ECON 272 - Notes on Hayek vs. Keynes

The Economic Calculation Debate between F. A. Hayek and J. M. Keynes:  Can the economy be planned and manipulated with any degree of success?

This was NOT an ideological debate -- it was a technical debate.  The question was "can" not "should" the economy be planned and still meet the basic necessities of life?  Or more specifically, can economic (government) planners "calculate" where resources should be allocated without market prices and profits and loss.

F. A. Hayek built upon his teacher - Ludwig von Mises, who wrote about the impossibility of economic calculation (determining where resources should go) in his 1920 article "Economic Calculation in the Socialist Commonwealth." Hayek then later added to this work in his "debate" with J. M. Keynes.

F. A. Hayek:  His answer was NO - it is impossible to allocate resources through government planning such that the economic order can meet the basic necessities of life (and go beyond that) – Why not?

Two kinds of knowledge in society:

Government planners are unable to even meet the basic necessities of life -- this knowledge problem (coordination problem), along with a lack of incentives to be productive -- lead Hayek to predict that the planned economies around the world would eventually fail.  He was right.

Hayek believed in a general theory of Say's Law.  Productivity drives an economy.   Government spending will create misallocations (booms and busts).

NOTE:  Although Hayek believes in the general theory of Say's Law -- he is NOT a Classical Economist!!  He is an "Austrian Economist" - a different school of thought in economics (founders were from Austria - has nothing to do with the economy of Austria today).

J. M. Keynes:  His answer was YES – not only can government planners be successful at directing resources, they are necessary for maintaining stability within markets.  Why?

Planners have the knowledge necessary to plan (via "experts" and economic data):

Keynes convinced many policy makers and economists that planning was both possible and necessary (but not all).

Demand drives an economy.  Government spending (in one form or another) is often necessary to manipulate markets out of a slump. 

So politically Keynes won the debate in the 30s -- Why?  There are several theories (which do you think makes sense?):

1.

2.

3.

4.

But after Keynes was long gone (1946) -- the Soviet Union and other planned economies collapsed.  Hayek is awarded the Nobel prize in economics in 1974 (although I don't know how respectful that is anymore) and died in 1992 after the fall of the Berlin wall, etc. in the late 1980s -- and many economists decided that "in the long run" Hayek has won the debate intellectually.  Others still disagree and think that Keynesian economics (government planners are better than markets or entrepreneurs when it comes to resource allocation).  So the debate still continues.................

TO SUM UP THE DIFFERENCES:

Hayek:

1. Say's Law is correct (in its basic form) - productivity drives an economy and creates jobs.

2. Saving is important to this economic growth.  Savings leads to capital investment and productivity.

3. Knowledge is key -- markets provide knowledge to direct resources such that people's values/wants are met.  Without this knowledge, coordination will not happen.

4. Government distorts market signals - creates booms and busts.

Keynes:

1. Say's Law is wrong - spending drives an economy.

2. Saving  "bad" when the economy needs a stimulus -- when people save, they are not spending.

3. Planners have enough knowledge to plan an economy -- we need "experts" and statistics, and the government can stabilize the economy.

4. Markets are chaotic - they create booms and busts.

    So let's dive into Keynes!

DO ICE