The Keynes-Hayek showdown

By Nicholas Wapshott
November 7, 2011

By Nicholas Wapshott
The views expressed are his own.

Eighty years ago an anguished debate between two economists began in Britain — and came to shape the politics of the world after World War Two. The differences between John Maynard Keynes and his nemesis Friedrich Hayek sharply described alternative approaches to addressing the ebb and flow of the business cycle, with Keynes arguing that to put the jobless back to work governments could and should intervene in the market and Hayek insisting that such actions were based on an inadequate understanding of how economics really worked and would only delay the day of reckoning.

That snarky disagreement was so vicious and ill-mannered that one old-school economics professor described it as “the method of the duello” being “conducted in the manner of Kilkenny cats.” On Tuesday, in the Asia Society on Park Avenue, New York, two teams of economists, one representing Keynes, the other Hayek, will slug it out before an audience of 250 and bring the debate to America. Seventy years ago, Keynes’s ideas were eagerly embraced by young American economists who began implementing the Cambridge economist’s ideas first in Franklin Roosevelt’s administration, then in every government until Jimmy Carter, when Hayek’s disciple Milton Friedman introduced monetarism as a guiding principle.

The Keynes-Hayek debate has never been so topical. Today the fault line between right and left can be defined as the difference between those, like President Obama, who believe that the broken economy can be fixed by the government providing a giant fiscal stimulus, and those, like all the Republican presidential contenders, who believe government in America is too big and should be dismantled to make way for the operation of the free market. While Obama pushes his Jobs Bill, which would inject about half a trillion dollars into the economy, the GOP in the House is preventing any such manipulation of the economy from taking place.

The belated American Keynes-Hayek debate was provoked after the stock market crash of 2008 and the freezing up of the banks and Wall Street financial institutions the following year. A trillion-dollar Keynesian stimulus was quickly followed by a Hayekian wave of buyers’ remorse that deemed that the swift reduction of the national debt was more important than giving jobs to the unemployed. Congressman* Paul Ryan’s economic plans urging fiscal continence without delay were supported by the Tea Party movement that demanded that new government borrowing cease. Last summer’s debt ceiling talks continued the battle and was met by Obama’s doomed Jobs Bill by which the president is attempting to pin blame for joblessness upon his opponents.

The Reuters debate will put such practical prescriptions and counter-arguments into perspective. Four Keynesians – economist James Galbraith, son of the high priest of Keynesianism, John K. Galbraith; New Yorker columnist John Cassidy,  Sylvia Nasar, the historian of economic thought and author of Grand Pursuit; Steve Rattner, the architect of Obama’s auto company bail-out – will slug it out with four Hayekians – Economics Nobel Prize-winner Edmund Phelps; Professor Lawrence H. White of George Mason University; Diana Furchtgott-Roth, a senior fellow at the Manhattan Institute; and Stephen Moore of the Wall Street Journal. If this group of distinguished thinkers follows the spirit of the original debate, the usual academic civilities may soon make way for acerbic fireworks.

The spirit of the original debate is likely to inform Tuesday’s lively discussion, framed like an Oxford Union debate and presided over by Sir Harry Evans, Thomson Reuters’ editor-at-large. Keynes and Hayek first argued over whether deliberately creating new demand in an economy — by cheap money lent by banks, by slashing taxes, and by governments directly investing in public works programs –- could be sustained, or whether, as Hayek argued, such measures would only in the long run delay the day of reckoning. Keynes’s famous riposte was that even temporary jobs were worth having because “in the long run we are all dead.”

After publication of Hayek’s The Road to Serfdom in 1944, a second front was opened against the Keynesians that suggested that the increase in the size of government that accompanied widespread intervention in the economy tended towards a loss of individual freedom and the rise of authoritarianism, a charge that was hotly denied. It is this accusation of inadvertently inviting tyranny that has sharpened the language in what was always a vituperative clash of personalities and ideas.

The ever-quotable Keynes once remarked that “even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist.” Those words of wisdom have never been more true than today as we face next November a Keynes-Hayek presidential election. Those who attend the Reuters Keynes-Hayek debate, to be relayed live on and posted for all those unable to be there in person, will witness the opening salvos in the latest American chapter of a saga that came to define politics and economics in the twentieth century. What is said may frame the intellectual background for how Americans vote next year.

Nicholas Wapshott’s “Keynes Hayek: The Clash That Defined Modern Economics” is published by W. W. Norton.

PHOTO: Boxing gloves are seen at a gym in the low-income neighborhood of La Vega in Caracas, March 18, 2011. REUTERS/Carlos Garcia Rawlins

*Editor’s note: This article originally identified Paul Ryan as a senator. The sentence has been corrected.


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Wasn’t that debate shown on YouTube? Sk

Posted by Greenspan2 | Report as abusive

@eleno, you are right about one thing: economists are not scientists anymore than sociologists are. The problem is that the “models” can never take into account the complex, dynamic world. So, neither model can be proven or dis-proven. Arguments are won on subjective values.

My subjective value is to raise all boats because the alternative theory is deregulation and deregulation seems to always lead to catastrophe. Face it, we need the Government to reign in the greedy. But we need the greedy to stimulate the market. However, during this recession the greedy have failed to stimulate the markets so there’s no one left but the Government to do it.

The WAY Government should do it is to tax the wealthy to pay for the stimulus for two reasons: The wealthy are not doing their part to stimulate growth, and we all can’t go into debt doing what the wealthy should be doing.

I am pro Government stimulus suggesting that I’m a Keynesian, but note that I am also pro balanced budget. As an economist, I like a balanced, sustainable approach because it’s just more practical.

Posted by LEEDAP | Report as abusive

@shovel99: You are absolutely right. People thinking a government can stimulate by LENDING money don’t understand the social psychology of debt. At best one can avoid direct mayhem with supplying liquidity into the market. But sustainable growth ? No way. Growth is related to employment. Because it creates positive EXPECTATIONS on future market demand.

In fact, a government that runs itself into a gross debt of GDP above 100 % only makes it worse. How can someone build a positive view on the economy with a huge Sword of Damocles hanging above it ? The real-life situations in Europe, Japan and the US should have shown us enough.

Posted by FBreughel1 | Report as abusive

It is interesting and important to discuss these theories. This is what they are, just theories because we have not yet managed to get things right. I feel there are other issues that need to be taken in account. These are Misuse of Power, Corruption of our Political and Financial system, Lack of Democratic participation by ALL voters through poverty and poor education, mis-use of psychological knowledge and financial power to manipulate the electorate,……we can come up with a long list. Unless we have a true democratic system and true level playing field in all human activities, including an impartial legal system, we won’t achieve anything through such debates.

Posted by Omen100 | Report as abusive

Are we truely free if government doesn’t allow us to fail! Is it cost effective or proper for government to try to be everything to everyone? Even our poorest in America make more than 90% of the rest of planet earth! We’re living miles above our means and the resst of the globe and next year we’ll be the great adjustment folks-prepare for deflation for years! Hope we come out the other end a better country-with a balanced budget somewhere in the US someday!

Posted by DrJJJJ | Report as abusive

I’m a staunch Hayekian but I have to admit that your points are pungent and your mataphors more so. Nevertheless, Bush’s “crony capitalism” is far from a free-market system. Hayekians are not saying: “Give us more Bush” or “sacrifice more virgins”, we’re saying the exact opposite, “Give us less Bush” and “sacrifice more Keynesians”.

Posted by NewsAddict | Report as abusive

“This approach is similar to a primitive religion, when the sacrifice of a virgin fails to appease the Volcano gods, they conclude that maybe the first wasn’t really virgin enough and sacrifice some more virgins.”

Ahem… then there was the time that the Progressive Left was outraged that anyone would view yet another debt-financed ‘stimulus’ with some suspicion, and did heap scorn upon them, saying, debt is savings, consumption is production, and war is peace…

Posted by CounterSophist | Report as abusive

Where’s the video of the debate? Was it not recorded?

Posted by qwertyasdf | Report as abusive

So far, Keynes has fared better than Hayek in their race to attract supporters. One of the reasons can be that Keynes has an analytical theory, while Hayek uses one words. Hayek, in his Road to Serfdom, attacks monopoly and especially state monopoly, but he offers no analytical theory. So far, no Hayekian economists can offer better monopoly model and prove more significant damage done by monopoly. Gordon Tullock has made some contribution in the latter aspect, but not in the former one. In addition, the Hayekians also need to disprove Keynes’ theory analytically. These, and many other wrong economic theories, are discussed in my ebook “Economics in Deep Trouble” (Amazon).

Posted by HakChoi | Report as abusive

Nice points Eleno.

Let me dis-spell a common Keynesian myth to counter those who say ‘stimulus’ is what we need. You forget that the ‘stimulus’ is simply shifting coins from the economy’s left pocket to it’s right. The government can’t create wealth, it can only tax and then redistribute. And in this case it’s shifting from the private sector, which is indisputably more efficient and creates more productive jobs, to the public sector, which is notoriously more inefficient and creates unproductive jobs. This is indisputable.

But yes, throw in the printing press and the government can ‘create’ this wealth (aka debt). But the problem with this is that no new resources, the means to produce, are conjured into existence with this paper money. You still have an economy capable of the same output only you are pulling resources to a certain governmental-designated sector with this new money (which is also inflationary). So no, governmental stimulus is not the solution, it is the problem. It is taking capital and flushing it down the toilet, or worse, inflating bubbles that burst and all they leave behind is the debt we accrued to inflate them.

HakChoi trying to substantiate economy-encompassing theories such as these with obtuse mathematical theory to predict outcomes is folly. It’s not reality. Seriously, one man and a few underlings deciding on the interest rate of the largest economy in history? Give me a break.

It still baffles me that we don’t listen to Austrians with more attentiveness when they have warned of this exact crisis and given a play by play of startling accuracy years and years before. We seem to look to the people who created the problem, who had no idea the crisis was coming to fix it when they don’t understand what they did to create it in the first place.

One more thing, to the person who said that the Great Depression happened because we did ‘nothing’ Hayek-style. You need to stop reading revisionist history and understand that Hoover and FDR were two very interventionist presidents and what was practised preceding and anteceding the collapse of 1929 was not Hayek-inspired capitalism (although it was closer to it that what we have now). The reason the Depression went on so long is the same reason Japan has been in the doldrums so long, they don’t let their economies correct and try and prop up unsustainably structured economies with inflationary monetary policy. They also did strange things like price fixing.

Posted by Petarghh | Report as abusive

I’m reading Wapshott (I bought it from the US) and he was very quick to point at that Friedman and Hayek were at odds on many things, only really agreeing that prices were the important signal sent by the market and price manipulation was wrong. So Wapshott is exempt from criticism on that point.

With regard to the reasons for the crisis, I can see merit in both Keynes & Hayek. Keynes, like Herbert Simon who won a Nobel prize for saying something similar, felt that the classical assumption of “rationality” was inapplicable to man. Man simply wasn’t clever enough to be a fully rational profit maximiser. Instead he was a momentum investor with a bias to the short term, and hence the market often witnessed “waves of irrational psychology”. Banks too were pro-cyclical, lending too much in good times and not enough in bad times. Later, post-Keynesians like Hyman Minsky offered very plausible (especially in hindsight) and simple explanations of financial crises. Minsky warned that long economic expansions were potentially deadly because they lead to a build up of “Ponzi debt” which is what happened. He also predicted in the 1980s that anything that could be securitised, would be. In this context, Greenspan’s “put” which minimised market downturns and prolonged the upturn, and his relaxed view on financial innovation can be shown to have been foreseen as deadly by Minsky.

Both Keynes and Minsky recognised that free markets and the banking sector had to be regulated to keep activity within normal bounds, and not going from boom to bust.

Hayek (I think) contended that artificially low monetary policy distorted the balance between saving and investment, and led to a build up of “malinvestment”. This can be seen to have happened too. So Keynes and Hayek were compatible in describing the roots of the crisis. Tut, tut, Mr. Greenspan.

Technically I think Hayek’s prescription to resolve the crisis is correct, but morally Keynes’ solutions are better. Propping up failed institutions introduces moral hazard and rewards failure by socialising losses. However, the social cost of prolonged unemployment and poverty justify state sponsored solutions. Hayek felt that in the long run free markets would allow the economy to self-heal, but as Keynes famously said “in the long run we’re all dead”.

Wapshott describes Hayek’s contradictions very well. Despite being very pro free markets, he recognised that utilities and other natural monopolies required regulation, as well as recognising other market failures. As Keynes said, they both recognised that a line needs to be drawn where free markets were left unfettered, they just disagreed where that line should be.

Hayek was, surprisingly to me, very anti-Conservative. He would have loathed the Tea Party. Conservatives were too nationalistic (hear hear) and not open to change. They wanted to retain the dominance of wealthy interests in the system and as such, were potentially as tyrannical as socialists. Ironically, Wapshott points out that Hayek never once worked in the private sector! Keynes was a master trader & speculator so clearly did believe in the markets. He distrusted socialism and advocated spending to alleviate the unemployment that would lead to extreme politics.

Both Keynes and Hayek have been badly misrepresented by many. Keynes, as said above, wanted intervention to dampen surplus eras too and only wanted deficits when necessary to alleviate periods of insufficient demand. His multiplier theory still holds water as far as I know. Keynes, it is often forgotten, wanted looser monetary policy to accompany his fiscal policies. He wasn’t “one or the other”. I read Peter Clarke’s bio of Keynes earlier this year. In that book I think it is said that Keynes, in all his works, only ever mentioned the word “deficit” a handful of times.

Was rescuing AIG and RBS, and “cash for clunkers” really Keynesian? I don’t think so.

Posted by Stuttgart88 | Report as abusive

A trillion-dollar Keynesian stimulus? Really? Funny no one noticed that at the time. I didn’t notice anything near that size in terms of Keynesian ‘stimulus’. Spending perhaps…but certainly not stimulus.

Posted by larrymotuz | Report as abusive

What did Keynes or Hayek say about Demand Side Depreciation?

It is 42 years after the Moon landing. The economics profession cannot specify what has been lost on the depreciation of automobiles each year for any country or for the planet. So if planned obsolescence has been going on how would that affect the figures?

But we are supposed to care about these pseudo-debates about the ideas of a man who died 23 years before the Moon landing? We don’t even know the depreciation during those 23 years.

Posted by psikeyhackr | Report as abusive