Samuelson, Hayek and the ‘inevitability’ thesis

Historical debate between Hayek and Samuelson about mixed economy and welfare state  revived by two of my econ professors in their new paper (Hayek, Samuelson, and the logic of the mixed economy?).

Professors Farrant and McPhail analyze Hayek’s ‘inevitability’ thesis (“each step away from the market system and towards social reform of the welfare state is inevitably a journey that must end in a totalitarian state”) and argue that the confusion surrounding this thesis is attributable to Hayek himself, despite Hayek’s strong disagreement with the way Samuelson explained this topic in his textbook Economics (11th edition).

...Much of the apparent confusion over the inevitability thesis, we suggest, is largely attributable to Hayek himself (with the water muddied further by the secondary literature on the Hayek–Samuelson exchange), with Samuelson having ready cause to read Hayek as making an ‘inevitability’ claim about the situational logic supposedly inherent to the mixed economy since Hayek often suggested that the logic of the mixed economy and redistributive welfare state ultimately and inevitably resulted in a totalitarian polity.

...Hayek repeatedly appears to consider the mixed economy and welfare state practices to have their own inherent logic, which, once set into play by government policy to redistribute income and attain social justice, apparently necessitates ever-further government intervention, the government perhaps ultimately finding itself inexorably “driven to establish an essentially totalitarian system” (Hayek, 1978, p. 301). Again, the above illustrates the immense importance Hayek placed on his oft-repeated statement that “if you don’t mend your principles you will go to the devil”’(1978, p. 105).

...we note that Hayek repeatedly suggests that attempts to achieve social justice ultimately tend towards full-blown command planning and a totalitarian polity....Samuelson correctly understands Hayek to oppose any welfare state practices that involve income redistribution because they apparently lead, in Hayek’s view, to political serfdom...Many are called as prophets. . . few are chosen as seers by the scorekeeping historian. . . [f]orty years after Friedrich Hayek wrote down his nightmare of the welfare state leading remorselessly to the totalitarian murder of freedom, Scandinavians enjoy freedom second to none that the world has ever seen (Samuelson, 1983b, p. 59).

The journal also has an essay by Samuelson, who argues that he stands by his initial assessment of The Road to Serfdom and the ‘inevitability’ thesis. Samuelson tries to formally settle the unresolved intellectual bicker he and Hayek had back in the 70s and 80s.

...Hayek over-praised the optimality of individualistic spontaneity. Charles Darwin’s genius long earlier had eclectically enumerated both the pluses and minuses of individualistic natural selection...Having spent a lifetime near libertarians, I can confirm that they are an individualistic idiosyncratic bunch. For example, my conservative mentor Gottfried Haberler was defined by Mises to be  “communist.” The number of Mt. Pelerin resignations never quite reached the number of its new members.)..Anthropological experts in “content analysis,” focusing their microscopes on the Hayek text (1944),might score its impact to be traceable to both (1) its version of history and (2) its projection of the future.

…If Hayek believes that the spending of newly printed currency on employment and consumption will worsen our current terrible depression, then Hayek is a nut. Alas, one fatal error eclipses a few elementary true truths á la Mises and Hayek: Easy money now often does entail tighter money later which will come as a surprise to uncompleted projects and new contingent contemplated investment projects.

...Two-thirds of a century after the book got written, hindsight confirms how inaccurate its innuendo about the future turned out to be. Consider only Sweden’s fig-leaf middle way. As I write in 2007, Sweden and other Scandivanian places have somewhat lowered the fraction of GDP they use to devote through government. But still they are the most “socialistic” by Hayek’s crude definition. Where are their horror camps? Have the vilest elements risen there to absolute power? When reports are compiled on “measurable unhappiness,” do places like Sweden, Denmark, Finland and Norway best epitomize serfdoms?

...No good deeds go unpunished! Never then, or before, or later did I have reason to think or to say: Yes, I have misunderstood you. Yes, I have incorrectly quoted from you. Mea culpa. Exactly what I have written above evaluating The Road to Serfdom is precisely what I believed about it in the 1940s and continued to believe about it up to the present 2007.

Consider this by Hayek (Foreword to the 1956 American paperback edition of The Road to Serfdom, pp44 in the definitive edition of The Road to Serfdom):

The hodgepodge of ill-assembled and often inconsistent ideals which under the name of the Welfare State has largely replaced socialism as the goal of the reformers needs very careful sorting out of its results are not to be very similar to those of full-fledged socialism. This is not to say that some of its aims are not both practicable and laudable. But there are many ways in which we can work toward the same goal, and in the present state of opinion there is some danger that our impatience for quick results may lead us to choose instruments which, though perhaps more efficient for achieving the particular ends, are not compatible with the preservation of a free society. The increasing tendency to rely on administrative coercion and discrimination where a modification of the general rules of law might, perhaps more slowly, achieve the same object, and to resort to direct state controls or to the creation of monopolistic institutions where judicious use of financial inducements might evoke spontaneous efforts, is still a powerful legacy of the socialist period which is likely to influence policy for a long time to come.

Apparently, Hayek overstretched his warnings and considered that economic planning and reforms would lead to (ultimately result in) a totalitarian state. For the sake of justifying freedom, he blinded himself to the possibility of having a managed mixed-economy. See the success of the Nordic countries. Also, it is hard to believe that  the US (and other Western countries) would end up being  totalitarian states, especially after the financial crisis (with all those bail-out interventions and activist government policies).

I remember having these discussions in Professor McPhail’s senior seminar class (History of Economic Thought) in Fall 2007. The original scanned letters between Hayek and Samuelson were pretty interesting! Btw, the first economics book I purchased (while I was doing A levels economics) was written by Samuelson and Nordhaus. Their book is probably the best introductory textbook in economics. Also, every time I read Hayek’s pieces (apart from The Use of Knowledge in Society), I find it hard to believe him (realistically speaking) despite the persuasive arguments he presents.

Here is a popular video about the road to serfdom.

More discussion about the topic here.

Marginal Propensity to Consume and Invest

The marginal propensity to consume (MPC) of poor people is high. Similarly, the marginal propensity to invest of a small scale enterprise with good prospects of future return is relatively high. Fiscal stimulus geared towards propping up these two measures would be more effective than tax cuts to the rich, argues Stiglitz. Moreover, investment in infrastructure, education and technology also helps stimulate the economy. In short, follow Keynesianism!

Tax breaks for business may prove to be a sink-hole as bad as the troubled assets relief programme.

Some of the spending in the stimulus serves multiple ends. Increased unemployment benefits have the largest multiplier effects – cash-strapped families spend every cent given – and meet vital social needs. It is imperative to provide health insurance to the unemployed: without that, a single serious incident can push a family into bankruptcy. Helping the unemployed meet house payments reduces foreclosures, addressing one of the underlying causes of the crisis. There are thus triple benefits.

We are in uncharted territory in this crisis. But household tax cuts, except for possibly the poorest, should have no place in the stimulus. Nor should business tax breaks, except when closely linked with additional investment. The one tax cut that should be included is a temporary incremental investment tax credit; it provides a big bang for the buck, encouraging companies to invest now when the economy needs the spending. Increased investments in infrastructure, education and technology, relief to states, and help to the unemployed need pride of place.

Why government intervention works?

Here is Jeff Madrick:

However, it is possible to look at the question of regulation empirically rather than theoretically. One useful area is cross-country analysis, whereby economists look at how countries with bigger governments and higher taxes fare. In recent years, Peter H. Lindert, a leading economic historian from the University of California, Davis, has comprehensively analyzed the literature. One argument against government is that public spending is unproductive and crowds out private spending. But, time and again, he found that studies claiming that high taxes reduce economic growth simply did not hold up.

Lindert’s exhaustive statistical analyses were based on eighteen countries over ninety years. No matter how he juggled the data, he found no relationship between the growth of GDP per capita and productivity and the level of taxes or the extent of social spending. There is a dramatic “conflict between intuition and evidence,” he writes. “It is well-known that higher taxes and social transfers reduce productivity. Well-known—but unsupported by statistics and history.” And he goes on: “Neither simple raw correlations nor a careful weighing of the apparent sources of growth shows any clearly negative net effect of all that redistribution.”

These days we all know how easily statistical analyses can be rigged. But if the case against big government were open and shut, then there would not even be a debate among economists. As Lindert notes, if a dollar of social spending reduces GDP by, say, sixty cents, then why are so many European nations doing well? They spend 25 to 35 percent of their national income on the poor, the elderly, the sick, and the unemployed, which therefore means, according to anti-government economists, they must have reduced their GDP by 15 to 20 percent. In other words, if they simply eliminated this spending, they would all be as rich or much richer than the United States, even as their people work many fewer hours.

Very interesting article. Read the full article to get some Kurgman and Stiglitz flavor!! Madrick is the author of a new book The Case for Big Government

On a similar note, here is what 2009 looks like for international development:

Markets and the State are already being rebalanced to fit these new times. It is time to say exactly who governs what, why, when and how. This will not be easy, but those who have been clamouring for more state involvement in development will also have to deliver better state involvement. This will be a big debate in 2009 with questions around (a) the appropriate balance of regulation, stimulus, and the provision of missing goods and markets, (b) how the balance is identified and (c) how the activity will be paid for. These debates must yield concrete actions very quickly.

...2009 will see: new ways of thinking about how the state and market can work together to encourage sustainable behaviour; new ideas influenced by the idea of wellbeing and what constitutes ‘consumption’; new ways of coordinating donor financing to generate new technologies; fresh perspectives on justice and accountability; novel ways of listening and reconciling ideas from around the world; and a more serious effort to understand everyday attitudes to international development.

Trade in South Asia: So open yet so closed

South Asia has opened its door to the rest of the world but it remains closed to its neighbors. Poor market integration, weak connectivity, and a history of friction and conflict have resulted in two South Asias. The first South Asia is dynamic, growing rapidly, highly urbanized, and is benefiting from global integration. The second South Asia is rural, land locked, full of poverty, and lagging.

That is from a WB policy research working paper Making Regional Cooperation Work for South Asia’s Poor.

SAARC is probably the least integrated regional blocs in the world. Moreover, SAFTA, the proposed free trade bloc, has not made any headway despite years of talks. It is a market of more than 1.3 billion people and an emerging one with increasing purchasing power. All talks on SAFTA or any regional development initiatives are clouded by off-and-on dispute between India and Pakistan.

Acemoglu on the financial crisis

Daron Acemoglu argues:

…Free markets are not unregulated markets. Well-designed institutions and regulation are necessary for the proper functioning of markets. Institutions have received more attention over the past 15 years, but focus was on understanding why poor nations were poor – not on understanding which institutions are necessary as the basis of markets and for continued prosperity in advanced economies.

…The first point is that fixing the short-run problem with policies that harm long-run growth is a bad option from a policy and welfare perspective. Innovation and reallocation are the keys to long-run growth, but potentially powerful groups tend to resist such changes. In developing nations, it is easy for impoverished populations suffering from adverse shocks and economic crises to turn against the market system and support populist, anti-growth policies. These threats are as important for advanced economies, particularly in the midst of the current economic crisis.

…A comprehensive stimulus plan, even with all of its imperfections, is probably the best way of fighting these dangers. Nevertheless, the details of the stimulus plan should be designed so as to cause minimal disruption to the process of reallocation and innovation. Sacrificing growth out of our fear of the present would be as severe a mistake as inaction. The risk that the belief in the capitalist system may collapse should not be dismissed.

Finally, wrong notions that led economists to ignore the impeding problems:

• Astute policy and new technologies had ended the era of aggregate volatility.
• The capitalist economy lives in an institutional-less vacuum where markets miraculously monitor opportunistic behaviour.
• We could trust the long-lived large firms to monitor themselves because they had sufficient “reputational capital”.

Maoists (ridiculous) definition of capitalism

So the left-wing Finance Minister Bhattarai of Nepal has his own distorted definition of capitalism:

Industrial capitalism or productive national capitalism caters to the market within the country and utilises the labour and resources of the country. We are in favour of that sort of capitalism. Bureaucratic capitalism involves very unproductive capital and is parasitic. It takes advantage of state power and tries to make an easy, quick profit. But it doesn't produce goods and it doesn't provide employment. Comprador capitalism involves trading in goods and producing a profit in between. It doesn't produce goods or create jobs within the country. Historically in Nepal, we've had comprador and bureaucratic capitalism. We may also call it crony capitalism. Instead of that we want to have national or industrial capitalism which has roots within the country, will produce goods required by the people, and provide employment in the country.

The capitalism the Maoists favor is inward-looking and is distant from the usual model of capitalism through which developed countries became developed. Essentially, he thinks that FDI is a form of bureaucratic capitalism, which are “very unproductive capital and parasitic” because all they care about is profits. But, he also wants investors (especially foreign ones) to be confident and invest in the country. Isn’t this a contradiction??

Investors, regardless of their origin, invest when they see prospect for profitable investment. It is not the government’s business to regulate profits. It can regulate the way of doing business but not profits. This creates an environment where there is lack of appropriability on returns on investment, leading to shortfall of required investment. This is precisely what is happening right now in the Nepali economy. Industrial sector is going downhill. Domestic investors are losing large retail customers abroad. See this article and this blog post.

Fyi, this is capitalism in econ literature:

Capitalism is an economic system in which wealth, and the means of producing wealth, are privately owned and controlled rather than publicly or state-owned and controlled.In capitalism, the land, labor, capital and all other resources, are owned, operated and traded by private individuals or corporations for the purpose of profit,and where investments, distribution, income, production, pricing and supply of goods, commodities and services are primarily determined by private decision in a market economy largely free of government intervention. A distinguishing feature of capitalism is that each person owns his or her own labor and therefore is allowed to sell the use of it to employers. In capitalism, private rights and property relations are protected by the rule of law of a limited regulatory framework. In the modern capitalist state, legislative action is confined to defining and enforcing the basic rules of the market, though the state may provide some public goods and infrastructure.

Btw, currently the finance minister is reading Confessions of an Economic Hit Man, by John Perkins. I hope he understands how crucial it is for the country to not borrow excessively to fund politically motivated projects and resuscitate sick, moribund industries! The government is expecting foreign assistance of Rs 65 billion 793.8 million for this fiscal year. This is composed of grants and loans, which comes with multiple strings (often unpleasant ones) as bonus attachment. I hope Bhattarai comprehends the core thesis of the book!! It is a good book.

No value of paper money in Zimbabwe

So the Reserve Bank of Zimbabwe has introduced ZW$50 billion note. The hyper inflation has collapsed the economy and it is reported that this new note is enough to purchase just two loaves of bread. This week the exchange rate was US$ 1= ZW$25 billion.

Hyperinflation in Zimbabwe at present is estimated to be at 231 million percent. Unless the whole economy (and hopefully Mugabe and his juntas) collapse, it will be hard to revive the economy using the same currency, whose cost of printing is slightly lower than the true worth of note. A classis case of economic and political mismanagement, indeed! On top of this, the country is facing Cholera outbreak, whose cause Mugabe blames on the West.

Meanwhile, a note from Zimbabwe:

It is just after midnight in Harare. I have just returned from a midnight tour of the ATMs in Harare with a cousin. There are queues of people still waiting to get their weekly cash withdrawal limit of $100,000,000,000 (US$2.50). I saw the queues this morning when I went for my first meeting at 7.45am. I did not know then that I would be seeing them throughout the day. Most of the ATMs had run out of money. Rather than go home, people saved their precious place in the lines by lying down where they stood and taking a nap. Covering themselves with sacks, newspapers and whatever warming clothing they had. Those ATMs that were still paying out cash had queues of policemen and soldiers…

Photo source here

…There was a power outage from 6 p.m. and it had taken us two hours to find a house I last visited 20 years ago as a boy. But I did ask how she was coping in Harare; and to her nephew she poured her heart out. No clean water for weeks on end, no food in the shops and constant power cuts. She drives an hour and half across the township in search of clean drinking water, which she brings back in plastic containers. When the city council water does run through the taps in the house, the water is discolored with sewer water. The shops in the neighborhood are empty of basic necessities including mealie meal.

…With civil service wages eroded by hyperinflation, people necessarily spend more time in the parallel economy trying to make ends meet. Interestingly, there are no runs on banks. The value of the withdrawals is so meaningless that the banks will be able to meet depositor demands with ease.

More here.