Bruce Caldwell discusses The Road to Serfdom with The Washington Independent.

The editor of the “definitive” edition of Hayek’s The Road to Serfdom is interviewed by The Chronicle of Higher Education.

On the problem of theory selection in economics:

I was initially attracted to Hayek not for his politics or his view on markets, but for what he had to say about the limitations of economics. Hayek developed his ideas about the dispersion of knowledge during the socialist calculation debate of the 1930s. His ideas led him to reject, of course, the assumption of perfect information that inhabited most of the models of his day, but also the rationality assumption and even the use of equilibrium theorizing, which is one reason he is so little taught today in the standard economics curriculum. Hayek viewed the economy as a complex adaptive system, and thought that when we confront such a phenomenon, our ability to control it is severely limited. Often the best we can do is to make broad pattern predictions or provide explanations of the principles by which such phenomena behave.

If Hayek was right, this implies severe limitations on our ability to adjudicate among rival theories. This fallibalist conclusion is evident in a paper first published back in 1955. As he put it:

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Bruce Caldwell offers a refresher course on Hayekian economics to the economists gathered at the Institute for New Economic Thinking conference at Cambridge:

Let me begin by clearing up a misconception. Hayek is sometimes wrongly portrayed as thinking that market systems always work just fine. Now this is a man whose first book was titled Monetary Theory and the Trade Cycle. Suffice it to say that Hayek was no Dr. Pangloss when it came to the workings of a market economy. Hayek thought that a trade cycle was an unavoidable concomitant of a credit using
market economy. Hayek’s description of the unfolding of a typical cycle actually maps pretty well with at least a part of what happened in the latest meltdown, especially in terms of the Fed’s interest rate policy and its effects on the American housing sector.

In Hayek’s theory, problems start when the market rate of interest is held too low for too long. This always politically popular policy leads to malinvestment – too many investment projects get started that cannot ultimately be sustained. When people realize what has happened, investment spending collapses and a recession begins. In Hayek’s theory, recessions are the painful but necessary adjustment that returns the system back to equilibrium. His policy advice at the time, simply to let the system adjust, was as popular then as it is today. His great fear was that attempts to combat the recession with expansionary policy would perpetuate the malinvestment, delay the necessary and painful process of adjustment, and set up the prospects of future inflation. This too perhaps sounds familiar.

Perhaps of more interest than his cycle theory are Hayek’s views on regulation and on the limitations of economics as a discipline. Regarding regulation, two things should be noted at the outset. First, Hayek was not opposed to all regulation; more forcefully, he frequently criticized the concept of laissez faire. Second, he was no policy wonk. All of his observations were made at a very general level. This was in partstrategic: when he established the Mont Pelerin Society he found himself trying to keep together a coalition that ranged from Ludwig von Mises to Chicago School economists like Friedman and Stigler to ordo-liberals like Walter Eucken to people like Michael Polanyi and Karl Popper who, in this group anyway, might well be considered social democrats. He was not always successful: Mises walked out of one of the sessions at that first meeting muttering that everyone there was a damn socialist. In any event, given that we are trying in this conference to consider foundational issues about economics, a discussion of general principles may not be entirely out of place …

Bruce Caldwell speaking at the Heritage Foundation on Hayek and the America meltdown.

UPDATE: I’ve found a PDF text version of Cadlwell’s talk titled “Ten Mostly Austrian Insights for These Trying Times”.  This is just an outstanding general introduction to Hayek’s political economy — I can’t recommend it highly enough.

Here are the section headers listing Caldwell’s “Ten Insights”:

1.  The business cycle is a necessary and unavoidable concomitant of a free market money-using economy.

2.  The 1970s and why Keynesian economics was rejected.

3.  Some regulation is necessary, but….

4.  … a lot of regulation, what Hayek called ‘legislation,’ is fraught with problems, and will make matters worse.

5.  The economy is an example of an essentially complex phenomenon, for which precise forecasting (on which the construction of rational policy depends) is ruled out.

6.  The two sides of unintended consequences when dealing with complex orders.

7.  Basic economic reasoning captures what we can know and say about the essentially complex phenomenon that we call the economy.

8.  But what about social justice?

9.  The basic Hayekian insight – how freely adjusting market prices help solve the knowledge problem and allow social coordination.

10.  The basic public choice insight – why government cures so often are not only worse than the disease, but lead to further disease.

A highlight from the paper:

Hayek argued that, when dealing with spontaneous orders or other complex adaptive systems, often the best that we can do is to make pattern predictions, or to offer explanations of the principle by which a phenomenon may work. His examples were usually drawn from areas other than economics. Thus he explained that we all can understand the principle by which footpaths are formed, even if we never observed one being created (Hayek [1952] 2009, p. 104). He noted that the theory of evolution allows us to understand how speciation works, and to rule out certain evolutionary changes, but it does not allow us to predict specific changes that will occur (Hayek, [1964] 1967, pp. 31-34.) What might constitute equivalent sorts of explanations or predictions in the domain of economics?

In my view, the basic sorts of insights about the workings of a market order that economists teach in their introductory classes, what I have elsewhere (Caldwell, 2004, chapter 15) called basic economic reasoning, is what Hayek was talking about when he discussed ‘explanations of the principle’ and ‘pattern predictions.’ These insights have evolved slowly, emerging in the writings of the great economists of the past three centuries or so, and are now captured in such everyday classroom constructions as supply and demand curves and production possibility frontiers. These tools allow us to talk about the fundamental fact of scarcity, the choices that scarcity makes necessary, the costs of choice, and of ways to push back against scarcity, at which point the notions of the division of labor, specialization, comparative advantage, the productivity of capital, and the gains from trade are introduced. If one adds to these the concepts of elasticity of demand and supply, and some basic intuitions about market structures, one can explain an awful lot about the world, as anyone who has ever taught an introductory economics course knows.

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