The inaugural conference of the Institute for New Economic Thinking, established
with a US$50 million grant by George Soros, took place at King’s College,
University of Cambridge in Cambridge, United Kingdom 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 150 academic, business, and government policy thought leaders from
around the world convened to explore the reasons prevailing economic theory
failed to predict the financial and economic crisis that erupted in 2007-2008.
Conversations were structured to examine the implications for reform, to
provoke creative energy, and to foster the development of original
contributions to economic thinking.
Through the good office of the institute's director, Dr Rob Johnson, I was one
of the invited attendees but regrettably was
unable to be there. One of the session topics was "1930 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
Roosevelt Institute.
Keynes and Hayek is a subject I wrote on in 1999 and posted on the
Post-Keynesian Thought online discussion list. Readers may find the article of
interest.
John Maynard Keynes at Cambridge University, who advocated government
intervention to protect the economy from the effects of the business cycle, and
Friedrich Hayek at the London School of Economics, who advocated the merits of
free markets, had been theoretical opponents in economic theory since the
1930s.
Events in the 1930s had showed the socio-economic damage caused by free
markets. Subsequently, the macroeconomics of Keynes's 1936 General Theory
dominated academic circles as well as government policy establishments.
By the time Keynes died in 1945, Hayek and the classical, trade-cycle theory
had very few serious followers. Economic policy at that time emphasized demand
management in which the business cycle was believed to be an undesirable defect
to be managed with fiscal policies of deficit financing.
Discouraged, Hayek left economic theory work, eventually chaired the Committee
on Social Thought at the University of Chicago in 1950, and later at the
University of Freiberg (1962-68) and Salzburg (1968-77). He worked on
psychology (The Sensory Order, 1952), political theory (The Constitution
of Liberty, 1960), and legal studies (Law, Legislation & Liberty,
Volumes l-lll, 1973-79) along generally conservative lines.
The so-called Socialist Calculation Controversy was prompted by the Austrian
School's critique of central planning. From the 1920s until the 1940s, Hayek
and his fellow Austrian and teacher, Ludwig von Mises, argued that socialism
was bound to fail naturally as an economic system, although they seemed to
allow for socialism's 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 individual choice
without "distortive" regard for social impacts is considered as necessary input
for an efficient economy that would lead to prosperity. Hayek argues that
free-market prices are the true expression of a rational economy.
For three decades after World War II, reality ran counter to Hayek's theories.
Even conceptually, macro-economists began to suggest that with the aid of
computerized macro input/output models, central planning can accommodate the
very information problem that Hayek had raised. After all, if the boundless
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
theories in economics.
Paradoxically, Hayek, who implies scientific determinism in his ideological
argument for free markets, is unsympathetic to the efficacy of applying the
sophisticated tools of the physical sciences to the social sciences.
The shift from the "guns or butter" trade-off of the pre-war era to the "guns
and butter" fantasy of 1960s and '70s pushed post-war prosperity into spiraling
inflationary bubbles in countries that had benefited from Keynesianism, led by
the United States and the UK.
As more and more surplus value was siphoned off to non-productive military
expenses, wages could only rise by permitting inflation to stay ahead of them.
Employment thus became hostage to the militarization of peace. Even then, full
employment could not be maintained by Keynesian measures in peace time because
surplus value, having been stored in military inventory, was not being
re-circulated in the economy through higher wages to sustained needed demand.
The traditional counter-cyclical therapy, such as stimulating consumption and
postponing savings through government deficit spending, strained the elasticity
of wage/price convergence, pushing the economy into stagflation.
The macro models, imperfect as they were, showed that the principle of "guns or
butter" was not immune to macro-economic management. Too many guns would
produce inflation that wages simply could not catch up with.
Under Cold War mentality, cutting butter became the only option. Capital
understood that managed inflation is pro-labor and anti-capital. Keynesian
economics was essentially pro-labor in its macro approach by treating
unemployment as a social virus for which healthy doses of managed inflation
should be tolerated as its cure. Government fiscal 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 remain an untouchable priority. The rationale
was that guns were needed geopolitically in a world 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 was bad for them and
that the pain workers with low wages were suffering was caused by big
government and inefficient central planning that distorted the natural
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 the economy
to run into prolonged runaway inflation and recurring government deficits that
hurt both labor and capital, setting a stage for a anti-labor onslaught through
anti-inflation and anti-government rationalization in the name of protecting
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 thought that would seize
policy initiative from the Keynesians in government. Hayek's discredited
free-market theories appeared tailor-made for this purpose.
To provide theoretical underpinning for this three-legged pro-capital strategy,
the old classical economics prescriptions - savings, investment, balanced
budgets, competition, productivity determined wage levels and supply-side
growth - were dug up from the intellectual graveyard and dusted 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 imperialism, was 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 bankruptcy by the ruinous
arms race stage managed by the "guns and butter" policy of the US, the only
capitalistic superpower, which had become rich in World War II and could
violate the Bretton Woods gold standard fixed exchange rate with immunity.
To anoint respectability on the worn theories of free-market voodoo economics,
as propaganda against Keynesianism in the West and socialist planning in the
Third World, Hayek was plucked from three decades of homelessness in the
economics fraternity, to be awarded a surprise Nobel 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 publish an article advocating the
abolition of the Nobel Prize for economics, as a reaction to the awarding of
the prize to Milton Friedman and Hayek who would be attacked for "certainly
never been much troubled by epistemological worries", not withstanding that
Hayek's Nobel speech, delivered in Myrdal's presence, dealt with the subject of
the methodology 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 March 23, 1992, in Freiberg,
Germany) to guru status, as the greatest philosopher of capitalism 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. Keynes was seduced by political
necessity. His famous phrase, "In the long run we will 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 fight inflation with
unemployment.
They also differed with regard to technical measures, as relating to interest
rates, money supply, liquidity, etc, deemed appropriate for achieving the
desired effects.
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