What Does The Free Market Require?
Does the free market require intelligent thought and predictive ability among its participants to function?
Suppose you have three potential entrepreneurs - a butcher, a baker, and a candlestick maker. These three businessmen are very poor predictors of what consumers want, having all failed out of business school, and chosen their current occupations by the flip of a coin. Unluckily for the butcher and the baker, a vegetarian form of the Atkins diet has swept the nation. Luckily for the candlestick maker, Grey Davis, ex-governor of California, has been elected President of the United States, and his first act in office is to implement universal electricity entitlements for all - with prices fixed for consumers while variable for retailers. As one might imagine, this well-intentioned scheme of electricity "privatization" results in widespread and continual power outages for the entire country, at great benefit to the candlestick maker.
The candlestick maker, being terrible at business, doesn't and could not predict this, of course, but she nevertheless profits considerably from her favorable stroke of luck, and responds to her good fortune by increasing production. The butcher and the baker, on the other hand, suffer miserably from an unpredicted and unpredictable decline in consumer demand from bread and meat, given the new vegetarian Atkins diet, and respond to this event as any two mindless automatons might do - by decreasing their meat and bread production and switching occupations to candlestick making.
Intelligent thought is not really a requirement for a functioning market. Nor is predictive ability. If consumers' preferences were determined at random, and so too firms' production decisions, the market system would still work by weeding out the producers who do not satisfy the consumer, and by rewarding those producers who do satisfy consumers. With a little bit of intelligence, but not much, other entrepreneurs who witness the successful profit-making producer will enter that industry and produce more of that product, thus lowering the price and returning the market to equilibrium and discouraging more from entering. When profits turn into losses, marginal producers will exit that industry, thus increasing price and returning the market to equilibrium and discouraging more from exiting. Although some intelligence is required for this sort of entry and exit, it is only the intelligence of a mindless automaton that is necessary to mimic the actions of others based on simple signals.
The market system is quite similar to the mechanisms of evolution in this respect. Organisms that cannot adapt to their environment long enough to pass on their genetic information to the next generation die out, sparing the next generation from suffering from the same deficiencies because the next generation will not exist. On the other hand, organisms that can adapt to their environment long enough to pass on their genetic information to the next generation will survive. Through the mechanisms of random mutation and natural selection, nature "chooses" those organisms which are sufficiently well suited to their environments, suited in terms of both unconscious biological response, instinct, and yes, even conscious choice, if you posit free will or some form of compatibalism.
A system of spontaneous order, of organized chaos - of action but not design.
Is this a bad thing? Is there something objectionable to the fact that the market could work just fine without complex thought?
Not at all. That's the beauty of the market - it doesn't require any special intelligence on the part of its participants. Central planning, on the other hand, does. And that's one -- if not the greatest -- of socialism's weaknesses.
Hayek puts it just so in "The Use of Knowledge in Society":
I am convinced that if it were the result of deliberate human design, and if the people guided by the price changes understood that their decisions have significance far beyond their immediate aim, this mechanism would have been acclaimed as one of the greatest triumphs of the human mind. Its misfortune is the double one that it is not the product of human design and that the people guided by it usually do not know why they are made to do what they do. But those who clamor for "conscious direction"—and who cannot believe that anything which has evolved without design (and even without our understanding it) should solve problems which we should not be able to solve consciously—should remember this: The problem is precisely how to extend the span of out utilization of resources beyond the span of the control of any one mind; and therefore, how to dispense with the need of conscious control, and how to provide inducements which will make the individuals do the desirable things without anyone having to tell them what to do.
The problem which we meet here is by no means peculiar to economics but arises in connection with nearly all truly social phenomena, with language and with most of our cultural inheritance, and constitutes really the central theoretical problem of all social science. As Alfred Whitehead has said in another connection, "It is a profoundly erroneous truism, repeated by all copy-books and by eminent people when they are making speeches, that we should cultivate the habit of thinking what we are doing. The precise opposite is the case. Civilization advances by extending the number of important operations which we can perform without thinking about them."
Read that last bit again: "Civilization advances by extending the number of important operations which we can perform without thinking about them."
This is the great "genius" of the market, which of course has no mind itself, nor does it require the intelligent thought of a planner or a designer or a creator, but requires nothing more than the responses of mindless automata, which take in input in the form of price signals and spit out output in the form of increases or decreases in production and consumption. Far from being an inhuman mechanism, the free market is the one social mechanism that respects the fact that humans have imperfect knowledge and yet still allows us the freedom to experiment, to make mistakes, and at the same time results in a stable, peaceful, and prosperous social order.
fn1. This question arose in the context of a debate I've been having over one of my favorite comparisons - the spontaneous order of biological evolution and the spontaneous order of market interaction. The name of this blog is derived from Hayek's term "Catallaxy," which is synonymous with this spontaneous order of the market. I've posted elsewhere on this comparison; see: "Human Action, Not Human Design," "The Magic Meme is Spreading," and "Foreign Policy Creationism." For Don Boudreaux's take, see: "Magic," "Creationism Lives!," "More on Blue-State Creationism," and "Messiah-Mongering," among others. Especially see: "Smith and Darwin." Boudreaux quoting Stephen Jay Gould:
fn2. I am aware that Austrian economics makes a big deal out of the entrepreneur’s important role in exercising his or her predictive ability to see and respond to market phenomenon before they occur. I do not dispute the importance of this observation. What I do dispute, however, is that this predictive ability is a necessary aspect of the market. To see why, consider the following argument:
If I successfully predict a market event before my competitors do, I may make a great deal of money. But if no single entrepreneur predicts an event until it happens, consumers will still get what they want, just not as quickly.
Suppose you have an uncanny ability to predict otherwise unpredictable natural disasters. So you go to wherever a natural disaster will occur, a few weeks in advance, and bring along with you excess supplies of potable water, flashlights, plywood, chainsaws, etc. You are well prepared for the emergency when it happens, whereas everyone else is not, so you are able to reap the profits of increased demand.
But consider the alternate scenario - no one has any ability to predict natural disasters whatsoever - no weather forecasts, no meteorology, no emergency stocks of supplies. When a natural disaster finally occurs, no one predicted it and no one is prepared. People are certainly worse off under this scenario than under the first, for they must wait much longer to get what they need. But eventually, once entrepreneurs realize what has happened, they can respond after the fact - by shipping in additional supplies from other areas and so forth. The market still works and people still get what they want, but there was no prediction. Prediction is nice and helpful, but it is not necessary.
Unless, of course (and I do not know if this is the case or not, but am simply assuming based on past experience with Austrian methodology) the Austrian response is to simply define the term "prediction" in such a way as to claim that every action entails a prediction of the future insofar as the results of the action are uncertain and motivated by an attempt to affect change. Of course, this is true, but trivial. And even if we accept this tautology, it is still compatible with what I said earlier - that a functioning market does not require intelligent thought, and that this tautological definition of prediction can be easily accomplished by a mindless automaton.