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The Christian Faith and the Financial Crisis
Part Two: The Financial Crisis (4)


b) Friedrich Hayek

Much more obviously relevant to Griffiths is the fact that during the 1930s the LSE became a main centre of opposition to the economic theories being developed in Cambridge by John Maynard Keynes. Perhaps ironically, the director of the LSE at the time was William Beveridge, author of the wartime 'Beveridge Report' on 'Social Insurance and Allied Services' which provided a basis for the postwar 'welfare state', made possible through the application of Keynes's methods. Although not a member of the Fabian Society, Beveridge was intellectually very much part of the Fabian tradition but the Professor of Economics at LSE, Lionel Robbins (who would later, as Lord Robbins, be active in the IEA), set himself in opposition and in 1931 he invited the young Austrian economist, Friedrich Hayek to join the faculty.

In opposition to Keynes, Hayek reaffirmed the traditional position of classical liberal economics that so long as money retained a stable, reliable value, the market could be relied on to regulate itself. Producers can make rational decisions on the basis of 'price signals' they receive from consumers. The price is going up, too little is being produced; the price is going down, too much is being produced. But these signals are distorted by 'monetary incontinence', that is, by excessive supplies of credit provided by the banking system. Investment should be financed on the basis of 'genuine savings' - a genuine willingness to postpone consumption on the basis of money the consumer genuinely possesses. The depression had been a product of over-investment, meaning that money was being poured into products the wider society did not either want or need. The contraction in spending it imposed had been a necessary corrective and it should have been allowed to run its course. It would not have been so severe if the over-investment that provoked it hadn't been fuelled by easy credit.

Hayek argued this case - which was not far removed from the conventional economics adopted at the time by the National Government - at a time when Keynes's Treatise on Money (1930) and General Theory on Employment, Interest and Money (1936) were arguing the opposite case: that to get the economy going again everything should be done to stimulate demand, which in turn required government intervention. In Hayek's opinion, that was inflationary. It could have a temporary effect in reducing unemployment but it could only work on a long term basis if the rate of inflation continued to grow, ultimately raising the spectre of hyperinflation. The policy needed to offset this was government control of prices and incomes, but the logic of that was, eventually, a fully planned economy, i.e. socialism, which in Hayek's view could only follow the same logic of totalitarianism it had followed in the Soviet Union.

The free market or a Soviet style totalitarianism were in Hayek's view the only alternatives. Any intermediate stage was simply a stopping place on the way to the one or the other. This was the case he argued in his most influential book, The Road to Serfdom, published in 1944. Here Hayek was anxious to establish that Fascism, far from being a last stage of capitalism as the Marxists argued, was simply a variety of Socialism, the attempt to replace the free play of the market by conscious control of the economy. Which ultimately he believed was impossible because it was impossible for a government bureaucracy to know everything that needed to be known about the needs and wishes of an entire population. To quote Hayek, from a pamphlet first published by the IEA in 1980:

'Because the division of labour is among millions of people who do not even know of the existence of most of the others for whom and in co-operation with whom they unwittingly work, their aim becomes impersonal and, in a sense, abstract. The aim of the efforts of all can no longer be the satisfaction of known demands, for they have no knowledge of the subsequent use of their products. The aim must therefore become solely the yield from the sale of their products on the market. To obtain such a return, each individual must seek to meet the demands of other people at least as cheaply as anyone else does. Everybody's effort must thus be directed at producing goods and services at costs as much as possible below current prices. The difference between costs and returns, which we disdainfully call "gain" or "profit", thus becomes the true measure of the social usefulness to others of our efforts. And production at a loss, when costs exceed the yield, becomes an offence against the best use of resources. And this is especially true when it means, as it so often does, that someone else's resources are being misused.' (3)

(3) F.A.Hayek: 1980s Unemployment and the Unions. The Distortion of Relative Prices by Monopoly in the Labour Market, Hobart Paper 87, London, Institute of Economic Affairs, 1984 (1st ed 1980), p. 31.

Robert Skidelsky's biography of Keynes describes a rare foray by Hayek into Keynes's stronghold in Cambridge 'in 1931 at the same time that the Circus in Cambridge was puzzling over the Treatise on Money which, of course drew completely opposite conclusions to Hayek: the slump was due to underinvestment, not overinvestment; the cure lay in increased spending, not saving.' After Hayek had spoken:

'His exposition was greeted with complete silence. Keynes was in London, but Richard Kahn, who was in the audience, felt he had to break the ice. 'Is it your view', he asked Hayek, 'that if I went out tomorrow and bought a new overcoat, that would increase unemployment?' 'Yes,' replied Hayek, turning to a blackboard full of triangles, 'but it would take a very long mathematical demonstration to explain why.' The contrast with Keynes's 'Whenever you save five shillings you put a man out of work for a day,' uttered on the wireless the same month, could not have been starker.' (4)

(4 ) Robert Skidelsky: John Maynard Keynes - The Economist as Saviour, 1920-1937, London, Macmillan Papermac, 1994, p. 456.

The twenty years Hayek spent in LSE, from 1931 to 1950, must have seemed like a period of total defeat. By 1950, Keynes was everywhere triumphant to the extent that his teaching had become almost synonymous with economics. Hayek went off to teach at the University of Chicago, perhaps the only university in the Anglo Saxon world where classical free market economics was still being taught as relevant to current economic policy rather than as an interesting historical phenomenon. In the 1970s, however, a process of reversal began, an intellectual challenge to the still dominant Keynesian consensus followed in the 1980s by a triumph of the Hayekian view, both in Britain under Margaret Thatcher and in the United States under Ronald Reagan. Later, though, I will be asking if this really was a triumph of Hayek's ideas.