Hayekian Limits of Knowledge in a Post-Keynesian World

Steve Horwitz explains how The work of Friedrich Hayek shows why EU governments cannot spend their way out of the Eurozone crisis:

Politicians and bureaucrats lack the knowledge to know which pieces fit with which pieces as they cannot know the nature of the idled resources and what consumers want. They are unable to know what is needed to create a sustainable recovery. One of the most fundamental insights of Hayek and the Austrians was that prices, profits, and losses serve as knowledge surrogates to coordinate the decentralised decisions of producers and consumers, themselves often based on knowledge that they could not communicate any other way.

Politicians who are structurally unable to know how best to allocate stimulus resources will inevitably distribute them to those persons and groups who will give them the most electoral support. The Austrian caution about the limits of politicians’ knowledge suggests that no matter what is drawn up on the blackboard, the politicisation of stimulus spending is not an accident and cannot be avoided. Stimulus spending that goes to groups that will provide the most votes will ensure that the right combinations of capital and labour will not be formed.

On this blog I often outline my views of the macro-economy based on the Post-Keynesian tradition (including MMT, MR, circuitists, horizontalists, etc) because I believe they offer the most accurate version of monetary operations and a stock-flow consistent approach. Where I generally depart from these economic sects relates to their specific policy prescriptions. On these matters, I more frequently side with Austrians for the reasons highlighted by Horwitz above.

To explain my position in a bit more detail, I agree that government deficits can help sustain growth and employment while the private sector attempts to increase its savings. This view, however, does not imply that government spending should increase or that it will be productive. Aside from the difficulty of knowing what to produce, government spending and deficits are often prone to corporate favoritism that serves to enlarge the income inequality gap. From my perspective, these concerns too often go unaddressed in proposals for larger deficits and increased public spending. The Post-Keynesians may hold the upper hand regarding causal relationships among macroeconomic factors but they could learn a thing or two about the limits of knowledge.   

Network Models Can Restore Emergence in Economics

Currently active on my kindle is Positive Linking: How Networks Can Revolutionise the World
by Paul Ormerod. For a brief background of how I came upon this subject, my most recent interest in economics began a couple years back when I began reading classic works of Hayek and Keynes, among others. Probably surprising to many, I found the work of both these giants in the field to offer timeless insights about the macroeconomy that had seemingly been lost leading up to the financial crisis. More specifically, I was curious about the broader ideas of uncertainty and emergence that each touches on, though in different manners. Allowing my reading selections to follow a random path, I stumbled upon books in theoretical and particle physics discussing those intriguing subjects in the context of chaos theory and network effects. Ormerod’s book, among other things, is trying to encourage mainstream economics to re-incorporate these lost ideals from the past with new lessons from physics and other social sciences.

Aside from Ormerod, there are numerous others simultaneously working to construct new models of the economy that include these areas of research. One of those is Steve Bannister, at Naked Keynesianism, who offers this conclusion to a critique of the Lucas critique:

I propose two things to restore the dominating importance of emergent macro properties on economic behavior. One is a recommitment to econometric modelling. Ever increasing data and increasingly better tools will continually improve modelling and forecasting results.

The other is a methodology that is vastly underused in economics, but widely used in various other sciences: network system analysis based on the mathematical theory of graphs. These methods lets us directly measure and model emergent dynamic behaviors from groups, like the individuals in an economy. No added up methodological individualism required; no agent-based model needed. Observe, model, and predict directly at the macro level.

While I believe empirical models, properly done, are fundamental to understanding and policy, network models provide us with a dynamic theory, emergent macro behaviors, that  support our correct Keynesian beliefs that it is the macro foundations of micro behavior that matter, not the other Lucasian way around.  

Kevin Vallier - Hayek on Serfdom and Welfare States

So let’s distinguish between two kinds of welfare states: the welfare state of law and the welfare state of administration. Hayek’s preferred welfare state is limited by his insistence that the law be regulated by clear, public, general principles rather than administrative bodies. That’s why his safety nets are so general and uniform: because safety nets should follow these same general principles. In this way, Hayek endorses a welfare state of law.

Read it at Bleeding Heart Libertarians
Hayek on Serfdom and Welfare States
By Kevin Vallier

Most people are seemingly aware of Hayek’s Road to Serfdom and position against the welfare state, yet too frequently these views are informed by those who have not read his work. Vallier offers clarity in understanding how Hayek could both oppose a welfare state and favor a policy of universal basic income. Milton Friedman similarly supported a measure of basic income despite arguing for limited government. The left, right and libertarians are therefore actually in relative agreement over this policy goal. Stark differences regarding how to administer the program unfortunately remain and likely prevent any action for the foreseeable future.

Points of Public Interest

1. The Complexity of Hayek - Greg Fisher comments on similarities and differences between Hayek’s work and complex systems. Complexity theory is a fascinating subject I hope to study in the future.
2. Social Security, the Financial Crisis & Modern Monetary Theory - John Carney continues to display how MMT, in focusing on the monetary system, forgets the many ways in which government can harm real economic growth and wealth.
3. US Credit and Economic Views: It’s the Housing Market Stupid - Constance Hunter wisely notes the deflationary pressure of over $1 trillion in underwater mortgage debt. This remains a key aspect of my view that inflation will remain muted for several years.
4. Tuning In to Dropping Out - Alex Tabarrok draws attention to the lack of college graduates in STEM fields and the disappointing level of dropouts both in high school and college. Focusing subsidies on STEM majors and offering “vocational” programs are a couple potential solutions for improving education within the US.
5. GAO: Almost Half of Bailed Banks Repaid the Government With Money “From Other Federal Programs” - Matt Stoller examines the truth behind Treasury’s claims that “TARP made money.”
6. For Profit Education, Pigs at the Trough - Russ Winter looks at how For Profit Education programs are abusing the government system to earn massive profits, while loading students with debt and only graduating around 33%.
7. Josh’s Twenty Common Sense Investing Rules - Joshua Brown provides a great outline for individual investors, not traders.

Points of Public Interest

1. Restraining unit labor costs is a right-wing conspiracy - Steve Randy Waldman discusses how the Federal Reserve’s explicit actions are helping reduce labor’s share of output over time.
2. The rule of more - A former professor of mine, Susan Dudley, is quoted on the subject of inconsistent cost-benefit analysis that allows the regulatory system to be gamed. (h/t Cafe Hayek)
3. Keeping an Eye on Wealth Creation - Renowned investor Hugh Hendry continues to expect a Chinese hard landing and, most importantly, expresses his view that “ the road to hyperinflation is via hyperdeflation.”
4. Hayek, Equilibrium and Complexity - Paul Omerod succinctly explains the importance of Hayek’s thinking to the study of complex systems.
5. The Longest Quarterly Letter Ever - Legendary investor Jeremy Grantham offers his updated investment outlook and continues to recommend patience. (h/t Zero Hedge)

The Next Keynes

“One thing is certain: if there is another Keynes out there, he or she will be someone who shares Keynes’s most important qualities. Keynes was a consummate intellectual insider, who understood the prevailing economic ideas of his day as well as anyone. Without that base of knowledge, and the skill in argumentation that went with it, he wouldn’t have been able to mount such a devastating critique of economic orthodoxy. Yet he was at the same time a daring radical, willing to consider the possibility that some of the fundamental assumptions of the economics he had been taught were wrong.”

-Introduction by Paul Krugman to The General Theory of Employment, Interest, and Money, by John Maynard Keynes

Nearly 80 years ago, the Great Depression and World Wars inspired a debate between two of the greatest economists of the 20th century, John Maynard Keynes and F. A. Hayek. The global economic paralysis and social upheaval of their time could not be explained or remedied by then current economic theories.  Both men relied heavily on knowledge of past research and experience to forge recommendations for a new path forward. Since then, their alternative perspectives have largely shaped political discussion of macroeconomics. Although Keynes’ ideas garnered significant weight first, Hayek’s warnings have proved extremely prescient regarding the outcome of government intervention.

Today’s global economy appears more reminiscent of that period than any time since. Industrialized nations are teetering on the edge of another recession, struggling to find solutions in the face of impotent monetary policy. Meanwhile, within the developing world, radical changes are being brought about by revolts against enshrined leadership. Numerous lessons learned during the early 20th century have been forgotten and must be re-learned. However, much has also changed about the global economy throughout the decades. While the old lessons remain important, modern theories are warranted to address today’s political and economic issues.  

So far, the Great Recession has failed to spur any radical changes from previous conceptions of macroeconomics or political theory. Witnessing mass unemployment and increasing levels of poverty around the globe, one can only hope that new theories and practices will be developed that inspire a brighter future. While I certainly don’t expect to become the next Keynes (or Hayek), I believe the qualities noted above that made Keynes special are worth striving towards. Moving forward it’s incredibly important that theorists fully understand the strengths and weaknesses of historical theories, yet are willing to step beyond the boundaries and approach today’s questions from a fresh perspective.

Stemming from the current economic malaise and general dissatisfaction with government is a willingness to accept novel ideas. The directions taken will likely determine the length of the current crisis, as well as size and forms of governance for years to come. The time is ripe for another Keynes. Hopefully our generation will find and listen to him or her.