“The Use of Knowledge In Society”

1. “The Use of Knowledge In Society” Econ 640, 2006, Barry Brownstein

2. Hayek’s Key Insight: • “The economic problem...is a problem of the utilization of knowledge which is not given to anyone in its totality.” • Economics – can central planning utilize dispersed knowledge and succeed? • Organizations – can hierarchal organizations utilize knowledge? • Our own lives.

3. Prologue: Exploring Your BeliefsAbout Knowledge “ Our ignorance is sobering and boundless. Indeed, it is precisely the staggering progress of the natural sciences which constantly opens our eyes anew to our ignorance…With each step forward, with each new problem which we solve, we not only discover new and unsolved problems, but we also discover that where we believed that we were standing on firm and safe ground, all things are insecure and in a state of flux.”- Karl Popper

4. Exploring Beliefs About Humility • “Greatness lives in each of us - but only in proportion to the degree we don’t concern ourselves with it. Or put another way: only in proportion to the degree we focus on the greatness that is in others” - Warner • “He who is taken by his own cleverness makes one both wary and weary.” -Warner • “Brilliance that is blind to its own brilliance inspires.” – Terry Warner

5. Gratitude • “I am wearing clothes others made for me, eating food others grew and prepared for me, using tools others designed…speaking words others defined and explained.” –David Reynolds

6. Beliefs About Freedom to Pursue Ends • The pursuit of our own ends is completely dependent on the fact that others have been free to pursue their own ends. • Yet some absurdly forget thus and frequently assume others are misguided and that they should plan for them. This is the “fatal conceit.” • “To plan for others by making them conform to our plan for them is to restrict how they may use their own knowledge for themselves and for those with whom they would freely interact. It hinders what new knowledge and use of it they might uncover in their various everyday activities if they were at liberty to plan their own lives.”

7. a given cause or action can have many different outcomes • synergistic • very sensitive to initial conditions • open, self-organizing systems far from equilibrium; allows for discovery • inherently unpredictable • a given cause (action) has one effect (outcome) • additive • not highly sensitive to initial conditions • closed system in equilibrium • predictable Newtonian (Linear) vs. Complex Systems

8. What is the Economic Problem? • “The economic problem...is a problem of the utilization of knowledge which is not given to anyone in its totality.”- Hayek

9. Knowledge Is Dispersed • “...the knowledge of the circumstances of which we must make use never exists in concentrated or integrated forms but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.” - Hayek

10. Not All Knowledge is “Scientific” (Textbook) • ‘the unorganized knowledge… of the particular circumstances of time and place.” • “tacit” knowledge is inarticulable- “we know a great deal that we cannot tell.” • examples-riding a bicycle, grammatical rules, medical diagnosis. • “The rate at which we develop knowledge is crucial to our competitive success. ..The organizational design must enhance the amount of distributed, implicit knowledge contained within the company.”- McMaster

11. Central Planning Vs. Markets • “Which system “ is likely to be more efficient depends mainly on the question under which of them we can expect the fuller use be made of the existing knowledge.” • “If ... the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place, it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances…”

12. Decisions made at the top Communication goes through ‘proper channels’ resistance to new ideas Decisions made by those with ‘best’ local knowledge new ideas welcomed and filtered responsibilities and incentives to generate new knowledge new knowledge may invalidate current beliefs and practices Planning Vs. ‘Markets’ in the Firm

13. “In the Box” about Organizations • “Our corporations have used only one model in recent history. And because of this we think only in terms of hierarchy, positions of authority, command and control and limited access to information. • “it’s very easy to speculate about alternative forms of organization… However, we find it very difficult to take them it seriously and the idea of putting them into practice is almost unfathomable. When presented with an alternative we can’t imagine it would work…in our situation.”- McMaster

14. Decision Making • “If you can assemble diverse group of people who possess varying degrees of knowledge and insight, you’re better off entrusting it with major decisions rather than leaving it to the hands of one or two people.”- Surowiecki • “Intelligence alone is not enough because intelligence alone cannot guarantee you different perspectives on a problem.” -Surowiecki

15. Groupthink • “Information that might represent a challenge to the conventional wisdom is either excluded or rationalized as obviously mistaken people come away from discussion with their beliefs reinforced, convinced more than ever that they are right.” • “Deliberation in a groupthink setting has the disturbing effect of not opening people’s minds but of closing them.” • “Cognitive diversity is essential to good decision making”

16. The Case of Bruegger’s Bagels • Vermont based Bruegger’s had the nations’ largest market share of bagels • special recipe and baking process • Purchased by Quality Dining, an operator of Burger Kings, in 1996 for $142 million • In less than year lost $203 million or 35cents a bagel and sold the company back for $50 million • Quality had transferred Bruegger’s execs to Indiana providing no phones and little office space

17. Epilogue: Do You Rely on Financial Experts? • Do you believe that Jim Cramer (Mad Money –CNBC) really can forecast all those stocks or do you believe he is an entertainer? • Do you find yourself repeating the financial views of “experts” such as “Housing prices may stop growing as quickly but prices will not fall?”

18. Psychology of Bubbles • “People all around me are getting wealthy so why shouldn't I ?” • “See how clever I am, see how much money I've made.” • “Everyone (including the media) says that (fill in the blank is a good investment.” • “I will be branded a fool and people will get angry, if I talk about a bubble to people.”

19. Forecasting • “..the knowledge of the circumstances of which we must make use never exists in the concentrated or integrated form…” • “Seer–sucker theory – no matter how much evidence exists that seers do not exist, suckers will pay for the existence of seers” • Q. In a ‘average’ year of interest volatility, if you invested a $1000 in treasury bill futures and were correct about the direction of interest rates for 52 straight weeks how much money would you have?

20. T- Bill Question • Week 1 –On Monday buy (if you expect interest rates to fall) or sell (if you expect interest rates to rise). On Friday close out your position. • Week 2- Begin with $1000 plus your winnings from Week 1 and buy or sell the futures contract. • Week 3 –Week 52 etc.

21. A “Taxis” Fallacy: The Fallacy of “They” • We hear: “They” are buying; are selling. They” are never wrong. “They” manipulate markets and prices. • Who are “they”? – the “big fellows in New York” etc. • “They” are but a ripple in an ocean of the market made up of unseen economic forces far more powerful than any group can control.” • The public blames “they” for their own ignorance when they buy high or sell low.

22. If A causes B, then A occurred before B. Event A occurred before event B. Therefore, A caused B. If oil price gains cause stock price losses, then oil gains occurred before stock losses. Oil rose before stocks fell. Therefore, oil gains caused stock losses. Post Hoc Ergo Propter Hoc, or “After This Therefore Because of This." Correlation does not imply causation!

23. Does Bernanke Drive Markets? • These three headlines were all issued on 10/24/05 • “Dollar Turns higher after Bernanke named Fed chief.” • “Dollar Steady after Bernanke named Fed chief.” • “Dollar Declines as Bush Nominates Bernanke.”