Friday, March 22, 2013

What Would Hayek Do?

The European edition of WSJ, yesterday, carried an op-ed, by Emaonn Butler of the Adam Smith Institute in London, What Would Hayek Do?

By discussing how Hayek would have responded to the financial and economic crisis which began in 2008, the column also does a good job of highlighting the differences between Friedrich Hayek  and more hardcore Austrian economists, such as, Ludwig von Mises and Murray Rothbard.

Butler writes:
"Why did no one see this coming?" asked Queen Elizabeth II at the London School of Economics shortly after the 2008 crash. The LSE's finest stared at their shoes.

Mainstream—Keynesian—economists have been humiliated. They did not predict the crash, cannot explain it and their supposed solutions have been failing since 2008. Only their disparaged, so-called Austrian School colleagues—followers of the late Friedrich Hayek—have a convincing narrative and a plan to fix things.

 Trouble is, there are precious few Hayekians in government.

So, four years on, we are still trying to spend our way out of recession. U.K. Chancellor George Osborne's much-vaunted 2% spending cuts—spread over two years—announced in his budget this week hardly dent the 53% rise in public spending under the previous government. For all his supposed "austerity," Mr. Osborne has added as much to U.K. net debt in less than three years as his supposedly spendthrift predecessor Gordon Brown did in 10. Indeed, the £759.5 billion debt Mr. Osborne inherited will soar to £1.6 trillion by 2017-18. Meanwhile, big doses of "quantitative easing" have failed to revive things. Despite a sliding pound, U.K. exports are stagnant. Official growth forecasts have been halved. This Keynesian-style spend-borrow-print policy just isn't working.

Step forward Friedrich Hayek. He knew a thing or two about banking crises. When economists were throwing their hats into the air to welcome the Roaring Twenties, he knew things weren't right. He started researching business cycles and predicted that the boom would turn to bust. Four years later, Wall Street crashed.

The boom, Hayek explained, was caused by central banks making credit too cheap. That spurred people to borrow for spending and investments that were ultimately unviable. The fractional-reserve banking system compounded the fake boom by creating new money to throw at the borrowers.

The same happened this latest time round, say the Austrians. Booms make central bankers look brilliant, so Alan Greenspan kept interest rates far too low for years. Meanwhile, the Bank of England let inflation rise at a time when—with cheap Chinese imports flooding in—prices should actually have been falling. Britons, among others, borrowed to buy houses we can not pay for and invested in producing luxuries that people can no longer afford. The government joined in on the spree: that 41% spending-to-GDP ratio in 2007 was up from about 35% in 2000.

Now that reality has reasserted itself, all those misplaced assets must be written off. Some can be reshuffled into uses that make more sense. Others just have to be scrapped. That is and will continue to be a painful process. Production chains are long and complex and there will be losses all round. And the boom was long, so many investment mistakes have accumulated. But Britain has to restructure. The Keynesian spend-borrow-print prescription of reigniting the boom is like trying to deaden a hangover with another drink, say the Austrians.

Curing the underlying problem would be a lot easier if governments would let markets do their job, rather than smother them with taxes and regulations. Market prices tell us where we should be investing. Except artificially low interest rates, which persist today, have kept everyone thinking that credit grows on trees. Minimum wages and price controls, too, stifle the signalling function of prices. Hayek would scrap them. Employment regulations must also be curbed—they gum up the labor market and slow the movement of workers from failing boom-time companies to emerging, productive ones. By raising the cost of market entry, regulations also stymie competition, which is exactly what markets require if they're to add value to the economy.

High taxes also discourage start-ups and so, again, hamper assets from being shuffled into more productive uses. Higher tax rates don't even necessarily help balance governments' books. Entrepreneurs (and movie stars) are leaving France in droves to escape Fran├žois Hollande's disastrous wealth and income taxes. The U.K.'s 2010 hike in capital-gains taxes, to 28% from 18%, has been followed by a 76% drop in asset disposals since, according to research published last month by the Adam Smith Institute.

These burdens on business need to be reduced, and if it does mean lower revenues and more checks on government spending, fine: Westminster's outlays have ballooned over the last two decades.
Butler is correct in the above, except perhaps in identifying Hayek as the leading Austrian that current day Austrians modeled their thinking after. Hayek was part of the picture, but so was Ludwig von Mises and Murray Rothbard. Indeed, in a list complied by Walter Block, of the Austrians who warned about the financial crisis, I see many who were more likely influenced to a greater degree by Mises and Rothbard.

Butler also makes this point about Hayek:
 Hayek was no fan of hair-shirt austerity—deep and sudden spending cuts, he thought, could damage a country's delicate capital structure. The best time for ambitious government cut-backs would have been during the boom, but it's too late for that now.
This might be partly true. Hayek was always was somewhat sympathetic to interventionist policies in that he rarely suggested radical cuts in government, which would have ended many distortions in the market. This was much different from the thinking of Mises and Rothbard, who were much more hardcore and would have called for much more drastic cuts in government spending to end such theft and distortions. That said it is hard to think of Hayek defending government spending on the grounds it could "damage a country's delicate capital structure."

It is hard to see Butler's view that Hayek would consider government spending part of the capital sector. Hayek knew well that the capital sector was part of the private economy, though part of the private economy that was distorted by central bank interest rate manipulation. Hayek would have more likely viewed government spending as a "social safety net." Thus, even Hayek, would have likely seen much government spending that should have been cut, though nowhere near using the knives that Mises and Rothbard would have taken to government spending.

Hayek was good compared to the economists now advising governments, but he was not as hardcore as Mises and Rothbard. If we really want to understand how to end the current crises caused by government intervention in the economy, we should perhaps ask What would Rothbard do? And his answer would have been to shutdown central banking and end all government spending!


(ht Richard Ebeling)

1 comment: