Dick Armey On Hayek vs. Keynes

Former GOP House Majority Leader and economic professor Dick Armey wrote an insightful column in yesterday's Wall Street Journal. Eschewing a detailed analysis of the current mega-spending bill which the President and Democratic majorities in both Houses of Congress wish to pass, Armey instead returns to fundamentals of economics. He begins by writing,

"In the long run, we are all dead," John Maynard Keynes once quipped. An influential British economist, Keynes used the line to dodge the problematic long-term implications of his policy proposals. "

It is significant to Armey that Keynes never answered for the long term impacts of his great idea, governmental deficit spending.

Armey continues by drawing a contrast rarely made, between Keynes and his contemporary and critic, Fredrick Hayek,

"According to Nobel economist Friedrich Hayek, a contemporary of Keynes and perhaps his greatest critic, Keynes "was guided by one central idea . . . that general employment was always positively correlated with the aggregate demand for consumer goods." Keynes argued that government should intervene in the economy to maintain aggregate demand and full employment, with the goal of smoothing out business cycles. During recessions, he asserted, government should borrow money and spend it.

Keynes's thinking was a decisive departure from classical economics, because arbitrary "macro" constructs like aggregate demand had no basis in the microeconomic science of human action. As Hayek observed, "some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics."

Classical economists up to that time had emphasized a balanced budget and government restraint as the primary goals of fiscal policy. The simplistic notion that "aggregate demand" drove investment and employment threw all of that out the window, but it had one particular convenience for policy makers. Government spending is, according to Keynes's construct, a key component in determining aggregate demand, so more spending, even to resod the Capitol Mall or distribute free contraception, drives the economy in the short run."

This is a really significant point, because Armey reminds us, or, if necessary, teaches us that, prior to Keynes entirely theoretical addition of 'macro' economics to the then-dominant microeconomics, the former was largely a definitionally equivalent of money supply, velocity and GDP, arising from the summation of microeconomic activity.

Prominent Keynesians such as Paul Samuelson, through his best-selling textbook, conveniently trotted out Say's law and gently mocked it, neglecting to ever include Hayek's contrasting views.

In the current era, however, Hayek's intellectual descendants are more numerous and vocal. Armey closely marries the political with the economy, uniting the two parts of the originally-named study of political economics by continuing,

"A father of public choice economics, Nobel laureate James Buchanan, argues that the great flaw in Keynesianism is that it ignores the obvious, self-interested incentives of government actors implementing fiscal policy and creates intellectual cover for what would otherwise be viewed as self-serving and irresponsible behavior by politicians. It is also very difficult to turn off the spigot in better economic times, and Keynes blithely ignored the long-term effects of financing an expanded deficit.

It's clear why Keynes's popularity endures in Congress. Intellectual cover for a spending spree will always be appreciated there. But it's harder to see any justification for the perverse form of fiscal child abuse that heaps massive debts on future generations."

This passage nicely captured a key, real issue in applied Keynesianism. I've noted that the effects of huge deficits, at this time, will likely cause significantly higher inflation and interest rates for Americans. Moreover, Armey, and Buchanan, address the human behavior realities of public deficit spending which Keynes ignored.

Returning to Hayek, Armey writes,

"Hayek, who famously debated Keynes in a series of articles after the release of "General Theory," gave what I believe to be the most devastating critique of government action to stimulate "aggregate demand." Hayek viewed the boom and bust of the business cycle as primarily a monetary phenomenon created by governments' artificial inflation of money and credit.

Sound money policy, conversely, allowed the disparate knowledge of millions of economic actors to be conveyed through the price system, rationally allocating capital and labor through relative prices. The problem with government attempts to manipulate the economy through fiscal policy -- spending that takes resources away from those who are productive and redistributes it to politically favored interests -- is that it is audacious. It assumes that government knows better how to spend and invest than individuals acting in their families' best interest.

"The real question," according to Hayek, "is not whether man is, or ought to be, guided by selfish motives but whether we can allow him to be guided in his actions by those immediate consequences which we can know and care for or whether he ought to be made to do what seems appropriate to somebody else who is supposed to possess a fuller comprehension of the significance of these actions to society as a whole."

Again, Hayek tackled Keynes on aspects of his theory for which the General Theory has no response. It's easy to see in Hayek's critique the brilliance he possessed in noting how Keynes casually swept away the microeconomic resource allocation mechanisms which underpin all economics, and simply assumed away the very real problem of how government would better allocate resources, sans price signals, than individuals would with the same resources, or more.

If there were ever a valid argument for preferring tax cuts for individuals and corporations over government spending, Hayek delivered it.

Armey concludes with a very common sense summation of Hayek's observations,

"In reality, no one spends someone else's money better than they spend their own. The charade of the current stimulus package, chockablock with earmarks to favored pet constituencies and virtually devoid of national policy considerations, is the logical consequence of Keynesianism in action. It is about politics and power, not sound economics, and I believe that the American people will reject it."

Let's hope Dick Armey is right, and that American voters let their Congressional members know it.