Solving the Problem of Capital

In Hayek’s view, the solution to the “peculiar problem” of capital involves using existing resources to invest in future capital. This can be done by maintaining existing assets or by producing new ones. As Hayek sees it, what matters most is not that particular assets be preserved, but rather that society consistently secures an adequate overall capital portfolio.

Hayek ultimately claims that the best way to accomplish this task is to allow markets to coordinate capital production and utilization. Yet to understand the significance of this position, we must appreciate why he considers the problem of economic coordination so vexing in the first place. According to Hayek, the most important obstacle to prosperity in complex modern societies is that the information needed for successful economic organization can never be acquired by any one mind (1945, 519). Public officials hoping to plan an economy might possess considerable scientific expertise, but they are irretrievably lacking in “knowledge of the particular circumstances of time and place” (521)—facts about momentary conditions, changing desires, and productive means available for use. This sort of knowledge is critical for economic organization, but it is also dispersed throughout society and cannot be aggregated in a centralized form (521-24).

Hayek contends that the only way to make an economy responsive to time- and-place information is to decentralize economic decisions to the private individuals who possess this information (1945, 524-25). Yet this suggestion raises puzzles of its own: Given that individuals must remain ignorant of the great majority of what others know, how can they be any more sensitive to this information than central planners could be? And given that individuals’ priorities may not align directly with the broader public good, how can they be motivated to promote it?

Hayek finds answers to these questions in the operations of the price system. When individuals transact, they help to establish general exchange rates between goods in a common metric of dollar prices (1945, 525). These prices, and especially their fluctuations, communicate important information about economic circumstances, desires, and available resources in a form that individuals can readily understand. Moreover, prices drive people to act on this information for the sake of protecting their financial interests (526). By relying on prices to coordinate economic decisions in a decentralized way, market economies can thus solve society’s fundamental economic problems in a way that no central planner could. Hayek therefore writes:

It is through the mutually adjusted efforts of many people that more knowledge is utilized than any one individual possesses or than it is possible to synthesize intellectually; and it is through such utilization of dispersed knowledge that achievements are made possible greater than any single mind can foresee. (1960, 28)1

This general perspective helps to explain why Hayek sees the decentralization of decision making in a market economy as the most effective way to solve the problem of capital, and hence of environmental capital as well. By responding to price signals, economic actors are led to utilize their resources with sensitivity to broader societal needs, and a system of free enterprise so organized can achieve better coordination than could ever be realized through central planning. Hayek admits that decentralization puts decisions into the hands of individuals who lack bureaucrats’ scientific expertise, especially in the environmental domain. But he insists that this disadvantage is overbalanced by the fact that, alongside scientific expertise, “There will always exist . . . an even greater store of knowledge of special circumstances that ought to be taken into account in decisions about specific resources which only the individual owners will possess and which can never be concentrated within a single authority” (1960, 321). Moreover, “while it is possible to communicate to the owners of particular resources the more general considerations that they ought to take into account, it is not possible for authority to learn all the different facts known to the individuals” (321).

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