British journalist Nicholas Wapshott’s new book, Keynes Hayek: The Clash That Defined Modern Economics is about a heated debate, eight decades past, between two of the most influential economists in modern history. That debate, which took place in the midst of the Great Depression, concerned the causes and cures of business cycle downturns.
The book comes out at a propitious time. The ongoing economic crisis raises many of the same questions that fueled the intellectual duel between the British-born liberal lion John Maynard Keynes and F.A. Hayek, his free market Austrian friend and opponent. The confluence between subject matter and current events surely helped Wapshott sell his book to a publisher and likely will sell many copies to readers. But potential buyers should be aware that the book says nothing about how the economic dispute between Keynes and Hayek might apply to today’s economic situation. This omission proves fatal.
Wapshott does not ignore the present in favor of the distant past, although the bulk of the book’s narrative is set in the 1930s. But he seems to think his subjects’ contemporary relevance is best reduced to the big-picture conflict between government intervention (Keynes) and free markets (Hayek). Wapshott focuses on the disagreements the two had over political philosophy and practice rather than the technical specifics of their economics. Those political disagreements are important, but they arose from crucial differences in economic theory.
For example, Keynes believed that intelligent, well-meaning planners manipulating economic aggregates such as demand and employment can bring about a happy end to business cycles. Hayek, by contrast, insisted that individual decisions and imbalances between specific prices and demand, or interest rates and specific plans for long-term productive projects, are where the economic action is.
Modern Keynesians tend to sniff at the notion that their man and Hayek were equal participants in the “clash that defined modern economics.” They note that Hayek did not wield a similarly huge influence on modern macroeconomics, and they are right in the sense that the Austrian questioned the value of macroeconomics as an intellectual project in the first place.
At its root the Keynes/Hayek clash concerned alternate theories about how business cycles work. Wapshott does a workmanlike job walking readers through the lectures, books, articles, reviews, rebuttals, and counter-rebuttals that made up the bulk of their dispute. That is the book’s greatest value, and it’s the most thorough and lengthy such discussion available in the lay literature.
Before the two men began feuding, Keynes was already a hero to the rising generation of economists at Cambridge, but his ideas were considered somewhat heretical by the dons of the London School of Economics. The LSE’s Lionel Robbins imported Hayek, a monetary/business cycle theorist and disciple of Ludwig von Mises, to represent a counter-Keynesian perspective. (Robbins and Keynes had feuded as members of a government commission, where Robbins refused to sign on to Keynes’ prescriptions for public works spending and tariffs as a solution to the Depression.) The Austrians thought free markets tended toward a workable equilibrium that reflected people’s desires and choices; the new Keynesian ideas posited that free markets sometimes guided economies into ditches from which only concerted government action could pull them out.
This book is about nothing if not economic theory and history; the personalities simply aren’t that gripping, despite slightly interesting scattered details about Hayek’s marital troubles and the torrid affairs between Keynes’ disciples. Yet Wapshott somehow never spends more than a sentence or two at a time on complicated economic ideas. He devotes far more space to discussing the feuding economists’ intemperate tone than he does to explaining what they meant. Readers who don’t already have a basic understanding of Hayekian and Keynesian economics will get little help here.
The book is riddled with errors of judgment, especially about Hayek’s position. Wapshott thinks that Austrian theory is “mechanistic” and based on a belief that the “free market was virtuous.” In fact, Hayek’s notion was that markets were highly organic, especially compared to Keynes’ vision of manipulating economies like machinery, and Hayek’s Austrian perspective was studiedly and deliberately value-free in its economic analysis. While Austrians tend to think free markets redound to the greatest benefit of the greatest number, that conclusion arose from their scientific understanding of how the world worked, not a moral judgment about how it should be.
Wapshott thinks the Misesian critique of socialism was that prices “were made redundant,” when what Mises actually said about socialism is that it made prices, and the information we get from prices, impossible. Wapshott thinks Hayek’s understanding of the function served by prices was not about the spread and coordination of decentralized information and knowledge (which it was) but rather about freedom. At the end of the book, where you’d expect Hayek’s economic views about business cycles to be central to the discussion, Wapshott forgets them entirely in favor of his politics.
But the Keynes/Hayek argument was more complex than just the political question of government vs. markets. It was about complicated notions of price adjustment, especially the vital question of price adjustments for labor. In a 1930s context of very powerful unions, Keynes thought it was politically impossible to achieve the nominal wage reductions necessary to clear the market for labor—that is, to let wages fall so that hiring would be cheaper and unemployment thereby reduced. He instead promoted inflation as a means to trick labor into taking lower real wages.
Wapshott seems to want us to take Keynes’ side on this. He writes sentences like, “Keynes believed that the chronic unemployment endured by Britain and America in the 1920s and 1930s was evidence that the full employment equilibrium was a fallacy,” without mentioning prices or wages. The point from Hayek’s side is that no equilibrium is possible when prices don’t or can’t adjust. In neither country did wages—the price of labor—adjust downward in order to increase the demand for labor—that is, employment.
Unemployment was understandably one of the great battlegrounds of the Keynes/Hayek feud. In a business cycle bust, did unemployment have to be cured by government manipulation of aggregate demand—by spending any way, any how, as Keynes advocated? Keynes thought that if you have idle people and capital goods, you should get them working again by any means available, even if the projects prove inflationary or produce nothing that anyone wants (such as holes by the side of the road).
From Hayek’s perspective, booms and busts were caused by unnatural credit creation, setting in motion productive processes (say, home building) that end up not paying off in the end, given people’s real desire for future goods vs. present ones. Under normal circumstances, those desires would tend toward equilibrium via adjustments in interest rates. But interest rates are skewed by artificial credit creation. While the additional credit has short-term stimulative effects (booms), in the long run a structure of production that does not match actual saved capital will collapse, leading to damaging busts.