At the start of this month I took part in a (highly enjoyable!) LSE/Radio 4 debate on Keynes versus Hayek (45 minute radio edit available here and ‘un-cut’ 90 minute video version available here) with Lord Skidelsky and myself representing Keynes opposed by George Selgin and Jamie Whyte..
The structure of the debate limited our opening contributions to around 4 minutes each and the format meant (rightly) that what was emphasised was the differences and disagreements. Which was entirely correct for a public debate/radio programme but the advantage of writing a blog is that allows me to be more nuanced.
I actually have a lot of time for some Hayek’s work – I usually disagree with the policy recommendations which (especially amongst Hayek’s modern day adherents) seem to be driven as much by political ideology as by economic analysis but there is something in Hayek’s analysis of the causes of financial crashes that the left cannot ignore.
So whilst I disagree with most modern day Hayekians on the supposed virtues of cutting public spending during a ‘balance sheet recession’ (Richard Koo’s term, recently used (perhaps unwittingly) by the Chancellor) I can see their point that, given how the modern financial system currently operates, a long period of low interest rates can lead to severe mal-investment and unsustainable bubbles.
The crucial word there being ‘currently’. I can also envisage circumstances in which low interest rates allow a heavily reformed financial system (more banks, more industry focussed banking, regional banks, less speculation) to actually support the productive economy.
But the question that really interests me at the moment, and what inspired this blog post, is the issue of how to deal with the failure of large banks. An issue that I hope doesn’t arise in the near future but which may well do rather quickly if the worst case scenarios come to pass).
At the debate Whyte and Selgin were keen to brand the policies pursued in 2008 (broadly put – huge central bank liquidity support coupled with direct government recapitalisation and varying degrees of nationalisation) as ‘Keynesian’. I’m not at all sure that is fair, I think Kaynes would been far more inventive – perhaps using QE to capitalise a National Investment Corporation. But, that aside, it certainly wasn’t Hayekian.
Their argument (again broadly put) was that bad banks should have been allowed to fail and that by propping them up the government is stopping money going to well functioning banks and holding bank the recovery. The ‘liquidation’ of bad assets has to be allowed to happen in order for a sustainable recovery to begin.
Back in 2008, I supported the actions taken by Western Governments, I thought large scale bank failures would have turned the recession into an actual depression as savers took large loses, payments systems broke down and cash machines actually ceased to operate. That would have been a disaster.
But bank failure in 2011 or 2012 or 2020 could be different. Back in 2008 the crisis surprised policy makers and the response was haphazard and driven by fear and confusion.
If an institution is not viable, it will fail eventually whatever steps are taken to prop it up. The problem is that when it does fail, it brings a lot of others down with it. The larger and more interconnected the failing institutions, the greater the risk they pose to the world economy - and the louder the cries of people who depend on those institutions that governments should act to prevent their failure.
If the international financial system is so fragile that it can only survive with constant infusion of mammoth amounts of public money, then IT IS ALREADY IN A STATE OF COLLAPSE. And as any mining engineer knows, propping it up is not only expensive, it is dangerous.
I would like to suggest that the international financial system should be ALLOWED to collapse. That doesn’t mean that governments should abandon their responsibility to protect the people affected and as far as possible prevent long-term damage to the economy. On the contrary, governments should be actively involved in managing the collapse of the current unsustainable system and the building of a new system that meets our needs better.
This point, which could be dubbed ‘Interventionist Hayekian’, seems right to me.
I also think it is possible to get to the same conclusion in a fundamentally Marxist way. Basic Marxist Crisis Theory says, amongst other things, that as booms expand the amount of capital employed increases, eventually the rate of profit begins to fall leading to a recession in which much of the capital stock is destroyed – allowing higher profits on the remaing capital stock and hence a resumption of expansion.
If we then add on some of the work of modern Marxist economists on how capital has been ‘financialised’ then we get to an interesting conclusion. Foster and Magdoff have written (in a book that I’d highly recommend despite it being somewhat to the left of my usual reading habits):
For the owners of capital the dilemma is what to do with the immense surpluses at their disposal in the face of a dearth of investment opportunities. Their main solution from the 1970s on was to expand their demand for financial products as a means of maintaining and expanding their money capital. On the supply side of this process, financial institutions stepped forward with a vast array of new financial instruments; futures, options, derivatives, hedge funds, etc. The result was skyrocketing financial speculation that has persisted now for decades.
One could then argue that if financial capital has replaced physical capital and the state is preventing financial assets from being destroyed there is no way, according to standard Marxist theory, for the ‘crisis’ to end. Which leads one into calling for revolution and the overthrow of capitalism or acknowledging that simply nationalising failed banks is unlikely to ever end the crisis.
We are in an odd place indeed when Marx and Hayek are pointing in the same direction.
Which take us to Minsky, who although he called himself a Keynesian was a far more interesting and nuanced thinker who paid as much attention to Fisher on debt –deflation as he did to Keynes (and his Keynes was far more about the Treatise and the Tract than the General Theory).
As the standard interpretation of Keynes was assimilated to traditional economics, the emphasis upon finance and debt structures that was evident in the 1920s and the early 1930s was lost. In today’s standard economic theory, an abstract nonfinancial economy is analysed. Theorems about this abstract economy are assumed to be valid for economies with complex financial and monetary institutions and usages. As pointed out earlier, this logical jump is an act of faith, and policy advice based upon the neoclassical synthesis rests upon this act of faith. Modern orthodox macroeconomics is not and cannot be a basis for a serious approach to economic policy.
And this is what we need – a modern way of thinking about the macroeconomy which takes asset bubbles seriously, we looks at over-speculation and which understands how banks operate rather than assuming them out of existence.
The odd thing is that it will probably draw as much from Hayek as from Keynes.