Keynes vs. Hayek: The Rise of the Chicago School of Economics
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Posted June 22, 2005
Author: Tim Florian
Posted: June 22, 2005
Updated: January 3, 2007
Economic freedom is freedom from government intervention in the production and distribution of goods and services. After World War II, governments were trying to rebuild their economies from the ground up. They looked to the ideas of the top economists of their day for guidance. These ideas have shaped economic systems and the idea of economic freedom for many years.
- Learn about differences between Keynes' and Hayek's economic philosophies.
- Describe economic freedom according to Hayek and the Chicago School of Thought, and as current economists describe it.
- Explain how Keynes' economic policies could limit economic freedom.
The ideas of John Maynard Keynes and Friedrich von Hayek have dominated the economic landscape since the end of World War II. Both of these influential economists had distinct ideas about economic freedom, ideas that were very clearly in opposition to each other. The following link provides a two-minute video clip that explains the ideological differences between Keynes and Hayek. Go to the PBS website; then choose the Battle of Ideas, The Core Debate clip (choose the media player your computer is equipped with).
In this lesson, the students will read about the different views of Keynes and Hayek on the role of government in the economy. They also will learn how their views influenced the famed “Chicago School of thought,” as well as our current economic system.
Following World War II, one major economic question dealt with the appropriate role for government in the economy. John Maynard Keynes, an English economist, developed theories that called for a large role for government in the economy. Daniel Yergin and Joseph Stanislaw (1998), explain Keynes' argument in this way: "The government would borrow money to spend on such things as public works; and that deficit spending, in turn, would create jobs and increase purchasing power. Striving to balance the government's budget during a slump would make things worse, not better. Keynes's analysis laid the basis for the field of macroeconomics, which treats the economy as a whole and focuses on government's use of fiscal policy--spending, deficits, and tax. These tools could be used to manage aggregate demand and thus ensure full employment. As a corollary, the government would cut back its spending during times of recovery and expansion."
For more information about Keynes, have the students read the short article about Keynesian Economics
Keynes' views on economics were challenged by Friedrich von Hayek who argued that "The problem was that under central planning, there was no economic calculation--no way to make a rational decision to put this resource here or buy that good there, because there was no price system to weigh the alternatives." Central planners could make technical decisions but not economic ones. Over the rest of the century, that criticism would prove to be extraordinarily prescient. "Socialism shocked our generation," Hayek later said. Yet, he added, it profoundly altered the outlook of idealists returning from the war. "I know, for I was one of them.... Socialism told us that we had been looking for improvement in the wrong direction"(Stanislaw and Yergin 1998).
To Hayek, less government intervention meant more economic freedom. He believed that when people are free to choose, the economy runs more efficiently. In the United States, the strongest supporters of Hayek's ideas were a group of economists at the University of Chicago. Known as the "Chicago School of Economics," this loosely formed unofficial group of economists was generally associated with free market libertarianism. The name refers to economists who received their schooling in the Economics Department at the University of Chicago. To date, nearly half of all Nobel Prizes in Economics have been won by researchers with ties to Chicago.
Click on "The Chicago School ," and read the essay, which critiques the Keynesian philosophy.
Divide the students up into groups of three or four. The students will read the essay and discuss the impact of Keynes and Hayek on the Chicago school of economic thought. Have the students answer the following questions in their group.
According to Becker, what was the Chicago school's contribution to economic science?["Chicago always had a strong tradition of a belief in the power of markets," said Gary Becker, who went to Chicago as a graduate student in 1951 and won the Nobel Prize in 1992. "Chicago's contribution was to show the power of markets and people's choices, not only in public policy but also in economic science."]
How was the Chicago school in direct conflict with the Keynesian school of economic thought? [By the end of the 1950s, people were already talking about a distinctive Chicago School, which--in opposition to the new Keynesianism--emphasized laissez-faire (free markets) and argued against government intervention.]
According to the Chicago economists, what should government’s role in the economy be? [For the Chicago economists, the conclusions for government policy were clear: Wherever possible, private activity should take over from public activity. The less government did, the better.]
According to Friedman, what produced the best results for economic freedom? [He saw a direct, explicit, connection between capitalism and democracy. Free markets produced the best results, and economic freedom rested, in turn, on political liberty.]
- In your own words, what is economic freedom? [Answers will vary: Economic freedom is the freedom from government intervention in economic activity.]
Have students answer the following short-answer questions.
1. Summarize the Chicago school of economic thought in your own words. [The Chicago School emphasizes free markets to achieve economic freedom. Markets work best when they are left alone to regulate themselves. The pressures of prices control the market and allocate resources more efficiently than government policies.]
2. In your own words, summarize Keynes' views on economics. [Keynes believed that government intervention is needed to stabilize the market. He proposed that the government should use fiscal policy, which includes the use of spending, deficits and taxes, to manage demand. Spending more during recessions and less during recovery and expansion would help to balance out the booms and busts.]
The views of Keynes and Hayek have been a driving force in the U.S. economy since the end of World War II. In the 1950s, 1960s and into the 1970s, Keynes' view of government as a key actor in the economy was the more popular theory. Since the 1970s, however, Hayek's view that government should only participate in the most limited way in our economy has gained popularity. The influence of Hayek's ideas and of the Chicago School, the chief supporter of the ideas, continues to be felt today. It is important to note, however, that Keynes and Hayek (and the Chicago School) represent the ends of the continuum, and that in practice, even the most market-oriented society (such as the United States) has a truly "mixed" economy, with the government playing a small but substantial role.
The Chicago School brought a strong belief in the system of free markets to our economy. This is in sharp contrast to the old ideas of using the government to help regulate the economy in economic bad times. This is not to say that Keynes was an advocate for central planning; he was an advocate for the use of government to help regulate the economy. Hayek, on the other hand, believed that economic freedom is tied to free markets, and the less government intervention, the better.
The students can compare the United States to other countries in terms of economic freedom. They can examine where the countries have been and where they are going in terms of economic freedom.
Follow the link to examine economic freedom from around the world. Pick three countries, each from different levels of economic freedom, and explain what makes them different in terms of levels of freedom. Additionally, what does the future hold for these countries? Do they have more economic freedom now than in the past, or vice versa?