Henry Hazlitt and the Failure of Keynesian Economics
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Ideas On Liberty NOVEMBER 2004 Henry Hazlitt and the Failure of Keynesian Economics by Richard M. Ebeling or four decades, from the mid-1930s to would establish his reputation as the leading the 1970s, Keynesian economics almost monetary theorist of his time.5 Instead, the monopolized economic policy in the book was savaged by reviewers, including FUnited States and around the world. The many of the most prominent economists in “new economics,” as it was called, was Great Britain and the United States. The going to assure mankind economic stability, most devastating criticisms were made by a full employment, and material prosperity— young Austrian economist named Friedrich all through wise government management of A. Hayek, who in a lengthy two-part review monetary and fiscal policy. So dominant was demonstrated the logical confusions and the- this view that only in 1959 did the first oretical misunderstandings that ran through book-length refutation of the ideas of John the entire work.6 Maynard Keynes appear: Henry Hazlitt’s For the next five years Keynes devoted his The Failure of the “New Economics”: An time to devising a new theory for his argu- Analysis of the Keynesian Fallacies.1 ment that a free-market economy was inher- Keynes (1883–1946)2 had a acquired an ently unstable and that only the guiding international reputation shortly after World hand of government could assure full War I, when he published The Economic employment in the face of the economic dis- Consequences of the Peace, a biting criticism aster being experienced during the Great of the Treaty of Versailles that formally Depression of the early 1930s. This work ended the war.3 In the 1920s he was a lead- finally appeared in February 1936 under the ing critic of the gold standard and a vocal title The General Theory of Employment, proponent of a government-managed cur- Interest, and Money.7 rency to maintain full employment. In his Except for some of Keynes’s young pro- 1924 book, A Tract on Monetary Reform, tégés at Cambridge University, most of the Keynes declared that gold was a “barbarous reviewers of the book were highly critical of relic” and that governments should use their many of its theoretical “innovations,” as well control over the money supply to maintain a as its inflationary prescriptions for unem- stable domestic price level even if this ployment.8 Even some economists who later required abandoning a stable foreign became proponents of Keynes’s “new eco- exchange rate between the British pound and nomics” were initially highly critical of his the other currencies of the world.4 work. For example, Alvin Hansen, who was In 1930 Keynes published A Treatise on one of the leading advocates of Keynesian Money, a two-volume work that he expected economics in the United States in the 1950s and 1960s, wrote in late 1936 that The Gen- Richard Ebeling is the president of FEE. eral Theory “is not a landmark in the sense 15 The Freeman: Ideas on Liberty • November 2004 that it lays the foundation for a ‘new eco- for a prolonged period in what Keynes called nomics.’ . The book is more a symptom of an “unemployment equilibrium.” Couldn’t economic trends than a foundation stone workers improve their prospects by accept- upon which a science can be built.”9 ing lower money wages? No, Keynes Yet within a few years, and most certainly insisted, because workers suffer from a by the end of World War II, Keynes’s ideas “money illusion”—even if prices were falling had virtually pushed aside every other expla- and a cut in wages would make them no nation of the causes and cures of economic worse off in real buying-power terms, work- depressions.10 Keynes’s book became the ers would refuse to accept less money. foundation stone for the new “macroeco- Rather than demand that workers accept nomics.” His face even appeared on the lower pay, Keynes favored raising the gen- cover of the December 31, 1965, issue of eral level of prices so employers could make Time magazine. The feature article, titled profits without cutting wages. In other “We Are All Keynesians Now,” stated: words, Keynes’s solution to unemployment was price inflation. Today, some 20 years after his death, his theories are a prime influence on the Deficit Spending world’s free economies, especially Amer- ica’s. Now Keynes and his ideas, Government deficit spending would pro- though they still make some people ner- vide additional market demand, pushing vous, have been so widely accepted that prices up and stimulating more hiring. they constitute both the new orthodoxy in Public-works projects would “prime the the universities and the touchstone of eco- pump.” This policy would continue until nomic management in Washington. “full employment” was attained. But since, Now even businessmen, traditionally hos- in Keynes’s view, businessmen were usually tile to Government’s role in the economy, shortsighted and irrational in their fears have been won over. They have begun about investment prospects, the private sec- to take for granted that the Government tor would always lag behind in creating jobs. will intervene to head off recession or The government would have to be con- choke off inflation, [and] no longer think stantly at the monetary and fiscal controls, that deficit spending is immoral.11 injecting spending into the economy to pre- vent it from sinking back into unacceptable Keynes argued in The General Theory that levels of unemployment. the free-market economy contained no built- In Keynes’s conception of the world, gov- in mechanism to assure full employment. ernments guided by his ideas would be wise The crucial weakness, he said, lies in the and farseeing, assuring that the mass unem- relationship between savings and invest- ployment of the 1930s never happened ment. People tend to consume more as their again. Government would manipulate inter- incomes go up, but the increase is not as est rates, the level of prices, and the amount great as the increase in income. In other and direction of investment to assure that words, they also save a portion of their society had high employment, socially bene- higher income. The problem, he insisted, is ficial investment, and general economic that saving is “non-spending” and if people stability. do not spend all the extra income they earn, There were critics of Keynesian economics businessmen may not have the incentive to in the 1940s and 1950s, but they were virtu- invest enough to employ all those who want ally ignored by academic economists and to work at prevailing wages. policymakers.12 Some mainstream macro- As a result, a large portion of the labor economists also took Keynes to task. But force may be left unemployed because the many of their criticisms were couched in private sector has failed to create enough terms clearly meant not to antagonize their jobs. The economy, therefore, may be stuck Keynesian colleagues. 16 Henry Hazlitt and the Failure of Keynesian Economics Then in 1959 came Henry Hazlitt’s The money supply in the early 1930s increased Failure of the “New Economics.”13 What the degree to which prices and wages had to was unique about Hazlitt’s exposition was fall to re-establish full employment.) his chapter-by-chapter dissection of the Hazlitt considered Keynes’s inflationary arguments in Keynes’s General Theory.14 “fix” crude and dangerous. First, Hazlitt Central to Keynes’s theory was his insis- pointed out that Keynes’s focus on macro- tence that “Say’s Law” was wrong in claim- economic “aggregates” concealed the micro- ing that “supply creates its own demand.” economic relationships among a multitude Just because people supply goods on the of individual prices and wages. The price market does not mean they will demand level, wage level, total output, aggregate what others are selling. They may abstain demand, and aggregate supply were all sta- from spending by holding idle cash balances. tistical fictions that had no reality in the Thus there could be a general glut of goods actual market. Thus the wage level could not on the market. be too high relative to the general price level. But in the 1930s many wages for different Say’s Law types of labor were out of balance with the prices of individual goods sold on the mar- Hazlitt showed that Keynes had misunder- ket. What was needed to restore full employ- stood what the Jean-Baptiste Say and other ment was an adjustment of numerous indi- nineteenth-century economists meant. vidual wages and resource prices to the Goods can virtually always find buyers if lower prices of many consumer goods. The prices are sufficiently attractive. The pre- extent to which any individual money wage Keynesian “classical” economists never or resource price might have to adjust down- denied that goods can go unsold and labor wards depended on the distinct supply and unemployed if suppliers fail to adjust their demand conditions in each of the individual prices and wages to match existing market markets. demand. An inflationary policy attempts to bring Furthermore, Hazlitt explained, many of some individual price-wage relationships the classical economists, especially John Stu- back into balance by pushing prices up art Mill, understood that individuals could throughout the economy, Hazlitt explained. “hoard” money rather than immediately spend it. But this was most frequently due to Because Keynes, with his lump, aggregate the temporary uncertainties of an economic thinking, is opposed to restoring employ- crisis, usually caused by a prior, unstable ment or equilibrium by small, gradual, inflationary boom.15 piecemeal adjustments . we must The central flaw in Keynes’s thinking, achieve the same result by inflating the Hazlitt insisted, was his unwillingness to money supply and raising the price level, acknowledge that the high unemployment in so everybody’s real wages are slashed by Great Britain in the 1920s and the United the same percentage.