Hayek’s Best Test of a Good Economist

Abstract

A careful reading of the quotations that Hayek left us upon his death on hundreds of cards explains what is, in his opinion, the ultimate and definitive test of whether or not someone is a true economist. It is curious to draw attention to the fact that Hayek had already referred to this matter in Appendix III to his Pure Theory of Capital, which he wrote in 1941 and which ends with the following words: «More than ever it seems to me to be true that the complete apprehension of the doctrine that ‘de-mand of commodities is not demand for labour’ is ‘the best test of an economist’» (Hayek 1976, p. 439). Here, Hayek wishes to highlight one of the key points of the theory of capital: the real productive structure is very complex and is formed by many stages, in such a way that an increase in the demand for con-sumer commodities will always be detrimental to employment in the stages furthest away from consumption (which is precisely where most of the workers are employed). Or, in other words, the employers can perfectly well earn money, even if their rev-enue (or «aggregate demand») drops, if they reduce their costs by replacing labour by capital equipment, thus indirectly gen-erating a significant demand for employment in the stages of capital goods production furthest away from consumption (Huerta de Soto 1998, pp. 213-313).

It is more than illustrative how Hayek, in the select group of quotations on economic theory that he has left us in hundreds of his handwriting cards, wished to refer, once again, to these key ideas of the theory of capital. Effectively, Hayek now tells us that «Investment is more discouraged than stimulated by a high de-mand for consumer goods, and so is employment because in an ad-vancing economy more workers are employed to work for the distant fu-ture than for the present»(emphasis added). And he also says that «In the end is the decrease of final demand at current prices that leads to new investment to reduce costs». Therefore, Hayek con-cludes that «employment is not determined by aggregate demand». In short, for Hayek, the best test for an economist is to understand the implicit fallacy contained in the underconsumption theories and in what is called the shrift paradox or paradox of saving: «It is not consumer’s demand that secures the generation of incomes. It is investment of the excess of incomes over consumer’s expendi-tures which keeps incomes up». A large number of economists are unable to understand these principles because they adopt the macroeconomic aggregate approach that Hayek considers to be a serious error that leads, in the final analysis, to social engineering and socialism («Socialism is based on macroeconomics —a scien-tific error»). The only way of understanding what happens at «macro» level is by using microeconomics: «We can understand the macrosociety only by microeconomics». Furthermore, even the Chicago School monetarists are victims of this error: «Even Milton Friedman is reported to have once said ‘we are all Keynesians now’». The approach based on the model of equilibrium and mac-roeconomics is erroneous because «a science which starts with the conceit that it posses information which it cannot obtain is not a science». The same may be said of Welfare Economics, which, for Hayek, is «the spurious scientific foundation of socialist policies».