49, NO.5, MAY 1999, pp. 6-7
Hayek Made No Contributions?
By Roger Garrison
one asks what substantive contributions [F. A. Hayek] made to our understanding
of how the world works, one is left at something of a loss. Were it not
for his politics, he would be virtually forgotten." This assessment was
offered up late last year in online magazine Slate by Paul Krugman,
1991 winner of the prestigious John Bates Clark Award. In fairness, we
have to wonder if the assessments of other Clark medalists—Paul Samuelson
and Robert Solow, for instance—would be any more charitable.
few weeks before Krugman branded Hayek as a nonstarter, Gene Epstein, economic
editor of Barron's, profiled this Yale-bred, MIT-based economist.
Epstein's article was largely positive and wholly respectful: "Krugman's
sharp-tongued feistiness can produce enlightenment, as well as pleasure."
That certain combination of analytical acumen and northeastern political
instinct has jelled into a "thinking man's John Kenneth Galbraith."
a mildly critical tone, Epstein wondered if Krugman hadn't committed an
error of omission. His writings on recessions seemed to suggest that he
knew little or nothing about Hayek's theory of the business cycle, a theory
built upon the cumulative efforts of Menger, Böhm-Bawerk, and Mises.
Krugman conceded that he wasn't familiar with the Austrian theory.
is reminded of the notorious episode in which John Maynard Keynes reviewed
Ludwig von Mises's Theory of Money and Credit, which was published
in German. He faulted Mises for failing to offer anything original and
then later remarked that when he read German, he understood only what he
already knew. Similarly, if we get our appreciation of Hayek through Krugman,
we can't credit Hayek for much. Unlike Keynes, though, Krugman cannot invoke
language as an excuse. Hayek did not get the Nobel Prize for his political
views; he got it for his work on business cycle theory. Why would Krugman
not be completely familiar with Hayek's contributions. Stay tuned.
not a follower of Austrian theorizing, Krugman is, if anything, a quick
study. On the same occasion in which he denied Hayek any standing as an
economic theorist, he launched a vitriolic attack on the Austrians and
their "hangover theory" of recessions. "I regard [their theory] as being
about as worthy of serious study as the phlogiston theory of fire." Though
he failed to identify the
Barron's article or its author as the
spark that set off this firestorm, he was clearly reacting to Epstein.
theory" is a term obviously intended to denigrate the Austrian account
of the unsustainable boom. Yet, it is descriptive of many—if not most—modern
business-cycle theories. The idea that booms lead to busts like drinking
binges lead to hangovers is at home in both Monetarism and New Classicism.
Even the sophomore-level textbooks feature a stilted version of the hangover
theory. In the late 1970s, the analogy between the abuse of monetary tools
and the abuse of illegal substances became so well understood in the financial
world that the argument by analogy was in danger of getting reversed. A
memorable cartoon of the period showed a balding Wall-Street banker having
a heart-to-heart with his errant teenage son: "Think of it this way, Timmy:
Taking drugs is kinda like increasing the money supply. ..."
Austrian hangover is unique. The misallocation of resources during the
period of artificially cheap credit has the feel of genuine growth, but
the good feelings are followed by bad ones. The commitment of too many
resources to projects that will yield output only in the remote future
has as its counterpart an undue scarcity of resources for producing output
in the near and intermediate future. With the passage of time, the misallocation
becomes apparent, after which follows a period of liquidation and reallocation—in
a word: a recession.
of this is to deny that a sharp increase in money demand (or a collapse
in the money supply) can seriously retard recovery—as certainly happened
in the 1930s. But Krugman would have us believe that monetary disequilibrium
is the whole story: People, for some reason, want to hold more money than
currently exists. Accordingly, his solution is simply to print the money
up and let them hold it.
view of recessions is best put in perspective by comparing it with the
contrasting views of Keynes and Hayek. These arch rivals of the thirties
were in agreement that the increase in money demand, the "scramble for
liquidity," was a secondary aspect of the downturn but in disagreement
about what the primary aspect was. Keynes thought it was investment demand,
which, in a decentralized economy, is prone to collapse. Hayek thought
it was malinvestment induced by short-sighted or politically motivated
actions of the central bank. Krugman elevates what both Keynes and Hayek
saw as a secondary aspect to the status of the primary aspect. And then,
creating difficulties for the historian of thought, he attributes the high-money-demand
theory of recessions to Keynes himself.
rejecting all hangover theories, Krugman pronounces the Austrian variety
"intellectually incoherent"—largely on the basis of a telling question:
"[How can] bad investments in the past require the unemployment of good
workers in the present?" Krugman's implicit answer: They can't—and therefore
we need not pay any attention to Hayek. (The question itself is a good
one and is likely to find its way onto a macro exam at Auburn University.)
Hayekian would answer in terms of the intertemporal complementarity that
characterizes the economy's capital structure. During the downturn, good
workers are out of work because the capital they need to work with is in
short supply, having been committed to long-term projects now in need of
liquidation. Krugman's response ("Well, fine. Junk the bad investments
and write off the bad loans.") is all too facile. His advice is well taken,
but the market process that implements it is time-consuming. During the
junking and capital restructuring, the demand for much of the labor force
(labor whose capital complement has not yet been recreated) is low. And
low demand translates into unemployment—except under the decidedly unAustrian
assumptions of instantaneous wage-rate adjustment and near-infinite labor
that in Austrian theory the unemployment is somehow related to capital
restructuring, Krugman poses another question: "Why doesn't the investment
boom—which presumably requires a transfer of workers in the opposite direction
[from short term projects to long-term projects]—also generate mass unemployment?"
Gottfried Haberler asked the same question in his 1937 book, Prosperity
and Depression. The answer is that during the cheap-credit boom, there
is a net increase in labor demand. And because of the effects of a low
interest rate, many workers are bid away from jobs in the late stages of
production and into jobs in the early stages. During the downturn there
is a net reduction in labor demand. As liquidation gets underway, workers
are released in the higher stages and (eventually) reabsorbed elsewhere
in the economy.
of these future exam questions have been answered by drawing on Hayek's
contributions. Significantly, both answers involve heavy doses of capital
theory, which serves as the underpinning of the Austrian theory of the
business cycle. One of the most profound effects of the Keynesian Revolution
was to tear macroeconomics loose from these underpinnings. Today, capital
theory simply has no standing in mainstream macroeconomics. Accordingly,
Hayek has no standing in the eyes of Krugman and other modern mainstream
macroeconomists. It is a pity.
Roger Garrison is Professor of
Economics at Auburn University and author of Time and Money: The Macroeconomics
of Capital Structure (Routledge, 2001).