from Peter Radford
Wow. I never realized I was a chapter twelve kind of guy. Less so a part one guy. Who knew?
I have come to this realization as a result of reading Paul Krugman’s speech at a recent conference commemorating the 75th anniversary of Keynes great General Theory.
In general terms: chapter twelve is where he expounds on uncertainty. Part one is mainly taken up with all the arguments about aggregate demand and the refutation of Say’s Law. Good stuff all round. Great stuff even. But I am absolutely a chapter twelve guy.
This also came to me while I was reading a few articles about Hayek, who, as you all know, didn’t agree with Keynes at all. Their argument was public and long.
Hayek was one of those many people back in the 1930′s who was desperate to create arguments to rebut the legitimacy of socialism. Those were heady days of intellectual debate. The Great Depression cast a very long shadow over the benefits of capitalism, and the Soviet Union and Fascist Germany were very much alive as alternative methods of economic and political life. Hayek was a refugee from repression and discrimination in central Europe and saw Keynesian thinking as opening the door to the evils of government tyranny.
So he, and others, created an alternative. They gave an Austrian twist to classical economics, by injecting it with large doses of libertarian politics. Hayek attacked the viability of centralized planning – socialism – by arguing that a central planner could not possibly have access to all the necessary knowledge needed to elaborate and then execute a plan for an entire economy. In order to defend this position he had to engage in word games – he was a fan of Wittgenstein after all. In particular he tried to differentiate between a meta-system he called the “catallaxy” , and mere “economies” which he regarded as much smaller, and subcomponent, entities. He admitted that economies – things like business firms – could be centrally planned, but he argued that they drew their viability from the catallaxy which could not be. It was too complex and intractable for rational analysis. It was subject to the magic of emergence that created apparent order from the equally apparent chaos below. Firms existed in this larger system, and it could be centrally planned because of their relatively small scale. But nothing could be planned at the higher expansive level. It was all too much. Far better, Hayek argued, to allow the system to works it magic, than run the risk of interference, especially since that interference inevitably would be associated with intrusion into private liberties. The cost of that lost liberty was always going to be more than any gain from central planning of the system.
The problem with this is that Hayek, in his desperation to justify market magic, totally ignores the central subject of chapter twelve: uncertainty. The very reason that firms exist is that the production process is so riddled with uncertainties – time lags, asset specificities, agency issues, and so on – that it is necessary to enclose it within its own space away from the market. In other words knowledge is insufficient within the broader market to accomplish production. Coordination won’t happen out there because uncertainty disrupts and enervates every process. The coordination of most production has to be centrally planned in order to offset this lack of knowledge. So a firm’s strategic plan is a substitute for having complete knowledge. It fills out the gaps created by uncertainty by making a hypothesis about the key unknowns. With those gaps suitably filled in, production can proceed. Of course the plan can go awry. The hypothesis can be falsified. In which case the firm fails to make a profit and either goes bankrupt or makes a new plan. Markets are simply not up to the task of containing our modern production processes without an intermediate layer. That layer is what we call the business firm. Firms exist because of the insufficiency of knowledge in the meta-system. The market can exist because firms take care of the complex stuff. The catallaxy draws its legitimacy from what is centrally planned. Not the other way round.
Either way the existence of this epistemic road block undermines the classical market magic argument. It undoes Hayek. The implication of uncertainty is that a modern economy depends, in large measure, on central planning. To the extent that enough space is enclosed and protected from the incapacity of the market, we can rely on the external market – Hayek’s meta-system – to take care of the easier task of matching supply and demand.
Oh. Wait. Uncertainty intrudes there too.
Which is what Keynes was trying to explain in chapter twelve.
And if that is so, we can toss out the classical dogma of markets, we can ignore the notion that government interference is always bad, and we must acknowledge that markets fail with regularity. Indeed, we should accept that, as modern production becomes ever more complex, markets become ever more brittle. Which is why the modern economic landscape is littered with behemoth centrally planned economies called corporations.
In short, we should expect markets to fail and act accordingly. We should shore them up with all sots of structural aids like institutions and so on.
Hayek’s vision, and that of the subsequent neoclassical theorists is simply not relevant in a modern economy. It ignores the complexity of modernity and tries to recapture the workings of a pre-industrial economy and then impose them on us. It doesn’t work. It hasn’t for a hundred years or more. If it ever did.
What it does do well is to buttress a certain kind of political view. It adds legitimacy to a more libertarian ideology. Which was the purpose. As economics it fails.
Anyway: chapter twelve. Who knew?