July 15, 2020 Reading Time: 3 minutes
path, mountains

To get through the current crisis, Jared Bernstein argues, we must look to Keynes. It is an old argument, reapplied to our current context. The old argument is straightforward: the free market cannot fix itself. It follows, then, that we should not expect the economy to automatically recover once the pandemic outbreak is over. A more effective approach, Bernstein and others following in the tradition of Keynes maintain, would see the market managed by the savvy hand of the state.

Yet, how precisely the state should manage the economy is unclear. And the idea that capitalism is “not to be overthrown but to be ‘wisely managed’” is a dangerous one.

As Friedrich A. Hayek explained in a famous 1945 essay on The Use of Knowledge in Society, governments are unable to acquire the requisite knowledge to allocate resources effectively. The knowledge required is decentralized–of a particular time and place. Indeed, it is often tacit, meaning it cannot even be articulated by those possessing it. 

In a market economy, Hayek argued, this knowledge gets embedded in prices through the process of bidding and asking on particular goods and services in particular places at particular times. It is not possible to convey that knowledge in the absence of market prices. Hence, a government cannot manage the economy wisely because it lacks the requisite knowledge.

A second problem, which Hayek identified in The Road to Serfdom, arises as the government attempts to manage the economy without the requisite knowledge. Without the knowledge of individual preferences, in particular, the government will tend to substitute the preferences of its leaders for those of the individuals in society. Individuals will do their best to achieve their own ends given the constraints imposed by government officials. And, since the ends of individuals do not perfectly align with those of government officials managing the economy, they will tend to undermine the plans of government officials. 

What will a government do when its plan inevitably fails? It could abandon its plan, letting individuals pursue their own ends without the added constraints. But the fear, according to Hayek, is that the government will insist on its plan. Such an insistence would result in even greater efforts to subvert the plans of individuals for the plan of their leaders. And, when this revised plan fails, the government will have to decide whether to abandon its plan or double down once more. Continued insistence on the plan results in more and more encroachments on individual liberty. The end result is serfdom.

Rather than following in the tradition of Keynes, as Bernstein recommends, those in the post-pandemic economy would be better served by following in the tradition of Hayek. The Hayekian free market approach does not amount to do-nothingism, as opponents often suggest. Hayek acknowledged an important, though limited, role for the state to assist those most in need. But providing assistance to the widow of a COVID-19 fatality or a temporary loan to small businesses struggling due to no fault of their own is very different from efforts to “wisely manage” the economy.

Moreover, there is some evidence that a turn toward Hayek, as opposed to Keynes, would improve our ability to grapple with the next crisis. A recent study by Christian Bjørnskov looks at 212 crises across 175 countries from 1993 to 2010. He finds that, following a crisis, countries with higher levels of economic freedom–that is, with institutions closer to those proposed by Hayek than Keynes–suffered smaller economic contractions and faster recoveries.

Keynesian ideas have dominated the political worldview for decades. But we would be better off following Hayek.

Nicolás Cachanosky

Nicolas Cachanosky

Nicolás Cachanosky is an Assistant Professor of Economics at Metropolitan State University of Denver. With research interests in monetary economics and macroeconomics, much of his recent work has focused on incorporating aspects of financial duration into traditional business cycle models. He has published articles in scholarly journals, including the Quarterly Review of Economics and Finance, Review of Financial Economics, and Journal of Institutional Economics. He is co-editor of the journal Libertas: Segunda Época. His popular works have appeared in La Nación (Argentina), Infobae (Argentina), and Altavoz (Peru).

Cachanosky earned his M.S. and Ph.D. in Economics at Suffolk University, his M.A. in Economics and Political Sciences at Escuela Superior de Economía y Administración de Empresas, and his Licentiate in Economics at Pontificia Universidad Católica Argentina.

Get notified of new articles from Nicolás Cachanosky and AIER.