Hayek and Demonetization

A twitter user made an insightful observation on demonetization and Hayek's famous essay titled, 'The use of knowledge in societies'. 

The point is that demonetization is being called "good idea but bad implementation". The argument is that demonetization is not just bad implementation, it is a bad idea too. Hayek's analogy helps here.

In his essay, The use of knowledge in societies, Hayek made an insightful observation on the role of prices and the infeasibility of planned economy. The argument is simple. 

Many think that economics is about the appropriate allocation of resources. Hayek says that allocation of resources is a mathematical problem and is easy to solve. The problem, however, is about our "knowledge of resources". The data of resources isn't stored in a central database from which data can be downloaded and be slapped with algorithms to spit out appropriate allocation. Knowledge is dispersed throughout the economy. If one may use Foucault's concept of power, knowledge is spread the way blood flows in the body through capillaries. There's no precise way to capture by a single person.

Prices come into play here. Price is a system that aggregates the micro knowledge and gives it a concrete shape. Hence, they should be relied up on.  Centrally administered planning. fails because of its inability, rather infeasibility to gather such knowledge.

The second complexity arises due to the dynamic nature of knowledge. One can theoretically argue that given enough time, one can gather knowledge. However, the trouble is that knowledge is not static. It's changing every second. So, even the best possible person can't detect it real time.

Now, apply it to demonetization. Cash in the economy is also like knowledge, spread throughout the economy. The argument that demonetization is a good idea but bad implementation misses the same point that many economists miss, as Hayek argued above. It assumes that government had all the information but failed to execute. The point is that it's not possible to have all such information. No matter how well it was planned, it was bound to fail because the information is just not enough.

Demonetization is thus as bad an idea as a planned economy that determines prices centrally.

One may make theoretical arguments against this line of reasoning but it's a fresh way to look at things.

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