The ideas of Laissez-faire economic theory can be found everywhere: on the internet blogs, on television news programs, on radio, from think tank public position papers, university channels, and political campaigns like the present Obama/Romney 2012 presidential race. Laissez-faire economic policies were key to Reagan’s administration as became stock Republican Trickle Down economic propaganda ever since. Laissez-faire theory even made major inroads into Democratic political platforms; however, this economic school of thought can be traced back to the early 1800s. The actual term “Laissez-faire” was first used in France during the 1600s, but didn’t become a creed until the 1830s when British manufacturing leaders urged passing of the Poor Laws (Polanyi, Karl, The Great Transformation: The Political and Economic Origins of Our Time, Beacon Press. Kindle Edition. p. 141-142). Sometimes Laissez-faire economic notions are explicitly presented, but most often they are assumptions underlying political memes which make them easier to accept without critical examination. These background assumptions are difficult to identify and counter-argue even for those familiar with Laissez-faire economic doctrine because these beliefs are so well embedded in public discourse.
Laissez-faire economic doctrine can appear in many forms and contexts: Malthusian natural selection, Edmond Burke Conservatism, Herbert Spencer Social Darwinism, Neo-liberal economics, Austrian Carl Menger, Ludwig von Mises’ Austrian school Capital Theory, Friedrich von Hayek’s Austrian Capital Theory, Ayn Randian nihilistic individualism, Milton Friedman Monetarism, Lew Rockwell Libertarianism, and Globalist Thomas Friedman. There are of course many others apologists for Laissez-faire theory, but I want to exam Austrian economist Friedrich von Hayek because he debated John Maynard Keynes directly and left an extensive record of arguments and counter arguments at the critical time Keynesianism became the dominate economic school of thought during the 1930s. The two economists knew each other personally. The obituary for the son of Friedrich von Hayek, Laurence Hayek, recounted that both Keynes and Hayek took fire watch shifts on the roof of the King’s Chapel during German bombing raids.
Friedrich von Hayek began his economic studies as a Fabian socialist, but never was attracted to Marxism. After the WWI armistice of November 11, 1918, he returned to Vienna in defeated German-Austria intending to study economics. The former Austrian-Hungarian Empire was reduced to a lesser state of German-Austria that suffered from economic depression as the allies extracted postwar reparations. During this difficult time in post WWI German-Austria, the nineteen years old Hayek read John Maynard Keynes’ book “Economic Consequences of the Peace” that was critical of the victorious Allied leaders’ desire to punish Germany with harsh reparation agreements, and warned of revolution in the chaotic defeated states. Because of Keynes’ concern for these suffering countries from extreme hardship, hyper-inflation being one, Hayek said Keynes was “something of a hero to us Central Europeans.” (Wapshott, Nicholas, Keynes Hayek: The Clash that Defined Modern Economics, Norton. Kindle Edition. p.4.). So one can say Hayek was a Keynesian on this issue of the post war Treaty of Saint-Germain-en-Laye that placed economic hardship on Germany and Austria. Hayek was also impressed and agreed with Keynes’ solutions for the government to stabilize Austrian prices and currency as proposed in Keynes’ article “A Tract on Monetary Reform.”
As a law student at the University of Vienna Law School Hayek read Austrian economist Carl Menger on price theory. After Hayek graduated in 1921, a lecturer from the University of Vienna named Ludwig von Mises hired him. With the help of Mises, Hayek worked in the United States as an economic researcher in 1923. Hayek also started work on an economics Ph.D at New York University, and once worked with an economics advisor to President Wilson. Hayek returned to Austria in 1924 and continued studying under Mises as his mentor. In 1927 Mises appointed Hayek as director to the Austrian Institute for Business Cycle Research. Hayek was determined to met Keynes and took the opportunity when invited to a meeting of the London and Cambridge Economic Service in 1928 where the two first met face to face. This organization was founded by Keynes and was composed of the London School of Economics (LSE) and Cambridge University to provide new kinds of statistical data for stock share prices, wages, and production.
At this first meeting Hayek and Keynes got into a fierce debate concerning economic theory that would continue in academia for years. Hayek met two important allies at LSE who would help him publicly confront Keynes ideas. Lionel Robbins was director of the LSE, and William Beveridge who did not like Keynes held the chair of political economy at LSE. As a free-marketer Robbins believed that the London School should oppose the Cambridge school of economic theory characterized by classical economist Alfred Marshall and Keynes. Robbins helped Hayek with writing his papers and speeches in English including strategic advise on how to attack Keynes. In 1931 Robbins invited Hayek to give four lectures arguing against Keynesian economic theories.
However, before giving the four LSE lectures, Hayek’s made a first appearance to the mostly Keynesian Marshall Society in London, Cambridge. Richard F. Kahn, a physicist turned economist and then professor at King’s College in Cambridge, attended this first public lecture. Kahn is credited for the discovery of the “ratio” effect which Keynes renamed “the multiplier” effect as money is repeatedly spent working its way through the economy. Kahn wrote of this first lecture by Hayek.
Joan Robinson, who had a reputation for ruthlessly dispatching her opponents, was less forgiving. “I very well remember Hayek’s visit to Cambridge on his way to the London School,” she recalled nearly forty years later. “He expounded his theory and covered the blackboard with his triangles. The whole argument, as we could see later, consisted in confusing the current rate of investment with the total stock of capital goods, but we could not make it out at the time. The general tendency seemed to be to show that the Slump was caused by inflation.” She cruelly summed up Hayek’s unfortunate debut on the British stage as a “pitiful state of confusion.” (Ibid., pp. 71-72).
In spite of this bad start, Hayek still wanted to give the four lectures to the London School of economics to show Keynes’ theories were wrongheaded by presenting Austrian Capital Theory. British author Nicholas Wapshott has an excellent historical record in his book, Keynes Hayek: The Clash that Defined Modern Economics, (2011) about the debates between Keynes and Hayek that is well worth reading. Currently there is a massive amount of propaganda constructed around Hayek and the Austrian School of Economics to hide the many flaws of this Laissez-faire school of economics.
Hayek’s four lectures were about prices, the natural equilibrium of production, interest rates, credit, and monetary theory. These lectures would eventually be published in a book entitled “Prices and Production (1935).” These lectures secured Hayek’s position at LSE, but did not catch Keynes’ immediate attention. Then in August 1931 Hayek attacked Keynes’ recent publication, “Treatise on Money” in the LSE’s journal named, Economica, with Robbins as the journal’s editor. Hayek’s diatribe entitled, “Reflections on the Pure Theory of Money of Mr. J. M. Keynes,” was essentially an ad hominem attack on Keynes. Hayek could only show contempt for Keynes writing in the review that,
Having in his opening remarks excoriated Keynes for his intellectual inadequacies and his lack of knowledge of basic Austrian economic theories, Hayek sets off on a long, complex, and often barely comprehensible explanation for why Keynes’s ignorance of Austrian capital theory, including Hayek’s own contribution, which had not yet been published in English and therefore Keynes could not have read, ensured that A Treatise [on Money] was of little use in explaining the fluctuations of the business cycle. Throughout, Hayek adopted an ill-tempered tone of indignation, as if Keynes had deliberately set out to offend him personally. “I have no fundamental objection to this somewhat irritating distinction [between entrepreneurs’ profits and money income],”29 he writes, before listing what he seems to imagine are a succession of personal slights. “I cannot agree with his explanation of why profits arise,”30 he writes. “I must confess that I am absolutely unable to attach any useful meaning to his concept.”31 And “I shall repeatedly have occasion to point out”32 another of Keynes’s perceived misapprehensions. While Keynes, who was not without a large ego himself, was so confident he often changed his mind and admitted his faults, Hayek’s stance was based on absolute certainty that he was right in every particular. Keynes reveled in controversy and debate and welcomed those who disagreed with him, while Hayek, in Robbins’s assessment, “was no proselytizer. He had strong convictions himself. But in discussion his focus was always directed not to persuade but rather to pursue implications.”33 Rather than confine himself to explaining his differences with Keynes’s reasoning and conclusions, Hayek’s tetchy remarks are littered with ad hominem snipes, such as “he seems to think . . .” and “in spite of some clearly contradictory statements of Mr. Keynes,” whom he accuses of “very mischievous peculiarities.” He condemns Keynes’s obscurity of language while compounding his rival’s error, as in: “Most of the difficulties which arise here are a consequence of the peculiar method of approach adopted by Mr. Keynes, who, from the outset, analyses complex dynamic processes without laying the necessary foundations by adequate static analysis of the fundamental process.”34 (Ibid,. pp. 90-91).
Director Lionel Robbins of the London School of Economics used Hayek to counter Keynesian economics based in Cambridge by helping Hayek with his English writings and lectures. Some believe Robbins was key in getting Hayek hired at the London School of Economics to hold the Tooke Chair in Economic Science and Statistics in 1931. Robbins also wrote on economics from a Hayekian analytical model for years, but eventually became a full-fledged Keynesian economist while publicly voicing his regret for adhering to Austrian capital theory. Hayek moved back to Austria in 1969.
Lionel Robbins, Director of the London School of Economics, and others at the school attempted to bring Keynes and his stimulus policy down to discourage the British government from engaging in deficit spending. Ironically, all of these economists later became Keynesians and abandoned Hayek.
After the four Hayekian lectures Keynes responded and eventually won the day and Hayek was all but forgotten for a time.
What brought Hayek down was his inability to respond to the counter arguments presented in Keynes’ Magnus opus, The General Theory of Employment, Interest and Money.