Meltdown – What Would Hayek Say?

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.

I say “basic intuitions” above to emphasize that this does not have to be complicated; there is a reason why the introductory course is often labeled “Principles of Economics.” I once had a conversation with a colleague about cartels. The person was a technically well-trained game theorist, and game theory is custom-made to analyze things like cartel behavior. I mentioned to her in passing the three conditions that must be met for a cartel to be able to continue to keep prices high through time (a large share of total output, no close substitutes for the product, and the ability to catch and sanction those who cheat on the collusive agreement) and said that I didn’t worry too much about cartels because it is difficult to maintain all three conditions. This insight emerged in the 1940s and 1950s, before game theory had swept the profession, and is something that is easily explained with a few supply and demand curves to first and second year college students. Sadly, from the look on her face it was clear that she had never heard of the three conditions.

The principles course, if well-taught, is probably the most important course that anyone who wants to understand how a market system works can take. It shows how markets work, and also how they sometimes fail to work. It also helps one to identify which policy problems are real ones, and which are pseudo-problems. For those, for example, who are worried about the world running out of a natural resource like oil, it shows how the unhindered market very effectively deals with such shortages (the price of oil rises, which encourages conservation on the demand side, and makes profitable the search for new supplies of oil, as well as for substitutes, on the supply side).

Many of the most compelling examples in a principles class, however, have to do with bad policy responses, and most of these involve some form of price-fixing. Case studies that look at the effects of minimum wage laws, of agricultural price supports, of rent controls, of comparable worth policies, of price ceilings on gasoline or natural gas, of laws prohibiting the resale of concert tickets, all drive home the very predictable adverse effects of these policies. It is ironic that in a field in which forecasting is so difficult, the one area where it is relatively easy to predict results is when some form of price-fixing is involved. Indeed, in the case of price ceilings, the effects are so predictable that economists have come up with generic categories (e.g., the emergence of black markets, deterioration in product quality, and the emergence of non-price mechanisms for the allocation of the good) to describe the effects of the intervention. A good economics course will help to identify more appropriate policy responses, responses that utilize markets rather than fixing prices or trying to legislate specific outcomes. The entire field of “free market environmentalism,” with its emphasis on the establishment of property rights and on the design of institutions that make the best use of market mechanisms, is a case in point.

Last but not least, a good principles of economics class can serve as a counterweight to some of the widely-held myths that pass as facts within the popular  Take the critique of “neo-liberalism,” as recently articulated by Naomi Klein in her book The Shock Doctrine (2007). According to Klein, neo-liberals embrace the shock doctrine, the idea that multi-national corporations should enlist the power of national states during times of crisis (sometimes crises that they are complicit in fomenting) to impose a world-wide regime of free trade, thereby ensuring a steady supply of resources from less developed countries, a steady market for their goods world-wide, and a steady flow of profits to their owners. I encourage you to read Klein’s book. Half of it could have been written by Murray Rothbard: I refer here to the places where she talks about the dangers to our liberties and economic freedoms when big states and big corporations collude, or where she documents in sickening detail case after case of states trampling on the civil liberties of its citizens, from Chile and Argentina to Russia and China. A good libertarian could take the facts documented in the book and construct a devastating case about the dangers of untrammeled state power. Unfortunately, Naomi Klein was raised by socialist parents in Canada and apparently never had an economics course, so that is not the argument that she offers her reader. Instead, she makes the fantastical accusation that economists from the University of Chicago, and in particular Milton Friedman, developed the doctrine to support the power of corporations and their owners. She is exactly wrong, of course, about Friedman’s position. He supported free trade for a number of reasons, but a principle one was that it serves to limit the power of corporations.

Rather than an extended argument, I will only offer here an anecdote to illuminate Friedman’s position.  When I was in graduate school I was fascinated about the question of oligopolies. Markets work well when they are competitive, but what happens when an industry, like the U.S. automobile industry at the time (this was before the oil embargo and the subsequent increase in the price of gasoline brought the American automobile industry to its knees, and to Washington to beg for protection), grows too powerful? How could such powerful firms be constrained? I got my answer one day when Milton Friedman came to speak at a nearby university. I chanced to run into him as he was leaving the auditorium after his talk, so I asked him his opinion on the matter. He turned to me, put his hand on my shoulder (he had to reach up to do that, a unique experience for me, because I am not tall), and asked, “Now given your knowledge of economics, what one policy could we implement that would limit the power of the automobile industry?” “Open up our markets to foreign competition?” I ventured. He smiled, patted me on the shoulder as if to say, “Good boy,” and went on his way.

Sadly, this basic insight, that international trade is a way of constraining the power of large domestic firms, has little traction among the oceans of protesters who show up at every trade meeting. They do not realize that the policies that they favor would, by granting them protection from foreign competition, make American corporations more powerful.

This entry was posted in Caldwell. Bookmark the permalink.

2 Responses to Meltdown – What Would Hayek Say?

  1. Roger McKinney says:

    Very interesting! Thanks!
    However, on the idea of business cycles, I think Hayek and Mises would agree that if Austrian economics were taught, people would react in a counter policy way that would thwart the Feds’ manipulation of money. Also, the cycle would be less severe without the Feds.

  2. Pingback: VABALOG » Blog Archive » Huvitavat ja õpetliku ajaviidet (video ja audio eri)

Comments are closed.