Critique of Austrian Economics
Part I: The Legacy of Friedrich Hayek
Section IX: Summary of the Critique of Hayek
We have found seven serious problems with Hayekian economics:
1) As discussed in Section II, Hayek was unclear whether his structure of production represents a yearly flow of goods or a distribution of wealth. Mises and Rothbard, like Hayek, seem to mean one and also the other. Skousen is at least consistent but, unfortunately, he is consistently wrong. He definitely means the amount of goods flowing by every year. This author’s work (1999) is about stock, not supply.
2) As discussed in Section III, Hayek’s triangle is printed sideways and backwards. The former problem can be corrected by rotating the graph but the latter problem is more fundamental. Hayek is speaking from the perspective of the owner of the final product looking back on his costs of production. He is speaking from Marx’s perspective. The perspective that we want is from right now, at time zero, looking forward into the future.
3) As discussed in Section IV, there must be some temporal measure or the Hayekian’s incessant references to “lengthening the period of production” would not mean anything at all. Their theory of business cycles depends on credit expansions lengthening the period of production and on the inevitable contraction shortening it. It is impossible to talk about something being lengthened or shortened unless one knows how to measure it.
4) As discussed in Section V, Hayekian theory depends entirely too much on the specificity of capital goods. In reality, many companies make products or provide services which are used in all of Hayek’s five stages – and they experience cyclical behavior too. Rothbard was wrong when he said “To the extent that the new money is loaned to consumers rather than businesses, the cycle effects do not occur” (1970, p. 940 footnote).
5) As discussed in Section VI, Garrison’s conception of the natural rate of interest is faulty. The Hayekians are naïve to cling to this mythical concept. There is no such thing as a natural rate of interest. In any case, credit limits are more important than interest rates. The necessity of a bust following boom times is adequately explained by the transfer of capital from smaller companies to larger ones.
6) In Garrison’s own words: “the [Hayekian] theory of the business cycle is a theory of the unsustainable boom. It is not a theory of depression per se. In particular, it does not account for the severity and possible recalcitrance of the depression that may follow on the heels of the bust” (2001, p. 120). In 1930, Hayek could explain how the depression started. In 1936, he could not explain why it still persisted. See Section VII.
7) Austrian economists seem naïve because their belief in a natural interest rate implies an ethical judgment on what is natural or unnatural, their discussion of the inevitable collapse of a credit expansion is typically presented as a sort of morality play and because they advocate an impractical 100% reserve requirement based solely on ethical considerations. See Section VIII.
Seven strikes and you are out! Hayek’s horse fell dead underneath him in 1936. Seventy years later, his followers are still beating that horse saying “Get up! Get up! We have to finish the race!”
The DWCS, presented in Section IV, is a good start towards reforming Hayekian economics. While far from a complete solution to their problems, it at least puts a horse under them again. For a complete solution, they should consult this author’s work (Aguilar 1999). But, to understand where I am coming from, we need to first consider the legacy of that other great defender of the free market, Ludwig von Mises.