The Magazine

Dueling Economists

A century of back-and-forth between Hayek and Keynes.

Jul 1, 2013, Vol. 18, No. 40 • By CHARLOTTE ALLEN
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In 1928, Hayek was invited to debate Keynes at a meeting of the London and Cambridge Economic Services. Hayek’s critique during the course of that debate—plus an essay entitled “The Paradox of Saving” (1929), which argued that private investment was a generally rational process that produced exactly the goods that would find ready sales (so government intervention was always a distortionary mistake)—earned Hayek an invitation to lecture at the London School of Economics in 1931. The LSE’s head, the economist Lionel Robbins (1898-1984), had been converted from socialism by Austrian-School theory, and Hayek’s lectures generated a faculty position for him. 

At the same time, Keynes was on the radio urging Britons to spend their earnings on consumer goods instead of hoarding them in savings accounts, persuading the British government to abandon the gold standard—which Keynes blamed for having devastated the economy during the 1920s—and preaching the gospel of deficit spending. So, at Robbins’s urging, Hayek wrote a blistering, if impeccably polite, review of Keynes’s A Treatise on Money, a work that reiterated Keynes’s theories about the inadequacies of the market in alleviating human misery during economic downturns. Keynes responded to Hayek’s review with a riposte, and the two continued to debate for months in the pages of Economica, a journal edited by Robbins, and in a stream of letters. (Hayek even fired one off to Keynes on Christmas Day, 1931.) In retaliation for the assault on A Treatise on Money, Keynes dispatched one of his Cambridge disciples, Piero Sraffa (1898-1983), to spearhead a brutal critique of Hayek’s Prices and Production (1931).

 And so was launched a decades-long battle between John Maynard Keynes and Friedrich Hayek, lasting long after their deaths, in the hearts and minds of academic economists, the general public, and, most significantly, political leaders in Great Britain and the United States. It was a battle that Keynes won on almost every front, as Hayek was hampered by (among other things) a dense and nearly incomprehensible prose style that made figuring out what he was trying to say rough going. The one exception was Hayek’s runaway bestseller The Road to Serfdom (1944), which argued in simple, declarative language that central economic planning was not only counterproductive, but coercive and totalitarian. The book was, in part, Hayek’s brief against National Socialism. Keynes and other liberals had aligned Nazism and capitalism, but Hayek argued that Hitler’s corporatist ideology was profoundly antithetical to the workings of the free market. The success of The Road to Serfdom inspired Hayek to found, in 1947, the still-extant Mont Pelerin Society, then a rump group of friends of Hayek, including Mises, Robbins, the scientific philosopher Karl Popper, and Milton Friedman, then a 35-year-old economist at the University of Chicago. Friedman’s brother-in-law, Chicago law professor Aaron Director, had been taken by Hayek’s ideas while visiting him at the LSE, and had been instrumental in getting the University of Chicago Press to publish the American edition of The Road to Serfdom

Still, Hayek seemed determined to snatch defeat from the jaws of victory. For inexplicable reasons, he never got around to writing a sustained critique of Keynes’s magnum opus, The General Theory of Employment, Interest and Money (1936), effectively ceding the arguments to his rival. And unlike Keynes, who successfully transitioned from homosexual polyamorist to respectable husband, Hayek scandalized his LSE colleagues, especially Robbins, by abruptly leaving his wife of 24 years, Helen, with whom he had two children, in 1950, in order to marry his cousin Helene. Helen announced her intention to contest the divorce, so Hayek quit his LSE post and took a teaching job at the University of Arkansas, which was in a jurisdiction where the marriage laws were more permissive. Needing a larger salary to support two households, he sought a teaching job in the University of Chicago’s economics department—only to discover that, despite his friendships with Friedman and George Stigler (another Chicago economist), the popular success of The Road to Serfdom assured that Hayek would not be taken seriously as an academic economist. He did manage to secure a position with Chicago’s Committee on Social Thought—but as a professor of social and moral science, not economics. Hayek’s next book, The Constitution of Liberty (1960), which was supposed to be his own magnum opus (and set him up financially for life), proved to be a resounding flop, generating few sales and scathing reviews, even from Robbins. 

Membership in the Mont Pelerin Society dwindled. In 1960, Hayek suffered the first of several bouts of clinical depression, and the next year, he experienced the first of several heart attacks. In 1962, panicked over his diminished financial prospects and the idea of Helene living in poverty after his death, he left America to accept a teaching post at the University of Freiburg, and then, in 1969, at the University of Salzburg. In 1974, Hayek shared the Nobel Prize for economics with the Swedish Keynesian Gunnar Myrdal, but few American economists remembered who Hayek was.

Meanwhile, Keynes’s star soared. “We are all Keynesians now”—a phrase attributed to Richard Nixon when he took America off the gold standard in 1971, but actually composed by Milton Friedman—was an apt description of postwar leaders of all political stripes in Britain and, especially, the United States. FDR, although voicing a belief in “sound money,” made public-works schemes financed by tax dollars and swollen budget deficits a central feature of the New Deal. Furthermore, Keynesianism reverberated through university economics departments as the reigning orthodoxy, especially at Harvard, where the young John Kenneth Galbraith became so enamored of Keynes that he made a 1937 pilgrimage to Cambridge to study with the master. Roosevelt’s successor, Harry Truman, was famous for his disdain for economists—he declared that he wanted to meet a one-handed economist so as not to hear the words “on the other hand”—but his Employment Act of 1946 was essentially a Keynesian document toned down to meet Republican concerns about deficits.

Dwight D. Eisenhower might have been a Republican, but, according to Wapshott, he “spent taxpayers’ money like no peacetime president had before him, although he overcame conservative objections by passing off the expenditures as essential for national security.” (The Interstate Highway System that Eisenhower spearheaded in 1956 went under the moniker of the National Defense Highway program.) As Wapshott explains, Eisenhower was the first president to realize that government manipulation of the economy could be put to political use, to help win elections. That lesson got driven home the hard way in 1960, when a recession occasioned by Eisenhower’s belated attempts to cut public spending swept John F. Kennedy into the White House later that year. Writes Wapshott: “[S]uccess at the ballot box comes from managing the economy to bring the business cycle into line with the four-year electoral cycle.” Kennedy, and especially his big-spending successor Lyndon B. Johnson, learned that lesson well.

The fact that the 1960s represented an apex of prosperity for all classes of Americans helped. In 1965, Time made Keynes its Man of the Year, even though he had been dead for nearly two decades. Keynesianism underlay Nixon’s attempts at wage and price controls (not to mention his abandonment of the gold standard), Gerald Ford’s acquiescence in more of the same, and Jimmy Carter’s 1978 endorsement of the Humphrey-Hawkins Full Employment Act, which required the president and the Federal Reserve to keep aggregate demand high enough to guarantee everyone a job.

There was a respite during the late 1970s, when the chickens came home to roost: In the United States, there was “stagflation,” that combination of galloping unemployment and runaway price hikes that was not supposed to occur under Keynes’s paradigm; in Britain, there was a decline in living standards in an oppressively state-run economy. In 1979, Margaret Thatcher, who had read The Road to Serfdom as an Oxford undergraduate and revered the aged Hayek, became prime minister and began dismantling Britain’s bloated public sector. The following year, Ronald Reagan was elected president, with Hayek’s disciple Milton Friedman as an adviser. After a brief, inflation-killing recession attributable to Hayek’s tight-money policies that Reagan promptly put into effect, America bounded into “Reaganomics”-fueled prosperity. And yet, neither Reagan nor Thatcher could effect the near-privatized society that Hayek envisioned. Reagan, in particular, could not resist tinkering, as with the Reagan tax cuts (disapproved of by Hayek because there were few commensurate spending cuts). As a result, America went from the world’s largest creditor to the world’s largest debtor by the time Reagan left the White House.

It was the old problem, identified here by Wapshott: that it is more politically productive for a democratically elected government to manipulate prosperity into existence—even a short-lived and ultimately catastrophically damaging existence—than to allow market forces to run their course and generate the equilibrium that Hayek and the classical liberals predicted. Hence, such phenomena as George H. W. Bush’s 1990 tax hikes, despite his read-my-lips pledge; Newt Gingrich’s Contract with America, which was supposed to cut Big Government; Bill Clinton’s flirtations with Keynesian stimuli; and George W. Bush’s own capitulation to stimulus programs and massive bailouts in 2008, as recession crashed over the economy like a tidal wave.

Of course, Barack Obama’s presidency has been a kind of Keynesian dream come true, starting with an $800 billion stimulus package and including massive government investment in “green” technology (think Solyndra) and the shuffling of millions more Americans onto the dole by way of record food-stamp enrollment, near-interminable unemployment benefits, and the easing of work requirements meant to spur people off the welfare rolls. And all of this has been paid for, so to speak, by way of aggregate federal borrowing that is rapidly approaching $17 trillion.

There is, as Hayek might have predicted, no evidence that any of these panaceas has actually worked. So perhaps it is high time to give Hayek a chance to prevail in the Keynes-Hayek skirmishes—although, given the perennial allure of borrowed federal money, it’s probably more like a fat chance. 

Charlotte Allen is a frequent contributor to The Weekly Standard.