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Frank H. Knight on Uncertainty and Rational Action

Author(s): John McKinneyReviewed work(s):Source: Southern Economic Journal, Vol. 43, No. 4 (Apr., 1977), pp. 1438-1452Published by: Southern Economic AssociationStable URL: http://www.jstor.org/stable/1057110 .

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FRANK H. KNIGHTON UNCERTAINTY ND RATIONALACTIONJOHN McKINNEY

C. W. Post College of Long Island University

The writings of Frank H. Knight(1885-1972) present peculiar difficulties tocritics and interpreters. He was not only oneof America's leading economists, he wroteextensively about social and political philos-ophy, ethics and social science methodology.Yet in spite of the broad range of his inter-ests there is an underlying unity to histhought. It is not easy to understand andappreciate one aspect of his teaching, such ashis economic analysis, without relating it toother aspects. In this essay, we shall look atKnight's conception of economic rationalityand his treatment of uncertainty and erroragainst the background of his views aboutthe nature of economic science and its appro-priate method. Knight is a great teacher be-cause of his ability to provoke hard thinkingabout the most basic principles of economicanalysis.

I. BACKGROUND AND INFLUENCESAn important clue to Knight's characterand attitude is his religious background. Theson of a preacher, his early college trainingwas received at two sectarian institutions inTennessee where the religion was a form

of Evangelical Protestantism. He reactedstrongly to these early influences, taking aposition best described as secular humanism,from which he was severely critical of Chris-tian ethics and all forms of "ecclesiasticalauthoritarianism" [7, 371]. The early reli-gious faith was replaced by a profound skep-ticism, which is the principal ingredient inKnight's political and economic con-servatism, a deep mistrust of the ability of"collective rationality" to effect constructivesocial reform [7, 335-369]. Nevertheless, inspite of the strength of his reaction, there

remain in his teaching many echoes of nine-teenth century theological debates, partic-ularly those concerning free will and pre-destination.For at the center of Knight's thought,unifying his ideas in the various fields, is theindividual mind, the spiritual location of

what Knight calls true "activity," which con-sists ". . . in thinking, in deciding, in solvinga problem . . ." Activity is contrasted withthe mechanical sequences of inert nature,". . amenable . . . to generalized scientificdescription ... as activity is not." "Activ-ity," "problem-solving" and "freedom" aresaid to ". . refer to the same fact in differentaspects . . ." [7, 206]. Knight is concerned toprotect the realm of mind in which man exer-cises free will from all forms of authoritariancontrol. In his view a particularly insidiousform of such control is posed by the develop-ment of determinist science. It is not far-fetched to recognize in this concept of a dis-embodied mind a lineal descendant of theimmortal soul of Evangelical Protestantism,its salvation or damnation dependent on theoutcome of an act of choice.It is also important to take note ofKnight's intellectual debt-fully acknowl-edged-to William James and Henri Bergson[6, 97], the principal figures at the turn of thecentury in what some intellectual historianshave called a "neo-romantic" movement.Both of these philosopher-psychologists, likeKnight, wished to protect man's free willfrom what they regarded as threats from themechanical materialism of modern science.They used the term "scientism" to describewhat they judged as a viscious attempt toextend the domain of modern science beyondits proper boundaries, to include all humaninterests. Their views were at the height of

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FRANK H. KNIGHT ON UNCERTAINTY AND RATIONAL ACTIONtheir influence when Knight was a graduatestudent of philosophy at Cornell University,during the second decade of this century.'From James, Knight takes the concept ofpluralism, which becomes the dominanttheme of his moral and social philosophy. AsKnight expresses it: "Men 'exist' . . . in sev-eral different universes of reality, betweenwhich philosophy has built no adequatebridges, and does not seem to be in the wayof doing so" [7, 230]. Each of these "uni-verses" has its own kind of truth which maycontradict the truth of other universes.Which truth we choose depends on our pur-pose. As James said: "If a certain formula... violates my moral demand, I shall feel asfree to throw it overboard ... as if it disap-pointed my demand for uniformity of se-quence; the one demand being ... as sub-jective and emotional as the other" [4, 147].It is Knight's Jamesian pluralism whichcreates the most serious difficulties for hiscritics, since this often leads him to bringextended arguments to their culminations inlogical contradictions.From Bergson comes the idea, closely re-lated to pluralism, of emergentevolution [1].Knight says, "I think we have to look ... athuman history in terms of emergent evolu-tion. New things come in, things that are notexplicable, not predictable, in terms of whatwent before, and in general things which arecategorically new do not replace the old butare superimposed on it" [8, 43]. Thus emer-gent evolution implies pluralism.Also, significantly, Knight is indebted toBergson for his general conception of scienceand its method. Bergson's philosophy isbased on a dichotomy between two kinds ofperception, one he calls "intellect," the other"intuition." This dichotomy corresponds toa dualism between coexisting physical andmental orders. Intellect's domain is the phys-

'See especially "The Limitations of Scientific Methodin Economics" (1924) [6, 105-147]. This essay, intendedas a coupdegrace for American institutional economics,is heavily indebted to Bergson. "Economic Psychologyand the Value Problem" (1923) [6, 76-104] presentsKnight's version of Jamesian pluralistic progmatism.

ical order, it is attuned to the purely spatialaspects of objects and events. It functions byconverting all questions into procedures forcounting, weighing and measuring in ex-tended space. Bergson believed that intellectfound its highest expression in modern sci-ence. But human consciousness and freedomare not accessible to intellect. The dimensionin which they have their existence is not thatof space but of time, or "real duration," andthis can be sensed only by intuition [2]. In-tellect attempts to deny real duration and toreduce time to mere spatial movements ofthe hands of a clock. Bergson wrote, "I saw... that scientific time does not endure, thatit would involve no change in our scientificknowledge if the totality of the real wereunfolded all at once, instantaneously, andthat positive science consists of the elimina-tion of duration."2 But this is equivalent tothe elimination of all purposive or creativeactivity. As Knight says, it is "surely familiarto anyone who has made a serious study ofthe philosophy of science [that] . . . for sci-ence, time is essentially a spatial dimension."When there is "real time" this is "intelligibleonly in terms of will-really active or cre-ative change" [10, 141].Or: "Insofar as thereis 'real change' in the Bergsonian . . . sense, itseems clear that reasoning is impossible" [11,209].

II. THE METHOD OF ECONOMICSCIENCEThough Knight's concern is to keep sci-ence within an appropriately restricted do-

main, he does not, like numerous critics oforthodox economics, protest what is oftenregarded as the economist's attempt to re-duce man to mere mechanism, passively re-acting to hedonist pleasures and pains.3Rather, he seeks, in his role of scientist, todevelop a rigorously mechanical inter-pretation of human conduct, and then, as asocial philosopher and moralist, impress

2 Letter to William James, quoted by Perry [15, 348].Emphasis in original.3 For such a view, see Thorstein Veblen, "The Pre-conceptions of Economics" (1899) [19, 81-179].

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JOHN McKINNEY

upon his readers the "sweeping limitations"which must be placed on such an inter-pretation. The scientific endeavor consists es-sentially in a series of heroic abstractions,required to fit rationally purposive humannature to the specifications of Bergsonianintellect.The Invisibility of Motives

The subject-matter of economics is whatKnight calls "instrumental rationality," theefficient employment of means to realizegiven ends. This is one kind of motivatedconduct, and the first problem the econo-mist-as-scientist must confront is the unob-servable character of his data. "Science, weare perpetually reminded, deals with ob-served facts, and their relations of coexis-tence and sequence" [6, 79]. For Knight, tobe observable is to be accessible to Berg-sonian intellect, that is, observation is con-fined to the measurable spatial dimension.The economist's relevant data are not ". . .objective in the physical meaning-are notdata of sense observation" [7, 228]. Eco-nomic motives cannot be pointed at, pickedup, handled, weighed and measured.Knight offers several, not obviously con-sistent, solutions to this problem. An early,interesting proposal is that the economist-as-scientist rigorously confine his analysis towhat is objectively observable in the meaningwe have noted, that is, he must restrict him-self to "sense data." This is what Knightcalls "behaviorism," and it excludes evenverbal expressions of intentions or attitudesbecause "speech . . . cannot without absurd-ity be treated as mere physical behavior . .."[6, 90-91]. Nevertheless, the behavioristmethod does not, so Knight argues, excludereference to motives.

They are brought in in this way. Knightclaims-in line with a view widely held bynineteenth century philosophers-that theconcept of force is a metaphysical intruderinthe schema of classical mechanics, ". . . thephysicist constantly recognizes that he reallyknows nothing about force ... it is not opento human observation." Then, insofar as thescientist's task is ". .. to describe what is

observed to happen [and eschew] ... anyknowledge of what 'makes' things hap-pen . . ." [6, 81], he should get rid of thenotion of force.Yet, Knight claims, the scientist has beenunable to carryout this program of purifica-tion. He explains this failure as due to ourinability to eliminate "consciousness fromour ideas of material things ... It is impos-sible to construct in thought a world of realobjects in purely objective terms; if objectsare to have the qualities of consistent behav-ior they are inevitably thought of as possess-ing rudiments of mind. We interpret the be-havior of the most material thing by to some

degree putting ourselves in its place" [6,120].Therefore, the physical scientist havingbeen unable to purify his science of the met-aphysical notion of force, the economist mayassert his right to cling to his status as scien-tist, even if he brings in unobservable mo-tives [6, 85].But this proposal, to treat motives as "an-alogues of force," does not seem promising.If we accept Knight's conception of behav-iorism, which debars us from counting evenlanguage and communication as observablebehavior, it is not easy to see how one couldever claim to have observed anyone econo-mizing, even if licensed to say that the indi-vidual's physical movements were activatedby motives as analogues of forces.A second proposal makes use of Knight'ssingular view-maintained throughout hiscareer-of mathematics and logic as empi-

rical sciences. Knight holds that the humanmind has certain inborn powers of insightinto the most pervasive features of objectivereality. The "... highly abstract proposi-tions which form the axioms of logic andmathematics [are] at the same time knowl-edge of the external world and knowledge... of the way in which minds work."Mathematical relations are descriptive ofthese pervasive empirical features, and theyare, according to Knight, "... empiricallyverifiable, to any worthwhile degree of accu-racy . . ." by counting and measuring [10,157]. This idea surely owes much to Berg-

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FRANK H. KNIGHT ON UNCERTAINTY AND RATIONAL ACTIONson's doctrine, that intellect becomes attunedto spatial measurement in the evolutionaryprocess.Knight claims that by analogy with thealleged empirical and a priori character ofmathematics, the basic postulates of the de-ductive science of economics are also both apriori and empirical. He arguesthat it ". . . isnot necessary to regard the general, a priorilaws of mathematics or economics ... asbeing 'intuitively' known in any inscrutableway. They may be ... treated as mere factsof observation . . . characteristics so obviousit is impossible to escape recognizingthem . . ." [6, 136]. Thus the laws of dimin-ishing utility and diminishing returns areheld to be a priori empirical truths of thischaracter, and economics a deductive elabo-ration of these basic postulates.Knight's idea of inductively verifyingmathematical propositions involves a con-fusion between demonstrating an analytic re-lation that cannot be contradicted by anyexperience and testing a contingent empiricalproposition. No empirical evidence can re-fute the proposition that "3 plus 1 equal 4."It may be possible to formulate the laws ofdiminishing utility and diminishing returnsso that they also cannot be contradicted byany experience. Exceptions can be held dueto irrationalities or dynamic factors ignoredin the static formulation of the laws. Butthen the deductive science erected on suchfoundations has no claim to be called empi-rical. It is a purely logical construction.Finally, Knight falls in with a traditionthat goes back to those classical economists,such as John Elliott Cairnes and John StuartMill, who examined the methodologicalfoundations of their science. According tothis tradition, economics is based on obser-vation, but it is a special kind of inner obser-vation, of the working of the theorist's ownmind. He monitors his own conscious experi-ence, thus inwardly observing his own pat-terns of motivation. Then he explains theovert actions of other individuals by pro-jecting similar patterns of motivation intowhat are to him their invisible consciousstates. This point of view was taken up and

developed at length by Carl Menger and hisAustrian followers. Menger called hismethod of inner observation methodologicalindividualism. Economic explanation traceseconomic developments to free choices,events occurring in the individual mind, theultimate independent source of economicdata.As an economic theorist, Knight is a meth-odological individualist. A market economyis an organization of voluntarily associatedindividuals. Here the behavior of the wholeis a consequence of the action of the parts.This is contrasted with a biological organ-ism, wherein the parts are adapted to thepurpose of the whole [12, 23-24]. To accountfor the conduct of the independent parts, wemust have intuitive insight into the workingof minds, and so make use of a kind ofknowledge without a counterpart in the nat-ural sciences. Knight quotes the AustrianFriedrich von Wieser's contention that byobserving "ourselves from within," we find"in common experience all the most impor-tant facts of economy" and gives his opinionthat Wieser's position is "essentially sound"[10, 163].However, here we have a characteristicKnightian paradox. Methodological individ-ualism, in its Austrian formulation, rests ontwo fundamental assumptions. It takes theindividual as given, prior to social organiza-tion. This is the methodological counterpartof the seventeenth and eighteenth centurydoctrine of a social contract. All institutionsand social changes are explicable in terms ofindividual actions. Any apparent causalchain moving from institutions to individ-uals can never be regarded as a final ex-planation. Second, it assumes that all ra-tional individuals have access throughintrospection to a form of indubitable self-knowledge, and, consistent with the first as-sumption, it must hold that such knowledgeis prior to and independent of social formsand institutions, including language.But Knight shows that both these assump-tions are false. In fact, alongside his method-ological individualism, coexisting with it in astate of pluralistic contradiction, is an ex-

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JOHN McKINNEYtreme form of sociological determinism."Man is as completely social as a termite inbeing unable to live outside a group of con-siderable size ... (even a Crusoe is no realexception) ..." [10, 282]. "If there is anynonsense that surpasses the contract theoryof the origin of society, I should like to havean example of it ... it is not society whoseorigin needs explaining as much as it is theindividual" [8, 47].Moreover, the ability to think is said todepend on communication with other hu-man beings, ". . . knowledge and intelligenceare completely 'unthinkable' apart from acontinuing and developing social process oflearning. Therefore, ... observing fromwithin must be interpreted in the light of thesocial-mental, intercommunicative characterof all thinking .. ." [10, 162]. Knight seemsto feel he is here making a realistic qual-ification which does not compromise the es-sential soundness of the method of in-trospection. But if the mind is molded by asocial process, it cannot be taken as the ulti-mate independent source of data for explain-ing social processes.We shall return to this paradox of man'ssimultaneous individual and social existence,and argue that, by r solving it, we can giveeconomics a firmer- empirical foundationthan can be found in the invisible realm ofthe mind.

The Unpredictabilityof PurposiveActionThere is a second problem the economist

must face in his attempt to bring purposiveactivity within the order of Bergsonian sci-ence. This is its inherent unpredictability.Such conduct is problem-solving, and the". .. heart of the matter is that the solutionof a problem cannot be predicted in advanceof the 'activity' of solving it... and when thesolution is found it is no longer a problem."In fact, Knight says the essential nature ofproblem-solving activity is ". .. indescrib-able ... for any literal description of it is notmerely a failure but definitely falsifies its na-ture" [7, 206].

Economic analysis begins with the propo-sition that all rational individuals know,from intuitive insight, "... that maximumefficiency is achieved through ideal alloca-tion of allocable resources [but they alsoknow] that no individual achieves this max-imum . . ." [10, 167]. This is because all ra-tional action ". .. implies some chance oferror and some actual error" [8, 72]. No onecan achieve the maximum at which he aimsbecause to do so he would ". .. have to haveperfect foreknowledge as well as perfectknowledge" [10, 167].The technique the economist must employto bring problem-solving activity within theken of Bergsonian science is abstractionfrom liability-to-err. Since Knight claimsthat error is the correlate of effort, the econo-mist in this way abstracts from effort. Thenotion of error is held to be antithetical toscientific explanation. Knight even suggeststhat the alleged "repugnance to the scientificintellect" of the notion of force is due to thefact that force, like motive of purpose, in-volves ". . . contingency, a kind of error .. ."He holds that the scientific intellect craves". . . automatic exceptionless uniformity ...an ultimately unchanging as well as passivenature of things" [10, 183].Thus through abstraction from error theeconomist turns purposive activity into me-chanical sequence, "... machines do notmake mistakes" [11, 202]. This concept ofrational action involves numerous paradoxeswhich Knight delights in pointing out. Mostsignificantly, it excludes all experimental orcreative activities-these become "irra-tional"-and therefore most of the forms ofactivity we regard as exercises of intellect. Itis consistent with this conception to holdthat ". . . the animals are superior to man inthat they are more intelligent, sensible;a hogknows what is good for him and does it!" [6,35].It should be clear that abstraction fromuncertaintyhas a significance for Knight thatit lacks for many economists who have fol-lowed him in associating perfect knowledgewith the perfect market. For Knight the exis-

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FRANK H. KNIGHT ON UNCERTAINTY AND RATIONAL ACTIONtence of uncertainty and error is the mark ofhuman consciousness. To say a scientificanalysis must abstract from these is equiva-lent to an assertion that human purpose andeffort are inaccessible to scientific in-vestigation. In the course of a discussion ofhuman consciousness, Knight says: "Sciencecan find no place for it, and no role for it toperform in the causal sequence" [11, 201].The principal application of Knight's doc-trine of uncertainty is the explanation ofprofit. The profit theory is his best knowncontribution to economic theory, and weshall examine this theory before turning toour more fundamental criticism of his meth-odological ideas.

III. THE UNCERTAINTYTHEORY OF PROFITKnight's profit theory is a variation on thesame general analysis that produced the ear-lier profit theories of John Bates Clark [3]and Joseph A. Schumpeter [17]. These theo-rists begin with an attempt to provide a de-finitive account of the required conditionsfor general equilibrium of perfect com-petition, though in later discussions Knightprefers to speak simply of the "perfect mar-ket," since he regards the idea of com-

petition, which suggests a kind of personalrelationship, a rivalry, as inconsistent withideally impersonal and dispassionate eco-nomic conduct [10, 268].Under ideal equilibrium conditions, pricesare equal to costs of production and thereare no profits or losses. Profits are definednegatively as incomes that could not exist insuch an equilibrium state. The theories differin their specifications of the required equilib-rium conditions. Clark and Schumpeter arein general agreement that it is absence of thatdynamic change which has characterizedcapitalist civilization. Knight argues thatchange need not cause disequilibrium if it isforeseen. Therefore the cause of disequilibriaand so of profits is uncertainty. Perfect equi-librium of the perfect market is an un-reachable goal "... so long as omniscienceremains unattainable" [11, 21].

Perfect knowledge is extended to includethe occurrence of unpredictable individualevents provided these belong to classes ofevents a proportion of which are known withcertainty to occur. In such cases, the eventscan be insured against in some way, and theinsurance costs added to cost of production,so there will be no profit or loss. These insur-able contingencies Knight calls "risks."Profits depend on contingencies with un-measurable probabilities of occurrence. It issuch contingencies that are more character-istic of business and personal experience, andit is these latter Knight calls true uncer-tainties.

The usually listed conditions for perfectcompetition include many buyers, many sell-ers, none able to influence price; factor mo-bility; product homogeneity. To theseKnight adds "omniscience."4 The econo-mists of the classical period were of courseaware that operation of a competitive mar-ket requires "adequate" knowledge of thecommodities traded, and effective communi-cation among the market participants.5Nu-merous economists, notably Irving Fisher,preceded Knight in considering the con-sequences of imperfect knowledge for eco-nomic relations. But Knight seems to be thefirst to insist upon "accurate and certainknowledge of the whole economic situation"as the "crucial" condition for perfect com-petition [11, 48]. The result is a model whichtakes us out of all contact with recognizablehuman experience, as Knight repeatedlystresses, ". . . rigor would demand a commu-nity of immortal individuals who never learnor forget or change their minds . . ." [10,189]. Schumpeter protests the idea that theneoclassical economists, such as Leon Wal-ras, had in mind, or would have accepted, anassumption of omniscience [16, 974].Knight's Risk, Uncertainty and Profitshows early evidence of the kind of plural-istic contradiction which characterizes hislater writing. An interesting aspect of the

'See Knight's list of conditions [11, 76-8 ].5See Stigler, "Perfect Competition Historically Con-templated" (1957) [18, 235-240, 242-253].

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JOHN McKINNEYwork is the author's promise to keep "radi-cally separated" his principal task of "de-scription and explanation" from "all ques-tions of defense or criticism." We are toldthat the ". .. inquiry is by no means a de-fense of the existing order [but ratherempha-sizes] the inherent defects of free enterprise"[11, preface x]. A tone of skepticism is main-tained throughout. Knight deplores J.B.Clark's attempt to give normative signifi-cance to the marginal productivity theory ofdistribution [11, 109], and indeed all "moralflub-dub" brought in to rationalize the exist-ing order [11, 360]. Yet the book presents a"functional" theory of income distributionand, as Schumpeter says, any such theory". . must be under suspicion of ideologicalbias" [16, 895]. In later writing, Knight him-self makes a similar point [10, 202].In spite of his protestations, it is difficulttoregard the theory that emerges in the courseof Knight's book as merely dispassionateanalysis. Rather, it seems to be an exercise inbourgeois apologetics. This is even more trueof Knight's theory than of other functionalanalyses, For, unlike Clark and Schumpeter,Knight makes entrepreneurship a form ofcontrol over private property.When we relax our assumption of omni-science and allow uncertainty on the scene,we experience a "cephalization" of economicaffairs,"doing things" becomes secondary to"deciding what to do" [11, 268]. Thus weintroduce the entrepreneur. The enterprisesystem comes into existence with the volun-tary specialization of decision-making. Someindividuals make production decisions, giv-ing contractual incomes to others, the sup-pliers of productive resources, and receivingfor their share the uncertain excess ofreceipts over outlays. However, Knight ar-gues that the entrepreneurial function doesnot consist in making such decisions. It liesin taking responsibility for them, ". .. thecrucial decision is the selection of men tomake decisions ... any other sort of deci-sion-making or exercise of judgment is auto-matically reduced to a routine function" [11,297]. But in order to take responsibility one

must have assets to make good his guaran-tees, which means he must be a propertyowner, ". .. the basis of effective assumptionof responsibility is necessarily either theownership of property or the creation of alien on future human productive power andis in fact almost altogether the former" [11,351]. These considerations lead Knight to hisremarkable doctrine of the "illusion of own-ership" [11, 368]. He claims that large prop-erty owners, while thinking of themselves asmere hedonists, enjoying their yachts andcountry estates, are in fact "social function-aries" [11, 359], taking responsibility for thedecisions that direct economic life, thoughnot themselves making them.One difficulty a reader is likely to experi-ence in considering Knight's work concernsthe assignment of causal agency to so per-vasive a trait of all experience as uncertaintyor liability-to-err. Knight says that uncer-tainty is the "cause," not only of profits, butalso of "enterprise and the wage system ofindustry" [11, 271], not to mention "humanconsciousness" [11, 203]. A causal agent thatexplains everything explains nothing.But we can perhaps give the theory a morerestrictedmeaning. There are organized mar-kets, such as the commodity and securitymarkets, where some participants maychoose a more speculative and therefore po-tentially more profitable position, so en-abling other, more cautious, participants tohedge their positions. Knight's theory pro-poses to generalize this situation to the wholemarket system. The essential feature of thefree enterprise system is held to be the volun-tary specialization of uncertainty-bearing.A serious difficulty in applying the theoryis our inability to identify the individualswho choose the entrepreneurialrole. Like allfunctional theories, there is no way to relateit to any empirical data. "It is impossible forentrepreneurship to be completely special-ized in a pure form, except in the rare andimprobable case of a man who owns nothingin a particular business and contributesnothing to it but responsibility" [11, 299]. Asthere are no pure profit incomes, so there are

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FRANK H. KNIGHT ON UNCERTAINTY AND RATIONAL ACTIONno incomes, in an uncertain world, withoutan element of profit. It is difficult to imagineevidence that would bear upon Knight'smost striking speculation, that aggregateprofits are negative [11, 366], so that men ofwealth pay the society for the privilege ofassuming the responsibility for decisions.6However, the theory does seem to requirethat large property-owners, particularlythose with substantial equity holdings, leadlives in which they experience more of boththe burden and the stimulus of uncertaintythan do ordinary citizens, for example,workers contemplating the possibility ofunemployment. If so, we are inclined to bor-row some characteristic Knightian skepti-cism. The enterprise system functions mostimperfectly to provide shelters for those whochoose to insulate themselves from the un-foreseen consequences of economic decision-making.

IV. THE BASIC PLURALISTIC PARADOXCritical evaluation of Knight's views

about the nature and method of economicscience requires us to return to the pluralisticparadox already mentioned, that concerningman's dual existence as an individual and asocial being. This paradox is fundamental tomuch of Knight's social and moral philoso-phy. Moreover, there can be no doubt that itexpresses an important insight into the na-ture of free society. As citizens, we must beheld responsible for our actions, yet we knowthat our decisions to act in particular waysare conditioned by our past circumstances,and over these we have had but limited con-

6 However, this contention seems based on dubiousreasoning. The argument is that the entrepreneurialclass tends to bid up the prices of productive resourcesabove their true value as determined by final sale of theproduct. It might be that over-exuberant enterpreneurswould bid up the money returns to resource owners. Butunless the prices of final goods were fixed, this need notreduce "real" profits. An economy characterized by en-trepreneurial over-exuberance would tend to high in-vestment, so high savings. If the propensity to save outof labor incomes is lower than that out of propertyincomes, equilibrium would require a high propertyshare, including Knightian profits.

trol. As Knight says, it is "... basic to themoral life and to all serious discussion ofhuman and social problems ... to regardtheindividual ... unalterably 'given' as hestands . . . morally 'self-made' . . ." Yet hegoes on to say that the individual is ". . . nota datum, and social policy cannot treat himas such" [7, 252-253]. However, it can beargued that for purposes of ethics and poli-tics this duality cannot be left in the form ofa paradox. It needs to be replaced by a con-ception of a social individual. As Knight saysin another context, social action is concernedwith ethical ideas which ". . . have for theircontent ... ideal individuals, to be createdby ideal social institutions . . ." [10, 133], apoint of view that rules out the "giveness" ofindividuals.We shall call Knight's combination ofradical individualism and sociological deter-minism the basic pluralistic paradox.7 Ourpresent concern is to note that it leads to acontradictory conception of science and itsmethod as, simultaneously, an individualand a social activity.In modern science, we are said to find thehighest development of the instrumental ra-tionality which is the subject-matter of eco-nomic science. Knight claims such ration-ality is "inherently individualistic" [10, 283].He even claims it is pre-social, that ". . . hu-man nature seems to have been produced bythe subsequent socialization . . . of a specieswhich first achieved ... individual in-strumental intelligence" [7, 21]. Moreover,the power over nature that has come frommodern science is held to be "individualpower" [7, 37].The individualist conception of science hasthree corollaries which account for most ofthe problems with which Knight wrestles inhis methodological discussions. First, it in-volves the sense datum theory of knowledge.The individual mind is opposed to physicalnature and comes to know the latter throughsensory impressions that impinge upon it

7 Don Pantinkin [14, 802-805] seems to recognize thisbasic paradox.

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JOHN McKINNEYand mold it. Thus the question about how wecan ever come to know "scientifically"aboutmotivated human conduct. When we assigna motive for an individual's act, where is thesensory impression that provides us withsuch knowledge?Second, the individualist conception im-plies that the external world is knowableonly if it is static, unchanging. This is sobecause the mind must remain passive inknowing. True knowledge is that to whichnothing has been contributed by the mind. Ifit interacts with and changes the data in thecourse of knowing, then knowledge cannotbe objective. Therefore the requirement thatwe must abstract from all creative effort inthe subject-matter.Finally, the individualist conception leadsto Knight's views about the ethical implica-tions of a science of society. Physical sciencehas provided individual power over nature.Social science, by analogy, must be intendedto provide individual power over society. Butsuch power is immoral. "Scientific method inthe sense of being useful for prediction andcontrol has meaning in human society onlyfor an absolute dictator" [8, 70].Now Knight shows that an individualistprogram of scientific investigation cannot becarried out. Scientific observation-though,according to Knight, in principle an encoun-ter between an individual mind and the ob-jects and events of physical nature-actuallyrequires a community of observers. This isbecause of the fallibility of our senses. Obser-vations must be "tested." This means notonly that there must be other observers ableto check one's observations, but also thatthis scientific community must be based oncommitment to an ethic, that each will tellthe truth about what he has sensed. There-fore, it turns out that the ultimate test ofscientific truth is not correspondence withsense data. Rather, it is what Knight calls a"conscious critical consensus" among mem-bers of the scientific community [10, 156].What is puzzling is that these insights donot lead Knight to abandon the individualistconception. His purpose in calling attentionto the social-moral element in scientific in-

vestigation seems rather to be a desire totaunt the "scientific dogmatist" for havingrecourse to principles antithetical to the"spirit of science" as Knight conceives it.ObservableMotives

Modern science is not based on sense ob-servation, if this is taken to mean that thetruth of scientific laws depends on our abilityto translate statements of laws into descrip-tions of sequences and coexistences amongatoms of sensation. We have no way of mak-ing such translations for theoretical conceptslike molecules, electrons, protons. Andthough in one of the many meanings of theword observe, scientists may be said to ob-serve such phenomena, by noting the con-sequences of the theories in which they areincorporated, such observation is not a mat-ter of the passive receipt of sensory impres-sions.Thus observation is a purposive activity.Knight notes that this is so, but this insight isused by him only to provoke a profoundHumean skepticism about the possibility ofany objective knowledge. "The commonidentification of 'observed fact' with 'sensedata' is manifestly a confusion.... no obser-vation ... is quite compulsory and unavoid-able; no objectification will stand up under... scrutiny; every perception of reality ismore or less a voluntary act" [6, 96-97]. Butthe purposive character of observation in theexperimental sciences is not inconsistent withan objectivity determined by a consciouscritical consensus of the scientific commu-nity. This consensus is not concerned withthe reliability of sense impressions but withthe experimental consequences of scientificlaws.If the theories of the physical sciences arenot constructed out of sense data passivelyperceived by an isolated individual, then itshould not be disturbing that we are unableto translate our descriptions of the variousforms of intelligent or motivated conductinto such terms. How is one able to observeanother's qualities of mind and character?There is no doubt that he does so. Assertionto the contrary is a "metaphysical paradox,"

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FRANK H. KNIGHT ON UNCERTAINTY AND RATIONAL ACTIONa by-product of an untenable view of thenature of scientific observation. The moods,motives, habits and attitudes of our fellow-men are far more familiar aspects of ourenvironment than are the protons and elec-trons, or even the masses, velocities and ac-celerations, of physical theory. Knight doesnot deny this, but he wishes to argue that thisunderstanding derives not from observationbut from intuition. To understand humanconduct, we must turn away from scienceand "train our intuitive power" [6, 125].However, he points the way to another,less mystical, explanation of how one comesto understand others and anticipate their re-sponses. Once again, though, he does nottravel along it himself. He stresses the essen-tial role of language and communication inall intelligent conduct. We have alreadynoted his view that intelligence is "unthink-able" apart from society. Learning involves"intercommunication with other selves" [10,162]. Why not go on from this insight to theview that intelligent conduct involves observ-able operations with the symbols of socialdiscourse? Even when we think silently weuse these symbols. We do not first think in aprivate language and then learn how to ex-press these thoughts in the common lan-guage. Thinking and knowing depend on theuse of symbols in accordance with sociallydetermined rules. If such operations are re-garded as observable, we can bridge thedualism between the mental and the physicalwhich is responsible for so many of Knight'sparadoxes. Then mind no longer refers to aseparate order of existence but to an attri-bute of those overt activities that involveheeding, remembering, deliberating, know-ing.But, as noted, this is a route Knight doesnot take. He preserves the mind-body dual-ism, and relegates language and communica-tion to the realm of mind, where they areaccessible only to intuitive insight. Speechwould be scientifically observable only if itwere "literal," by which Knight evidentlymeans consisting exclusively of propositionsabout the alleged sense objects [6, 134-135].Otherwise, speech requires interpretation,

and the mind cannot retain the passivity saidto be required for sense observation. More-over, inconsistent with his view that inter-communication is necessary to the existenceof a mind or self, Knight does not abandonthe idea that intelligent thought preexists itsexpression in language. He professes to find"... how we ever learn to communicatethought and feeling ... profoundly mys-terious" [6, 90].Also, the awesome generality Knightclaims for economic laws seems to imply thatthese are derived from some kind of pre-linguistic awareness. We recall that in-strumental rationality, the subject-matter ofeconomics, is said to be pre-social. We verifythe axioms of economics by "observingwithin" and these axioms are supposed to beobvious to any rational being, presumablyeven a pre-social one. Therefore his con-tention that the ". . . more general principlesof economic theory would be valid under anyconditions possible on earth . . . economictheory is not dependent on social forms orinstitutions..." [7, 137].If we take the view that the use of symbolsis an observable activity, on a reasonableinterpretation of observation, then we dowatch exercises of intellect and learn aboutthe habits, attitudes and character traits ofour fellow men. The method is not intuitionbut an elementaryform of the inductive tech-niques of modern science.Most of the expressions we use to speak ofattributes of character and personality be-long to the general class of dispositionalstatements. These do not state particularfacts, the existence of an object or the occur-rence of an event. They are concerned withpotentialities, tendencies, propensities to actin various ways. When we say a person ischaritable or greedy, we are not reporting anevent, but indicating a range of possible ac-tions or responses of which he is capableunder suitable conditions. Such dispositionalstatements belong to a different level of dis-course from statements that report atomicfacts, but like these, they can be judged trueor false, according as they do or do not en-able us to predict or explain the person's

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JOHN McKINNEYconduct. Knight speaks of potentiality as a".. . non-empirical, metaphysical concep-tion ... repugnant to the scientific mind"[10, 142]. Yet statements of scientific laws intheir correct conditional "if-then" formula-tion are dispositional. They make no refer-ence to particular objects or events. Rather,they state potentialities in situations. Yetmost scientists do not hesitate to call themtrue or false, depending on the ability of thelaws to predict and control the relevant sub-ject-matter. Similarly, to ascribe an act to themotive of greed is not to refer to a priorevent, an invisible causal agent, but to relatethe act to an attribute of character, onewhich involves a propensity to act in such away. Since motives are not causal agents, it ismisleading to call them analogues of forces.When economists speak of economic mo-tivation they should mean a complex of atti-tudes and propensities acquired in highlyspecial social and historical circumstances.This pattern enables one to be a more or lessable participant in the affairs of the moneyeconomy. When we explain economic devel-opments by relating them to economic mo-tives, we are referring to these observableinstitutional patterns. Economic theory isnot a deductive elaboration of axiomsknown intuitively. It is surely most implau-sible to regard the highly abstract idea of ameans-end schema as a form of pre-lingual,pre-cognitive awareness. This schema in-corporates the idea of a utility calculus, or acalculus of "desiredness in general,"whereby the varied ends of action are ren-dered homogeneous and quantified. Thisfunction is performed by the use of money inthe modern market economy. It strains cre-dulity to suppose that such an idea couldoccur to an individual who had never beenexposed to the discipline of pecuniary in-stitutions.Effort and Error

If one takes account of the social andtherefore experimental nature of scientific in-vestigation, he is likely to question Knight'sviews about the relation of uncertainty and

error to rational action. We recall thatKnight uses his postulate of omniscience tobring rational action within the ken of deter-minist science. The postulate accomplishesthis by converting purposive conduct intomere mechanism.This necessity is due to the alleged sharpdichotomy between the inherently unpredict-able character of purposive action, and the"passive, unchanging" nature of thingswhich satisfies the "cravings"of the scientificmind. But this alleged craving hardly seemsconsistent with modern science as an experi-mental activity. Experimental observation isaction that deliberately alters the data. Thusthe experimentalist is concerned with an or-der of nature filled with contingency andpossibility. So it is that scientists insist uponthe provisional character of all empiricalknowledge, an attitude unlikely in a commu-nity mesmerized by the idea of a dead, un-changeable universe.Whether or not one illuminates the idea offree and rational action by opposing it toscientific determinism depends upon what heunderstands by the latter. Knight writes oftwo conceptions which he says are part ofBritish-American social thought. He callsthese "positivism" and "pragmatism" [10,122]. The positivist aims at a comprehensiveprophecy of the course of human history,leaving no aspect undetermined. It must beconceded that the feasibility of such an un-dertaking is inconsistent with the idea of hu-man freedom for, as Knight says, ". . . if hu-man and social phenomena can becompletely explained in terms of their ownhistory, the result is the same as that of acomplete mechanical explanation; there is nosuch thing as purposive action or as practicalrelevance" [6, 285]. But it is pragmatism, asKnight shows, which is characteristic ofmodern experimental science, and on a prag-matic view, not only are human purposesoperative, they are essential to the pragmaticidea of scientific law. "The experimental sci-ences in general predict hypothetically-'ifA, then B' . . . and especially with referenceto the consequences of human acts, 'if' they

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FRANK H. KNIGHT ON UNCERTAINTY AND RATIONAL ACTIONare performed" [9, 186]. Knight arguesagainst both positivism and pragmatism asmethods for economics, but he cannot ruleout the latter on the ground that it allows noscope for human freedom. Nor is it reason-able, on such a view of science, to look hope-fully for gaps in our knowledge of physicalnature, as Knight does, seeking undeter-mined spaces in which to lodge human free-dom [11, 221].The opposition between freedom and de-terminism puts the emphasis in the wrongplace. It implies that an observer of another'sconduct should make its unpredictability thecriterion of its purposive character. But weshould say that an individual is most rationaland free when he is able to act deliberatelytorealize his intentions, and both he and anobserver are able to predict his course ofaction. To say of an individual that his con-duct is unpredictable is to say he is mentallyor emotionally unstable.Knight notes that an individual's "effec-tive functioning" in free society depends onhis ability to predict other persons' responsesand actions. But he attributes one's ability todo this to the fact that free choice "is of verylimited scope even in the individual life, eventhough infinitely important" [10, 140]. Pre-dictability is thus held to depend on the dom-inance of thoughtless traditional or habitualpatterns of action. But it can surely be ar-gued that we better understand and moreconfidently predict another's conduct whenwe know his goals and can interpret his actsas purposive means to these ends. This viewseems confirmed by Knight's contention inanother context that economics, the scienceof rational action, provides more reliable"predictive knowledge" than the other socialsciences, even "though not to be comparedfor accuracy or reliability with the physicalsciences" [8, 158].There is of course an element of unelimi-nable unpredictability about any creativeact. This is what Knight has in mind in iden-tifying purposive action with uncertainty. Ifthe teacher could predict in exhaustive detailthe activity of the gifted student in proposing

a theory and designing an experiment to testit, he would solve the student's problem-or,rather, there would be no problem. But theteacher can predict that the student will at-tempt a solution, that he will be successful,that he will select the career of a scientist. Itis such predictions that are relevant to theordering of human affairs, and these aremuch more analogous to the natural scien-tist's predictions than are comprehensiveprophecies. Moreover, creative activity andrational action are not synonomous. Muchof what we call rational economic activitydoes not involve unpredictable novelty inthis sense.

It is conceivable that an assumption ofperfect foresight has pedagogic value in pre-senting some economic doctrines, for ex-ample, the principles of capitalization. ButKnight builds the postulate of omniscienceinto the definition of rational economic ac-tion. It is doubtful if this is a simplifyingprocedure. When one attempts to work outthe postulate's implications, he inevitably ar-rives at paradox, as Knight repeatedlyshows. "It should be understood that it isimpossible for more than one individual ...to take the result of the world as ... predict-able and act upon his knowledge, unless allwho do so act in complete and express collu-sion." He goes on to say that this "is a gen-eral limitation on the theory of intelligentbehavior..." [13, 448] but it seems ratheran infirmity of the postulate of omniscience.The postulate is inconsistent with many ven-erable economic doctrines. How about theproposition, derived from the marginal anal-ysis, that it is irrational to attempt to coverfixed costs? What relevance could this haveto a community of omniscient beings whonever make mistakes? If rational action en-tails omniscience, then all of monetary eco-nomics lies outside its scope, for Knight con-tends that frictionless perfect foresightimplies unending inflation and a vanishingvalue of money [11, 193-194].It might be held that the assumption ofperfect knowledge is appropriate so long asthe theorist confines the analysis to static

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long-run situations, the stationary state witha constantly recurring circular flow. Thereare surely objections to treating such a situa-tion as a model even of ideal type economicconduct. But Knight does not confine theanalysis in this way.During the thirties, Knight devoted mostof his energies to the development of a the-ory of capital. Abstraction from uncertaintyis an essential feature of his treatment. Yetthe appropriate analysis for the determina-tion of the rate of interest is, according toKnight, the shortest run in the Marshalliansequence of time periods, the momentary sit-uation with the supply fixed, and the price-the rate of interest-uniquely demand deter-mined. This is because capital is what Knightcalls an "accumulating good." The currentsupply, consisting of the entire existing stockof capital, is large compared to the currentincrement, the current rate of saving, so thatchanges in the latter have a negligible effect.Normal price equilibrium, an equilibriumbetween currentflows, is inapplicable. More-over, important features of Knight's treat-ment-for example, the rate of interest cannever fall to zero-depend on his contentionthat a theory of a long-run equilibrium rateof interest is "untenable" [13, 614-630]. Weneed not pause to reflect on the significanceof an analysis of capital, interest and in-vestment that abstracts from uncertain ex-pectations, evidently the crux of the prob-lem. Yet we must concede that Knight offersmany profound insights into the nature ofcapital, including the role of knowledge inthe process of accumulation, though most ofthis by way of qualifying exceptions to theformal theory [5, 26-47].Exposition of the principles of a perfectmarket involves a number of abstractions,many of these pointed out by the neoclassicaleconomists. Each trader must be assumed tohave determinate demand and supply sched-ules which remain stable during the equili-brating process. In addition, there are thefamiliar conditions of product homogeneity,numerous buyers and sellers. But the appro-priate assumption about knowledge is, notthat that possessed by each trader is per-

fect-whatever that may mean-but thatthere is adequate communication amongbuyers and sellers. Considerations of move-ments to equilibrium or even the stability ofequilibrium tacitly raise questions about in-formation. The movement to equilibrium isessentially a process of communication. Thepostulate of omniscience, rather than sim-plifying the analysis, literally assumes theproblem away.Theoryand Action

Knight's ambivalence concerning scienceas at once an amoral individualist and anethical social activity leads to a confusingview of the relation of economic theory tosocial action. From the individualist point ofview, knowledge yields individual power.But economists surely do not regard theirtask as the design of social engineering tech-niques for the private advantage of a dicta-tor.

What does Knight believe to be the properrelation of economic theory to social action?The economist must not pretend to predictand control the course of economic develop-ment. The theory of the perfect market pro-vides a blueprint for an organization offreely cooperating individuals. It has ethicalsignificance as "the embodiment of completefreedom" [10, 258]. Its application to socialproblems is to tell us not to do things. Theseimplications do not have the status of contin-gent empirical propositions but of cate-gorical ethical injunctions: Don't set min-imum wages! Don't erect tariff barriers! [8,5-8] These injunctions are said to be "eco-nomic truisms," and in later essays Knightdevotes much space to expressing his per-plexity that anyone could ever doubt them[10, 252-254]. The economist is said to bedealing in obvious truths, both the allegedfacts of inner experience from which he de-rives his axioms and the negative policy pro-posals which are the final fruits of his deduc-tions [9, 187].Of course, a discipline devotedto final, self-evident yet untestable, truthscan make no claim to a place among theempirical sciences.However, for Knight, significant social

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problems are not problems in economics.Economics is the science of instrumental ra-tionality, the choice of means for given ends.But the more important problems are con-cerned with the choice of ends. This choicerequires a higher rationality than in-strumental rationality. It is expressed in asocial activity, free discussion directed to theresolution of value conflicts, including con-flicts of interest arising out of the unequaldistribution of economic power. The higherrationality aims at establishing a consensus,while instrumental rationality seeks to estab-lish control. Knight repeatedly insists thatscience has no contribution to make tohigher rationality; it must be scrupulouslyshielded from scientific techniques. Never-theless, he finds several interesting parallelsbetween the social activity of resolving valueconflicts and the scientific activity of discov-ering truth. First, the values establishedthrough free discussion are, like the truths ofnatural science, objective, not merely sub-jective tastes or preferences. Otherwise, itwould be impossible to discuss them. Dis-cussion must be directedto the establishmentof impersonal truth. "No discussion can becarried on in propositions beginning with thewords 'I want'" [10, 132]. Therefore theconsensus reached at the end of discussionconfers objectivity on values, just as a con-scious critical consensus warrants the objec-tivity of scientific observation. Second, in theethical commitment that binds the scientificcommunity Knight finds an ideal for all freeassociation, including the discussants ofvalue problems, "... co-operation amongindividuals acting freely and in a spirit ofethical, even religious, integrity" [10, 132].The difficulty here is that the required ob-jectivity of "valid values" remains elusive.This alleged objectivity is altogether a matterof intellectual agreement among the dis-cussants. But is this adequate to establishimpersonal truth? In the middle ages theview that the world is flat was supported by aconsensus among learned men. Yet few to-day would argue that this was a guarantee ofobjective truth. The modern consensus thatconfirms scientific truth is more than a mere

meeting of minds. It is concerned with theresults of overt activity, of observation andexperiment.Knight, in accordance with his pluralism,conceives of an independent moral orderwith its own incomensurable kind of objec-tive truth. It must be granted that moraldiscourse has a distinctive character.Yet it ismisleading to attempt a sharp separation be-tween the kind of knowledge relevant tomoral as contrasted with other judgments. Itis only the context in which facts are viewedthat is different. Choices or judgments takeon a moral quality when they have implica-tions for individuals other than the decision-maker. In the life of an individual suchchoices are occasioned by some conflict thatarises in the course of experience. The choiceis of a guide to action. Such guides are hy-potheses to be tested by the knowledgegained in the further course of experience.When all moral judgments are regarded assubject to such tests, we can speak of anempirical morality capable of providing ob-jective knowledge.

Similarly, if Knight's higher rationality isto yield objectively valid values, then valuejudgments must be expressed as hypothesesconcerning the outcome of social action di-rected to the reform of institutions. Higherrationality must be joined to a social tech-nology. To be sure, this last term is a fightingexpression for Knight, but, as we have seen,this is because of his identification of tech-nology with invidious individual advantage.Living in the twentieth century, it wouldbe reckless to dismiss as fanciful Knight'sfear of the use of scientific techniques forpurposes of totalitarian control. But theproper safeguard against this possibility isnot the relegation of scientific intelligence tothe less important aspects of human exis-tence. Rather it is the consistent applicationof scientific method, to include social prob-lems. The scientific commitment to truth as avalue, which, as Knight says, "... includesall other values . . ." [10, 132] rules out de-ception and manipulation. We can agreewith Knight that self-control or social con-trol are significantly different from control

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JOHN MCKINNEYover physicalnature,and yet insist that allforms of control dependfor their effective-ness on knowledgethat is the product ofsociallycontrolled nquiry.

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Southern Economic Journal, Jan.-Apr., 1961.185-193, 273-282.10. . On the History and Method of Economics.Chicago: The University of Chicago Press, 1956.11. Risk, Uncertainty and Profit (1921). NewYork: Harper and Row, 1965.12. . Social Economic Organization (1933). NewYork: Augustus M. Kelley, 1951.13. . "The Quantity of Capital and the Rate ofInterest," Journal of Political Economy,Aug.-Nov., 1936. 433-463, 612-642.14. Pantinkin, Don, "Frank Knight as a Teacher,"American Economic Review, December, 1973.787-810.15. Perry, Ralph Barton. The Thoughtand CharacterofWilliam James. Cambridge, Mass: Harvard Uni-versity Press, 1948.16. Schumpeter, Joseph A. History of EconomicAnaly-sis. New York: Oxford University Press, 1954.17. . The Theory of Economic Development(First

German Edition, 1911). New York: Oxford Uni-versity Press, 1961.18. Stigler, George J. Essays in the History of Econom-ics. Chicago: The University of Chicago Press,1965.19. Veblen, Thorstein. The Place of Science in ModernCivilisation. New York: The Viking Press, 1919.

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