Hayek and Keynes

by Don Boudreaux on March 17, 2009

in Complexity & Emergence, Economics, State of Macro

I’ve spent much time lately re-reading Hayek’s and Keynes’s works from the 1930s — reading not as systematically as I would like, but diving into these works with an interest and fervor that I’ve not felt since the early 1980s.  I highly recommend Bruce Caldwell’s splendid “Introduction” to volume 9 of Hayek’s Collected Works — a volume entitled “Contra Keynes and Cambridge.”  Also, I highlight this important passage from one of Hayek’s essays contained in the just-mentioned volume, “Personal Recollections of Keynes.”

Keynes appears to have been misled here by a mistake opposite to that of which he accused the classical economists.  He alleged, with only partial justification, that the classics had based their argument on the assumption of full employment, and he based his own argument on what may be called the assumption of full unemployment, i.e., the assumption that there normally exist unused reserves of all factors and commodities.  But the latter assumption is not only at least as unlikely to be true in fact as the former; it is also much more misleading.  An analysis of the assumption of full employment, even if the assumption is only partially valid, at least helps us to understand the functioning of the price mechanism, the significance of the relations between different prices and of the factors which lead to a change in these relations.  But the assumption that all goods and factors are available in excess makes the whole price system redundant, undetermined and unintelligible.  Indeed some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics [boldness added - and note that Hayek, correctly, accuses Keynes of having assumed full unemployment.].

 

The notion that all unemployed resources of a certain aggregate class such as “labor” or “land” or “steel mills” are largely identical and interchangeable with other resources in that same class, and, hence, can be easily and profitably employed simply by increasing demands for “labor” or “land” or “steel mills,” is the bastard off-spring of lazily thinking in terms of aggregates and forgetting the enormous complexities that are part and parcel of any successful, viable, market economy.

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{ 6 comments }

Adam March 17, 2009 at 2:03 pm

One small correction, Professor Boudreaux: you made the text darker, but Caldwell brought the boldness on his own.

OK, I apologize for the unprovoked pun…

Don Boudreaux March 17, 2009 at 2:07 pm

Touche!

OregonGuy March 17, 2009 at 2:51 pm

One of the dead guys I return to constantly is Dave Ricardo. The best one-page I've found was written by Steven Suranovic.

http://internationalecon.com/Trade/Tch40/T40-0.php

Allocation is about choices. I think the argument has gone off the rails when the word "sustainability" is introducted into the conversation. Scarcity is the real problem. Sustainability is an attempt to make the allocation of scarce resources one about political outcomes–in terms of normative values–rather than relying upon price signals that determine investment; both public and private. And, increasingly, public pressures are intruding more and more into what should be private decisions.

I just wish politicians could understand that a mandate doesn't create an additional resource. It just limits the uses to which we may put a resource to use. And intentionally creates opportunity costs, even "if" they don't understand what those costs are, or how they occur.
.

JP March 17, 2009 at 2:57 pm

Prof. Boudreaux — In a post earlier today, Tyler Cowen says, referring to Keynes, "aggregate demand matters, and the multiplier is real." I (and I suspect a lot of other regular readers) am confused.

Milton Recht March 17, 2009 at 3:48 pm

If I remember correctly, Keynes was writing about a heavily unionized labor force in England. As consistent with unions today, unions then were more interested in maintaining wage levels as opposed to employment levels.

Workers were employed at either full wages or unemployed. Employers and employees did not have a chance to agree on reduced wages, hours or benefits. Furthermore, unionization introduces rigidity, which slows productivity improvements. The belief prior to Keynes was that the employees (and their unions) were voluntarily choosing to be unemployed by insisting on a union wage. Keynes also failed to see that part of the unemployment was a structural shift caused by industrialization/mechanization/assembly line, etc. and there was not a need for as many workers for the same output.

Since labor prices were "sticky", Keynes' only option was to try to justify an effort to increase demand to get employers to rehire unemployed unionized labor.

Without unionization and it concomitant "sticky" wage, Keynes probably would not have promoted his economics.

Unfortunately, Keynes did not have a good theory for increasing demand and production without lowering prices.

Daniel Kuehn March 18, 2009 at 6:12 am

It would have been nice to read this post before posting on "Vulgar Keynesianism".

I think the problem here is that you're making a lot of very uncharitable assumptions about Keynes. First, I did not at all get the impression reading the General Theory that Keynes thought capacity was chronically underutilized. Perhaps that belief about what Keynes said was asserted in that Hayek essay (which I have not read – I shall look it up), but I'm not sure what to do with an assertion like that. When Keynes discussed underutilization it was in a very special case and that special case dictated special responses. So? Perhaps you can make a successful argument that that special case never actually exists, but it's very unfair to quote Hayek and assume that's solid evidence that Keynes thought markets chronically broke down. Perhaps you weren't assuming that? Perhaps you're just remarking on Hayek's views on Keynes? That seems fair – I hope you weren't going farther than that.

The other uncharitable assumption is that Keynes was somehow unaware that individual actors are very diverse and differentiated. Again, I don't see why aggregation implies this ignorance. To raise the medical example I provided in "Vulgar Keynesianism" – an organ is composed of lots of different cells and different tissue, and each of those cells are at different stages in their life cycle and of different strength and efficiency. But that doesn't mean you can't consider and study what the heart or the stomach does as a whole. Of course you need to understand the intricacies of the specific component parts of the heart – but by making statements about the heart as a whole and diagnosing it as an aggregate doesn't imply that the doctor is unaware of the constituent parts. If you're assuming that Keynes is unaware of the constituent parts you're reading an awful lot into him – and I really think you're assuming your own conclusions about him.

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