Keynes v Hayek Round Two

This hub is going to be a little different than my other hubs. This is going to be an analysis/commentary of one of my favorite videos about economics. It features the ideas attributed to John Maynard Keynes (an interventionist) and F.A. Hayek (a non-interventionist). I hope that this hub will both be entertaining and informative. Let's go!

KEYNES:

Here we are. Peace out, Great Recession!
Thanks to me – as you see – we’re not in a depression.
Recovery. Destiny. If you follow my lesson.
Lord Keynes! Here I come! Line up for the procession!

Keynes (I do not literally mean John Maynard Keynes, just the character named Keynes in the video; the same rule applies when I am talking about Hayek) has a point. We are not in a depression. The National Bureau of Economic Research reported that “the Great Recession” ended back in 2009. However, this statement should be taken with a grain of salt and does a disservice to people as it tends to distract from the very real problems that Americans—and the world—are still facing.

HAYEK:

We brought out the shovels and we’re still in a ditch.
And still digging. Don’t you think it’s time for a switch
from that hair of the dog? Friend the party is over,
the long run is here, it’s time to get sober.

As mentioned earlier, it is true that we are not in a depression, but it is also true that we have not quite made the recovery that many of us had hoped for. We still have high unemployment that has been above nine percent since May of 2009. It came down a little bit in February and March of 20011 but then rose above nine percent and has remained there until recently. The Bureau of Labor statistics reports that November’s statistics report an 8.6% unemployment rate. However, this may be due in part to less people looking for work. In other words, more people are dropping out of the labor force and these people are not included in the national unemployment rate.

Hayek has a very valid point. We are seeing some growth, but we need to face reality. We still have a lot of work to do. The economy is still in turmoil, millions are still unemployed, and there is still the threat of a double-dip recession. Indeed “the long run is here” and “it’s time to get sober”.

KEYNES:

Are you kidding? My cure works perfectly fine.
Have a look, the Great Recession ended back in ’09.
I deserve credit. Things would have been worse.
All the estimates prove it. I’ll quote chapter and verse.

Actually, that is not quite true. Look here, here, and here to see why. Deficit spending only takes money from the private sector and crowds out investment. Keynesianism’s greatest flaw is that it is built on an economic fallacy called the Broken Window Fallacy.

HAYEK:

Econometricians, they’re ever so pious.
Are they doing real science or confirming their bias?
Their Keynesian models are tidy and neat.
But that top down approach is a fatal conceit.

Hayek is informed by his perspective called Austrian Economics. One of the main features of this school of economic thought that separates it from all other schools is its reliance on deduction, rather than induction. It is often criticized for not being based in empirical evidence, but the Austrians rightly counter that although data and mathematical models can be useful when kept in the proper context, they cannot give us an accurate picture of the economy and its inner processes. Because the economy is the sum of the human action of many individuals who are acting out of their own motivations and for their own individual reasons and purposes, it is impossible to treat economics as if it were a physical science because there are too many variables to take into account. This makes it impossible to isolate and control for variables like scientists can in fields like chemistry, physics, or biology. For the Austrian, treating economics in that way is a huge mistake.

KEYNES:

We could have done better had only spent more.
Too bad that only happens when there’s a world war.
You can carp all you want about stats and regressions.
Do you deny that world war two cut short the Depression?

Keynes could not have been more wrong on this point. War does not help the economy. All it does is divert resources from one part of the economy and allocates it into things like bullets, guns, tanks, bombs, and other things that will likely be destroyed. It is a terrible waste.

HAYEK:

Wow. One data point and you’re jumping for joy.
The last time I checked wars only destroy.
There was no multiplier. Consumption just shrank
as we used scarce resources for every new tank.
Pretty perverse to call that prosperity.
Ration meat. Ration butter. A life of austerity.
When that war spending ended, your friends cried disaster.
Yet, the economy thrived and grew faster.

After the Second World War, Keynesians were worried about the decreased spending that would come after the end of the war. Things had not gotten better. Even worse, people were living in austerity as Hayek correctly pointed out. Things did not get better until sometime after the war when spending finally decreased and resources were shifted back into the private sector. The Keynesians were just wrong about war spending, post-war spending, and economic growth.

KEYNES:

You too only see what you want to see.
The spending on war clearly goosed GDP.
Unemployment was over, almost down to zero.
That’s why I’m the master. That’s why I’m the hero.

Let’s just see what Hayek has to say about this.

HAYEK:

Creating employment is a straight forward craft
when the nation’s at war and there’s a draft.
If every worker were staffed in the army and fleet
we’d have full employment and nothing to eat.

GDP, or Gross Domestic Product (Y), is the sum of consumption (C), investment (I), government expenditures (G), and net exports (X). Put simply, C+I+G+X=Y. Just looking at GDP is an example of taking the data out of context can be misleading. G was a huge part of the reason why there was a boost to GDP. At the same time this was going on, there was a tremendous work effort to produce for the war. Women and men who were not fighting in the war were working to produce while the rest of the male population was fighting in the war. This resulted in huge austerity measures. As Hayek pointed out, if everyone able to work was working in military or producing for the military, we would indeed have full employment at the cost of not being able to produce enough of the stuff that people need.

HAYEK:

Jobs are a means, not the ends in themselves.
People work to live better, to put food on the shelves.
Real growth means production of what people demand.
That’s entrepreneurship, not your central plan.

Short-sighted efforts to treating the symptoms of economic problems while only focusing on means, like jobs, come with a heavy price. Rent control and minimum wage laws are great examples. Putting a cap on rent prices leads to shortages of rental units and a minimum wage leads to greater unemployment as employers cannot afford to pay for low skilled/inexperienced workers at the minimum wage. Messing with prices is one of the main sources for most of our problems. Prices serve as vital information that tells us where resources ought to be allocated. If prices are not determined by market forces, we end up with more misallocation of resources than we would have otherwise. Instead, we should not be so concerned with jobs per se as we should be concerned with how to achieve our ends. That means entrepreneurship, not central planning!

KEYNES:

My solution is simple and easy to handle.
It’s spending that matters. Why’s that such a scandal?
Money sloshes through the pipes and the sluices.
Revitalizing the economy’s juices.
It’s just like an engine that’s stalled and gone dark.
To bring it to life we need a quick spark.
Spending’s the life blood that gets the flow going.
Where it goes, doesn’t matter. Just get spending flowing!

There is one problem, Keynes. The economy is not like an engine. It is much more complex than that.

HAYEK:

You see slack in some sectors as a general glut.
But some sectors are healthy only some are in a rut.
So spending’s not free, that’s the heart of the matter.
Too much is wasted as cronies get fatter.
The economy’s not a car. There’s no engine to stall.
No expert can fix it. There’s no “it” at all.
The economy is us. We don’t need a mechanic
Put away the wrenches, the economy is organic.

Government spending comes at the price of taking resources from the private sector. It crowds out private investment and Keynes is again committing the Broken Window Fallacy. Even if stimulus spending worked in theory, government typically does a terrible job of implementing that stimulus. Solyndra is a perfect example. For more examples, click here.

KEYNES:

So what would you do to help those unemployed?
This is the question you seem to avoid.
When we’re in a mess, would you have us just wait,
doing nothing until markets equilibrate?

HAYEK:

I don’t wanna do nothing, there’s plenty to do.
The question I ponder is who plans for whom.
Do I plan for myself or leave it to you?
I want plans by the many, not by the few.
Let’s not repeat what created our troubles.
I want real growth not a series of bubbles.
Stop bailing out losers, let prices work.
If we don’t try to steer them they won’t go berserk!

It is not true that free-market economists like Hayek, Mises, or Friedman said that we should do nothing. The real question is, as Hayek put it, “who plans for whom”? Do individuals decide what is best for them and their families, or does the State?

KEYNES:

Come on are you kidding? Don’t Wall Street gyrations
challenge your world view of self-regulation?
Even you must admit that lesson we’ve learned
is more oversight is needed or else we’ll get burned.

This is a common fallacious argument. Hayek tells us why.

HAYEK:

Oversight? The government’s long been in bed
with those Wall Street execs and the firms that they’ve bled.
Capitalism is about profit and loss.
You bail out the losers there is no end to the cost.
The lesson I’ve learned is how little we know.
The world is complex, not some circular flow.
The economy is not a class you master in college,
to think otherwise is the pretense of knowledge.

Central planners are in no position to know the appropriate prices for goods and services and they typically create moral hazards by bailing out losers. This is in large part what led to the mess that we are in. Click here for more information on how central planning led us to this point. Click here to read Hayek’s famous essay, “The Use of Knowledge in Society”. Indeed, it is a mistake to think that one is smart enough to know what price milk and butter should be, what resources should go where, who is a winner and who is a loser. Remember Solyndra?

KEYNES:

You get on your high horse and you are off to the the races.
I look at the world on a case-by-case basis.
When people are suffering I roll up my sleeves
and do what I can to cure our disease.
The future’s uncertain, our outlooks are frail.
That’s why free markets are so prone to fail.
In a volatile world we need more discretion
so state intervention can counter depression.

Your short-term thinking is one of your biggest flaws, Keynes. Spending for the short term only leaves us with debt and inflation. We might get a bubble out of it, but that always comes back to bite us in the long-run. I will leave it up to Hayek to wrap this up.

HAYEK:

People aren’t chess men you move on a board
at your whim, their dreams and desires ignored.
With political incentives, discretion’s a joke.
Those dials are twisting; just mirrors and smoke.
We need stable rules and real market prices
so prosperity emerges and cuts short the crisis.
Give us a chance so we can discover
the most valuable ways to serve one another.