Clash of the Titans

Thomas Boylan

Keynes Hayek: The Clash that Defined Modern Economics, by Nicholas Wapshott, WW Norton & Company, 400 pp, £12.99, ISBN 978-0393343632

One must have a sneaking admiration for Nicholas Wapshott for taking on the challenging task of negotiating the “clash” between Keynes and Hayek, which he claims has shaped some of the pivotal debates of twentieth century economic theory and policy. Wapshott is not an economist, and does not appear nor claim to have had any exposure to formal economics. He is a former senior editor of the London Times and the New York Sun, and has written a number of biographies, along with two works on political figures, Thatcher, with George Brock (1983) and more recently Ronald Reagan and Margaret Thatcher: A Political Marriage (2007).

The timing of this book is opportune, with the world economy in its fifth year of crisis, the euro zone lurching painfully we hope towards a “resolution” of its crisis, and a recent presidential campaign in the United States, where interestingly the vice-presidential candidate on the Republican side declared himself an enthusiastic advocate of Hayek’s ideas. The intellectual conflict, the “clash” of Wapshott’s title, has rumbled on for over eighty-five years since it first emerged in the late 1920s. The clash between the respective economic roles of government on the one hand and free market mechanisms on the other, which lay at the centre of the Keynes-Hayek encounter, finds resonance in a good deal of our debates on the search for a solution to our current crisis. Towards the end of this book, Wapshott is of the opinion, as was Hayek at the end of his long life – he died in 1992 at the age of ninety-three – that the clash with Keynes was perhaps more an inevitable difference about visions of economic policy rather than a clash of economic ideas. These differences arise arguably from their different intellectual and cultural backgrounds, historical experiences and the influence of personality differences. One can distinguish a Keynesian pragmatism underlain by a sustained optimism in the capacity of intelligence to inform and influence correct responses to any crisis, as against a Hayekian market morality that reflected an altogether more pessimistic view of human behaviour, and certainly any collective endeavour, as a correct response to social and economic crises.

Wapshott’s insight is only partially correct, and as with most aspects of this clash, economic ideas are central and remain so, even after eighty-five years. These ideas have of course been subject to modification, adjustments, and re-interpretation. The Keynesian re-interpretation industry, which began within a year of publication of his magnum opus, The General Theory of Employment, Interest and Money, in 1936, has produced arguably one of the most voluminous bodies of literature in twentieth century economics. Meanwhile the Hayek-academic industry has its own momentum, but would come in well behind the Keynesian in horse-racing parlance. Wapshott, not being an economist and playing to his strength as a professional journalist, has produced a lucid and accessible account of this clash of titans of twentieth century economics, along with their followers, both academic and political. Inevitably this must involve considerable simplification on Wapshott’s part, but on balance he has negotiated a very difficult terrain with considerable skill, which is itself a very considerable achievement. His organisational strategy is to focus not so much on economic theory as on its relevance to economic policy-making. In this the author has absorbed an extensive literature, with respect to both Keynes and Hayek, a good deal of it of recent vintage, reflecting the continuing skirmishes in this ongoing ideological struggle.

How is one to make sense of this clash between Keynes and Hayek over such an extended period? There are, at least, three phases in the dynamics. The first is what could be termed the formative phase that shaped the intellectual and ideological orientations of the protagonists in their respective environments of England and Austria. What was established in this phase also defined the intellectual and ideological battle-lines that would inform what Thomas Kuhn would later describe as the foundations of their respective paradigms. This covered the post-World War I period up to 1928, when they met for the first time when Hayek was invited to lecture in England.

The second phase, which extended from 1928 to the mid-1940s, could be termed the theoretical one and represented the relentless search for the theoretical underpinnings of their respective intellectual positions that had taken shape earlier. This was the period that saw the production of their major theoretical economic works, all of which were, as Wapshott would have it, essentially a dialogue between the two men. It was also something of a dialogue of the deaf, conforming very closely to Kuhn’s concept of “incommensurability” between their respective paradigms. The dialogue was also characterised by an intensity of argumentation that at times came perilously close to violating the norms of civility and courtesy in academic exchanges. While there was much at stake for Keynes and Hayek, and notwithstanding the intensity of their exchanges, neither man ever lost their mutual respect for their final positions. Wapshott documents very engagingly this mutual academic respect and indeed the enduring friendship between them.

The final phase is ushered in with the publication of Hayek’s The Road to Serfdom in 1944, by which time he had completed all his major economic works, and this book represented his turn to political philosophy and political theory, in which he made significant and enduring contributions. Keynes was dead, aged sixty-two, within two years of the publication of The Road to Serfdom and this final phase of the clash is characterised by the fluctuating fortunes of their impact on economic theory, and more particularly on economic policy and politics, for the remainder of the twentieth-century and into the new century. Their respective impact and influence first gave rise to the “Age of Keynes” for the first thirty years following the Second World War, and then to an “Age of Hayek”, though this is arguably to inflate somewhat the latter’s influence. Any one of these three phases warrant book-length studies in their own right, and aspects of each phase have indeed been the subject of detailed studies, but Wapshott to his credit attempts to embrace and cover all three, albeit to different degrees and with variable degrees of success. To understand the fundamental aspects of the “clash”, insight into the formative phase of this narrative is arguably the most important, notwithstanding Wapshott’s allocation of effort in his book. It was in this period that the intellectual commitments and orientation of both men were initially articulated and then adhered to throughout their respective careers. Consequently our attention in this review will focus primarily, but not exclusively, on this phase of Wapshott’s narrative.

The formative phase for Hayek was in post-World War I Vienna, where he encountered two major influences that arguably shaped his entire later intellectual orientation. One was the raging inflation that engulfed Germany and large parts of central Europe, including Austria. Hayek’s first salary, as a legal assistant in the University of Vienna in 1921 amounted to five thousand old kronen. The following month he was paid fifteen thousand kronen to compensate for the fall in the value of the currency. By July 1922 he was receiving a million kronen; hyper-inflation, and the havoc it would cause, was now a horrific reality. This had an enormous influence on Hayek and for the rest of his life he would vehemently oppose any course of action that would facilitate inflation, an issue that would loom large in his dispute with Keynes. Ironically, Keynes in his celebrated monograph, The Economic Consequences of the Peace (1919), which represented the most stringent critique of the economic implications of the Treaty of Versailles for the defeated countries, identified the dangers of inflation running out of control. If Keynes had never written anything after this short work, it is arguable that he would have been celebrated for its forceful argumentation and prescient conclusions. It was this work that first projected Keynes into the public arena and that enthralled the younger Hayek. Keynes reminded his readers that the undermining of currencies was an invitation to revolution. He quoted Lenin as having declared “that the best way to destroy the Capitalist System was to debauch the currency”. Keynes gave credit to Lenin for his perspicacity when he wrote “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.” Hayek would at this stage have surely agreed with Keynes, though later followers of Hayek would accuse Keynes of being “a crude inflationist”.

If the hyper-inflation of the 1920s represented a horrific existential experience, an experience that ruined thousands of families like the Hayeks, which rendered their savings worthless, undermined the value of their possessions and rendered the government bonds that loyal and patriotic Austrians purchased to fund the war totally valueless, the second major influence on Hayek at this time was in a different domain, namely his exposure to the Austrian School of Economics. When he resumed his academic studies in 1918, he joined the University of Vienna’s law department, which taught economics. The concept of the Austrian School as a collective entity sharing a set of shared doctrines was not as distinct at that time as it would later become following its confrontation with Marxist economists in an intensely animated debate on the possibility of establishing an efficient socialist economy in which the market and its associated price mechanism would be rendered redundant as an allocative mechanism. Against this position, Ludwig von Mises, the twentieth-century successor to Carl Menger, the nineteenth century founder of the Austrian School, argued in a famous paper published in 1920 that the possibility of rational economic calculation in socialism was impossible, since without a free market there is no pricing mechanism, and without a pricing mechanism there is no economic calculation.

It was Mises who undermined any benign dispositions that Hayek might have possessed towards the virtues of socialism. His 1920 Economic Calculation in the Socialist Commonwealth and his influential 1922 Socialism: An Economic and Sociological Analysis fundamentally unsettled even Hayek’s social democratic beliefs and succeeded in convincing him of the undesirable and ultimate falsity of collectivism in any form. At this time Hayek was also absorbing the influence of the other leading figures of the Austrian School. He read Carl Menger’s Principles of Economics (1871) and Investigations into the Method of the Social Sciences (1883), works which established the theoretical foundations of the Austrian School. Menger’s work opposed the nineteenth-century British Classical School by refocusing attention on the centrality of the individual economic agent, in particular, in their role as consumers based on the concept of utility or personal satisfaction. This contrasted with the classical school with its predominant emphasis on production and the costs of production as the major, if not the exclusive, source of value. The classical school had given rise to the labour theory of value at the hands of Ricardo, which was of course adopted and developed by Marx. The Austrian School was part of a major shift in economic theorising from the 1870s which re-oriented economic thinking away from the classical theoretical framework to what became known as the neo-classical mode of theorising. Hayek’s teacher, Friedrich von Wieser, emphasised the central role of prices in understanding how free markets worked to facilitate free exchange among economic agents, along with the role of the entrepreneur in facilitating progress through the development of new products and markets. A pivotal figure in this context was an extremely influential member of the Austrian School, Eugen von Böhm-Bawerk, who devised the very influential Austrian theory of capital and interest, which was central to the theoretical clash between Hayek and Keynes. One other name must be mentioned here, that of the Swedish economist Knut Wicksell, who was the major figure in the theory of money and the business cycle in the early part of the twentieth century, and to whose work both Hayek and Keynes appealed but from which they drew very different conclusions.

By the time Hayek had completed his studies at the University of Vienna, and certainly by the time he first arrived in England in 1928, he was a committed member of the Austrian School, from whose theories and doctrines he would never waiver. Hayek succeeded Mises as the intellectual leader of the Austrian School not only in Europe but in the English-speaking world by virtue of his stay at the London School of Economics and later at the University of Chicago. It is not easy to convey the full array of the canonical doctrinal content of the Austrian School, but the following tenets capture the hard core of their position, and hopefully convey part of the uniqueness of their contribution. Firstly, and in contrast to all other schools of economics, the Austrians insist on a totally a priori approach to framing their understanding of economic agents and their behaviour. Their fundamental principles of what motivates the individual are known with certainty. This position is referred to as their radical subjectivism, with the knowing subject at the centre of their theorising. This position goes back to their protracted dispute with the German Historical School in the nineteenth century, when the German universities were dominated by a historical approach to economics, an approach underlain by a dominant inductivist methodology in the pursuit of economic understanding. This was anathema to the Austrian a priorist deductive methodology. Secondly, the Austrians saw the enhancement of free voluntary exchange between economic agents as the most desirable and indeed the only method of achieving harmonious outcomes between individuals. Hence their commitment to the market as the central economic and social institution to ensure the maximal freedom of the individual in the pursuit of these aims. Finally, money is accorded a crucial role in their conceptual framework. In contrast to classical economic thinking, money is not neutral, in that it can for the Austrians have real effects and depending how it is managed it can and will contribute to producing the business cycle and causing inflation and unemployment. Money is not only accorded a technical function but is also given a much wider social role, in which trust in money as a social institution is crucial in order to guarantee a stable value for the monetary commodity. The confidence engendered by monetary stability is, for the Austrians, the crucial facilitating mechanism for maximising the extent of voluntary exchange and therefore of economic welfare and individual freedom of choice. Consequently inflation or the generation of instability in the value of money will restrict, if not undermine, all of the foregoing advantages arising from a stable monetary regime. A policy of monetary stability is justified for the Austrians on both narrow economic grounds and on the basis of their broader economic and social philosophy. Imbued with this world view and armed with a formidable technical arsenal of economic theory in the form of Böhm-Bawerk’s theory of capital and interest and of Austrian monetary theory, the clash with Keynes was inevitable.

While Hayek in the 1920s moved from a social democratic position into the liberal camp, and later into what many commentators would term a libertarian position, Keynes, a liberal from the outset and who remained a staunch one throughout his life, was being challenged by the changing circumstances in Britain and in particular the high unemployment that dogged the country in the early 1920s. This led him to question the key assumption of his former teacher at Cambridge, Alfred Marshall, that over time an economy would reach a stage of equilibrium at full employment. The urgency of the situation for Keynes was over how much time and by what mechanism would Marshall’s equilibrium at full employment be reached? Between 1921 and 1922 the British economy suffered the horrific combination of high interest rates, high wages, falling prices, a rising pound (which led to trade imbalances) and high unemployment. In July 1923, notwithstanding the economic situation, the Bank of England, in an attempt to maintain the exchange rate, raised interest rates from 3 to 4 per cent. This single event appears to have been a bridge too far for Keynes. The following month at the Liberal Summer School at Cambridge, he launched a blistering attack on the establishment and called for an expanded government role in the management of the economy. In December of the same year he launched a full-scale assault on the government’s reliance on free market ideas to solve its economic problems. Both major biographies of Keynes, Roy Harrod’s in 1952 and Robert Skidelsky’s three-volume study published between 1986 and 2000, point to this particular development, namely the raising of the rate of interest in July 1923, as the beginning of the Keynesian Revolution. Having identified laissez-faire as a primary target, Keynes elaborated on his attack and in the Sidney Ball Memorial Lecture at Oxford, pointedly entitled “The End of Laissez-Faire”, he suggested that the doctrine was spurious, illogical, and had now been overtaken by events. In 1926 he published his celebrated monograph of the same title. This can be viewed as a critical stage of ground-clearing in order to prepare for his replacement of existing theory with an alternative framework and its policy implications. Constructing that alternative theoretical framework, which would justify an expanded role for government in the economy, include the provision of public works, an active and expanded role for fiscal and monetary policy and a co-ordinated strategy of aggregate demand management in order to maintain high levels of employment, would take another decade and would culminate with the publication of his General Theory of Employment, Interest and Money in 1936.

During the 1920s, however, Keynes’s principal academic activity was to elaborate and schematise his understanding of both the theory of money and the practice of banking, and its implications for monetary policy. This endeavour resulted in his A Tract on Monetary Reform (1923), but culminated in his two-volume Treatise on Money of 1930, a work that came to be viewed as an authoritative work on the subject and which further consolidated his reputation. It was Hayek’s review of this work in 1931 in the newly established journal of the London School of Economics that was the spark that ignited the public clash between the two men. Hayek had been brought to the LSE by Lionel Robbins, who had been appointed in 1929 to the chair of political economy. Robbins had served with Keynes on the Macmillan Committee on Finance and Industry, where they clashed on a number of issues and as a result intensely disliked each other. Robbins had ambitions for the school and set about the task of countering the dominant influence of Cambridge, the home of Marshall and Keynes, by introducing developments in European economic thinking. But he was also motivated by a political agenda, in that he increasingly opposed the interventionist, even socialist drift of economic theorising, much of it spearheaded by Keynes and emanating from Cambridge. Robbins was also rare among British economists at this time in that he read German and was familiar with the work of Mises, Wieser and Böhm-Bawerk and the Swede Wicksell, all of whom were either major influences on or former teachers of Hayek. This contrasted with the insularity of the British academic establishment with respect to European economic theorising, something that appalled Hayek on his arrival in Britain. Robbins’s invitation to Hayek to lecture at the LSE had two main aims: to expose British academia to major trends in European economic theorising, but also, more pointedly according to Wapshott, to present a rival view to that of Keynes’s position in the Treatise on Money.

When Hayek arrived at the LSE – we are now in what I earlier termed the theoretical phase of this narrative – he delivered a series of four lectures. These later became the basis for his Prices and Production (1930). In a way the prominence of the clash between Keynes and Hayek could be viewed as the battle of two books, Keynes’s Treatise on Money (1930) and Hayek’s Prices and Production (1931), arguably two of the most turgid tomes produced in the twentieth century. Wapshott devotes no attention to the Treatise on Money, which is at least in keeping with Keynes’s own disposition at the time when he essentially lost interest in a large part of his earlier work and proceeded to change his mind as he focused his full attention on the construction of the General Theory. Wapshott does devote considerable space to Hayek’s four lectures at the LSE, but not to Prices and Production. This is a wise tactic, since the density of that work, with its abstruse theorising, ambiguities and lack of clarity at critical junctures would I suspect have defeated him.

Hayek’s review of the Treatise on Money highlighted the intensity of the clash between them. Hayek accused Keynes of being seriously careless in his definition of terms and charged that his meaning was difficult to decipher and characterised by patent obscurity, that his conclusions did not follow from his premises and that his knowledge of European economic theory was sadly lacking. In a word for Hayek, Keynes knew little of Austrian School economics, in particular its theory of capital, which was underlain by their unique articulation of the “roundaboutness” of the methods of production, which introduced time lapses in production with their implications for savings and investment connected in turn to the time preferences of individual savers and investors. Hayek’s review, while technical in character, was also politically charged and intensely polemical in tone. In the Treatise as in The General Theory, Keynes advocated the very active use of fiscal and monetary policy to stabilise and then maintain levels of aggregate demand, output and employment. The central policy recommendation of the Treatise was what Keynes called “monetary policy à outrance”, a close relative to our current “quantitative easing”, to halt the slump in the international economy. Hayek opposed this monetary activism as highly inflationary within the framework of the Austrian theory of the business cycle and defended the position that the State should not intervene but allow the natural adjustment mechanisms to work themselves out. Keynes, a seasoned master of invective, responded in kind, accusing Hayek of precisely the same faults he had been accused of: opaqueness, serious lack of clarity in the definition of key terms and drawing conclusions that did not follow from his premises. The scene was truly set for a potential extended clash between the two combatants. But shortly after Keynes had replied to Hayek’s review, he conveyed to him that he was turning his full attention to the writing of what would emerge as The General Theory of Employment, Interest and Money. Keynes had other priorities in the circumstances of the Great Depression that by 1931 had the international economy in its grip, and a prolonged debate on the finer points of Austrian capital or business cycle theory were not going to help him solve the unfolding crisis.

Following the publication of The General Theory the “clash”, as Wapshott would define it, was effectively over. The rapid and widespread adoption of both the conceptual framework of The General Theory and its policy implications, first in Britain and shortly after World War II in the United States ushered in the “Age of Keynes”. The conceptual framework of The General Theory provided us with the modern architecture of macroeconomics, the framework by which the aggregative quantities of the overall economy along with their interactions and quantitative measurement are analysed. This was a major conceptual victory over the Austrian School, which rejected macroeconomics as a meaningful framework to undertake economic analysis, advocating instead the primacy of the micro, which was consistent with the commitment to individualism and to individual behaviour as the source of all economic and social activity. The policy implications of The General Theory provided both the rationale and policy instruments for demand management policy, through active fiscal and monetary policy to achieve stabilisation and sustained economic growth, which it duly did for the next quarter century following World War II. The Keynesian orthodoxy had captured the high ground of macroeconomic theorising and of prescriptive policy management.

Keynes effectively overwhelmed Hayek, and notwithstanding the relative merits, and they are very considerable, of Austrian capital theory and business cycle analysis, Keynes’s analysis, its relevance and perceived effectiveness in the circumstances of the time won the day. Hayek never replied formally to The General Theory, something he regretted in later life. By the 1950s he was a marginal figure in Anglo-American macroeconomics and effectively succumbed to Keynes and the Keynesians. From the mid-1940s he turned to political philosophy and political theory, including the philosophy of law. The Road to Serfdom, published in 1944, brought him to a much wider public than his economic writings ever achieved. The book was informed by an underlying fear of an ongoing march to totalitarianism, understandable in the context of the times. Keynes thought well of it, and believed it contained many perceptive insights, but he rejected Hayek’s underlying thesis. Hayek went on to produce a number of outstanding contributions to political philosophy, including the Constitution of Liberty (1960), and his three-volume work on Law, Legislation and Liberty, published between 1973 and 1979. There is arguably a contestable hypothesis that could be put forward as to whether there is continuity between Hayek’s earlier work on economics and his later work on political philosophy. Wapshott makes too much of the continuity version of the hypothesis; it is equally arguable that the two bodies of work could have been produced quite separately.

The final six chapters of Wapshott’s book constitute a straightforward chronicle of the changing fortunes of the influence of both Keynes and Hayek. It is also the less engaging part of this final phase of the narrative of the “clash”. By the 1970s, Keynesianism was in retreat arising from the overuse, or abuse of fiscal and monetary policy, which gave rise to the phenomenon of stagflation, the invidious combination of rising inflation and unemployment. The response to stagflation facilitated a return to prominence of Hayek’s ideas, arising in the political domain from Margaret Thatcher’s enthusiastic advocacy of his work. At the outset of her leadership of the British Conservative Party, she is reported to have harangued the party’s research department for their indecisiveness by reaching for her iconic handbag and slamming a copy of Hayek’s Constitution of Liberty on the table. “This is what we believe,” she declared. Hayek was back. More pertinent to the economic debate was Thatcher’s commitment to the newly minted doctrine of monetarism. But here Wapshott gets the story wrong. Monetarism was the creation of Milton Friedman, who was also an admirer of Hayek, but whose economics owe little to Hayek, just as Hayek was never a monetarist in the conventional understanding of that term. Thatcher’s allegiance to Hayek was not to Hayek the monetarist, but to Hayek the political philosopher. For Thatcher’s monetarism she looked to the high theorist Friedman, who was a frequent visitor to 10 Downing Street during her occupancy. The award of the Nobel Prize to Hayek in 1974 hugely validated his standing and gave renewed impetus to the standing of both his economic writings and his philosophical work. Meanwhile Mrs Thatcher, after her election in 1979 set about rolling back the state in Britain through privatisation and deregulation and in the process reconfigured the basis of postwar British politics. Meanwhile in America her friend and ideological partner Ronald Reagan was elected in 1980 and served two terms as president. He too launched a campaign of deregulation, but his conduct of fiscal policy was at variance with his rhetoric. When Reagan entered the White House America was the world’s largest creditor; by the time he retired it had become the world’s largest debtor. This was due to his deep tax cuts, mainly favouring higher income groups, and his unprecedented expenditure on defence. Public debt grew from a third of GDP in 1980 to more than half of GDP by the end of 1988, from $900 billion to $2.8 trillion. When asked about the record deficit, Reagan’s memorable reply was “I don’t worry about the deficit, it’s big enough to take care of itself.” One shudders to think what Angela Merkel’s reaction would be if confronted with this piece of incisive analysis! What we had here, notwithstanding Reagan’s rhetoric to the contrary, was in John Kenneth Galbraith’s equally memorable phrase, “involuntary anonymous Keynesianism”, which rescued America from the recessions of the 1980s.

Wapshott has produced an informative, well written, even entertaining book, which is generally very accessible to the general readership for whom it is intended. The experts in the field will be less impressed, and with some justification. Some things, by way of interpretation, he gets wrong. But the problem lies more in the method rather than any fault with his engagement with an intimidatingly large body of literature. In choosing to pursue a technique much beloved of the Greek essayist Plutarch, who wrote about parallel lives, the focus can become at times too narrow and potentially restrictive. As with any method of organisational approach, it has its strengths and weaknesses. In general the relative intensity of Wapshott’s focus on the “clash” and the role it is portrayed as having played in twentieth century economics is valid only to a point and beyond that looks decidedly exaggerated when viewed from our vantage point in the twenty-first century. Viewed in retrospect the clash between Keynes and Hayek in the early 1930s may be regarded as one of many sideshows that preoccupied the former. It was certainly an interesting one, but merely one of many battle fronts that he was fighting at this time against critics both within Cambridge and across a wider arena. To think that Hayek represented the principal intellectual or theoretical rival to Keynes is simply misleading but that is perhaps one effect of the book’s approach and organising principle. That said, Wapshott has made an ambitious attempt to grapple with fundamental issues in economic and social theory and policy, and has, within the limited parameters of his approach, largely succeeded in providing an engaging account of the work of two iconic figures who have made significant and lasting contributions to these debates.

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