Book review: Keynes vs Hayek

Book Review of Nicholas Wapshott’s “Keynes Hayek: The Clash that Defined Modern Economics” by Owen MBA, Duke Useni.

Nicholas Wapshott tells the story of an economic debate that persists until today: to what extent should government have a role in the economy.  It tells the personal and professional stories of economists John Maynard Keynes and Friedrich Hayek with engaging and lucid depth. Last year’s debt ceiling debate in Washington DC is an indicator of this debate’s relevance today.

Keynes essentially invented modern macroeconomics in his “The General Theory of Employment, Interest and Money”.  He argues that government intervention is necessary to solve the problem of unemployment caused by inadequate demand. 

Hayek gained fame in his “Road to Serfdom,” in which he argues that central planning will lead to totalitarianism, and that government spending in a recession will delay the inevitable economic reckoning and will prolong the misery.

Keynes Hayek: The Clash that Defined Modern Economics is a terrific book that has the detail and references to help you find a position in this debate.

NOTE:  Russ Roberts has produced a great pair of MTV-style videos (first, second) that tell the story of Keynes vs. Hayek.  

Book Review: What Can the Rolling Stones Teach You About Economics?

Forbes editor John Tamny spoke at Vanderbilt yesterday to promote his new book "Popular Economics: What the Rolling Stones, Downton Abbey and LeBron James Can Teach You About Economics."

 "A one-man antidote to economic obfuscation and mystification." - George Will 

 "The book establishes Tamny, the editor of RealClearMarkets and the political economy editor at Forbes, as the modern and American Frederic Bastiat." - Veronique de Rugy

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DISCLOSURE: the author is a former student and Vandy Alum

MY TAKE:  The book is filled with fun anecdotes illustrating what Henry Hazlitt called "The One Lesson of Economics:

The art of economics consists in looking not merely at the immediate hut at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

So for example, when you think about taxes, you should look beyond their revenue raising potential, to their negative effect on growth.  In the case of the Rolling Stones, the high marginal income tax rates (83%) and high capital gains taxes (98%) caused the Stones to move production of their "Exile on Main Street" album to the South of France.

Although the effect of the tax on the Stones was probably minimal (after all, the album was produced and turned out great), Tamny asks us to also look at the UK sound engineers, caterers, and anyone else would would have been involved in the production of the album had it been made in the UK.

This is the hardest lesson to teach students, as it asks them to step back from their natural inclination to "do something" to make the world a better place.  But with enough examples like those in the book, students will eventually realize that taxing productive activity to help the less fortunate not only reduces the gains from productivity, but it also increases the gains to becoming less fortunate.  And it is a whole lot more bureaucratic and inefficient.

 These stories also do a good job of updating Hayek's critique of Keynes that the aggregation of modern macroeconomics obscures the real (and perverse) effects of government spending:  stories about individual transactions that were distorted or deterred by government intervention make Hayek's original critique much more accessible.  In fact, in his talk, John often began his answers by reminding us that the macroeconomy is just a collection of individual transactions.

I want to close by saying that it is my second favorite economics book, behind this one.

Were Hayek and Von Mises right?

The Economist seems to think so:

A one-paragraph explanation of the Austrian theory of business cycles would run as follows. Interest rates are held at too low a level, creating a credit boom. Low financing costs persuade entrepreneurs to fund too many projects. Capital is misallocated into wasteful areas. When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up.

• Were interest rates held too low? The case seems self-evident for Ireland and Spain, where the European Central Bank was setting a one-size-fits-all monetary policy. Many people would also argue that the Federal Reserve kept rates too low. Some lay the housing boom of 2003-06 at the Fed’s door,

• Was capital misallocated? Again most people would accept that too many houses and apartments were built in Ireland and Spain, as well as individual American states like Florida and Nevada. In some places these dwellings may sit idle for a while, keeping downward pressure on property prices.

• Economists who would not describe themselves as Austrian have reached conclusions that chime with Hayek. Carmen Reinhart and Kenneth Rogoff, in their book “This Time is Different”, argued that past financial crises have been followed by long periods of sluggish growth.

The wisdom of blog readers

Our friends over at Organizations and Markets celebrate their 5th year of blogging with a list of the most popular blog posts. Its a fun read.

Management Journal Impact Factors 2008
PhD Candidate Shortage in Accounting
Agency Theory in Management
Method versus Methodology
Physics Envy and All That
Agency Theory and Intrinsic Motivation
21 Economic Models Explained
The University of Phoenix and the Economic Organization of Higher Education
Management Journal Impact Factors 2005
The SWOT Model May Be Wrong
Design Puzzles
Is Entrepreneurship a Factor of Production?
Porter’s Five Forces, Updated
Econ Courses at Open Yale
Four Theories of Profit
Summary of Dodd-Frank Act
Market-Based Management
Why Study the Humanities?
Accounting: A Brief History
Funny Professor Names
Taxes al Carbon
Keynesian Economics in Four Paragraphs
The New Bashing of Economics: The Case of Management Theory
One Part of the Financial Sector Is Still Growing
Management Journal Impact Factors 2009
In Praise of the US Auto Industry
Contronymns
How Does Management Affect Capabilities?
Management Journal Impact Factors 2006
March & Simon: Early Socialist Calculation Revisionists
Do We Need a Project Project?
Has Corporate Corruption Increased?
Coase and the Myth of Fisher Body
The Logic of Appropriateness
John Nash’s Dissertation
The History of Marketing
The Hawthorne Effect Revisited
What Would Hayek Say?
Why Did the Chicken Cross the Road: Strategic Management Edition
How to Read an Academic Article

Keynes vs. Hayek (Cochrane)

John Cochrane reminds us who won the policy debates of the 1930's:

Most fiscal stimulus arguments suffer from three basic fallacies.

First, if money is not going to be printed, it has to come from somewhere. ... Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending.

Second, investment is “spending” every bit as much as consumption. Fiscal stimulus advocates want money spent on consumption, not saved. ... But the economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.

Third, people must ignore the fact that the government will raise future taxes to pay back the debt. If you know your taxes will go up in the future, the right thing to do with a stimulus check is to buy government bonds so you can pay those higher taxes. Now the net effect of fiscal stimulus is exactly zero, except to raise future tax distortions. The classic arguments for fiscal stimulus presume that the government can systematically fool people.

Instead of fiscal stimulus, Cochrane advises us to rebuild credit markets:

The first step is to stop chaotic interventions. Who would buy bank stock, lend long-term, or buy securitized debt, knowing that the government might rewrite the rules at any point? Second, the government must focus on the policy issue, which is making sure new savings can flow to new borrowing, not who takes the hit for old bad loans.

Keynes vs. Hayek, round II

The effects of tornados

A colleague at University of Alabama sent a note about the recent tornado:

It was very, very bad. The tornado cut all the way across town. Many communities were devastated and many businesses destroyed. The town will recover, but there is a great deal of rebuilding to do.

Our prayers and thoughts go out to Tuscaloosa, especially those who lost loved ones.

As the community rebuilds, income will increase. But no one would argue that the people of Tuscaloosa are better off. This fallacy (?) features prominently in the Keynes vs. Hayek debate, round 2:

Markets Reveal Value

A recent article in the WSJ reports that:

Four mutual-fund companies have marked down their investments in Uber Technologies Inc. by as much as 15%, the first such price cuts that suggest these investors are souring on the ride-hailing giant following a scandal-ridden year.

A 15% swing in price in one day is huge. This happens because Uber is privately held and there isn't an organized market for the shares. They do not have to announce write downs of their shares in, say, GM or Merck. They simply check their favorite financial news site. But they likely had a team gathering information and poring over the numbers in order to come up with the new Uber price point. This is costly. One of the great virtues of markets (described beautifully by Hayek) is that they reveal value to the uninformed nearly costlessly. Yet another reason economists are so infatuated with markets.

DC replaces NY

One of my former students is a sell-side analyst who follows the construction industry. Instead of conference calls with the companies she tracks, she now spends her time traveling to Washington. One of von Hayek's biggest criticism of Keynes is that politicians, rather than markets, allocate capital.

The chart at left identifies the new winners and losers of the Obama regime, i.e., those who can curry government favor.