Hayek vs Keynes

Lord Keynes writes:

I. Hayek’s influence is overrated.

The first point is that the fight over economic policy today has little if anything to do with Hayek. Today’s debates are essentially between New Keynesians versus New Classicals/monetarists. All of them are neoclassicals, and the free market New Classicals and monetarists are not Austrians.

Secondly, back in the 1930s and 1940s there were epic debates between Keynesians and Austrians like Hayek: and the Austrians lost those debates.

In fact, a good many of Hayek’s bright students at the LSE in the 1930s like Abba Lerner and Nicholas Kaldor simply abandoned his theories once they came to understand Keynes’ ideas. The defeat of Hayek and the Austrians was rather spectacular, as the world converted to Keynesian economics, and Austrians like Hayek and Mises were relegated to outer darkness.

When neoclassical synthesis Keynesian came under attack in the 1970s, it was not Austrian economics that overthrew it, but Milton Friedman’s monetarism and then the revived New Classical macroeconomics.

Furthermore, one of the major debates between Hayek and the emerging Keynesians in the 1930s and 1940s was over Hayek’s business cycle theory. One can note that even the Marshallian neoclassicals found his business cycle theories dubious, even before Keynes published the General Theory in 1936. The following anecdote illustrates this:

Immediately before giving his early 1931 lectures at LSE, which were his introduction to the school, Hayek gave a one-lecture to the Keynes-dominated Marshall Society at Cambridge. Richard Kahn, one of Keynes’ followers and later his literary executor, described the scene. Hayek had “a large audience of students, and also of leading members of the faculty. (Keynes was in London.) The members of the audience—to a man—were completely bewildered. Usually a Marshall Society talk is followed by a lively and protracted barrage of discussions and questions. On this occasion there was complete silence. I felt I had to break the ice. So I got up and asked, ‘Is it your view that if I went out tomorrow and bought a new overcoat, that would increase unemployment?’ ‘Yes,’ said Hayek. ‘But,’ pointing to his triangles on the board, ‘it would take a very long mathematical argument to explain why’” (Ebenstein 2003: 53).

It is no wonder that by the late 1930s Hayek’s LSE students were deserting him in droves.

Lest you think I am exaggerating, let Hayek speak for himself:

“At about the same time [viz., 1946], I discredited myself with most of my fellow economists by writing The Road to Serfdom, which is disliked so much. So not only did my theoretical influence decline, most of the departments came to dislike me, so much so that I can feel it to the present day. Economists very largely tend to treat me as an outsider, somebody who has discredited himself by writing a book like The Road to Serfdom, which has now become political science altogether. Recently—and Hicks is probably the most outstanding symptom—there has been a revival of interest in my sort of problems, but I had a period of twenty years in which I bitterly regretted having once mentioned to my wife after Keynes's death that now Keynes was dead, I was probably the best-known economist living. But ten days later it was probably no longer true. At that very moment, Keynes became the great figure, and I was gradually forgotten as an economist” (Kresge and Wenar 1994: 127).

II. A command economy is not a mixed economy, and Keynesian stimulus is not about war.

From 3.00 to 4.00 in this video, there is a truly stupid attempt to paint Keynes or Keynesians as supporters of war as a method of stimulus, in the comments on the Second World War.

And the producers of this video can’t even understand the nature of Western economies in WWII. Of course, the US and other nations did have huge government spending in WWII, but they also had moderate command economies in these years, with price controls and rationing. I say “moderate” because the US command economy was certainly not as extreme as that of the Soviet Union.

Other nations like the UK, Canada, and Australia also had moderate command economies during WWII.

The real lesson from WWII that is devastating to Austrian and other libertarian buffoons is that advanced capitalist nations showed that their type of command economy was extraordinarily successful – in fact they won the war for us. We owe our freedom from German and Japanese fascism to central planning of production and the way the economy was run in those years. The experience in WWII refuted the Austrian idea that government can never plan production on a large scale. If that were true, how on earth did any government produce anything in these years, let alone win the war? Of course, the WWII was a horrific disaster and any wartime economy is brutal and wasteful military spending.

None of the comments above is, in any way, an endorsement of war or a reason to re-establish command economies today – they are just statements of fact. I don’t personally support a command economy, nor do Keynesians, and it is not in doubt that rigid, communist command economies in backward nations were grossly immoral, brutal systems that faced severe problems and, in the long-term, serious inefficiencies.

But Keynesians do not advocate a command economy; they support a mixed economy, a very different thing from a command economy. Modern capitalist economies are mixed economies, where there is a vast space for private production of commodities and private enterprise.

In a Keynesian system, we can stimulate the economy into full employment without war or military spending. You can give a huge Keynesian boost to the economy by (1) large infrastructure spending, social spending, education spending, or increased R&D. Alternatively, you can also give a stimulus by (2) simply cutting taxes without cutting spending, which is also a classic Keynesian method.

These are the two methods of stimulus preferred by every Keynesian I know, not war.

III. Hayek recanted his views on “secondary deflation”.

Towards the end of his life, Hayek basically recanted his earlier view on the role of deflation in 1929–1933:

“There is no doubt, and in this I agree with Milton Friedman, that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation! So, once again, a badly programmed monetary policy prolonged the depression” (Pizano 2009: 13).

Hayek argued that a secondary deflation had negative effects on the US economy after 1929 and admitted that his earlier views had been wrong:

“Although I do not regard deflation as the original cause of a decline in business activity, such a reaction has unquestionably the tendency to induce a process of deflation – to cause what more than 40 years ago I called a ‘secondary deflation’ – the effect of which may be worse, and in the 1930s certainly was worse, than what the original cause of the reaction made necessary, and which has no steering function to perform. I must confess that forty years ago I argued differently. I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way” (Hayek 1978: 206).

In saying that he agreed with Milton Friedman, Hayek presumably would have accepted a monetarist solution of stabilizing the money supply by open market operations and other interventions (some claim that Hayek also supported limited fiscal policy actions, but I have yet to see evidence of this).

In other words, even the Hayek in this video is a travesty. By the end of his life, he moved closer to a monetarist position on “secondary deflation,” and approved of “evil” state interventions to stabilise the money supply.

IV. Hayek and Keynes shared some important ideas on economics.

As I have pointed out before, there are some interesting similarities in the thought of Hayek and Keynes. This involves the issue of methodology and the role of econometrics. Even Hayek himself noted Keynes’ negative views on econometrics:

“But Keynes himself did not think very highly of econometrics, rather to the contrary. Yet somehow his stress on aggregates, on aggregate income, aggregate demand, encouraged work in both macroeconomics and econometrics. So, very much against his own wishes, he became the spiritual father of this development towards the mathematical econometric economics. Now, I had always expressed my doubts about this, and that didn’t make me very popular among the reigning generation of economists. I was just thought to be old-fashioned, with no sympathy for modern ideas, that sort of thing”(Kresge and Wenar 1994: 127).