The economy organises itself: organisation without an organiser
The economy self-organises, it requires the direction neither of Socialist Planner nor Walrasian Auctioneer. It emerges from individual decisions to pursue mutually beneficial exchange on the basis of their localised knowledge and, in a liberal society, reveals valuable information about what society as a whole deems the best state of economic affairs. Illiberal policies confound this process and suppose the interventionist has better knowledge than the individuals involved.
Self-organisation has a vague whiff of magic about it. How can there be organisation without an organiser? How can order emerge from within?
The evidence is that it certainly can, just look at our economies. No government or person could plan the whole thing, or organise it day to day. Even the simplest products involve mind-bogglingly complex webs of interactions to produce. And yet there is no organiser but the system itself.
There is a famous story (though I cannot seem to find the reference) of a Soviet commissar leaving the British officials who were showing him around London bemused by a question: “who is the commissar responsible for milk shipments to London?” The answer of course was nobody. Local milkmen contracted with wholesalers and transporters in transactions likely wholly unknown to Whitehall even while Whitehall itself depended on them.
How do these vast complex systems called economies self-organise to provide us (on the whole) with exactly what we need and desire on a daily basis?
This question obsessed Adam Smith and Friedrich Hayek. The answer they posed became enshrined in a mathematical proof at the core of the “UQ model” of economies as complex evolving networks formed by individuals acting on the basis of their psychology and social position.
The process of self-organisation encoded in the “Smith-Hayek theorem” is what I want to explain to you in this little essay, and to elaborate on some of the salient points of the process which it alerts us to. In particular, it makes us aware of the importance of localised knowledge, the value of mutually beneficial exchange, and the manner in which illiberal policies assume a rather arrogant position about the superiority of the policymaker’s knowledge while confounding the process of self-organisation.
Once again, I have to ask you to bear with me. This is a subtle concept and requires some attention. But in exchange for that I can promise you a little of that burst of joy which can only come from scientific discovery and understanding the deep simplicity of something otherwise mind-boggling.
How self-organisation works: the Smith-Hayek theorem demystified
We’ve seen elsewhere how individuals react to their social position on the basis of their psychology: making tradeoffs or applying rules, being subject to salience, chains and anchors and the persuasions of others. As yet we haven’t considered exactly how that behaviour leads to the formation of economic networks. Luckily, it’s not too difficult understand how the economic networks are formed, at least on the surface.
A connection in the network which is the economy comes to exist between two individuals if one of them decides to exchange goods, services or some form of money to another. Simple as that. It’s really a matter of definition.
But behind the definition is a question to which Smith and Hayek posed the answer: under what conditions will individuals decide to exchange goods, services and/or some form of money?
First things first, the individual needs to become aware of, perceive, the person with whom they will exchange. Second, the individual needs to become aware of, perceive, the goods and services they may exchange with the person with whom they will exchange.
This seems obvious but many problems are made sense of by it: the regional/city divide in economic activity, the problem of finding a “customer base”, the existence of marketing agencies, the importance of social ties in the labour market, and the existence of centralised marketplaces and middlemen. We need to know with whom and what we’re going to exchange before we can exchange with them.
Third, the individual needs to actually be in possession of the goods, services or money which they will exchange. The connection they are forming must be “feasible”, something they can actually do. Neoclassical economics emphasises (rightly) this when it says people always choose under constraints. Not everything is possible and so we have to make do with what we have.
Again it might seem fairly obvious that it must in fact be feasible to exchange goods, services and money, but many problems are explained as originating with it: the existence of the financial system, the existence of logistics divisions and agencies, and the constant failure of otherwise quite promising entrepreneurial ventures. We need to “have the goods”, as the saying goes, and at the exact right time and place before we can exchange.
So we so far have knowledge of what, with whom and how we might exchange. But what makes us actually choose to engage in that behaviour?
Knowledge. Knowledge of why we ought to engage in that exchange. This knowledge guides our decisions about what course of action to take amongst the alternatives available to us.
Knowledge is what is applied when we think. It is a network which we use when we think about our socioeconomic environment to form connections between the goods and services and money, the people who might exchange them with us, the places in which they are exchanged, their attributes, and the wants, needs and emotions our psyche presses us to respond to. As I have written elsewhere, applying our knowledge informs us not only of the how but also the why to exchange. Our consciousness endows it with aesthetic qualities which allow us to establish that we prefer certain things to others.
We require, fourthly, that the knowledge individuals have must be such that the outcomes they think will attend upon their exchange of goods, services or money are more preferable than the outcomes of any other course of action.
One final condition delineates the conditions under which, specifically, market exchange will occur. Market exchange is a special case (though prevalent) of economic exchange distinguished by its being mutual. There is a quid pro quo, a “this for that”. In a market exchange, the goods and/or services of one person are exchanged for the money of the other.
In order for this to be the case, we need the four conditions above to hold not only for one individual with respect to the goods and services they might exchange, but also another with respect to the money they might exchange. We also require that the individuals concerned not merely decide coincidentally that they will engage in bilateral exchange, they must deliberately exchange goods and services for money. In other words, they must both abide by the institution of market exchange and expect that it will be abided by.
We might collect these five conditions for market exchange together:
1. Both individuals are aware of, perceive each other
2. Both individuals are aware of, perceive, the goods, services and money which they might exchange with each other
3. Both individuals are able, find it feasible, to exchange the goods, services and money which they might exchange with each other
4. Both individuals find the outcomes they think, on the basis of their knowledge, will follow their engaging in market exchange to be preferable to all other courses of action
5. Both individuals deliberately decide to abide by the quid pro quo institution of market exchange, and expect that it will be followed.
If you’ve followed my writings about the psychology of economic behaviour, you will know that this being the case is sufficient for me to decide to exchange with you. As it happens it is also necessary.
If all five of these conditions are met we will find a market exchange form and an economic connection made. If any are not met, there will be no market exchange. Still, if the first four conditions hold with respect to one individual, we will find an economic connection form, only it will be a non-market exchange. If any of the first four conditions don’t even hold for one individual, we will find no economic exchange and no connection form.
As these conditions are applied for every pair of individuals in the economy we will observe the forming of the network of interactions which comprises the economic system. They govern, person by person, the formation of market exchanges and economic networks: which connections will form, which ones won’t.
Notice that the overwhelming majority of potential connections are going to fail the first two conditions, and yet still more are going to fail the third, fourth and fifth, so economies are incomplete, there are connections which aren’t made. This means there is room for our economies to evolve and develop.
Notice also, more importantly, that nowhere in the five conditions above was mentioned any other than the two people party to the exchange. There was, of course, an overall socioeconomic system in which they were interacting and no decision making occurs in complete isolation from the actions of others. But the necessary and sufficient conditions fundamentally apply to the individual people between whom exchange may occur, nobody else. If each of those five conditions were true of them, and them alone, a connection in economic systems will form.
Thus, no one organiser is necessary in order for economic systems to organise. They organise themselves as the individuals within them decide to exchange goods, services and money with others and form connections.
The importance of localised knowledge for self-organisation
The “UQ model” reveals that the process of self-organisation is all about knowledge. Connections in economic systems form if we have knowledge of with whom, what, how and why to exchange goods, services and money. Economies are especially remarkable systems in two respects noticed by the two geniuses in whose honour the Smith-Hayek theorem is named.
Adam Smith (one almost feels the need to genuflect) has been misconstrued as being some sort of Gordon Gekko preaching the gospel of greed. This is not true. In fact, Smith was a professor of moral philosophy, and Joan Robinson argues that his whole project was to argue for the morality of the system lifting his countrymen from poverty. What Smith was recognising in the Wealth of Nations, is the range of motivations which might anchor knowledge and thereby allow economic exchange to occur by satisfying condition 4. above.
Condition 4. places no requirement on the exact form of the knowledge the individual has, it requires only that the outcomes they expect to attend upon exchange within that knowledge be more preferable than those expected to attend on any others. As long as we think exchange will sufficiently satisfy some combination of our own wants, needs and emotions and those of others, we will find connections form and economies self-organise.
It might indeed make the system work better if we have a regard for others rather than be purely selfish — this is the message of Smith’s Theory of Moral Sentiments. No-one really wants to live in a no-holds barred, each-to-his-own, pirate economy. Even pirates don’t. Smith simply recognised in the Wealth of Nations that the economy doesn’t require us to be saints to self-organise, we can be self-interested human beings as well.
Friedrich Hayek’s genius was to realise just how little knowledge is required by each individual for economic self-organisation. We can see this in all five conditions for economic exchange to occur and a connection to form. All that is required is that one person knows a person, a good, service or money they can exchange with that person, how they can so exchange, and why (within their own personal schema of knowledge) they ought to. It is entirely unnecessary for self-organisation that the individual know anything at all about the economy beyond their particular locality.
This is truly remarkable and ought to inspire awe. The basis for our economic systems in all their vast extraordinary complexity is that each individual knows, in their own locality, with whom, what, how and why to exchange goods, services and money. The knowledge which leads to the self-organisation of our economies can be as complex as a prospectus for a long-term multibillion-dollar, multinational investment strategy in a heavy infrastructure project, but it can also be, and more often is, as simple as having a craving for coffee and knowing the local café is open.
Furthermore, and this is perhaps the true genius of Hayek, because this knowledge is localised and distributed, the knowledge the economy as a whole develops and applies can be of far better quality than if one individual tried to develop it alone.
Because the economy coordinates localised knowledge dispersed across many individuals, it can harness the efforts of billions of people to develop localised knowledge over a long period of trial and error. Billions of people collectively can know far more than any single organiser could possibly know. So, because economic self-organisation coordinates localised knowledge, much more extensive, deep and developed knowledge can be developed and applied across the economic system by self-organisation than a single organiser could possibly ever develop, let alone apply.
The process of economic self-organisation means far more knowledge can be taken advantage of to form the networks of economic systems than if they were organised by a planner. It’s ingenious and so clever it makes you almost wonder whether there has to be some sort of God providing for humankind.
Mutually beneficial exchange reveals valuable information
There is yet still further value created by the self-organisation of the economic system. Economic self-organisation reveals what society deems to be, based on its current knowledge, the most preferable state of economic affairs out of all possible alternatives available to it. Let’s consider this for a moment.
So long as exchange is not compelled or coerced (involuntary), it must by definition be voluntary. Now by condition 4., both parties to a market exchange must find the outcomes they expect to attend upon the exchange more preferable than any other course of action. If this preference is not the result of facing the coercive sanctions which attend upon disobeying compulsion (it is preferable not to break rules) then it must be the result of the parties to an exchange thinking it is associated with the most preferable outcomes of all courses of action available to them.
Notice that for market exchange, this goes both ways. The self-organisational process means that each market connection formed voluntarily in economic systems must be mutually beneficial to the parties involved. Both parties must think that exchange of goods, services and money to be associated with the most preferable outcomes out of all alternative courses of action. There is no other way, outside of coercion and compulsion, to have that connection form. And this is true of every single connection formed and not formed: the self-organisation of the economy comes from individuals making decisions using their knowledge about the best state of economic affairs.
If people are free of compulsion and coercion, the structure of the economy which emerges from self-organisation must be the result of the collective knowledge of society about what is the best state of economic affairs out of those available.
Immediately we see the critical importance of liberalism to the economic system. The real kind in which the individual’s right to be left to pursue their own lifestyle is paramount, not the relabelled progressivism where the individual is to be compelled in service of some utopia.
Illiberalism confounds the process of self-organisation. We cannot know whether economic connections which are compelled or coerced would also be beneficial or mutually beneficial to the parties to them, because there is no voluntary aspect to their exchange.
Liberalism allows the self-organisation of our economies to make use of the knowledge in society. It is by the self-organisation of the economy that we discover what the various parts of society do, and as importantly, do not think the best state of economic affairs out of those available.
Before you say “thanks Doctor Pangloss”, note the caveat here. The structure of the economy which self-organises reveals the collective knowledge society has about what is the best state of economic affairs out of those available. This is not saying that it is impossible to improve upon the current state of affairs. It is entirely possible that there are as-yet unavailable states of affairs or (since “available” here means “available to perception”), that there are as-yet unknown states of affairs which the collective knowledge of society might deem more preferable. It is also entirely possible that the collective knowledge of society might change, evolve, such that a different state of affairs might be deemed the most preferable out of all those available.
But this does not negate the fact that the process of self-organisation in economic systems creates value by revealing what society deems to be, based on its current knowledge, the best state of economic affairs out of all those available.
Economic self-organisation and the arrogance of illiberal policy
We have seen how economies are self-organising systems which coordinate localised knowledge and by so doing take advantage of far more knowledge than would be feasible if they were organised by a planner. And we have seen how the structure of the economy which emerges from self-organisation reveals the collective knowledge society has about what is the best state of economic affairs out of those available. This is important because of the very sharp advice it offers to the policymaker seeking to compel or coerce economic exchange in service of political ideology.
Any policy which aims to compel, coerce, or engineer economic exchange or abstention therefrom is an epistemological statement. It is a statement that the policymaker has knowledge which the people party to that exchange do not have and which is superior to that they do have, and that the policymaker has superior values which are to be imposed upon the people party to that exchange. This is not merely illiberal, but potentially a deeply arrogant position to take.
I want to be very clear what I mean here. It is possible that the policymaker has knowledge which the individuals whose actions they are seeking to govern do not. There are trends observable at the level of the system which can’t be observed at the level of the individual. This is a concept called “emergence”.
What I mean to say is that localised knowledge by its very nature is a priori deeper and closer to what problems may be at hand. The policymaker needs be aware of this and be able to make a strong case for what has not been accounted for in that localised knowledge and why it is important to account for it.
But aside from this practical advice the process of economic self-organisation offers to policymakers, there is a pure joy in understanding this process which is the right and true aim of all science. The insights of Adam Smith and Friedrich Hayek, encapsulated in their eponymous theorem at the core of the “UQ model”, explain to us how the vast complexities which are our economies organise themselves.
Billions of people every day, all acting on their own localised knowledge about with whom, what, how and why to exchange goods, services and money, knowledge which is both remarkably simple and remarkably deep at the same time, our vast, complex and unfathomable economies organise themselves to provide us (on the whole) with exactly what we need and desire. That such complexity can be organised without an organiser compelling or coercing, and in fact works best when there is no such organiser, is truly astonishing and ought to inspire awe.