Thatcher, Blair and the Road to Serfdom

Among yesterday’s many predictable tributes to Margaret Thatcher on both sides of the house, one from Labour MP Gisela Stuart caught my ear. (Hansard)

Whole generations have forgotten what 1979 was like. I came here from Germany in the 1970s. I know that Margaret Thatcher would not want us not to learn any lessons from the battles that she had fought—some lost, some won, and some which continue. I am thinking in particular of the role of the market. It is interesting that Margaret Thatcher considered that Hayek’s book “The Road to Serfdom” should be compulsory reading. Many Government Members, and probably even more of my hon. Friends, will be surprised to learn that I agree that it should be compulsory reading, as a reminder of the role of the market. [Hon. Members: “Come over to this side!”] No, it is not a question of “Come over to this side”.

Similar arguments have been advanced about the force of the market. It has been argued that it actually liberates. The market does not need to be made social, because it is already social. It challenges vested interests, and lets outsiders in. In Germany, that was a social democratic argument advanced by Ludwig Erhard, the father of the social market economy. One legacy of the entrenchment of Thatcherism in the ’80s that might have to be looked at now and in years to come is the polarisation of the argument with false options. We are boxing ourselves into corners, which will not be terribly beneficial to either side of the House. If we believe that markets are social and important—in everything Margaret Thatcher did, she realised that they could challenge the status quo, vested interests and outsiders, and bring them in—perhaps we should recognise that they are also socialist.

The central thesis of the Road to Serfdom is that if the state is allowed to encroach into all parts of the economy, if all wages are set by the government, and so on, we will all become slaves of the state. It seems to me to be a warning of its time – a time when much of industry was state controlled, and nationalisation was thought to bring greater efficiency and security. Some will argue that it is still very relevant because the extent of government regulation of business has a similar effect.

Hayek is also the author of the Constitution of Liberty, referred to in some Conservative tributes, which among other things argues that economically unequal societies progress further and faster than more equal ones. This is the antithesis of the Spirit Level – though it is theorising where the latter is number crunching, so neither really gets to grips with the arguments of the other.

So Hayek is a dangerous author to endorse if you’re on the left, but it shouldn’t be remotely controversial that a Labour MP endorses the central thesis of the Road to Serfdom – after all the Labour Party now supports privatisation, free trade, flexible labour markets and a dynamic economy. Or does it? Tony Blair warns in the New Statesman that Labour today is not being at all clear where it is coming from or where it wants to go. Blair suggests some policy ideas – more than the rest of his party has, and outside its comfort zone – but the timing is more interesting. The 80s were devestating in the industrial north. The Thatcher tributes were a sign of the extent to which a Labour Party that has so far endorsed her legacy in policy terms, may now wish to unlearn some of those painful lessons.

* Joe Otten was the candidate for Sheffield Heeley in June 2017 and Doncaster North in December 2019 and is a councillor in Sheffield.

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  • Geoffrey Payne 11th Apr '13 - 1:29pm

    Labour of course suffered a huge electoral defeat at the last general election persuing it’s free market agenda, as did the Tories in 1997. I am told that Hayak believed that contrary to his overall anti-statist philosophy, he believed that banks should be well regulated. However that did not stop the Tories demutualising the building societies, or New Labour advocating light touch regulation of the city. Northern Rock existed as a building society for over 100 years, including through the depression of the 1930s. As a demutualised bank it lasted for 15 years.
    I think British politicians have taken Hayak’s ideology as far as it can possibly go. The country is massively in debt as a result of the banking crises and the present governments austerity policies which have targetted the poor. As a result we have seen the rise of the extreme right – whether the BNP or UKIP. I think it has left the Uk a more nastier and illiberal place as a result.

  • Paul In Twickenham 11th Apr '13 - 2:02pm

    That’s very interesting. I’m sure David Steel was having a nice little chuckle at the mention of Hayek!

    It dovetails nicely with the short clip of Thatcher squashing Simon Hughes from the dispatch box that Stephen Tall put up yesterday. She accuses “Liberals” of preferring people to live in poverty than for the the income gap between rich and poor to increase while the economic tide “lifts all boats”.

    Hayekism, Randianism (the “no such thing as society” statement taken in its full context sounds like it was lifted straight out of “Atlas shrugged”), Laffer curves, supply-side economics, Reaganomics… to me the common theme is that they all supply intellectual arguments for making the rich richer and the poor poorer.

    Hayek’s book is called “The Road To Serfdom” and when you look at the rapid growth in income inequality since 1980 – the fact that in the USA the percentage wealth owned by the top 1% has increased from 20.5% in 1979 to 35.4% in 2010 – you have to ask who has is being made serfs by whom?

  • Joe,

    there is an interesting critique here by By Philip Pilkington, a writer and research assistant at Kingston University in London The Origins of Neoliberalism, Part I – Hayek’s Delusion . Some of the ponts he makes:

    “.. When pure logic and empirical reality ceased to support Hayek’s emotionally charged ideology he turned, to the more malleable sphere of meaning and metaphysics. He became concerned with watery terms like “freedom” and “liberty”, which he then set out to impregnate with a meaning that would support his dreams. The most famous result of this period of conversion, which resembled less St. Paul on the road to Damascus and more so an alcoholic who had hit rock bottom, was Hayek’s 1944 work The Road to Serfdom. In a very real way it was this book that marked the close of Hayek’s career as a serious economic thinker and set him on the path of the political propagandist, agitator and organiser.”

    “The implicit argument here was that, Britain for example, which had begun to increasingly plan its economy during the war, was on a slippery slope that would end in totalitarianism. It must be understood that Hayek’s argument had no factual basis. Only a polemicist could argue that the two totalitarianisms that existed in this period – namely, Hitler’s Germany and Stalin’s Soviet Union – had formed because a naïve democratic government had engaged in some economic planning that then got out of hand and resulted in tyranny.”

    “Hayek’s entire ideology and career had begun to come apart in the 1930s. His theories were shown to be inconsistent in the academic journals of the time and the practical implications of those theories had shown themselves to be both discredited and dangerous. A man in such a position only has two choices: he can either completely re-evaluate his ideas which, if they were held with unshakeable conviction and constituted a core component of his emotional make-up, as seems to have been the case with Hayek, would have likely resulted in a mental collapse; or, alternatively, he can engage in a massive repression, shut out reality and construct around himself a fantasy world.”

    “Hayek opted for the latter. So too did all of what was to become the neo-Austrian school which soon developed into a sealed hermetic cult of True Believers who reinforced each other’s unsubstantiated ideas and defended each other from the threatening world outside the circle. But this cult was largely fringe. Although it did command some respect among neoliberals in the Thatcher and Reagan administrations, it was the respect accorded to the eccentric rather than that accorded to the practical man. Lip service was paid to the doctrines of Hayek and the Austrians, but their extremist and impractical economic policy implications were sterilised and kept out of immediate contact with the levers of power. Milton Friedman’s more pragmatic doctrines of monetarism were preferred so far as economic policies went.”

  • David Allen 11th Apr '13 - 5:05pm

    Gisela Stuart’s view is clearly Germanic. The German belief in a social market means private enterprise and opposition to “serfdom”, but it also means powerful trade unions, powerful works councils, powerful state institutions, powerful regional governments, and a Christian Democrat / Social Democrat tradition of consensus. There is a lot to be said for this political balance. There is a lot less to be said for accepting the free market, discarding the balancing powers of workers and the state, declaring that greed is good, deregulating all round, and letting the bankers rip.

  • Alex Sabine 11th Apr '13 - 5:15pm

    Hayek’s real critique was directed not at state activity or government spending as such – though to be sure he was a small-state liberal in the 19th century tradition – but at the (then very prevalent) belief that the economy and society should be planned from the centre rather than left to the allegedly ‘blind’ and ‘chaotic’ market forces of supply and demand.

    He noted the paradox that even the most rational or sophisticated central planning – due to its inherent deficiency in information, and the lack of signalling of shifting consumer preferences which the price mechanism provided – was unable to match the supposedly ‘irrational’, unplanned market when it came to the determination of economic priorities, the allocation of manpower and resources, the location of industries and so forth. That the supposedly more chaotic system actually produced a ‘spontaneous order’, and that this absence of central direction also underpinned a free society in a number of important ways. But for a long time this message fell on deaf ears.

    The context for this is that various governments of both right and left had come to the view (based partly on wartime experience) that the central mobilisation of resources according to a ‘national plan’ would work better than the market in guiding economic development. This was not specifically a socialist notion; it could be a state-capitalist one and had much appeal for middle-of-the-road intellectuals, paternalistic conservatives, those who believed in industrial gigantism and all sorts of other ‘men of goodwill’. Technocrats in industry and the civil service believed that planning held the key to faster growth.

    There was another factor, too that bewitched democratic socialists and converted even many non-socialists to the virtues of planning: the apparent economic success and industrial might of the Soviet Union, and the threat that this potentially posed to the free world. Fascist Italy was also thought to offer evidence of the superiority of planning.

    The truth, which for many decades escaped these people, was of course very different. There had been a one-off spurt of industrial production when there was a clear model to follow for the transition from agriculture to heavy industry. But the genius of innovation that is the essence of a free, unplanned economy was absent. And anyway most of the figures turned out be mere propaganda. In the course of correcting the injustices and ‘irrationality’ of capitalism, much worse injustices were inflicted on the subject population. The Soviet Union lagged behind capitalist countries in alleviating poverty. Centralised planning had destroyed freedom without even the compensation of material benefits.

    Again, it wasn’t just socialists or Marxists who were attracted by the idea that markets – certainly in the ‘commanding heights’ of the economy – should be supplanted or directed by state planning. Many businessmen, particularly those responsible for large firms, believed that competition was wasteful. Harold Macmillan had endorsed planning in the interwar years, though his government of the 1950s and early 1960s fortunately didn’t get all that far in implementing it.

    It was the intellectual fashion of many of the brightest thinkers of the time: some central body must seize hold of the economy and give it impetus and direction. Yet in practice the problems of planning in a free society in peacetime were legion. Among many other drawbacks, it was ultimately incompatible with free trade: planning, whether of the socialist or other varieties, was a philosophy for a closed economy. Yet as the dust settled in the postwar world, trade was getting freer. If the state leaves consumers free tomake their own purchasing decisions, it cannot plan to any useful effect.

    And so the intellectual edifice behind the idea that planning was the way forward for free societies eventually crumbled. The fact that it did so was mainly driven by experience, by events. But for those who were prepared to heed them, the warnings about its follies and conceit were contained in Hayek’s writings. That isn’t to say he was right about everything, but he was right in his central message at a time when the intellectual Establishment and many of the West’s most distinguished statesmen and politicians were sucked in by the superficial allure of planning as a ‘middle way’ between the ‘anarchy’ of markets and the tyranny of Communism. In fact it was a dangerous delusion.

    Interestingly, one country that did not follow the postwar planning fad was West Germany.  Instead, their economics minister Ludwig Erhard decided to dismantle the planning apparatus as speedily as possible. As economic director for the Anglo-American occupation zones, he ended food rationing and lifted price controls in 1948 despite resistance from the social-democratic opposition and the Allied authorities, and as Economics Minister following the subsequent elections he embarked on a radical liberalisation (removing a battery of controls on trade and simultaneously cutting tax rates and raising tax thresholds) that set the Federal Republic on the path of its ‘Wirtschaftswunder’ or ‘economic miracle’.

  • Alex,

    I think you have set out the Philosophy well. The problems came with its practical implementation. I see Hayek as a throwback to the Laissez Faire of the classical economists in many ways and largely averse to virtually any kind of state intervention in the economy whether it be Central Banking, social security systems, regulatory controls or organised Labour.

    The system of integrating Labour Unions and management in a ‘Social Partnership’, as developed in Europe by Ludwig Erhard among others, proved a much more effective and pragmatic approach for West Germany and other Northern European states.

  • Matthew Huntbach 12th Apr '13 - 5:35am

    Joe Otten

    Joe, it is a while since I read Road to Serfdom, but my recollection is not that Hayek was saying that Hitler and Stalin were caused by economic planning, rather that the drift towards economic planning of the time would lead to a form of tyranny. So Pilkington’s critique seems to be attacking a straw man.

    Hayek’s The Road to Serfdom is well worth reading, and I regard it as a good liberal text, but it is readable and exciting because it is moving away from a considered academic text towards being political polemic, something that makes us think, but we should think about in in a critical way. Pilkington is correct in this way – the book marks the point where Hayek moves from a serious economist to someone pushing a political line. After that book he just carried on pushing that same line in a more and more dogmatic way, I don’t regard anything written after that Hayek as much worth reading.

    Those who claim to be Hayek’s followers have, of course, picked out those parts which suit them and ignored those parts which don’t. When I first read The Road to Serfdom, having heard about it through its reputation, I was surprised by how much of it could be taken and used to attack the modern free market extremists. Of course, much the same can be said about most other ideologies, most obviously Marxism: the early writing is fresh and new, the later is stale and turgid, it has been used by those who have found a way of taking advantage of aspects of it to further their self interests, those who continue to adhere to it dogmatically and are unable to exercise a critical analysis of it should be shunned, they have nothing to contribute practically or intellectually.

    The Road to Serfdom was a necessary antidote to thinking that was common at the time it was written. You can see from the wording it uses that it was written under the assumption that almost everyone would think strong state planning was necessary and modern, which was true at the time. In order to demonstrate its dangers, and to make the argument for the other side, yes, it was a good idea to show how it linked to the tyrannies of the time.

    However, we have moved on from those days. What was daring and new then is tiresome orthodoxy now. The extreme free marketeers love to play the game that somehow they are still a rebel fringe fighting a statist establishment. That’s as nonsensical as the tired old Communist parties still portraying themselves as the people’s champions decades after they had stopped being that and become the new aristocracy. They are the masters now. Political development means looking at them and their claims and what it was claimed in the past that their ideology would achieve, and working out what went wrong. I don’t believe that extreme free market policies have delivered the promised freedoms, and in some cases what looked beneficial in the short term has had bad consequences in the long term. As I’ve said elsewhere, that applies, I think, to almost everything that Margaret Thatcher did.

    One thing that goes wrong is when the means gets confused with the ends. If the ends is a more free society – and that was Hayek’s ends in The Road to Serfdom – the means was the use of the free market, but modern extreme marketeers have started to identify freedom itself with just free market economics and so have lost the wider ideals – which are still so well captured in that great slogan of ours “freedom from poverty, ignorance and conformity”.

    Among the things to have gone wrong with the original liberal ideas of free market ideology is the failure to realise the impact of the very large scale it now works on. Theory which might have worked with small town suppliers does not work so well with global corporations. Hayek (and Rand) did not realise how the bureaucracy of capitalism – the finance industry – would take it over and strangle it, just as the bureaucracy of socialism – The Party – would take it over and strangle it. Or he was too stiff and dogmatic and unwilling to change when it started happening, same as with the old Communists. Also, while I cannot accuse Hayek of being an American, many of his followers, and America is a country with huge amounts of land an natural resources. A place like ours where all the land was parcelled out to a small class of aristocratic owners almost a thousand years ago is somewhat different. Notice how adherents to extreme dogmatic free market ideology here tend to pepper their speech and writing with Americanisms, which is an indication of how their brains have unconsciously absorbed ways of thinking that may be applicable in America but are less so here. We aren’t a pioneering country with huge amounts of free land only recently settled. What works in that context may not work in ours.

  • Matthew,

    “Those who claim to be Hayek’s followers have, of course, picked out those parts which suit them and ignored those parts which don’t.”

    I think that it is fair assessment and a point made by Pilkington in his subsequent articles.

    Discussing Hayek’s influence and the Chicago school in America The Origins of Neoliberalism, Part II – The Americanisation of Hayek’s Delusion he quotes Mirowski and Van Horn:

    “The starting point of neoliberalism is the admission, contrary to classical liberalism, that its political program will triumph only if it acknowledges that the conditions for its success must be constructed, and will not come about “naturally” in the absence of concerted effort. This notion had direct implications for the neoliberal attitude toward the state, the outlines of what they deemed a correct economic theory, as well as the stance adopted toward political parties and other corporate entities that were the result of conscious organization, and not simply unexplained “organic” growths. In a phrase, “The Market” would not naturally conjure the conditions for its own continued flourishing, so neoliberalism is first and foremost a theory of how to reengineer the state in order to guarantee the success of the market and its most important participants, modern corporations. Neoliberals accept the (Leninist?) precept that they must organize politically to take over a strong government, and not simply predict it will “wither away.”

    In his third article he turns to Europe, arguing that the continent would come to adopt its own form of neoliberalism to accommodate the strength of organised labour in Europe, where once again, the end result would be a somewhat different creature from that conceived of by Hayek, The Origins of Neoliberalism, Part III – Europe and the Centre-Left Fall under Hayek’s Spell.

    Pilkington concludes: ” The oddness of the world in which we live today is that neoliberalism as a system of governance has become entirely dysfunctional. Those ambitious souls in the present ruling generation that received the torch from the inventors of the discourse believed it to be a pragmatic doctrine. This is not surprising given that we have seen that this is precisely how it was constructed. But as we have also seen neoliberalism was built on a fundamental fantasy – a sort of primal repression. Any serious student of history in general and economic history in particular knows that such policies are bound to be deflationary in the medium to long-run and that they will likely generate economic meltdowns and result in social and political turmoil.”.

  • Simon Banks 12th Apr '13 - 3:53pm

    It is quite widely accepted that there are some things markets do badly if at all. For example, they are prone to short-termism. The financial markets crash we’re still suffering from was not caused by government encroachment but by unintelligent markets unable to see that the property and credit boom was unsustainable. They are also, as various crashes have shown, prone to panic and crowd behaviour.

    Writing in 1944, Hayek was right to point to dangers of ever-extending state planning, ending not in serfdomIthat was verbal overkill) but in inefficiency and unresponsiveness to what people really want. In Britain the lessons learnt from the war effort proved to be largely inapplicable to peacetime conditions. But many areas of public concern are ill-suited to market control except through governments contracting in the market for the work to be done that they have decided needs doing. I can’t see sewers or coastal defences or nature conservation or emergency planning being left entirely to the market. Leaving the care of people who cannot fund their own care entirely to charities (their work not funded or procured by government, but depending on their own decisions and the funds they could raise from private individuals and companies) would risk severe injustice.

    There are two other problems about market worship. One is that it leads to the destruction of local community collective decision-making – and that really does threaten democracy by withering the roots. The other is that in respect of matters where demand is not limited by what one person may find a use for (land ownership and use, for example, as opposed to choice of coats or cheese) an ideological market approach gives me 1,000 times your power if I have 1,000 times your disposable wealth, as opposed to the one person one vote of democracy.

  • @ Simon Banks

    “It is quite widely accepted that there are some things markets do badly if at all. For example, they are prone to short-termism.”

    So rather like governments then? Like beiling out businesses in the run up to an election when they woulf fail later but it may be enough to buy the governing party votes.

    “The financial markets crash we’re still suffering from was not caused by government encroachment but by unintelligent markets unable to see that the property and credit boom was unsustainable. They are also, as various crashes have shown, prone to panic and crowd behaviour.”

    Cheap money from a central banks is state intervention which is what inflated the asset price boom, fuling the credit boom. And governemnts were unintelligent running large deficits (and larger cyclical deficits) at the peek of a credit boom they created.

    The governments also intervened to socialise the privae losses (in part as they had not designed sufficient bankruptcy mechanisms for the financial setor). So again a goverment failing.

    None of this shows that markets are perfect or that government is bad but your argument is a very skewed view of the last few years.

    Many don’t claim markets are perfect just often preferable to government. Who are also flawed and carry out actions under threat of force.

  • @ JoeBourke

    “Discussing Hayek’s influence and the Chicago school in America”

    Using the term “Chicago School” tends to make me think someone is coming at an issue of Economics from (what the article you refer to describes as) “political propagandist” view point. It tends to be used to basically mean belonging to a school that doesn’t draw heavily on Keynesianism.

    It is used to capture basically the ideas of lots of different academics who have worked there, each of whom are better described as members of individual schools of thought. Hayek is sometimes lumped in to this bucket when he is clearly in the Austrian School. Friedman again in the Monetarist school is included. Gary Becker who is again very different is often lumped in.

    The University and the Economics Department there tend to mock the idea to quote the Departments front page:

    “Any definition of the “Chicago School” would have to find room for the following ideas (in chronological order from the 1940s to the present): the economic theory of socialism, general equilibrium theory, general equilibrium models of foreign trade, simultaneous equation methods in econometrics, consumption as a function of permanent income, the economics of the household, the rationality of peasants in poor countries, the economics of education and other acquired skills (human capital), applied welfare economics, monetarism, sociological economics (entrepreneurship, racial discrimination, crime), the economics of invention and innovation, quantitative economic history, the economics of information, political economy (externalities, property rights, liability, contracts), the monetary approach to international finance, rational expectations in macroeconomics, and mechanism design.
    The unifying thread in all this is not political or ideological but methodological, the methodological conviction that economics is an incomparably powerful tool for understanding society.”

    Not really a school of thought. To diverse in terms of areas of interest and even view point on different topics to be unified. What you mean is “neo-classical in origin” which personally I think is made to try and link in the “Chicago Boys” who are a distinct group but really more monetarist.

  • PSI,

    you are of course quite right to point out that the Chicago school is far broader in scope than the Austrian School and Hayek’s basic formulations.

    In the US, a broad distiction is sometimes made between the philosophical underpinnings of what is referred to as “Freshwater” and “Saltwater” economists. If you view econmics as principally a social science that is itself a branch of political science, then philosophical underpinnings are an important element of the theoretical foundation.

    Matthew Huntbach has commented “Those who claim to be Hayek’s followers have, of course, picked out those parts which suit them and ignored those parts which don’t.” This can equally be said about the post-war implementation of Keynesiasm.

    John Kenneth Galbraith in his 1987 seminal work ‘A history of Economics’ had this to say in his concluding paragraphs:

    “..economics does not usefully exist apart from politics, and so it will not, one hopes in the future. The political asymmetry of the Keynesian revolution – the assmmetry of the political actions required to remedy general underemployment as compared with those required to arrest a general excess of demand – has been adequately observed. Failure to recognise the practical consequences of this was, as it remains, one of the major misjudgements in modern economics. Another serious mistake has been the belief that monetary policy is politically and socially neutral – that the revenue that high interest rates return to those who lend money has been other than a rational manifestation of the self-interest of those with money to lend. Wrong as well, has been the failure to recognise the political role of economics itself in the dialectic between the business enterprise and the state. The continuing survival of classical theory can be understood only when it is seen that classical beliefs protect business autonomy and its income and serve to obscure the economic power exercised as a matter of course by the modern enterprise by declaring that all power rests, in fact, with the market.

    The separation of economics from politics and political motivation is a sterile thing. It is also a cover for the reality of economic power and motivation. And it is a prime source of misjudgement and error in economic policy. No volume on the history of economics can conclude without the hope that the subject will ne reunited with politics to form again the larger discipline of political economy.”

  • Alex Sabine 13th Apr '13 - 1:24am

    Some astute points by Psi.

    Geoffrey: To cite the current financial crisis as evidence that Hayek’s theories have been tested to destruction just won’t wash.

    For a start, (unlike Milton Friedman), Hayek opposed central banking, because he argued that governments and their agencies would be no better at controlling the money supply than they were at planning the allocation of physical goods and services. He thought the policies of central banks were likely to amplify the peaks and troughs of the business cycle rather than mitigate them.

    Since central banks have existed for a long time now, it’s hard to test counter-factuals. But there is a wealth of academic work showing how the policies of the US Federal Reserve played a key role in turning the stockmarket crash of 1929 into deep and prolonged recession. And most economists now agree that, whatever stupidities and mistakes the banks committed in the 2002-08 period, they were able to do so because they were awash with central bank money and loose monetary policy was fuelling asset bubbles even though inflation targets were being hit.

    The other issue that is widely accepted is that ‘moral hazard’ encouraged banks to behave recklessly, and the essence of this is that they knew that if it all went belly-up they would be bailed out by the taxpayer. Hayek wouldn’t have been at all surprised to see that the combination of a glut of cheap fiat money and insulation against the consequences of bad commercial decisions would lead to ruin.

    Now, there are good reasons why central banks, deposit protection schemes, reserve requirements and so on were introduced; without them, modern fractional reserve banking – whereby banks only hold a portion of their deposits as reserves from which to satisfy demands for payment – would arguably be impossible, since the risk of bankruptcy would be too high. But in virtually eliminating this risk by making it clear that government will rescue failing banks, the result has been to create perverse incentives to lend recklessly.

    This is a classic dilemma. In my view reform efforts need to be directed at finding ways by which the market is made competitive rather than oligopolistic, so that banks do not become ‘too big to fail’ and systemic risk is minimised; and mechanisms must be put in place whereby banks can be allowed to fail with the minimum of collateral damage. As I’ve said before, what banking needs is more real capitalism and less state-capitalism, which has led to the privatisation of profits and the socialisation of losses.

    You may completely disagree with my conclusions, and think the answer is to bring banking under permanent state ownership or state control of its lending decisions. That is another way of addressing the problem, albeit I fear the cure might prove worse than the disease.

    But whatever ought to be done to improve things, it is simply false analysis to say that the banking system in the run-up to the crisis was an example of a Hayekian free market run riot.

    For one thing, as usually happens when the state is heavily involved in an industry, it was a highly concentrated market with a few large global players and little competition. The state, in the form of the world’s major governments and central banks, was the major player in the market: supplying the money, setting interest rates and the banks’ reserve requirements, responsible for prudential supervision, insuring depositors and other creditors, injecting liquidity and standing ready to bail out failing institutions. The idea that this was a laissez faire test case is fanciful.

    The reality is more complex and is a story of failure by all the main players – banks, governments, central banks and indeed individuals who borrowed much more than they could afford – and what you might call ‘design flaws’ in the system resulting from the very nature of fractional reserve banking and fiat currency.

    I do not think we should be dogmatic about what the solutions are, but ask which specific problems we need to deal with, how to ensure the incentives are better aligned and less perverse, how to reconcile the inescapable tension between the economy’s need for liquidity and the risk of large bank balance sheets, and so on.

    If we conclude that banking can never be a free market because of the inherent instability of the system, then it seems to me that the task is to not to supplant the market with the state but to find practical ways of subjecting banks to market disciplines that will reduce – but, given human nature, cannot eliminate – the risk of financial folly.

  • Alex,

    “If we conclude that banking can never be a free market because of the inherent instability of the system, then it seems to me that the task is to not to supplant the market with the state but to find practical ways of subjecting banks to market disciplines that will reduce – but, given human nature, cannot eliminate – the risk of financial folly.”

    That seems to me an eminently sensible conclusion. Hayek did express concerns about the ability of Central Banks to distort interest rates to manage inflation or to balance employment and price stability, for instance. There seems to be ample empirical evidence to warrant concluding that central banks have frequently failed in this regard at great cost to the economies under their influence.

    Monetarism is a blunt instrument and it appears that it fails in being too loosely targeted. For example, monetary policy, which sets the cost of capital, often distorts asset prices since it looks chiefly at goods prices and in particular at the price of labor with a view to targeting inflation. In this it disregards asset appreciation and the wealth effect it communicates that is based on “fictitious capital,” that is, unrealized, “paper gains, supported by credit.

    Hayek’s position reflects more the neoclassical equilibrium view than the Austrian view of economic calculation.

    In the wake of the financial crisis there was considerable focus on both the Austrian School analysis and the work of Hyman Minsky. Minsky was an academic econommist, banker and US Treasury adviser. In his principal work “The financial instability hypothesis”, he incorporated many ideas already circulated by John Stuart Mill, Alfred Marshall, Knut Wicksell and Irving Fisher

    Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge borrowers, speculative borrowers, and Ponzi borrowers.

    The “hedge borrower” can make debt payments (covering interest and principal) from current cash flows from investments. For the “speculative borrower”, the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal. The “Ponzi borrower” borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat.

    When the use of Ponzi finance becomes general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance the principal even if able to cover interest payments. As with a line of dominoes, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investment.

    Minsky was at pains to poimt out that private bank lending creates new money (deposits). New money creation is not constrasined by central bank reserves (the UK and Canada have no reserve requirements) but only by bank capitalisation regulations and demand (i.e. sufficiency of credit worthy borrowers willing to pay the interest rates demanded).

    In the UK at present, 5 companies control 80% of all financial transactions in the economy. Free markets tend towards this consolidation of big players, (whether in banking, utilities, supermarkets or whatever) despite the best efforts of competition authorities.

    There is an interesting article Austrian Economics and Modern Monetary Theory reviewing the Austrian approach and the Modern Monetary Theory that has developed from Minsky’s work.

    It is hard not to agree with the Author’s conclusion that all future evidence will vindicate Hayek again and again in at least one point: ” The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

  • Ed Shepherd 14th Apr '13 - 7:36am

    I think that un(der)employment is far worse now that it was in the 1970s. In the 1970s, a larger proportion of those employed would have been full-time, permanent workers who were members of an occupational pension scheme (OPS). Now, we have millions who are stuck with temporary, often low-hours, jobs who have no access to an OPS. Flexible labour markets disguise the fact that millions of qualified people are doing menial, low paid jobs with no chance of increasing their earnings or getting a better job. Those workers will have to be dependent upon the state when they retire (another way in which Thatcherism increased the role of the state rather than decreased it). The quality of employment is as important as the fact of being employed. The position of a 1979 Leyland worker with a permanent job, a union to help him, an OPS and the chance to earn overtime is far better than that of a 2013 temporary worker in a warehouse with no union, no pension and no job security. It seems to me that Hayek’s way has created a modern form of serfdom.

  • Ed,

    there is no question that the nature of employment has changed since the 1970’s. This is true across all the Western democracies. It is only 20 years since Japan’s ‘Jobs for life’ culture was cited as part of the economic strength that gave them a competitive advantage over anglo-saxon economies fixated on making a fast buck.

    I believe it is globalisation that has been the key driver of change rather than neoliberalism, which I see more as a reaction to rather than a cause of the major advances in the uptake of technology and acquisition of know-how by the developing world.

    In harking back to the economic doctrines of classical Liberalism, as Hayek does, we are in danger of falling into the trap John Maynard Keynes warned of in his time – “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”

    Joe Otten, in his article, cites the social democratic argument advanced by Ludwig Erhard, the father of the social market economy. Erhard is sometimes held-up as an acolyte of Hayek and the Austrian school, but Von Mises spat bile at West Germany’s “social market economy,” and regarded it as just another interventionist state that would allegedly lead to totalitarian socialism.

    As this article points out, Erhard was not the slave of any economic dogma, but rather a practical man that used Marshall aid to good effect for his country and did not hesitate to change course when events required it The Myth of Ludwig Erhard and Economic Policy in Germany in 1948 . The tale is one of a great deal of macroeconomic management of the West German economy by the government from the early 1950s.

  • JoeBourke (12th April 6:56),
    I was trying to make the point that when I hear someone attacking “the Chicago school” I get suspicious that they are likely to be coming from a political view point rather than an economic one. I have often read people picking parts of Austrian thinking putting them with monetarist ideas throwing in bits of anything else they can find written by someone who has at some point worked there to try and represent it as contradictory. Which is possible to do if you use a term to group such a wide range of ideas together, hence why I find the term unhelpful.
    As to the salt/fresh distinction I think that is much more helpful (as we are talking about historical views of economics) as there are less attached “political prejudices” associated, it is less loaded as a term. That said it is still vast and captures too many ideas and approaches. I also fear we are at risk of disappearing down a line that will put others to sleep.

    Alex Sabine
    To reinforce your point on Moral Hazard, the only person who I have heard try and dispute the impact of this has been Krugman who tries to claim that no one thought of banks failing before the crisis (that is a simplification but not by much). It is a simple fact that some UK firms relied upon banking services from one of the “too big to fail” institutions on the basis of their structural significance indicated their safety. Some have continued after the crisis having had their belief reinforced by the crisis’ ill-fated bailouts (though the Cyprus situation may have shaken their confidence a little). Safe to say the analysis of the expected protections did exist despite claims of people who don’t work with or for institutions that held (/still hold) those beliefs.
    Also the point you make about government intervention adding to concentration in the UK that is very apparent, the old approach to payments from the Bank of England illustrates this well. It is a little harder to spot how it is encouraged on the international scale but there are undoubtedly mechanisms.

    JoeBourke (13th April 2:59),
    “In the UK at present, 5 companies control 80% of all financial transactions in the economy. Free markets tend towards this consolidation of big players, (whether in banking, utilities, supermarkets or whatever) despite the best efforts of competition authorities.”

    I’m not convinced that the scary concentration of transactions is due to free markets causing consolidation. The whole industry (and historically settlements and payments in particular) have been heavily influenced by the state (for valid reasons) and it is always easier to deal with fewer more homogeneous bodies. It is quite possible that less interference from the state there would be less concentration.

    But as Alex Sabine says earlier we can’t really test counter-factuals.

  • Timothy Taylor 16th Jan '17 - 9:27pm

    Perhaps you should read what Hayek was actually saying, the problem is that the rich and powerful have distorted what he said for their own advantage. I suggest the Zombie Doctrine by Nhomi Klien

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