Sunday, August 26, 2012

I don't like Hayek vs Keynes

I'm pro Hayek, pro Keynes and very much Anti Friedman. I see an awful lot of discussion which is Hayek vs Keynes and I don't quite understand it. Certainly, these two great thinkers had disagreements and their approaches (one top down, the other more bottom up) were different but their models are not mutually exclusive. It's the mix of Hayek, Keynes and Schumpeter which has always made economic sense to me.

To explain why I feel this way, I'll use four graphs. The first two examine the process of evolution as opposed to diffusion, the third is an examination of value chain vs state of evolution and the last is one the cycle itself.

As activities commoditise they can enable higher order systems to appear e.g. electricity begets radio, computing, Hollywood whereas nuts and bolts beget machines which in turn beget generators etc. These higher order system are where new value is generated and hence we see a flow of capital from past industries (which are commoditising) to new industries (which are being created).

The process of evolution is not however smooth as companies build inertia to change (due to past success), which is why when an activity commoditises it's often associated with new entrants into the market and disruption of existing players.

Figure 1 - Evolution & Diffusion

Figure 2 - The Process of Evolution

Figure 3 - Evolution vs Value Chain

The above can be simplified to a cycle of commoditisation enabling the genesis of new activities (which we often call innovation but there's problems with that specific term). The shift from product to commodity and utility services and the associated inertia barriers to change mark a phase change in an industrial ecosystem. We go from a relatively peaceful state of competition with sustaining change exceeding disruptive to a fight for survival, with new entrants and disruptive change exceeding sustaining. We literally go from peace to war.

Of course, the explosion of new higher order systems (due to componentisation effects) create a rapid growth of new industries (genesis) and a time of wonder and amazement. This cycle of wonder, peace, war repeats throughout history both in specific industries and at the macro economic scale through Kondratiev waves or what we more commonly called ages.

The age of electricity started not with the genesis of electricity provision (which can be traced back to  Parthian times) but with Westinghouse & Tesla and utility provision of modern day electricity supply. This disrupted past industries (war), created an explosion of wondrous new activities built upon this component supply (growth) and eventually the new giants of industry settled down (peace). I've created a simplified map of this onto figure 4 to show the cycle (ignoring the value chain).

Figure 4 - Cycle of Change.

So, now to Schumpeter, Hayek and Keynes. The overall cycle describes concepts in Schumpeter's work on business cycles. During the growth and peace cycles, the application of Hayek's policies seem the most logical - limiting excessive growth in credit and the impact of central bank policies such as low interest rates which encourage speculation, lower savings and bubbles etc.

However during the war phase (where much of past industry is suffering inertia often compounded by the demands of financial community) then direct investment in new industries and the stimulation of demand - a Keynesian approach - seems a more effective way of balancing this market change.

But this is no different to the issue of managing activities which due to changing characteristics vary from agile development (in the genesis phase where they are more chaotic) to six sigma (in the commodity phase where they are more linear). There is no one size fits all policy and instead you need to use the right policies for the right stage of evolution.

This is why I don't get the whole Hayek vs Keynes debate - which noticeably is a very US based discussion and occurs to a much lesser extent in Europe. The debate is as simplistic as the whole Agile vs Six Sigma, SQL vs NoSQL, Push vs Pull, Hierarchical vs Networked debates of one size fits all.

The answer always seems to be both are right, you just need to know when to use each. So, I'm pro Keynes and Pro Hayek as there is both a time to steer markets and a time to set them free. Furthermore, since markets evolve at different rates then you need to use both approaches at the micro level i.e. one market you let run free whilst in another you can be busily investing and stimulating in at the same time.

Does this make me Pro Friedman? Absolutely not. I'm Anti Friedman and I have little time for the Big Dogma of Monetarist theory / Neoliberals which has been created in his image. I do understand the political reasoning of supply side fiddling with QE because it helps maintain the illusion of house and stock prices (through cheap foreign capital) but continues the stagnation of our real internal industry and society. It is not worth it.

We need to direct our industries to overcome their inertia and that requires direct investment along with stimulation of demand. I find scant evidence that the financial community can resolve this in a timely fashion as they have inertia of their own. Instead, China's huge investments (at this moment in time) in internet technology, renewable energies and manufacturing technologies such as 3D printing & printed electronics suggests an alternative way. They seem to know how to play this game and they're aiming to grab the future.

We should have buried the monetarist dogma long ago and started actually playing the game. The whole Keynes vs Hayek debate feels like just another artificial campaign to maintain the status quo and all the suffering that comes from it (social inequality, lack of true mobility etc). I, for one, don't like it.


Russ Nelson said...

I'm guessing that you haven't read Hayek's Nobel acceptance speech on the pretense of knowledge, then. How can you possibly say that you are pro-Hayek??

swardley said...

I'm very aware of Hayek's speech but as right as it is, it is as flawed for the same reason. The problem is time.

Most economic hypothesis attempt to predict over time but we're talking about the interactions of a complex set of components and events, many of which are uncertain. The interaction of these make prediction over time impossible, it acts as an uncertainty barrier we can't see through.

So, to my point there is a time to steer the market and a time to set it free ... the obvious question is when is that time? The answer is, you can't know with certainty.

Now look at my evolution graph on figure 2. There is no time axis. This is because you can map evolution but only if you abolish the concept of time and map it instead over user and supply competition (ubiquity vs certainty).

The more evolved something is, the more accurately we can state where it is on the curve (because it has become more certain). Time is simply where it was at different stages of evolution i.e. nuts and bolts to 2000 yrs to travel that curve whilst computing took about 60 yrs.

Using the graph you can only truly map evolution backwards over time (i.e. once something has become a commodity, you can say where it was) and never forwards over time. The uncertainty barrier of time remains intact.

But, we can guesstimate where something is likely to be on the curve, so we can guesstimate which part of the cycle we're likely to be in (peace, war or build) and therefore what policies and approaches should be chosen.

So, whilst we can't predict over time (i.e. this policy is suitable for this specific time), we can say this method (i.e. steer or set free) is more likely to be appropriate now.

The problem is and always has been prediction over time. No amount of data will ever get you past this problem, it's inherent in the axis of figure 2.

So Hayek is right to have said we cannot predict as per the physical sciences due to the complex interactions of the market for which we have an incomplete picture. Even if we had a complete picture we still couldn't do it, over time.

But, he was also wrong on the same point because we can make guesstimates to where we are and use this to determine what is likely to be the best course of action.

Now the counter should be that the market is best to make those guesstimates. Alas the market has inertia to change and is too focused on the fools errand of trying to predict over time (from interest rates to stock prices to ... you name it).

I'm very much Pro Hayek but also Pro Keynes in terms of their policies. Deciding which one to use is something which can be estimated just not predicted over time.

Time, has always been the problem.

swardley said...

So, like any gardener we can learn when to prune, when to feed, when to treat and when to harvest.

However, just like any gardener, we can guesstimate when this will be, we can observe and determine it needs to happen now but we can't predict over time with certainty.

Hyak's arguments is that much economic hypothesis is akin to a gardener trying to predict specific times when they will need to treat the crop for some pest infection.

But that fallacy does not mean the gardner has to be blind and cannot have an idea of what will happen, or the seasons of change or how the crop can be best managed - just not when in detail.

swardley said...

Oh, and like any gardener ... we also know when to leave it alone to do its own thing within certain boundaries.

A good gardener knows when to stimulate and when to stand back. They are both pro Hayek and pro Keynes.

Shannon Williams said...

I think you are taking a very reasoned approach, but unfortunately it assumes a logical Gardner capable of making rational decisions. In the political world to exercise the type of power that could impact markets and demand requires political power that only exists for brief moments in democracies. In general political parties and movements struggle to gain loyalty as the reasonable Gardner. Much better to promote a simple view, "Warer every day" or "we can't afford to water" as it is easier to sell. At some level, what this leads to is reaction based, primarily blind gardening that happens on a much to infrequent basis. A benevolent dictator might be the solution, but monetary policy is probably a decent trade off for political freedom.

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