Planning vs. Freedom, Black vs. White

An old university buddy of mine sent me a cryptic note yesterday that only an economist would understand:

“Keynes vs. Hayek 2008?”

He was referring to the pending government bailout of financial institutions, which economist Friedrich von Hayek would surely denounce as socialist and anti-freedom. John Maynard Keynes, on the other hand, would surely favor the bailout. He reasoned that the economic instability brought on by a prolonged recession could birth another Hitler or Stalin via social upheaval. Such an outcome would be infinitely more damaging than a government bailout worth a measly 1/20th of our annual GDP.

Keynes’ philosophy of planning and action to circumvent financial crises was definitely in favor among politicians in the 20th century. Friedrich von Hayek’s laissez-faire economics had its tradition carried on by conservative economists such as Milton Friedman, and they became became popular among libertarian-conservatives throughout the world in the late 20th century and remain popular today.

Commentators have compared this battle of ideas — action versus inaction — to an ideological war in which we will see one victor. The truth is, neither idea is correct. The world is not always so black and white, right or wrong. The ideal solution lies somewhere between the two extremes, and not exclusively in one or the other.

Every once in a while, the market does require government action to circumvent recession. However, these actions need to be measured so as to only support the market system, and not overly interfere with the market’s function (in this instance, the market’s essential function is to punish banks and investors for taking undue risk, and punish homeowners for buying more home than they could afford). This process must play out in order to revive stability in the long term. If we don’t change the system, we’ll be struck again and again by the same problems further in the future.

The current government bailout under consideration is too large, and places too much emphasis on health of the banks. Some of these banks SHOULD fail!

The Treasury is listening to Keynes, and pretending Hayek doesn’t exist. Why don’t you listen to both dead economists, Mr. Paulson?