Knowledge And Decisions

When the automobile began to replace the horse and buggy, a conscientious, hard-working and intelligent buggy-manufacturer could not earn what someone with the same characteristics was earning in the automobile industry. That is precisely why and how people and capital were transferred out of the horse-and-buggy industry. It is why and how they (or others) were transferred into the automobile industry. The disparities in rewards for equal effort, risk, ability, etc., are precisely the systemic means of voluntarily transferring human and non-human resource inputs from one place to another in a changing economy. If they are to be equally rewarded for “merit” — that is, for their input — regardless of how this affects output, or the desirability of that output to consumers, then either transfers must be involuntary (based on orders from authorities) or else the transfers are unlikely to take place at all, leaving the economy stagnant.

While some losses and gains from changing economic conditions may reflect differences in foresight, many are windfall losses and gains, based on things which neither the gainers nor the losers were able to predict on the basis of their knowledge or understanding beforehand. At one time, before uses were discovered for petroleum, the presence of oil in a piece of land lowered its value, since this unaesthetic ooze could find its way to the water supply or make a nuisance of itself elsewhere. It was the kind of land that unscrupulous operators would unload on the unsuspecting. Some people found themselves owning land with oil on it through gullibility — but when such land later became valuable, the owners became just as rich as if they had wisely foreseen it all.

Since the total income from residual claims is only about 10 percent of national income, the purely windfall portion of this 10 percent can hardly be a major element of national income, In view of the very large windfall gains and losses involved in life in general (economically and otherwise), it is hard to explain, on purely rational grounds, the enormous concern over this particular deviation from strict “merit” reward. The country or the period of history of one’s birth can easily halve or double one’s life expectancy and change one’s income by factors of ten or a hundred times, and the difference between being born malformed, or mentally retarded, or to abusive parents — rather than merely being “normal” — has consequences that dwarf other unmerited inequalities that happen to be quantifiable.

The role of inherent risks, growing out of high costs of knowledge, is ignored in analyses which proceed as if an omniscient observer is describing predetermined events in an economic or social system. It is precisely the lack of omniscience which is responsible for many institutional features and many social and economic results. Windfall gains and losses — whether in the sale price of land or in the difference between wages in a growing versus a declining industry — are part of these phenomena. Alternative institutions must be judged not by how they would operate with implicitly given knowledge but how they function in the face of uncertainty and risk. It is always possible to institutionally prevent or confiscate “unmerited” gains or losses, at a sufficiently high cost in enforcement efforts, reduction of freedom of choice, or losses in allocational efficiency. But eliminating the social phenomena growing out of uncertainty or risk in no way reduces the uncertainty or risk themselves, but merely changes the way the system as a whole can adjust to them.

To reward “merit” is to reward some subjective estimate of input as judged by some unitary scale of values applied by some observer(s). To reward output is to reward tangible results as assessed by those actually using the output, in the light of their own respective, diverse preferences. Only by the rarest coincidence would these different procedures lead to the same result. The question, then, is what is to be gained by substituting one set of surrogate preferences for diverse individual preferences, and adding the costs of consensus about values?