Watching the failure of the “New Economics”
In his classic critique of John Maynard Keynes, “The Failure of the ‘New Economics’,” Henry Hazlitt notes in a passage entitled “Equilibrium of an Ice Cube”:
It is not too difficult to account for Keynes’s misuse of the term “equilibrium” and for the uncritical acceptance of this misuse by so many writers. The older economists thought of equilibrium as an actual state of affairs. They contrasted “stability” with “disturbance,” a “period of equilibrium” with a “period of transition.” But any living economy is always in “transition” – and fortunately so. An economy that had reached completely “stable equilibrium” would be an economy that had not only stopped growing but had stopped going.
The way Hazlitt derides the Keynesian concept of “equilibrium” reflects the view I have developed working with my colleague Dennis Santiago — namely that the human action we call “economics” is a lot closer to the physical concept of entropy than to metaphors such as bubbles.
Entropy is derived from the second law of thermodynamics and is a fancy way of describing the movement of energy in the physical world. We’re not talking the quantum world of atoms here, but rather things you can see and measure — the sensible, classical world as defined by Richard Feynman. A pendulum is an example of entropy, with roughly equal energy moving from one side to another.
Another example of entropy is an ice cube melting in a glass of water in a warm room. The disaggregation of the ice crystals into liquid or the energy spent in the change of state from ice to water and then ultimately into vapor, is entropy. The process is continuous and can repeat endlessly. When the room gets colder, the water vapor condenses and freezes. Think of the Fed trying to turn up the heat in the room when it comes to the US economy.
Entropy is applied to information theory as well as the physical world of people and markets, as when a piece of information is provided to a single agent. The progression of the data to other people mimics the way energy moves through the physical world – and data moves through financial markets. How that information moves from one person to another, driven by the relevance of that data, affects consumers and whole societies.
For classical liberals like Hazlitt, each person or company is free and independent regarding what it contributes to an economy. Call that contribution “energy” using the entropy metaphor. People were not the rational, consistent actors “assumed” by the Keynesian faith for the sake of selling their crackpot ideas, but independent agents.
But by the time Hazlitt stopped writing for The New York Times in 1946 and moved to Business Week, the evolution of US economic thinking toward a more “dynamic”, a.k.a. Keynesian model, was complete. Over the next half century, anything like a free market perspective in American economic thinking became more and more rare as generations of American economists adopted the Keynesian world view of government-managed economies and endless public debt.
Why did the Keynesian faith win out? Economist salesmen like Keynes focused on the future, a perfect formula for the political class to use to drive growth well into the 1990s. This Keynesian message of growth via inflation and debt was also perfectly aligned with the message produced on Wall Street of ever rising earnings growth and stock prices. With the Keynesian revolution, however, also came debt, inflation, and progressively larger and larger financial and economic busts.
In his new book, “Where Keynes Went Wrong and Why World Governments Keep Creating Inflation, Bubbles and Busts“, Hunter Lewis attacks Keynesian economic thinking when it comes to the role of the state in the economy and more. In an overt tribute to Hazlitt, Lewis wastes no time in calling out Keynes as an elitist who really had contempt for free individuals and markets.
Lewis divides his work into three opening sections, including a review of Keynes’ writings and statements, and then a discussion of how Keynes’ economic ideas went badly wrong. Lewis relates the abandonment of traditional American economic values to current events, and the shameful behavior of President George W. Bush following the 2007 financial crisis.
President Bush famously said to conservative critics: “I’ve abandoned free market principles to save the free market system.” He was talking about authorizing useless fiscal stimulus and bailouts for Wall Street banks. Lewis asks: “How exactly did Bush know that his actions were necessary or that they would prevent the worst? How could he be sure that his actions would not make matters worse, either immediately or over time?” How, indeed.
The answer, Lewis says, is because of Bush’s economic advisers — Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke. These men are adherents of the neo-Keynesian faith which, in bad times, says to increase spending and monetary policy, whether funded with tax dollars or debt. The predominance of the Keynesian world view is so complete, Lewis argues, that policy makers in Washington from Bush to Barack Obama see policy responses “through a Keynesian lens,” to quote economist Gregory Mankiw of Harvard.
For Americans and any other people who value personal freedom, the work of J.M. Keynes ought to be anathema, not a widely followed and respected economic rule for policy. Hunter Lewis provides an excellent overview and refutation of Keynes’s work that informs readers who are trying to understand the roots of the economic crisis affecting us and and provokes them to participate in the solution.