The Austrian Teacher.

Hayek's Challenge: An Intellectual Biography of F. A. Hayek, by Bruce Caldwell (Chicago, 489 pp., $55)

FRIEDRICH HAYEK said of his book The Fatal Conceit that "it is a work for which one has to be an economist, but this is not enough!" This sentence captures the essence of both the book and its author. Hayek was an economist, of course--but he was much more. His contributions extend to fields as disparate as cognitive psychology and political philosophy. So the study of Hayek's thought is not without its difficulties: One must think like an economist, but this is not enough.

Bruce Caldwell--who is an economist, and a historian--confronts the difficulties inherent in Hayek scholarship with this new book. Caldwell admits to some trepidation about his work. "I am an historian of economic thought, and my own self-image is that I am a careful one," he writes. "One need not be a genius to recognize that writing outside one's field is not a good way to be careful." Such reservations notwithstanding, Hayek is fortunate in his biographer. Hayek's Challenge is a success, and Caldwell proves himself capable of presenting Hayek's ideas--in all fields--with both depth and clarity.

The book is divided into three main sections. Roughly the first quarter discusses the rise of the Austrian school of economics and its antagonism with the German historical school in the late 1800s--the background against which Hayek would emerge. The next section of the book--just over half--traces the development of Hayek's thought over the course of his life. Readers interested in the facts of that life will be disappointed, as few are given. What is provided in great detail, rather, is a discussion of Hayek's main works, summarizing both their general themes and their specific arguments. In the final section of the book, Caldwell assesses Hayek's legacy. Here Caldwell is less historian and more interpreter, offering his thoughts on the success and relevance of Hayek's work and placing it in the context of contemporary thought.

Where Caldwell succeeds best is in showing how certain of Hayek's basic concerns affected his views across the board, on seemingly unrelated matters; and those who know Hayek in only one of his guises should find it rewarding to get to know the man as a whole.

Consider, for example, Hayek on income redistribution. Readers of NATIONAL REVIEW are perhaps most likely to think of Hayek as the author of The Road to Serfdom and The Constitution of Liberty, works of political philosophy in which he defends market institutions against interventionist policies designed to achieve "social justice." (Hayek's work in this area played an important role in the conversion of Robert Nozick, another great defender of free markets, from socialism.) What many may not know, however, is that Hayek's antipathy toward socialistic meddling was but one manifestation of his more general concern with what he called the "knowledge problem"--his insights into which are, according to Caldwell, his most important contribution to economics.

In the 1937 essay "Economics and Knowledge," Hayek formulated the "knowledge problem" this way: "How can the combination of fragments of knowledge existing in different minds bring about results which, if they were to be brought about deliberately, would require a knowledge on the part of the directing mind which no single person can possess?" Hayek's answer was that market institutions manage to gather the "fragments of knowledge" and coordinate individuals toward efficient outcomes. No one knows just what combination of production inputs will minimize costs and produce the quantity of goods that satisfies demand. But the operations of the market, in which prices are not fixed but respond to changes in supply and demand, are a "discovery procedure" (as Hayek would later put it) for such information.

Lest that sound like a small insight--the stuff of an introductory economics textbook--note how Hayek's answer diverges from standard neoclassical economic theory. In the textbook version, individuals are assumed to have perfect rationality and foresight. They then unfailingly make decisions about the allocation of their resources that maximize their utility. While this model no doubt has its uses, its unrealistic assumptions are often seized upon to discredit laissez-faire economics.

Hayek, like many of his peers (and the Austrians in particular), was also inclined toward skepticism of the elusive, perfectly rational homo economicus. But rather than take the apparent implausibility of the standard model as a reason to reject free markets, Hayek saw that free markets helped compensate for the limitations of human knowledge and rationality. By spontaneously gathering dispersed information and coordinating it through the setting of prices, markets make the choices of individual men both better informed and more rational than they would otherwise be. Hayek also understood--long before most, and to his great credit--that the incompleteness of any individual's knowledge makes central economic planning both impossible and undesirable. (Undesirable in that the planner must, as Hayek explained in the 1939 pamphlet "Freedom and the Economic System," "impose upon the people the detailed code of values that is lacking"--paving a path toward despotism.)

Caldwell goes on to show how Hayek's reflection on the knowledge problem led him to conclusions about the methodology of economics. Just as no central planner knows enough to bring about an efficient economic outcome, no economist knows enough to make precise forecasts. Instead, economists must content themselves with offering general explanations of the principles by which economic outcomes arise, and making predictions about the pattern of future events (rather than predicting specific outcomes). This skepticism continues to rub economists of a positivist persuasion-which is to say nearly the entire field--the wrong way.

According to Caldwell, Hayek's main message concerned "the limits that we face as analysts of social phenomena." In this vein, Caldwell ends with a plea for a renewed interest in the study of economic history--a field that has been almost entirely displaced by economists' ever-increasing interest in mathematical models and empirical analysis. The positivist hope has been that such work would establish law-like relations between events and economic outcomes; but for Hayek--and, as is clear by the end of the book, for Caldwell too--such ambitions smack of hubris.

None of which is to say that empirical work should be abandoned. Hayek's call is for modesty in the profession's aims, not for complete asceticism. But one doesn't have to be an economist--or a political philosopher, or a cognitive psychologist, or anything else--to reflect on the last century and see the catastrophes to which overly sanguine economic planners can lead. For this reason alone, Hayek's challenge is worth remembering, and Bruce Caldwell has done a great service by reminding us of it.

Mr. Steorts is a former Harvard Crimson columnist and NATIONAL REVIEW intern.