Did Hayek Advocate Public Works in a Depression?

The answer to the question posed in the title of my post depends on the proper interpretation of passages in Hayek’s essay “The Campaign Against Keynesian Inflation” (in New Studies in Philosophy, Politics, Economics, and the History of Ideas, London, 1978, pp. 191–232) and in “The Gold Problem” (published in 1937; see Hayek 1999: 169–185).

The context of the first passage is clearly Hayek’s response to the charge that he advocated deflationary depression as a solution in the early 1930s:

“… a ‘secondary depression’ caused by an induced deflation should of course be prevented by appropriate monetary counter-measures. Though I am sometimes accused of having represented the deflationary cause of the business cycles as part of the curative process, I do not think that was ever what I argued. What I did believe at one time was that a deflation might be necessary to break the developing downward rigidity of all particular wages which has of course become one of the main causes of inflation. I no longer think this is a politically possible method and we shall have to find other means to restore the flexibility of the wage structure than the present method of raising all wages except those which must fall relatively to all others. Nor did I ever doubt that in most situations employment could be temporarily increased by increasing money expenditure. There was one classical occasion when I even admitted that this might be politically necessary, whatever the long run economic harm it did.

The occasion was the situation in Germany in, I believe, 1930 when the depression was beginning to get quite serious and a political commission—the Braun Committee—had proposed to combat it by reflation (though that term had not yet been coined), i.e., a rapid expansion of credit. One of the members of the committee, in fact the main author of the report, was my late friend, Professor Wilhelm Röpke. I thought that in the circumstances the proposal was wrong and wrote an article criticising it. I did not send it to a journal, however, but to Professor Röpke with a covering letter in which I made the following point:

‘Apart from political considerations I feel you ought not—not yet at least—to start expanding credit. But if the political situation is so serious that continuing unemployment would lead to a political revolution, please do not publish my article. That is a political consideration, however, the merits of which I cannot judge from outside Germany but which you will be able to judge.’

Röpke’s reaction was not to publish the article, because he was convinced that at that time the political danger of increasing unemployment was so great that he would risk the danger of causing further misdirections by more inflation in the hope of postposing the crisis; at that particular moment this seemed to him politically necessary and I consequently withdrew my article.

To return, however, to the specific problem of preventing what I have called the secondary depression caused by the deflation which a crisis is likely to induce. Although it is clear that such a deflation, which does no good and only harm, ought to be prevented, it is not easy to see how this can be done without producing further misdirections of labour. In general it is probably true to say that an equilibrium position will be most effectively approached if consumers’ demand is prevented from falling substantially by providing employment through public works at relatively low wages so that workers will wish to move as soon as they can to other and better paid occupations, and not by directly stimulating particular kinds of investment or similar kinds of public expenditure which will draw labour into jobs they will expect to be permanent but which must cease as the source of the expenditure dries up.” (Hayek 1978: 210–212).

A more striking statement by Hayek on public works can be found in another passage in Hayek’s essay “The Gold Problem” (originally published in 1937 as “Das Goldproblem,” but available in an English translation in Hayek 1999: 169–185):

“Even though there are many concerns about organizing public works ad hoc during a depression, everything speaks in favour of having public agencies perform during a depression whatever investment activities need to be carried out in any case and can possibly be postposed until then. It is the timing of these expenses that presents a problem, since funds are often extremely hard to raise in the midst of a severe depression and the accumulation of reserves in good times generally faces the objections mentioned above. There is little question that in times of general unemployment the state must intervene to mitigate genuine hardship either by disbursing unemployment compensation or, as in earlier times, by legislation to help the poor. (Hayek 1999 [1937]: 184).

I would be curious to see other discussion of these passages in the scholarly literature, and especially the last one. Ebenstein, for example, maintains that Hayek was still disinclined to support public works though he conceded that they might work (Ebenstein 2003: 70–71; cf. Guest 1997: 59).¹ In The Road to Serfdom (1944), Hayek appears to accept the possibility of public works spending even if “in experimenting in this direction we shall have carefully to watch our step if we are to avoid making all economic activity progressively more dependent on the direction and volume of government expenditure” (Hayek 2001 [1944]: 126).²

If fact, if Hayek really meant what he said in “The Gold Problem” all the rubbish one sees in Russ Roberts and John Papola’s Keynes vs. Hayek rap videos should be doubly embarrassing to them. In these videos they try and smear Keynesian countercyclical policy as “central planning,” yet it would appear that Hayek may actually have supported such a policy in a depression. Evidently the good Professor Roberts and Mr Papola should have read their Hayek more carefully. Perhaps they should make a new video exposing Hayek as a “wicked” and “evil” central planner, himself advocating policies that would take us down the dreaded road to serfdom.

But let’s turn to more serious points that emerge from these passages above:

(1) Hayek appears to have opposed deflationary depression in Weimar Germany in the early 1930s because of the political harm it would do, which presumably refers to the rise of Hitler and his Nazi party. He showed great astuteness there, a quality lacking in many of his modern Austrian progeny. Hayek’s solution was apparently increasing employment temporarily “by increasing money expenditure.”

(2) If Hayek really wanted to provide “employment through public works at relatively low wages so that workers … move as soon as they can to other and better paid occupations” by government deficit financing or by money creation, then how is his solution to secondary deflation fundamentally different from a Keynesian one? The answer is that it would not be: Hayek comes very close here to advocating a Keynesian solution to the depression, if (and I emphasise this) the political considerations warrant it. This is still quite a startling insight.

(3) This statement from Hayek shows a side to him that should be driven home to modern Austrians:

“There is little question that in times of general unemployment the state must intervene to mitigate genuine hardship either by disbursing unemployment compensation or, as in earlier times, by legislation to help the poor.”

That should warm the heart of any social democrat. We should reclaim the Hayek who wrote that sentiment. Hayek was a Classical liberal who accepted the argument for a minimal state and here even state welfare for people in distress. If Hayek was pressed, how would he have justified such government welfare in ethical terms? I suspect he would have appealed to some utilitarian/consequentialist ethical theory, a theory which Mises also adhered to. Hayek was really far from the insanity of modern Rothbardian anarcho-capitalists with their natural rights propertarian ethical theory, which, when taken to its logical conclusion, would entail the destruction of our species.

Of course, it really doesn’t matter to me whether Hayek advocated quasi-Keynesian policies in a depression in some circumstances. I think his economics is mostly wrong. But the sight of Hayek advocating public works spending is certainty of historical interest. It certainly puts Hayek in a different category from the hordes of Rothbardian Austrians urging liquidationism as the right solution in cases of recession or depression in all circumstances.

George Selgin in his recent LSE debate with Skidelsky took Keynesians to task for (allegedly) smearing Hayek as a supporter of liquidationism in the early 1930s. But now it looks like Keynesians could turn the tables on Selgin: it was not mere monetary stabilisation that Hayek urged but fiscal policy. Is that what Selgin would support in a deep depression or to stop a deep depression from happening?

It is relevant here to note that the Austrian radical subjectivist Ludwig Lachmann also believed that a Keynesian solution to a deep depression could have worked:

“Policies based on Keynesian macro-economic recipes might have succeeded (had they then been tried) in 1932 and did succeed in 1940 because it so happened that at the bottom of the Great Depression as well as during the Second World War all sectors of the economy were equally affected. In 1932 any kind of additional spending on whatever kind of goods would have had a favourable effect on incomes because there was unemployment everywhere, as well as idle capital equipment and surplus stocks of raw materials.” (Lachmann 1973: 50).

Notes
(1) Ebenstein says: “Hayek became considerably more integrated with the rest of economic academia, at least with respect to practical policy and personal comity—though not with respect to emerging mathematical method—after his initial grand entry at the London school of Economics. While he did not backtrack from his fundamental analyses, he countenanced and even advocated that activist monetary policies could be appropriate policy and that even public works might have a role to play in evening out the vagaries of the business cycle— though he was disinclined to take the latter direction because it ‘might lead to much more serious restrictions of the competitive sphere.’” (Ebenstein 2003: 70–71).

(2) I would also note that Hayek’s support for monetary stabilisation in his earlier writings is inconsistent with his call for monetary denationalisation later in life. How would the state prevent a collapse in the money supply when it had no control over it?

BIBLIOGRAPHY
Ebenstein, A. O. 2003. Hayek’s Journey: The Mind of Friedrich Hayek, Palgrave Macmillan, New York and Basingstoke.

Guest, C. 1997. “Hayek on Government: Two Views or One?,” History of Economics Review 26: 51-67.

Hayek, F. A. von. 1937. “Das Goldproblem,” Österreichische Zeitschrift für Bankwesen 1.9 (September): 255–271. [English translation in Hayek 1999].

Hayek, F. A. von. 1978. New Studies in Philosophy, Politics, Economics, and the History of Ideas, Routledge & Kegan Paul, London.

Hayek, F. A. von. 1999. “The Gold Problem” (trans. G. Heinz), in S. Kresge (ed.), The Collected Works of F. A. Hayek. Volume 5. Good Money, Part 1. The New World, Routledge, London. 169–185.

Hayek, F. A. von. 2001 [1944]. The Road to Serfdom, Routledge, London.

Lachmann, L. M. 1973. Macro-Economic Thinking and the Market Economy: An Essay on the Neglect of the Micro-Foundations and its Consequences, Institute of Economic Affairs.

Ludwig Lachmann on Government Intervention

I have recently read this interesting passage in a book by Gene Callahan:

“Because of his focus on uncertainty, Lachmann came to doubt that, in a laissez-faire society, entrepreneurs would be able to achieve any consistent meshing of their plans. The economy, instead of possessing a tendency toward equilibrium, was instead likely to careen out of control at any time. Lachmann thought that the government had a role to play in stabilizing the economic system and increasing the coordination of entrepreneurial plans. We call his position ‘intervention for stability.’” (Callahan 2004: 293).

The question immediately arises: what government interventions did Lachmann support?

I have yet to find passages in Lachmann’s writings that support government interventions “for stability.” Lachmann appears to have accepted a small state, as in Mises’s Classical liberal conception of government:

“[sc. Lachmann thought that] … government intervention in economic affairs should be minimal. The role of government should be as circumscribed as possible and conform to the classical liberal ideal of supporting the free market by strengthening the institutions of private property and voluntary business contract.” (Grinder 1977: 22).

Perhaps Lachmann’s idea of interventions for stability refers to the admission by some Austrians that an economy can suffer a “secondary deflation” that will plunge it into unnecessary suffering, and that some kind of monetary stabilisation is required.

This appears to have been Hayek’s position late in life, as he retreated from his liquidationist extremism:

“Although I do not regard deflation as the original cause of a decline in business activity [sc. after 1929], such a reaction has unquestionably the tendency to induce a process of deflation – to cause what more than 40 years ago I called a ‘secondary deflation’ – the effect of which may be worse, and in the 1930s certainly was worse, than what the original cause of the reaction made necessary, and which has no steering function to perform. I must confess that forty years ago I argued differently. I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way” (Hayek 1978: 206).

In saying this, Hayek presumably would have accepted a monetarist solution of stabilizing the money supply by open market operations and other interventions.

The effects of “secondary deflation” are also acknowledged by Roger Garrison:

“Deflation caused by a severe monetary contraction is another matter. Strong downward pressures on prices in general put undue burdens on market mechanisms. Unless, implausibly, all prices and wages adjust instantaneously to the lower money supply, output levels will fall. Monetary contraction could be the root cause of a downturn - as, for instance, it seems to have been in the 1936–7 episode in the USA. The Federal Reserve, failing to understand the significance of the excess reserves held by commercial banks, dramatically increased reserve requirements, causing the money supply to plummet as banks rebuilt their cushion of free reserves. But what caused the money supply to fall at the end of the 1920s boom? The monetarists attribute the monetary contraction to the inherent ineptness of the central bank or to the central bank’s (ill-conceived) attempt to end the speculative orgy in the stock market, an orgy that itself goes unexplained. In the context of Austrian business cycle theory, the collapse in the money supply is a complicating factor rather than the root cause of the downturn. In 1929, when the economy was in the final throes of a credit-induced boom, the Federal Reserve, uncertain about just what to do and hampered by internal conflict, allowed the money supply to collapse. The negative monetary growth during the period 1929 to 1933 helps to account for the unprecedented depth of the depression.” (Garrison 2005: 515).

“The problem of policy-induced intertemporal discoordination can easily get compounded by a loss of business confidence and/or by a collapse of the banking system. These complicating factors can cause the economy to suffer a general economic contraction.” (Garrison 2002: 249).

A more interesting admission is made by Jesus Huerta de Soto:

“As Austrian economists in general and Mises in particular demonstrated as early as 1928, in the specific event that idle resources and unemployment are widespread, entrepreneurs, relying on new loans, may continue to lengthen the productive structure without provoking the familiar reversion effects, until the moment one of the complementary factors in the production process becomes scarce.⁶⁶ At the very least, this fact shows Keynes’s so-called general theory to be, in the best case, a particular theory, applicable only when the economy is in the deepest stages of a depression with generalized idle capacity in all sectors.”⁶⁷
….
⁶⁶ Mises, On the Manipulation of Money and Credit, p. 125 (p. 49 of Geldwertstabilisierung und Konjunkturpolitik, the German edition).

⁶⁷ For Roger Garrison, the true general theory is that of the Austrians and “Keynesian theory [we would also say monetarist theory] becomes a special case of Austrian theory.” See Garrison, Time and Money, p. 250.

(Huerta de Soto 2006: 553).

Of course, Huerta de Soto then goes on to deny that government intervention will work in such circumstances, but the concession that he attributes to Garrison - that Keynes’ theory might work “when the economy is in the deepest stages of a depression with generalized idle capacity in all sectors” - is quite an admission. What else was the Great Depression?

To return to Lachmann, I am curious to know if other people have read anything of Lachmann’s arguments for government interventions “for stability.”


BIBLIOGRAPHY

Callahan, G. 2004. Economics for Real People: An Introduction to the Austrian School (2nd edn), Ludwig von Mises Institute, Auburn, Ala.

Garrison, R. W. 2002. Time and Money: The Macroeconomics of Capital Structure, Routledge, London.

Garrison, R. W. 2005. “The Austrian School,” in B. Snowdon and H. R. Vane (eds), Modern Macroeconomics: Its Origins, Development and Current State, Edward Elgar, Cheltenham.

Grinder, W. E. 1977. “In Pursuit of the Subjective Paradigm” [Introduction], in L. M. Lachmann, Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy (ed. by W. E. Grinder), Sheed Andrews and McMeel, Kansas City.

Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala.

Hayek on Secondary Deflation

Austrians frequently assert that deflation is not to be feared, and even that deflation has no undesirable consequences. One of the more absurd statements from their literature is by Murray Rothbard. This can be found in Man, Economy, and State (p. 766):

“Goods are useful and scarce, and any increment in goods is a social benefit. But money is useful not directly, but only in exchanges. And we have just seen that as the stock of money in society changes, the objective exchange-value of money changes inversely (though not necessarily proportionally) until the money relation is again in equilibrium. When there is less money, the exchange-value of the monetary unit rises; when there is more money, the exchange-value of the monetary unit falls. We conclude that there is no such thing as ‘too little’ or ‘too much’ money, that, whatever the social money stock, the benefits of money are always utilized to the maximum extent. An increase in the supply of money confers no social benefit whatever; it simply benefits some at the expense of others, as will be detailed further below. Similarly, a decrease in the money stock involves no social loss. For money is used only for its purchasing power in exchange, and an increase in the money stock simply dilutes the purchasing power of each monetary unit. Conversely, a fall in the money stock increases the purchasing power of each unit” (Rothbard 2004 [1962]: 766).

Rothbard clearly never heard of debt deflation or Irving Fisher’s debt deflation theory of depressions, or if he did never properly understood the process, and one cannot take seriously his view that “a decrease in the money stock involves no social loss.”

Hayek, to his credit, had a different view of the role of deflation in 1929–1933, at least later in life:

“There is no doubt, and in this I agree with Milton Friedman, that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation! So, once again, a badly programmed monetary policy prolonged the depression” (Pizano 2009: 13).

Hayek, then, argued that a secondary deflation had negative effects on the US economy after 1929 and admitted that his earlier views had been wrong:

“Although I do not regard deflation as the original cause of a decline in business activity, such a reaction has unquestionably the tendency to induce a process of deflation – to cause what more than 40 years ago I called a ‘secondary deflation’ – the effect of which may be worse, and in the 1930s certainly was worse, than what the original cause of the reaction made necessary, and which has no steering function to perform. I must confess that forty years ago I argued differently. I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way” (Hayek 1978: 206).

In saying that he agreed with Milton Friedman, however, Hayek presumably would have accepted a monetarist solution of stabilizing the money supply by open market operations and other interventions, but not a Keynesian solution of fiscal policy.

Despite the acknowledgement that some monetary intervention was necessary in situations like 1929–1933, Hayek still failed to see that mere monetary stabilization will not stop debt deflationary collapse.

Merely preventing a contraction of the money supply by itself will not prevent price deflation when it is caused by a severe contraction of aggregate demand, through deleveraging, shocks to business confidence, net negative changes in debt, and a slump in consumption and investment. To prevent such crashes, fiscal policy and more radical interventions to fix broken financial systems are necessary.

If monetary policy were really all that is needed to prevent price deflation, then why did Japan’s ZIRP in the 1990s not prevent the descent into price deflation in 1999? And why did price deflation persist in Japan for years after the beginning of quantitative easing in 2001?

UPDATE

I have a new post here related to this one on Rothbard’s view of deflation:

http://socialdemocracy21stcentury.blogspot.com/2011/01/rothbard-refutes-rothbard-on-effects-of.html


BIBLIOGRAPHY

Hayek, F. A. 1975. A Discussion with Friedrich A Von Hayek, American Enterprise Inst., Washington.

Hayek, F. A. 1978. New Studies in Philosophy, Politics, Economics and the History of Ideas, Routledge & Kegan Paul, London.

Pizano, D. 2009. Conversations with Great Economists, Jorge Pinto Books Inc., New York.

Rothbard, M. N. 2004 [1962]. Man, Economy, and State: A Treatise on Economic Principles, Ludwig von Mises Institute, Auburn, Ala.