The Failure Of Economic Theory ©
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Why We Are Destroying Society Based Upon Misconceptions
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“As his onetime protégé, Gerard Henderson, later remarked, Santamaria is lucky that his economic theories were never actually tried.”- Peter Walsh, "Memoirs Of A Failed Finance Minister"
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The same could be said of almost all economic theories, and of all pure economic theories. Economics is sometimes called ‘the dismal science’. I take issue with the science (no scientist would ever consider indulging in guesswork based on - as we shall see later in this blog - a false premise, or premises), but not with the dismal. I would call it ‘the dismal nonsense’.
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Before economists get upset, I should point out that there is a fundamental difference between economic analysis and economic theory. Examining the present (analyzing) and predicting the future (theorizing) are two different things. Of course, some analysts do so through the spectrum of their personal belief in one theory or another, which can distort their analytical work.
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However, in this first part of this blog I am concentrating on economic theory.
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Economic theories have been with us, in one form or another, since the early days of the human race. Like all theorists from academics to soothsayers, the popularity of a theory waxes and wanes – in the case of an economic theory or model confidence in it wanes when it fails, which all pure economic theories and models will do. Why do I say this? There are several reasons, the major one being because economic theory is based on a model of an economy which not only purports to predict human behavior and responses, but also postulates that everybody will react in the same way - both of which are contrary to all human experience. As anybody will tell you, you cannot predict human responses, and different people will react in different ways to the same set of circumstances.[1]
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Thus, the economic model - any economic model - is fatally flawed from the beginning.
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An example of this would be the theory of “supply-side” economics, developed in the U.S. by Professor Robert Mundell of Columbia University, and then popularized by Arthur Laffer of the University of Southern California. This theory was that, if tax rates were progressively lowered and Government spending held down, this would encourage economic growth to such an extent that Government Revenues would actually rise due to both an increase in production and an increase in savings. This theory was displayed by Laffer in the form of a curve - the ‘Laffer Curve'. This had two basic assumptions: firstly, that everybody would save at least part of their tax cuts; and, secondly, it would discourage tax avoidance and evasion.It was tried by the Reagan administration in their early years in office. There was a short spurt of economic growth, but, over time, it became sluggish, the growth in revenues didn’t happen as predicted, the Government ended up with enormous deficits as a result, and the theory was abandoned.
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Although there are almost as many theories on the failure of ‘supply-side’ economics as there are books on the Reagan administration (somewhere over forty), none of them mention the obvious reason for its failure: it was wrong, and could have been proven as such before it was tried. There are plenty of examples of where Governments had gone down that route prior to Mundell/Laffer, and very few examples of it creating substantial sustained economic growth, certainly none of the size predicted by Mundell/Laffer.[2]
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As for the two assumptions: savings didn’t go up significantly, and tax avoidance and evasion continued at about the same rate as before.Most economic theories are never tried - at least, not in full. The birth of modern economics is said to have begun in the 19th century. However, all of these writings were the product of politicians pushing a particular barrow: they were, in other words, party platforms, or manifestos, written to suit the political aims of the party the author was a member of at the next election. They were certainly not intended as long-term theories.Prior to World War II, there is no evidence of any prevailing economic theory, despite the fact that there was a proliferation of works on the subject. Since the First Industrial Revolution, the basic theory had been laissez-faire: anything went, with minimum or no Government intervention. This was partly due to the weak position Governments found themselves in (political stability was rare worldwide), and partly due to the nature of Capital (the stock markets and companies): money is for making, and the more, the better – a subject we will return to.
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This all came to an end with the Depression of the 1890’s, the Second Industrial Revolution (the invention of the car, the aircraft, the cinema, the radio, etc.), World War I, the last great boom of laissez-faire in the twenties, the Great Depression that followed, and World War II. This sixty-year period changed the face of many things, notably Governments: at the end of World War II, most Western democracies had a stable political system, underpinned by two major parties.
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A remark often attributed to Karl Marx[3] goes as follows: ‘Men make their own history. But they do not make it just as they please; they do not make it under circumstances chosen by themselves, but under given circumstances directly encountered and inherited from the past.’ This was certainly true of Marx himself, who spent most of his early years under persecution due to his Jewish background at school, and later his treatment at University due to his association with a group known as the ‘Young Hegelians’. It was also true of the men behind the economic theories that have dominated the post-World War II era.
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The first, of course, is John Maynard Keynes: Keynes began his adult life at Cambridge studying mathematics, but quickly found economic and political theory more to his tastes. The three key events in the making of Keynes as an economic theorist were World War I (he was actually a delegate to the Versailles Peace Conference, but resigned in protest due to the political chicaneries and what he correctly viewed as the unrealistic repatriations being asked of Germany[4]). After this, he returned to Cambridge as an academic, from where he witnessed both the Great Boom of the ‘20s and the Great Depression of the ‘30s.
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The effects of the latter cannot be underestimated. The conventional wisdom at the time was that time and nature would restore prosperity if the Government did not intervene. This, of course, did not occur, and Keynes became extremely upset by the pitiful conditions he was witnessing. In 1930, Keynes offered some solutions in a pamphlet entitled Treatise On Money, which he later developed into his famous work, The General Theory Of Employment, Interest and Money. The General Theory is based on two propositions:
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Firstly, Keynes said that the existing theory of unemployment was nonsense. In a depression, according to Keynes, there was no wage so low that it could eliminate unemployment. Accordingly, it was wicked to blame the unemployed for their plight;
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Secondly, Keynes proposed an alternative explanation about the origins of unemployment and depression. This centered upon the total spending of consumers, business investors, and public agencies. When these were low, sales and jobs suffered. When it was high, all was well.
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From these propositions, Keynes concluded that because consumers were limited in their spending by the size of their incomes, they were not the source of fluctuations in business and economic cycles. The major forces were business investors and governments. Therefore, in depressions the thing to do was either to enlarge private investment or to create public substitutes for private investment deficiencies. In mild economic contractions (recessions), the creation of easier credit and lower interest rates should stimulate business investment and restore the total spending of consumers, business investors, and public agencies caused by full employment. Severer contractions required as therapy the sterner remedy of deliberate public deficits either in the shape of public works or subsidies to afflicted groups.
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Keynes’ theories gained currency during World War II, and were formally adapted by most Western Governments after it. This was assisted by the Bretton Woods agreement, which Keynes had a major hand in drafting, proving for stability in currency markets via the fixing of exchange rates, and the creation of international oversight bodies such as the United Nations, the World Bank, and the International Monetary Fund.
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Keynesian economics worked well enough (with various local variations) through the ‘50s and into the late ‘60s, when it began to fail. There are a large number of reasons given for the failure of Keynesian economics, ranging from the outrageous/untrue blames (Equal pay and rights for women, which they always should have had, anyway), through the possibly plausible (the effect of the Vietnam War and the OPEC oil shocks of 1973/4), right through to the absurd (a 25% tariff cut in a small to medium sized economy like Australia’s could not possibly have caused the worldwide eclipse of Keynesian economics).
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I would advance three reasons for the collapse of faith in Keynesian economics:
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1. The collapse of the Bretton Woods financial agreement in 1971, leaving both currencies and commodity prices in a state of uncertainty, which was caused at least in part by the Nixon Administration’s decision to abandon the Gold Standard. There were attempts after this to manage exchange rates by Governments (or the central bank of that nation on their behalf) setting the rate, but this left the exchange rate ripe for manipulation by the markets, which then followed;
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2. Keynes’ theories were based around economies being based upon the manual manufacturing of goods. This process began to be largely automated in the ‘60s, with a consequential shift in economic growth and employment being towards the provision of services, thus destroying the major assumptions that underpinned Keynes’ theories on Employment; and
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3. The changes that occurred in Society during the ‘60s and ‘70s, which contradicted much of Keynes’ theories on the structure of society.
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Simply put, the theories of Keynes had effectively reached their ‘use-by’ date. The world Keynes had written about no longer existed, and thus the theories of Keynes no longer could be applied – or so economists and Governments thought.
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For some years after that, Governments floundered around looking for a new economic theory they could base their policies on. Finally, in the late ‘70s, an answer was found.
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At this point in time, the majority of casual readers will assume I am about to describe Milton Friedman’s theory of monetarism. If so, I am afraid that you are incorrect. Friedman’s first significant book, Capitalism And Freedom, was based upon other theories Friedman was pushing, many of which did not originate with him (a fact that he, himself, has acknowledged). It is to the original author of these theories that we will now turn our attention to.
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Friedrich von Hayek was born in Austria in 1899, and gained formal qualifications in psychology, law, and economics. He spent most of his life in Austria with the exception of a short period in the United States during 1922 and 1923 until he moved to London in 1931 to escape Hitler. In London, he took up a chair at the London School of Economics (it was not, however, a chair in economics). Von Hayek dropped the ‘von’ from his name in his writings[5], which began with an article in 1938, enlarged into a pamphlet published by the University of Chicago Press in 1939, and finally developed into a book, The Road To Serfdom, in 1944.
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Within the pages of The Road To Serfdom we find most of today’s economic tenets - totally free markets, the emphasis on the freedom of the individual, privatization, the importance of competition within economic sectors, lack of Government regulation (particularly in the corporate sector), destruction of the trade union movement...and so on. Indeed, the only things missing are the abolition of protectionism, and social welfare, both of which von Hayek seemed to be ambivalent about[6].
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However, there are two points that need to be made, and both are made in the book itself, at the beginning of the preface and the beginning of the conclusion...
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‘When a professional student of social affairs writes a political book, his first duty is plainly to say so. This is a political book.’
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‘The purpose of this book has not been to sketch a detailed program of a desirable future order of society.’ [Author’s emphases added.]
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So, it isn’t an economic text, nor is it designed as a workable theory. Furthermore, in Chapter One, von Hayek laments the abandonment of the theories of certain writers - Cobden, Bright, Smith, Hume, Locke, Milton, Erasmus, Montaigne, Cicero, Tactius, Pericles and Thucydides - which is an odd mix of philosophers, historians, economists and politicians[7]. The implication there is, of course, that their work inspired The Road To Serfdom.
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So, the casual reader may fairly ask, if it is not an economic text, nor a philosophical treatise, nor claims to present a workable theory, what, then, is the purpose of The Road To Serfdom? The answer is that von Hayek’s aim in The Road To Serfdom was to show a possible method of preventing the spread of National-Socialism, Hitler style. Before the reader points out that Hitler was a fascist and not a socialist, it should be pointed out that Hitler started his climb to power through the left - the Nazi Party was, prior to Hitler taking it over, the National Socialist German Workers’ Party, and Hitler’s infamous book Mein Kampf - allegedly written by Hitler whilst in prison in the early ‘20s - was a clever mix of socialism and calls to German patriotism, with just hints of the fascist beneath appearing now and again.[8]
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Thus, the repeated abuse of National-Socialism which appears throughout The Road To Serfdom, and the far-right wing calls which, in themselves, implies in places a restriction on personal freedoms. In fact, The Road To Serfdom is full of contradictions like that. Notably where he suggests giving workers shares in their employers’ company to promote productivity - which was also suggested by Marx and other socialists[9] - and in the sections where he tries to differentiate between good and bad socialism[10], and Hitler’s form of Government and Mussolini’s. Interestingly for a person with qualifications in psychology, von Hayek falls into the same trap that most professional economists fall into - of trying to predict human behavior, although he did correctly identify lack of security in employment and unemployment as the two main causes of personal insecurity[11].
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So, what is The Road To Serfdom? It is a cry of pain and grief - a personal outpouring lamenting what has happened to his homeland. It is not, by any stretch of the imagination, an economic text, let alone a viable theory.
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How, then, did this become the predominant economic theory of the last twenty-five years? After the publication of The Road To Serfdom to much acclaim (including from Maynard Keynes[12]), von Hayek attempted in his post-war writings to convert it into a viable theory, whilst moving through various academic positions. However, his obsession with Nazi National-Socialism became all-encompassing, and his works of the ‘60s and ‘70s are really only of interest in regards to how much they contributed to modern political rhetoric. Probably the best example of this is Law, Legislation And Liberty: A New Statement Of The Liberal Principals Of Justice And Political Economy (1973).[13] Following this, he was awarded the Nobel Prize for economics in 1974, which he shared with a Swedish economist who supported Keynesian principles (the irony here was accidental).
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At this point, we return to Milton Friedman. It should be noted that both Friedman and von Hayek were employed together on the staff of the University of Chicago - Friedman had been appointed in 1946, and von Hayek in 1950. Friedman was employed in the Economics school, and von Hayek was Professor of Social and Moral Values. It should be remembered that, in those days economics fell within the field of the arts[14], and, thus, there is little doubt that that Friedman was greatly directly influenced by von Hayek. They were to remain colleagues until 1967, when von Hayek retired to his native Austria.
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In 1962, Friedman co-authored with his wife Rose Friedman, who was an economist in her own right, and whose tutors included von Hayek, a book called Capitalism And Freedom (1962). Capitalism and Freedom was The Road To Serfdom turned into an economic text, together with a few ideas of their own: the need for balanced budget, low inflation, low taxation, low welfare, no protectionism (the so-called ‘level playing field’), and the removal of environmental controls added to von Hayek’s theories (with von Hayek’s “Nazi National-Socialism” replaced by the generic ‘communism’).
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On top of this, the Friedmans insisted that education at all levels (Primary, Secondary and Tertiary) would only be fairer if paid for (their preference was for payment via a voucher system), and that only the free market could guarantee consumer protection and workers’ rights. Much of this additional material came from the work of Adam Smith (both von Hayek and Smith were acknowledged in the text), however, Smith was not an economist either. Indeed, Smith had no economics training, nor any known prior interest in the subject. He was a social historian. Smith’s book The Wealth Of Nations (1776) is often mistaken as an economic text, but, if one studies the period immediately prior to its publication, it becomes clear that Smith was actually describing the situation as it then existed, rather than putting forward a theory. This point becomes clearer from the original title of the book, An Enquiry Into The Nature And Causes Of The Wealth Of Nations.[15]
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To return to our narrative: the year after Capitalism and Freedom was published, Milton Friedman, working with a different economist (Anna J. Schwartz), invented the theory of monetarism in their A Monetary History Of The United States 1867-1960. This theory, like many pure economic theories, was based on a mathematical equation, which can be summarized as: a change in the money supply (value of money in a country’s economy in whatever form) directly affects and determines production, employment, and price levels. The fact that the money supply was not capable of being accurately measured in a free market – a fact already known from prior experiences - did not seem to register with Friedman, who carried on preaching what were provably contradictory theories.
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Friedman was awarded the Nobel Prize for economics in 1976. As a result, he was invited to deliver a series of lectures, which he did between September 1977 and May 1978. These lectures, which incorporated Capitalism And Freedom (and, thus, The Road To Serfdom) and the theory of monetarism, were delivered under the title of Free To Choose. These lectures were taped and widely distributed, and were followed by a TV series under the same title in 1979, and expanded –again, with the same title - into a book (again co-authored with his wife) in 1980.
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An interesting point about Free To Choose is that Von Hayek himself is barely mentioned, despite the fact that about two-thirds of the contents in all the forms Free To Choose took was either taken from The Road To Serfdom (with the generic 'communism’ replacing ‘Nazi National-Socialism’), or based upon it. The reason for this was not only that von Hayek had retired some ten years earlier, but also his later writings had ruined his reputation. In fact, von Hayek’s writings had become so manic-obsessive and paranoid that they were useless in any context. An unbiased reader of, say, The Fatal Conceit: The End Of Socialism (1988) could only describe it a fascist tract. The only things of note of von Hayek’s books written between the 1973 reprint of Law, Legislation and Liberty and his 1992 demise are: their inaccuracy; the strident tone used; his risible comparisons (i.e., between Keynes and Marx, made more risible by the fact that Keynes and von Hayek had been friendly up until Keynes’ death in 1947); and the dictatorial messages. Most of these final books would have done Hitler proud. Indeed, von Hayek had ended by preaching what he had begun and gained fame by deploring.
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In place of the references to von Hayek in Free To Choose, the Freedmans substituted large slabs of The Wealth Of Nations – out of context, and, thus, devoid of their original and intended meaning.The approach of Free To Choose (in all its myriad forms) can be seen from the conclusion to Chapter Five of the book. Note that the use of the word freedom in Free To Choose means freedom from Government intervention:
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"A society that puts equality – in the sense of equality of outcome – ahead of freedom will end up with neither equality nor freedom. The use of force to achieve equality will destroy freedom, and the force, introduced for good purposes, will end up in the hands of people who use it to promote their own interests. On the other hand, a society that puts freedom first will, as a happy by-product, end up with both greater freedom and greater equality. Though a by-product of freedom, greater equality is not an accident. A free society releases the energies and abilities of people to pursue their own objectives. It prevents some people from arbitrarily suppressing others. It does not prevent some people from achieving positions of privilege, but so long as freedom is maintained, it prevents those positions of privilege from being institutionalized; they are subject to continued attack by other able, ambitious people. Freedom means diversity but also mobility. It preserves the opportunity for today’s disadvantaged to become tomorrow’s privileged and, in the process, enables almost everyone, from top to bottom, to enjoy a fuller and richer life."[16]
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Similar (although more verbose) passages appear in both The Road To Serfdom and Law, Liberty And Legislation: thus, von Hayek’s theories (which, remember was not supposed to be a sketch of a more desirable model of the future) had became a fully-fledged economic model of a supposedly more desirable future.
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The timing of Free To Choose (in all three formats) was adroit; although it occurred more through accident than by design (as noted earlier, the original lectures were commissioned as a result of Friedman being awarded the Nobel Prize). Furthermore, the Friedmans had tried to avoid economic jargon, and mostly succeeded, thus making it comprehensible to the general viewer/reader. As noted earlier, in the late ‘70s Western-based Governments worldwide were casting around for a solution to the turmoil caused by the collapse of Keynesian theories in the early ‘70s. Here was their answer. It did help that Governments sympathetic to the causes on offer were either in power (Australia, Japan, Most of Europe) or, most importantly, about to come to power – notably Ronald Reagan as President of the United States.
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The latter is of vital importance, and cannot be understated. The United States is the largest Western Economy. Although it is not often mentioned, Reagan’s degree studies at Eureka College, Illinois (graduating in 1932) included economics. He was strongly influenced by both von Hayek and by Friedman, as he had shown when Governor of California between 1968 and 1976. Once the U.S. moved, everyone would either follow by choice, or be forced to. The Reagan administration started off by trying ‘supply-side’ economics and the theory of monetarism; when these failed, Reagan and his advisors quickly switched to von Hayekism/Freidmanitism, which they described as Rational Economics, which quickly became economic rationalism[17].
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This was reinforced when Sir Keith Joseph converted Margaret Thatcher as Prime Minister of the United Kingdom to Economic Rationalism, at about the same time Germany adapted it, thus ensuring its spread throughout the European Community.
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The last set of theories relevant to today are those of David Ricardo – the classic example of the politician whose writings became economic tracts long after his death. Ricardo began life as a businessman, and built up a substantial wealth. In 1819, he purchased a seat in the U.K. Parliament (as could be done in those days), having written the Tory Party’s policy manifesto under the title Principles of Political Economy and Taxation. The latter compared Government money to rent, and called upon governments to lower welfare to subsistence levels to force everybody not in the workforce to work, insisted on his ‘iron law of wages’, which states that all attempts to improve the real income of workers were futile, and that workers had what rights they could negotiate, with the largest profits coming to companies coming if ‘rent’ (wages, in this case) were eliminated from the costs of production. His writing was poor, and had little to no influence at the time. As a political theory then, it was a failure.
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The fact it was then taken up 150 years later in entirely difference circumstances was entirely due to the fact that Ricardo’s ‘theories’ began to be propagated widely in the early '80s onwards: they were never theories, but short-term political fixes, which failed when Ricardo himself was alive, simply because they were so unpopular (because they were so unfair) that they became unworkable.
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The theories of Ricardo were first revived by the Thatcher Government – in part. Only New Zealand, to date, has tried to implement them in full, although Australia is doing so now, and both England and the United States are trying to follow – ironically, just as New Zealand are repealing the more unfair aspects of Ricardo’s theories.The medium to smaller Western countries then either adapted Economic Rationalism for their own volition (i.e., New Zealand), or were forced to, like the obvious example, Australia. The Liberal-National Party coalition lead by Malcolm Fraser was in office when Economic Rationalism came into vogue. Fraser, being a true conservative as against an economic radical such as his then-Treasurer, John Howard, compromised by holding an enquiry into the economy in 1979 – the so-called Campbell Report[18]. It was published in 1981, and recommended the implementation of Economic Rationalism. However, Treasury opposed the recommendations (although not the Treasurer, which lead to a breakdown in the relationship between the Government and Treasury). Nothing occurred.
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The ALP had been converted to Free Trade by Gough Whitlam in the ‘60s[19], thus, it was hardly surprising that the ALP’s first step was to depreciate the Australian dollar, and implement minor anti-trade measures. However, it was forced into floating the dollar and deregulating the markets by huge market inflows of Australian dollars in December 1983, which had to be bought by the Reserve Bank, using Taxpayers’ funds. This could not be done indefinitely without sending Australia broke, finally forcing the Government to float the dollar and deregulate the financial markets.[20] After this, Australia could – and was – forced to implement much of the Economic Rationalist package through the power of the markets. Effectively, Australia – and most of the rest of the world – had ceded economic (and, to an extent, social and political) sovereignty to the private sector.
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Well over twenty years have now passed since Economic Rationalism became THE economic theory. Has Economic Rationalism worked? Very few people would answer this in the affirmative. Indeed, most would be emphatic in proclaiming it a failure. Economists would argue that is because the Economic Rationalist theories of von Hayek and the Friedmans weren’t fully tried. Unfortunately, in most Western countries this is untrue. They were tried – and, indeed, they are still being applied in some countries, including Australia. It is of note that many countries have now attempted various measures to modify the adverse effects of Economic Rationalism, and that Sir Keith Joseph, who was as earlier noted responsible for its introduction into the United Kingdom, came to so regret it that he later suggested to both Thatcher and John Major ways of alleviating the damage caused. Unfortunately for the United Kingdom, his advice was ignored.
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An interesting side point is that Australia, under the Keating Government, reverted in 1992 to Keynesian policies to stimulate the economy out of recession. This was highly successful. Unfortunately, the power of the markets led to Australia reverting to a form of Economic Rationalism before the Howard Government was elected, and Howard proceeded to implement those aspects of Economic Rationalism that the Hawke and Keating Governments had not.
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The Australian experience here is sobering. Due to the power of the markets, and the tendency of some Governments to stick to their ideology, even when it can be proven to be failing, Economic Rationalism is still the prevalent economic theory. Anybody who doubts that should just compare the Bush Governments’ reasons for not ratifying the Kyoto Agreement on Greenhouse Gases with the section on the Environment in Free To Choose – Pages 213 to 222.
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Where does Globalization fit into all this? Although the argument, which is free trade vs. protectionism, is almost as old as mankind, the modern theory began with Daniel Bell's book The End Of Ideology: On The Exhaustion Of Political Ideas In The Fifties[21]. Bell's book was forgotten almost as soon as it was published. It was then rewritten in the '80s by Francis Fukuyama, then working in the U.S. State Department, in various papers which he later consolidated into a book, The End Of History and the Last Man[22] . These theories were based on the assumption that political borders were breaking down, and that there would only be one 'super power' left: the United States. The only difference in the two books was that Bell saw Trade in an 'ideal' World as a spider's web, whereas Fukuyama predicted the World would look like the spokes of a wheel, with the U.S. the central hub.
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The first theory is correct in part - in regard to the Soviet Union bloc only. However, advances in technology has made World Boundaries irrelevant for much of business. The second theory is wholly incorrect, as the Chinese Government (and others) would point out.The various 'Free Trade' rounds that have emerged from this have, because of the second flaw, been mostly futile. The most productive debates have come about in the context of free market economics. In this regard, it is not surprising that the debate has ended up in a dispute that has raged, literally, for centuries: protectionism for local industries via tariffs and bounties versus free trade via removal of same. As Free Trade has always been part of economic rationalism[23] , it is hardly surprising that Free Trade has won out, to this limits of local political tolerance.
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This, of course, is where the whole thing collapses. The major free trade agreement finished in 1994 has so many qualifications and exemptions as to be meaningless. The body set up to monitor the agreement - the World Trade Organization - has few powers, and is little more than a paper tiger. The new round of trade negotiations are going nowhere slowly (the Doha Round of talks, as they are known, started in 1998. Net agreed to date: nothing.). The main impact of the whole process to date has been to enable larger countries to force Economic Rationalism upon smaller countries - for example, for a poor country to gain aid from the International Monetary Fund and/ or World Bank, they must implement the following ten points:
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1. A guarantee of fiscal discipline and a curb on budget deficits;
2. A reduction of public expenditure, particularly in the military and public administration;
3. Tax reform, aiming at the creation of a system with a broad base and with effective enforcement;
4. Financial liberalization, with interest rates determined by the market;
5. Competitive exchange rates, to assist export-led growth;
6. Trade liberalization, coupled with the abolition of import licensing and a reduction in tariffs;
7. Promotion of foreign investment;
8. Privatization of state enterprises, leading to efficient management and improved performance;
9. Deregulation of the economy;
10. Protection of property rights.
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Sound familiar? Yep, we're back with Economic Rationalism and another way of forcing it down everyone's throat. Just one slight problem - as pointed out earlier in this blog, Economic Rationalism doesn't work. It didn't work when it was the prevalent theory prior to World War II, and it doesn't work today.
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There are five basic reasons for the failure of Economic Rationalism:
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Firstly, both von Hayek and the Friedmans made the common error of trying to predict human behavior – and assuming everybody would react to a given situation in the same way;
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Secondly, they confused philosophy and economics: there is a vast difference between individual liberty (such as the liberty of free speech and freedom of movement) and economic liberty – von Hayek should have understood this (being a psychologist, one would expect him to), but he seemingly overlooked it in his obsessional anti-Nazi diatribes;
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Thirdly, neither von Hayek nor the Friedmans took any notice of what had happened when the markets were totally free – i.e., before World War II – and thus did not take account of the nature of free markets;
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Fourthly, the third industrial revolution which totally revolutionized (and decimated) the workforce occurred. One cannot blame von Hayek for not being able to predict it in 1944 – but there can be no such excuse for the Friedmans, because the impact had begun in the late ‘60s, and was beginning to develop into the white-collar sector when Free To Choose the book was written. The third industrial revolution is, of course, the Communications and Information Technology age that we now find ourselves in; and
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Finally, the assumption made by everyone was that people would, in this new world, behave ethically and not take advantage of it for personal gain. This failure to take the all-corrosive effects of that basic cardinal weakness of the human nature - naked Greed, without heed of the law or the consequences - is the ultimate failure of modern economics.
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The five together made economic rationalism a disaster waiting to occur. It also means that economic rationalism was out of date before it was implemented. And it also explains why Governments behave like they do: without regard for wishes and/or needs of the majority of their constituents.
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What can we do about it? Not a lot, until the inevitable depression comes along, driving everyone back to their collective senses.
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Until then, here's to a happy apocalypse...
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FOOTNOTES:
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[1] I have actually confirmed this point with experts, and confirmed it by studying both economics and psychology myself, although it should be obvious to everybody based upon their own experiences.
[2] An interesting side-point is that Laffer, after his theory was proven wrong, made an unsuccessful tilt at politics, then went into private practice as a consultant, based on an investment theory on which the jury remains out.
[3] Marx wrote almost all of his works after the early 1840’s, including Das Kapital, with Friedrich Engels, so it could be attributed to either. It also was used in several publications, thus is not attributed to any in particular here.
[4] If the repatriations had been realistic, Germany would have almost certainly had an economic boom in the ‘20s like the rest of the Western World. The fact that this didn’t occur was one of the factors in the rise of Hitler.
[5] All von Hayek’s writings were published under the name ‘F.A. Hayek’. This was more to disguise his background, which was reasonable, given the general view of Austrians at the time in the U.K.
[6] This ambiviance is quite odd. In regard to protectionism, he seemed to approve of that he saw in the U.S., but not that he saw in the U.K. and Germany. He also preferred Sweden’s welfare state to the U.K.’s, which was (and still is) far more generous.
[7] And several of them would not have agreed with von Hayek’s theories, if their own writings are any guide.[8] Two other points need to be added about Mein Kampf - one is that the fascism is obvious to the modern reader, but very few at the time would have noted it (including, it must be said, von Hayek). I also doubt the author was Hitler. The theories may have been, in places, but the prose style was closer to that of Gobbels.
[9] Does it work? On the evidence we have to date, no. Linking productivity to shareholdings works one when the shareholdings are of some significant value, but that only happens at the very top levels of a company.
[10] Which he admitted in the introduction to the 1967 reprint of The Road To Serfdom was incorrect. It should, of course, be remembered that Stalin’s USSR was an ally of Britain during World War II, during which the book was written and published.
[11] I would tend to excuse von Hayek here, as his emotional state obviously was the biggest influence on his writing.
[12] An interesting point here is that one of the greatest admirers of The Road To Serfdom was none other than Maynard Keynes, and Hayek and Keynes carried on a friendly correspondence that lasted until Keynes' death. This makes Hayek’s attacks on Keynes following Keynes death the more risible, as was inadvertently made clear by the publication of their correspondence under the title The Battle With Keynes and Cambridge: Essays, Correspondence, and Documents (1992), as part of an attempt to bring von Hayek’s works back into print. The series was discontinued shortly afterwards, for reasons I am unable to confirm.
[13] Originally published under two titles and as four volumes in the sixties. The 1973 version was both consolidated and revised by von Hayek.
[14] This still occurs in many tertiary institutions.
[15] If one studies 16th Century History, one would encounter many other writings by Adam Smith on non-economic topics.
[16] Free To Choose, Pages 148 and 149.
[17] Many people claim credit for invention of these terms. I am unable to identify who actually invented them, but they came into vogue at about this time.
[18] Report Of The Committee Of Enquiry Into The Australian Financial System, 1981, known as the Campbell Report after the enquiry’s’ chairman, the late Sir Keith Campbell.
[19] See The Whitlam Government 1972-1975 by Gough Whitlam, Chapter 3.
[20] This summary is based on a number of descriptions, many of which are contradictory. My summary is deliberately neutral, for legal reasons. There are many other versions, including that in The End Of Certainty by Paul Kelly (1992) Pages 79 to 94; Keating: The Inside Story by John Edwards (1996) Chapter 7; The Hawke Memoirs by Bob Hawke (1994) Chapter 16; Confessions Of A Failed Finance Minister by Peter Walsh (1995), Pages 98 and 99, etc.
[21] The End Of Ideology: On The Exhaustion Of Political Ideas In The Fifties by Daniel Bell, Free Press, 1960.[22] The End Of History and the Last Man, Free Press, 1992.
[23]Except for Von Hayek, who was in favour of protectionism until shortly before his death in 1991.
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