Monday, September 5, 2011

Keynes, Hayek and Economics

The new academic year is about to start, and hence you may be about to make the journey to Birmingham to begin your undergraduate degree in economics, and may have somehow stumbled across this blog - if so, welcome! If not, welcome still. The point of this blog is to help those studying econ101ab at Birmingham to see that what they are studying is important and topical, and can help you think more clearly about all the major topics on any given day....

You'll hopefully learn, if you haven't already, about something called Keynesian economics, named after John Maynard Keynes, a British economist who wrote most famously between the two World Wars. His ideas were controversial as they went again the grain of classical economic thinking, the thinking most prevalent at the time; that of balanced budgets, and allowing the forces of the market to do their work, waiting for the long run to see that all was well.

Keynes made a fairly simple point, notably that there may just be situations where the economy doesn't just pick up. Recall, he wrote his most famous contribution, his General Theory, during the Great Depression when the economy failed to pick up and things didn't seem at any point soon to be getting better. Classical economists would say that in the long run, the depressed demand in many markets would lead to the necessary re-adjustments (falling real wages) such that eventually, things would pick up again - in the long run. Keynes's retort, famously, was that "in the long run we're all dead".

Keynesian thought led to demand management, where governments use fiscal and monetary policy to engineer stability: To remedy the downturns and temper the boom times. It hasn't always been the flavour of the month however, and the strong monetarist counter-revolution of the late 1960s and 1970s appeared to have destroyed Keynesianism. However, a certain group of economists, of the Austrian variety aligning themselves behind Friedrich von Hayek have persistently argued against Keynes and Keynesianism. Hayek's main thesis was that man isn't capable on his own of understanding the market, nor is any government, and hence should refrain from attempting to set up mechanisms in the face of the market; such attempts are doomed to fail.

Such Austrian economists are prolific bloggers, and hence you can read their thoughts at Cafe Hayek and EconLog perhaps most vociferously. Today in the US (and Canada) it's Labour Day, and hence it was predictable that at these blogs, something would be posted in the ilk of responding to Keynesian economics, which is percieved by Austrians to have been particularly sympathetic to workers.

Hence, Don Boudreaux, who has a habit of posting the letters he's written to just about everyone who happened to utter anything he disagreed with, writes and posts on Cafe Hayek, his letter regarding what good Keynes apparently brough humanity. It's an interesting read, and I would encourage you to read the blogs of Austrians because they will challenge you to substantiate the things you believe and are taught in what is a Keynes dominated profession, much to the dislike of Austrians.

What you will find as you study economics is that views you previously held that were away from the centre ground, so to speak, will be challenged, and I doubt you'll be able to keep to them. For example, strong views regarding minimum wages I doubt you'll keep once you're done your degree. Equally, if you enter with strong right-wing views which may border on the Austrian, I think you'll also be challenged away from them.

The fundamental assertion of Austrians is that the market knows best, the market does best. You'll learn about the Fundamental Theorems of Welfare Economics, and hence you will learn that the market is an effective tool for communicating the most information to the most people - provided a set of assumptions hold.

Now, the last bit is important, because it's something that the writers at EconLog and Cafe Hayek choose to ignore because it doesn't suit their prior dispositions regarding the economy. Boudreaux has at times compared the healthcare and education markets to the market for buying pet food, for example. However, as you will learn if you study Contemporary Issues in the UK Economy in your second year, and also via microeconomics, the market is only effective if the price mechanism works. It breaks down when information is imperfect.

The important thing though again that you will learn when studying economics is that the knee-jerk reaction towards governments running everything where the market fails is another mistake to make - it's one made by thost on the left usually. It may well be the case that a failure in the market due to imperfect information of some sort or another cannot be remedied by government, and the government will only make the situation worse. The market for rail travel may be an example; all the assumptions of perfectly functioning markets are not upheld, but it doesn't mean that the government will run the railways better than the private sector.

However, health is dramatically different to pet food. Buying the wrong pet food may lead to an unhappy dog for a day or so; the mistake is easily rectified. Buying the wrong healthcare treatment from the wrong healthcare provider may well not be so easy to rectify. Information is not so readily available to all market participants, and hence you see that working from principles of information we can conclude that healthcare is not likely a market best left to market forces - regardless of your prior prejudices in this area. Now, the solution will not necessarily be a full blown NHS, but it also won't be a fully free market.

The bottom line to this post is this: Boudreaux, the writer of the blog post linked up earlier, takes a position on the fringes of the economics profession, and in order to do that, he has to ignore much evidence contrary to what he originally believes. He has to ignore all the above regarding information in health markets and other such markets. But on the other hand, he's just as wrong as the person who believes only the government should be running most (if not all) things - both must ignore basic economic theory to justify their position. Hopefully by the end of your three years, you'll take neither position, and you'll be able to reason and justify all the things you believe about the economy, hence when you read people like Boudreaux, you can understand why he's wrong.

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