Stiglitz and Hayek, Strange Bedfellows

January 2nd, 2012 at 2:00 pm David Frum | 13 Comments |

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What is wrong (and right) with Joe Stiglitz’s analysis of the Great Depression? Click here for Part 1. Click here for Part 2.

Yet for all the problems with the Stiglitz theory of the Great Depression and the Long Recession, there is some useful wisdom as well.

Stiglitz is framing a critique–not only of the Friedman/Schwartz theory of the Depression–but also of the neo-Keynesian theory of today’s economic problems.

The neo-Keynesian view of the current situation (expressed most pungently by Paul Krugman) goes something like this:

The US economy has been hit by a financial crisis, not an economic crisis. The crisis has deprived consumers of the cash and credit to buy goods and services. Aggregate demand has slumped, and so therefore has employment. If government stepped in as a substitute buyer of goods and services, demand would revive – perhaps as rapidly as a mere “matter of months,” as Paul Krugman boldly stated in a recent blogpost.

More conservative commentators, who dislike the neo-Keynesian call for lotsa-lotsa government spending, argue that today’s unemployment is “structural”–the product of a mismatch between the skills possessed by today’s workers and the demands of today’s consumers. Some (but not all) proponents of the structural unemployment theory espouse the full-blown Austrian economics theory of the business cycle, the malinvestment theory, whereby any attempt to mitigate unemployment must perversely aggravate unemployment.

(There’s a funny anecdote about the Austrian theory of the Great Depression, told by Joan Robinson in 1971.)

I very well remember Hayek’s visit to Cambridge [in 1931] on his way to the London School [of Economics]. He expounded his theory and covered the blackboard with his triangles. … The general tendency was to show that the slump was caused by inflation. R.F. Kahn … asked in a puzzled tone, ‘Is it  your view that if I went out tomorrow and bought a new overcoat, that would increase unemployment?’ ‘Yes,’ said Hayek. ‘But,’ pointing to his triangles on the board, ‘it would take a very long mathematical argument to explain why.’

The structural unemployment argument has many problems of its own. For one thing, it quickly becomes tautological – the very fact of prolonged unemployment is seized on as proof of a skills-demand mismatch.

Yet surely there is something to this point in our current context. The best section of Stiglitz’s article is his exposition of the pressure on less-skilled labor in the years before the 2008 financial crisis.

That seeming golden age of 2007 was far from a paradise. Yes, America had many things about which it could be proud. Companies in the information-technology field were at the leading edge of a revolution. But incomes for most working Americans still hadn’t returned to their levels prior to the previous recession. The American standard of living was sustained only by rising debt—debt so large that the U.S. savings rate had dropped to near zero. And “zero” doesn’t really tell the story. Because the rich have always been able to save a significant percentage of their income, putting them in the positive column, an average rate of close to zero means that everyone else must be in negative numbers. (Here’s the reality: in the years leading up to the recession, according to research done by my Columbia University colleague Bruce Greenwald, the bottom 80 percent of the American population had been spending around 110 percent of its income.) What made this level of indebtedness possible was the housing bubble ….

Surely this is right? Before the crisis, very large numbers of Americans lived in a world that seemed to have less and less demand for what they could do. American skill levels – even basic literacy – seem to increasingly inadequate to generate rising incomes. Thanks in large part to misguided immigration policies, skills in America seem to be in multi-generational outright decline.

Higher aggregate demand may find some kind of work for such Americans to do. The longer-term outlook is not so good however when we disaggregate, as those strange bedfellows Stiglitz and Hayek urge us to do. Stiglitz is no conservative, of course, and he’s not bashful about government spending. But he does share one of Hayek’s most valuable insight: the insight that “aggregate demand” is an aggregation of demands for particular things.

[J]ust as there cannot be a uniform price for all kinds of labour, an equality of demand and supply for labour in general cannot be secured by managing aggregate demand.  The volume of employment depends on the correspondence of demand and supply in each sector of the economy, and therefore on the wage structure and the distribution of demand between the sectors.

The particular labor of most Americans was decreasingly well-paid in the last economic expansion. When recovery comes, what will it look like for the large majority of American wage-earners? A future that offers most Americans higher employment but only at declining wages represents something more than an economic problem.


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13 Comments so far ↓

  • nhthinker

    Frum is seemingly coming around.
    In aggregate, the US has spent too much on consumption and not enough on future efficiency and productivity.
    Continuing to overspend, primarily on consumption, just digs the hole deeper.

    It was thought that more housing and more financial instruments were the appropriate way to grow the American economy. (It allows us to increase domestic “productivity” without having to compete with global labor). Larger homes and larger cars were an American luxury- the idea that we could put more financial incompetent people in large homes and large cars was culturally idiotic.

    “A future that offers most Americans higher employment but only at declining wages represents something more than an economic problem.”

    We are still unwinding those poor decisions and we have not come up with a realistic alternative to grow the economy or make our workers more skilled at lower wages to be more globally competitive. It is an illusion that America can consume more than it produces indefinitely…once that is recognized by enough Americans the economy will lurch to less consumption out of necessity-.

    While Frum wishes for a magic bullet that will allow continued over-consumption as compared to production at a disaggregated level, it is not likely to be a wish that is ever granted.

  • jg bennet

    A common term in much of the world for what Hayek espoused is “NEOLIBERALISM”. A British scholar, Samuel Brittan, concluded in 2010, “Hayek’s book [The Constitution of Liberty] is still probably the most comprehensive statement of the underlying ideas of the moderate free market philosophy espoused by NEOLIBERALS.” IT Says it right here

    Free Trade job loss map

    2011 Trade Deficit as of October 2011 negative 604 billion!!


    #1 According to the U.S. Department of Commerce, the U.S. trade deficit for the month of October 2011 was $57.6 billion.
    #2 The United States has had a negative trade balance every single yearsince 1976.
    #3 Between December 2000 and December 2010, the U.S. ran a total trade deficit of 6.1 trillion dollars.
    #4 The U.S. trade deficit with China causes unemployment and lower revenue. This is money that is not going to support U.S. businesses and U.S. workers. If that money was actually going to our businesses and to our workers it would increase tax revenues.
    #5 Since China entered the WTO in 2001, the U.S. trade deficit with China has grown by an average of 18% per year.
    #6 During 2010, we spent $365 billion on goods and services from China while they only spent $92 billion on goods and services from us.
    #7 Since 2005, Americans have gobbled up Chinese products and services totaling $1.1 trillion, but the Chinese have only spent $272 billion on American goods and services.
    #8 The U.S. trade deficit with China in 2010 was 27 times larger than it was back in 1990.
    #9 According to a recent report from the Economic Policy Institute, between 2001 and 2008 the United States lost 2.4 million jobs due to the growing trade deficit with China. Every single state in America experienced a net job loss due to our trade deficit with China during that time period.
    #10 The United States has lost an average of 50,000 manufacturing jobs per month since China joined the World Trade Organization in 2001.


    Dollar drains are trade deficits that result when imports exceed exports in monetary terms.

    For instance, a country that imports more goods from overseas than it exports to foreign countries is, in effect, sending its currency overseas in return for those goods. This can lead to a shortage of currency in circulation at home, creating a tight money situation in which companies have difficulty obtaining the loans and funds they need to grow or to continue operations. Consumers feel the effects of dollar drains as well, since they cannot obtain loans for the purchase of property or for other immediate needs; a shortage of currency in the home economy affects every aspect of that economy.


    A ready supply of circulating money is necessary for economies to engage in setting monetary policies; loosening or tightening the supply of money in the market is one of the most important tools government has in determining fiscal policy. When there is a shortage of currency in the economy, the government cannot exercise this control over the economic situation. If the dollar drain continues for a significant length of time, the government may be forced to curtail foreign purchases or to borrow heavily from other countries in order to meet its obligations. This can lead to inflation and devaluation of the currency on the international FOREX market.

    **Most analysts believe the long-term solution to dollar drain is to promote and encourage consumers to purchase goods manufactured in their own country where possible; this can stem the flow of currency out of the country and lessen the trade differential over time.**

    Neoliberals do all they can to avoid speaking ill of their god the free market & like, economic jihadis, they faithfully strap on an Armini vest and shout “God/free market is good and proceed to commit industrial suicide. “Mulla is Good Mulla is Good!”

    In the newspapers that supported the Republican party & Lincoln free trade was considered industrial suicide.

    • Sinan

      Be careful, free trade is still one of the ideological pillars of modern economic theory. If they ever reviewed the facts in the way you just summarized, they might have to rethink their ideas. As Hamilton said in the 1790s in his report on manufactures…well, first you take care of your own nation and then maybe start thinking about other economies….

      • jg bennet

        Here is the great economist Paul Samuelson on how we should rethink free trade. It is an audio interview of him and well worth listening to which may stir a few interesting comments.

        Samuelson spent most of his life promoting unqualified free trade, he came close in his declining years to admitting he was wrong. In a paper in 2004, he suggested that there might be some circumstances in which a nation did not benefit from free trade. His analysis was carefully hedged; but, given his unique status not only as a textbook writer but as the first American economist to win a Nobel Prize, the effect on the faithful was as if the pope had conceded there might not be a God after all.

        • beowulf

          Full employment economic models assume balanced trade just as free trade economic models assume full employment.

          Our problem is off the map of most economists– we have neither full employment nor balanced trade. For the economy to recover, our options are to either run up the budget deficit or bring down the trade deficit. Wynne Godley knew the score:

          “The budget balance is equal to the difference between the government’s receipts and outlays, but it is also equal, by definition, to the sum of private net saving (personal and corporate combined) plus the balance of payments deficit.
          If the private sector decides to save more, the government has no choice but to allow its budget deficit to rise unless it is prepared to sacrifice full employment; the same thing applies if uncorrected trends in foreign trade cause the balance of payments deficit to increase.”

    • nhthinker

      The author Joseph Stiglitz has been sounding the alarm on trade imbalances for many years…

      The contention that Hayek thought it was appropriate to use Keynesian government spending to support overconsumption that includes a significant trade imbalance as has been happening in the US, is just plain nuts!

  • Hunter1

    Frum is training his sights on a deeper problem, as much sociological as economic — viz., the consequences of globalization, combined with the conservative/corporate campaign to de-regulate and de-unionize, in driving down wages among the less skilled as they compete for fewer and fewer jobs. As the floor slips beneath their feet, wages of skilled and professional workers will likewise face sharp downward pressure. Where will that leave us as a society? We see that conservatives are pursuing – and winning – the battle to de-legitimize the core vision of the American social compact: that we are bound together in a common destiny. Thus, we can be sure that the assaults on the social safety net will intensify. Our politics will, perforce, become even nastier, if that is possible, as larger segments of the population grow poorer. And it is very hard to see how this momentum can be stopped, let alone reversed, over the next decade or two. Further polarization of American society is what Frum fears most. He’s not wrong. Economic insecurity leads to truly terrible social movements.

    • Emma

      Right on point. I suspect that Frum’s private views are becoming more apocalyptic, and we are beginning to see those views leak out into his public statements. Over the long-run, democratic institutions cannot survive in a highly polarized society. Whether left or right, we should all tremble at the alternative.

  • Ludwig von Mises

    “It’s elementary my dear Watson,”

    Borrow-to-spend economies fueled by a fiat currency which is issued by a central banking cartel always end up in failure. Yes, some economists have learned through experience that it takes longer than they had expected for financial critical-mass to be achieved, because of all the various muddle-through-economic schemes that the banksters have come up with including but not limited to flooding the globe with digital/paper money which has no intrinsic collateral to back it up—not to mention the 1.5 quadrillion uncollateralized derivatives market, the over hypothecated commodities market and the insanely leveraged stock and bond markets.

    The paper/digital markets have become larger than the real economy. In the end; however, the can kickers will run out of road. If you don’t think so, then I have a tulip that I’ll be happy to sell you. It’ll be worth more than those derivatives when that market finally goes to ZERO. And if you think that the housing bubble was breath-taking to watch, then, boy, are you going to love it when the sovereign debt bubble finally finds the pin that its been searching for all these years: POP! Worldwide inflationary depression. I know, I know, you think I’m trying to scare you, right? Nope, I’m actually holding back by not telling you the best parts of all the future fun and games that are in store for amerika.

    Yes, amerika may, indeed, have some road left, but the “Road To Serfdom” always leads to a financial crisis, first. Can you say, “banking holiday?” Can you say, “a currency devaluation of 40% over a weekend?” Can you say, “F.A. Hayek was right?”

    If you can’t say all of the above now, then you’ll say it sometime later on…… and remember, I’m not telling you the best part, so go ask Frum.

    The upside to all of this turmoil is that it will be fun to watch the Neocons running for cover as we classical liberals point out to the enraged mobs which way you phony crooks are headed.

    Frum, undoubtedly, will have to be running at a break-neck pace of heels over head if he wants to keep from getting a pitch fork up his *ss when the sh*t finally hits the fan.

  • ottovbvs

    I don’t find anything particularly surprising that there might be a measure of agreement between Stiglitz and Hayek. After all Keynes and Hayek agreed far more than the generally ill informed right wing polemicists who constantly invoke their names here begin to understand. And that’s quite apart from their joint fire watching activities. There’s probably a bit of truth in Stiglitz’s thesis about structural changes in the US economy playing some role in the great depression but like other lesser reasons (protection) it was probably more exacerbatory than fundamental. At bottom the great depression was basically monetary in origin as both Keynes and Friedman agreed. As to todays problem the notion that our unemployment problems are structural has been conclusively disproved. This is a red herring argument dreamed up by conservatives to distract attention from the real nature of our problems.

  • beowulf

    “Does he think a system of social insurance is a harmful form of planning?
    Hayek: “Certainly not a system of social insurance as such, not even with the government helping to organize it. The only point where the problem can arise is how far to make it compulsory. . . .”
    Does he support a guaranteed minimum income?
    Hayek: “I have always said that I am in favor of a minimum income for every person in the country.”
    Does he believe that America needs a central bank?
    Hayek: “That the monetary system must be under central control has never, to my mind, been denied by any sensible person.” ”

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