Dispatch #103: Markets, knowledge, & the power of decentralization: Revisiting Hayek

This dispatch explores Friedrich Hayek's timeless essay The Use of Knowledge in Society, breaking down his argument on decentralised knowledge & the power of market-driven decision-making.

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I just finished re-reading Friedrich Hayek’s essay The Use of Knowledge in Society, and I can’t help but admire its clarity. Hayek had this rare ability to take something incredibly complex—how economies function—and distill it into something so lucid that you wonder why it isn’t common sense. A lot of this type of wisdom has been missing in the Indian policy-making space historically. This paper, published in 1945, is one of those rare pieces that forces you to see the world differently.

What struck me the most was Hayek’s ability to illustrate a problem that persists even today. Despite technological advancements, access to vast data and its dissemination mechanisms, and artificial intelligence, centralized planning still struggles with knowledge dispersion.

The knowledge required to run an economy is not contained within a single mind, committee, or institution. Instead, it is dispersed across millions of individuals who each possess local, context-specific information that a central authority cannot efficiently collect or process. This realization is what makes Hayek’s argument timeless.

At its core, Hayek’s argument is deceptively simple: the most crucial economic problem isn’t about allocating resources per se; it’s about how dispersed knowledge is aggregated and utilized in society. If you’ve ever wondered why centrally planned economies struggle while market-based economies adapt so quickly, this post provides the answer.

Hayek explains the problem statement while also giving a solution, right at the beginning of his essay:

In ordinary language we describe by the word “planning” the complex of interrelated decisions about the allocation of our available resources. All economic activity is in this sense planning; and in any society in which many people collaborate, this planning, whoever does it, will in some measure have to be based on knowledge which, in the first instance, is not given to the planner but to somebody else, which somehow will have to be conveyed to the planner. The various ways in which the knowledge on which people base their plans is communicated to them is the crucial problem for any theory explaining the economic process, and the problem of what is the best way of utilizing knowledge initially dispersed among all the people is at least one of the main problems of economic policy—or of designing an efficient economic system.

The answer to this question is closely connected with that other question which arises here, that of who is to do the planning. It is about this question that all the dispute about “economic planning” centers. This is not a dispute about whether planning is to be done or not. It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals. Planning in the specific sense in which the term is used in contemporary controversy necessarily means central planning—direction of the whole economic system according to one unified plan. Competition, on the other hand, means decentralized planning by many separate persons. The halfway house between the two, about which many people talk but which few like when they see it, is the delegation of planning to organized industries, or, in other words, monopoly.

The Knowledge Problem: Why No One Can Know Everything

Imagine you’re running a restaurant in a tier-2 city in India. One morning, your supplier calls to tell you that the price of tomatoes has unexpectedly shot up. You don’t know why—maybe unseasonal rains affected the crop, or maybe a surge in festival demand caused a supply crunch. You don’t have time to investigate. You just know that at the current price, making your signature paneer butter masala or tomato-based curries will be far less profitable. So what do you do? You adapt. Maybe you reduce tomato-heavy dishes on the menu, introduce more yogurt-based gravies, or experiment with regional specialties that rely on different ingredients.

Now, let's take another example. Consider onion prices, a frequent concern in Indian markets. When there's a shortage due to poor monsoon rains or supply chain disruptions, prices soar. Traders, farmers, and consumers all react in real time—farmers might rush to plant more onions for the next season, traders adjust their imports, and households switch to alternatives like cabbage or radish. The government may step in with buffer stocks, but often, it's the spontaneous adjustments by millions of people that stabilize the market. No central planner can micromanage these millions of decisions better than the price system itself.

Now multiply this by millions of businesses, consumers, and workers making similar adjustments in real time. The market transmits information to everyone through prices without requiring anyone to have a PhD in economics or access to government reports. This is Hayek’s core insight: knowledge is decentralized, and the price system is the most efficient way to communicate it.

Central Planning vs. The Spontaneous Order

Hayek’s essay was, in many ways, a direct challenge to the socialist economists of his time, who believed that economic planning could be done scientifically, with a central authority deciding who gets what. But he pointed out a fundamental flaw: no central planner, no matter how intelligent, could ever possess the sheer volume of local knowledge needed to make efficient economic decisions.

Think about the Soviet Union’s infamous struggles with production targets. Factories would be given quotas—produce X tons of steel, Y pairs of shoes—but they had no real-time information about what people needed. The result? Warehouses full of size 12 men’s shoes when people needed size 8. Meanwhile, in a market economy, a shoe store that notices a sudden demand for size 8 simply orders more. No committee meeting is required.

This phenomenon is not limited to history. A similar issue can be observed in India’s public transportation sector. Government-subsidized fuel prices often lead to inefficiencies in transport networks, with artificially low prices causing excessive reliance on private vehicles while public transport remains underfunded. When fuel prices are kept artificially low, more people choose to use personal vehicles rather than opting for public transport, leading to traffic congestion and pollution. At the same time, underinvestment in buses and metro systems due to lack of funds results in overcrowding and inefficiency in public transport.

In contrast, when transport pricing is left to market mechanisms, fuel costs reflect actual supply and demand, making public transport a more attractive option. As fuel prices rise, individuals seek more cost-effective commuting alternatives, prompting greater demand for efficient and well-maintained metro systems, electric buses, and ride-sharing services. This increased demand leads to more investment in public transport infrastructure, improving its quality and accessibility. Governments and private players respond by expanding metro networks, deploying cleaner and more energy-efficient buses, and enhancing ride-sharing options, making urban mobility smoother and more sustainable. Furthermore, reduced dependency on personal vehicles helps alleviate traffic congestion, decreases air pollution, and contributes to overall urban well-being. In the long run, this shift towards a well-funded and demand-driven transport system ensures that cities remain livable, efficient, and environmentally friendly for all residents.

Real-World Applications: From Uber to Supermarkets

The beauty of Hayek’s insight is that it applies far beyond traditional economic theory. Take ride-sharing apps like Uber. Ride-sharing companies such as Uber don’t centrally dictate how many drivers should be in each city at any given moment. Instead, they use dynamic pricing—when demand is high, prices go up, which signals more drivers to get on the road. This is a direct application of Hayek’s idea: decentralized decision-making, guided by real-time price signals, leads to efficient outcomes.

Or consider supermarkets. Have you noticed how they stock more ice cream in summer and more hot chocolate in winter? No government agency dictates this; it happens because thousands of individual purchasing decisions signal to stores what consumers want. Supermarket managers don’t need to understand why demand shifts; they just respond to the information prices give them.

A fascinating Indian example is the rise of e-commerce platforms like Flipkart and Amazon India. During major sales events like the Diwali festive season, prices fluctuate based on supply and demand. Sellers adjust their inventory, logistics firms ramp up deliveries, and consumers make buying decisions based on real-time price changes. This dynamic coordination happens seamlessly without a central authority dictating who should sell what at what price.

The Market as a Knowledge Processor

If Hayek were alive today, he’d probably marvel at how much his 1945 essay still applies. In an age of big data and AI, some still argue that we can “outplan” the market. But Hayek’s lesson remains: no matter how advanced our tools are, the most effective way to use society’s vast, dispersed knowledge is through decentralized decision-making.

Technology may have changed, but the fundamental nature of knowledge remains the same. Decentralized systems—whether in economic markets, logistics, or even social networks—thrive because they allow real-time adjustments based on localized information.

So next time you hear someone say, “The government should just step in and fix this,” ask yourself: is this a problem that can realistically be solved from the top down? Or is it one of those countless challenges best addressed by individuals making decisions based on real-time information? Hayek would probably bet on the latter.

Hayek’s essay is not just a critique of central planning; it’s an enduring reminder of the power of decentralized, spontaneous order. And as we navigate the future—whether in economics, technology, or governance—understanding and applying his insights will be more relevant than ever.

Hayek concludes his essay by adding:

The problem is thus in no way solved if we can show that all the facts,
if they were known to a single mind (as we hypothetically assume them to be given to the observing economist), would uniquely determine the solution; instead we must show how a solution is produced by the interactions of people each of whom possesses only partial knowledge. To assume all the knowledge to be given to a single mind in the same manner in which we assume it to be given to us as the explaining economists is to assume the problem away and to disregard everything that is important and significant in the real world.