*Hayek quotes himself here, from "Scientism and the Study of Society, " reprinted in The Counter-Revolution of Science.
According to Hayek, economics (and presumably all social sciences) cannot productively use the scientific method. The data necessary to construct good scientific theories are "necessarily limited" and important information may not be available. In contrast, Hayek asserts that in the physical sciences, all important information is "directly observable and measurable." Because of the limitations on the availability of data, instead of observing what is important, social scientists declare that only what is observable is important. This tendency "quite arbitrarily limits the facts which are to be admitted as possible causes of the events which occur in the real world. . . . We know . . . a great many facts which we cannot measure and on which indeed we have only some very imprecise and general information." Because these facts cannot be confirmed by quantitative measurement, they are excluded from consideration in mainstream economics. Thus, Hayek asserts, scientism causes economists to accept false theories with good scientific support, such as the causal connection between employment and aggregate demand, and reject true theories without scientific support, such as Hayek's alternative explanation of structural unemployment. Although Hayek is correct in identifying the society as the most complex object of study, his analysis is otherwise completely incorrect, and his alternative is utterly without any intellectual support.
Hayek first mischaracterizes the scientific method. Although he mentions Popper approvingly, he deprecates the notion of falsifiability and instead imputes to science a requirement of behaviorism, also known as positivism. Taken from psychology, behaviorism specifically asserts that because we cannot directly observe what is in a person's mind, the mind has no physical; at best we can merely talk about correlations between observable inputs and observable behavior. More generally, as proposed in philosophy by the Vienna Circle, positivism asserts that only that which is directly measurable has any physical meaning. The Vienna Circle, including Carnap, Popper's primary intellectual opponent, quickly realized positivism's untenability and abandoned the concept. So far as I know, no philosopher today holds that positivism is a foundational concept in the philosophy of science. Had Hayek criticized economists and social scientists for positivism, his critique would have been correct and perspicacious.
But Hayek believes that science itself requires positivism. Positivism, according to Hayek, is a routine, unobjectionable element of the physical sciences: "[I]n the physical sciences it is generally assumed, probably with good reason, that any important factor which determines the observed events will itself be directly observable and measurable." This is simply not true of any science, not even physics. In 1946, Albert Einstein criticized Ernst Mach's positivism, saying,
[Mach] did not place in the correct light the essentially constructive and speculative nature of all thinking and more especially of scientific thinking; in consequence, he condemned theory precisely at those points where its constructive-speculative character comes to light unmistakably, such as in the kinetic theory of atoms.*Hayek's attribution of naive positivism to science is simply mistaken.
*Quoted in Einstein's Philosophy of Science, by Don A. Howard.
Curiously, Hayek opens his speech with a purely scientific critique of a simplistic correlation between employment and aggregate demand. Assuming such this simplistic correlation really is fundamental to economic theory at the time, it is falsified by the directly observable experience of inflation: a simplistic correlation would predict that increasing the money supply when there is above-normal unemployment will not cause inflation. Under Popperian falsification, Hayek's criticism is dispositive: we have directly observed events which contradict predictions of the theory, therefore, there is something incorrect or missing from the theory. However, the phenomenon of observations contradicting theory is routine in science; that a theory has been contradicted by observation does not in any sense invalidate a discipline as unscientific or "scientistic."
Hayek, however, does not conclude that the simplistic correlation between employment and aggregate demand is incomplete; he makes the much stronger assertion that it is "fundamentally false [emphasis added]." He must mean that there is no actual causal relationship whatsoever between aggregate demand; that all the observed correlations, which he admits, are either spurious or indicative of parallel or indirect causation. Hayek, however, concludes that any correlation between employment and aggregate demand is incorrect because it is measurable, and because it admits of only what proponents "regard as scientific evidence."
Hayek's alternative is that all unemployment (other than routine frictional unemployment) is fundamentally structural. Without apparent qualification, Hayek asserts that "the chief actual cause of extensive unemployment . . . [is] the existence of discrepancies between the distribution of demand among the different goods and services and the allocation of labour and other resources among the production of those outputs." Hayek, however, cannot actually prove this theory. Hayek admits he cannot offer quantitative evidence in support of his theory: "[W]hen we are asked for quantitative evidence for the particular structure of prices and wages that would be required in order to assure a smooth continuous sale of the products and services offered, we must admit that we have no such information." Hayek continues, "[W]e can never produce statistical information which would show how much the prevailing prices and wages deviate from those which would secure a continuous sale of the current supply of labour [emphasis original]." His single attempt is to declare the theory would be proven false "if, with a constant money supply, a general increase of wages did not lead to unemployment." This account, however, is obviously inadequate either to support his own theory or to challenge an account linking aggregate demand to employment, because by a "constant money supply," Hayek is holding demand constant a priori. Where Hayek does not misunderstand science, he directly rejects it.
Hayek's only "intellectual" support for both his criticism of the scientific method as used by economics and the social sciences is not just an assertion of "a mistaken conception of the proper scientific procedure"; it is essentially "theological," in that it relies explicitly on revealed truths that cannot be contradicted by experience. Hayek asserts, "We know: of course, with regard to the market and similar social structures, a great many facts which we cannot measure and on which indeed we have only some very imprecise and general information." This assertion makes no sense: if have only "imprecise and general information," then we can know these supposed facts only by revelation, not by any sort of scientific inquiry. Indeed, Hayek admits that "the effects of these facts in any particular instance cannot be confirmed by quantitative evidence." These supposed facts cannot be observed directly, their effects cannot be observed directly, and yet they are still, according to Hayek, actual facts. Hayek's justification of his own theory is thin to the point of nonexistence: "few . . . will question the validity of the factual assumptions [!], or the logical correctness of the conclusions drawn from them." Hayek engages here in a wholesale repudiation not just of positivism, but of scientific knowledge in general.
Everything about Hayek's reasoning directly mimics the arguments of creationists and pseudoscientists. Who are you going to trust, Hayek asks, your preconceptions and prejudices, or your lying eyes? That Hayek received a Nobel Prize in cconomics is as absurd as it would be to award the Nobel Prize in physics to Deepak Chopra; that Hayek is even mentioned in a university curriculum about economics is a disgrace to the discipline, not because of his ideology (everything is ideological) but because of his contempt and dismissal of the scientific method.