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Hayek Was a Neoclassical – Yes, NEOCLASSICAL! — Economist

Published August 27, 2012 Hayek 39 Comments

In a long and productive scholarly career, F. A. Hayek worked for the most part in relative obscurity. That obscurity was interrupted by three, maybe four, short periods when his fame extended beyond his fellow economists to a wider public. The first was in the early 1930s when, arriving in London in the depths of the Great Depression, he became, while still a young man, the second most famous economist — surpassed only by Keynes himself — in Britain. Next, at the end of World War II, in middle age, he achieved international celebrity when his book The Road to Serfdom became a surprise best-seller. Then, in his old age, to the surprise of almost everyone, Hayek was awarded the 1974 Nobel Prize in economics. Finally, when he was almost 90, Hayek enjoyed a final moment of glory after the Soviet empire imploded in the late 1980s, providing ultimate vindication for his argument, advanced almost six decades earlier, but widely dismissed and mocked by many economists who should have known better, that comprehensive central planning was ultimately an unworkable system for running a modern economy. Now, once again, some 20 years after his death, Hayek seems to be enjoying another of his periodic bursts of fame — this time because the presumptive Republican nominee for Vice-President of the United States, Paul Ryan, likes to cite Hayek as one of his intellectual inspirations, offering Hayek as an alternative source for his ideological position to Ayn Rand, whom Ryan had to throw overboard because of her militant atheism, Hayek’s discreet agnosticism apparently not (yet?) making him untouchable.

Hayek’s renewed celebrity earned him the dubious honor of being written about in the New York Times Magazine by Adam Davidson, a financial journalist for Planet Money, and a columnist for the New York Times Magazine. Davidson does not get off to a good start, calling Hayek “an awkwardly shy (and largely ignored) economist and philosopher who died in 1992.” Hayek did die in 1992, and he was an economist and a philosopher, but to say that Hayek was “largely ignored” is a curious way to describe a Nobel Prize winner, even if one makes due allowance for the surprise with which the award of the Nobel Prize to Hayek was met. That was bad enough, but to call Hayek “awkwardly shy” is sheer fiction, and not just fiction, but an absurd fiction. I have never seen Hayek described by anyone as shy. And in my intermittent acquaintance with Hayek, over almost 20 years from the time I met and took classes from Hayek as an undergraduate student when he visited UCLA in the 1968-69 academic year, I never observed an awkward moment. Hayek to be sure evidenced a certain reserve, but it was the courtly, aristocratic reserve of the Viennese haute bourgeoisie, the “von,” which Hayek dropped from his surname upon becoming a British subject in the 1930s, marking the elitist background from which Hayek sprang. Among his family connections were his cousins Ludwig Wittgenstein, the philosopher and Paul Wittgenstein, the concert pianist, who, after losing his right arm in World War I, commissioned Maurice Ravel to compose his Concerto for the Left Hand. The Wittgensteins’ father, Karl, was perhaps the wealthiest industrialist in Austria. After a preposterous start like that, nothing that Davidson says about Hayek can carry any credibility.

But in his third paragraph, Davidson goes completely off the rails:

For the past century, nearly every economic theory in the world has emerged from a broad tradition known as neoclassical economics. (Even communism can be seen as a neoclassical critique.) Neoclassicists can be left-wing or right-wing, but they share a set of crucial core beliefs, namely that it is useful to look for government policies that can improve the economy. Hayek and the rest of his ilk — known as the Austrian School — reject this. To an Austrian, the economy is incomprehensibly complex and constantly changing; and technocrats and politicians who claim to have figured out how to use government are deluded or self-interested or worse. According to Hayek, government intervention in the free market, like targeted tax cuts, can only make things worse.

Here Davidson doesn’t just get Hayek wrong, he gets everything wrong. Where to start? “For the past century, nearly every economic theory in the world has emerged from a broad tradition known as neoclassical economics.” Fair enough, though the dominance of neoclassical economics probably goes back to at least 1880, and certainly no later than the publication of Alfred Marshall’s Principles of Economics in 1890, 120 years ago. But what can Davidson possibly mean by the bizarre parenthetical side comment “even communism can be seen as a neoclassical critique?” Does he mean that communism is a version of neoclassical economics? Or perhaps he means that Communism is a critique of neoclassical economics. Either alternative would be truly amazing if, by Communism, he means the economic doctrines of Karl Marx, doctrines Marx had developed well before the principal founders of neoclassical economics, William Stanley Jevons, Carl Menger and Leon Walras, published their versions of the marginal utility theory of value in the early 1870s. Perhaps Davidson means something else by Communism, but for the life of me, I can’t imagine what it might be. Then, paying no attention to the theoretical content of neoclassical theory, Davidson identifies the set of crucial core beliefs of neoclassical economics as follows: “it is useful to look for government policies that can improve the economy.” The mind boggles. This is not just cluelessness; it’s cluelessness masquerading as profundity.

Then we are told that Hayek and his fellow “Austrians” reject the notion that it is useful to look for government policies that can improve the economy. But this has nothing to do with neoclassical economics. Davidson seems to have relied on George Mason University economist, Peter Boettke, for some of his ideas, but I find it hard to imagine that Davidson is quoting Boettke accurately when he writes:

In actuality, Ryan is like a lot of politicians who merely cherry-pick Hayek to promote neoclassical policies, says Peter Boettke, an economist at George Mason University and editor of The Review of Austrian Economics.

Does Davidson know what a neoclassical policy is? Does Boettke? Does anyone? I don’t think so, because neoclassical economics, as such, has no policy agenda. But whatever a neoclassical policy might be, Davidson assures us that Hayek is totally against it.

Now, although the term “neoclassical policy” is a pure nonsense term, I can guess how Davidson, after talking to a bunch of Austrians — I hope not Boetkke or Bruce Caldwell, who is also quoted in Davidson’s piece — picked up on the propensity of modern self-styled Austrians — generally followers of the fanatical Murray Rothbard, as distinguished from the authentic Austrians of Hayek’s generation — to deploy “neoclassical” as a term of abuse, providing sufficient justification for these modern Austrians to dismiss any economic doctrine or policy they don’t like by strategically applying the epithet “neoclassical” to it.

So let me assert flatly that F. A. Hayek was a neoclassical economist through and through. He was also an authentic Austrian economist, schooled in both branches of Austrian theory by way of his association with his primary teacher at the University of Vienna, Friedrich von ~~Weiser~~ Wieser, one of the two principal successors of Carl Menger, the founder of the Austrian School, and through his subsequent collaboration with Ludwig von Mises, a leading student of Eugen von Bohm-Bawerk, the other principal successor of Menger.

In an introductory essay (“The Place of Menger’s Grundsatze in the History of Economic Thought”) to a volume, Carl Menger and the Austrian Theory of Value, edited by J. R. Hicks, commemorating the centenary of Menger’s classic work Grundsatze der Volkwirtschaftslehre (Principles of Economics) propounding the marginal-utility theory of value, Hayek explained that Menger’s theory had been incorporated into the larger body of economic theory that grew from the foundational contributions of Jevons, Menger, and Walras. While Menger’s work had become less influential in the second half century following publication of Menger’s Grundsatze than it had been in the first half-century after its publication, Hayek attributed that fact to a shift, under the influence of Keynes, in the interests of economists from micro- to macro-economics. Keynes’s work was not neoclassical economics, and it has been an ongoing project ever since Keynes published the General Theory to determine whether, and to what extent, Keynes’s theory could be reconciled with neoclassical economic theory. Here is how Hayek summed up his essay.

It seems to me that signs can already be discerned of a revival of interest in the kind of theory that reached its first high point a generation ago – at the end of the period during which Menger’s influence had mainly been felt. His ideas had by then, of course, ceased to be the property of a distinct Austrian School but had become merged in a common body of theory which was taught in most parts of the world. But though there is no longer a distinct Austrian School, I believe there is still a distinct Austrian tradition form which we may hope for many further contributions to the future development of economic theory. The fertility of its approach is by no means exhausted and there are still a number of tasks to which it can profitably be applied.

So we are all (or almost all) neoclassical economists, and none more so than Hayek, who was steeped in the neoclassical tradition. But no tradition is static. When a tradition stops changing, when it stops evolving, it becomes a relic, not a tradition. And with change come differences of opinion and disagreements, even bitter disagreements, between practitioners operating within a single broad tradition. Many Austrians now view themselves as completely distinct and separate from the broader neoclassical tradition from which their own doctrines evolved, but that was never Hayek’s view. And for all the severe criticisms and complaints he voiced about the direction of economics since the 1930s, he never viewed himself as being cut off, or alienated, from the mainstream of neoclassical economic theory. That Hayek could be both a critic and a practitioner of neoclassical economics is obviously too complicated a proposition for Mr. Davidson, and many others for that matter, to comprehend, but to Hayek it seemed entirely natural and unremarkable.

Stephen Moore Turns F. A. Hayek into Chopped Liver

Published July 30, 2012 Friedman , Hayek 13 Comments

Tuesday, July 31 2012 is the 100^th anniversary of Milton Friedman’s birth. There is plenty to celebrate. Milton Friedman, by almost anyone’s reckoning, was one of the great figures of twentieth century economics. And I say this as someone who is very far from being an uncritical admirer of Friedman. But he was brilliant, industrious, had a superb understanding of microeconomic theory, and could apply microeconomic theory very creatively to derive interesting and testable implications of the theory to inform his historical and empirical studies in a broad range of topics. He put his exceptional skills as an economist, polemicist, and debater to effective use as an advocate for his conception of the classical liberal ideals of limited government, free trade, and personal liberty, achieving astonishing success as a popularizer of libertarian doctrines, becoming a familiar and sought-after television figure, a best-selling author, and an adviser first to Barry Goldwater, then to Richard Nixon (until Nixon treacherously imposed wage-and-price controls in 1971), and, most famously, to Ronald Reagan. The arc of his influence was closely correlated with the success of those three politicians.

So it is altogether fitting and proper that the Wall Street Journal would commemorate this auspicious anniversary with an appropriate tribute to Friedman’s career and his influence. But amazingly, the Journal was unable to find anyone more qualified to write about Friedman than none other than one of their own editorial writers, Stephen Moore, whose dubious contributions to the spread of economic understanding and enlightenment I have had occasion to write about in the past. Friedman has many students and colleagues who are still alive and active. One would think that there would have been more than a handful of them that could have been asked to write about Friedman on this occasion, but apparently the powers that be at the Journal felt that none of them could do the job as well as Mr. Moore.

How did Mr. Moore do? Well, he recites many of Friedman’s accomplishments as a scholar and as an advocate of less government intervention in the economy. But in his enthusiasm, Mr. Moore was unable to control his penchant for making stuff up without regard to the facts. Writing about the award of the Nobel Prize to Friedman in 1976, Moore makes the following statement:

Friedman was awarded the Nobel Prize in economics for 1976—at a time when almost all the previous prizes had gone to socialists. This marked the first sign of the intellectual comeback of free-market economics since the 1930s, when John Maynard Keynes hijacked the profession.

Here is a list of Nobel Prize winners before Friedman

1969: Ragnar Frisch, Jan Tinbergen

1970: Paul Samuelson

1971: Simon Kuznets

1972: Kenneth Arrow, J. R. Hicks

1973: Wassily Leontief

1974: F. A. Hayek, Gunnar Myrdal

1975: Leonid Kantorovich, T. C. Koopmans

So there were eleven recipients of the Nobel Prize before Friedman. Of these Gunnar Myrdal was a prominent Social Democratic politician in Sweden as well as an academic economist, so perhaps he qualifies as a socialist.

Wassily Leontief was a Russian expatriate; he developed mathematical and empirical techniques for describing the production process of an economy in terms of input-output tables. This was an empirical technique that had no particular ideological significance, but Leontief did seem to think that the technique could be adapted to provide a basis for economic planning. So perhaps he might be also be classified as a socialist.

Paul Samuelson was a prominent adviser to Democratic politicians, an advocate of Keynesian countercyclical policies, but never supported socialism. Kenneth Arrow has been less involved in politics than Samuelson, but has also been a supporter of Democrats. Apparently that is enough to make someone a socialist in Mr. Moore’s estimation.

Ragnar Frisch and Jan Tinbergen were pioneers in the development of econometrics and other mathematical tools used by economists. They also tried to make those tools serviceable to policy makers. Frisch and Tinbergen were classic technocrats who, as far as I can tell, carried very little ideological baggage. But perhaps Mr. Moore has subjected the baggage to his socialism detector and heard the alarm bells go off.

J. R. Hicks was a prominent English economic theorist who was not identified strongly with any political party. Although he helped create the standard Keynesian IS-LM model, he was theoretically eclectic and as far as I know never wrote a word advocating socialism.

Simon Kuznets was an archetypical empirical technocratic economist who was one of the fathers of national income accounting. He actually was the coauthor of Milton Friedman’s first book, Income from Independent Professional Practice, hardly evidence of a socialistic mindset.

T. C. Koopmans, an early pioneer of econometric techniques, was awarded the Nobel Prize largely for his work in developing the mathematical techniques of linear programming which is a method of finding solutions to a class of problems that can be understood in terms of allocating resources efficiently to achieve a certain desired result, such as maximizing the nutritional content from a given expenditure on food or minimizing the cost to obtain a given level of nutrients. Leonid Kantorovich, a Soviet mathematician, developed the mathematical techniques of linear programming even before Koopmans. His results were actually subversive of Marxian theory, but their deeper implications were not understood in the Soviet Union. Again, the Nobel Prize was awarded for technical contributions, not for any particular economic policy or economic ideology.

But the most amazing thing about Mr. Moore’s statement about the bias of Nobel Prize Committee in favor of socialists is that he effectively re-writes history as if F. A. Hayek had not already won the Nobel Prize two years before Friedman. What is one supposed to make of Moore’s statement that the award of the Nobel Prize to Friedman in 1976 “was the FIRST sign of the intellectual comeback of free-market economics since the 1930s?” What was Hayek, Mr. Moore? Chopped Liver?

To QE or not to QE

Published July 22, 2012 expectations , Hawtrey , Hayek , monetary policy 32 Comments

Steve Horwitz, one of my favorite contemporary Austrian economists – and he would be likely be one of them even if there were not such a dearth of Austrian economists to plausibly choose from — published an opinion piece in US News and World Report opposing another round of quantitative easing. His first paragraph focuses on the size of the Fed balance sheet and the (unenumerated) “new and unprecedented” powers that the Fed has accumulated, as if the size of the Fed balance sheet were somehow logically related to its accumulation of those new and unprecedented powers. But the size of the Fed’s balance sheet and the extent of the powers that it is exercising are not really the nub of Horwitz’s argument; it is the prelude to an argument that begins in the next paragraph

[P]revious rounds of quantitative easing have done little . . . to generate recovery. Of course it’s . . . possible that it’s because it wasn’t enough, but a tripling of the Fed’s balance sheet hardly seems like an insufficient attempt at monetary stimulus.

In other words, if QE hasn’t worked till now, why should we think that another round will be any more successful? But if the objection is simply that QE doesn’t matter, one might well respond that, in that case, there also doesn’t seem to be much harm in trying.

Horwitz then turns to the argument that some proponents (notably Market Monetarists) of additional QE have been making, which is that for about two decades the level of aggregate nominal spending in the economy or nominal gross domestic product (NGDP) was growing at an annual rate in the neighborhood of 5%. But since the 2008-09 downturn, the economy has fallen way below that growth path, so that the job of monetary policy is to bring the economy at least part of the way back to that path, instead of allowing it to lag farther and farther behind its former growth path. Horwitz raises the following objection to this argument.

[M]ost economic theories explaining why an insufficient money supply would lead to recession depend upon “stickiness” in prices and wages. Those same theories also indicate that, after a sufficient amount of time, people will adjust to that stickiness in prices and wages and the money supply will be sufficient again.

If that adjustment hasn’t taken place in almost four years, then perhaps it is not this “stickiness” that could perhaps be overcome by more monetary stimulus, but rather real resource misallocations that are causing delaying recovery. Those real misallocations cannot be fixed by more money. Instead, we need less regulation and more freedom for entrepreneurs to reallocate resources away from the mistakes of the boom, to where they are most valuable now.

I have three problems with this dismissal of monetary stimulus. First, Horwitz takes it as self-evident that a tripling of the Fed’s balance sheet is the equivalent of monetary stimulus. But that of course simply presumes that the demand of the public to hold the monetary base has not increased as fast or faster than the monetary base has increased. In fact, the slowdown in the growth of NGDP and inflation in the last four years suggests that the public has been more than willing to hold all the additional currency and reserves (the constituents of the monetary base) that the Fed has created. If so, there has been no effective monetary stimulus. But isn’t it unusual for the demand for the monetary base to have increased so much in so short a time? Yes, it certainly is unusual, but not unprecedented. In the Great Depression there was a huge increase in the demand to hold currency and bank reserves, and voices were then raised warning of the inflationary implications of rapidly increasing the monetary base. In retrospect, almost everyone (with the exception of some fanatical Austrian economists who tend to regard Professor Horwitz as dangerously tolerant of mainstream economics) now views the voices that were warning of inflation in the 1930s with the same astonishment as Ralph Hawtrey expressed when he compared such warnings to someone “crying fire, fire in Noah’s flood.”

Second, Horwitz may be right that most economic theories explaining why an insufficient money supply can cause unemployment rely on some form of price stickiness to explain why market price adjustments can’t do the job without monetary expansion. But price stickiness is a very vague and imprecise term covering a lot of different, and possibly conflicting, interpretations. Horwitz’s point seems to be something like the following: “OK, I’ll grant you that prices and wages don’t adjust quickly enough to restore full employment immediately, but why should four years not be enough time to get wages and prices back into proper alignment?” That objection presumes that there is a unique equilibrium structure of wages and prices, and that price adjustments move the economy, however slowly, toward that equilibrium. But that is a mistaken view of economic equilibrium, which, in the real world, depends not only on price adjustments, but on price expectations. Unless price expectations are in equilibrium, price adjustments, whether rapid or slow, cannot guarantee that economic equilibrium will be reached. The problem is that there is no economic mechanism that ensures the compatibility of the price expectations held by different economic agents, by workers and by employers. This proposition about the necessary conditions for economic equilibrium should not be surprising to Horwitz, inasmuch as it was set out about 75 years ago in a classic article by one of his (and my) heroes, F. A. Hayek. If the equilibrium set of price expectations implies an expected inflation rate over the next two to five years greater than the 1.5% it is now generally estimated to be, then the economy can’t move toward equilibrium unless inflation and inflation expectations are raised significantly.

Third, although Horwitz finds it implausible that price stickiness could account for the failure to achieve a robust recovery, he is confident that “less regulation and more freedom for entrepreneurs to reallocate resources away from the mistakes of the boom, to where they are most valuable now” would produce such a recovery, and quickly. But he offers no reason or evidence to justify a supposition that the regulatory burden is greater, and entrepreneurial freedom less, today than it was in previous recoveries. To me that seems like throwing red meat to the ideologues, not the sort of reasoned argument that I would have expected from Horwitz.

HT: Lars Christensen

W. H. Hutt on Say’s Law and the Keynesian Multiplier

Published July 4, 2012 Alchian , expectations , Hayek , Keynes , monetary theory , W. H. Hutt 26 Comments

In a post a few months ago, I referred to W. H. Hutt as an “unjustly underrated” and “all but forgotten economist” and “as an admirable human being,” who wrote an important book in 1939, The Theory of Idle Resources, seeking to counter Keynes’s theory of involuntary unemployment. In responding to a comment on a more recent post, I pointed out that Armen Alchian relied on one of Hutt’s explanations for unemployment to provide a microeconomic basis for Keynes’s rather convoluted definition of involuntary unemployment, so that Hutt unintentionally provided support for the very Keynesian theory that he was tried to disprove. In this post, I want to explore Hutt’s very important and valuable book ARehabilitation of Say’s Law, even though, following Alchian, I would interpret what Hutt wrote in a way that is at least potentially supportive of Keynes, while also showing that Hutt’s understanding of Say’s Law allows us to view Says Law and the Keynesian multiplier as two (almost?) identical ways of describing the same phenomenon.

But before I discuss Hutt’s understanding of Say’s Law, a few words about why I think Hutt was an admirable human being are in order. Born in 1899 into a working class English family (his father was a printer), Hutt attended the London School of Economics in the early 1920s, coming under the influence of Edwin Cannan, whose writings Hutt often referred to. After gaining his bachelor’s degree, Hutt, though working full-time, continued taking courses at LSE, even publishing several articles before taking a position at the University of Capetown in 1930, despite having no advanced degree in economics. Hutt remained in South Africa until the late 1960s or early 1970s, becoming an outspoken critic of legal discrimination against non-whites and later of the apartheid regime instituted in 1948. In his book, The Economics of the Colour Bar, Hutt traced the racial policies of the South African regime not just to white racism, but to the interest of white labor unions in excluding competition by non-whites. Hutt’s hostility to labor unions for their exclusionary and protectionist policies was evident in much of his work, beginning at least with his Theory of Collective Bargaining, his Strike-Threat System, and his many critiques of Keynesian economics. However, he was opposed not to labor unions as such, just to the legal recognition of the right of some workers to coerce others into a collusive agreement to withhold their services unless their joint demand for a stipulated money wage was acceded to by employers, a right that in most other contexts would be both legally and morally unacceptable. Whether or not Hutt took his moral opposition to collective bargaining to extremes, he certainly was not motivated by any venal motives. Certainly his public opposition to apartheid, inviting retribution by the South African regime, was totally disinterested, and his opposition to collective bargaining was no less sincere, even If less widely admired, than his opposition to apartheid, and no more motivated by any expectation of personal gain.

In the General Theory, launching an attack on what he carelessly called “classical economics,” Keynes devoted special attention to the doctrine he described as Say’s Law, a doctrine that had been extensively and inconclusively debated in the nineteenth century after Say formulated what he had called the Law of the Markets in his Treatise on Political Economy in 1803. The exact meaning of the Law of the Markets was never entirely clear, so that, in arguing about Say’s Law, one can never be quite sure that one knows what one is talking about. At any rate, Keynes paraphrased Say’s Law in the following way: supply creates its own demand. In other words, “if you make it, they will buy it, or at least buy something else, because the capacity to demand is derived from the capacity to supply.”

Here is Keynes at p. 18 of the General Theory:

From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; — meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product.

In J. S. Mill’s Principles of Political Economy the doctrine is expressly set forth:

What constitutes the means of payment for commodities. Each person’s means of paying for the productions of other people consist of those which he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. Could we suddenly double the productive powers of the country, we should double the supply of commodities in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply; everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange.

Then, again at p. 26, Keynes restates Say’s Law in his own terminology:

In the previous chapter we have given a definition of full employment in terms of the behavior of labour. An alternative, though equivalent, criterion is that at which we have now arrived, namely, a situation in which aggregate employment is inelastic in response to an increase in effective demand for its output. Thus Say’s Law, that the aggregate demand price of output as a whole is equal ot its aggregate supply price for all volumes of output [“could we suddenly double the productive powers of the country . . . we should . . . double the purchasing power”], is equivalent the proposition that there is no obstacle to full employment. If, however, this is not the true law relating the aggregate demand and supply functions, there is a vitally important chapter of economic theory which remains to be written and without which all discussions concerning the volume of aggregate employment are futile.

Keynes restated the same point in terms of his doctrine that macroeconomic equilibrium, the condition for which being that savings equal investment, could occur at a level of output and income corresponding to less than full employment. How could this happen? Keynes believed that if the amount that households desired to save at the full employment level of income were greater than the amount that businesses would invest at that income level, expenditure and income would decline until desired (and actual) savings equaled investment. If Say’s Law held, then whatever households chose not to spend would get transformed into investment by business, but Keynes denied that there was any mechanism by which this transformation would occur. Keynes proposed his theory of liquidity preference to explain why savings by households would not necessarily find their way into increased investment by businesses, liquidity preference preventing the rate of interest from adjusting to induce as much investment as required to generate the full-employment level of output and income.

Now the challenge for Keynes was to explain why, if there is less than full employment, wages would not fall to induce businesses to hire the unemployed workers. From Keynes’s point of view it wasn’t enough to assert that wages are sticky, because a classical believer in Say’s Law could have given that answer just as well. If you prevent prices from adjusting, the result will be a disequilibrium. From Keynes’s standpoint, positing price or wage inflexibility was not an acceptable explanation for unemployment. So Keynes had to argue that, even if wages were perfectly flexible, falling wages would not induce an increase in employment. That was the point of Keynes’s definition of involuntary unemployment as a situation in which an increased price level, but not a fall in money wages, would increase employment. It was in chapter 19 of the General Theory that Keynes provided his explanation for why falling money wages would not induce an increase in output and employment.

Hutt’s insight was to interpret Say’s Law differently from the way in which most previous writers, including Keynes, had interpreted it, by focusing on “supply failures” rather than “demand failures” as the cause of total output and income falling short of the full-employment level. Every failure of supply, in other words every failure to achieve market equilibrium, means that the total effective supply in that market is less than it would have been had the market cleared. So a failure of supply (a failure to reach the maximum output of a particular product or service, given the outputs of all other products and services) implies a restriction of demand, because all the factors engaged in producing the product whose effective supply is less than its market-clearing level are generating less demand for other products than if they were producing the market-clearing level of output for that product. Similarly, if workers don’t accept employment at market-clearing wages, their failure to supply involves a failure to demand other products. Thus, failures to supply can be cumulative, because any failure of supply induces corresponding failures of demand, which, unless there are further pricing adjustments to clear other affected markets, trigger further failures of demand. And clearly the price adjustments required to clear any given market will be greater when other markets are not clearing than when those other markets are clearing.

So, with this interpretation, Hutt was able to deploy Say’s Law in a way that sheds important light on the cumulative processes of contraction and expansion characterizing business-cycle downturns and recoveries. In his modesty, Hutt disclaimed originality in using Say’s Law as a key to understanding those cumulative processes, citing various isolated statements by older economists (in particular a remark of the Cambridge economist Frederick Lavington in his 1921 book The Trade Cycle: “The inactivity of all is the cause of the inactivity of each”) that vaguely suggest, but don’t spell out, the process that Hutt describes in meticulous detail. If Hutt’s analysis was anticipated in any important way, it was by Clower and Leijonhufvud in their paper “Say’s Principle, What it Means and Doesn’t Mean,” (reprinted here and here), which introduced a somewhat artificial distinction between Say’s Law, as Keynes conceived of it, and Say’s Principle, which is closer to how Hutt thought about it. But to Clower and Leijonhufvud, Say’s Principle was an essential part of the explanation of the Keynesian multiplier. The connection between them is simple, effective supply is identical to effective demand because every purchase is also a sale. A cumulative process can be viewed as either a supply-side process (Say’s Law) or a demand-side process (the Keynesian multiplier), but they are really just two sides of the same coin.

So if you have followed me this far, you may be asking yourself, did Hutt really rehabilitate Say’s Law, as he claimed to have done? And if so, did he refute Keynes, as he also claimed to have done? My answer to the first question is a qualified yes. And my answer to the second question is a qualified no. I will not try to justify my qualification to my answer to the first question, except to note that the qualification depends on the assumptions made about how money is supplied in the relevant model of the economy. In a model in which money is endogenously supplied by private banks, Say’s Law holds; in a model in which the supply of money is fixed exogenously, Say’s Law does not hold. For more on this, see my paper, “A Reinterpretation of Classical Monetary Theory,” or my book Free Banking and Monetary Reform (pp. 62-66).

But if Hutt was right about Say’s Law, how can Keynes be right that cutting money wages is not a good way (but in Hutt’s view the best way) to cure a depression that is itself caused by the mispricing of assets and factors of production? The answer is that, for all the care Hutt exercised in working out his analysis, he was careless in making explicit his assumptions about the expectations of workers about future wages (i.e., the wages at which they would be able to gain employment). The key point is that if workers expect to be able to find employment at higher wages than they will in fact be offered, the aggregate supply curve of labor will intersect the aggregate demand curve for labor at a wage rate that is higher, and a quantity that is lower, than would be the case in an equilibrium in which workers’ expectations about future wages were correct. From the point of view of Hutt, there is a supply failure because the aggregate supply of labor is less than the hypothetical equilibrium supply under correct wage expectations. But there is no restriction on market pricing, just incorrect expectations of future wages. Expectations need not be rigid, but in a cumulative process, wage expectations may not adjust as fast as wages are falling. Though Keynes, himself, did not discuss the possibility explicitly, it is also possible that there could be multiple equilibria corresponding to different sets of expectations (e.g., optimistic or pessimistic). If the economy settles into a pessimistic equilibrium, unemployment could stabilize at levels that are permanently higher than those that would have prevailed under an optimistic set of expectations. Perhaps we are now stuck in (or approaching) such a pessimistic equilibrium.

Be that as it may, Hutt simply assumes that allowing all prices to be determined freely in unfettered markets must result in the quick restoration of a full-employment equilibrium. This is a reasonable position to take, but there is no way of proving it logically. Proofs that free-market adjustment leads to an equilibrium are based on some sort of tatonnement or recontracting process in which trading does not occur at disequilibrium prices. In the real world, there is no restriction on trading at disequilibrium process, so there is no logical argument that shows that the Say’s Law dynamic described by Hutt cannot go on indefinitely without reaching equilibrium. F. A. Hayek, himself, explained this point in his classic 1937 paper “Economics and Knowledge.”

In the light of our analysis of the meaning of a state of equilibrium it should be easy to say what is the real content of the assertion that a tendency toward equilibrium exists. It can hardly mean anything but that, under certain conditions, the knowledge and intentions of the different members of society are supposed to come more and more into agreement or, to put the same thing in less general and less exact but more concrete terms, that the expectations of the people and particularly of the entrepreneurs will become more and more correct. In this form the assertion of the existence of a tendency toward equilibrium is clearly an empirical proposition, that is, an assertion about what happens in the real world which ought, at least in principle, to be capable of verification. And it gives our somewhat abstract statement a rather plausible common-sense meaning. The only trouble is that we are still pretty much in the dark about (a) the conditionsunder which this tendency is supposed to exist and (b) the nature of the process by which individual knowledge is changed.

In the usual presentations of equilibrium analysis it is generally made to appear as if these questions of how the equilibrium comes about were solved. But, if we look closer, it soon becomes evident that these apparent demonstrations amount to no more than the apparent proof of what is already assumed[11] . The device generally adopted for this purpose is the assumption of a perfect market where every event becomes known instantaneously to every member. It is necessary to remember here that the perfect market which is required to satisfy the assumptions of equilibrium analysis must not be confined to the particular markets of all the individual commodities; the whole economic system must be assumed to be one perfect market in which everybody knows everything. The assumption of a perfect market, then, means nothing less than that all the members of the community even if they are not supposed to be strictly omniscient, are at least supposed to know automatically all that is relevant for their decisions. It seems that that skeleton in our cupboard, the “economic man,” whom we have exorcised with prayer and fasting, has returned through the back door in the form of a quasi-omniscient individual.

Both Sraffa and Hayek Were Right and Wrong About the Natural Rate of Interest

Published June 28, 2012 expectations , Hayek , monetary theory 30 Comments

Last September, after Robert Murphy and Lord Keynes wrote about the Sraffa-Hayek debate of 1932 about the natural rate of interest, I wrote a post about that controversy in which I took an intermediate position defending Hayek against Sraffa’s charge that his use of the natural-rate concept was incoherent, while observing as well that the natural rate of interest in nominal terms is not unique, because any real intertemporal equilibrium is consistent with any choice of price level and any rate of inflation. The condition for a real intertemporal equilibrium with money is simply that the level and rate of change of prices be foreseen correctly. In such an equilibrium, own rates could differ, but by no more than necessary to compensate for different real service flows and different costs of storage associated with different assets, inasmuch as the expected net real return from holding every asset must be equal in equilibrium. But while expected real returns from holding assets must be equal, that unique real return is consistent with any nominal return reflecting any arbitrary rate of price change. It is not by choosing a particular nominal rate of interest — a rate that equals the natural rate — that the monetary authority brings about intertemporal equilibrium. Rather, it is the consistency between whatever nominal interest rate the monetary authority has chosen and the expectations by economic agents of future prices that is the necessary and sufficient condition for intertemporal equilibrium. Any nominal interest rate can become the natural rate if it is supported by an equilibrium set of price expectations. Hayek almost, but not quite, understood this point. His incomplete understanding seems to have prevented him from responding effectively to Sraffa’s charge that his concept of a natural rate of interest was incoherent based on the potential existence of many different own rates of interest in a barter equilibrium.

As a result of last September’s post about Sraffa and Hayek, my colleague Paul Zimmerman and I wrote a paper about the Sraffa-Hayek debate and Keynes’s role in the debate and his later discussion of own rates in chapter 17 of the General Theory. I gave a talk about this paper at Brock University in St. Catherines, Ontario on Sunday at the annual meeting of the History of Economics Society. At some point in the near future, I hope the paper will be ready to circulate on the internet and to submit for publication. When it is I will provide a link to it on the blog. So it was an interesting coincidence that two days after the conference, the Sraffa-Hayek debate about the natural rate and about own rates was the subject of renewed interest in the blogosphere.

The latest round was started by Andrew Laiton who wrote about multiple own rates of interest. Laiton apparently thinks that there could be multiple real own rates, but seems to me to overlook the market forces that tend to equalize own rates, market forces wonderfully described by Keynes in chapter 17. Nick Rowe followed up with a post in which he seems to accept that real own rates could differ across commodities, but doesn’t think that that matters. All that matters is that the monetary authority choose a particular own rate and sets its nominal rate to match the chosen own rate. (Daniel Kuehn agrees with Nick here.)

Nick is right that there is no natural rate that can be defined apart from a particular choice of a nominal price path for at least one commodity over time. But in an economy with n commodities and t time periods, there are nt possible choices (actually many more possible choices if we take into account all possible baskets of commodities and all possible rates of price change). The job of the monetary authority is to pin down a path of nominal prices. Given that nominal choice, the natural rate consistent with intertemporal equilibrium would find expression in a particular nominal term structure of interest rates consistent with the equilibrium price expectations of agents. Hayek himself proposed constant NGDP as a possible monetary rule. What Hayek failed to see is that it was the choice of a particular value or time path of nominal GDP that would determine a particular nominal value of the natural rate, not, as Hayek believed, that by choosing a nominal interest rate equal to the natural rate, the monetary authority would ensure that NGDP remained constant over time.

The Bank for International Settlements Falls into a Hayekian Trap

Published June 27, 2012 Great Depression , Hayek , monetary policy 9 Comments

On April 9, 1975, F. A. Hayek, having recently received the Nobel Prize in economics, was invited to give a talk to a group of distinguished economists at the American Enterprise Institute in Washington DC. He was introduced by his old friend and colleague from Vienna, Gottfried Haberler. During his talk, Hayek pointed out that although a downturn can be triggered by microeconomic factors causing a lack of correspondence between the distribution of demand across products and industries and the distribution of labor across products and industries.

These discrepancies of demand and supply in different industries, discrepancies between the distribution of demand and the allocation of the factors of production, are in the last analysis due ot some distortion in the price system that has directed resources to false uses. It can be corrected only by making sure, first, that prices achieve what, somewhat misleadingly, we call an equilibrium structure, and second, that labor is reallocated according to these new prices.

Lacking such price readjustment and resource reallocation, the original unemployment may then spread by means of the mechanism I have discussed before, the “secondary contraction,” as I used to call it. In this way, unemployment may eventually become general.

In the subsequent discussion, Haberler asked Hayek to elaborate on the concept of a “secondary contraction,” and the appropriate policy response to such a phenomenon. Haberler asked:

I was very glad you said that you find some justification in the view that depressions are aggravated by a cumulative spiral and that there is such a thing as a secondary deflation. Don’t you think that it is possible to do something about that aggravation without recreating the fundamental maladjustments which, in your opinion, caused the depression.

Hayek replied:

I hope I implied this. The moment there is any sign that the total income stream may actually shrink, I should certainly not only try everything in my power to prevent it from dwindling, but I should announce beforehand that I would do so in the event the problem arose.

Later in the discussion, Haberler again pressed Hayek on his position regarding a downward deflationary spiral such as occurred in the 1930s. Hayek responded to Haberler as follows:

You ask whether I have changed my opinion about combatting secondary deflation. I do not have to change my theoretical views. As I explained before, I have always thought that deflation had no economic function; but I did once believe, and no longer do, that it was desirable because it could break the growing rigidity of wage rates. Even at that time I regarded this view as a political consideration; I did not think that deflation improved the adjustment mechanism of the market.

In a terrific commentary on the recent annual report of the Bank for International Settlements, Ryan Avent disposes of the arguments offered by the BIS for tightening current monetary policies.

I was especially struck by the following passage, quoted by Avent, from the report.

Although central banks in many advanced economies may have no choice but to keep monetary policy relatively accommodative for now, they should use every opportunity to raise the pressure for deleveraging, balance sheet repair and structural adjustment by other means.

Here, in another, slightly less ferocious, guise, is the deflationary argument that Hayek himself disavowed nearly 40 years ago: that secondary deflation could be used to “break the growing rigidity of wage rates,” or in updated BIS terminology could “raise the pressure for deleveraging, balance sheet repair and structural adjustment.”

Plus ca change, plus c’est la meme chose.

OMG! John Taylor REALLY Misunderstands Hayek

Published June 3, 2012 Friedman , Hayek , monetary policy , Uncategorized 15 Comments

Since Friday’s post about John Taylor’s misunderstanding of Hayek, I watched the 57-minute video of John Taylor’s Hayek Prize Lecture. I will not offer an extended critique of the lecture, which was little more than a collection of talking points based on little empirical evidence and no serious analysis or argument. If that description sounds like a critique, so be it, but the lecture was more in the way of a ritual invocation of shared beliefs and values than an attempt to make a substantive case for a definite policy or set of policies. Whether those present at the lecture were appropriately reinforced in their shared beliefs by Taylor’s low-key remarks and placid delivery, I have no idea, but he obviously was not trying to break any new intellectual ground.

Though I found Taylor’s remarks generally boring, I did perk up about 33-34 minutes through the lecture when Taylor observed that Hayek had himself, on occasion, deviated from his own principles. How does Taylor know this? He knows this (or thinks he does, at any rate), because, as a fellow of the Hoover Institution at Stanford University, he has access to Hayek’s correspondence, which contains Keynes’s famous letter to Hayek praising The Road to Serfdom, a letter Taylor quotes from just before he gets to his point about Hayek’s “deviation,” and access to a letter that Milton Friedman wrote to Hayek complaining about Hayek’s criticism of his 3-percent rule for growth in the stock of money. Hayek made the criticism in a 1975 lecture entitled, “Inflation, the Misdirection of Labour, and Unemployment,” which was published in a 52-page pamphlet called Full Employment at any Price? (of which I own a copy) along with Hayek’s Nobel Lecture and some additional Hayek had written about inflation and unemployment.

Here is what Hayek said about Friedman’s rule:

I wish I could share the confidence of my friend Milton Friedman who thinks that one could deprive the monetary authorities, in order to prevent the abuse of their powers for political purposes, of all discretionary powers by prescribing the amount of money they may and should add to circulation in any one year. It seems to me that he regards this as practicable because he has become used for statistical purposes to draw a sharp distinction between what is to be regarded as money and what is not. This distinction does not exist in the real world. I believe that, to ensure the convertibility of all kinds of near-money into real money, which is necessary if we are to avoid severe liquidity crises or panics, the monetary authorities must be given some discretion. But I agree with Friedman that we will have to try and get back to a more or less automatic system for regulating the quantity of money in ordinary times. The necessity of “suspending” Sir Robert Peel’s Bank Act of 1844 three times within 25 years after it was passed ought to have taught us this once and for all.

A polite, but stern, rebuke to Friedman. Friedman, not well disposed to being rebuked, even by his elders and betters, wrote back an outraged response to Hayek accusing him of condoning the discretionary behavior of central bankers, as if unaware that Hayek had already explained 15 years earlier in chapter 21 of The Constitution of Liberty why central bank discretion was not a violation of the rule of law.

Somehow or other, Professor Taylor must have come across Friedman’s letter to Hayek, and thought that it would be edifying to mention it in his Hayek Prize lecture. Bad idea!

The following is my rough transcription of Taylor’s remarks, starting at about 33:50 of the Manhattan Institute video, just after Taylor quoted from Keynes’s letter to Hayek about The Road to Serfdom and Friedman’s comment about the letter that Keynes had obviously not read the chapter of The Road to Serfdom entitled “Why the Worst Get on Top.”

Now there’s always pressure for even the best-intentioned people to move away from the principles of economic freedom. And just to show you how this can happen, Hayek, himself, deviated, at least in his writings. There’s a book he wrote called Full Employment at Any Price [no intonation indicating the question market in the title], written in the middle of the 1970s mess of high inflation, rising unemployment. So people, you know, just really said, we gotta get – he wanted, of course, to get back to the rule of law and rules-based policy, but what about – well, we gotta do something else in the meantime. Well, once again, Milton Friedman, his compatriot in his cause — and it’s good to have compatriots by the way, very good to have friends in his cause. He wrote in another letter to Hayek – Hoover Archives – “I hate to see you come out, as you do here, for what I believe to be one of the most fundamental violations of the rule of law that we have, namely, discretionary activities of central bankers.”

So, hopefully, that was enough to get everybody back on track. Actually, this episode – I certainly, obviously, don’t mean to suggest, as some people might, that Hayek changed his message, which, of course, he was consistent on everywhere else.

Well, this is embarrassing. Obviously not well-versed in Hayek’s writings, Taylor mistakes the Institute of Economic Affairs, Occasional Paper 45, Full Employment at any Price? for a book, while also overlooking the question mark in the title. That would be bad enough, but Taylor apparently infers that the title (without the question mark) represented Hayek’s position in the pamphlet, i.e., that Hayek was arguing that the chief goal of policy in the 1970s ought to be full employment, in other words, exactly the opposite of the position for which Hayek was arguing in the pamphlet that Taylor was misidentifying and in everything else Hayek ever wrote about inflation and unemployment policy. Hayek was trying to explain that the single-minded pursuit of full employment by monetary policy-makers, regardless of the consequences, would be self-defeating and self-destructive. But, ignorant of Hayek’s writings, Taylor could not figure out from reading Friedman’s letter that all Friedman was responding to was Hayek’s devastating criticism of Friedman’s 3-percent rule, a rule that Taylor, for some inexplicable reason, still seems to find attractive, even though just about everyone else realized long ago that it was at best unworkable, and, in the unfortunate event that it could be made to work, would be disastrous. As a result, Taylor thoughtlessly decided to show that even the great Hayek wasn’t totally consistent and needed the guidance of (the presumably even greater) Milton Friedman to keep him on the straight and narrow. And this from the winner of the Hayek Prize in his Hayek Prize Lecture, no less.

Just by way of sequel, here is how well Hayek learned from Friedman to stay on the straight and narrow. In Denationalization of Money, published in 1976 and a revised edition in 1978, Hayek again commented (p. 81) on the Friedman 3-percent rule.

As regards Professor Friedman’s proposal of a legal limit on the rate at which a monopolistic issuer of money was to be allowed to increase the quantity in circulation, I can only say that I would not like to see what would happen if it ever became known that the amount of cash in circulation was approaching the upper limit and that therefore a need for increased liquidity could not be met.

And then in a footnote, Hayek added the following:

To such a situation the classic account of Walter Bagehot . . . would apply: “In a sensitive state of the English money market the near approach to the legal limit of reserve would be a sure incentive to panic; if one-third were fixed by law, the moment the banks were close to one-third, alarm would begin and would run like magic.

So much for Friedman getting Hayek back on track. The idea!

John Taylor Misunderstands Hayek

Published June 1, 2012 Hayek , monetary policy 17 Comments

In an op-ed piece in today’s Wall Street Journal, John Taylor, seeking to provide some philosophical heft for his shallow arguments for “rules-based fiscal, monetary, and regulatory policies” and his implausible claim that “unpredictable economic policy . . . is the main cause of persistent high unemployment and our feeble recovery from the recession,” invokes the considerable authority of F. A. Hayek. Taylor’s op-ed, based on his Hayek Prize Lecture to the Manhattan Institute on the occasion of receiving the Institute’s Hayek Prize for his new book First Principles: Five Keys to Restoring America’s Prosperity, shows little sign of careful reading of or serious thought about what Hayek had to say on the subject of rules.

Perhaps I shouldn’t take it too personally, but I can’t help but observe that just about six months ago, I wrote a post entitled “John Taylor’s Obsession with Rules” in which I quoted liberally from Hayek’s writings on monetary policy, especially from Hayek’s Constitution of Liberty. My earlier post was prompted by a critique of NGDP targeting that Taylor posted on his blog in which he compared NGDP targeting unfavorably with Milton Friedman’s 3-per cent rule for growth in the money supply. Taylor criticized NGDP targeting, because, unlike the Friedman rule, it allowed the Fed to exercise discretion in achieving its target, evidently not grasping the obvious fact that the Fed has no more control over M2 than it does over NGDP.

I cited Hayek’s views about monetary policy to make two basic points: 1) inasmuch as monetary authorities exercise no coercive power over individuals, the liberal principle that government action be undertaken only in strict conformity with known rules of general applicability does not apply to central banks, and 2) the nature of monetary policy unavoidably requires a central bank to employ some discretion in discharging its duties. Thus, the strict Friedmanian 3-percent rule, considered by Taylor to be the epitome of rules-based monetary policy, had no basis either in Hayek’s understanding of liberalism or in his understanding of the requirements of monetary policy. Indeed, Hayek on a number of occasions explicitly repudiated the 3-percent rule. After quoting several passages from Hayek explaining these points, I concluded with the following advice: “Professor Taylor, forget Friedman, and study Hayek.”

Well, I’m not sure what to make of Taylor’s invocation of Hayek in his op-ed. I guess if you are awarded the Hayek Prize, it’s only fitting to say something nice about the old sage, and at least feign some interest in what he had to say. But if Taylor did made a substantial investment in studying what Hayek wrote about following rules in the conduct of monetary policy, I see no evidence of it in his op-ed.

Let’s compare what Taylor with what Hayek said. Here’s Taylor:

Hayek argued that the case for rules-based policy goes beyond economics and should appeal to all those concerned about assaults on freedom. He wrote in his classic 1944 book, “The Road to Serfdom,” that “nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles known as the Rule of Law.”

Hayek added, “Stripped of all technicalities, this means that government in all its actions is bound by rules fixed and announced beforehand—rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one’s individual affairs on the basis of this knowledge.”

Now Hayek (from Chapter 21 of The Constitution of Liberty):

[T]he case against discretion in monetary policy is not quite the same as that against discretion in the use of the coercive powers of government. Even if the control of money is in the hands of a monopoly, its exercise does not necessarily involve coercion of private individuals. The argument against discretion in monetary policy rests on the view that monetary policy and its effects should be as predictable as possible. The validity of the argument depends, therefore, on whether we can devise an automatic mechanism which will make the effective supply of money change in a more predictable and less disturbing manner than will any discretionary measures likely to be adopted. The answer is not certain. (p. 334)

Taylor also mentions the point that a rules-based monetary policy enhances the predictability of monetary policy, which presumably results in increased predictability of the economic environment in which economic agents make their decisions.

Rules for monetary policy do not mean that the central bank does not change the instruments of policy (interest rates or the money supply) in response to events, or provide loans in the case of a bank run. Rather they mean that they take such actions in a predictable manner.

But in Chapter 21 of the CoL, Hayek went on to explain why a central bank could not effectively conduct policy by mechanically applying rules in a fully predictable fashion. (This conclusion might have to be revised if the monetary regime had a mechanism for targeting the expectations, but that possibility raises too many complicated issues to pursue here.) Back to Hayek:

There is one basic dilemma, which all central banks face, which makes it inevitable that their policy must involve much discretion. A central bank can exercise only an indirect and therefore limited control over all the circulating media. Its power is based chiefly on the threat of not supplying cash when it is needed. Yet at the same time it is considered to be its duty never to refuse to supply this case at a price when needed. It is this problem, rather than the general effects of policy on prices or the value of money, that necessarily preoccupies the central banker in his day-to-day actions. It is a task which makes it necessary for the central bank constantly to forestall or counteract development in the realm of credit, for which no simple rules can provide sufficient guidance.

The same is nearly as true of the measures intended to affect prices and employment. They must be directed more at forestalling changes before they occur than at correcting them after they have occurred. If a central bank always waited until rule or mechanism forced it to take action, the resulting fluctuations would be much greater than they need be. . . .

[U]nder present conditions we have little choice but to limit monetary policy by prescribing its goals rather than its specific actions. The concrete issue today is whether it ought to keep stable some level of employment or some level of prices. Reasonably interpreted and with due allowance made for the inevitability of minor fluctuations around a given level, these two aims are not necessarily in conflict, provided that the requirements for monetary stability are given first place and the rest of economic policy is adapted to them. A conflict arises, however, if “full employment” is made the chief objective and this is interpreted, as it sometimes is, as that maximum of employment which can be produced by monetary means in the short run. That way lies progressive inflation. (pp. 336-37)

So my advice of six months ago, “Professor Taylor, forget Friedman, and study Hayek” is still good advice. I hope, but am not confident, that Professor Taylor will follow it.

Hayek on How Attempts to “Correct” the Market Lead to its Destruction

Published May 22, 2012 Hayek 21 Comments

In my post yesterday, I partially exonerated Henry Farrell for defending Tony Judt’s over-the-top statement that F. A. Hayek was explicit that:

if you begin with welfare policies of any sort — directing individuals, taxing for social ends, engineering the outcomes of market relationships — you will end up with Hitler.

This seems over the top, because we know that Hayek, unlike many more extreme libertarians — Hayek was not really a libertarian – of either Austrian or Continue reading ‘Hayek on How Attempts to “Correct” the Market Lead to its Destruction’

Was Hayek a (Welfare) Statist?

Published May 21, 2012 Hayek , Uncategorized 14 Comments

There’s been a little flurry in the blogosphere of late about what F. A. Hayek thought about the welfare state, apparently touched off by a remark made by the late Tony Judt in a newly published book, the result of a collaboration between the late Tony Judt and Timothy Snyder Thinking the Twentieth Century. Judt makes the following charge.

Hayek is quite explicit on this count: if you begin with welfare policies of any sort — directing individuals, taxing for social ends, engineering the outcomes of market relationships — you will end up with Hitler.

Tyler Cowen, in a generally favorable and admiring take on the book and Judt’s writings, observed that Judt was being unfair to Hayek.

Then, Henry Farrell weighed in on Judt’s side and cited the discussion between Andrew Farrant and Edward McPhail who contend that Hayek wrongly held that any form of welfare statism would lead to totalitarianism while Caldwell denied that this was Hayek’s argument in The Road to Serfdom, maintaining that Hayek’s subsequent criticism of the welfare state was more subtle and less categorical than the argument of The Road to Serfdom against full scale planning. Farrell criticizes Cowen and Caldwell for defending Hayek, even while acknowledging a bit of sloppiness on Judt’s part in not making clear that Hayek did distinguish between the provision of some forms of social insurance from welfare-state policies. To support his case against Hayek, Farrell quotes from Hayek’s introduction to the 1956 American edition of The Road to Serfdom in which Hayek cited the experience of England under the post-war Labour government in warning that the statist policies of the Labour government would cause an adverse change in public attitudes that would eventually erode even the English pubic’s attachment to liberal principles.

However, even if Hayek qualifies his claims in the first paragraph quoted, he’s changed his tune towards the end. He very explicitly claims that the paternalist welfare state is creating the conditions under which (unless the policy is changed or reversed) totalitarianism will blossom, reducing the populace (as described in the bit of Tocqueville that Hayek quotes) into a “flock of timid and industrial animals, of which government is the shepherd,” which will surely sooner or later come under the control of “any group of ruffians.” More tersely: Welfare Statism=Inevitable Long Term Moral Decline=Hilter! ! ! !

Hayek surely had his moments of brilliant insight, but this wasn’t one of them – for all his protestations of anti-conservatism it’s a fundamentally conservative, and rather idiotic claim. I don’t think that Judt was being unfair at all.

Responding to Judt’s attack on Hayek as reinforced by Farrell, Kevin Vallier tried to shift the conversation toward an understanding of what Hayek actually thought about the welfare state, offering a conceptual distinction — of whose relevance I am somewhat skeptical — between a welfare state of law and a welfare state of administration, the former referring to a welfare state in which benefits are administered in a uniform fashion according to legally prescribed rules and a welfare state in which the benefits are distributed by officials at their own discretion.

In reply, Farrell dismisses the point that Hayek was not opposed to the provision of a safety net and various forms of social insurance. Farrell regards this as an irrelevant detail.

This is, in fact, agreed to by all parties – hence my suggestion in the original post that “Hayek clearly believes that there are non-statist, non-paternalist ways of achieving some (if not all) of the same ends.” But the reason why Hayek sees this as allowable, as Vallier acknowledges in his own defense of Hayek, is that it is not statist – it involves coercion, but does not have the statist logic that Hayek views as pernicious.

Now if you find this a bit confusing, I can’t blame you, because it is. But the confusion is not all Farrell’s. It is also Hayek’s. He did try to get more mileage out of his argument in The Road to Serfdom than it could sustain, and to do so he had to resort to sociological intuition, hand-waving and rhetoric, in contrast to the comparatively rigorous argument of The Road to Serfdom. Nevertheless, the avowedly socialist postwar Labour government nationalized many industries, and tried to implement central planning, so Hayek’s concerns about the consequences of the Labour government must be considered in a wider context than just expansion of the welfare state.

What was unfair about Tony Judt’s comment was a failure to distinguish between the different levels of the argument that Hayek was making. The arguments may have been related, but they were not the same. The argument of The Road to Serfdom was an argument about the logical implications of central planning. The argument about the welfare state was an argument about a slippery slope. Those are very different arguments, and not to acknowledge the difference is unfair, even (or, perhaps, especially) if Hayek’s argument about the welfare state was less than compelling.

HT: David Levey

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner

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