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American Economic Association

Methodological Individualism and Social Knowledge


Author(s): Kenneth J. Arrow
Reviewed work(s):
Source: The American Economic Review, Vol. 84, No. 2, Papers and Proceedings of the
Hundred and Sixth Annual Meeting of the American Economic Association (May, 1994), pp. 1-
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RICHARDT. ELYLECTURE

Methodological Individualismand Social Knowledge

By KENNETH J. ARROW*

It is a touchstone of accepted economics methodology has invaded other social sci-


that all explanations must run in terms of ences, under the name of rational-actor
the actions and reactions of individuals. Our models. But today I will confine myself to
behavior in judging economic research, in the extent possible to the role of method-
peer review of papers and research, and in ological individualism in economics.
promotions, includes the criterion that in The unwieldy adjective, "methodologi-
principle the behavior we explain and the cal," is needed to distinguish the concerns
policies we propose are explicable in terms of constructing positive theory from the nor-
of individuals, not of other social categories. mative and policy implications wrapped up
I want to argue today that a close examina- in the term, "individualism." This distinc-
tion of even the most standard economic tion is not easy to keep clear, and the temp-
analysis shows that social categories are in tation to join methodology and ideology is
fact used in economic analysis all the time strong. Thus Paul Samuelson (1963) starts a
and that they appear to be absolute necessi- speech on the policy limitations of individu-
ties of the analysis, not just figures of speech alism by comparing the competitive model
that can be eliminated if need be. I further of the economy to the physicists' theory of
argue that the importance of technical in- dilute gases, and comparing the need for
formation in the economy is an especially state intervention to increasing density and
significant case of an irreducibly social cate- consequently increased interaction of atoms.
gory in the explanatory apparatus of eco- He appears to suggest that a failure of
nomics. methodological individualism leads to a fail-
In the usual versions of economic theory, ure of individualism as a normative guide.
each individual makes decisions to consume Friedrich von Hayek, with totally opposed
different commodities, to work at one job or values, is even more explicit in identifying
another, to choose production methods, to explanation and values. To quote, "true in-
save, and to invest. In one way or another, dividualism... is primarily a theory of soci-
these decisions interact to produce an out- ety, an attempt to understand the forces
come which determines the workings of the which determine the social life of man, and
economy, the allocation of resources in only in the second instance a set of political
short. It seems commonly to be assumed maxims derived from this view of society"
that the individual decisions then form a (Hayek, 1948 p. 6; emphasis in the original).
complete set of explanatory variables. A I am old-fashioned enough to retain David
name is even given to this point of view, Hume's view that one can never derive
that of methodological individualism, that it "ought" propositions from "is" proposi-
is necessary to base all accounts of eco- tions. The two issues, method and value, are
nomic interaction on individual behavior. In distinct. In fact, the typical economist's ar-
recent periods, a specific version of this gument today for government intervention
to protect the environment rests on individ-
ualistic valuation, and the implementation
of policies assumes individualist behavior in
* Department of Economics, Stanford University,
responding to regulation or taxes or some
Stanford, CA 94305. This work has been supported by
NSF Grant SES-9209892. Another version of this lec-
version of prices. On the other hand, it is
ture was delivered as the Lazarsfeld Lecture, 11 certainly possible to model economic behav-
November 1993, at Columbia University. ior in terms of socially defined variables,
1
2 AEA PAPERS AND PROCEEDINGS MAY 1994

such as conformity, common pools of dividualism. Presumably his earlier (Menger,


knowledge, and governmental behavior, and 1871) treatise exemplified its use, and in-
still argue that individual choice is apt to deed even the social concept of a market
dominate intervention by social entities be- does not appear there.
cause the latter are inefficient. Menger certainly does not elaborate the
I first want to sketch very incompletely concept very fully. He recognizes that the
the explicit advocacy of methodological in- "singular" economies engage in trade with
dividualism particularly among the Austrian each other, but the needs served, he empha-
school and those influenced by them. I then sizes, are those of individuals, not of "the
want to indicate the useful implications of nation as a unit." The so-called, "national
methodological individualism for positive economy" is a complex of economies, not
economics. It is usually thought that main- an economy, in Menger's view (Menger,
stream economics is the purest exemplar of 1985 appendix I). The meaning of individu-
methodological individualism, so I will then alism was taken up again by a later, though
examine some standard economic models to atypical, Austrian, Joseph Schumpeter
see if in fact they do conform to its require- (1909), in a paper on the concept of social
ments. As we will see, they do not. In fact, value. Among other points not relevant here,
every economic model one can think of in- he emphasizes that, while there are no so-
cludes irreducibly social principles and con- cial values, properly speaking, in a private-
cepts. property economy, nevertheless under per-
Particular stress will be placed on the role fect competition the interaction of the
of information in the economic system. Lim- individuals produces something which we
itations on individualistic methodology ap- may usefully call a social value. In Shake-
pear very strongly when considering the role speare's Troilus and Cressida, the Trojans
of information, though again the individual- debate the value of Helen of Troy:
istic viewpoint is not to be completely
neglected. Hector: She is not worth what she doth
cost the keeping.
I. SomeHistoricalRemarks The hothead, Troilus: What's aught
save as 'tis valued?
Though economic thinking since at least Hector: But value resides not in partic-
ular will.
the time of Adam Smith has the individual [Act II, Scene II, lines 52-54]
decision-maker at the core, the self-
conscious formulation of the individualistic Hector's answer, like Schumpeter's, sug-
perspective is usually associated with the gests the ineradicable social element in the
Austrian school. Its founder, Carl Menger, economy.
was led to methodological controversy by More currently, James Buchanan has
his sharp disagreement with the historical identified himself with typical vigor as a
school of economists. His 1883 book covers methodological individualist and indicts
a wide range of topics, including what seems macroeconomics and, with more qualifica-
to me to be an unacceptable dichotomy tion, general equilibrium theory and neo-
between theoretical and empirical research. classical theory in general as departures
A major strand is certainly an attack on the from the correct understanding of an econ-
notion of a "national economy," which is omy as an order, rather than as a resource-
rather the outcome of many "individual allocation mechanism (see e.g., Buchanan,
economic efforts." To understand a "na- 1989). Like Hayek, he does see a link be-
tional economy" requires understanding of tween methodological and normative indi-
the "singular economies in the nation," to vidualism: "I suggest that an accepted un-
use Menger's words as translated (Menger, derstanding of the economy as an order of
1985 pp. 93-94). Yet Menger does not sup- interaction constrained within a set of rules
ply a fuller definition of methodological in- or constraints, leads more or less directly to
VOL. 84 NO. 2 RICHARD T. ELYLECTURE 3

a normatively preferred minimal interven- neous order" to the individualist theme.


tion with the results of such interaction" (p. Whereas Smith went from individual inter-
88). He explicitly rejects Hume's dichotomy actions within a given social framework to
between "is" and "ought."1 resource allocation, Menger and others hold
that the institutional rules themselves
II. The Case for Methodological change as a result of a myriad of individual
Individualism actions. Menger exemplifies this theory with
an ingenious hypothetical account of the
The starting point for the individualist origins of money (Menger, 1883 pp. 152-55).
paradigm is the simple fact that all social Some individuals, perceiving that barter with
interactions are after all interactions among goods having an irregular demand is diffi-
individuals. The individual in the economy cult, have the idea of acquiring a good in
or in the society is like the atom in chem- steady demand when they can, even though
istry; whatever happens can ultimately be they do not want that particular good. Once
described exhaustively in terms of the indi- this happens, the advantage to others to do
viduals involved. Of course, the individuals the same increases, and some goods become
do not act separately. They respond to each recognized as being readily accepted. In the
other, but each acts within a range limited political sphere, Edmund Burke had argued
by the behavior of others as well as by this point much earlier, in his attacks on the
constraints personal to the individual, such French Revolution, as had legal scholars
as his or her ability or wealth. and philologists in the early 19th century. In
A market would appear to an economist Burke and Hayek, this leads to a principled
to be an obvious illustration of a social rejection of deliberate changes in society,
situation as an interaction among individu- for the existing institutions, having arisen by
als, and individuals are certainly an indis- so many individual choices, embody the wis-
pensable part of both its description and its dom of the ages. Menger (1883 pp. 145-46)
analysis. But an army is equally composed is more reserved; he considers that some
of individuals, and no analysis of its work- social changes occur consciously and for
ings can ignore how individuals give orders pragmatic reasons, while others are indeed
or react to them. Similarly, if we want to the unintended outcomes of individual ac-
study congestion on roads or bridges, the tions. Buchanan (1989 p. 92 and footnote 5)
role of the many individuals who can choose is even more emphatic in rejecting the uni-
one route or another or drive slowly or versality of unconscious institutional design.
rapidly is essential to the study of the exis- It strikes me, by the way, that the current
tence and dynamics of congestion. focus of evolutionary analysis on strategy
Thomas Schelling (1978) has given a wide choice in games might be better directed
variety of social interaction situations where toward changes in the rules of the game.
the social outcome was surprisingly differ- This would be a formalization of the notion
ent from the individual motivations. To be of spontaneous order.
sure, Adam Smith already taught us that It is clear that the individualist perspec-
the efforts of entrepreneurs for maximum tive does play an essential role in under-
profit lead to minimization of profit for all. standing social phenomena. Particularly
Generalizing from the "invisible hand" ar- striking is the emergent nature of social
gument, Menger, Hayek, and other Austri- phenomena, which may be very far from the
ans have associated the notion of "sponta- motives of the individual interactions. It is a
salutary check on any theory of the econ-
omy or any other part of society that the
explanations make sense on the basis of the
1For an illuminatingdiscussionof individualism
with individuals involved. Any attempt to under-
special regardto the implicitproblemsof knowledge, stand disequilibrium dynamics must require
see LawrenceA. Boland(1982 Ch. 2). the understanding of the information and
4 AEA PAPERS AND PROCEEDINGS MAY1994

strategy choices available to individual the formaltheory,at least, no one. They are
actors. determined on (not by) social institutions
Social and historical determinismis not knownas markets,which equate supplyand
as populara viewpointas it used to be, and demand.
an individualisticperspective is a guard I pass over manyother questionsof social
against such theories. Whether in Marxist roles in this description.Tastes may be so-
or other forms, such theories relied heavily ciallycaused;expectationsare influencedby
on disembodied actors such as classes or others; firms are organizations,not individ-
national spirits, rather than on the actual uals. But I want to argue the case most
persons. The newer trends in historical favorableto individualism.
analysis are more concerned with contin- The failure to give an individualisticex-
gency than with determinism,contingencies planation of price formationhas proved to
arising from the flexibilityand freedom of be surprisinglyhard to cure, though there
individualhumandecision-making. are some ingeniousstories. They all depend
In this quick presentation of individual- on the closest realizationof individualismin
ism, I have avoided the term, "rational economic theory, which is to be found in
choice." The individualistviewpoint is in game theory, and indeed Buchanan (1989
principlecompatiblewith boundedrational- p. 82) asserts that, "game theory offers
ity, with violationsof the rationalityaxioms, the appropriate mathematical framework
and with the biases in judgmentcharacteris- that facilitatesan abstractunderstandingof
tic of humanbeings. The additionalstep to economics."
rationalchoice is, of course, of the greatest
practical importance to theory formation, IV. GameTheory
but it is not in principle necessary for the
individualistviewpoint. The currentformulationof methodologi-
cal individualismis game theory.This is not
III. CompetitiveEquilibriumand a particulartheoryof social interaction,but
Methodological Individualism rather a languagefor such a theory. It may
not be surprisingthat its authors are an
I have emphasizedthe desirabilityof an Austrianeconomist and a Hungarianmath-
individualist perspective. I now want to ematician-economistat least closely con-
argue that economic theories require nected culturallyto Austria.
social elements as well even under the In a game, each agent chooses one among
strictest acceptance of standard economic a set of strategiesavailableto him or her. In
assumptions. the usual formulations,the set of available
The prototypicaleconomicmodel, despite strategies is fixed, independent of the
battering, is general competitive equilib- choices of others. The outcome or payoffof
rium. Individualsand firms take prices as the game for each playeris a functionof the
given. Individualschoose consumptionde- strategies of all the players. Hence, all the
mands and offers of labor and other assets, interactionsamongplayersare embodiedin
subject to a condition that receipts cover the payoff functions.The choice of actions
expenditures.Firms choose inputs and out- is totally individualistic.For the game for-
puts subject to the condition that the out- mulation to be meaningful, the outcomes
puts be producible given the inputs. How defined by the payoff functions must be
they make these choices depends on many possible;for example,demandshould never
factors:tastes, attitudes towardrisk, expec- exceed supplyfor any commodity.
tations of the future. But, it is held, these It has proved difficultto define competi-
factors are individual. tive equilibriumas the outcome of a non-
Even if we accept this entire story, there cooperative game. It is not difficult to
is still one element not individual:namely, constructa game whose equilibriumpoint is
the prices faced by the firms and individu- a competitive equilibrium;indeed, Gerard
als. What individualhas chosen prices? In Debreu and I did somethingclose to that in
VOL. 84 NO. 2 RICHARD T. ELYLECTURE 5

our proof of existence of competitive equi- sions of oligopoly theory. The optimizing
librium (Arrow and Debreu, 1954), and an strategy for each firm depends on the
unpublished version uses a game strictu strategies chosen by the other firms. But
sensu. But the game was purely a mathe- how does a firm know what the other firms
matical construct; when nonequilibrium are doing? Indeed, it is of the essence that
strategies were played, the outcomes were they are chosen simultaneously. Each firm
not feasible. Games whose outcomes are has an expectation or conjecture (to use
always feasible and whose equilibria are Ragnar Frisch's term) about the others' ac-
Walrasian have been constructed, but their tions. Why should they be consistent? This
relation to real-life phenomena has varying problem is again actively on the agenda of
degrees of weakness (see e.g., David game theorists. It is a problem of knowl-
Schmeidler, 1980). edge.
The most realistic-sounding noncoopera- Even if we do not question the concept of
tive-game-theory model of competitive equi- an equilibrium point, there is another
librium I know of is due to Douglas Gale difficulty, first raised by Joseph Bertrand
(1986a,b), though in its present form it ap- (1883) in his very belated review of
plies only to a pure exchange economy. Pairs Cournot's book. What after all are the
of individuals meet at random and bargain strategies of the two players? Cournot as-
(bargaining is itself formulated as a sub- sumed that firms choose quantities. Is it not
game). With the endowments obtained as a equally reasonable that firms choose prices?
result of the bargaining, they again meet in If we assume rational consumers, they will
pairs chosen at random, and so forth. The all buy from the sellers with the lowest
bargaining at any time is, of course, affected price. The outcome of this game is entirely
by the (rational) expectations of the results different from Cournot's; under simple as-
of future bargains. These expectations are, sumptions it is in fact the competitive equi-
in effect, prices. Gale's model is a possible librium even if there are only two firms.
formalization of the Austrian viewpoint. What this example shows is that the rules
However, prices never appear as objective of the game are social. The theory of games
phenomena; they are only subjective, that gets its name and much of its force from an
is, expectations held in the agents' minds. analogy with social games. But these have
For a different perspective on the individ- definite rules which are constructed, indeed,
ualist nature of game theory, consider an- by a partly social process. Who sets rules for
other economic model, oligopoly. This prob- real-life games?
lem could be considered the very origin of More generally, individual behavior is al-
noncooperative game-theoretic analysis in ways mediated by social relations. These are
economics (there are, I believe, even earlier as much a part of the description of reality
examples of noncooperative game theory in as is individual behavior.
the analysis of social games); the analysis, in
completely modern form, goes back to V. Externalities
Augustine Cournot (1838). We recall the
formulation. A set of firms are producing Even within standard economic theory, I
the same good. Each chooses a quantity; the have taken the case most favorable to indi-
price is that which clears the market for the vidualistic analysis. Economics has for about
total quantity supplied by all firms. Any one a century (since Alfred Marshall [1920; first
firm then has a profit equal to the revenue edition, 1890]) recognized the importance of
from its chosen output less the cost of pro- what we have come to call externalities.
ducing that output. Each firm maximizes its Roughly speaking, these are social interac-
profit given the outputs of the other firms. tions not mediated through the market. The
This seems straightforward enough, and analysis is currently applied especially to
yet there are some difficulties. One is a environmental issues; air and water pollu-
recurrent question ever since game theory tion, global warming, toxic wastes, but also
was formalized and even earlier in discus- congestion.
6 AEA PAPERS AND PROCEEDINGS MAY1994

This ground is too familiar for discussion, of the goods to corner the wisdom of the
and much study proceeds along individualis- ancients and the accumulated experience of
tic values, though calling for some kind of the race" (p. 185).
collective action. One technical remark is Of course, other forms of knowledge than
useful as a preliminary to the following dis- purely technological are essential to the so-
cussion of knowledge and information as cial system in general and the economy in
social as well as individual characteristics. particular. In many ways, these forms are
For many, though by no means all, external- stressed by Hayek. In his famous 1945 paper
ities, the effect depends on the total of on knowledge in society (Hayek, 1948 Ch. 4),
many individual contributions. For example, he emphasizes the dispersed and tacit nature
individual combustion activities contribute of knowledge and argues that the economy
to a stock of sulfur dioxide in the atmo- solves the problem of allocating resources
sphere, the effect of which on individuals under these conditions. His motive was to
depends only on the total, not on the indi- rebut the possibility of a centrally planned
vidual contributions. Let us call such exter- society, one in which the relevant knowledge
nalities funded. This does not change the is concentrated in one place. But in the
underlying logic of externalities but does course of his argument, he has put obstacles
simplify the analysis. in the way of a better understanding of the
generation of knowledge.
VI. Social Knowledge He does acknowledge (pp. 79-80) that
scientific knowledge differs from the tacit
Among the externalities that Marshall was knowledge held by individuals and not eas-
concerned with, a prime example was infor- ily transmitted to others. In scientific knowl-
mation, especially technical knowledge. The edge, expert opinion may indeed count for
caustic dissenter, Thorstein Veblen (1919 more than the knowledge dispersed
pp. 180-230; originally appearing in 1908), throughout the economy. However, Hayek
in reviewing John Bates Clark's textbook, tends to minimize the role of scientific
identified socially held technical knowledge knowledge and does not really discuss tech-
as a main determinant of economic activity nological knowledge at all, a good deal of
in every economy. In primitive societies, to which is transmittable to others. Let me call
quote, "[t]he 'capital' possessed by such a scientific knowledge and the more transmit-
community-as, e.g., a band of California table parts of technological knowledge to-
'Digger' Indians-was a negligible quantity, gether "reproducible knowledge." (Of
more valuable to a collector of curios than course, a fuller account would have to rec-
to any one else, and the loss of which to the ognize varying degrees of reproducibility.)
'Digger' squaws would mean very little. In many ways, the distinction between re-
What was of 'vital concern' to them, indeed, producible and tacit knowledge is parallel
what the life of the group depended on to that between evolutionary and conscious
absolutely, was the accumulated wisdom of changes in social organization that I re-
the squaws, the technology of their eco- ferred to earlier.
nomic situation." (Earlier, he had said, Suppose we try to pursue the individualist
''women seem in the early stages to have viewpoint about knowledge, that knowledge
been the most consequential factor instead is held by individuals. What is striking is
of the man who works by himself.") Veblen that neither Hayek nor his socialist oppo-
did not deny that the capital goods are nents were concerned with changes in
more significant in modern economies, but, knowledge. The stock of knowledge is given.
"[t]he commonplace knowledge of ways and Hayek takes this knowledge to be dis-
means, the accumulated experience of tributed among economic agents and at-
mankind, is still transmitted in and by the tributes to the socialists the view that it is or
body of the community at large; but, for can be held centrally. (This is in fact a
practical purposes, the advanced 'state of caricature of the position of the market
the industrial arts' has enabled the owners socialists, from Enrico Barone through
VOL. 84 NO. 2 RICHARD T. ELYLECTURE 7

Oskar Lange and Abba Lerner.) More mod- revelation of quality information is much
ern economics is concerned with the acqui- more transparent.
sition of new knowledge, and the test of the With this perspective, it may be easier to
individualist viewpoint has to be an attempt think of information breeding information
to understand how and why new knowledge and to suppress the role of individuals. This
is held by individuals to see if the account is is very much like the role of genetic infor-
adequate. mation. As the late 19th century writer,
New knowledge is acquired in two dif- Samuel Butler, said: "A chicken is an egg's
ferent ways: (1) acquisition from observing way of making an egg."
nature (whether by research or by less for- Indeed, models in which socially available
mal procedures); and (2) learning from other information is a variable are not uncom-
individuals, which in turn can be subdivided mon, especially in the literature on techno-
into (a) intended learning (communication, logical innovation and economic growth.
education), and (b) inferring the knowledge One class includes those models which em-
of others by observing their behavior. phasize the diffusion of technology (for
Let us consider the second mode, learn- well-known examples, see Zvi Griliches
ing from others, first. There are clear empir- [1957], Everett Rogers [1962], and Mansfield
ical problems with maintaining the individu- [1968 Part IV]). The tradition in turn de-
alist orientation. Technical and other rives from earlier work in anthropology and
knowledge exists in social form: books or sociology, in which traits (in particular,
universities (professors in many courses are technologies) in possession of one group
largely interchangeable). These are exam- spread to another at rates proportional to
ples of intended communication, though not the contact between the groups. These in
precisely individualistic as to recipients. In- turn are related to theories of the spread of
ference from the behavior of others is even epidemics.
less individualistic. The existence of new Modern theories of economic growth in-
products is itself a transmission of informa- corporate many of the same elements. Sub-
tion, an externality; it shows that certain tle observation is not needed to see that we
ways of progress are possible, even if the have had great changes in our technological
principles are not made public. When the knowledge. The need for economic analysis
atomic bomb was new, there was great con- is to explain steady or even accelerating
cern about secrecy; but wise physicists ob- rates of growth in advanced economies.
served that the most important information Neoclassical economics without increased
was that the achievement of nuclear fission knowledge should lead to diminishing rates
was possible, and that could hardly be held of growth, even apart from Malthusian con-
secret. In practice, reverse engineering and siderations and exhaustible resources.
the diffusion of basic unpatentable knowl- While dissemination of existing informa-
edge imply a much more rapid transmission tion can certainly account for some gains in
of technical information than merely the productivity, it is clearly necessary for sus-
existence of new products (see Edwin tained growth to have information new to
Mansfield [1985] who estimates that new the entire system, not merely learned from
technology becomes available to other firms others. Where does this new knowledge
within one or two years). come from? The literature has two view-
It is curious, by the way, that so much of points, although they are not really exclu-
the literature of the last 20 years has con- sive. One is that the growth in knowledge is
centrated on using prices as a source of exogenous to the economy (Robert Solow,
information (e.g., Sanford Grossman, 1976; 1956), the other that it is endogenous, a
Roy Radner, 1979; Grossman and Joseph E. result of economic processes (the "new
Stiglitz, 1980). Interesting as this work is, growth economics").
the assumptions needed to imply that prices The first is equivalent to saying that
reveal much of the private information of knowledge produces knowledge. The
others are unrealistically strong, while the second emphasizes that knowledge is pro-
8 AEA PAPERS AND PROCEEDINGS MAY1994

duced by individual decisions to invest re- REFERENCES


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