On July 9th, Nobel economist and New York Times columnist, Paul Krugman, gave his read on the recently unearthed letters between J. M. Keynes and F. A. Hayek in the London Times in October 1932, which have been posted and discussed on ThinkMarkets. (and in the Wall Street Journal).
Krugman insists that Hayek is worse than he thought and that Keynes was better than he imagined. He attacks Hayek for insisting that the best cure for recovering from the Great Depression would be to free up markets both domestically and internationally, and to rein in government spending. This, Hayek said, would create the political and fiscal environment that would foster a positive private sector return to a job generating rebalancing of supply and demand, and a sustainable investment climate.
Not surprisingly, Krugman instead, hails Keynes as the advocate of fiscal stimulus that would “prime the pump” through deficit spending and government sponsored job creation.
He thinks it is all a great tragedy that the same battle has to be fought all over again for sound Keynesian policies, nearly eighty years after the exchange of these letters. But what, instead, is Krugman missing?
Most reputable economic historians have come to consider the high tariff policy of the United States in the early 1930s to have led to retaliation by other countries — a general “beggar-thy-neighbor” tit-for-tat — that only made the depression even worse, internationally, than it needed to be.
A growing number of economics historians have taken second looks at the domestic policies under first Herbert Hoover and then Franklin Roosevelt, and come to the conclusion that Hoover’s “high-wage” policy in an attempt to artificially maintain “purchasing power” and then the economy-wide rigidities during Roosevelt’s first New Deal under the NRA and AAA controls (which resembled aspects of the Italian fascist corporativist state), all worked to keep price-wage and supply-demand relationships out of balance. This, too, prolonged any process back to sustainable profitability in the private sector for a return to fuller employment.
And, in addition, the growing budget deficits and rising national debt (by the historical standards of that time) all generated uncertainty surrounding future tax burdens in a political environment in which the administration’s rhetoric out of Washington, D.C. was all covered with a strong anti-business tone, which served to inhibit any private sector confidence for investment and job creation.
And, finally, all the public works projects and “job stimulus” spending actually failed to bring an end to high unemployment through the 1930s. Unemployment was still in the significant double digits in 1937 and 1938. Plus, many of the accounts written at that time — by people “on the ground” — emphasize that a very large part of such spending was guided by local and state political favoritism and party loyalty expenditures to reinforce and buy the reelection of the Democratic Party.
The New Deal policies were flawed and a failure.
On the other hand, the types of policies that were being advocated by economists such as F. A. Hayek were pointing the way to a renewed, sustainable and balanced restoration of supply and demand, and cost-price relationships that would have resulted in a return to prosperity and normal employment patterns.
If the advice of economists like Hayek and his London School of Economics colleagues of that time had been followed, the Great Depression could have been far less severe, and much shorter in duration.
I do agree with Dr. Krugman that it is unfortunate and a tragedy that this debate has to be fought once again. But the tragedy is that after the failures of Keynesian policies then and in the post-World War II period; after the reinforcement of anti-market rigidities that retarded and delayed a rebalancing of the economy in the 1930s; and after all the big government “experiments” and extensions of political power over the market place that only caused anti-investment and anti-recovery uncertainty in the private sector during those New Deal days; after the reintroduction of neo-mercantilist trade policies that undermined the global market; and after the huge fiscal irresponsibility that undermined financial confidence in the country in the 1930s business community . . .
After all of these failures of interventionism and “activist” monetary and fiscal policy in the 1930s, the same public policy madness is still recommended as “wisdom” today.
I fear that Dr. Krugman is one of those “practical men of affairs” who is the slave of a defunct economist named John Maynard Keynes. He is hearing Keynes’ voice in the air, and is distilling his frenzy from an academic Cambridge scribbler from a few decades past.