Conference of the Institute for New Economic Thinking, established
$50 million grant by George Soros, took place at King’s College, University
of Cambridge in Cambridge,
on April 8-11, 2010.
The landmark event was
intended to reflect the organization's commitment to invigorate the
conversation surrounding economic theory, method, and policy. More than
academic, business, and government policy thought leaders from around
convened to explore the reasons prevailing economic theory failed to
the financial and economic crisis that erupted in 2007-2008.
structured to examine the implications for reform, provoke creative
foster the development of original contributions to economic thinking.
the good office of INET Director, Dr. Rob Johnson, I was one of the
attendees but regrettably was unable to attend.
One of the Session
and the Challenge of the
Depression for Economic Thinking: Friedrich Hayek versus John Maynard
Keynes. Marshall Auerback was in
attendance and posted his comments on the topic on the
website of New Deal 2.0, a project of the Franklin and Eleanor
Keynes and Hayek is also a subject I
written on in 1999 and posted on the Post-Keynesian
Thoughton line discussion list.Readers
may find the article of interest. It was
published on April 15, 2010 in Asia
Times on Line.
Keynes and Hayek
By Henry C.K. Liu
Keynes at Cambridge University, who advocated government
intervention to protect the economy from the effects of the business
Hayek at the London School of Economics, who advocated the merits of
markets, had been theoretical opponents in economic theory since the
Events in the 1930s had showed the socio-economic damage
caused by free markets. Subsequently, the macroeconomics of Keynes's
General Theory dominated academic circles as well as government policy
By the time Keynes died in 1945, Hayek and the classical,
trade cycle theory had very few serious followers. Economic policy at
emphasized demand management in which the business cycle was believed
to be an
undesirable defect to be managed with fiscal policies of deficit
Discouraged, Hayek left economic theory work, eventually
chaired the Committee on Social Thought at the University
of Chicago in 1950, and
the University of Freiberg
(1962-68) and Salzburg
worked on psychology (The Sensory Order, 1952), political theory (The
of Liberty, 1960), and legal studies (Law, Legislation & Liberty,
l-lll, 1973-79) along generally conservative lines.
The so-called Socialist Calculation Controversy was prompted
by the AustrianSchool's
critique of central planning. From the 1920s until the 1940s, Hayek and
fellow Austrian and teacher, Ludwig von Mises, argued that socialism
to fail naturally as an economic system, although they seemed to allow
political imperative, albeit only as a fallacy.
Hayek maintains that only free markets, with individuals
making disaggregated decisions in their narrow self-interest, can
generate the information
necessary to intelligently coordinate social behavior. Freedom of
choice without “distortive” regard for social impacts is considered as
necessary input for an efficient economy that would lead to prosperity.
argues that free market prices are the true expression of a rational
For three decades after WWII, reality ran counter to Hayek’s
theories. Even conceptually, macro-economists began to suggest that
aid of computerized macro input/output models, central planning can
the very information problem that Hayek had raised. After all, if the
complexities of fluid mechanics in producing a silent-running submarine
propeller can be simulated by mathematical models, why not the dynamics
of a planned
economy. Mathematics was challenging ideology in the evaluation of
Paradoxically, Hayek, who implies scientific determinism in
his ideological argument for free market, is unsympathetic to the
applying the sophisticated tools of the physical sciences to the social
The shift from the “gun or butter” trade-off of the pre-war
era to the “gun and butter” fantasy of 1960s and '70s pushed post-war
prosperity into spiraling inflationary bubbles in countries that had
Keynesianism, led by the United States
and the U.K.
As more and more surplus value was siphoned off to
non-productive military expenses, wages could only rise by permitting
to stay ahead of them. Employment thus became hostage to the
militarization of peace.
Even then, full employment could not be maintained by Keynesian
peace time because surplus value, having been stored in military
not being re-circulated in the economy through higher wages to
The traditional counter-cyclical therapy, such as
stimulating consumption and postponing savings through government
spending, strained the elasticity of wage/price convergence, pushing
economy into stagflation.
The macro models, imperfect as they were, showed that the
principle of “guns or butter” was not immune to macro-economic
many guns would produce inflation that wages simply could not catch up.
Under Cold War mentality, cutting butter became the only
option. Capital understood that managed inflation is pro-labor and
Keynesian economics was essentially pro-labor in its macro approach by
unemployment as a social virus that healthy doses of managed inflation
should be tolerated as its cure. Government
policy was deemed the natural venue to administer the medicine.
Capital, to combat this serious threat to its very
existence, adopted a strategy with three legs.
The first leg required that guns remained an untouchable
priority. The rationale was that guns were needed geopolitically in a
that had become fatally dangerous to capitalism.
The second leg required that government be blamed for high
inflation and unemployment. Voters had to be convinced that inflation
for them and that the pain workers with low wages were suffering was
big government and inefficient central planning that distorted the
self-adjustments of a free market.
The third leg required the introduction of the threat of
hyperinflation in the economy to scare the gullible masses into
accepting an anti-government
and anti-inflation frame of mind. This leg of the strategy encouraged
to run into prolonged runaway inflation and recurring government
hurt both labor and capital, setting a stage for a anti-labor onslaught
anti-inflation and anti-government rationalization in the name of
the welfare of the nation.
The general public bought into the propaganda readily, but
the intellectuals had to be won over with a new school of economic
would seize policy initiative from the Keynesians in government.
discredited free market theories appeared tailor-made for this purpose.
To provide theoretical underpin for this three legged
pro-capital strategy, the old classical economics prescriptions:
balanced budgets, competition, productivity determined wage levels and
supply-side growth, were dug up from of the intellectual graveyard and
off with new bells and whistles to be paraded as the
sound economic policy goals of good government.
Conservative politicians began to demonize Keynesianism
domestically and rational socialist economic planning internationally. Third
World socialism, burdened with endemic poverty from
never given a chance economically by the new financial imperialism and
politically by Cold War containment.
The Soviet Union, as the only socialist super power, fresh
from a war-torn economy, was pushed gradually but systemically into
by the ruinous arms race stage managed by the "guns and butter"
policy of the US, the only capitalistic super power which had become
rich in WWII
which could violate the Bretton Woods gold standard fixed exchange rate
To anoint respectability on the worn theories of free market
voodoo economics, as propaganda against Keynesianism in the West and
in the Third World, Hayek was plucked from
of homelessness in the economics fraternity, to be awarded a surprised
Prize in Economics in 1974.
For ideological balance, Gunnar Myrdal was named co-winner
for the Nobel Prize in the same year. Myrdal would later published an
the abolition of the Nobel Prize for Economics, as a reaction to the
of the prize to Milton Friedman and Hayek who would be attacked for
never been much troubled by epistemological worries,” not withstanding
Nobel speech, delivered in Myrdal’s presence, dealt with the subject of
of economics. Myrdal’s disdain for Hayek was shared by many in academic
circles, particularly in Europe.
Nevertheless, overnight, the extremist right transformed a
joker in the person of Friedrich August von Hayek, born in 1899, died
1992 in Freiberg, Germany, to guru status, as the greatest philosopher
since Adam Smith.
Actually, Hayek and Keynes were both fundamentally classical
liberals, the former rooted Austrian idealism, the latter in English
pragmatism. The basic ideas for both are based on individual freedom.
was seduced by political necessity. His famous phrase: “in the long run
all be dead,” implies his recognition of the importance of
immediate socio-political constraint over timeless doctrinal purity.
The difference between them was that to keep the economy
going, Keynes would fight unemployment with inflation and Hayek would
inflation with unemployment.
They also differed with regard to technical measures, as
relating to interest rates, money supply, liquidity, etc., deemed
for achieving the desired effects.
For politicians, inflation and unemployment are the -keeping measurements in economic
Keynes' thesis is that government spending is needed to
bolster aggregate demand in times of unemployment.
Hayek believed that if it were not for government
interference with the monetary system, the economy would have no
fluctuations and no periods of depression. To him, trade cycles are
government monetary authorities creating a semi-monopoly where the
is controlled by government. Since banks issue secondary money, which
in basic money, a system of indeterminate control is created. So
monopoly over the issue of money is ultimately responsible the
structural problems, because nobody in charge of such a monopoly could
true to the logic, independent of political pressure.
Hayek allowed that the Keynesian period from about 1950 to
1975 would go down in history as the Great Prosperity, as opposed to
the Great Depression
of the 1930s. To Hayek, the hyperinflation of Germany
in 1922 was not to maintaining prosperity but was forced upon Germany
due to financial difficulties caused by a war debt strategy. If the
inflation was to maintain prosperity, a much more moderate rate would
achieved the aim.
Hayek blamed the collapses of the inflationary booms during
past trade cycles on the gold standard, which put a brake on those
after a few years. History has never had a time where a policy of
was unlimited by any framework of monetary order. So Milton Freidman’s
theory cannot solve any basic problems.
Hayek admitted that cuts in inflation have been accomplished
through extensive unemployment. He acknowledged that ending inflation
lead to long-lasting periods of unemployment like the 1930s, because
monetary policy was wrong during the boom as well as during the
first prolonging the boom and intensified the depression, and then by
deflation to go on and prolonged the Depression. But after an extended
of inflation, an economy cannot get out of it without substantial
To Hayek, inflation causes unemployment by drawing people
into jobs which exist only because relative demand is temporarily
and these temporary employments must disappear as soon as the increase
the quantity of money ceases.
Yet, in the United States,
a long period of high unemployment would automatically strain
income-maintenance programs, such as unemployment insurance, welfare,
run up enormous deficits as to threaten monetary stability and
Hayek acknowledged that there would be intense political
struggles on the question of whether social-security benefits ought to
to inflation. He advocated using inflation to reduce the real cost of
security system. He hoped that the horror of financing this colossal
bureaucracy would shock the country into a more
rational government framework.
To avoid inflation, Hayek's prescription has been to
advocate that monetary policy be pursued with the goal of maintaining
in the value of money. Since politicians cannot be trusted in a
democracy to regulate
the money supply, market forces should be allowed to adjust towards a
Hayek wanted a free market of money. He viewed the gold
standard as an unconstructive regulation. The gold standard, he argued,
it were nominally readopted, would never work because people are not
play by the rules of the game, which for the gold standard require that
unfavorable balance of trade leads directly to a contraction of
no government can do that; they would opt for going off the gold
Hayek attacked monetarism as represented by Friedman, by
pointing out the gold standard as based on an irrational superstition.
toyed with the idea of a commodity-reserve system, but the idea of
actual stocks of commodities as reserves is so complex and impractical
shifted to place the issue of money in the hands of firms whose
depend upon their success in keeping the money they issue stable. In
there is no necessity of depending upon their obligation to redeem in
commodities: it depends on the fact that they must so regulate the
their money that the public will accept the money for its stability.
better than anything else.
The Keynesian economic formula seeks a symbiotic
relationship with the political forces of the modem welfare state.
accepts the need to adjust monetary policy to a rising wage structure.
restriction on monetary policy so that it can be adjusted to deliver a
politically acceptable level of economic performance.
Hayek considers the Keynesian formula to be an unsustainable
spiral. As unions push up wages, government has to provide enough money
employment at these wages, and this leads into an inflationary spiral.
Keynes does not dispute this conclusion for the long run,
but practical application of Keynesian measure seems to work at least
short run. Hayek’s The Road to Serfdom
warns of the invasion of the welfare state in people’s private lives,
fundamental conflict between liberty and bureaucracy.
The Austrian economists who view the economics system as the
calculus of independent individual decisions differ with Milton
which think macro-economically in analyzing total quantity of money,
price level, total employment, etc., in aggregates and averages terms.
is an arch-positivist who believes nothing must enter scientific
except what is empirically proven, while Hayek theoretically rejects
usefulness of statistical studies.
Hayek observes that the Keynesian explanation of
unemployment is more acceptable by economists over the classical
because the former can be statistically tested while the latter cannot.
that point of view, Friedman's monetarism and Keynesianism have more in
each other than Hayekian theory has with either.
Hayek’s rejection of socialists thinking is based on his
view that prices are an instrument of communication and guidance, which
embodies more information than each market participant individually
him, it is impossible to bring about the same price-based order based
division of labor by any other means. Similarly, the distribution of
based on a vague concept of merit or need is impossible. Prices,
prices of labor, are needed to direct people to go where they can do
good. The only effective distribution is one derived from market
that basis, Hayek
intellectually rejects socialism.
In Hayek's social philosophy, value and merit are and ought
to be two distinctly separate issues. Individuals should be remunerated
on the basis of value and not in accordance with any concept of
it be the Puritan ethic or egalitarianism.
Hayek went a far as to deny that the concept of social justice
has any meaning whatever, on the basis that justice refers to rules of
conduct. Since no rules of the conduct of individuals can determine how
good things of life should be distributed, the question of justice is
Since a free market is the natural outcome of a multitude of individual
how the market decides is amoral.
Accordingly, a spontaneously working market, where prices
act as guides to action, cannot take account of what people need or
because it operates according to a neutral distribution system which
designed. Such a distribution system cannot be just or unjust.
And the idea that things ought to be designed in a ‘just’ manner means,
effect, that one must abandon the market and turn to a planned economy
somebody decides how much each ought to have. And the price for that
the complete abolition of personal liberty.
Hayek’s free market ideas have been applied to much of
unregulated globalization, the socio-economic damage is now very
withstanding Hayek’s repugnant social philosophy, even his “scientific”
on the effectiveness of free markets has not been substantiated by
Written on Jan
21, 1999 – first posted onPost-Keynesian
Thought on line discussion list on the same date. This article has
not been updated since.