Keynes Hayek: The Clash That Defined Modern Economics

Nicholas Wapshot “Keynes Hayek: The Clash That Defined Modern Economics” W.W.Norton., 2011, 296 pp. plus 41 pp. of notes

This book traces the never-ending debate, beginning with the 1929 stock market crash, concerning the role government should play in fixing and regulating the economy. This debate and shifting policies in Western countries, with special emphasis on the U.S., has revolved around John Maynard Keynes and Friedrich Hayek and the schools of thought centered on their writings. The differences between these two defines the divide between liberals and conservatives. 

 Keynes in the depth of the 1930’s depression was, naturally enough, looking for a cure for mass unemployment. His remedy proposed increasing total aggregate demand using a number of routes: through monetary means, by lowering interest rates and funneling new money into the economy; by tax breaks; and through public works. (The application of all three of these remedies simultaneously for three decades ultimately resulted in stagflation). 

 Hayek, on the other hand, believed that only by turning over the whole of society to market forces can individuals become truly free. In Hayek’s vision, government would be left to manage only those elements of society that could be run by no one else, such as defense. Among the services Hayek believed should be privatized were ‘all those from education to transport and communication, including post, telegraph, telephone and broadcasting services, all the so-called public utilities, the various social insurances and, above all, the issue of money’. (The application of Hayek’s non-regulation philosophy led to most of the market crashes beginning with the S&L fiasco in the 70’s and including the 2008 crash). 

My Notes: 

 Pg. 11: Keynes wrote in “The Economic Consequences of the Peace” that the Treaty of Versailles would likely lead to another world conflict. 

 Pg. 44: Keynes and Hayek came to represent two alternative views of life and government, Keynes adopting an optimistic view that life need not be as hard as it was if only those in positions of power made the right decisions, and Hayek subscribing to the pessimistic notion that there were strict limits placed on human endeavor and that attempts to alter the laws of nature, however well-intended, were bound to lead at best to unintended consequences. 

 Pg. 86: In 1925 Keynes had vehemently declared that Britain should abandon the gold standard. Finally in September 1931 they did so. 

 Pg. 121: Hayek is associated with microeconomics, looking at the different elements such as costs and value that made up an economy (a bottom up view); Keynes is associated with macroeconomics which appraised the economy as a whole (a top down view). 

 Pg. 148: Keynes denied one of the most commonly accepted laws governing economics, Says’s Law, which says that supply creates its own demand. The notion still underlies the whole classical theory, which would collapse without it. Keynes believed savers often preferred to keep their savings in ‘liquid’ form (i.e., cash), so that they could take advantage of rapidly changing circumstances.

Pg. 188: In 1937 Roosevelt re-embraced classical economic orthodoxy with spending cuts, a credit squeeze, and an increase in taxes. Soon after, America was heading back into recession. This recession lasted throughout 1938 and caused industrial production to slump by a third, prices to fall 3.5 percent, and unemployment to climb to 19 percent. 

 Pg. 194: Hayek asserted that the common perception that the extremes of Left and Right were polar opposites was a misapprehension, for both, by replacing market forces with comprehensive state planning, assaulted individual liberties as economic planners cannot know the will of others, they end up acting like despots.

Pg. 220: Hayek declared that he was a ‘liberal’ (what we would today call a libertarian). He went on to state that the fundamental traits of the conservative attitude is a fear of change, a timid distrust of the new, while the liberal position is based on courage and confidence, on a preparedness to let change run its course even if we cannot predict where it will lead. The conservative position rests on the belief that in any society there are recognizably superior persons whose inherited standards and values and position ought to be protected and who should have a greater influence on public affairs than others. The liberal does not deny that there are some superior people, but the liberal denies that anyone has authority to decide who these superior people are. Hayek declared that conservatives were like socialists, and that both held detestable, undemocratic views. Like the socialist, he regards himself as entitled to force the value he holds on other people. 

Pg. 229: Keynesian critics pointed out that policies in terms of aggregate expenditure will be overdone. If the unemployed are concentrated in certain depressed areas and industries, while there is full employment elsewhere, a general increase in expenditure would serve only to drive prices up in the full employment area, without having much effect on the depressed industries. Then the paradox of depression and unemployment in the midst of inflation would be experienced, i.e., stagflation.  

Pg. 233: Eisenhower spent taxpayers’ money like no peacetime president before him; he overcame conservative objections by passing off the expenditures as essential for national security. The vast network of interstate highways that started in 1956 was billed the “National Defense Highway” program. The 1957 launch of Sputnik began the ensuing space race lasting over the next fifty years costing $18.7 billion annual budgets and a further $20 billion plus spent on Pentagon satellites and rocket. “We are living under a curious kind of military Keynesianism” wrote Richard Hofstadter. 

Pg. 240: Johnson always was a spender. He extended civil rights to African-Americans, embarked on a ‘war on poverty’ and instituted Medicare to give health care to everyone over age sixty-five, and Medicaid for those who could not afford health insurance. 

Pg. 242: Nixon was the most overtly opportunistic postwar president, he let his ambition steer the economy less in the nation’s best interest than in his own, to guarantee his reelection. Milton Friedman, Nixon’s economic adviser during the 1968 campaign, concluded, Nixon was the most socialist of the presidents of the U.S in the twentieth century.” In Nixon’s “New Economic Policy” he approved the devaluation of the dollar followed by the removal of the dollar form the gold standard; a financial stimulus of lower taxes and increased spending that plunged the federal budget into a $40 billion deficit; cheap federal loans to prevent Lockheed from going broke; and in August 1971, a legal ban on the raising of prices and wages. 

Pg. 248: Friedman became intrigued with the study of the business cycle and began to contemplate the causes of the Great Depression. He reasoned that had the Federal Reserve between 1929 and 1933 increased the supply of money by lowering interest rates rather than sharply contracted it, the slump would have lasted only a couple of years. 

Pg. 259: In Britain, the Conservatives had compromised with Labour over the welfare state and the management of the economy in an attempt to capture the middle ground on which elections are won. This had led to the state owning the railways and buses, the coal mines, all shipbuilders, all steel-makers, the telephone network, the electricity, gas, and water utilities, British Airways, British Petroleum, the ports, and airports, and much else besides. Margret Thatcher set about shrinking the size of the public sector, reducing the supply of money, cutting taxes, freeing businesses from regulations, repaying the national debt, and selling off state assets in a process known as privatization. It was pure Hayek with a dash of Friedman. 

Pg. 263: While Volcker’s monetary squeeze led to a deep recession that lasted sixteen months in 1981-82, inflation fell dramatically, from 11.8 percent through 1981 to 3.7 percent in 1983. Unemployment rose to its highest level since the Great Depression. In 1980, Reagan inherited a jobless rate of 7.1 percent; by 1983 and 1984 it had reached 9.7 and 9.6 percent. The much derided Phillips curve, which appeared to have lost its relevance when stagflation stuck in the mid-1970s, seemed to be back in business. By Laffer’s reckoning, Reagan’s tax cuts proved every bit as effective as the Kennedy tax cuts. In the four years after Kennedy’s cuts reduced the top rate from 90 percent to 70 percent, growth in real federal income tax revenue leapt from 2.1 percent in the previous four years to 8.6 percent. Reagan’s tax cuts were deeper. He sliced income taxes 25 percent across the board, with tax rates for the highest earners slashed from 70 percent in 1981 to 28 percent in 1988. Corporate taxes fell from 28 to 20 percent. Of course, Reagan increased spending on defense which soared from $267 billion in 1980 to $393 billion in 1988 in constant dollars. Public debt grew from a third of GDP in 1980 to more than half of GDP by the end of 1988, from $900 Billion to $2.8 trillion. The budget imbalance was paid for by public borrowing. When Reagan entered the White House, America was the world’s largest creditor; by the time he left it had become the world’s largest debtor, owing foreign lenders about $400 billion. Reagan quipped: “I don’t worry about the deficit, Its’ big enough to take care of itself.” 

Pg. 274: In 1997, Clinton introduced the Balanced Budget Act, mostly cutting Medicare costs to balance the budget by 2002. In the summer of 2000 he announced a budget current account surplus for the third year in a row, $69 billion in financial year 1998, $124 billion in 1999, and an estimate of at least $230 billion in 2000 the first surplus in three consecutive years since 1947-49.