Tuesday, 20 May 2014

Hayek on Handling Recession

Sam’s comment this morning was so good, I need to comment on it twice.

He’s right that there’s no need for vitriol at half the population. But he’s wrong in arguing that governments should be piling up debt during a recession:

However, it seems pretty clear that the human suffering mitigated by maintaining transfers through a recession drastically outweighs the suffering created by the govt taking on debt to be mostly paid by rich taxpayers of the future.

Nobel Prize winner Friedrich Hayek would disagree with him twice over.

First, it’s certainly true that young people have been involuntarily burdened with a humungous monetary debt just to keep this generation in … if not clover, then at least in the same hole they found themselves when the recession struck.  But there’s also an important sense in which this generation pays for these debts now.  As Hayek’s colleague Ludwig Von Mises points out “financing a war through loans does not shift the burden to the sons and grandsons.” That is to say, the real burden of required real resources for a war (or a war on welfare) “falls upon the living generation” and is “a method of distributing the burden among the citizens.”

A burden about whose justice we disagree.

Second, a recession (or depression) is actually the recovery phase after an unsustainable boom. It’s the period where all the misallocations and malinvestments are shaken out. You have no choice about the pain of an economic depression (or recession). But you do have a choice about how long the pain lasts.

When economic troubles strike, policymakers are eager to do something to try to help the citizenry. In this Learn Liberty video, Prof. Lawrence H. White argues that government doesn't necessarily know how to relieve economic woes, and in fact, often wastes and mismanages resources. Individuals in the market know better what they need in their circumstances, as economist Friedrich Hayek argued during the Great Depression. Relying on government to fix our economic woes instead of allowing individuals to make decisions for themselves means putting all of our eggs in one basket. Individual decisions in the market won't be mistake-free, but each individual mistake will be smaller and will correct more quickly. The unusually slow and painful recovery that we have seen in this recession point to problems with the "government should do something" view. What do you think might be the best way to handle economic difficulties? Why? 


  1. It has taken a while to find this information online and in my notebooks ....but I take issue with Sam's contention about it being better to have spent money during the recession rather than cutting spending.

    A classic example of where he is wrong is during what is known as the 'Long Depression' during the 1870s; I use that as an example because it has numerous parallels with recent events - such as printing money (and its failure)

    The country which came out of it fastest, and in best shape, was Great Britain.

    Gladstone was Prime Minister and he did a number of things -

    1. Cut government spending (yes, cut)
    2. Made 'charity' a local affair (where those claiming to be charitable could put their money where their mouth was)
    3. Removal of almost any restriction to trade and commerce

    Point 3 is most interesting; in anticipation of the economy picking up at some point Gladstone made sure the breaks were not on when it eventually happened.

    Britain was unique in having economic policy as if it were boom times, and not losing their nerve over yet another periodical, and temporary, economic downturn.

    The result?

    Britain's economy picked up far quicker than those of Western Europe and America (by 1876 it was all over) and was back to being a powerhouse by the end of the decade.

    In other words doing things this blog and others have been urging Mr Key to do for 6 years

    But wait - there's more....

    What did America do during the 1870s? (and yes, I am talking about the 1870s, not the last 5 years)

    1. Massive tariffs imposed on imports
    2. Printed money to spend their way out of it (yes those rogues in the US Congress were at it back then too!)

    When printing money didn't work (remind you of anything?) and oddball ideas such as silver as well as gold being the currency also failed pretty quickly, they came up with an ingenious idea - they would simply make it up!

    Government decided to simply 'invent' prosperity by developing various western states and regions in order to provide employment and pretend it was 'real' investment

    The result?

    America was basically stuffed economically from 1873 to 1896 and the only 'prosperity' was manufactured; when certain states entered the Union they would simply announce wonderful GDP figures and convince people the economy was growing - e.g If Canada and Mexico became states tomorrow then US GDP has magically risen substantially overnight... "yay! recession over - look our economy expanded 19% since yesterday!"

    Whereas Britain in the 1870s and beyond was 'The Workshop of the World' and had real production, real businesses, real investment and recovered quickly due to no government involvement in trying to do something about a severe downturn - and went on to even greater prosperity through to WW1 - America was sluggish for 20 years with various recessions and financial panics.

    There was almost no net increase in industrial production between 1873 and 1890.

    I am reluctant to provide links on Peter's blog but do a search for 'long depression' on Wikipedia, and the University of Newcastle website in the UK has a lot of good historical information including lots of graphs.
    There is also a lot of detailed information in the biography of Gladstone by Roy Jenkins.

  2. Shit! Honoured to get two mentions, cheers Peter!

  3. And with regard to the pain of readjustment during the recession, do we get to choose (through our policy decisions) who bears the brunt of the pain?

  4. Sam, you are misunderstanding the whole point of it.

    A substantial percentage of people are addicts to handouts and welfare; you are saying "better not go cold turkey because it makes you feel awful".

    It is the welfare programs established in the first place in order to try to prevent people "bearing the brunt of pain" in a recession which causes all the problems.

    Gladstone sums it up well -

    "...But let the working man be on his guard against another danger. We live at a time when there is a disposition to think that the Government ought to do this and that and that the Government ought to do everything. There are things which the Government ought to do, I have no doubt. In former periods the Government have neglected much, and possibly even now they neglect something; but there is a danger on the other side. If the Government takes into its hands that which the man ought to do for himself it will inflict upon him greater mischiefs than all the benefits he will have received or all the advantages that would accrue from them. The essence of the whole thing is that the spirit of self-reliance, the spirit of true and genuine manly independence, should be preserved in the minds of the people, in the minds of the masses of the people, in the mind of every member of the class. If he loses his self-denial, if he learns to live in a craven dependence upon wealthier people rather than upon himself, you may depend upon it he incurs mischief for which no compensation can be made...."

  5. Mr Lineberry - that's true, it's quite possible the pendulum has swung too far with regard to welfare in certain parts of the world. The problem of the dependency trap is real, and extremely challenging. However, it seems like if there was ever a justification for welfare, it would be during a recession where workers have lost their jobs due to no fault of their own.

  6. But Sam, even workers trade independently like any business. A worker chooses to invest (educate) in a certain field and choose to sell their labour to an employer. If he chooses to sell skills that are no longer required due to technological advances or economical reasons then that is the workers responsibility.

    Workers just like everyone else have a choice and they may not like to take on the risks of life but refusing to see the writing on the wall will be at their own peril.

  7. Great quote from Gladstone, Mr L. Does put it well.

    Sam, it is the crux of the point. It's not a good life to live off the wealthy. It's a slave's life. Higher income earners & the determined learn to take the tax grab against them in their stride, as part of doing biz. In NZ the formula is take 30% off whatever you make & that's your real income and what you really have to work with. One could go on, but that 30% is part of the price structure in the economy, ie, in the prices of everything. And who loses most in that equation?

    There is a price for 'craven dependency' on the dependent. Hard fact, but not immediately obvious.

  8. Thanks Sam P; it is just appalling that successful people need to operate on a 70% rule of thumb and the sooner that is done away with the better.

    Think of all the things the 30% could be spent on to enhance your life.


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