The Q&A session for this past week’s Economics 101 class
(free online from Hillsdale College) included some definitions of three basic
economic schools of thought. I refer to these fairly frequently, so I thought
maybe it would be useful to have a short lesson defining them. We’ll look at
these: Keynesianism, the Chicago School, and the Austrian school.
When we say “school,” we aren’t referring to a
brick-and-mortar institution; we’re referring to a way of thinking. Those who
agree with and follow those ideas “belong to” that school of thought. The
schools aren’t necessarily mutually exclusive. Two of these three are
proponents of the free market.
Keynesianism
John Maynard Keynes was a British economist who put forth a
theory in the 1930s, purporting that government intervention could accomplish full
employment and reduce the impact of business cycles.
There’s a 3-minute video intro to lecture 7 of the Hillsdale Econ
101 course, which explains the Keynesian model.
In the actual lecture Professor Gary Wolfram charts out the
theory on a supply and demand curve. In the real world, there’s typically a gap
between the number of potential employees and the number actually hired. Even
in full employment, that’s around 3-4% (which was declaimed as too high all the
way through the Bush administration, but has been double to triple that—or worse,
depending on your measures—all the way through the Obama administration, while
the same people keep claiming the economy is improving. So, one thing about
statist/Keynesians is that government intervention is a good thing, to be taken
on faith, regardless of measurable evidence.) Keynes’s theory is contained in
his main work, The General Theory of
Employment, Interest and Money, published in 1936.
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| Keynes's magnum opus |
Keynesianism claims that government spending—any government
spending—results in economic growth. (Read my Glass Breaking Fun.)
That’s why you see such “growth” in Washington, DC, the past few years, while
the rest of the country struggles. The DC growth is because government is literally
trying to grow the economy by hiring people to do whatever (metaphorically
digging holes and filling them in)—without noticing that any money for that
purpose is taken from what could be spent to innovate or invest in the
non-government real economy. It is Keynesianism that claims the way we got out
of the Great Depression was by spending our way out because of WWII.
Keynesianism is most popular with people who want increased
government power, so it’s not surprising that it was championed by such
politicians over the past near century. However, as Keynesian theories have
been implemented, empirical evidence of their failures has led more and more
economists to leave that school of thought and take another look at the free
market schools. However, Keynesianism resurged in 2007-2008, with what is now referred
to as the Great Recession, which continues apace with ongoing government
interference. Hmm.
One of the most prominent Keynesian economists still
claiming Keynes was right is Nobel Laureate Paul Krugman, who is widely
published and consistently wrong.
The Austrian School
Contemporary with Keynes were Ludwig von Mises and Friedrich
Hayek, who are usually considered the two main Austrian economists. Ludwig von
Mises, who is generally considered the original Austrian theorist, immigrated
from Europe in 1940, ahead of the advance of the Nazis, landing in New York; he
taught at NYU for most of the remainder of his life. He considered himself a
classical liberal—that is, “liberal” in much the way our founders were; he
believed in limited government and free markets among a moral people. Mises is
often cited by libertarians today, although I’m not sure he completely fits in
their world.
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| Ludwig von Mises photo from Wikipedia |
My personal view is that, on the Spherical Model, Mises is
western hemisphere (most local control that can be managed for any given
issue), but also northern, where laws protect people’s God-given rights to
life, liberty, and property. Libertarian theory tends to encompass the entire
western hemisphere, including the below-the-equator belief that government
should have no role, and free market should rule, even including addictive drugs
and sex trade. (See Why I’m Not Quite a Libertarian.)
Friedrich Hayek, who won the Nobel Prize in Economics in
1974, wrote The Road to Serfdom, which
should be required reading for any educated individual. Hayek was a follower of
Mises. While friendly with Keynes personally, Hayek disagreed with his theory.
(Meanwhile, Keynes read Hayek’s book and said he agreed with it entirely.) When
he left Austria, Hayek taught in Britain
for some time before ending up at the University of Chicago. Much of his work
describes business cycles. Some of what he demonstrated was that government
interference actually causes business cycles—both lengthening and intensifying
the pain. Without the interference, the market serves to correct itself, with
just minor dips and quick corrections. When there is a shortage of labor, the economy
self-corrects by raising pay rates, until there is equilibrium. When there is a
surplus of labor, the economy self-corrects by lowering pay rates, until there
is equilibrium. He favors trust in the free market and government restraint.
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| Friedrich A. Hayek photo from Wikipedia |
Henry Hazlitt, another Austrian commentator, wrote a point
by point rebuttal of Keynes’s The General
Theory, called The Failure of the New
Economics. The Austrians looked more at innovation and various movements
from equilibrium, accepting that those are not necessarily negative things to
be avoided.
The Chicago School
The Chicago school of economics usually refers to Milton
Friedman, and also his wife, Rose Director Friedman. Thomas Sowell, a former
Marxist who later studied in Chicago under Friedman, is probably included.
Friedman is a free-market economist. He is against government
intervention. The difference between his work and the Austrians is more a
matter of focus than disagreement. The Austrians look at movement from one
cycle to the next. The Chicago school examines the conditions that exist at
equilibrium. They look at government intervention, what it does, and why it always
goes wrong: the information needed is unknowable, the timing will always be
late. And government interference obscures the market signal: producers get
incorrect signals about whether to produce long-term capital products or
short-term consumer products—or producers fail to get a signal, because of
uncertainty in the market, and therefore hold back production until there is
clarity (what we’re seeing in the market now). Some of the “interference” is
control of the money supply, and the Chicago school looks closely at that.
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| Milton Friedman photo from Wikipedia |
All of these theories deal with macroeconomics—the movement of the economy as a whole—rather than microeconomics, which is the study of
why individuals make the economic decisions they do. If there is a basic
macroeconomic principle for government it should be “first, do no harm.” The
argument “Well, we have to do something,” is wrong; doing nothing is always an
option and often the best one. Government is not responsible for the economy;
government’s only economic role is preservation of rights—enforcing contracts,
protecting property rights, settling disputes over property claims, and
possibly standardize monetary units (although Wolfram actually discusses the
suggestion of privatizing money supplies, which is an interesting idea).
Less government interference, beyond its limited role,
always leads to greater prosperity. Imagine the economic prosperity we would be
experiencing if government had refrained from interfering this past century.
