How Hayek Helped Thwart Economic Statism

The Colorado Freedom Report:  An independent journal of politics and culture.

The Colorado Freedom

How Hayek Helped Thwart Economic Statism

by Ari Armstrong, February 19, 2006

The Mont Pelerin Society. An organization so free market that Ludwig von Mises once told a group that included Milton Friedman, "You're all a bunch of socialists!"

Commanding Heights, a documentary (based on a book) released by PBS, essentially tells the story of how Friedrich von Hayek witnessed the rise of state controls over the economy -- in virulent forms in central and eastern Europe and in less ambitious forms in England and the U.S. as guided by John Maynard Keynes -- and then finally saw a renewal of free-market ideas as implemented by Margaret Thatcher and (to an extent) Ronald Reagan. Here I review only the first third of the series.

The video tells the story of how Hayek learned the ideas of Mises, wrote The Road to Serfdom, suffered decades of professional alienation, and then won the Nobel Prize and witnessed the resurgence of free-market ideas.

Earlier this month, on February 15, I spent several hours at the home of Jerry Van Sickle in Boulder to reproduce hundreds of letters and documents that belonged to his father, John. (I also scanned some of these documents last year.) Among the folders is one titled, "Mont Pelerin." John Van Sickle, an American economist who studied under Mises while in Europe between the wars, was a member. And his letters contain notes to and from Mises, Hayek, Friedman, and other free-market economists of the 20th century. Jerry graciously agreed to release this note his father sent to Hayek (or "Fritz"):

Commanding Heights is required viewing for the class, Free People, Free Markets: The Foundations of Liberty. The class, associated with the Independence Institute, is offered for college credit through the University of Colorado at Colorado Springs. The general public may attend, without getting college credit, at a reduced rate (and apparently my fee has been waved).

Commanding Heights (Heights hereafter) gets its name from the large industries of an economy, and the debate over whether those industries should be controlled by the state or by private owners. The video does a good job chronicling the basic history and offering interviews by 20th Century leaders such as Thatcher, Friedman, Hayek, and Winston Churchill -- as well as their opponents. (Friedman supplied the quote by Mises used above.)

Unfortunately, the video suffers a variety of defects such that it will tend to mislead those not already familiar with the basic issues. So the video is worth watching, but only as supplementary information, not a primary source. (By the way, the entire transcript is available through PBS.)

Heights makes complete hash of such central concepts as "capitalism" and "inflation." It offers the sequence of historical events, but it often offers bogus interpretations of those events. Thus, the video improperly concedes much of the debate to the critics of capitalism.

For example, Episode One, Chapter 4 is titled, "A Capitalist Collapse." The four subsections are "German hyperinflation," "American boom and bust," "Fascism takes hold in Europe," and "Can Keynes save capitalism?" But hyperinflation and the Great Depression were the direct consequences of statism, not capitalism. Fascism as well the state controls favored by Keynes (though different in degree) are diametrically opposed to capitalism. So how do those things indicate a "capitalist collapse?" The socialists are the ones who wrongly blamed capitalism for the failures of state interventionism.

The video does claim that government intervention "made things worse" during the Great Depression, but it offers no details or explanations.

Heights asserts that the stock-market crash of 1929 was the result of a "bubble" from irrational investing. In The Capitalist Manifesto, philosopher Andrew Bernstein rejects the "bubble" theory. He writes, "Contrary to popular belief, including that of many economists, the prosperity of the 1920s was genuine, not a chimera built on air. The decade was a period of extraordinary economic growth... The spectacular stock market rise accurately reflected this productivity" (pages 376-7).

Bernstein continues, "What factor(s) then caused the shattering crash of 1929? In a phrase: growing statism. For one thing, President Hoover supported a tariff proposal that by the summer of 1929 had grown ominously into the Smoot-Hawley Tariff Act: duties would be imposed on thousands of imported items of all kinds. The American economic growth rate peaked in July; stock prices in September. On October 21st, an amendment to limit tariffs to agricultural products was defeated in the Senate. On October 24th, the stock market suffered its first one-day crash. On October 29th, amid rumors that Hoover would not veto the Smoot-Hawley Bill, stock prices crashed even further" (page 378). This protectionism sparked global restraints of trade. (Bernstein references Richard Salsman, Jim Powell, Gene Smiley, and Burton Folsom.)

The "bubble" theory is mere prejudice. But for Heights to not even mention the Smoot-Hawley Tarriff is the grossest of errors.

The Austrians, it should be noted, posit yet a third theory for the stock-market crash. In For a New Liberty, Murray Rothbard writes of "the tragically neglected 'Austrian School' of economics and its theory of the money and business cycle, developed in Austria by Ludwig von Mises and his follower Friedrich A. Hayek and brought to the London School of Economics by Hayek in the early 1930s... Hayek's Austrian business cycle... alone offered a satisfactory explanation of the Great Depression of the 1930s" (page 173). Rothbard explains the core of the theory: "Bank credit expansion [in the 20th Century a result of the Federal Reserve] not only raises prices, it also artificially lowers the rate of interest, and thereby sends misleading signals to businessmen, causing them to make unsound and uneconomic investments" (page 187).

So Bernstein and the Austrians disagree about what led to the stock-market expansion of the '20s, but their debate is about the relative harms of types of state intervention that led to the crash and depression. (It's also possible that both theories explain part of the phenomenon.) But all free-market economists condemn the tariffs and recognize their devastating impact during the Great Depression.

Bernstein also describes other ways in which statism contributed to the Great Depression. Prior to the Depression, the Federal Reserve (a statist institution) intentionally manipulated interest rates to reduce funds available for investment (pages 378-9). (So Bernstein at least agrees with the Austrians that state manipulation of the money supply is bad.) State governments forcibly protected small, non-diversified banks from competition (page 380). "The Hoover administration... applied pressure on business leaders to keep prices and wages high -- at exactly the time when they needed to fall..." (page 380). "Hoover pushed burdensome tax increases on the country in 1932... [which] left that much less money available for investment in productive enterprise. Hoover significantly increased government spending for social welfare programs..." (page 381). Then, of course, the "interventionist schemes of the Roosevelt administration were an unmitigated disaster" (page 382), with its high tax burdens and odious, pervasive economic controls.

Another of Heights's big errors is to constantly talk about state economic intervention as "planning," and to treat "market forces" as some sort of mysterious energy. Bernstein again offers a nice counter: "Capitalism is the only system of rational planning, which is impossible under socialism. This is a critical point in understanding the specifically economic cause of capitalism's prosperity and socialism's penury. Planning takes place every day under capitalism on the part of millions of thinking individuals" (page 342).

Thus, Heights gives far too much credit to the productivity of socialism. Heights treats as a primary Hayek's argument that "central planning" leads to a powerful police state. But the choice is not between socialist "planning" that tends to become brutal, on one hand, and a chaotic but free capitalist system on the other hand. Capitalism is both the system of rational and productive economic planning (by individuals who interact voluntarily) and of individual rights. As Bernstein eloquently argues, it is precisely because capitalism rests on individual rights that protect the freedom to think that capitalism is enormously productive.

So in many respects Heights completely misses the point. (Its other errors generally are similar to the ones discussed or related to them.) The series is interesting for its relation of basic historical events and for its interviews. Unfortunately, it is also a case study in how not to make the case for capitalism.

The Colorado Freedom