David R. Henderson  

Hayek and 20th Century Economic Thought

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How important is the work of Friedrich Hayek in 20th-century economic thought? David Warsh has written an excessively nasty piece on that, which doesn't mean it contains no kernels of truth. Alex Tabarrok has written a defense of Hayek which is closer to the truth than Warsh's piece. Russ Roberts and Pete Boettke have also written important thoughts about this that I largely share. Rather than go through point by point about where I agree or disagree with the various players, I refer you to my recent review of Nicholas Wapshott's book, Keynes Hayek: The Clash that Defined Modern Economics.

Some highlights from my review:

On Hayek's non-participation in the contemporary debate about Keynes's General Theory:

Wapshott writes that Keynes "went out of his way to invite Hayek's criticism," even sending Hayek advance copies so that Hayek could publish his critique by the time the book was released. Why? Writes Wapshott: "Keynes was a master publicist and knew the value of courting controversy."

And how did Hayek respond? He didn't. As Wapshott puts it, "Hayek declined to enter the ring." Much later, Hayek would say that this was a "failure for which I have reproached myself ever since." Part of Hayek's reason, though, was that he was trying to finish a competing book, The Pure Theory of Capital, and had become "hopelessly stuck in chapter 6." Hayek was still trying to work out, as young Austrian economists still do today, the effects of monetary policy, via interest rates, on the structure of production. Possibly because Hayek didn't directly respond to the General Theory, some of the younger Hayek acolytes, such as John Hicks, Abba Lerner, and Nicholas Kaldor, went over to the Keynesian side. Wapshott quotes Galbraith's observation about the various young Keynesian economists, especially Kaldor, attending LSE seminars to poke cruel fun at Hayek.

On The Road to Serfdom:
Fortunately, Hayek didn't quit. He wrote The Road to Serfdom, a volume that made him famous in the United States and one that Keynes called "a grand book." Hayek seemed to have regrets about the work, though, because of some of the nastiness that American intellectuals heaped on him in response to it. In the 1980s, Hayek wrote, "I discredited myself by publishing" the book. (I think he used the word "discredited" differently from the way I would. The Road to Serfdom, though somewhat overstated, is a fine work. In context, Hayek seems to have meant that the book cost him some of his reputation.)

On "The Use of Knowledge in Society:"
Hayek then turned to some of his path-breaking works on economics and knowledge. One of these was his 1945 article, "The Use of Knowledge in Society," published in one of the most prestigious American economics journals at the time, the American Economic Review. This is probably one of the ten most important economics articles of the 20th century. With this and some earlier articles on the economics of knowledge, Hayek drove the final intellectual nail through the coffin of socialism.

On Hayek's winning the 1974 Nobel prize in economics:
Nevertheless, from the late 1930s on, Hayek felt as if he was in the wilderness. He became increasingly depressed, but his depression ended after he won the Nobel Prize in 1974. I saw him the next year at a weeklong conference and offered to carry his bag up some stairs so that I could get a chance to talk to him. There was a definite bounce in his step and a twinkle in his eye.

On why I think Wapshott's subtitle is wrong:
But is Wapshott's subtitle justified? Certainly, the clash between Hayek and Keynes was important. One might even argue that it should have defined modern economics. But did it? No. Keynesianism did lose ground from the mid-1960s on, but that was due mainly to Milton Friedman, not Friedrich Hayek. From the late 1950s to the late 1960s, Friedman delivered three body blows to the Keynesian corpus.

On the uncertain future of macroeconomics:
To say, as I do, that the debate between Keynes and Hayek did not define modern economics is not to say that it couldn't do so in the future. Many economists still have not fully contended with Hayek's point that the information that matters most is held in decentralized form in the minds of each of us. But we aren't there yet.

COMMENTS (4 to date)
Jack Gardner writes:

My confusion: Henderson quotes Wapshott as saying that Friedman found there was an explosion of money growth before each economic downturn. Henderson says Friedman found just the opposite, a decline in the money supply or its growth before each downturn.

My own impression is that there is always an increase in the money supply over a number of years, even decades, before there is a relatively sudden decline in the supply of money and credit? It is the build up of money inflation and debt which creates the problem, then the sudden decrease when debt cannot be refinanced is the trigger for the economic decline.

So, "explosion" may not be the right word to describe such progressive inflation, but Wapshott is correct in saying this is the cause? Which Friedman identified? Procedding each collapse? But Henderson is correct that the immediate trigger is the implosion of money supply and credit?

1. Am I right? 2. Are both Henderson and Wapshott correct, if incomplete? 3. Did Friedman recognize all of this?

Jonathon Hunt writes:

I'm so glad Warsh has decided for us all that Friedman was right and Hayek was wrong on monetary policy. Regardless, Friedman and Hayek almost never disagreed on anything else.

David R. Henderson writes:

@Jack Gardner,
No, I don’t think Wapshott is correct in saying this is the cause. Of course, that gets to my difference with many of the Austrians. Murray Rothbard claimed that there was an increase (I don’t think even he would have called it an explosion) in the money supply throughout the 1920s. I think that the 1920s' 45% growth over almost a decade (or just over 4% annualized) is not an explosion.
The point is that Wapshott left out Friedman’s key finding. I believe, although I haven’t checked Friedman’s and Schwartz’s classic, that there were other recessions that did not come after anything other than very small growth in the money supply. What there always was, though, was a sharp decline in the money supply or in its rate of growth. Referencing Friedman without referencing that is like talking about Hamlet without the Danish prince.

Jack Gardner writes:

Very interesting, thanks. Evidently there were bubbles in the economy and the stock market, bursting in 1929. Would this mean that most of the slow money growth had found its way into relatively few areas? Then the crash and new tariffs caused uncertainties and a slowing of money circulation, resulting in defaults on debts, credit restrictions, and savings growth? And this is the way the money supply shrank, as opposed to actions by the Fed to pull money out of the system? Or did both occur? Or how else could the money supply shrink?

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