitor hot spots, warn people of places selling fake PPE, and report hospital wait times and other relevant information. In response to the crisis, Hong Kongers spontaneously adopted near-universal masking on their own, defying the government’s ban on masks…the foot soldiers of the protest movement set up mask brigades – acquiring and distributing masks…shared digital maps that kept track of police blockades and clashes; now digital maps kept track of outbreaks and hand-sanitizer distribution”.
Zeynep Tufekci notes “when the government refused at first to close the border with mainland China, more than 7,000 medical workers went on an unprecedented strike, demanding border closures and PPE for hospital workers…Some of the signals to the government were decidedly more confrontational. Through Telegram channels, “anti-epidemic actions” were threatened if the government did not respond to the virus by closing down borders”. Volunteers sanitized “the subdivided flats that Hong Kong’s own working poor inhabit using UVC lights…collectively organizing ordering takeout from beleaguered restaurants that suffered in the past few months, hoping to help them survive this crisis…Hong Kong also teaches that people aren’t helpless, even when their government isn’t helpful”.
Fourth, the pandemic highlights the blurring distinctions between market and centrally planned economies. Winston Mok notes “despite the rhetoric, we may be witnessing a convergence of economic policies in responding to Covid-19. While nations may be distancing from one another, their policy practices may be getting closer on the ideological spectrum…Italy and Spain had no choice but to adopt the Chinese model of lockdown…some Western economies have been decidedly socialistic. Through wage subsidies, payroll has been nationalised in some European countries to save jobs. Even the United States has resorted to universal basic income”. Western economies are also re-adopting industrial policies “to reduce reliance on a China-centric supply chain”. This includes setting up funds to spur state-directed investments, relaxing state-aid rules and even nationalising companies.
Winston Mok notes “in contrast, China has offered modest support beyond its limited unemployment safety net. China’s many migrant workers who do not have work contracts or contribute to the unemployment insurance scheme are essentially self-insured…China has not spent too much on alleviating short-term hardships for what may be long-term structural adjustment problems. China’s government subsidies are more for worker retraining than mere worker retention. Fully recognising the capitalistic logic of creative destruction, the pandemic being the latest impetus, China has saved its bullets for supporting enterprises amid the downturn”.
Overall, the pandemic has blemished the reputation of the Western models. It has re-awakened interest in the provision of public goods and broadened support for enlarging the role of the state. In this context, as overlaps between governments and the private sector; and between planning and markets grows, the debate on merits of different models becomes irrelevant.
Economic models in the information society
The debate on economic coordination should be reframed within the context of a transition from an industrial state to an information society. Hayek’s views on economic models were set during an era of industrialisation, large households and traditional values in the 1950s. The landscape had changed dramatically. In the information society, coordination works differently because information is abundant. Coordination falters if regimes, regardless of ideology, don’t respond to the new realities from changing economic organisation.
Noah Smith argues “the 21st century may turn out very differently” in advanced economies because of service sector domination. “The service industries of the future may not be as subject to the magic of free markets as agriculture and manufacturing. Prices in health care are not very good signals of cost and value because of asymmetric information, uncertainty and other problems; this is why you don’t often see people price-shopping for health services…the service industries of the future may not benefit nearly as much from market discipline as the physical industries of the past. That may be why prices for big-ticket service items haven’t been driven down the way prices for physical goods have”. “The structural shift to service economies might thus give socialism an advantage it never enjoyed in the 20th century”.
In this context, Western economies experience deflationary pressures for industrial goods and Baumol cost-type increases for services. These weaknesses are not inherent in the Western model but arise from economic maturity[1]; including the effects of financialisation and aging. The Asian variants are not immune either. Japan was the earliest to experience extended deflation. It is likely other Asian economies, including China, will eventually succumb to the afflictions of economic maturity.
The landscape change extends beyond pricing effects. Nicholas Gruen suggests the notion that markets supply private goods and governments supply public goods “ignores how profoundly individual and collective endeavour are enmeshed”. “In areas like education, health, aged care, finance, research, legal services and cultural industries like the arts, and in networks like media, transport, energy, telecommunications and other infrastructure, and in city planning, output is better thought of as the joint product of competitive and collective (collaborative and regulatory) activity”.
In this regard, Nicholas Gruen notes “the internet is reconfiguring the ecology of public and private goods. Digital artefacts, like language, are potential public goods – available for endless, costless reuse…the free-rider opportunity afforded by the internet now so overwhelms the free-rider problem that monetising a small fraction of a public good via advertising has made their owners vastly richer than they’d have been if they’d obsessed about free riders, as our policy debate does, and provided their services as private goods for a fee”. He suggests there are opportunities for “a whole class of digital public goods delivered by public–private partnership” but acknowledges the difficulty of getting support for such projects.
The modalities of coordination have also altered. Mary Harrington suggest the norm of “reciprocal social connections…conferring binding obligations” have been replaced by a “transactional lens, in which it was proper to disregard such considerations in favour of the asset-owner’s right to maximise economic gain”. In this regard, the platform economy has created “a mobile, liquid and creative economy, in which growth and innovation are unleashed to drive new gains. Economic relations are freely entered into by autonomous individuals and organisations, via agreements enforced by contracts, all founded on a presumption that each entity involved is – as is proper – engaged in the pursuit of its own interest”. This “enabled the release of considerable economic value that had previously been constrained by social limits”. But she cautions “the solution cannot be socialism, or indeed a massive wealth transfer to asset owners under the sign of socialism…We need to talk about how about how we incentivise prosocial corporate behaviour…we must now grasp the nettle of about re-institutionalising social purpose, and social obligations, in the world of commerce”.
Nicholas Gruen suggest “these issues concern the arteries of our information economy…they’re largely absent in our reform conversation…When markets work, they do so miraculously by harnessing the information distributed throughout society. Yet they also corrupt information flows wherever one side has better information than another – say, about the shoddy product they’re selling. So solutions to these problems must be pragmatic hybrids of competition and collaboration – accessing and leveraging local knowledge while minimising conflicts of interest throughout the production chain”.
In this context, Nicholas Gruen thinks that “around the Western world information policy is mostly stuck in early prototype. Thus, governments issue crude edicts with little care for their effectiveness[2]”. “We should be asking how we could build institutions to get important information to people in ways they can use. We already know the recent on-time departure rates for airlines, for instance, and the workers’ compensation premiums of firms, which offer a good proxy for workplace safety. What kinds of institutions would build routines to bring this and other relevant information to the attention of those who need it – buyers of airline tickets and prospective employees respectively – when they need it? We could begin without cumbersome regulatory edicts – with groups of industry and user representatives developing disclosure standards – and with governments and other civil society institutions using their convening power to forge greater regard for the collective public good (the standard) so competition between providers is actually in pursuit of something of value. We’d talk and experiment our way to better information flows and better lives. Isn’t this better than ideological barracking for free markets or intervention?”
The transition from industrial to an information society has thus changed the context of Hayek’s notion of a liberal democracy with free markets. Political regimes have become detached from economic regimes. In the 1950s, communism and socialism were ideologies to unite industrial workers and peasants against capitalist exploitation. Today’s rivalries are defined mainly in terms of geographies and values. Workers in the West see workers in the East as rivals rather than allies. Ideological differences have given way to geo-political competition between an incumbent Western order and a rising Asia.
The transition to an information society has also changed the context of economic challenges. An industrial economy is characterised by scarcity. Scarcity implies ample space to accommodate the expansion of private rights – ownership of assets, privacy and freedoms. An information society is abundant. Information effects – such as intangibility transparency, speed, polarisation, concentration-fragmentation, convergence, complexity – generates a range of different challenges. Modern societies are confronted by challenges from information and regulatory overload and constrained by shortened time frames. This implies that space can get crowded out very quickly. This increases the risks of collision between competing public and private claims. In a totalitarian regime, these conflicts are quickly resolved by top-down dictate. But in a liberal democracy, these conflicts can impede spontaneity and coordination.
Conclusions
The pandemic experience suggests markets do not function well on their own in a crisis. Government intervention is needed and the question arises as to whether the respective governments are focused and disciplined enough to coordinate an effective intervention. The pandemic also acts as an accelerated form of creative destruction speeding up the transition to an information society. The changing context of Hayek’s hypothesis is thus reflected by the emergence of global platforms as the latest threat to free markets and democracy.
These developments signal a decoupling between ideological regimes and economic coordination is taking place. In this regard, information is essential for coordination. One key feature of information is it is autonomous and therefore choice of ideology is irrelevant. Economies more adept at using information will be able to coordinate effectively, have better ability to innovate and scale, and generate higher levels of economic activity and prosperity. In this regard, the future of economies will be highly influenced by the rules they set on the use of information.
References
Andrew Salmon (16 May 2020) “Why East beat West on Covid-19 (Parts 1 & 2)”. Asia Times. https://asiatimes.com/2020/05/why-east-beat-west-on-covid-19/
Chen Kang (12 March 2020) “Power of the people invaluable in China’s fight against Covid-19”. ThinkChina. https://www.thinkchina.sg/power-people-invaluable-chinas-fight-against-covid-19
Joseph E. Stiglitz (27 March 2020) “Why our affluent society is facing shortages in the face of the coronavirus pandemic”? Time. https://time.com/5811505/affluent-society-shortages-coronavirus-pandemic/?utm_source=reddit.com
Friedrich A. Hayek (1944) The road to serfdom. The collected works of Hayek. Volume II. The University of Chicago Press. https://fee.org/resources/the-road-to-serfdom-condensed-edition/?itm_source=parsely-api
Friedrich A. Hayek (1945) “The use of knowledge in society”. The American Economic Review. https://fee.org/articles/the-use-of-knowledge-in-society/
Maru Mormina, Ifeanyi M Nsofor (22 October 2020) “What developing countries can teach rich countries about how to respond to a pandemic”. Originally published at The Conversation. https://www.nakedcapitalism.com/2020/10/what-developing-countries-can-teach-rich-countries-about-how-to-respond-to-a-pandemic.html
Mary Harrington (2 April 2020) “It can’t be big business as usual after coronavirus”. Unherd. https://unherd.com/2020/04/it-cant-be-big-business-as-usual-after-coronavirus/
Nicholas Gruen (28 August 2018) “The irredeemable in pursuit of the insatiable”. Inside Story. https://insidestory.org.au/the-irredeemable-in-pursuit-of-the-insatiable/
Noah Smith (30 January 2020) “Socialism may be just what the service economy needs”. Bloomberg. https://www.bloomberg.com/opinion/articles/2020-01-30/socialism-may-be-just-what-the-service-economy-needs
Philippe Aghion, Helene Maghin, André Sapir (25 June 2020) “Covid and the nature of capitalism”. Voxeu. https://voxeu.org/article/covid-and-nature-capitalism
Phuah Eng Chye (2015) Policy paradigms for the anorexic and financialised economy: Managing the transition to an information society.
Phuah Eng Chye (14 September 2019) “Information and development: Escaping the industrial maturity trap and moving forward to an information society”.
Phuah Eng Chye (9 November 2019) “Information and organisation: China’s surveillance state growth model (Part 1: China’s state model)”.
Phuah Eng Chye (23 November 2019) “Information and organisation: China’s surveillance state growth model (Part 2: The clash of models)”.
Phuah Eng Chye (4 July 2020) “Government of the Data (Part 3: The future of government platforms)”. http://economicsofinformationsociety.com/government-of-the-data-part-3-the-future-of-government-platforms/
Phuah Eng Chye (10 October 2020) “Hayek: The coordination problem, prices and information”. http://economicsofinformationsociety.com/hayek-the-coordination-problem-prices-and-information/
Winston Mok (9 June 2020) “World economic divide blurs as US, Europe step up state aid and China optimises market efficiency”. SCMP. https://www.scmp.com/comment/opinion/article/3087793/world-economic-divide-blurs-us-europe-step-state-aid-and-china
Zeynep Tufekci (12 May 2020) “How Hong Kong did it”. The Atlantic. https://www.theatlantic.com/technology/archive/2020/05/how-hong-kong-beating-coronavirus/611524/
[1] See “Information and development: Escaping the industrial maturity trap and moving forward to an information society”; “Economics of data (Part 4: The data economy)”.
[2] Nicholas Gruen. “In finance, for instance, mandated product disclosure statements for investments cost the economy billions annually, but go virtually unread. Meanwhile, as the scandals about financial advice surge from time to time, new regulation is developed. But it always resembles a PR makeover rather than serious policy action”.