Hayek vs. Keynes: The role of government and the dangers of totalitarianism and economic decadence

There is currently a generalized view of Keynes as the paragon of state intervention and of Hayek as the quintessential laissez-faire economist. Both views are wrong.

Keynes basic philosophy, as stated in his General Theory, is that governments should be entrusted with “the task of adjusting to one another the propensity to consume and the inducement to invest” to prevent effective demand deficiency. For him, the state should decide how much to produce (to achieve full-employment) while individuals should decide what to produce, with which resources (labor and capital) and to whom it should accrue.

For Hayek popular terms like “full employment”, “planning”, “social security”, and “freedom from want” were the fool’s-gold words, often invoked with catastrophic consequences, as in Germany where the full-employment between 1935 and 1939 was achieved at the expense of expropriating, deporting or killing 600 thousand Jews. For him monetary policy cannot provide a real cure except by a general and considerable inflation. Moreover, for him the rising monopolization of the economy was not inherent to capitalism (economies of scale) or justified by technological necessities but was instead the result of collusive agreements promoted by public policies.

Given the circumstances when they were writing, we can understand Keynes’ fear of recurrent massive unemployment destroying capitalism as well as Hayek’s alarm about the danger that rising government control would inevitably lead to a totalitarian state. However, after more than 70 years, and with the benefit of hindsight, we may now question if such fears were warranted.

After all, some of the totalitarian regimes were military defeated (e.g. the German Nazis and Italian Fascists), some imploded through inefficiency (e.g. communism in the Soviet Union and Eastern Europe) or have postponed their demise by embracing authoritarian mercantilist capitalism (e.g. the Chinese communists).

Equally, the subsequent recessions and accompanying massive unemployment were overcome without major social unrest, partly due to the generalization of unemployment insurance.

Nevertheless, we should not forget the tremendous losses caused by such collectivist experiments. The more than 60 million of casualties during the World War II started by Hitler, the 15 million victims of Stalin's reign of terror in the 1930s and Mao’s more than 20 million victims in the 1950s and 1960s during the so-called Great Leap Forward and the Cultural Revolution. Also pointless has been the waste of manpower as result of involuntary unemployment experienced in many countries ruled by collectivist (mostly socialist) regimes in 2009, namely: Zimbabwe (95%), Turkmenistan (60%), South Africa (24%), Spain (19%) or Tunisia (16%).

Given this grim past, the question is: could it have been avoided if the policy advice of Keynes and Hayek were more widespread and better understood? If not avoided it could at least be minimized. In particular this would be so, if the “prophets’ followers” shared their common care for capitalism.

Instead, most followers continued to ignore them on this, as well as the failure of all past predictions by both friends and foes of capitalism that it was doomed to fail. All such theories, from Karl Marx surplus value theory of capital accumulation, to Schumpeter’s claim that that the success of capitalism would lead to a form of corporatism and a fostering of values hostile to capitalism, especially among intellectuals, Milton Friedman’s theory on the suicidal nature of capitalists to Solzhenitsyn's attack on the commercialized nature of Western culture have been proved wrong.

Even more importantly, all attempts to create a pragmatic so-called “third-way”, from the recent British experience by Tony Blair’s New Labor, the Czech and Hungarian attempts to create a democratic socialism in 1968 and 1956, to the more distant Fascist “third way” of the 1930s, aimed at keeping the best of socialism and capitalism ended up dramatically retaining the worst of both systems, creating more collectivism, corruption and inequality.

For Keynes or Hayek there was no alternative to capitalism or “third-way”, simply a choice about the degree of government intervention in the economy. While assessing the supply of goods and services not provided by the private sector or the regulation aimed at promoting a level playing field, Keynes, the politician, was obviously more compromising about accepting a substantial role for the government while Hayek, the theorist, was more puritan.

Some types of state capitalism (notably the Scandinavian type) have now shown that fears about the rise of authoritarianism as a result of greater state involvement in the economy, as feared by Hayek, do not materialize until a high level of public spending as a percentage of GDP is reached (about 50%). Equally, the rising share of government in the economy has some smoothing effect on the business cycle as advocated by Keynes, but after a certain level (again, about 50%) it triggers a slowdown in productivity and consequent economic decadence. Thus, Keynes and Hayek’s views are correct within a given range of state intervention, but its limits are imprecise and poorly understood.