Prices Without Markets or Markets Without Prices? Insights for the Climate Debate from Friedrich Hayek

Ed Dolan
Ed Dolan
Oct 14, 2019 · 10 min read

As far as I know, Friedrich Hayek, the Nobel Prize winning economist and philosopher, never wrote a word about climate change. He did, however, have strong ideas on the role of science in public policy that bear directly on the twenty-first century debate over climate change. Judging from what he wrote about the role of science in public policy and the use of knowledge in society, I think that if Hayek had lived on into the twenty-first century, he would have supported a carbon tax. Let me explain why, using his own words and ideas.

Two kinds of knowledge

Hayek famously drew a distinction between two kinds of knowledge. One is “knowledge of the particular circumstances of time and place.” The other is scientific knowledge.

By its nature, knowledge of time and place is widely distributed among individuals, each of whom sees only a small part of the whole picture. Scientific knowledge, in contrast, is less widely dispersed. As Hayek puts it in a 1945 article, “The Use of Knowledge in Society,”

… as far as scientific knowledge is concerned, a body of suitably chosen experts may be in the best position to command all the best knowledge available — although this is of course merely shifting the difficulty to the problem of selecting the experts.

A number of years were to pass before Hayek returned to that problem. Laws and regulations will achieve their objectives only if they are based on sound science. But how should policy makers, who at best have only general scientific literacy, choose the experts on whom they must rely?

Conservative and liberal views of science

Hayek makes his clearest pronouncements on the theme of choosing the experts in a 1960 essay, “Why I am Not a Conservative.” There, he explores the differences between two broad views of the world. One is that of conservatives, the other of “liberals,” a term Hayek uses in the European sense for what Americans would call classical liberals or libertarians.

Liberals, says Hayek, are prepared to come to terms with new scientific knowledge, whether they like its immediate effects or not. Conservatives, in contrast, are more wary of science:

Personally, I find that the most objectionable feature of the conservative attitude is its propensity to reject well-substantiated new knowledge because it dislikes some of the consequences which seem to follow from it — or, to put it bluntly, its obscurantism. I will not deny that scientists as much as others are given to fads and fashions and that we have much reason to be cautious in accepting the conclusions that they draw from their latest theories. But the reasons for our reluctance must themselves be rational and must be kept separate from our regret that the new theories upset our cherished beliefs. I can have little patience with those who oppose, for instance, the theory of evolution or what are called “mechanistic” explanations of the phenomena of life because of certain moral consequences which at first seem to follow from these theories, and still less with those who regard it as irrelevant or impious to ask certain questions at all. By refusing to face the facts, the conservative only weakens his own position. Frequently the conclusions which rationalist presumption draws from new scientific insights do not at all follow from them. But only by actively taking part in the elaboration of the consequences of new discoveries do we learn whether or not they fit into our world picture and, if so, how. Should our moral beliefs really prove to be dependent on factual assumptions shown to be incorrect, it would hardly be moral to defend them by refusing to acknowledge facts.

Hayek’s characterization of conservative attitudes toward science certainly resonates in the context of today’s climate debate. However, any honest observer today would have to say that the progressive side of the debate is not entirely guiltless, either. It is true some conservative voices minimize or outright deny climate change. At the same time, though, some progressives seize on scenarios at the far end of the range discussed in the scientific literature and treat them as established truth. A visit to the contrasting websites of the Heartland Institute and the Extinction Rebellion should be enough to illustrate the way in which “cherished beliefs” influence interpretations of science.

How to choose the experts?

The passage from Hayek’s 1960 essay finally gives the answer to his earlier question of how to select a suitable group of experts to represent the state of scientific knowledge — or, perhaps, how not to select them: We should not base our selection on a dislike of any consequences that seem to follow from well-substantiated new knowledge.

His point is not at all that we should treat what scientists say uncritically. That would hardly be possible, since scientists routinely disagree among themselves. Rather, he is saying two things.

  • First, we should judge someone’s scientific credibility without regard to our ideological convictions. Do they have the necessary training? Do they follow methodological norms established by their profession? Are they treated as credible by their own peers, even by those who disagree with their conclusions?
  • Second, since there will be differences in findings among credible scientists, we should test our policy recommendations against a full range of views. If our policies make sense only for a limited part of that range, or only for views that lie outside the current scientific consensus, we should say so.

If these norms were observed, we would expect to see conservative, libertarian, and progressive policy analysts working from similar ranges of scientific estimates. Unfortunately, that is often not the case.

Decentralized knowledge and free market environmentalism

Let’s turn now from scientific knowledge to dispersed knowledge. “Knowledge of time and place,” as Hayek calls it, is both impossible to centralize and, at the same time, essential to efficient decision-making. Yet localized knowledge is not enough in itself. As Hayek puts it in his 1945 article,

[T]he “man on the spot” cannot decide solely on the basis of his limited but intimate knowledge of the facts of his immediate surroundings. There still remains the problem of communicating to him such further information as he needs to fit his decisions into the whole pattern of changes of the larger economic system.

The key to making global information available to local decision makers is the price system. If the price of an input you use for your farm or factory goes up, you don’t need to know why — you only need to know that it has somehow become scarcer, and that you should, if possible, use less of it. Similarly, if the price of something you produce goes up, all you need to know is that you should do your best to produce more.

No one today, whether progressive, conservative, or libertarian, disputes the importance of the price system when it comes to ordinary goods and services. Centrally planned socialism without prices is an idea people read about only in history books. However, the role of prices in environmental economics remains controversial.

The movement that champions the use of prices to solve environmental problems goes by the name of free market environmentalism (FME). FME rests on three pillars: property rights, the rule of law, and markets. Where all three are present, prices emerge for environmental resources. Those prices, in turn, let producers and consumers combine their local knowledge of time and place with global information about relative scarcities. All parts of the system are supposed to work together to reconcile conflicting human preferences for use of scarce environmental resources in an efficient and nonviolent manner.

The Property and Environmental Research Center (PERC) in Bozeman, Montana is a leader of the FME movement. Its website provides numerous case studies in which ranchers, farmers, fishers, loggers, and others have created workable property rights and markets for grazing land, water rights, fishing quotas, and timberland. Yet, for all the credit it deserves, there are problems that FME cannot solve.

In his book “Free Market Environmentalism for the Next Generation,” Terry Anderson, Senior Fellow and former President at PERC, and his co-author Donald Leal, identify climate change and greenhouse gas emissions as the most intractable issue — “the mother of all global problems.” There are no property rights in the global atmospheric commons.

Partly, they say, that is because competition for use of scarce atmospheric resources arose before technology was available to define and enforce property rights, and partly because competing users — people with smokestacks and people who want to breathe clean air — can’t agree on who should own those rights. Global heterogeneity, high costs of measuring and monitoring, and lack of global enforcement mechanisms further frustrate efforts to bring property rights and prices to bear on greenhouse gas emissions.

Finding that climate change is not amenable to FME prescriptions, Anderson’s response is to give up on emissions control and focus on adaptation to climate change. There he feels on safe ground. In a nod to Hayek, he maintains that falling prices for beachfront property and rising prices for food and water will guide individuals, “based on factors that are time- and space specific,” to reallocate inputs and outputs in order to adapt appropriately. Cities will be rebuilt on higher land, fish farms will replace ocean fisheries, heat-tolerant crops will be planted, and so on.

But what about a price for the most important scarce resource of all — the limited ability of the earth’s atmosphere to absorb greenhouse gas emissions? Anderson recognizes the theoretical desirability of such a price, but dismisses any possibility of establishing one.

Anderson considers a cap-and-trade approach. He grudgingly admits that cap-and-trade is a “market-like” mechanism, analogous to tradeable fishing quotas (which he endorses), even though the initial allocation of property rights in both cases is politically determined rather than spontaneously emergent. However, he considers it unlikely that most governments will be willing to agree on a cap-and-trade scheme and pointless for any one country to implement cap-and-trade in isolation.

And what about a carbon tax? The administrative problems of a carbon tax are not negligible, but they could well be less than those of a global cap-and-trade scheme. Yet Anderson refuses to consider a carbon tax on grounds that seem more ideological than pragmatic:

Putting aside the theoretical potential for either [cap-and-trade or a carbon tax] to work, let us emphasize that a carbon tax is hardly a “market like” approach, let alone an example of free-market environmentalism. Yes, a carbon tax would increase the price of carbon-related products and provide an incentive for people to reduce their use of such products, but it in no way creates tradeable property rights.

So, a carbon tax might work in theory. It might simplify the administrative problems of a global cap-and-trade scheme, even if it faced the same political headwinds. Yet Anderson gives carbon taxes only a single dismissive paragraph because they are not based on tradeable property rights.

PERC is not alone in this attitude. Other would-be free market environmentalists — notably, those from the Austrian school of economics — are even more contemptuous of carbon taxes and even more skeptical about cap-and-trade. For details, I refer readers to an exchange of articles, comments, rejoinders, and blog posts that Walter Block and I engaged in a few years ago.

Markets without prices or prices without markets?

Clearly, free market environmentalism faces a dilemma when it comes to greenhouse gases and climate change. Markets that generate prices based on securely enforced property rights are the gold standard for policy, but what if that option is not available? What if we must choose between markets without prices or prices without markets? Here is what Hayek had to say on this very issue, in yet another of his works, The Road to Serfdom:

Where, for example, it is impracticable to make the enjoyment of certain services dependent on the payment of a price, competition will not produce the services; and the price system becomes similarly ineffective when the damage caused to others by certain uses of property cannot be effectively charged to the owner of that property. . . In such instances we must find some substitute for the regulation by the price mechanism. But the fact that we have to resort to the substitution of direct regulation by authority where the conditions for the proper working of competition cannot be created, does not prove that we should suppress competition where it can be made to function

Markets without prices — or at best with only partial prices — are what we have now. We have markets for energy, capital goods, and consumer goods. Within each of those markets, producers and consumers make choices based on their own knowledge of time and place and on the prices of labor and materials — but with no prices to carry knowledge of scarcities that exist at the planetary level. As producers, should we use electric power from the coal-fired grid or install solar panels? There is no price on greenhouse gas emissions to help guide our choice. As consumers, should we install heat-conserving blinds or buy a new SUV? There is no carbon price to help us make up our minds.

With a carbon tax, we still would not have prices that were generated in real markets, but we would at least have prices. As the effects of the carbon tax rippled through the price system, it would transmit the kind of knowledge Hayek regarded as essential — knowledge about the global opportunity cost of carbon emissions that local decision makers could then integrate with their knowledge of time and place to make better decisions. Those would include decisions leading to a slower pace of climate change, and hence to invaluable extra years to adapt. They would also include decisions about the best techniques for adaptation itself, for example, whether to pour millions of tons of carbon-intensive concrete for sea walls, or instead, to move inland.

In short, if you can’t have both prices and markets, it seems that you choose markets without prices if you think ideologically, but prices without markets if you think pragmatically. We would all prefer to have both, but if that is not to be an option, we have to choose.

Which side would Hayek have come down on? Going by what he wrote on science, knowledge, and the price system, I have to conclude that he would have favored a carbon tax over doing nothing.

Based on a version earlier published at Smokestack photo courtesy of Hayek portrait inset courtesy of Mises Institute via Wikimedia Commons.

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Ed Dolan

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Ed Dolan

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