Solow on Good Hayek and Bad Hayek

8 Aug, 2014 at 11:10 | Posted in Economics | 8 Comments

As yours truly has written on several occasions here on the blog, there are many good reasons to be critical of Austrian economics. But we have to be careful so that we don’t throw out the baby with the bath water …

Just as I was wondering how to start this review, along came the Sunday New York Times Magazine with a short article by Adam Davidson with the title “Made in Austria: Will Friedrich von Hayek be the Tea Party’s Karl Marx?” One Tea Party activist reported that his group’s goal is to fill Congress with Hayekians. This project is unlikely to go smoothly if the price of admission includes an extensive reading of Hayek’s writings. As Davidson remarks, some of Hayek’s ideas would not go down well at all with the American far right: among them is a willingness to entertain a national health care program, and even a state-provided basic income for the poor.

The source of confusion here is that there was a Good Hayek and a Bad Hayek.

FUHayekThe Good Hayek was a serious scholar who was particularly interested in the role of knowledge in the economy (and in the rest of society). Since knowledge—about technological possibilities, about citizens’ preferences, about the interconnections of these, about still more—is inevitably and thoroughly decentralized, the centralization of decisions is bound to generate errors and then fail to correct them. The consequences for society can be calamitous, as the history of central planning confirms. That is where markets come in. All economists know that a system of competitive markets is a remarkably efficient way to aggregate all that knowledge while preserving decentralization.

The Good Hayek also knew that unrestricted laissez-faire is unworkable. It has serious defects: successful actors reach for monopoly power, and some of them succeed in grasping it; better-informed actors can exploit the relatively ignorant, creating an inefficiency in the process; the resulting distribution of income may be grossly unequal and widely perceived as intolerably unfair; industrial market economies have been vulnerable to excessively long episodes of unemployment and underutilized capacity, not accidentally but intrinsically; environmental damage is encouraged as a way of reducing private costs—the list is long. Half of Angus Burgin’s book is about the Good Hayek’s attempts to formulate and to propagate a modified version of laissez-faire that would work better and meet his standards for a liberal society. (Hayek and his friends were never able to settle on a name for this kind of society: “liberal” in the European tradition was associated with bad old Manchester liberalism, and neither “neo-liberal” nor “libertarian” seemed to be satisfactory.)

3940The Bad Hayek emerged when he aimed to convert a wider public. Then, as often happens, he tended to overreach, and to suggest more than he had legitimately argued. The Road to Serfdom was a popular success but was not a good book. Leaving aside the irrelevant extremes, or even including them, it would be perverse to read the history, as of 1944 or as of now, as suggesting that the standard regulatory interventions in the economy have any inherent tendency to snowball into “serfdom.” The correlations often run the other way. Sixty-five years later, Hayek’s implicit prediction is a failure, rather like Marx’s forecast of the coming “immiserization of the working class.”

Robert Solow

Added 1400 GMT: For more on how to make sense of Austrians like Hayek, read this new post by Brad DeLong.


  1. Most people who define socialism and capitalism make it sound as though this were black and white, although we have schools, a postal system, courts, police, Coast Guard, military etc. Does the black and white definition label all government activity ‘socialism’? It’s not capitalism versus socialism, its individuals vs a minuscule number of billionaires who are ending up owning everything including government and labor.

    Technology has made it easy and in many cases necessary to utilize economy of scale solutions. Economy of scale activity has overtaken many if not most activities today. Today economy of scale capitalism is not the same as Adam Smith defined tit250 years ago in his Wealth of Nations, published in 1776, when competition could exist. Today capitalism has been transformed into monopoly capitalism. There is generally no room for competition, because when an industry becomes dominated by a few behemoths through predatory pricing they successfully underprice the ‘little guys’ out. So, the remaining behemoths don’t compete on price basis but rather collude to keep the prices higher than before all the smaller competitors were either gobbled up or quit altogether. And, when this happens you generally find that quality and safety get left behind. Why does this happen, because huge companies can afford big time lawyers and big time lobbyists who ‘influence’ elected officials to distort laws to favor themselves. The Supreme Court has made it legal for Corporations to make unlimited, undisclosed cash donations to candidates in Federal elections. They now have the power to buy government favor legally. The Supreme Court and corporations call it ‘free speech.’ So where are the checks and balances with regard to the public’s access to law makers? The Supreme Court will be ruling on the proposed merger of Time Warner which has a monopoly on broadband with Comcast’s monopoly on cable TV. That’s a whole lot of monopolizing.
    It becomes impossible for new entrants to come into a monopolized market due to huge capital and resources necessary to compete.

    Only government can keep the greed of private monopolies in check. Only the government can set regulations that safe guard us from what huge corporations do, i.e. price gouge, produce unsafe products and unsafe exploitative working conditions for the community where the behemoth extracts its product off backs of the workers within these behemoths. I want government to stop letting behemoths merge because I as an individual am powerless to change a monopoly that can dish out whatever it wants to call a product, whether is safe or not.

    Fifty percent of people below the median income pay more than 50% of their income on rent. How can it be possible for people to raise a family when most of their income goes to paying the rent? People trapped by high unemployment can’t even get a job even when the pay is so cheap wages haven’t kept up with inflation for over 55 years! How do you ‘pull yourself up by your bootstraps’ making $8 an hour? 60 years ago just about everything done involved direct human labor. So if you worked hard you could learn a trade and find a market for your trade in your neighborhood. Today most unskilled labor has been replaced by machines that can crank out much more product without wages, benefits, retirement, health insurance, etc.
    If you have wealth you can reap huge income with just your capital assets, i.e. look at today’s stock market, it’s the highest it’s ever been. Now look at wages, they are proportionately the lowest they have been relative to prices since the 60’s.

    How free is our ‘enterprise’ when the only people who can afford a house these days is the bank because they have free access to loans without interest. How free and safe are we now when Republicans work to strip away safety by voting against bills that make it harder for individuals to get compensated for the gross lack of safety built into products and working conditions. Didn’t the Supreme Court outlaw class action suits? How does that protect the customer who is damaged by corporate maleficence? The bottom line is without unions or class action protection people have to take the crap that the behemoths can dish out.

    If monopoly corporations had to share their Board of Directors with their own workers then democracy in the work place would begin to heal the domination that labor has been under since our Capitalists were able to outsource labor to tragically poor and in many cases dictatorial countries where their workers have had no say ever and as a result are just work units for the rich. The bottom line is that economy of scale business gives only the stake holders, i.e. the stock holders a share of the income. Their greed is unchecked; their CEO’s often make 400 times what their average employees do!

    What is happening is that since the rich have all the money the economy cannot grow because only a small percentage of people can afford to buy anything, so the economy shrinks or at best flat lines. A shrinking economy reduces the need for labor, which makes it harder for middle and lower class families to send their kids to college. Or if they were lucky enough to get some education, many are still locked out of the labor market because without money in circulation there is no demand for more jobs. So the economy stagnates at best and eventually heads south. You can’t have jobs without a credible demand (real purchasing ability) for products, it’s that simple.

    Unless the money that’s concentrated into Swiss Bank accounts and other schemes to hide cash is finally leveraged out to benefit the middle and working class there can be no American dream but rather a steady decline in the standard of living resulting in greater eroding our mental and physical health and education, more jails, more court costs, less emergency care services, more foreclosures, more prisons, more murder/suicides and all the other dreadful spin offs while we sink further into a modern ‘Middle Ages,’ complete with billionaire barons, feudal conditions and one sided justice!

  2. Hayek did not exclude all of the middle ground of non-state actors that modify the information of context of prices. Hayek is an institutional economist. I am not sure which of Hayek’s texts to refer you to, maybe, “Law Liberty and Legislation,” 1973 or “The Use of Knowledge in Society,” 1945. I think he does try to address Clarke’s dilemma.

  3. Hayek’s “Road to Serfdom” is more fun to read than J. M. Clark’s “Alternative to Serfdom.” Clark, though, was the better economist. The false dichotomy between “free” market and “coercive” state relies on excluding the vast institutional middle ground of non-state actors that can modify the information content of prices.

    From the preface to Clark’s Alternative:

    “Throughout the treatment runs one dilemma. Man needs to belong to a community unit smaller and more personal than the overpowering state; but the units that meet this need—including trade unions—are not parts of an integrated community, but monopolistic groups, at war with others. To resolve these conflicts without destroying liberty seems to require, first, that the powers of these groups be fairly well balanced and, second. that they be responsibly exercised. The means of accomplishing this will tax our qualities of citizenship and our powers of social invention.”

  4. It’s high time someone took a new look at Hayek’s theories of knowledge, because they’ve been turned (whether by him or his followers is a moot point) into a catch-all against any kind of co-ordinated action.
    For Hayekians, only by collapsing information into a single axis (price) and trading can you aggregate knowledge.

    Once you concede that, you’re sunk in terms of any kind of civilised world.
    Which is of course why Hayekians always return to “local knowledge” as a bedrock.

    Still, it should be clear that at this point in history we know a lot more about information than we did then and the whole “collapse it all into price” looks pretty silly. But no economists has actually done the work to take it on…

    • To take this further, we have much more “information science” and even “game theory” than we did in Hayek’s day. We know much more about what is lost in different methods of “compression” – collapsing information into price is precisely a form of compression. Economists should be looking at what is lost when they undertake to use a price mechanism as their sole solution to co-ordination problems.

      The neo-Keynsian tendency is well illustrated by Solow – “markets are best, but the have emergent problems that must be managed.”

      The real breakthrough to come is to understand that the price mechanism is inherently much more flawed than Hayek claimed. (We have the information science to do that, but we don’t have the economists to read the information science, it appears.)

      Anyway, once we actually understand the flaws in the price compression, then we’ll have a much better understanding of so many of the behavioural economics phenomena that we see…

    • I think that Hayek was referring to knowledge as knowledge of price which would include everything from costs to wages to fees to values. Hayek disputes that he is neither a libertarian nor a conservative and I do not think that he offers us a pseudo-science. But, I also think there are areas where he was mistaken. I meant that Hayek should be understood.

      What we are faced with today is obfuscation over the reasons for price differences, for fees (in fact we are often not given any information about fees and simply charged), wages and salaries are hidden under “confidentiality” norms, and costs per scale are the stuff of arbitrage. However, if we know the prices, we could decide accordingly. One has to wonder what investors in hedge funds or derivative securities are thinking since this is where we can find obscurity and outright fraud.

  5. You could ask, “Why are there so many wars?” or “Why is there such a widespread inequality?” or “Is governmental intervention: socialism and socialism: totalitarian and totalitarianism: a welfare state?” The amnesia by history occludes the past unbridled capitalism of Marx’s day or the brutal, immoral, anti-democratic fascist and communist states before WWII. Casting Hayek as a libertarian means that he was opposed to any governmental intervention or redistribution and that any market interference meant socialism and totalitarianism, and this is simply not the case.

    Hayek engaged in the socialist calculation debate where he argued that central planning could never be as efficient as decentralized decision making through open markets and the price mechanism. Then, in his debate with Keynes who attributed economic slumps to discrepancies between investments and savings, Hayek argued that monetary interventions distorted investment allocations.

    In the Road to Serfdom, Hayek argued that central planning will undermine subjectivity, liberty, and individual autonomy. He did not as libertarians do today, e.g. Rand Paul, attack all governmental interventions in the economy. Hayek expects the government to provide monetary stability and antitrust protections, regulations regarding sanitation and toxic substances, road building, consumer protection, and health insurance among many others. Hayek considers himself a liberal and criticizes both laissez-faire and libertarianism. He did oppose governmental intervention in the price mechanism and in labor regulations preventing free choice of occupation!

    Hayek is however not the godsend economist for all our troubles but his oversights and naivete are instructive.

    Recommended reading: Hayek: The Good, The Bad, The Ugly
    Critical Review Volume 25, numbers 3-4, 2013 See especially Godard, F. The Road to Freedom’s Economistic Worldview.

    • Yes indeed, Hayek et consortes certainly has contributed a lot of nonsense pseudo-science. But given that, I still think that, after having got rid of all that dirty bath water, there might still be a baby left in the bath worth saving for the future …

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