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Hayek, Candies and Keynes

The debate between Friedrich Hayek and John Maynard Keynes over the nature and future of economics, spanned momentous times such as the Great Depression and the age of dictators, and it continues today posthumously in the discussion of how best to nurse back to health a wounded world economy. 

Keynes, the optimist, believed that solutions to unemployment could always be found and it was the government’s duty to implement them. Hayek, the pessimist, was always explaining why government attempts to fix the economy were pointless, as well as fraught with unintended consequences. Keynes was a man of action, not willing to sit quietly and wait for the market to work its magic. He was concerned about the short term pain of unemployment because, as he famously said, “in the long run we are all dead.” Hayek, on the other hand thought that there was no easy way out of a slump and that artificially lowering interest rates or increasing public spending, would eventually lead to inflation. True, in the long run we might all be dead but Hayek had personally witnessed hyperinflation in his native Vienna and that was enough for him. Keynes genuinely believed that his new big picture, top down, economic tools had made traditional remedies for unemployment such as “hard work, endurance, frugality, improved business methods, more cautious banking, and, above all, the avoidance of devices”, redundant. Hayek, on the other hand, thought that the economy as a whole could only be understood by considering the interaction of individuals in the marketplace.

 I don’t wish to minimize the genuine differences between these two giants of economic thought but re-reading some of their debates, I now recognize, as a parent, some adult/child interactions in their dialogue, that I had overlooked years ago. For example, why do parents worry about their children eating too many sweet things while children (and sometimes visiting friends or relatives) defend the practice? Children and relatives are usually just thinking about the one occasion they witness and the minimal harm that will be caused by that extra candy or piece of cake. Parents have a longer time horizon. They know how many sweet things children ate in the past and they have a good idea how many sweet things they are likely to eat in the future. Parents are trying to establish good, healthy eating habits for the long term whereas children want instant gratification now. A child may be correct in arguing that the marginal harm of an extra candy is bordering on zero but the parent is really concerned about the cumulative harm of all the candies the child is likely to eat. It is difficult for parents to be firm in their resolve when faced with crestfallen faces and perhaps an imminent tantrum, just like it is difficult for politicians to do nothing when faced with angry voters demanding that something be done – anything. Yes, I know that the pain of the unemployed cannot be compared with the pain of a child denied a candy. But, the point of the comparison is to demonstrate that it is only the initial pain (whether of unemployment or unfulfilled desire) that can be seen, the future pain from inflation or, from the effects of obesity, cannot be seen, although the harm will be real enough. Children can get away with unhealthy eating for a long time but sooner or later reality catches up with them. Similarly, economies can be badly managed for a long time but sooner or later the piper has to be paid.  Acting like an adult is frequently not fun, and often very difficult, but it is the right thing to do.

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“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” John Maynard Keynes

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About Malcolm Greenhill

Malcolm Greenhill is President of Sterling Futures, a fee-based financial advisory firm, based in San Francisco. I write about wealth related issues in the broadest sense of the word. When I am not writing, reading, working and spending time with family, I try to spend as much time as possible backpacking in the wilderness.

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18 Comments on “Hayek, Candies and Keynes”

  1. Michael Says:

    Nice.

    Reply

  2. Jon Sharp Says:

    Good but, Keynes never advocated structural deficits. It’s very important to point that out because otherwise imho your analogy becomes misunderstood. It sounds like Keynes advocated kids eating lots of candy and getting fat when he does no such thing.

    The point of your analogy (at least the point I think makes perfect sense) is that some governments try to have it both ways. The US, UK, Greece etc all ran structural deficits over the last decade+, cutting taxes and/or doling out gobs of money in the good times (and running up the national debt) and then doing the same in the great recession in the name of Keynes. Some governments chose to use the good times to cut their deficits and increase economic competitiveness (eg. Germany) so that when the downturn hit, they could pump money back into the economy (eg. by paying companies to keep workers on the pay roll) without allowing the debt to get out of control. Germany’s strategy has been very successful and they came out of recession earlier than most (tho’ admittedly wobbling a bit right now due to poor export conditions).

    As I see it, the point of your analogy is that governments often cannot help themselves because candy is addictive. So they like to give loads of money back to the electorate in the good times and shower even more on them in the bad in a crazy game of pass the parcel. They figure they won’t be there when the music finally stops and won’t get left with the parcel of unmanageable debt, soaring interest rates and inflation.

    Simply put, due to the political structure of western democracies it just may be that Keynes is right in theory, but von Hayek is right in practice.

    Reply

    • Malcolm Greenhill Says:

      Jon, thank you for this post. I agree with everything except your statement that Keynes was right in theory and we are certainly not going to settle that one here. One reason is that this was no straightforward exchange of ideas. Hayek understood English but Keynes did not understand German and so was largely ignorant of the works of the Austrian and German economists that Hayek took for granted. Hayek’s spoken English (at least in the early years) was very poor and he gave the impression of being an up-tight and conservative (in manners) Austrian, while Keynes was charismatic, articulate, persuasive and made a point of flaunting his non-conformity. Everyone liked Keynes but only a few liked Hayek. Keynes was concerned with day-to-day practical issues of policy while Hayek was a theoretician who believed that the job of the economist was to explain the longer term unintended consequences of human action. The debate was at times personal, vindictive and unintelligible, even to professional economists.

      I see the parent/child interactions firstly in Keynes’impatience with market processes. He was not willing to give markets the benefit of the doubt and allow them to find their own level. For Hayek, every attempt to lower interest rates and/or increase public spending meant a change in relative prices, sending misleading signals to business owners and contributing to inflation and a future recession. Keynes replied with his famous riposte that “in the long run we are all dead.”

      In addition to this general impatience with markets there was an almost desperate emphasis on short term policy considerations. In 1924 Keynes recommended spending $100 million dollars on public housing, better roads and improving the electricity grid “even though some of the schemes may turn out to be failures which is very likely.” He recommended pulling down the whole of South London from Westminster to Greenwich to create reconstruction jobs. He urged patriotic housewives to “sally out tomorrow early into the streets and go to the wonderful sales…And have the added joy that you are increasing employment, adding to the wealth of the country.”

      Finally, as I mentioned in the blog piece, Keynes’ was convinced that his newly discovered macro-economic tools had made the old fashioned remedies for unemployment, which depended on character, superflous.

      Reply

  3. Jim Finn Says:

    You’re right Malcolm: this blog is overdue. It’s clear from my humble observations that western democracies and their politicians are inherently reactive to the political fallout of economic conditions (despite often strident endeavors to appear proactive), and take whatever measures are necessary to placate the electorate, rather than to consistently nor thoughtfully apply a particular economic ideology to a particular economic condition. For better or worse, the electorate reinforces these behaviors by dispensing with (or threatening to dispense with) those politicians who appear to be less “economically compassionate” (Nicolas Sarkozy, Mark Rutte) – whatever that may entail. Sometimes the Hayekian concepts are effectively “sold” to the electorate and “austerity” measures are implemented, at least for a while, without significant antagonism (allowing interest rates to rise, not printing money, relying on market interactions to eventually lead to greater prosperity – you know this better than I), while at plenty of other times Keynesian measures seem to be the best way to save one’s political career. There appears to be no long-term consistency to the approach to the very serious long-term issues of structural debt, except to serve one’s own political constituency and to kick the can down the road until we will presumably face economic conditions so dire as to force a solution, political or otherwise. Although I hold a Hayekian bias, I believe the debate over which “economic managerial approach” to take is at this time less fruitful than the discussion over how we could possibly steer a democracy such as ours into any constructive, rational approach to this apparently oncoming train-wreck.

    Reply

    • Malcolm Greenhill Says:

      Jim, I’m definitely sympathetic to your position, but personally I find it difficult to hold faith with our current political system, which I see as as broken, whether irretrievably or not, only time will tell.

      Reply

  4. ajaydawar Says:

    Malcolm,

    Thanks for making this into a blog. I have been forwarding your newsltter to many and this makes it easier.

    Reply

  5. Argus Says:

    To cut to the chase: (a) in the short term politicians should be made criminally responsible for what they do—if they promise an end to inflation by pumping money into the system and we get inflation, they’ve broken their promise and ZIP off to jail.

    (b) In the long term we need get rid of politicians and put the People in charge fully responsible to/for themselves. (Switzerland has made an excellent start in that direction, but until ‘party politics’ — okay, political parties entire — are banned we make no progress.)

    People will always opt for the free lunch. Remove the possibility of charlatans offering ‘free lunches’ (politicians) and make people realise that the future is what they make it themselves (it would be, too, with politicians out of the running).

    Responsible for and to themselves, people would wise up in a hurry; and free/open debate would put Keynes back in his box (and vindicate Hayek and the so-called Austrians).

    Reply

    • Malcolm Greenhill Says:

      Thank you for these comments. I’m not optimistic about a voluntary reset as there are simply too many pigs feeding at the trough. I suspect we are going to have to wait for a big involuntary reset resulting from either inflation or deflation (default).

      Reply

      • Argus Says:

        I have the feeling you won’t have too long to wait.
        The big risk is that despite the experience and all the nausea, people will once again opt for what they know and are accustomed to.

        Reply

      • Argus Says:

        Perhaps the people won’t get that much time — the Nazis managed it in a couple of decades, assorted Communists took varying amounts of time.
        For myself it’s all academic anyway, I selfishly hope the ship stays afloat long enough to see me out — but for today’s young it will be a bumpy ride, I’m afraid.

        Do you see a solution?

        Reply

        • Malcolm Greenhill Says:

          Well, there’s always a small chance of a new, new thing such as biotech or cheap and abundant energy from shale oil and natural gas deposits. If we could somehow grow our way out of the debt problem by generating sufficient wealth to pay down the debt, that would be great. However, in the U.S. at least, the sheer magnitude of the unfunded liabilities suggests that default (through either inflation or deflation) is a much more likely scenario.

  6. authorbengarrido Says:

    How would Hayek deal with deflation? I ask because in my reading of history deflation is not self correcting, dangerous and a natural consequence of the business cycle. To rearrange your metaphor, isn’t the Austrian solution to deflation sort of like trying telling your kids to tough out a tumor?

    Reply

    • Malcolm Greenhill Says:

      Ben, you must have been reading some Keynesian tracts. Keynesians believe in a deflationary spiral with individuals delaying purchases because they think prices will be cheaper tomorrow. This is nonsense. In general, people like low prices, and when bargains get big enough, people do not wait for even bigger bargains. Consider Christmas shopping. Most do not wait until after Christmas when bargains are even bigger than before Christmas. While inflation can go on until it destroys an economy deflation stops when you tell your wife that the house next door is so ridiculously cheap that you simply have to buy it. House prices, for example, need to fall low enough that people can afford to service the debt on the mortgage they take out to make the purchase. It really is as simple as that. For the Austrian solution to deflation check out the depression that nobody has heard of. Of course the 1930’s depression shows what can happen when you apply Keynesian solutions.

      Reply

      • authorbengarrido Says:

        Mostly Keynesian, yes.

        My analysis of the Great Depression is a little different, as is the “Depression nobody heard of.”

        If we take the Austrian solution as the correct one, it seems odd that the societies that bounced back quickest from the Great Depression were the ones quickest to dump specie, print money and start stim packages. The slowest to recover let the market have its way. Japan as well seems a counterpoint to benign deflation. Not that Keynesian stimulus has worked to end the deflation either.

        I would explain the micro depression by noting the disturbance was mildest of the once a decade depressions that started in the 1860s. It was mild enough that the spiral didn’t have time to get started. I mean, people did try to be classical liberals during the Great Depression. The Keynesianism was a last ditch thing for most countries.

        Reply

  7. authorbengarrido Says:

    This kind of goes back to the legislative body I proposed, but elected politicians are beholden to their voters’ beliefs.

    I don’t really see a correlation between Austrian values and avoiding structural deficits, Reagan and Bush more or less got what they wanted, for example. However, I do see structural deficits as a property of a voting public that truly, honestly believes you can have lower taxes, more spending and no deficits because 60% of government spending is wasted.

    This is not even remotely true, and if I was going to assign blame for this magical thinking I think it’s much more fairly assigned to the opponents of government than the Keynesians.

    That said, magical thinking works just as well when you believe “evil corporations” are hiding immense profits that can be taxed without consequence whenever.

    In other words, I don’t think Hayek or Keynes is a solution to the candy problem. I think ignorant voters are the problem. Like I said before, ask someone in the grocery store about how the economy works and prepare to cringe, a lot.

    Reply

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