Introduction: Human’s Inadequacies in Retaining Knowledge

The need to foster institutions arises from certain intrinsic qualities of human nature, such as our limited capacity to absorb and evaluate information and to retain knowledge.

Information is used here to designate an item of explicit knowledge that everyone can learn.

Bits of information are evaluated and amalgamated into a body of knowledge, in which ideas are systematically related and which should remain open to revisions and new insights.

The word information frequently relates to the act of informing and the flow of information, whereas knowledge refers to the personal holding of a stock of knowledge in one’s mind.

People with much information may not necessarily be able to use it in interactive, applied and creative ways (information junkies Opens in new window).

Knowledgeable people are able to make use of what they know, often in novel and creative ways. When we complain of information overload, we speak of the problem of too many bits of information coming our way and our intellectual capacity to make sense of them by integrating them into a system of knowledge.

The science, which deals with knowledge and how people arrive at new insights, is called epistemology.

Epistemology: The Definition

Epistemology (after the Greek term episteme — knowledge, insight, understanding) is the science, which investigates how humans acquire and convey knowledge.

One of the main branches of philosophy, epistemology is concerned with the nature, origin, scope, and limits of human knowledge. The name is derived from the Greek terms episteme (knowledge) and logos (theory): the theory of knowledge.

The Knowledge Problem

Economic growth Opens in new window is limited by a lack of knowledge, although competing buyers and sellers help to utilize existing, and to develop further, knowledge.

Despite this cooperation of the many to obtain mutually beneficial outcomes, the problem of limited knowledge is a central tenet of human existence.

It is the ultimate cause of scarcity:

Since we do not know everything, we cannot satisfy every human want with available material resources. We do not live in Utopia — and therefore have to study economics.

Human ignorance and processes to overcome it—albeit imperfectly—are thus central to economics, the science of how to tackle scarcity.

The concept of the knowledge problem was introduced into economics by Friedrich August von Hayek who spoke of constitutional ignorance as an essential aspect of human existence.

In his 1974 Nobel Prize lecture, entitled the Pretense of Knowledge, Hayek returned once again to the theme to show that much of the economic profession pretended to know what was in reality unknowable.

The profession therefore risked giving irrelevant advice. The knowledge problem is the central theme of the Austrian critique of orthodox mainstream economics Opens in new window.

When developing a theory about complex reality, one has, admittedly, to make simplifying assumptions — just as a map depicts a simplified model of reality and omits much confusing detail. However, we must also avoid over-simplifications that inhibit our ability to understand.

Just as we do not have or need a map that is a 1-to-1 correspondence of the local landscape in the glove-compartment of our car, we also do not just have a napkin with arrows pointing North-South and East-West.

In theorizing, we always strive for an adequate level of abstraction. In that theoretical quest, it is not permissible to abstract from constitutional criteria, which are essential to what one wants to explicate.

The lack of knowledge is such a constitutional condition if one wants to explain scarcity and other economic phenomena. Assuming it away for simplicity’s sake leads to nonsense models.

To illustrate the point:

When one develops a theory of ballistics, it is acceptable, in the first instance, to abstract from air temperature and humidity.

One can then derive a simplified model, which can later be made more realistic by dropping these assumptions. However, one is bound to arrive at nonsensical conclusions, if one begins by assuming away the constitutional element of gravity.

Likewise, it makes no sense to start developing a theory of human medicine by assuming blood circulation and the nervous system away, or an economic theory assuming that people have perfect knowledge.

In reality, human beings suffer from two kinds of incompleteness in their knowledge when interacting with others:

Such sideways uncertainty arises in particular, when people want to exchange others to act on their behalf. They will often not know whether those agents will act honestly, reliably and to the best of their capability, or whether the agents will try to shirk obligations.

The assumption is often made in conventional economics textbooks that there is an economic man who has perfect knowledge of all available means and his own ends.

This enables homo oeconomicus (or femina oeconomica) to make rational choices that maximize his (or her) utility now and in the future.

Analyses based on this narrow kind of end-means rationality turn economics Opens in new window into a mere computation exercise. However, such model exercises fail to convince practitioners in business, because business people simply know that no one ever has all the requisite knowledge of all available means and that people are often unsure of their own objectives.

Normally, it is an essential part of their jobs for business people to chase better information about these matters. Business practitioners have to operate daily on the premise that individuals have a limited capacity to absorb information, to digest, convey and apply it — expressed technically: human beings suffer from limited cognitive capacity Opens in new window. This is a constitutional element in economic and business life.

People carry some of the knowledge they need in their own heads, but —most of the time—they can utilize what they know only in cooperation with others.

In the modern world, the knowledge that individuals have does not go very far to help them meet their aspirations.

An individual would not even be able to produce something as simple as a pencil. Indeed, no single person on earth has ever made a pencil all by himself.

It takes graphite miners in Bolivia, wood cutters in Canada, glue makers in Taiwan, tool makers in Germany, traders in New York, and thousands of unknown others to cooperate and contribute.

Much of people’s knowledge is specific to the place where they live and work and much consists of highly specialized knowledge. For everything else, they have to rely on what past generations developed, for example complex tools and ways of organizing work and trade. The connections between numerous experts, who will never meet or even know of each other, are necessary for as commonplace an item as a pencil to arrive into our hands (and all this for the price of a few cents!).

Does this seem like a miracle?

If producing a pencil seems a task of mind-boggling complexity, think of a standard motorcar, which contains about 5000 components made in many different factories in different countries, or a modern jet fighter that contains some ¾ million highly specialized bits and pieces!

For most of what is required to meet our wants and aspirations, we thus have to rely on cooperation with others, frequently uncountable numbers of unknown others who have knowledge of which we have not the slightest inkling.

To satisfy our wants we depend on the division of labor amongst specializes producers, which means on the division of specialized knowledge (Boulding, 1968/1962).

This specialization is so complex that it cannot be understood completely by any one human mind. The big question therefore is: How can all these diverse people around the world be coordinated to produce the desired end result, namely millions of different goods and services? Opens in new window