Fifty years ago, on October 9, 1974, what has become known as the Nobel Prize in Economics was announced for that year in Stockholm, Sweden. It was a joint award to Swedish economist Gunnar Myrdal (1898–1987) and Austrian economist Friedrich A. Hayek (1899–1992). Many in the economics profession would not have been particularly surprised by Myrdal being declared a recipient. After all, most of the economists awarded the economics prize up to that point had been developers of the theories or modeling tools for either government central planning or government intervention, including Jan Tinbergen, Paul Samuelson, Simon Kuznets, and Wassily Leontief.
While Myrdal had started as a monetary theorist in the 1920s and early 1930s, he was an active member of the Swedish Social Democrat Party for most of the 1930s and 1940s, even serving as the Minister of Commerce and Industry in a socialist government between 1945 and 1947; after leaving the government, he worked for the United Nations for 10 years. But he was most well-known for An American Dilemma (1944), a study of race relations in the United States. He had been a strong advocate of interventionist and welfare state policies during the interwar years, and in the post–World War II era, he proposed the extension of national welfare states to a global welfare state charged with international redistribution of income and wealth.
Gunnar Myrdal on planning and global redistribution
It was not too surprising, therefore, that in Myrdal’s Nobel Lecture “The Equality Issue in World Development,” he called for massively increasing foreign aid from industrially developed countries in North America and Western Europe to the poorer “developing nations” in Asia, Africa, and Latin America. He chastised the giving of such aid on the basis of the “national interests” of the giving governments. Instead, governments in the West should fight poverty in these other parts of the world as an altruistic moral “responsibility” to assure everyone’s right “to be free from hunger and malnutrition.”
Since governments have no money or goods to redistribute other than what they tax from their own citizens, the implication was for a compulsory moral responsibility for income earners in the West to reduce their standards of living for the benefit of others. In fact, Myrdal called for bringing down the “lavish food consumption” of people in the West. At a minimum, “the average American” should “reduce his consumption of beef, pork and poultry by 10 percent.” Thus, it was not only on the basis of altruism; Myrdal said it would be good for Americans to reduce their consumption of such meats for their own health reasons. So government-imposed compulsory sacrifice of some of your own standard of living ended up being for your own good!
Standards and qualities of life should continue to improve in the West, said Myrdal, but “It should be directed differently, and in a planned way, to serve our real interest in a better way…. Such planning could help us be more successful in solving the internal equality problems and would at the same time provide a much larger aid to development in underdeveloped countries.” A legitimate task for economists, in Myrdal’s view, was to draw inferences and policy implications “from the value premises of what is in people’s true interests.” Only by “radical changes in the consumption patterns in the rich countries” could we bring about “a new world economic order.”
What the world needed, Myrdal declared, was “rational national planning for curtailment of consumption and production for home consumption, of such commodities that are less necessary and often even harmful for health and happiness, which would also help to …release so many resources for egalitarian reforms within countries and between countries.” Governments had to break people’s misguided “consumption habits,” and to do it “in their own interest.”
Here was the arrogance and hubris of the social engineer, the political paternalist, the central planner who knows better what is good for you and, indeed, everyone else around the entire globe. Myrdal presumed to know how much you should eat and what types of food — for your own good. He knew who needed and desired what, taking just the right amounts from the Peters in the West so the political paternalists in government could transfer it to the Pauls in other parts of the world.
Many economists asked: “Who is Hayek?”
What a stark contrast was Myrdal’s corecipient of the Nobel Prize in 1974 in terms of both notoriety and policy perspectives. Fifty years ago, many economists and policy pundits wondered, “Who is Friedrich A. Hayek?” Some macroeconomists may have vaguely recalled the name as someone who in the 1930s had been a business cycle theorist before John Maynard Keynes had given the world his revolutionary “new economics” of activist fiscal and monetary policies to overcome the economic depressions caused by the supposed inherent instabilities of “capitalism.”
Others may have remembered that during the Second World War, Hayek had written The Road to Serfdom (1944), a book that many mainstream economists likely considered to be an “extremist” polemic against wise government policies out of an unreasonable fear of “socialism,” assuming they even knew anything about the content of Hayek’s book. Other than that, Hayek was off the radar screen of virtually the entire economics profession.
After the Second World War, he had shifted his interests and most of his writings to the political and social philosophy of (classical) liberalism concerning the meaning of liberty and the institutions most likely to sustain and cultivate a free and prosperous society. In the eyes of many of those who might have known about these later works, he was (as one critic said) a “dinosaur” from a long-gone era of free-market and limited-government ideas and policies.
For some of us in October 1974 who were already deeply interested in Austrian economics and devoted to the classical liberal ideal of personal and economic liberty and freedom of association both inside and outside of the marketplace, Hayek receiving the Nobel Prize was an unexpected and exhilarating surprise. None of my undergraduate economics professors at California State University, Sacramento, could understand my excitement. Of course, they were all textbook Keynesians or Stalinist Marxists, so it was not too surprising that none of them shared my excitement.
The selection of Myrdal for the Nobel Prize they could understand since he was a Keynesian and a socialist and therefore “obviously” deserving of the honor. But Hayek? He wasn’t even a professional economist anymore, and his free-market philosophy was “clearly” beyond the pale of respectability or seriousness. My professors shook they heads in disbelief and frustration at my enthusiasm. How could they have failed so miserably in their classes in getting me to see the collectivist and interventionist truth? They just put me down as a “lost cause.”
Hayek and Keynes in the 1930s
In fact, Hayek was one of the most profound and original economists and social philosophers of his time. Born in Vienna in the old Austro-Hungarian Empire, he fought in World War I, earned two doctoral degrees at the University of Vienna (law and political science), and with the assistance of his mentor, Ludwig von Mises, became the first director of the Austrian Institute for Business Cycle Research in 1927, at the age of 28.
Hayek burst onto the international scene through a series of lectures he delivered at the London School of Economics in January 1931 that were shortly after published as Prices and Production, with an English translation of his 1929 book, Monetary Theory and the Trade Cycle, appearing in 1933. He was offered a visiting position at the LSE that year, which later became a permanent one that he held until 1949, when he accepted an appointment at the University of Chicago with the Committee on Social Thought. He later held a position at the University of Freiburg, Germany, with a short period of time at the University of Salzburg, as well.
During much of the 1930s, Hayek was considered the leading critic and rival of John Maynard Keynes. As British economist John R. Hicks (who also was a Nobel Prize winner) explained in “The Hayek Story” (1967):
It is hardly remembered that there was a time when the new theories of Hayek were the principle rival of the new theories of Keynes. Which was right, Keynes or Hayek? There are many still living teachers of economics, and practical economists, who have passed through a time when they had to make up their minds on that question; and there are many of them (including the present writer) who took quite a time to make up their minds.
Keynes’s Treatise on Money (1930) had generated many critical reviews, but none was as devastating as Hayek’s two-part review essay in the pages of Economica in 1931–1932, which led Keynes to set his book aside and spend the next several years writing instead a new work that resulted in the Keynesian Revolution and modern macroeconomics, The General Theory of Employment, Interest, and Money (1936). During those same years, Hayek worked on revising, amplifying, and improving his own theory of money and the business cycle in a series of articles and essays that culminated in The Pure Theory of Capital (1941).
Hayek had offered his version of the Austrian theory of the business cycle, which had been first developed by Ludwig von Mises before the First World War and then in the 1920s. Inflations and depressions that accompanied the booms and busts of the business cycle were not inherent in the workings of the market economy. They were the result of central bank manipulation of the supply of money and credit and interest rates that brought about an imbalance between savings and investment, generating misallocations of resources and labor between the consumer and investment goods sectors of the economy. When the boom became the bust, the discovered malinvestments of capital and the misdirection of labor among sectors of the economy required a rebalancing of supplies and demands and the structure of relative wages and prices for a return to a sustainable full employment.
But by the war years, in the general interventionist climate of the time, Keynes’s ideas had captured the mind of a growing number of economists and policymakers. Prolonged periods of high unemployment were due to “irrationalities” in private-sector investment decisions that would persist, Keynes said, unless governments used fiscal and monetary policies to manipulate aggregate demand for output as a whole through deficit spending. Active government spending and taxing policies were the key to restore and maintain full employment. By the end of the 1940s, Keynes’s ideas triumphed in the economics profession, and Hayek’s ideas on money and the business cycle were buried in what one economist called the “Keynesian Avalanche.”
Hayek on prices and planning
At the same time, Hayek’s interests began to shift in another direction in the late 1930s and 1940s. The growing appeal of socialism and central planning in place of competitive market capitalism threatened both freedom and prosperity, in Hayek’s view. He edited a collection of essays on Collectivist Economic Planning (1935) that included an English translation of Mises’s important 1920 essay on “Economic Calculation in the Social Commonwealth,” in which Mises argued that socialist central planning, by doing away with markets and prices, removed the only viable institutional tools for rational economic decision-making.
Hayek picked up on this theme in his opening and closing chapters to the volume. But it was in a series of essays, “Economics and Knowledge” (1937), “Socialist Calculation: The Competitive ‘Solution’,” (1940), “The Use of Knowledge in Society” (1945), and “The Meaning of Competition” (1948) that Hayek developed and formulated his signature critique of government central planning. In the economist’s imaginary world of “perfect competition,” it is assumed that all market participants possess all the relevant knowledge of supply and demand conditions so errors and mistakes cannot occur, so to assure a condition of full and efficient economic equilibrium. But in the real world, Hayek reminded people, human knowledge is limited and dispersed among all the minds of all the members of the society. In addition, the real world is always open to unexpected change to which the participants in the market system of division of labor must constantly adapt and adjust to, to successfully assure fulfillment of their respective plans as consumers and producers.
Market-based competitive prices serve as the communications system to convey information to each and every member of the economic system about existing and changing supply and demand conditions. People do not have to know all the reasons why and for what purposes other people may want various consumer goods or the desire to utilize various factors of production (labor, land, capital) on the part of businessmen. Prices provide the needed and essential information that there is a demand for a product or service and what consumers would be willing to pay for it. Prices also tell us that there are uses for labor, land, and capital by others on the supply-side of the market, and they reveal what value they place upon them in the form of factor prices that guide businessmen and entrepreneurs in hiring and buying those inputs in the combinations that will minimize the costs of using them.
The resulting allocation of scarce resources among competing uses and the production and supplying of desired goods to interested consumers all occur without central direction or compulsory command. Indeed, essential to Hayek’s argument was the insight that it is impossible for any one or group of central planners to effectively obtain and utilize all that dispersed and decentralized knowledge existing in the minds of billions of people on the planet. It is far better to allow each individual to use his own knowledge as he sees fit to respond to the constantly changing circumstances of a dynamic world, with everyone’s individual actions coordinated through the prices of the marketplace.
The Road to Serfdom, published in the midst of Hayek’s other writings, was meant to bring out these inescapable consequences from centralized government control and direction of all economic activities under comprehensive socialist planning, including the threats to human liberty. In pursuit of “the Plan,” the actions of all individuals would have to be subordinated to what the government commanded. At the same time, with government ownership and control of all the means of production, all aspects of life would be dependent on the decisions and actions of government.
There was the danger of suppression of personal and civil liberties in a world in which government planning determined which books to be published, art to be created, movies to be made, places allowed for worship, or any other intellectual activities. The government would be the single employer, the single provider of housing and goods of all kinds, the arbiter of life opportunities and their outcomes. Hence, central planning is an economic system that would reduce people to a form of serfdom under a new type of “lord of the manor,” that being the monopoly master known as government. (See my article, “The 80th Anniversary of F. A. Hayek’s The Road to Serfdom,” in Future of Freedom, February 2024.)
Hayek’s shift to the political and social philosophy of freedom
In the postwar period, Hayek shifted his interests and writing to the political philosophy and institutional requisites for the free society. His book, The Counter-Revolution of Science (1952), challenged the presumption that human society could be understood, controlled, and transformed through the same scientific methods that had been developed in natural sciences such as physics and chemistry. Instead, Hayek argued there is a realm to the human world that is not present in the world of the natural sciences, that being the “subjective” world of mind, meaning, and human actions with their intended and unintended consequences. It was a wrong path to think that there was a “scientific method” that if effectively applied to the social world would enable the successful redesigning and directing of society into any forms the social engineer considered was better than the “spontaneous order” generated by the multitudes of individual actions and interactions inside and outside of the marketplace.
Hayek devoted most of the 1950s to writing The Constitution of Liberty (1960). In my view, part one of the book offers one of the most subtle arguments for the free society. Freedom is important not because of what we know, but because of what we do not know. We should want and respect the individual freedom of others precisely because we do not possess the knowledge they have. Nor can we ever fully or effectively anticipate all that might be forthcoming that benefits us and multitudes of others when each individual is at liberty to pursue his own ends using his own knowledge in his own way as he sees best. We should value human liberty precisely because of the unknown things that a free mind might discover. To the extent this is prevented or hampered by government planning and regulation, all of humanity loses something that a free mind might have imagined and tried and shared in some way with the rest of us.
It is why later in the 1960s, Hayek delivered a talk on “Competition as a Discovery Procedure” (1968). It is not only that we do not what others may be able to do that benefits themselves and others in the market process. Each of us also can never really know what we might be able to do and how unless we have the liberty and the opportunity to try. In other words, none of us knows our own potential and how we might act in certain situations unless we have the freedom and the incentives to find out. Only the freedom of the market economy most effectively offers the arena of human association and cooperation where this can be discovered.
His last major work, the three-volume Law, Legislation, and Liberty (1973; 1976; 1979) began to be published shortly before and then after Hayek was awarded the Nobel Prize in Economics. In it, he compares and contrasts the notions of planned order versus unplanned spontaneous orders; demonstrates the meaningless though no less politically dangerous idea of “social justice”; and offers a series of constitutional reforms he believed would more effectively secure a free society by limiting the powers of government.
Hayek’s Nobel lecture on “The Pretense of Knowledge”
Given the direction Hayek’s thinking had taken for the more than 40 years before winning the Nobel Prize, the theme of his Nobel Lecture was, “The Pretense of Knowledge,” delivered on December 11, 1974, at the Stockholm School of Economics. Nothing could have been in starker contrast to what Gunnar Myrdal argued in his Nobel Lecture.
At the time Hayek delivered this lecture, many leading countries in the West were experiencing high price inflation and accompanying rising unemployment, what was labelled, “stagflation.” Having just received the highest honor a member of the economics profession could be awarded, Hayek accused his fellow economists of having made a mess of things. The stagflation through which many of those countries was passing was due to the dominant economic theory of the prior 30 years — Keynesian economics.
It seemed so simple. If there is significant unemployment in the society, it must be due to an insufficiency of total, or “aggregate,” demand for output in general at prices high enough that would make it profitable for private enterprises to cover the costs of employing all those desiring to work at prevailing wages. Any “gap” between sufficient aggregate demand to assure “full employment” and actual aggregate demand with less than full employment could (and should) be filled with government deficit spending and monetary expansion to bring those unnecessarily unemployed back onto the employment rolls.
The quantitative key to determining all this was to measure total revenues earned by all enterprises at the existing average level of prices in the economy in comparison to what total costs would be if there were full employment at the existing average wage level. If total aggregate revenues are less than the amount necessary to fully employ all workers at that average wage level, the difference indicates the amount of government-induced additional aggregate spending required to reach the desired full employment target.
This both simplistically and superficially created the impression of scientifically quantitative exactitude, Hayek said. By focusing on measurable magnitudes — the price and wage levels in general; aggregate total revenues and total costs at the existing level of aggregate employment versus a measurable targeted level of full employment — the macroeconomy seemed open to fairly precise control and design. One version of this, especially popular in the 1960s and 1970s, was the Phillips Curve, often expressed as a presumed trade-off between price inflation and the level of unemployment. If a targeted lower rate of price inflation, then a higher rate of unemployment, and vice versa. Government policymakers just had to decide at which point along the price inflation–unemployment curve was best to plan and implement where the macroeconomy should be.
Macroeconomics’ false theory of unemployment
In Hayek’s view, these macro-aggregates hid from view all the real microeconomic factors and relationships at work beneath the macro-surface:
The correct explanation [of unemployment] appears to me to be the existence of discrepancies between the distribution of demand among the different goods and services and the allocation of labor and other resources among the production of these outputs. We possess a fairly good ‘qualitative’ knowledge of the forces by which a correspondence between demand and supply in the different sectors of the economic system is brought about, of the conditions under which it will be achieved, and of the factors likely to prevent such adjustment….
We have indeed, good reason to believe that unemployment indicates that the structure of relative prices and wages has been distorted (usually by monopolistic or government price-fixing), and that to restore equality between the demand for and the supply of labor in all sectors changes of relative prices and wages and some transfers of labor will be necessary.
Rather than a trade-off between a rate of price inflation versus a rate of unemployment, Hayek argued that prior inflationary policies were the cause of significant unemployment later on. Hayek emphasized a theme he had been focusing on since his monetary writings in the 1920s and 1930s: the non-neutrality of money. Changes in the supply of money and credit do not impact and effect prices and wages at the same time or to the same degree. Changes in the supply of money are necessarily “injected” into the market economy at some particular point, and from there proceed to influence other prices and wages and the profitability of producing different types of goods with certain combinations of inputs — capital, labor, and resources.
As Hayek once expressed it, think of a pebble dropped into a pond of water. From the epicenter from which the pebble disturbs the surface, ripples are sent out throughout the rest of the pond in a particular temporal sequence until the entire pond’s surface has been affected. The injection of new money affects some prices and wages before others, influences the profitability of producing some goods rather than others, and brings about resulting reallocations of labor and capital that will only be sustainable for as long as the monetary-induced patterns of relative prices, wages, production and resource uses are maintained. This requires a continuing expansion of the money supply and, over time, most likely an accelerating rate to preserve the artificially created structure of relative prices and wages as prices in general are rising period after period.
When the monetary inflation is either halted or even slowed down, the price, wage, and production patterns generated by the monetary expansion will potentially start to fall apart, like a house of cards. Once this begins to happen, it is discovered that prices and wages and production and resource uses must adjust and rebalance to a more sustainable pattern in a noninflationary setting. Thus, it is the misdirection of labor and other resources during the inflation that sets the stage for a nearly inescapable period of higher unemployment when the reallocation of labor must occur to reflect the postinflationary patterns of market demands and relative prices and wages. Hence, there is no trade-off between price inflation and unemployment: only periods of higher unemployment following an inflationary boom to correct for the errors and mistakes fostered during the monetary inflation.
Complex phenomena and the nonquantifiable
The reason this was not more clearly understood, Hayek argued, was the methodological prejudices of focusing on the quantifiable and the measurable as the only true or real facts and “data” of the market. The problem, Hayek insisted, is that economics, like social processes in general, are made up of “complex phenomena,” that is, multicausal and intricately interconnected relationships between multitudes of individual human beings in the social system of division of labor, the full details and facts about which it is inherently impossible for the economist to fully come to know and integrate into his analyses. This is especially the case not only due to the detailed “facts” of the market constantly experiencing change for one reason or another but because they also ultimately rest on the states of mind of all the market participants, which are not open to direct measurement or quantification.
Thus, the most the economist can do is make primarily qualitative “pattern predictions” of how markets work and why. He can understand and explain how and why observed discrepancies between supplies and demands suggest that prices and wages may be out of balance, and in what directions they need to move to reestablish balance in the market. But it is basically beyond his ability to measure and know by how much all such prices and wages need to change and readjust to restore market coordination, since it is only through changes in the actions and pricing decisions of market participants that the answers to these questions will be discovered. That is, it is only through the discovery procedure of market competition that the answers can be found. Hayek stated:
There may thus well exist better ‘scientific’ evidence for a false theory, which will be accepted because it appears as more [quantitatively] ‘scientific,’ than for a valid explanation, which is rejected because there is no sufficient quantitative evidence for it…. I must confess that I prefer true but imperfect knowledge, even if it leaves much underdetermined and unpredictable, to a pretense of exact knowledge that is likely to be false. The credit gained for seemingly simple but false theories by their apparent conformity with recognized scientific standards may, as the present instance shows, have grave consequences….
Indeed, in the case discussed, the very measures which the dominant ‘macro-economic’ theory has recommended as a remedy for unemployment, namely the increase of aggregate demand, has become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable.”
Herein was that general “pretense of knowledge” on the part of far too many economists and other social scientists in their belief that they could ever master, manage, and manipulate all the unknowable facts of the social world — the intentions, interpretations, and interconnected ever-changing actions of multitudes of human beings — to remake and redesign society in any desired pattern considered more “socially just” and economically “optimal.” This path, Hayek warned, too easily leads to “charlatanism or worse.” It is a lesson to learn and a threat to avoid today no less than when F. A. Hayek delivered his Nobel Lecture 50 years ago.
This article was originally published in the January 2025 issue of Future of Freedom.
