Efficiency and Externalities in an Open-Ended Universe: A Modern Austrian Perspective

3 CATALLACTIC EFFICIENCY:
WELFARE ECONOMICS IN AN OPEN ENDED WORLD

CATALLAXY AND ECONOMY

The arguments presented in the “Introduction” against efficiency and welfare economics stem from a concern that it has been constructed in the context of a fundamentally flawed vision of the world. Economists who are trying to assess the effectiveness of market activities confront a social phenomenon that is essentially different from the one depicted in the perfect competition model and the concept of social welfare that it has spawned. The essence of this difference is captured in the distinction, most consistently recognized in the works of Hayek (1976) and Mises (1966, pp. 232-234) (also see Buchanan, 1979B), between catallaxy and economy. Hayek has defined the distinction as follows:

An economy ... consists of a complex of activities by which a given set of means is allocated in accordance with a unitary plan among competing ends according to their relative importance. The market order serves no such single order of ends. What is commonly called a social or national economy is in this sense not a single economy but a network of many interlaced economies ... [T]he cosmos of the market neither is nor could be governed by a single scale of ends; it serves the multiplicity of separate and incommensurable ends of all its separate members. (1976, p. 108)

Following Hayek, we adopt the term “catallaxy” to describe this vision of what is usually called the market economy. It is characterized by the fact that there is no overall hierarchy of ends that can be ranked on a single scale of values. The term “economy” applies only to individuals and those institutions, i.e., business enterprises, households, etc., within the catallaxy that do proceed from the perspective of ends ranked on a single ladder of importance.

In this setting there is no room for the notion of social welfare as it is typically construed. Social cost-benefit analysis implies a common scale of value upon which the decisions, and therefore the ends, of separate market participants can be ranked and compared in terms of a single objective--the maximization of net social benefit. In this context, the efficiency problem is one of allocating resources to their highest valued use, implying a single scale of values upon which comparisons can be made. This is the case with externalities. External effects, positive or negative, result in market failure because they prevent resources from flowing to their most highly valued use. As Hayek has pointed out though, this is a meaningless goal when cast within the context of a catallaxy. He argues that the catallaxy cannot “assure[] that the more important comes before the less important, for the simple reason that there can exist in such a system no single ordering of needs” (1976, p. 113). The notion of “economic efficiency,” when implemented in a social setting, is inappropriately applied and therefore misconstrues the nature of the phenomena that is being judged. From the perspective of a catallaxy there are no social costs and benefits, per se, but only individual costs and benefits associated with the attainment of individually determined and ranked goals.

In assessing social welfare, economic efficiency, i.e., the efficiency of economies, has an important role, but only as a component of a more relevant notion which will be labeled “catallactic efficiency.” Economic efficiency, in the strict sense of the term, applies to assessments of the means-ends framework of individuals and organizational units within the catallaxy. It is confined to addressing the question of the relative appropriateness of alternative means in the pursuit of a given hierarchy of ends. In the overall scheme of economic science, the concept of economic efficiency, finds its most appropriate place in certain subfields such as the theory of the firm and the theories of organizational and consumer behavior. The concept cannot logically be transplanted from the assessment of the activities of economies within the catallaxy to the catallaxy as a whole. This is what standard welfare economics has inappropriately done. It has lead to an obfuscation of the real social welfare problem that is faced by a market system.

CATALLACTIC EFFICIENCY

Catallactic efficiency, by its very nature, is an expression of social efficiency. A catallaxy is a social order generated by the market activities of separate individuals and organizations, each pursuing their own purposes. A theory of catallactic efficiency should provide a framework from which this social order can be evaluated. It should provide a meaningful criteria that allows the economist to determine whether the system is working “better” or “worse” and that can give guidance in determining how the system can be improved.

In constructing a theory of catallactic efficiency we must be careful not to fall into the same trap that has snared the standard theory of economic efficiency. In other words our theory should capture the essence of the phenomenon that it is to pronounce judgement upon. The concept of catallaxy implies two important criteria for a theory of efficiency and ultimately, social welfare. First we need to start with the fact of individual autonomy. In other words, we must recognize, as outlined above, that we are dealing with a social order made up of individuals and organizations each pursuing their own, subjectively defined program of goals. This implies, first and foremost, that the theory should be what Hayek calls “ends independent” (1976, p. 36). In considering the question of efficiency the economist has no framework from which to pass judgement on the ends being pursued by market participants. As has been noted, there is no common hierarchy of values upon which to rank the different goals of all of society’s participants. On a more fundamental level, since value rankings are determined intrapersonally, there is no way for an outside observer to discover any individual’s ranking of goals or even the goals themselves. Economists, and therefore efficiency theory, have no choice but to abstract from the ends that are being pursued by market participants. Any attempt to pass judgement on particular ends for the purpose of determining either social or individual welfare cannot be considered scientific.

This signals an important and fundamental difference between economic efficiency and the theory of catallactic efficiency here under consideration. Implicit in more standard notions of efficiency, with the exception of a strict Paretian criteria of unanimity, is a judgement that some people’s ends are more “valuable” to society than others. This conclusion can have no place in either a theory of catallactic efficiency or the normative analysis of externalities that it gives rise to.

A further implication of the notion of ends independence is that value must be viewed as inherently subjective. If there is no common scale of social value, and no way of knowing the value scales of any particular individual, there is no way to make interpersonal cost-benefit comparisons or even intrapersonal comparisons across time. As a guide to social welfare, such comparisons necessarily must pass judgement on competing ends and would automatically blur the distinction that is being made between catallactic and economic efficiency. Therefore, the two fundamental tenets of Austrian economics, methodological individualism and subjectivism, must be part of any operational theory of efficiency.

In conjunction with and as an implication of subjectivism, any analysis of people’s preferences must be based on a recognition and acceptance of the guiding principle behind Rothbard’s theory of social utility, i.e., revealed or “demonstrated” preference. Since the economist cannot project a value scale onto individual actors within the catallaxy, preferences can only be deduced by observing activities. Furthermore, since states of knowledge can and do change with the passage of time, preferences that are revealed at a point in time cannot be assumed to remain constant over time. Again, this is an important part of Rothbard’s analysis that can and should be used as a building block for the theory presented here.

In addition to being “ends independent,” which implies the conclusions just reached with regards to subjective value, the theory should be careful not to make assumptions concerning the amount of knowledge that is “given” to market participants. Certainly, an assumption of perfect knowledge would make no sense in this context, but beyond this, the idea that knowledge is “given” at all must be avoided. At the individual level, or the level of “economic efficiency,” the acquisition of knowledge is the efficiency problem. This, as will be discussed in more detail below, is the most significant lesson in Kirzner’s theory of efficiency. Rather than being viewed as a given, the level of knowledge must be considered the most important “variable” in the social order. This will be true for both the individual and the society as a whole.

Economic Efficiency

Any theory of catallactic efficiency must start with economic efficiency. In other words, the question must be asked, what constitutes efficiency for the individual actors that make up the catallaxy? In this regard, wholesale adoption of Kirzner’s theory of efficiency for the individual is appropriate. It provides the necessary first building block for a theory of social or catallactic efficiency.

At no point can such a theory detach itself from the efficiency problem facing the individual. As has already been noted such detachments are part and parcel of more standard approaches to welfare economics. The most ironic example is found in the conclusions reached from a Pigouvian perspective when analyzing positive externalities. Even though, by definition, no one is made worse off as a result of external benefits that are generated in the production or sale of a good, “social welfare” is said to be reduced. From a different perspective, but still within conceptual framework of “economic” efficiency, Richard Posner, discussing the problem of negative externalities from a Coasean perspective, states that:

The question whose cost is not a profitable one in economic analysis... The relevant question from the standpoint of economic analysis is who could prevent the loss at lower cost, not whose cost the damage ’really’ is. (1973, p. 94)

Such dichotomies between the costs and benefits facing society and those facing the individual cannot be sustained in light of the catallactic perspective adopted here. Clearly the focus on ends independence and its implications for interpreting value as a purely personal and subjective phenomena preclude any such distinctions.

To review from the previous chapter, Kirzner starts with a view of man that might best be called “goal seeking,” as opposed to the more standard “utility maximizing” homo economicus. For establishing a theory of catallactic efficiency, this distinction is important. Conceptually, it takes the actor out of the timeless framework of “utility functions,” where ends and the perfect knowledge of means are a given. It also eliminates the temptation to illegitimately quantify utility functions and therefore combine them to form a social welfare function. Kirzner’s vision is also the view of man embedded in Hayek’s notion of catallaxy. Hayek’s discussions consistently refers to the ranking of goals on individually determined value scales.

The efficiency problem in this setting is one of achieving the desired goal or set of goals by the most consistent use of means possible. For the individual, efficiency depends on the extent to which his actions, the means employed, are consistent with the goals or ends that are hoped to be accomplished. This is a “knowledge problem.” The efficiency of an individual’s activities will improve as he obtains more knowledge that is relevant to his particular situation.

Another way of viewing this is that the efficiency problem for the individual is the problem faced in formulating and executing plans. All plans are made with respect to actions that will be taken at future points in time. Since knowledge about the future cannot be perfect, varying levels of uncertainty will always pervade the formulation of plans. This perspective inextricably links catallactic efficiency to the passage of time and takes it out of the context of comparative statics.

Implicit in this discussion is the fact that in order for individuals to formulate plans and accomplish any goals they must have access to physical resources. The more appropriate the resources are for the accomplishment of the individual’s goals, the more efficiently those goals will be obtained. Of course, this too is a question of knowledge. In order for any physical resource to be useful as means to an end, the user or potential user must first know that it exists. Beyond this he must have information concerning better and worse ways of obtaining it and then using it either by itself or in combination with other resources. The better this information, the more efficiently the resource will be used.

In the isolated context of individual efficiency, i.e., a Crusoe, the issue of obtaining or gaining control of the appropriate physical means is a personal one. It depends only on one’s own physical abilities and knowledge. In a social setting, acquiring appropriate means becomes an interpersonal issue and needs to be a central focus of any theory of catallactic efficiency. For the moment it is important to note that in order for individuals to make plans and eventually achieve their goals they must be able to acquire both the appropriate knowledge and the appropriate physical resources.

Note that all of this is consistent with our stricture that no particular level of knowledge be assumed for the individual. It should be clear that the assumption of perfect knowledge in this setting would eliminate the problem entirely. If the individual, acting in a non-social setting had full knowledge of all the means available and how those means could best be used, the question of more or less appropriate means would be moot, and therefore the efficiency problem would not exist.

This suggests a point of contention with Kirzner’s depiction of the efficiency framework within which the individual operates. While Kirzner does not assume any particular level of knowledge on the part of the actor, the concept of perfect knowledge does play a role in his theory. He postulates a condition of “perfect efficiency” where the actor has “perfect knowledge” in the sense described above. This is used as a foil against which the relative efficiency of an action can, conceptually, be judged. While I believe that the concept of perfect efficiency is unnecessary, at the level of the individual it makes little difference with regards to the nature of the efficiency problem. At most it would result in a quibble about whether the individual is striving to obtain the highest level of knowledge that is consistent with his means ends framework or is striving for something called perfect knowledge.

Conceptually though, perfect knowledge and therefore perfect efficiency, adds an element of “closed endedness” to the efficiency problem. Kirzner’s theory, without the foil of perfect knowledge, is a more realistic portrayal of the world that individuals face. In reality, people in pursuit of their plans are always obtaining new information and discarding old. Value scales, and therefore programs of action, are always being revised in a never-ending process of trial and error. There is no end to this process, either in reality or conceptually. A crucial analytical departure from Kirzner comes at this point. The efficiency problem, i.e., the knowledge problem, for the individual is completely open-ended. This leads us to conclusions concerning the nature of social or catallactic efficiency, that are at odds with some of the most important of those that are reached by Kirzner.

Social Welfare as Catallactic Efficiency

The economic problem of society is ... a problem of how to secure the best use of resources known to any member of society, for ends whose relative importance only these individuals know ... It is a problem of the utilization of knowledge ...

Hayek, 1945, pp. 77-78.

Efficiency for a social system means the efficiency with which it permits its individual members to achieve their several goals.

Kirzner, 1963, p. 35.

The efficiency of a catallaxy can be judged by the extent to which it promotes economic efficiency. In other words, it is to be judged by the extent to which the catallaxy encourages individuals existing in a social context, to pursue their own goals as consistently as possible. The individual is taken out of isolation and placed in a social setting described by the notion of catallaxy, i.e., where their are other individuals all pursuing their own, sometimes mutually incompatible, goals.

By its very nature, then, questions of catallactic efficiency must focus on the institutional setting in which individual actors operate. In particular there are two overriding issues. The first centers around the institutional setting that will best facilitate the use and discovery of information, the appropriateness and relevance of which can only be known by those who need to discover and use it. The second concerns the institutional setting that will allow individuals to gather the necessary physical resources. Here, the appropriateness and relevance of these resources can only be known by the person who is seeking them. As noted above, the resource and knowledge requirements are closely linked. The fact that a useful physical resource exists is meaningless until the knowledge of its existence and its relative usefulness are acquired.

Logically these questions might best be viewed in reverse order in which they have been presented here. The question of individual acquisition and use of resources in a social setting is crucial to the remainder of the analysis. In a fundamental sense, without access to physical resources all the knowledge in the world would be useless. In order for any individual to achieve his goals he must be able to make plans with respect to the use of resources and be reasonably confident that when the attempt is made to implement those plans that those resources will be available. In the case of the isolated individual, this concern would relate primarily to natural factors or personal carelessness that could lead to the destruction or alteration of resources that were being relied upon. But in a social setting, the problem of interpersonally conflicting plans with respect to the use of the same physical resource becomes an important consideration. When placed in a social setting, then, an additional problem concerning the efficient use of physical resources arises. Individual A can only be secure in his plans with respect to resource X if he is sure that individual B is not also making plans with respect to its utilization. In a social setting where different individuals are pursuing different ends, efficient resource use can only occur when conflicts in the use of resources are minimized.

This suggests that an important cornerstone of any institutional setting that is going to promote catallactic efficiency will have to be private property. The mere existence of a catallaxy is conditional upon individuals having rights to resources that they can then allocate in accordance with their program of goals. Without the ability, i.e., the right, to direct physical resources toward individually determined higher and lower valued uses, no goals could be pursued and no plans could be executed.

A corollary to private property, and following directly from it, is exchange. Exchange is the fundamental way in which individuals within a system of private property acquire relatively more appropriate means for the attainment of their ends. Indeed, an act of exchange is an act of giving up less appropriate means for more appropriate means. It is the dominant social mechanism for the promotion of economic or individual efficiency. Both parties to the exchange give up something that they consider to be less appropriate for the achievement of their ends for something that they see as more appropriate. In a catallaxy the fundamental way in which individuals pursue their goals is through the exchange process. Since all market exchanges are, at least ex ante, mutually beneficial, they also allow individuals to minimize conflict. This implies that catallactic efficiency must focus on the extent to which the exchange process facilitates the achievement of individually determined goals.

This reintroduces the issue of knowledge acquisition. In a social setting the better people are able to identify advantageous exchange opportunities the better they will be able to make plans, acquire more appropriate means, and pursue their goals more efficiently. In a catallaxy, the efficient pursuit of goals hinges on knowledge of exchange opportunities. The price system generates much of this information. In the most fundamental sense, the individual, by considering the array of product and price offerings that confront him, can discover those other individuals whose plans most consistently mesh with his own. Relative price and product comparisons give people information concerning what potential trading partners offer the most beneficial exchange possibilities.

A crucial efficiency concern facing a catallaxy is the problem of facilitating relatively more advantageous exchanges. The economist’s role is to identify the institutional setting, legal and otherwise, that will best promote the pursuit of individual goals through the exchange process, i.e., institutions that will allow the price mechanism to bring to light and facilitate the most advantageous exchanges possible. The role of an economic policy analyst is to identify problems and virtues of public policy proposals in light of this efficiency concern.

IDEAL INSTITUTIONAL SETTING VS. IDEAL MARKET OUTCOMES

The standard notion of economic efficiency, which focuses on a perfectly competitive general equilibrium, defines efficiency in terms of an ideal set of market outcomes--perfect knowledge, homogeneity of product, many firms, free entry and exit, etc. These give rise to the specific efficient outcome for any given market, namely a level of output that equates price, marginal private and social cost, and marginal private and social benefit.

It should be clear that in the open-ended setting of catallactic efficiency, specific outcomes of this nature cannot be preordained. Efficiency here is construed in terms of an open-ended process of pursuing goals, where people make mistakes, readjust their plans in light of new information, and continue on. It is inherently a process of trial and error, with no end-state of rest ever even considered by the participants in the process.

The task of the economist, when considering normative questions, is to identify those institutions that best facilitate this process. Within this context, an ideal institutional setting can be identified that serves a similar purpose to that of the conditions of perfect competition in standard welfare economics. This setting can be used as a benchmark against which real institutions can be judged and public policy proposals can be measured. The identification of this institutional setting will have no normative implications for particular activities or outcomes that occur within the context of that setting. In other words, there can be no judgments made about optimal output levels, the relationship between price and costs, the number of firms in a market, etc.. On the other hand, judgments can be made with regard to activities that operate outside of, or otherwise violate, the ideal institutional framework.

To reiterate, the overriding purpose of this ideal setting is to identify, generally speaking, the framework within which individuals, as social beings, are able to most efficiently pursue their goals. For reasons discussed above, it must incorporate the notion of private property as a fundamental starting point. No meaningful means ends framework is even possible without the ability to access and control physical resources. Beyond this, the role of this institutional setting is to allow the exchange process, through the price system, to disseminate as much information concerning appropriate exchange opportunities as possible.

The methodological rules that have been guiding this theory of catallactic efficiency generally, must also be incorporated into this ideal institutional setting. In particular, it should be “ends independent,” with all that this implies concerning the subjective nature of value. Hayek stresses this point. In setting guidelines for public policy making within the context of a catallaxy he argues that:

[policy should] be directed toward securing an abstract overall order of such character that it will secure for the members the best chance of achieving their different and largely unknown particular ends. The aim of the policy in such a society would have to be to increase ... the chances for any unknown member of society of pursuing with success his equally unknown purposes. (Hayek, 1976, p. 114)

An important implication of this is that any institutional setting that hinges on interpersonal cost-benefit analysis is ruled out a priori. For example, a legal environment such as that envisioned by Coase (1960), particularly in a positive transactions cost world, would not fit these criterion. While stressing the importance of private property, Coase’s world hinges on the ability to make interpersonal cost-benefit comparisons and therefore is not ends independent. (More will be said on this in chapter 5.)

Kirzner (1963) has set forth a general legal framework that is consistent with the goals of catallactic efficiency. His purpose was simply to state his own view of the “ideal” legal framework for the functioning of a society based on contract and exchange. According to Kirzner, this “ideal system may be thought of as, in one way or another, ensuring the smooth fulfillment of such cooperative arrangements” (1963, p. 14). Since his analytical concerns with respect to the individual planning process and the knowledge disseminating functions of the price system are the same as those being embraced here, the institutional setting that he describes is completely consistent with the concerns of catallactic efficiency. In Kirzner’s words:

In a market system each member of society is free to act, within very wide limits, as he sees fit. Moreover, the system operates within a framework of law which recognizes individual rights to property. This means that each individual is free at each moment to employ the means available to him for the purpose of furthering his own ends, providing only that this should not invade the property rights of others. (Kirzner, 1963, p. 13)

Kirzner first starts with a recognition of the importance of property rights. But he goes beyond this to describe, in a general sense, the nature and content of those rights. Specifically, there are three simple criteria that are general enough to act as a policy benchmark in dealing with a host of problems, including those associated with externalities.

1. Individuals should have rights to property, i.e., title to property should be held privately.

2. Property rights should take the form of allowing the individual “to employ the means available to him for the purpose of furthering his own ends.”

3. In pursuing his own ends the individual is obliged “not [to] invade the property rights of others.”

Number 1 simply establishes the principle of private property. Titles to property should be clearly delineated. As Hayek has stated:

The chief function of rules ... is to tell each what he can count upon, what material objects or services he can use for his purposes, and what is the range of action open to him ... by making it possible to derive from ascertainable facts to whom things belong. (1976, p. 37)

Criteria 2 and 3, though, go on to delimit the rights that individuals should have with respect to their entitlements. Clearly these rights are very broad and are limited only by the same rights of others.

The important point is that these three criteria are completely consistent with principles of catallactic efficiency. First, private property is incorporated as the fundamental starting point. As has been already argued, no meaningful planning process could take place in the absence of rights to physical resources. Second, this legal setting is “ends independent.” It emphasizes that people need to be allowed to use their property, both directly and through market exchange, in a way that is consistent with their own purposes. As a corollary to this, the single limitation on property usage (number 3) implicitly recognizes our concern that conflicts over the use of property, i.e., that two or more individuals may make incompatible plans with respect to the same property, can severely hinder the successful implementation of plans. Hence, property rights should be exclusive.

This institutional setting also has important implications for the exchange process and the effectiveness of the price system. Since it maximizes the extent to which the individual’s own plans come to bear on the use of property, mutually agreed upon market prices will reflect as much information about market participants preferences, expectations, and perceptions of resource scarcities as possible. This means that businessmen and entrepreneurs who use prices as a guide to their activities will face incentives to pursue production activities that will coincide as closely as possible with the purposes of consumers.

A further efficiency enhancing property of this institutional setting is that it provides a great deal of certainty in individual decision making. This aides both the individual planning process and furthers the goal of knowledge dissemination through the exchange process and the price system. The individual planning process is not static. It is forward looking and takes place through time. Since plan formulation necessarily involves the use of property at different points in the future, certainty with respect to legal rights and obligations removes what could be an important source of error from decision making processes.

Expectations about the future are an integral part of plan formulation and the information reflected in prices. These expectations are always burdened with some degree of uncertainty, and, sometimes, turn out to be wrong. By providing a high degree of confidence with respect to legal rights and obligations this legal setting removes what could be an important contributor to the overall level of uncertainty in the decision making process. Plans can be made with respect to legally acquired property, knowing that the right to execute those plans at some point in the future will be upheld. Kirzner also emphasizes this point, stating that “each individual can plan his activities with the assurance provided by the law, first that the means available to him at any one time are secure against appropriation by others, and, then, that he will not be prevented by others from enjoying the fruits of his productive activities” (p. 13).

This has important implications with respect to the exchange process. People are willing to pay certain prices based on the services that they expect to receive from the purchased goods. This is the basis for consumer preferences that are ultimately transmitted through relative prices and price movements. To the extent that people receive the services that they expect, their plans are consistent with the ends being sought. If, once the good was purchased, the rights with respect to the use of that product were altered such that the expected services could not be fully realized, then both the purchaser(s) of the product and the price system would be adversely affected. Prices would have captured and disseminated these erroneous expectations, adversely affecting catallactic efficiency.

The institutional setting outlined here will maximize catallactic efficiency relative to any other institutional arrangement. To reiterate Kirzner’s concern, it will maximize the efficiency by which the individual members of the social system will “achieve their several goals.” It does this by guaranteeing people individual control over resources, thereby minimizing conflicts in the planning process; by giving people the maximum amount of freedom in making mutually satisfactory exchanges leading to the acquisition of more appropriate means; and by providing a foundation that will allow the price system to disseminate as much of the relevant information as possible.

THE MEANING AND CAUSES OF INEFFICIENCY

As with efficiency, inefficiency is broken down into two categories, economic and catallactic. Economic inefficiency has reference to the internal consistency of the individual means-ends framework. Catallactic inefficiencies are the result of economic inefficiencies that impinge upon interpersonal relationships, particularly the process of exchange and the price system.

Because people are fallible, inefficiencies will always occur. As has been emphasized, the process of pursuing goals is inherently a process of trial and error. To the extent that errors are made in formulating and executing plans, inefficiencies will arise. Economic inefficiencies can arise because of misperceptions about the appropriateness of particular means to the ends being sought or because of misperceptions concerning future states of the world. Given individuals capable of learning from mistakes, the process of pursuing goals is inherently in continuous adjustment, proceeding from less to more efficient activities until the end being pursued is achieved.

Economic inefficiencies can generate problems for the catallaxy at large when exchange decision are made based on false beliefs. This is why actual market prices can never be “perfect.” They are always capturing some erroneous information about both demand and supply that has been generated by the false perceptions of individual traders. Again, given the incentives generated by profits and losses, plans based on any erroneous information generated by prices will tend to be revised and decisions will be reversed. Because of the open-ended nature of catallaxy, though, this is a continuously unfolding process where new, false information is always being filtered out.

Inefficiencies of this nature are due to the inherent imperfection of human beings and are unavoidable. As such they can be categorized as “natural inefficiencies.” These inefficiencies can never be eliminated and therefore are not policy relevant. For the purposes of normative economics it is more important to focus on the issue of what might best be called “institutional inefficiencies” (see Rizzo 1980A). These are inefficiencies that are generated by deviations from the “ideal” legal framework. They can arise because people are prevented in some way from fully utilizing their property or because rights to property are not clearly delineated. In the former case, the execution of formulated plans may be blocked or plans that could lead to a more complete fulfillment of goals may never be made. In the latter case, where title to property is not clearly established, the result may be interpersonal conflict over the use of property, conflict that can make it necessary for plans to be revised or abandoned.

To the extent that deviations or violations of the ideal institutional setting interfere with the process of contracting and exchange, catallactic inefficiencies will arise. Where existing rights to property are intruded upon, it is likely that exchanges have been made, possibly the property in question was purchased with the now foiled plans in mind. This can affect the information flows that are being provided by prices throughout the production chain. To the extent that the execution and realization of plans are prevented by abridgements of property rights, erroneous information with regards to expectations and preferences will be incorporated into prices. Furthermore, to the extent that production plans and entrepreneurial decisions are based on the erroneous aspect of these prices, they too will have to be revised.

In the case where titles to property are not clearly delineated, several inefficient results are possible. First, this could lead to separate and incompatible plans being made with respect to the same resource. In such cases conflicts can prevent or hinder the execution of plans. Again, this will have effects on the price system similar to those mentioned above. To the extent that these conflicting plans are incorporated into the exchange process, possibly through the purchase of complementary resources, prices will be reflecting both erroneous and conflicting expectations. A possible, but probably less likely, outcome is that the resource is completely unexploited because no one explicitly has the right to use it. In such a case the resource enters into no one’s means-ends framework and makes no contribution to the attainment of anyone’s goals. From a catallactic efficiency perspective, this would truly be a “wasted” resource. Furthermore, to the extent that the lack of rights to this resource prevents it from becoming the object of exchange, price signals concerning the scarcity of like resources and substitutes for this resource will be incorrect.

Of course this discussion of inefficiency impinges heavily on the issue of externalities. In the more standard Pigouvian and, later, Coasean literature, externalities are problematical because of the social inefficiencies they generate. Our task in the chapter to follow is to examine any catallactic inefficiencies that can be traced to externalities. The two theoretical issues that remain to be examined concern the kinds of externalities that are inefficient in the open-ended setting of catallaxy and the policy implications of such inefficiencies.

CONCLUSION: CATALLACTIC EFFICIENCY, KIRZNER’S COORDINATION STANDARD AND ENTREPRENEURSHIP

This view of catallactic efficiency is, in a fundamental sense, Kirzner’s standard of welfare economics without invoking interpersonal plan coordination as the normative goal. The problems that I see with coordination as a normative benchmark for welfare economics were outlined in the previous chapter. As was argued, where Professor Kirzner sees coordination as synonymous with improvements in information, I suggest that the knowledge improvement process often leads to disruptions in previously formulated plans and, at least temporarily, some discoordination. Furthermore, Kirzner adds an unnecessary aspect of closed endedness to his standard by invoking perfect knowledge and therefore perfect coordination as a way of defining “perfect efficiency.” I believe that it is more fruitful and less distracting to focus strictly on improvements in knowledge and the elimination of error as the desired end in a catallactic process. But all of Kirzner’s concerns with regards to the individual’s means-ends framework and the ability of the price system to capture and disseminate accurate information are embraced within this theory of catallactic efficiency.

Furthermore, Kirzner’s vision of the entrepreneur as arbitrager is crucial to a catallactically efficient process. From this perspective the essential social function of the entrepreneur is to facilitate exchanges. That is, to make possible exchanges that would not otherwise have occurred, leading to a more complete realization of goals. Every entrepreneurial act within the context of a catallactic process can be viewed in terms of the entrepreneur’s ultimate social function as an exchange facilitator. Contrary to Kirzner’s conclusions, I do not argue that these exchange facilitating acts are always coordinating. But this is part of the distinction between the efficiency benchmark presented here and Kirzner’s standard.

Clearly this theory of catallactic efficiency owes a great deal to Professor Kirzner’s pioneering work on both the nature of efficiency and the role of the entrepreneur. I see the theory presented here as simply an extension and refinement of his efforts.