On July 30, the British magazine The New Statesman published an article authored by the famous philosopher John Gray on the life, intellectual achievements, and mistakes of the renowned Austrian economist and Nobel laureate Friedrich Hayek. Gray’s piece examines the Austrian’s economic and political views. It is almost as if Gray puts Hayek on trial, the verdict of which has already been decided upon.
The bulk of the article overviews Hayek’s achievements in the sphere of economics, where Gray offers various criticisms aimed at his theory of the market system and the business cycle. Gray even claims that Hayek’s greatest intellectual rival, John Maynard Keynes, was definitely a better economist of the two. Unfortunately, virtually all of these very bold criticisms are left with no substantial argumentation. In some cases, a proper argument is presented but it is either incorrect, or completely disregards some very relevant historical facts. Lt’s take a look at the main errors in Gray’s critique and elaborate why is he entirely wrong in his evaluation of Friedrich Hayek’s economic thought.
Hayek and Impossibility of Central Planning
Gray begins by writing that while Hayek was right in his critical analysis of socialism and central planning, he failed to realize that the same criticisms apply to market economy. To evaluate this claim we must review the criticism in question.
According to Hayek, central planning is doomed because of the natural limits of human knowledge. For him, the main function of the market system is precisely to provide a method for the fast and efficient transmission of information between individuals and thus facilitate economic cooperation. This is possible thanks to the free and unrestricted interaction between supply and demand which forms market prices – the variations in their values immediately signal to entrepreneurs which goods or services and production processes it is most profitable to invest in. Hayek elaborates these ideas in his famous essays Economics and Knowledge and The Use of Knowledge in Society1.
Hayek’s criticism of socialism is based on this very theory of the market as a system for the transfer of knowledge and information. In a state-planned economy, where a market price system is missing, the central administration which manages the whole production and supply of goods and services has no way of knowing what the consumer preferences are and what the most efficient way of satisfying them is. Consequently, there is no way to know if the resources employed in production are being employed efficiently, or not.2
This makes central planning a particularly unstable economic system, which leads to a massive waste of resources, and according to Hayek, this is the primary reason for the collapse of all socialist states throughout the world.
Gray concedes the truth of this analysis, but adds that “the problem is that it also applies to market capitalism”. According to him, the market is also prone to commit serious errors and lead to an inefficient distribution and employment of resources. Gray claims that the market, like the planned socialist economy, also lacks a self-regulating mechanism and history offers many examples of mass irrational manias which have led to unsustainable economic booms fueling speculative market bubbles, which eventually lead to deep and painful crises and recessions.
However, the market does have a self-regulatory mechanism, and John Gray should be very much familiar with what it is if he is truly well acquainted with Hayek’s thought. This mechanism is of course market competition. It is indeed possible for individual enterprises to commit some errors in their operations and to produce something which the consumers value less than the resources employed in its production, but in such a situation these enterprises are sure to start losing money. And if they continue to register such losses, sooner or later they will be pushed out of the market by other, more efficient enterprises.
The phenomenon of free market competition is precisely what makes the market system more efficient than the central planning of socialism. It is odd that Gray somehow overlooks this very important detail, considering that he should be very much familiar with Hayek’s economic theory. After all, one of the latter’s most famous essay deals precisely with the meaning of competition, titled The Meaning of Competition, also available in the collection Individualism and Economic Order.
Hayek Against Government Intervention
Gray then proceeds to counter another famous position of Hayek’s – his contention that the primary cause of the Great Depression in the 1930s was the serious monetary expansion undertaken by the central banks (specifically in the USA) in the years prior, a position which marks one of the main and starkest differences between his economic paradigm and the one of Keynes. However, according to the British philosopher, “there were booms and busts long before the emergence of modern central banking”. With this argument he also attempts to support his prior claim that the market lacks a self-regulatory mechanism.
This criticism towards Hayek’s theory of the cause of business cycles is on its own wholly incorrect, precisely from a historical viewpoint. In summary, Hayek’s theory, adapted from his mentor Ludwig von Mises, tells us the following – when the state, through a specific central bank policy causes an increase in the supply of money, this leads to unsustainable production booms and the formation of speculative bubbles which are doomed to burst sooner or later, due to the waste of resources which they cause.
This theory very much holds its own historically. Gray’s claim that we know of speculative market bubbles from before the dawn of central banking is completely false. The earliest speculative bubbles known to history are three – “tulip mania” in Holland in 1636-37, and the “South Sea Company” and “Mississippi Company” bubbles of around 1720. All of them fit Hayek’s theoretical paradigm. The formation of each one of these bubbles was in fact preceded by 1) the creation of a central bank in the particular country and 2) a serious expansion of the money supply through a targeted government policy, just prior to their bursting3. If Gray had bothered to double-check his historical claims the would have known that just a couple of decades before these earliest business-cycle episodes, a central bank was founded in the country in which the bubbles formed – the “Bank of Amsterdam” in 1609, the “Bank of England” in 1694 and the “Banque Royale” (later to become “Bank of France”) in 1718.
So, is Gray correct in his claim that because the market lacks a mechanism of self-regulation, even when completely unrestrained by any government and central bank intervention, it would still have led to the depression of the 1930s? We have a very good reason to be skeptical of this argument and even to reject it completely, considering the fact that it fails on its own terms.
Hayek vs Keynes
After his unconvincing critique of Hayek’s primary economic theories, Gray attempts to paint John Maynard Keynes in a much brighter light, as an economist who was much more precise and fundamentally correct in his analysis of socio-economic realities. Keynes was indeed a very intelligent and in a lot of fields a very talented figure, but the truth is that Hayek was definitely the better economist.
According to Gray, it is Keynes’ practical experience as an investor and speculator on the stock market which gives him an undeniable edge in the sphere of economics. Gray claims that Keynes “understood – in a way that the inveterately professorial Hayek did not – the ineradicable uncertainty of economic life”.
It is odd however, that despite his “inveterateness” and the lack of the practical experience that his British rival had, Hayek was the one who in February 1929 predicted the coming market crash4. Keynes on the other hand, was absolutely blind to what was coming and in the mid-20’s he even told the Swiss banker Felix Somary and “there will be no more crashes in our lifetime”5.
To top off his critique, Gray argues again and again, that if Hayek’s economic policy recommendations had been followed, either during the Great Depression, or later during the so-called “Stagflation” of the 1970s, they would have had disastrous effects on the economy.
Such “what-if” retrospective predictions are of course highly speculative and subjective and it is very difficult to take them under consideration as serious arguments. It is a fact however, that none of Hayek’s policy recommendations were ever followed by any government in the world. So we have no actual real-worldproof which could lend support to Gray’s heavy accusations. We do however have an historical example of the effects of the economic policies recommended by Keynes and his followers.
As an economic doctrine, Keynesianism had reached its peak popularity in the United Kingdom and the United States in the period immediately after WWII. In the ’50s and ’60s the British government almost exclusively followed orthodox Keynesian economic policy recommendations and this eventually lead to the infamous crisis and “stagflation” of the ’70s when high levels of unemployment were accompanied by similarly high levels of inflation.
Soon after the worldwide consensus among economists is clear – the serious crisis was caused by the continuous “stimulation” of the economy through high government spending, chronic deficits and an ever-expanding money supply. Orthodox Keynesianism was completely discredited, and this allowed more free-market oriented economists such as Milton Friedman hailing from the so-called Chicago School to gain some prominence and a wider audience for their policy recommendation which were eventually adopted, at least partially, by statesmen such as Ronald Reagan and Margaret Thatcher.
However, for some reason, Gray completely ignores this curious historical fact and, based on his article alone, we would be led to believe that it was definitely Hayek’s policy recommendations, and not those of Keynes, which were somehow proven to be wrong and extremely dangerous. In reality such a conclusion is completely ludicrous considering that Hayek’s proposed economic policies were never applied in practice, while those of Keynes were – and with disastrous long-term consequences.
Considering all of the fact reviewed and discussed so far, there is no way that we can agree with Gray’s contention that Hayek somehow “lost” his debate with Keynes. What Hayek loses is the race to popularize his ideas – something at which his British rival was definitely much better. We cannot agree with the rest of Gray’s critique of the Austrian’s views on the efficiency of the free market and the primary cause of business cycles and speculative bubbles. Each of Gray’s criticisms crumbles entirely under scrutiny. The picture of the intellectual highs and lows of Friedrich Hayek’s career as an economist which Gray attempts to paint is at best only a very distorted and twisted reflection of the reality.
*Intern in IME
3For a detailed historical and economic analysis of these three bubbles, see: French; Douglas; Early Speculative Bubbles and the Increases in the Supply of Money; 1992; Ludwig von Mises Institute
4Machlup, Fritz; Buckley, William F.; Essays on Hayek; New York University Press; 1976; pp. 17
5Skousen, Mark; Dissent on Keynes; Ludwig von Mises Institute; 1992; pp. 163