Economics For Yesterday and Today: Keynes vs. Hayek
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From the New Deal to Stimulus
John Maynard Keynes (1883-1946) was an economist from the U.K. whose work had a heavy impact during the era of The Great Depression. His economics dealt heavily with spending, i.e., government deficit spending. He viewed the economy as an entity that could be centrally planned during tough economic times. During depressions, governments should engage in deficit spending in order to boost aggregate demand. He believed that consumption is what drives economics, as opposed to production, and that money needed to be pumped into a circular flow in order to bring the economy back to life.
F.A. Hayek (1899-1992) was an Austrian economist who opposed the Keynesian models of economics. He was a free-market, laissez-faire capitalist. He viewed the economy not as an entity but as a number of individuals engaging in production and trade. His perspective teaches that it is production, not consumption, that drives the economy and that government spending, especially deficit spending, just makes things worse.
Keynes referred to “animal spirits” as the driving force behind economic decisions in markets. Animal spirits are irrational, emotional processes, or whims, that replace reason and objective thought and are responsible for economic downturns.
Hayek gives a different explanation. He poses that the Keynesian model just produces a series of booms and busts, or bubbles. These booms begin when the Federal Reserve and the Banks expand credit and/or bring interest rates down to artificially low levels. After a while, interest rates return to market levels and then people realize that they cannot afford all of the credit that they have accrued; production goes down, and there are less and less available resources. A bust soon follows.
When government engages in deficit spending, it only makes matters worse by continuing the same policies that caused the very problem in the first place. Loss is just as important, or even more important, than profit in a capitalist economy. If too-big-to-fail banks and companies are bailed out, the losses won’t be noticed and those banks and big businesses will continue their bad practices. They won’t know what really works and what doesn’t work.
This bailout process creates a moral hazard. Those who need handouts and get bailed out are essentially spared the consequences of their actions. As a result, they are likely to not learn and repeat the same mistakes. They will end up coming back for more handouts.
In the end, all we get is a series of bubbles that always burst.
Keynes believed in government action, i.e., spending and regulation, during times of financial crises. It is often misunderstood that Hayek and others of the Austrian School of Economics believed in doing nothing. This is a fallacy. They believed that governments had a lot to do in order to help remedy economic illness.
First, the government needs to de-regulate business. Regulation kills innovation and growth. It is also very expensive. Regulations such as the minimum wage contribute to unemployment because it does not allow businesses to higher as many unskilled workers as they would be able to without having to pay wages above market levels.
They also believed that government needed to lighten the tax burden which made it so that businesses couldn’t produce as much because they had less money to do so. Families also needed the extra money from having their taxes cut so that they could use that money as they saw fit.
Many people were attracted to Keynes’ ideas, much more than they were attracted to Hayek’s Austrian perspective, and his theory is exactly what was put into practice during the great depression via legislation like the New Deal.
It was not until some years after WWII (after Keynes’ death in 1946) that people began to reject Keynes and listen to Hayek. Milton Friedman (1912-2006) was an American, free-market economist who said that if Keynes were to ever see how far the U.S. took his ideas of deficit spending, he would be horrified. Indeed, he would be.
Again, we are seeing Keynesianism all around us. Bush had to “abandon” his “free-market principles” in order to “save the free-market”. Obama carried it even further with his record breaking deficits. During the Great Depression, they had the New Deal and, today, we have TARP and “stimulus”. When will the madness end?
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Thank you,Sir! I hope the GOP can nominate someone good.
When will the madness end? With this crowd, probably when we are hurting really bad. Even the Soviet Marxists revised a semi-market approach from time to time when economic times got desperate. Good overview of the rivalry.
Thank you, Bibowen. I appreciate it.
One of the things that many people don't seem to understand about Keynes is that he pretty much always violated convention, altering his recommendations from one problem to the next. Unlike other economists who contend that theirs is a better system, Keynes is better portrayed as believing the best thing to do is whatever is needed at the time, rather than deficit spending is good. Otherwise, one must discount that Keynes advocated paying off debt as economic growth manifested.
When Hayek wrote "The Road to Serfdom," Keynes wrote to him saying that "Morally and philosophically I find myself in agreement with virtually the whole of it: and not only in agreement with it, but in deeply moved agreement." He did add, however, "What we need therefore, in my opinion, is not a change in our economic programmes, which would only lead in practice to disillusion with the results of your philosophy; but perhaps even the contrary, namely, an enlargement of them. Your greatest danger is the probable practical failure of the application of your philosophy in the United States."
One of your statements about Hayek seems almost an oxymoron to me: "They believed that governments had a lot to do in order to help remedy economic illness . . . First, the government needs to de-regulate business. Regulation kills innovation and growth. It is also very expensive."
That seems to me to be saying that what more the government can do is do less. Though I, too, believe the government oversteps its bounds, I have pondered how the libertarian economic system would benefit society.
Let's say the government stopped regulating automobile safety so manufacturers could save some money that can be passed on to consumers as lower prices. Will you be satisfied that you may have a civil suit if your family is killed in, or by, an vehicle that you, or someone else, saved a few bucks on because they used substandard materials? If the manufacturers lose, will the cost of paying off the lawsuit be passed on to consumers thereby not saving them money anyway over the government regulating the standards of materials that can be used in manufacturing automobiles?
Will we do away with building inspectors, and wouldn't that just result in the need for them? Doesn't it seem a bit unfair that someone to whom you gave your money in a preventable swindle would have your money to defend an action against you, while you wouldn't have the money to bring an action?
There are no perfect economic systems. All grind to a halt as a result of friction and gravity. Any philosophy that ends in utopia requires people to change from living on a conscious level to living on a conscience level, which defies human nature.
Keynes predicted WWII based on the settlement of WWI. Keynes contended the problem with coming out of the depression was that the economy was in perfect balance: there was no demand, and there was no supply to meet it. Keynes did not stand on what he said about resolving one problem to resolve all other problems. Keynes also recognized the benefit of an able working class without conceding that intelligentsia is a superior class.
An economy in which all can consume is better than one in which a few amass great wealth until the masses kill them and seize their wealth.
All that said, I admire your work. My comment is not a challenge to your Hub, but, rather, just something to think about. I am rating your Hub "up," and look forward to reading more Hubs you write!
Thank you, Tom. Your comment was much appreciated and your points are well taken. Let me first begin by stating that my hub was not a all encompassing comprehensive analyses on Keynes himself, but rather a brief overview of certain views that he expressed at one time or another that government uses in order to justify certain measures such as stimulus.
It is true that Keynes believed in handling problems on a case by case basis. He did believe in free markets, to an extent, and would most likely not approve of the United States' current spending habits.
Let me answer your questions with another. What makes you think that the government can protect consumers better than a free market economy? I am not saying that government has no role, according to libertarian and Austrian economic theory, government is to protect the consumers from force and fraud. If any company were to knowingly mislead someone into taking an unreasonable risk with their products, they would be guilty of fraud and must pay a price.
That is an absolutely desirable element of a free market. Rule of Law is the very most basic principle of free market economics. There would be no free market without rule of law.
In answer to my own question from earlier: every business has an interest in protecting its reputation and satisfying its customers. It must do so in order to survive. If it performs this necessary obligation poorly, it goes out of business.
Let's use OSHA as an example. OSHA was formed in 1971 in order to protect workers and improve their working conditions. Why? Because some thought that it was necessary for government to step in and regulate on behalf of the workers and in the name of their well-being and safety. They thought that without it, things would be worse.
What they failed to recognize that the rate of incidents in the workplace was already on the decline years before OSHA, and after OSHA the slope of the line remained the same. In other words, the free market was already making things better and OSHA didn't make one bit of difference.
The free market always has an incentive to satisfy the demands of consumers and to attract workers. The argument that we need a government to do these things is untrue. Government only makes things worse.
Concerning your automobile example: I am having a hard time understanding exactly what you are asking because it doesn't make much sense but I will attempt to answer it.
Let me begin by stating that even without government regulation, automobile manufacturers would still make safe cars. In fact, I contend that they would be safer. Why? Because that is what consumers want (For the sake of argument, let's assume that they do) and businesses have an obligation to themselves to deliver the goods or go out of business. They would do it better because they have an even greater interest in making their cars safe than some government official. If a government official fails, he might get fired. If a business fails, it may very well go out of existence.
So passing on the responsibility for ensuring safety to an outside entity that does not suffer the consequences, like government, doesn't make us safer. As long as the manufacturers play by all the rules, they are covered. Sure they may look bad and lose money anyway, but meeting regulatory standards is a kind of moral hazard for consumer safety. If government is their to soften the blow, then there is less incentive to meet safety standards that are higher than those of the government.
Now let's imagine that there is no government regulation over the automobile industry. If someone is purchasing a car, no matter what, they are purchasing it at a risk. No amount of government regulation takes away all risk. They know, or should know, that some cars are safer than others. Those safer cars are often more expensive. If a consumer wishes to be safer, he must pay a higher cost. That is just a fact of reality because safer cars have higher manufacturing costs.
If someone were to be injured as a result of a company manufacturing a cheaper (less safe) car, he may sue the company if he can prove that he was mislead into believing that the car was safer than it actually was. Fraud is not okay in a free market and if the company is guilty of fraud, it must pay the price.
Rule of Law protecting citizenry against fraud is a very desirable feature of a free market.
As for me, if I choose to buy a car, I take safety into consideration. If I want a safer car, I must be willing to pay the cost.If not, I accept the risk that I am taking.
As for passing the costs onto consumers: what do you think regulations do? They make cars much more expensive, thereby causing people to drive their cars longer. Since the regulations, the average age of automobiles on the road has gone up. Older cars are less safe. Another failure by government.
If a company were to pay heavy costs due to lawsuits and pass them on to the consumers, it hurts their business and endangers their existence. You just gave a perfect example of an incentive for avoiding law suits due to manufacturing less safe vehicles. In other words, if they make less safe cars, they risk losing business.
The same principles apply to your question about building inspectors.
A capitalist economy is driven by production, not consumption. That is one of the biggest Keynesian fallacies of all. Production must precede consumption. Without production, there is no consumption.
For further information, I encourage you to read my other hubs: namely, "Selfishness is Moral", "What is the Philosophy of Objectivism?", "Why I am a Libertarian: Brief Treatise about My Politics", and "Socialism v. Capitalism Part I: the Moral Argument".
I have read "Why I am a Libertarian." I will read the others soon.
Chevrolet produced the Corvair. Despite knowing it was unsafe, they sold them anyway as a low-cost alternative to the VW. Ford sold the Pinto as a low-cost alternative to imports. Both were unsafe, and the manufacturers knew it. They did not notify buyers of known defects because to do so would send sales to foriegn competitors with superior products.
It's one thing to say business will regulate itself, but money (greed) motives have often prevailed over self-regulation. Consumers often are swayed by price over safety.
I had a discussion elsewhere about supply creating demand. It works in some cases, but is not all-encompassing. In the case of the Great Depression, it was the creation of artificial demand that motivated companies to create supply. Even though the demand was artificially created, the employment was real as was the supply. This fostered additional real demand from people who were really employed, which brought about additional real supply - and so forth.
In another example, someone once bought a supply of coon skin caps because of the resurgent popularity of Daniel Boone. Unfortunately for him, there was no demand. Supply does not always create demand.
In other cases, supply does create demand. M&Ms are successful because they sell you a supply, whereas they would likely not be successful if they tried to sell them individually. People will buy three cans of corn for the price of two because they think they will eventually need the third can. They likely would not buy three cars for the price of two because three would be excessive.
So, we do away with copyrights, anti-trust, and intellectual property rights, and this evens the ground between the rich and poor how? Some poor inventor had to sue Ford for stealing his design of intermittent wipers. Some poor people had to sue Standard Oil for selling at a loss for the sole purpose of driving them out of business. The free market has its flaws that work out to the favor of those who have money at the expense of people who have ideas but little money.
I had another discussion with the same person who told me that America was able to avoid the revolutions Europe could not in the 19th century. Of course, he conveniently did not acknowledge the expansion of the country on the backs of Native Americans, nor the slave labor of black and Asian people. We have no more land to steal. We are no longer immune from international economic turmoil.
The only reason people can argue the benefits of a totally free market is that it has not been tried, and, therefore, its failures have not been exposed. I believe that is what Keynes added in his letter to Hayek.
Just as Keynes is misunderstood by many, so is Karl Marx. Certainly he wrote about a fairytale economy in which all people were equal that, in practice, produced anything but equality. However, that fairytale aside, Marx's brilliance was in his prediction that events were about to occur. Those events unfolded almost flawlessly.
Hayek places his faith in the market. Keynes went beyond economy, and placed human welfare as a necessary ingredient in economic theory.
Even Robert Nozick seemed to have acknowledged that his political writings on economic justice discounted that there may be other factors which justify economic injustice. I believe he may have been talking about preventing revolution. Too bad for Marie Antoinette that she did not get to read Marx or Nozick.
I do not know about the other manufacturers, but I do know that the Chevy Courvair was reviewed some time after Ralph Nadar's "unsafe at any speed". After further review, a government body found that the Courvair "compared favorably with the other contemporary vehicles used in the test."
(http://www.youtube.com/watch?v=PNeDbuvSnkw)
Like I said before, production must precede consumption. What decides what to produce and how much? What the producers think will turn out the greatest profit.
If those things you said were true of the Depression, how was unemployment so high for the entire decade of the 1930's? After all, it was the New Deal that extended the Depression by about ten years.
(http://www.youtube.com/watch?v=AQQon4tjlSA)
To answer your question, we totally do away with anti-trust laws, they are highly vague and are an assault on individual rights. Keep copyrights and intellectual property rights (to an extent; that is a policy that I have not thought of very thoroughly and is very complicated).
If it is true that Ford "stole" designs (I should make it clear that someone coming up with an idea before someone else and beating them to the patent is hardly "stealing" if that is indeed the case) that is a violation of rights. Theft is force and is not allowed in a free-market economy. So it is absolutely desirable to have a court system to maintain rule of law. Why must I keep repeating that?
As far as selling at a loss to beat out competition, there is nothing wrong with that. The only cases that any one coercive "monopoly" was able to corner the market were those that received special government help and privilege. By the way, Standard Oil drove oil prices down exceedingly.
As far as Colonialism and Slavery are concerned, let me just say that it was the Capitalist North that defeated the Feudal South (the South was Feudal, not Capitalist) and freed the slaves. It was government that instituted slavery, it was government that allowed the continuation of that practice, it was government that drove out Native Americans--not Capitalism. Capitalism is based on individual rights. Racism is a form of collectivism and a horrible violation of individual rights.
(http://www.youtube.com/watch?v=4xeebU8VhmY&feature
Karl Marx, although insightful, was a mad-man. He was a product of Immanuel Kant, the true villain. The man who sought out to destroy man's mind. He was the precursor to Karl Marx, to the Bolshevik revolution, to Red China, Cuba, Cambodia, etc. The greatest assault on man's mind began with Immanuel Kant and is continued today by modern intellectuals.
Economic Justice? Justice by what standard? The standard of life or of death?
I will repeat something that I wrote to someone else: "The ideals of socialism are utterly and completely evil. I would take freedom over equality any day of the week. If a nation seeks equality before freedom it will ultimately end up with neither. A nation that seeks freedom before equality will end up with a great measure of both. (paraphrased from Milton Friedman) Why? A nation that seeks equality before freedom quickly resorts to force and tyranny."
Social Justice (or economic justice) leads to inequality and slavery.
Another note for above: Demand and consumption are not the same thing. Both demand and consumption are caused by production and may subsequently become determinants of future production.
Not necessarily in order:
Here is a wikipedia profile about Robert Kearns, the inventor of intermittent wipers. http://en.wikipedia.org/wiki/Robert_Kearns
I'll leave the study of the Corvair out. You are correct that it was a government study that concluded it was as safe as other similar models, which contradicted both Nader's and the General Manager of GM's claims that it was unsafe. To that end, it was the market and not the government that forced the changes in design.
As for unemployment during the Great Depression, there was some relief from public works projects. There was still, however, great care placed on keeping the budget somewhat in balance which was complicated because of deflation resulting in lower revenues. By 1936 unemployment had dropped from 25% to 11%. When Roosevelt cut spending and increased taxes to try to balance the budget again, unemployment again spiked. As incomes fell, so did production.
We really don't know how much further it would have gone. WWII happened, and government expenditures far exceeded revenues. Unemployment was virtually eliminated.
Unemployment today is sent out in the form of checks. In those days, the government used unemployed people to do public works. Both form a quasi-safety net, and create some demand that would not exist without it. The alternative is that we would not provide any safety net. Do you think people will quit eating just because they have no money? How do you think they will get food?
I have to get ready for work. I've enjoyed our conversation. Peace be with you!
Thank you, Sir!
It was a long day, which will work out well come payday!
My point was that government works programs did cut unemployment. There were other factors that kept the depression going. The two biggest factors were the dustbowl and deflation.
We have seen some examples of deflation recently. Many people will claim they are adjustments, but either way it wiped out many people's ability to retire according to their plans a decade ago.
You asked about economic justice. Robert Nozick wrote about it using the Wilt Chamberlain example. He hypothesized that even if all money were divided equally among all people, that people would pay to have Wilt Chamberlain entertain them. It is, therefore, just that Wilt would have more money than other people. It would be unjust to tax him more to give some of his earned money back to the people he entertained. To do so would, in essence, make him a slave.
It was a brilliant argument because it put redistributionists into a position that they would have to contend that enslaving him was okay. It was highly regarded by Libertarian economists. He would, years later, write that there may be reasons that would override economic justice, though he never said that it was just to do so. He also never explained what those reasons may be.
The biggest problem I see with any "pure" form of economics is that universal laws start screwing with them. Whether capitalism, communism, or socialism, all eventually grind to a halt. Nonetheless, capitalism provides the greatest incentives, but, in its pure form, it, too, will lead to great chasms between those who have and those who don't have.
Once we bring human natures into it, we have the makings for great disaster.
The purest form of free market we have today are black markets. There are no government regulations, there are no taxes, and we have willing buyers and sellers. The result is disparity in quality of products, and substantial turf wars. This occurs with drugs, among other things, today, and it wasn't that long ago that it happened with alcohol.
Today, with regulation, we have standards for alcohol. We can pretty much be assured that its purity is relative to the proof, and we don't have people going blind or dying from "bathtub gin." We also don't have the turf wars now that the market is not so free as it once was. There were problems with alcohol when the market was free, and there are problems today with alcohol. They are just different problems.
It will be interesting to see how marijuana dispenseries offset the black market.
You have mentioned "rule of law" several times. I agree that fraud would continue to be a crime, but crimes don't result in making the victims whole. Certainly restitution can be part of a conviction, but one cannot collect on restitution. One must seek judgment in a court of equity in order to force collection. The criminal conviction often hampers the collection of damages one can prove in civil court.
Take Bernie Madoff for example. His criminal conviction virtually guarantees that all his victims - even the ones who got all they bargained for by getting out - will suffer losses. It would make little difference in a free market. Certainly regulations did not help his victims, but an absence of regulations may have kept him from being caught, or at least convicted.
Finally for tonight, you said that you might preserve copyright and intellectual property laws. Does that mean there are limitations on how much you are in favor of a free market? Here is a contrary view you might find interesting: http://harmful.cat-v.org/economics/intellectual_pr
Good info for the intellectual property stuff, and I simply disagree with you on free markets. We could go back and forth about it for a long time, so I will just leave it at that.
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Ghost32 Level 8 Commenter 12 months ago
Aha! A guy who gets it!
The madness will end, HOPEFULLY, on Election Day in 2012.
Okay, okay, on Inauguration Day in 2013. So I missed the target by one lousy Lame Duck.
Voted up, useful, awesome.
Remember in November 2012...and welcome to HubPages!