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.