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Home > Blogs > Anthony Harrington > Casting about for the new economics: rediscovering Hayek, part 1

Casting about for the new economics: rediscovering Hayek, part 1

Austrian School of Economics | Casting about for the new economics: rediscovering Hayek, part 1 Anthony Harrington

It is now widely believed that the 2008-09 global crash discredited the classical economic model of efficient markets beyond repair and that what is needed is a new vision. In fact the financier George Soros believes this so strongly that he has almost single-handedly funded a new body, The Institute for New Economic Thinking, or iNet, the governing board of which includes the Nobel Laureate economist Joseph Stiglitz.

I plan on exploring iNet in a future blog, but to begin with I want to look at the Austrian School of Economics, as epitomized by Ludwig Von Mises and Friedrich Hayek. What has made many people look afresh at the propositions of the Austrian School is their argument that the crash, and what they see as its wildly mishandled aftermath, is largely down to governments adopting interventionist policies.

This might seem at first glance to be hugely counter-intuitive, since the dominant cause for the crash is widely cited as the inappropriately light touch regulatory regime which encouraged banks to take bigger and bigger risks without reining them in. However, what really annoys the Austrian school is the “too big to fail” argument, which underwrote bank risk taking through the implicit assumption that whatever happened, the biggest banks would get bailed out. Government intervention in the markets at its worst, in other words, they would say. (We will pass here on the Austrian school’s irritation with fractional reserve banking and government control of fiat money, both of which are seen as archetypal techniques for jimmying the markets and turning us all into serfs.)

Sticking to the crash then, the Austrian School argument is that given the inevitability of government intervention, moral hazard ran rampant, and why wouldn’t it? Had the economy been such that it was clearly understood by all the players that banks would live or die by their own actions - as happens in (most) non-financial sectors of the private sector economy - we wouldn’t have had the behaviour that led up to the crash.

So where does Hayek fit into all this? (I will treat Mises in a separate blog.) There is an excellent series of interviews with Hayek available on the web, carried out by a number of notable lawyers and economists. Love him or loathe him – and it is axiomatic that anyone of a left-wing or socialist disposition will loathe Hayek, since for him socialism is the death of liberty – these webcasts are compelling viewing for anyone who wants to sharpen their own conception of fundamental economic and social principles.

In a set of three conversations with Robert Bork, Hayek set out the fundamentals of his view of economics, law and “the free society”. For him, law, ideally, simply sets out how dispersed information should be used in society within an evolutionary framework. This sounds like impenetrable code so a little patience please while I endeavour to unpack it.

“Evolution” here refers to his belief, harping back to the influence on him of his biologist parents, that Darwinian principles of evolution are at play in bringing the first human tribes together. These are essentially small groups, no more than forty or fifty. The goals of the group prevail and are the goals of the individuals. In other words, individual freedom does not yet exist. You work for the tribe and you take your goals and “meaning” from the tribe.

These basic groupings evolve through trade to something different. The laws of the tribe change to accommodate trade, which inevitably gives some individuals the right to take surplus goods – which as Hayek puts it, might well be attractive to their neighbours – out of the tribe for trade.

From this comes culture and civilization. In Hayek’s words, “Culture precedes intelligence, it gives rise to intelligence, it is not itself the product of intelligence.”

We’ll skip the rise of the merchant classes and so forth, but Hayek's point is that freedom here is about evolving beyond the repressive rule of the tribe and empowering the individual trader, who is motivated to trade by being able to maintain the resultant profits. Freedom and private property are thus inextricably linked. In fact, for Hayek, one of the fundamental reasons we are not still stuck in pre-industrial feudalism is down to the fact that a few European city states, which thrived on trade, were strong enough to resist wave after wave of Germanic tribal raiders.

These raiders, and the military classes in Europe which came into being to defend against them, had created a self-perpetuating feudal world which was only broken gradually over time by the superior culture of individualism, kept alive in “free” city states like Venice and Danzig. Ditto if you go back a thousand years to Athens. In other words, that notorious slogan on the gates of Auschwitz, “Arbeit Macht Frei” ("Work makes you free"), is total rubbish, as every serf labouring for his Lord knew in his bones. It’s not work, but trade that sets us free.

Let us now leap to the next central feature of his thought.

“One event that really changed my outlook was that I came across a criticism of economists talking about “the given data”. The author pointed out that this phrase completely obliterated the problematic process of how data is assembled when information is complex and dispersed.”

That comment set Hayek off on the theory of prices. Market pricing in a free market acts as a guide to individual behaviour - that’s the whole point. “With information [about prices and values] dispersed across society, you could interpret prices as signals to position yourself to act intelligently on the market.” Prices and the continuing flow of prices, in other words, mean that you are not flying blind in your efforts to utilize whatever private means you have to realize whatever goals you have set yourself. "Are dentists 'underpaid'? Fine, scrub that for a career choice, I’ll be a surgeon instead..." Or vice versa, depending on price. What you really don’t want, in the Hayek universe, is some government entity stepping in and depriving you of your freedom to choose, either by taxing your private means out of existence, or by rigging the 'fair' market price for dentists and doctors, or by coercing you in still more dramatic ways.

Which brings us to the next point, which will be developed in Part 2, this blog having already reached excessive proportions. For Hayek, the maintenance of freedom is all about limiting the role of governments to discriminate against particular groups. “Progressive taxation” - where that is interpreted to mean the redistribution of wealth from the rich to the poor - is blatant discrimination against a particular group, the rich. That is anathema to Hayek. (Did I mention that socialists would loath Hayek?) For him, even well-intentioned governments are bumbling do-gooders, hell-bent on creating ever thicker meshes of rules that constrain the markets and destroy individual freedom.

This, of course, puts Hayek on a collision course with John Maynard Keynes, who was all for government intervention in the markets in certain circumstances, such as implementing fiscal stimulus to counteract strong deflationary pressures, for example.

For Hayek, the list of what protects our freedoms is short. It sums up as: free markets, the sanctity of private property (which includes the right to keep what you earn, minus a fair proportion to the state in taxes), the limitation of state power, and a recognition by individuals that social freedom rests upon people voluntarily accepting certain restraints (not shoving someone off a station platform because you want to get in the door first, for example). Erode any of these and we’re back on the road to serfdom...

Further information on economic theory and the Austrian School of Economics:

Tags: discrimination , economic thought , fiat money , fractional reserve banking , freedom , Friedrich Hayek , John Maynard Keynes , liberty , Ludwig von Mises , personal freedom , state power
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