Market competition allows knowledge to be discovered and it provides the mechanisms by which individuals’ actions are coordinated; but the market is unpredictable, and state intervention – whether monetary, fiscal or otherwise – cannot prevent, nor can it lessen, the costs arising from that unpredictability.
Indeed, the very attempt is undesirable, for it retards necessary adjustments. Furthermore, the market cannot be expected simply to reward merit. However distasteful, it is important that ‘[w]e allow the individual share to be determined partly by luck in order to make the total to be shared as large as possible’ (Hayek 1978: 91). The free market serves prosperity and progress because it rewards those who apply their initiative successfully and those who are simply lucky enough to be in a position to satisfy the particular demands that arise from new and rapidly changing circumstances.
The free market economy is a complex phenomenon. It is not encompassed by the mechanistic process of market exchange. Rather, it is a system of local voluntary planning that is embodied in the nexus of private property, consent and contract. These comprise the institutional structure: a coherent set of practices whereby individuals are empowered to interact socially and through which they gain mutual advantages. Thus, business transactions – a sub-set of this social interaction – allow costs to be minimised within evolving institutional structures that support an extensive division of labour and the realisation of mutual gains from trade.
Social cohesion does not just happen. Without regulation there is anarchy and conflict; but the most appropriate regulatory structures tend to emerge spontaneously through the force of mutual advantage and the test of social competence. (Although this is the general conclusion, the most obvious exception is the revolutionary change that creates an institutional void.
Unless it is expected to achieve the restoration of an earlier socio-economic order, or to emulate evolved structures that have proven successful elsewhere, a revolution is best avoided!) The conception of law as the safeguard of freedom arose contemporaneously with the theory of the market mechanism, where the two principles of several property (that is, unshared tenure of ownership) and contract enforcement are most important. Without law enforcement there is no protection of private property; without private property there is no exchange; without exchange there are no prices; and without prices there is no coordination of activity nor tendency towards an economically efficient allocation of resources between alternative uses.
Together with the general observance of abstract rules of conduct, the principles of several property and contract enforcement create opportunities for individuals to act effectively within a coherent framework. The intensive interdependence of an extended complex socio-economic order relies upon a shared moral consciousness that understands the value of impartial rules of conduct. Such rules fall into different categories: there are those that every- body follows because of the like manner in which the environment is perceived by individual minds; those that are followed spontaneously because they form part of a common cultural tradition; and those that must be enforced because, though any individual would gain through non-observance, his action would damage the wider social order. The latter – enforcement through the legitimate exercise of coercive power – underpins the majority of voluntary private arrangements.
So what is legitimate in the exercise of coercive power by the state? Although, in a democracy, a majority can rid itself of a government, Hayek argues the need for further institutional restraint. Even in a democracy, the rule of law faces the threat of encroachment by government. The modern tendency to merge the legislative and executive functions undermines the impartiality of the law and creates (potentially) an instrument of political repression. It is because a democratically elected government can find itself bound, not by moral convictions, but by the obligation to satisfy a number of vested interests, that government must have no exemption from operating according to the liberal principles of impartiality and universality.
It is for this reason that Hayek looks to a ‘separation of powers’ to provide the means to bind government by the rule of law. By this arrangement, the legitimate function of government would be to administer resources placed at its disposal by the wishes of a majority; but government would be denied the further task of legislation. Instead, this might be invested in a constitutionally bound legislative assembly, whose sole function would be to make (and to make adjustments to) general laws of contract, tort and property. An independent constitutional court would define the properties of valid law and resolve any conflict of competence between the legislative assembly and the government. These are distinctly different tasks that ought to be kept separate to protect liberalism and, thereby, to further social and cultural evolution.