BookReviews

The great debate

An 80-year battle of ideas underlies today’s economic debate

Reviewed by Doug Bandow

US President Harry S. Truman famously wished for a one-armed economist, someone who would not explain “on the one hand, on the other hand.” Truman never met John Maynard Keynes or Friedrich Hayek. 

Journalist Nicholas Wapshott provides a fine account of an economic battle which continues from the grave. The fact that both Keynes and Hayek were one-handed economists helps explain why their debate still illuminates.

Fame and fortune early favoured Keynes. Educated at Cambridge, he became a leader of the Bloomsbury Group, which included artists and writers, such as Virginia Woolf. He worked for the British Treasury during World War I and wrote a devastating critique of the impact of the Versailles Treaty, The Economic Consequences of the Peace. He revolutionised economic thinking with The General Theory of Employment, Interest and Money.

Friedrich Hayek left the remnants of the Austro-Hungarian Empire, which was formally dismantled by the Versailles Treaty, to become Keynes’ most important intellectual foil. Hayek was a disciple of economist Ludwig von Mises, the dean of the Austrian school, eventually outshining the master.

From Vienna in 1927 the obscure Hayek first contacted the famous Keynes, seeking a copy of a book by another British economist. Explains Wapshott: “That Hayek should ask Keynes for a copy seems less an innocent inquiry than a purposeful attempt to snag Keynes’ attention, an audacious act of homage rather than a challenge.”

The challenge was soon to come.

After the Labour Party triumphed in 1929, Keynes became an advisor to the new government, though it largely rejected his recommendation to open the Treasury doors to reduce unemployment. At the same time, Hayek served as director of the Austrian Institute in Business Cycle Research. He warned against state manipulation of the economy, since doing so would only exacerbate the business cycle. Artificial booms inevitably led to busts, he argued; all government could do was deepen the crash and prolong the recovery.

“The battle lines between Keynes and Hayek were thus drawn,” writes Wapshott: “Keynes believed it was a government’s duty to do what it could to make life easier, particularly for the unemployed. Hayek believed it was futile for governments to interfere with forces that were, in their own way, as immutable as natural forces.” 

The two men first met in 1928 when they informally debated interest rates. Out of that encounter grew what Wapshott terms a “prickly friendship.” Keynes published A Treatise on Money in 1930, which Hayek reviewed critically. Hayek was invited to lecture at the London School of Economics the following year to counter Keynes’s influence.

Hayek faced not only Keynes but a growing band of Keynes loyalists. Of one exchange between Hayek and a Keynes acolyte, writes Wapshott: “This side duel in the great Keynes-Hayek debate was technical, obtuse, difficult to follow, and ill-tempered. Much of it amounted to little except an exercise in logistical sparring between two heavyweight thinkers.”

In 1936 Keynes published his landmark The General Theory. Notes Wapshott: “Keynes determined that the new book he was setting out on would be aimed not at the general public, nor at politicians, nor civil servants in the Treasury, nor the masters of finance in the banks, but at his fellow economists.” Keynes’s ideas, which Wapshott ably summarises, were complex and broke with economic orthodoxy at the time.

Keynes’s most important policy prescription was to use government spending as a multiplier to promote economic growth. Keynes explained: “The newly employed who supply the increased purchases of those employed on the new capital works will, in their turn, spend more, thus adding to the employment of others, and so on.” Hayek’s response was that a bust would inevitably follow any government-induced boom. He explained: “To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about.”

The stage was set for a grand intellectual confrontation, yet it didn’t happen. After publication of The General Theory, observes Wapshott:

“But answer came there none. Hayek remained hushed. Faced with confronting Keynes at full flow, Hayek blinked. Weeks passed, but his expected counter-blast was not forthcoming. Hayek’s life purpose, the very reason [LSE Director Lionel] Robbins summoned him from Vienna … appeared to have come to nothing. Keynes’s great work was met with neither a bang nor a whimper. Hayek’s response, so keenly awaited by classical economists throughout Britain and the Continent, was a yawning silence.”

Hayek later admitted feeling that he had “shirked what should have been a plain duty.” He explained that he wanted to finish his book as “a prerequisite for a thorough disposal of Keynes’s argument.” But that “thorough disposal” never came. Hayek’s The Pure Theory of Capital took another four years to complete and won little notice. Moreover, during a time of high unemployment politics favoured Keynes’s activist prescriptions. Hayek’s standing within the profession declined as even former allies declared for Keynes. The latter died at age 62 in 1946 while Hayek entered what Wapshott calls the “wilderness years.”

Hayek turned to political economy, in 1944 publishing The Road to Serfdom. Hayek targeted collectivism, particularly communism and fascism, rather than Keynesian economics. Although the book received professional brickbats, “Over time The Road to Serfdom established itself as a key work in challenging the legitimacy and usefulness of economic planning,” notes Wapshott.

Hayek organised the Mont Pelerin Society, which continues to bring together free market activists from around the world. He moved to the US where he became a professor at the University of Chicago. He wrote more books, including The Constitution of Liberty, which received less and less favourable attention, and later returned to Europe. His influence was at its nadir when even president Richard Nixon declared himself to be a Keynesian.

However, Hayek won the Nobel Prize for economics in 1974. Stagflation replaced prosperity and politicians like Ronald Reagan and Margaret Thatcher, who rejected Keynesianism, came to power. Communism collapsed. Wapshott proclaims it Hayek’s Counterrevolution—an overstatement, perhaps, but intellectual fashions had changed.

Still, though markets seemed ascendant, the policies of most governments could not be called Hayekian. States generally grew ever more expansive and expensive around the world. Politicians were more faithful in articulating Hayek’s criticisms than in implementing his principles. Wapshott acknowledges: “Hayek’s idealistic vision had been defeated by old-school politics.”

Then came financial collapse and economic recession in 2008. Governments around the world turned to bailouts and stimulus spending. “Keynes was back, with a vengeance,” writes Wapshott. Again, politicians preferred activity over passivity.

The battle between Keynes and Hayek continues to rage. Economist (and New York Times columnist) Paul Krugman says the stimulus was not big enough. Harvard University economist Robert Barro contends that government outlays actually shrink future growth. President Barack Obama wants more spending while his Republican opponents demand less debt. Similar political struggles are occurring across Europe.

“So, 80 years after Hayek and Keynes first crossed swords, who won the most famous duel in the history of economics?” asks Wapshott. Both have influenced their peers. Wapshott cites Milton Friedman, another Nobel laureate, as a free market economist who used many of Keynes’s analytical tools but “agreed with Hayek that whenever the state intervened in the economy, it hampered the free market’s ability to create wealth.”

Keynes has had more influence than Hayek on government policies. But the political struggle continues. America’s upcoming presidential election may prove to be just another round in this ongoing intellectual match.