Saturday, July 23, 2016

Yes, Virginia, Hayek was a Liquidationist in 1932

But you won’t know it from the weird Hayek apologists and Free Bankers who have essentially rewritten history to make it seem as if Hayek was in favour of MV stability by monetary stimulus and central bank intervention during the early years of the Great Depression (see here for a full discussion).

Not too long ago I had a run in with some of the Hayekian True Believers on Twitter.

One of them cited the second part of Hayek’s review of Keynes’ Pure Theory of Money (see Hayek 1932; the first part of the review is Hayek 1931), in order to prove that Hayek was definitely in favour of monetary stimulus and was not a nasty liquidationist.

Well, I checked this out and – low and behold! – Hayek gives us his opinion:
“I do not deny that, during this process [viz., the slump], a tendency towards deflation will regularly arise; this will particularly be the case when the crisis leads to frequent failures and so increases the risks of lending. It may become very serious if attempts artificially to ‘maintain purchasing power’ delay the process of readjustment – as has probably been the case during the present crisis. This deflation is, however, a secondary phenomenon in the sense that it is caused by the instability in the real situation; the tendency will persist so long as the real causes are not removed. Any attempt to combat the crisis by credit expansion will, therefore, not only be merely the treatment of symptoms as causes, but may also prolong the depression by delaying the inevitable real adjustments. It is not difficult to understand, in the light of these considerations, why the easy-money policy which was adopted immediately after the crash of 1929 was of no effect.

It is, unfortunately, to these secondary complications that Mr. Keynes, in common with many other contemporary economists, directs most attention. This is not to say that he has not made
valuable suggestions for treating these secondary complications. But, as I suggested at the beginning of these Reflections, his neglect of the more fundamental ‘real’ phenomena has prevented him from reaching a satisfactory explanation of the more deep-seated causes of depression.” (Hayek 1932: 44).

That is very explicit: “Any attempt to combat the crisis by credit expansion will, therefore, not only be merely the treatment of symptoms as causes, but may also prolong the depression by delaying the inevitable real adjustments.” Crystal clear. As late as the second edition of Prices and Production (1935), Hayek was still saying that “we can do nothing to get out of ... [sc. a depression] before its natural end” (Hayek 2008 [1935]: 274–275).

Hayek is defending the Austrian Business Cycle Theory (ABCT) here, and its liquidationist solution to depressions.

In the same year (1932), Hayek signed a letter opposing British government intervention in the economy, as explained by Ludwig Lachmann:
AEN: In the early 30’s there had been great interest among the profession in the ‘Austrian’ or Hayekian theory of the trade cycle. Yet as the 1930’s progressed even those who had been adherents seemed to have given up their belief in its correctness. What reasons do you think were behind this?

Lachmann: Well, you presumably know about the two different letters to the London Times that appeared in October, 1932. This, of course, was before I came to London. In one of them, Keynes and some Cambridge economists who were not, in general, his friends, like Pigou and Dennis Robertson, demanded that the government should take steps against unemployment. And three days later, Hayek, Robbins and Arnold Plant sent another letter saying that anything the government did by way of public works or similar methods would only make things worse and would not have the affect that Keynes claimed it would have.

That is to say, the ‘Austrians’ seemed to be committed to a policy of continuous deflation whatever happened. Yes, I’m quite sure that the apparent insistence of the ‘Austrians’ that the depression must run its course in the sense that both prices and wages in general must fall seemed to make it increasingly difficult for most other economists to support it, because it was by then obvious that wages didn’t fall, not in the Britain of the 1930’s anyway. That is to say, there was an obvious difference between the point of view expressed by Hayek, Robbins and their letter of October, 1932, and their willingness to admit the following year that a secondary depression was possible.”
Ludwig Lachmann, “An Interview with Ludwig Lachmann,” The Austrian Economics Newsletter, Volume 1, Number 3 (Fall 1978)
So Hayek changed his mind after he started to believe in the existence of “secondary depressions,” and then came to advocate monetary and eventually even fiscal interventions as a correct response to “secondary depressions” or “secondary deflations,” particularly when he came to accept the severity of downwards nominal wage rigidity in modern capitalist nations.

We know this because Hayek explicitly said so later in life:
“Although I do not regard deflation as the original cause of a decline in business activity, such a reaction has unquestionably the tendency to induce a process of deflation – to cause what more than 40 years ago I called a ‘secondary deflation’ – the effect of which may be worse, and in the 1930s certainly was worse, than what the original cause of the reaction made necessary, and which has no steering function to perform. I must confess that forty years ago I argued differently. I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way” (Hayek 1978: 206).
And by the time of Hayek’s 1937 essay “The Gold Problem” (“Das Goldproblem” in German; see Hayek 1999: 169–185, and 184), Hayek is found actually endorsing, not just MV stability, but deficit-financed public works as a response to depression (see here).

I don’t think people appreciate the full extent of Hayek’s humiliation, volte face and capitulation to Keynes on these issues today (even if this was only a strategic move by Hayek at the time).

But Hayek clearly wasn’t saying these things in 1930, or 1931 or 1932. At that time, Hayek was indeed a liquidationist in any meaningful sense of the term.

Further Reading
“Hayek was originally a Liquidationist: Free Bankers are Wrong!,” August 13, 2013.

“Hayek the Stable MV Theorist?,” August 13, 2013.

“The Evidence for Hayek the Stable MV Theorist is still Feeble,” August 21, 2013.

Hayek, F. A. von. 1931. “Reflections on the Pure Theory of Money of Mr. J. M. Keynes,” Economica 33: 270–295.

Hayek, F. A. von. 1932. “Reflections on the Pure Theory of Money of Mr. J. M. Keynes (continued),” Economica 35: 22–44.

Hayek, F. A. von. 1978. New Studies in Philosophy, Politics, Economics, and the History of Ideas. Routledge & Kegan Paul, London.

Hayek, F. A. von. 1999. “The Gold Problem” (trans. G. Heinz), in S. Kresge (ed.), The Collected Works of F. A. Hayek. Volume 5. Good Money, Part 1. The New World. Routledge, London. 169–185.

Hayek, F. A. von, 2008 [1935]. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard. Ludwig von Mises Institute, Auburn, Ala.

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Friday, July 22, 2016

Friedrich List on English Free Trade and the Colonisation of Germany

Friedrich List saw right through the English argument for free trade in Germany in his National System of Political Economy:
“In our days the English legislation not having separated German agriculture from the British manufactures, Germany, with a progress of twenty years in an industrial career achieved at immense sacrifices, would he blind to allow herself to be diverted by the repeal of the English laws from the great national object she is now pursuing. We have, indeed, a firm conviction that Germany, in that case, ought to increase her duties as compensation for the advantage which the repeal of the corn laws would give to the English over the German manufacturers. For a long time to come, Germany can adopt no other policy toward England than that of a manufacturing nation yet far behind, but exerting all her energy to overtake, if not surpass her rival. Any other policy would endanger German nationality. If the English need corn or timber from abroad, whether they import from Germany or any other country, Germany must not strive less to preserve the advantages which her industry has already obtained, and to secure a greater progress in time to come. If the English are unwilling to receive the wheat and the timber of Germany, so much the better; her industry, her shipping, her foreign trade will increase the faster, her system of internal communication will be improved the sooner, and the German nationality will acquire the more certainly its natural basis. It may be that corn and timber in the Baltic provinces of Prussia will not advance in price as promptly in this case as if the British markets were immediately opened; but the improvement of the means of communication at home, and the demand for agricultural products, created by home manufactures, will proceed with a degree of rapidity far from unsatisfactory, in a market established in the very centre of Germany, a market not only established, but made permanent forever no longer oscillating, as heretofore, from one decennial period to another, between famine and abundance. With respect to power, Prussia, in pursuing that policy, will gain a real influence in the interior of Germany, of an hundred times greater value than the sacrifices made in her Baltic provinces; but she will merely have made a loan to the future at a heavy interest.

It is obvious that by means of this report the English ministry meant to obtain admission into Germany for the common articles of wool and cotton, either by the suppression or the modification of our specific duties, or a diminution of the rates, or by the admission into the English market of German corn and timber; this would be making the first breach in the protective system of Germany. The articles of general consumption are, as we have shown, by far the most important: they constitute the basis of the national industry. With a duty of ten per cent. ad valorem, as demanded by England, and the undervaluations which always attend the ad valorem system, German industry would be almost wholly sacrificed to English competition, especially in times of commercial crisis, when the English manufacturers are obliged to dispose of their goods at almost any price. There is no exaggeration in averring that the propositions of England tend to nothing less than the overthrow of the whole system of German protection, with a view to reduce Germany to the condition of an agricultural colony of England.” (List 1856: 469–470).
Now it is true that tariff protectionism, while it was used in Germany in the early and middle 1800s, was used to a far lesser extent than in America, nevertheless German protectionism in the18th and 19th centuries that forced industrialisation was significant.

First, the foundation for German industry had been laid in the late 18th century by a Prussian program of creation of cartels and monopoly rights, export subsidies, bringing in of experts on industry as well as skilled labour, and the outright conquest of Silesia from Austria, a stronghold of industry (Chang 2002: 33). The Prussian state program of industrialisation was continued in the early 19th century, under the Minister of Mines Friedrich Wilhelm von Reden (1752–1815) and Christian Peter Wilhelm Friedrich Beuth (1781–1853) (Chang 2002: 34).

Even the Prussian-led Zollverein (1834–1919), although it created a free trade zone within the area that would become the German empire, had a distinctly protectionist phase in the 1840s and 1850s (Bairoch 1989: 30–31).

After the 1840s and the proclamation of the German empire in 1871, Prussia continued its program of industrial subsidies, promotion of cartels and a highly successful system of higher education focussed on the sciences and engineering (Chang 2002: 35).

Despite a free trade interlude between 1862 and 1878 (Henderson 1975: 213), it was actually the case that the new German empire increased tariffs from 1879 until 1885, especially on iron and steel (Skarstein 2007: 358, n. 11; Chang 2002: 33; Feldenkirchen 1999: 98–99), once these industries started to feel the effects of free trade.

Other notable policies were that, between 1879 and 1895, the Prussian state nationalised nearly all its railways, and nationalised railways existed in seven other German states (Henderson 1975: 210–212); the profits from nationalised railways were an important part of government revenue, and so of public investment.

Bairoch, Paul. 1989. “European Trade Policy, 1815–1914,” in Peter Mathias and Sidney Pollard (eds.), The Cambridge Economic History of Europe. Volume VIII. The Industrial Economies: The Development of Economic and Social Policies. Cambridge University Press, Cambridge. 1–160.

Chang, Ha-Joon. 2002. Kicking Away the Ladder: Development Strategy in Historical Perspective. Anthem Press, London.

Feldenkirchen, W. 1999. “Germany: The Invention of Interventionism,” in J. Foreman- Peck and G. Federico (eds.), European Industrial Policy: The Twentieth Century Experience. Oxford University Press, Oxford and New York. 98–123.

Henderson, William Otto. 1975. The Rise of German Industrial Power, 1834–1914. University of California Press, Berkeley.

List, Friedrich. 1856. National System of Political Economy. J. B. Lippincott & Co. Philadelphia.

Skarstein, Rune. 2007. “Free Trade: A Dead End for Underdeveloped Economies,” Review of Political Economy 19.3: 347–367.

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Lord Keynes @Lord_Keynes2