KEYNES VS HAYEK DEBATE : What is the Role of the State in Economic Growth ?
Document 1: F. Hayek, a liberal economist
Friedrich Hayek (1899-1992) was an Austrian (later British) economist and philosopher born in Vienna. He believed that the government should play a minimal role in the running of society. He was against any efforts to redistribute income in the name of social justice. He was also an opponent of the policies advocated by John Maynard Keynes designed to moderate the instability of the economy and the insecurity of employment.
Hayek’sbook Road to Serfdom was written against the backdrop of the second world war, where economic planning was being used both by German and Japanese fascist regimes, and on the Allied side, by the Soviet communist authorities and British and American governments. He argued that well-intentioned planning would inevitably lead to a totalitarian outcome.
His key idea, one that revolutionised how economists think about markets, is that prices are messages : they convey valuable information about how scarce a good is, information that is available only if prices are free determined by supply and demand, rather than by the decision of a planner.
Source : manuel en ligne core-econ, Chapter 9, Market Dynamics, p. 4
Document 2: The Keynesian Revolution
The essential element of Keynesian economics is the idea that the macroeconomy can be in disequilibrium (recession) for a considerable time. Keynesian economics advocates government intervention to help overcome the lack of aggregate demand to reduce unemployment and increase growth. Since John Maynard Keynes’ work, published in the 1930s, we know how government can intervene to reduce unemployment and stabilize economy. Increasingly since World War Two (1939-45) it is seen as a task of the government to intervene and work more actively to improve things in general. Interventionism is now expected. The natural working of the economy can sometimes give undesirable or unacceptable results, such as mass unemployment or inflation.
An important classical assumption stated that supply creates demand. However, Keynes believed the opposite was true. Keynes argued – demand determines the level of national output.
A classical economic theory was that any unemployment was due to wages being artificially kept above the equilibrium through minimum wages. According to classical theory, the solution to unemployment is to cut wages and allow wages to clear. However, Keynes argued this was unsatisfactory. A cut in wages wouldn’t necessarily solve disequilibrium. Lower wages would further depress income and spending, leading to lower aggregate demand, and therefore lower demand for labour.
Keynes was critical of the UK 1931 budget, which cut wages for hospital workers, and cut back spending on roads and new houses. He argued this would depress demand further and make the recession worse. Instead he advocated higher government spending financed by higher borrowing.
The Great Depression only ended in the UK and US, when government spending on military caused sufficient demand. Though, there is evidence partial stimulus. The problem with Keynesianism is that governments are often too timid – unless there is a war.
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Document 4 Keynes and Hayek, Prophets for today
Mar 14th 2014, 16:43 by C.R. | LONDON
(…) That has often been portrayed more recently as a battle between two economic titans. Hayek, in the 1970s, came to be seen as opposing everything Keynes and the Keynesian consensus stood for. (…)
But Keynes himself in fact did not dislike many of Hayek's ideas in the "Road to Serfdom". On the contrary, he had indirectly helped Hayek to write it. When Hayek and the rest of the London School of Economics moved to Cambridge in 1940 to escape the Blitz in London, Keynes found him rooms at his college, King's, to live and work in, and the two remained in regular contact until Keynes' death in 1946. Ideologically, they also sang from the same hymn sheet: both were liberals with a distaste for authoritarian regimes such as communism and fascism. (…)
Keynes rejected the populist interpretation of Hayek's argument—that any increase in state planning is the first step on the way to tyranny—but agreed with the overall view that the bounds of state intervention needed to be clearly defined for liberal democracy to remain safe (and more explicitly than even Hayek himself did in the book). Receiving an early copy of the "Road to Serfdom" from Hayek personally, Keynes wrote back to him, praising the book. But Keynes thought Hayek should have been more explicit in what sort of red lines would be necessary for increased state intervention not to imperil liberty: “You admit here and there that it is a question of knowing where to draw the line. You agree that the line has to be drawn somewhere, and that the logical extreme [total laissez-faire policies] is not possible. (…)”
In short, Keynes took the lessons of Hayek's work as a warning that the expansion of state should be limited and politicians need to know when to stop—which he fundamentally agreed with. Although he thought more state control in some areas may be justified, governments always need to demark a line beyond which they do not traverse.