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Essay

Was it Keynes or was it Hayek who got it right?


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Economics is often described as just a lot of opinions all vying for acceptance. In fact there is a sense in which the adoption of a particular theory by a government with a view to resolving some problem with a national economy can be seen as a valid experiment to test the theory.

During the Great Depression of the 30's John Maynard Keynes observed that the economy of the United States had settled at a low level of activity which was below that necessary to keep the lower stratum of society out of poverty and that there was no mechanism which would change the level of activity to a higher level. He worked out that the mechanism of the free market would result in economy which could settle in to a stable condition at any arbitrary level of activity. He observed that there was no inherent tendency for the level of activity to rise. He went on the develop a new economic theory based on stimulus by controlled government spending applied in such a way as to move the level of activity to a new and more appropriate stable point. The New Deal, which President Roosevelt put in place, tested the theory and showed that it was correct. The US economy was lifted out of depression into a new era of prosperity.

Hayek, one of Keynes's contemporaries, disagreed with Keynes's theory and proposed that the only mechanism which would ensure that an economy became prosperous was the mechanism of free markets. Hayek's theory was not tested as Keynes's was but he had a disciple, Milton Friedman, who, many years later, was given the opportunity to test Hayek's theory on the Brazilian economy. The results were a complete failure. Despite this, free market economics was adopted by Thatcher in the UK, Reagan in the USA, Keating in Australia and others as the panacea for the ills of the world's economies.

These experiments have been running for over twenty years and it seems that the results have not been as good as expected. While some people get rich under this kind of regime, the poor don't necessarily get richer and the ranks of the unemployed swell creating a new underclass of people locked in to poverty.

If a mere engineer may be permitted an observation, perhaps the problem with free market economics lies with the absence of truly "free" markets. With nothing to stop them, corporation will naturally attempt to control their markets either by monopoly or collusion to increase their profits at the expense of others.

It has always amazed me that the proponents of free market economics are happy to put up all kinds of trade barriers to protect their own players from international competition while spruiking their "free trade" credentials.

I have a typical engineer's mental model of the Australian "level playing field". We have apparently adopted a free trade approach to the rest of the world and we, the people who make things happen, are running around on this flat patch of ground beavering away as hard as we can and the rest of the world is standing on the high banks all around the playing field pissing down on us.

I might be entirely wrong about this but I see no evidence that the Friedmanites are right. Hayek has a lot to answer for in my book and it is time to call off the "free market" experiment and return to some good Keynesian economics.


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Created: 28.08.2004 and last revised 27/9/09
Author: Robin Chalmers Copyright in all the material on this site is asserted by the author
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