Appropriate role of the state in a capitalist society: Keynes and Hayek

Introduction

The role of the state in a capitalist society has been a central concern in the philosophy of both FA Hayek as well as JM Keynes. However, the central premise for each was different. Hayek envisaged a state where the market based order of the society was not to be subject to unnecessary intervention by the state. Here Hayek devised legitimate and illegitimate actions of the state and the role of the state was to be limited to the actions that were legitimate, which were those actions that did not threaten the market based order of the society or the liberties of the individuals living in the society. Therefore, in Hayek’s opinion, the role of the state in a capitalist society is restricted and he was opposed to central planning by the state.

On the other hand, Keynes took a different approach, wherein he postulated a state that would intervene in the market based order because the market was not able to do course correction when required. Therefore, according to Keynes, the state’s role in the market based order extended to inject demand when there is a failure of aggregate demand and to generally guide the course of the economy. Keynes favoured central planning.

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This essay discusses the role of the state in a capitalist economy in the context of the diverse theories of Hayek and Keynes.

Role of state in a capitalist society: Keynes and Hayek

Hayek was a classical liberal political economist, and one of the most important ones of this century. As someone belonging to the liberal tradition or school of thought, the idea of individual liberty was central to his ideas on the role of state in a capitalist society. As far as society itself is concerned, Hayek viewed it as an extended market order, in which individuals practice the division of labour. In such a society, the role of the state would be to not intervene in the economy in such as way so as to threaten the market based order of the society, as it is this order that is the most essential to the preservation of individual liberty and well-being. Moreover, Hayes proposed that the state should be a rechtsstaat, or a state that is guided by the rule

  1. Peter J. Boettke, Christopher J. Coyne and Peter T. Leeson, ‘The Continuing Relevance of F.A. Hayek’s Political Economy ’, accessed December 14, 2016, http://www.peterleeson.com/Continuing_Relevance_of_Hayek.pdf
  2. Jeremy Shearmur, “Hayek, Keynes and the State”, History of Economics Review 68.

of law. Ultimately, Hayek’s work, as far as the role of the state is concerned, is centred in the actions that the state can do (legitimate actions) and those that the state cannot do (illegitimate actions).

In order to understand Hayek’s philosophy on the role of state, it is important to also understand Hayek’s philosophy on the place of an individual within that state. It is at this point, that Hayek considered some actions of the state to be illegitimate, while others to be legitimate. At the outset, it is essential to note that the two most important and essential concepts to be safeguarded were individual liberty and the market based order of the society and this also guided Hayek’s precepts about the legitimate and illegitimate actions of the state, and ultimately the role of the state in a market based economy.

Hayek envisaged a capitalist system as preordained to sustain democracy in the best possible manner. Indeed, according to him, democracy was possible only within the capitalist system. This is clear from the observation of Hayek as written below:

“It is now often said that democracy will not tolerate capitalism. If capitalism here means here a competitive system based on free disposal over private property, it is far more important to realise that it is only within this system that democracy possible.”

Here capitalism was also defined by Hayek to mean a system which allows free disposal over private property, with only those restraints that are essential and legitimate. Clearly, Hayek appreciated the capitalist system and found it to be appropriate for the establishment and sustenance of a democracy, which is the only kind of state, in which individual liberty is protected.

Hayek seems to be intrigued by the notion of state and it is remarkable to him that mankind could devise such a remarkable concept in which men could actually coexist. As he says:

“The possibility of men living together in peace and to their mutual advantage without having to agree on common concrete aims and bound only by

  • FA Hayek, The Road to Serfdom (Cornwall: Routledge, 2001) 73.

abstract rules of conduct was perhaps the greatest discovery mankind ever made.”

The concepts of peace and mutual advantage are essential in a market based economy, which is structured to provide the maximum protection to individual liberty.

Central planning was one of the chief concerns that underpins much of the work done by Hayek. It is also this central planning, that ultimately distinguishes a democracy from a totalitarian state and Hayek used Nazi Germany to exemplify totalitarian state which is based on central planning. Thus, in a capitalist democratic state there should be a restriction on such central planning. In case, democratic states would pursue the ambition of central planning, it is inevitable that such states would also sooner or later become totalitarian states. This is clear from the following statement by Hayek:

“There are strong reasons for believing that what to us appears the worst features of the existing totalitarian systems are not accidental by-products but phenomena which totalitarianism is certain sooner or later to produce. Just as the democratic statesman who sets out to plan economic life will soon be confronted with the alternative of assuming dictatorial powers or abandoning his plans, so the totalitarian dictator would soon have to choose between disregard of ordinary morals and failure. It is for this reason that the unscrupulous and uninhibited are likely to be more successful in a society tending toward totalitarianism.”

Here, again the consideration of rule of law becomes essential and Hayek considers rule of law to be central to arguments against planning. For this, he gives a “two-fold argument”. The first argument is economic. Here, the state should confine itself to making only those rules that would apply to general situations. In every other situation that relates to circumstances of time and place, the state should refrain from making rules and leave that liberty to the individuals who according to Hayek are the best judges of deciding upon the action in those circumstances. Hayek

  • FA Hayek, Law, Legislation and Liberty: The Mirage of Social Justice, Volume 2 (Chicago: University of Chicago Press 1976) 136.
  • Jeremy Shearmur, “Hayek, Keynes and the State”, History of Economics Review 68, 70.
  • Ibid, 139.
  • FA Hayek, The Road to Serfdom (Cornwall: Routledge, 2001) 79.

believed that the more the state ‘plans’, the harder it becomes for individuals to plan their own actions. This can be explained better by reference to Hayek’s own words:

“The state should confine itself to establishing rules applying to general types of situations and should allow the individuals freedom in everything which depends on the circumstances of time and place, because only the individuals concerned in each instance can fully know these circumstances and adapt their actions to them. If the individuals are able to use their knowledge effectively in making plans, they must be able to predict actions of the state which may affect these plans. But if the actions of the state are to be predictable, they must be determined by rules fixed independently of the concrete circumstances which can be neither foreseen nor taken into account beforehand; and the particular effects of such actions will be unpredictable. If, on the other hand, the state were to direct the individual’s actions so as the achieve particular ends, its actions would have to be decided on the basis of the full circumstances of the moment and would therefore be unpredictable.”

The second argument is moral, where Hayek is of the opinion that if the state can foresee every incidence of its action, it leaves no choice to the individual but to follow that action. Thus, individual freedom of choice acts as a restriction on the power of the state to conduct centralisation of planning. Hayek believed too much centralizing of power in the hands of a ‘monolistic state’ was dangerous:

“Our freedom of choice in a competitive society rests on the fact that, if one person refuses to satisfy our wishes, we can turn to another. But if we face a monopolist we are at his absolute mercy. And an authority directing the whole economic system of the country would be the most powerful monopolist conceivable….”

Another important argument that Hayek made in his work with respect to the role of the state was that the state should not try to force social justice outcomes in a market based economy. To do so, in Hayek’s opinion was to inevitably lead to central planning, which is an anathema in a capitalist society.

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  • Ibid.
  • Ibid.

With respect to the role of the state, there are some specific legitimate actions that the state can do in a market based society. First, the general framework, within which voluntary cooperation between individuals and economic activity takes place, must be prescribed by the state. The point of doing so, is that the state must attempt to improve upon the institutions so that a system can be created in which competition can work as beneficially as possible. It is noteworthy that such a process is one of continuous adjustment in nature. Secondly, there are certain essential prerequisites for the success of a market based society, which such society cannot by itself provide and these are therefore, to be provided by the state. These include institutions of money, markets, channels of communication, prevention of fraud, etc. Third, there are certain legitimate objects of state action, which can only be done by the state and these include control of weights and measures, building regulations, factory laws, and where inevitable, state regulated private enterprise. Finally, the provision of certain welfare measures, such as insurance, remedies for unemployment, etc., should also be done by the state.

For Hayek, the role of the state in a capitalist system proceeds from the understanding of the place of the individual within that state. As a classical liberal political economist, Hayek found it incomprehensible that state should have too much power so that the very liberty of the individual or the market based order, is threatened by that power. Liberty itself was defined by Hayek to mean a “state in which a man is not subject to coercion by the arbitrary will of another or others (personal or civil liberty).” This arbitrary will could be that of another individual as well as the state itself. It is important to note that Hayek did differentiate between civil and political liberty and he attributed the tendency to treat the two as synonymous as an “inevitable confusion arising from the fact that ‘civil’ and ‘political’ derive respectively from Latin and Greek words with the same meaning.”

As arbitrary will would unnecessarily interfere with individual liberty, it was essential that there be some limitations on the state as well so that it’s will is not imposed on

  • Ibid, 40.
  • Ibid, 39.
  • Ibid, 84.
  • Ibid, 124-6.
  • F A Hayek, The Constitution of Liberty (Routledge Classics, 2014 edition) 1.
  • Ibid.

the individual in a manner that interferes with his liberty. Here, the rule of law was used by Hayek to create the primary limitation on the power of the state. For Hayek, rule of law was an important tool for regulating the activity of the state and as such, it was a “safeguard as well as the legal embodiment of freedom.” While the government makes laws which act as restrictions on the individuals to some extent where they may be forced to alter the means by which they want to attain their aims; the government is also restricted from taking ad hoc action that restricts individual efforts under the principle of the rule of law. The reason why Hayek abhors ad hoc action is that he considers it to be unpredictable, and this was the chief reason why Hayek argued against central planning, which was so central to the Keynesian model as discussed next.

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Keynes is considered to be the most “penetrating theorist of capitalist reconstruction, of the new kind of capitalist state that emerged in a reaction to the revolutionary working class impact of the 1917.” Keynes was critical of the lasseiz faire system, as the massification of the working class and its resultant difficulty in ensuring equilibrium was unacceptable. He used the 1929 Wall Street crash and the ensuing period of the Great Depression, to exemplify the problems that are associated with such a system and to also justify state interventionism and planning.

For Keynes, interventionism was a necessary aspect of the role of the state in a capitalist society because the state has to safeguard the risks that are associated with investments that take place in a capitalist and market based society. Here is the essential difference between Keynes’ philosophy from that of Hayek. Hayek absolutely negated the role of the state as a planner and Keynes encouraged it. The state’s juridical basis itself (for Keynes) is on this ability of the state to liberate people from the fear of the future. For this, Keynes prescribed government intervention as a legitimate form of activity in a capitalist state. However, this intervention is to be a consequence of an aggregate demand failure, wherein the state takes upon itself to assume the guiding influence. This is clarified by the following statement of Keynes:

  • FA Hayek, The Road to Serfdom (Cornwall: Routledge, 2001) 85.
  • Ibid 76.
  • Antonio Negri, Revolution Retrieved: Writings on Marx, Keynes, Capitalist Crisis and new Social Subjects (1967-83) (London: Red Notes, 1988) 8.
  • Ibid, 11.
  • Ibid, 13.

“The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways….I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment…. But beyond this no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community. It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary.” (emphasis supplied)

Keynes did not envisage the establishment of a socialist or welfare state and when he talks of intervention, he means it in the limited circumstances as evident in his own words. Therefore, when Keynes opposes the laissez faire kind of economy and suggests state intervention, he does not mean that the state would intervene into the economy to the extent of completely substituting public works in place of private. At the same time, Keynes believed that the enlargement of government functions was the only “practicable means of avoiding the destruction of existing economic forms in their entirety.” This needs further clarification.

Keynes believed that the market approach by itself is not self-correcting, as is evident from the Wall Street crash in 1929. Here, Keynesian approach to the role of the state is that the state is in a position to guide and support the private system. The Keynesian model noted that the government’s role is to inject demand into the economy when there are signs of slack and recession and then again to exercise restraint at the threat of inflation. Here, the principal role of the state is to achieve a full employment equilibrium, which may not necessarily be achieved by a market system which has no state intervention whatsoever.

  • JM Keynes, General Theory Of Employment, Interest And Money (Delhi: Atlantic Publishers, 2016)
  • Colin Rogers, “Michael Lawlor’s Own-Rates Interpretation of the General Theory”, in The State of Interpretation of Keynes, ed. John B Davis (New York: Springer 2012), 107.
  • Quoted by Hans E. Jensen, “J.M. Keynes's Theory of the State as a Path to His Social Economics of Reform in The General Theory”,Review of Social Economy (1991) 49(3): 292-316, 292.
  • Nikolaos Karagiannis, Zagros Madjd-Sadjadi, Modern State Intervention in the Era of Globalisation (Cheltenham: Edward Elgar Publishing, 2007), 32.
  • Ibid.
  • Ibid.

Unemployment was seen by Keynes as a deficiency of demand and here the government can inject demand into the economy by more spending, as increased government expenditure equals to increased aggregate demand. Here, Keynes justified this kind of state intervention, on the ground that this intervention would save twentieth century capitalism. Keynes was mindful of the benefits of the 19th century laissez faire perspective. However, he did say that was a requirement to qualify certain propositions of laissez faire because private enterprise, motivated solely by self-interest would not really maximise material welfare.

Conclusion

Hayek and Keynes exhibited contrasting views with respect to the role of the state in a capitalist economy. Although, both favoured capitalist system, they took opposing stands on how far the state should intervene in the market based order.

According to Hayek, the role of the state is to make general policy and leave the specific adjustments to individuals who are the best judge of the situational demands in different time and space. The state is not to attempt central planning, because that ultimately leads to the establishment of a totalitarian state.

According to Keynes, the role of the state extends to state intervention, when required by a market that shows signs of aggregate demand failure. Although Keynes appreciated the merits of laissez faire system, he blamed the Wall Street crash of 1929 to the uninhibited private enterprise and advocated a role for the state in creating demand by expenditure, when faced with such a failure, as well as restraining in the face of inflation.

Word Count: 3045

Bibliography

  • Boettke, Peter J., Coyne, Christopher J., and Peter T. Leeson, “The Continuing Relevance of F.A. Hayek’s Political Economy”, accessed December 14, 2016 http://www.peterleeson.com/Continuing_Relevance_of_Hayek.pdf
  • Ibid.
  • Geoffrey Pilling, The Crisis of Keynesian Economics (Routledge Revivals) (Oxon: Routledge, 2014), 42.
  • Ibid, 45.
  • Hayek, F.A. The Road to Serfdom. Cornwall: Routledge, 2001.
  • Hayek, F.A. Law, Legislation and Liberty: The Mirage of Social Justice, Volume 2. Chicago: University of Chicago Press, 1976.
  • Hayek, F.A. The Constitution of Liberty. Oxon: Routledge Classics, 2014 edition.
  • Jensen, Hans E. “J.M. Keynes's Theory of the State as a Path to His Social Economics of Reform in The General Theory”. Review of Social Economy 49(3) (1991): 292-316.
  • Keynes, J.M. General Theory Of Employment, Interest And Money. Delhi: Atlantic Publishers, 2016.
  • Rogers, Colin. “Michael Lawlor’s Own-Rates Interpretation of the General Theory”. In The State of Interpretation of Keynes, ed. John B Davis. New York: Springer 2012.
  • Karagiannis, Nikolaos, and Zagros Madjd-Sadjadi. Modern State Intervention in the Era of Globalisation. Cheltenham: Edward Elgar Publishing, 2007.
  • Negri, Antonio. Revolution Retrieved: Writings on Marx, Keynes, Capitalist Crisis and new Social Subjects (1967-83). London: Red Notes, 1988.
  • Pilling, Geoffrey. The Crisis of Keynesian Economics (Routledge Revivals). Oxon: Routledge, 2014.
  • Shearmur, Jeremy. “Hayek, Keynes and the State”. History of Economics Review 68.

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