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6: Was the Marginal Revolution Aborted? - Gerald P. O’Driscoll, Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek 
Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek, Foreword by F.A. Hayek (Kansas City: Sheed Andrews and McMeel, 1977).
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Was the Marginal Revolution Aborted?
Economic Analysis, serving for two centuries to win an understanding of the Nature and Causes of the Wealth of Nations, has been fobbed off with another bride—A Theory of Value (Joan Robinson, The Accumulation of Capital [London: Macmillan and Co., 1956], p. v).
KEYNES AND HAYEK
When writing this book, I have attempted to develop Hayek's ideas in a logical fashion, which, as previously noted, means departing at times from a strict chronological presentation of Hayek's ideas. In this logical and historical development, I have noted the controversies in which Hayek was involved. I did so, not for the purpose of entering these controversies on one side of the debate, but to elucidate and explain his position in these debates, so as to contribute to the development of his ideas. One controversy above all, however, merits special attention—the long controversy between Hayek and Keynes, and later, the Keynesians. By examining Hayek's Gestalt-conception of economics, as applied to the issues raised in this debate, one can go a long way toward understanding Hayek's dissatisfaction with the development of twentieth-century economics. In so doing, I shall also be presenting in more detail some themes at which I have thus far only hinted.
Even for those previously unfamiliar with Hayek's monetary writings, it should be clear by now that he was generally quite critical of both Keynesian thought and the quantity-theory tradition. It has long perplexed scholars that Hayek never wrote a detailed and critical review of The General Theory. This is in sharp contrast to his treatment of Keynes's Treatise. The absence of such a review must certainly not be taken as a sign of acquiescence. If anything, one has good reason to suppose that Hayek had more sympathy with the earlier rather than the later work of Keynes. In the Treatise, Keynes was still explicitly writing as a monetary theorist; we know that the neo-Wicksellian overtones of that work were appealing to Hayek.1 We also know that Hayek found little that was appealing in The General Theory. For while he wrote no formal review of Keynes's new magnum opus, he did outline the sources of his dissatisfaction with that work in the final pages of The Pure Theory of Capital.2 He there paved the way for the never-completed second volume of that work on the dynamic aspects of capital theory, Hayek's real interest.3
One can say that Hayek's major technical criticism of The General Theory is the absence of theoretical capital discussions in that work. Hayek had earlier accused Keynes of postulating Wicksellian conclusions without accepting the Böhm-Bawerkian capital theory upon which these conclusions were based.4 Keynes surprisingly accepted this rather harsh judgment and promised to rectify matters in the future. Patinkin has told us that “of course [he] did [do this] in The General Theory.“5
“Of course” Keynes did no such thing. The microfoundations of Keynes's investment function were certainly controversial until comparatively recently.6 Economists are still by no means in agreement over this subject—forty years after the publication of that work. Yet this problem can be treated as symptomatic of a larger problem in The General Theory, namely, the lack of a coherent capital theory. Keynes virtually admitted that he knew little capital theory when he wrote the Treatise. There seems to be no evidence that he acquired expertise in this area in the five years leading up to the publication of The General Theory. In fact, there are bits and pieces of evidence that he continued to feel quite uncomfortable about the whole subject, despite the fact that he had strong prejudices on capital theory.7 There is amazingly little in the way of capital theory proper in The General Theory, though capital considerations are of crucial importance in that work. Keynes himself seemingly was acknowledging this lacuna implicitly by his titling of chapter 16, which bridged his analysis of “The Psychological and Business Incentives to Liquidity” and “The Essential Properties of Interest and Money.” He entitled this important link, “Sundry Observations on the Nature of Capital.”
Among economists there is now a general inclination to denigrate capital theory. This attitude is largely a legacy of the Keynesian revolution. Some would go so far as to forsake capital theory entirely for a theory of interest.8 At least the latter implicitly acknowledge that the theory of capital is not merely the theory of interest, a distinction commonly not made. Capital theory as it presently exists is largely a theory of capital as a homogeneous globule, a concept that obviates consideration of any important, dynamical and specifically capital-theoretic problem. In recent years, few outside of Ludwig Lachmann have been concerned with the choice of capital goods.9 The recent Cambridge (U.K.) attack on marginalism in capital theory represents a virtual attack on putty-putty-type models of capital, in which the choice of heterogeneous capital goods is suppressed, if not assumed away. Neoclassical economists, by adhering to these models, invite the inference that marginalism and homogeneous capital models are in fact logically linked.
Of course, Keynes's emphasis on the choice of consumption versus investment, first articulated in the Treatise, and present in less obvious form in The General Theory, is a step toward capital theory, conceived of as the choice of capital goods; but it surely is not itself a theory of capital, dependent though it may be on such a theory.
However important he felt the technical flaws of The General Theory were, Hayek had a far more fundamental disagreement with the argument of that book. He objected to the whole conception of Keynes's system, to the very idea that there can be a theory of output as a whole, or of aggregate demand, aggregate supply, etc. Here we are entering into the most general considerations concerning the nature of economic theory. To do so, we require a framework of analysis.
Whatever we now know of the many precursors of modern marginalist and subjectivist economics, of Bernoulli, Dupuit, Gossen, J. B. Say, and Senior; and, even earlier, of Lottini, Davanzati, Montanari, and Galiani,10 British political economy at the eve of the Marginalist Revolution was Ricardian in approach. Be this because of Ricardo's continued intellectual dominance, or the recrudescence of Ricardian thinking effected by the appearance of J. S. Mill's Principles, British economics especially was largely ignorant of these earlier insights. Ricardian classical political economy was macroeconomics by and large.11 What was lacking in Ricardian theory was precisely a theory of choice and demand, a non-materialist theory of costs, and a consistent marginalism and subjectivism in approach. In short, Ricardian microeconomics was a skeleton insofar as it existed. Suffice to say, Ricardian value theory was at the root of this.
The contention that Ricardian political economy was macroeconomic in nature must be carefully considered. I do not wish to argue that Ricardian economics was chiefly concerned with the determination of output as a whole, aggregate demand, etc. These were the least well worked out aspects of Ricardian macrotheory:
Classical economists were not primarily concerned with the adjustments of the economy to the growth process, but with how such a process could be generated and sustained.... Even the static Ricardian model was concerned...with the progress of the economy toward the stationary state, and with what this implied for the functional distribution of income.12
A macroeconomic theory of growth, the macro distribution of income among well-defined classes, and the economics of the stationary state—quintessentially Ricardian questions.
The Ricardians were concerned to some extent with the theory of the demand for output as a whole, despite their adamant stand on the general glut question. To deny that the demand for output as a whole could ever be insufficient is not to deny that there is an aggregate demand. Aggregate demand was constituted by aggregate supply for the Ricardians and worked its way through the medium of aggregate money turnover, MV. It might be true that a motto for Ricardians could have been, “we can safely neglect the aggregate demand function.”13 But the Ricardians certainly had the concept of a demand for output as a whole. Their approach was simply different from the modern one. And of course their approach was not all that well worked out, either; as a consequence, most modern “classical” macroeconomic paradigms are largely the construction of textbook authors.
The tripartite Marginal Revolution was a microeconomic revolution against Ricardian formalism. It was a revolution that took three distinctive forms: “the marginal utility revolution in England and America, the subjectivist revolution in Austria, and the general equilibrium revolution in Switzerland and Italy.”14 But these were all microeconomic upheavals.
Yet in the end, “neoclassical” economics in Britain developed as a horrible brew, in which marginal utility theory was merged with Ricardianism. Much of this development can be attributed to Alfred Marshall, who, in this view, launched an effective counter-revolution. He openly wished to save what he could of Ricardianism. The reasons for this are complex and devolve in part around Marshall's personality. But these are beside the point here.
It is not my main point that Marshall preserved almost intact the essential features of Ricardian long-run value theory, in his own long-run analysis. I am concerned more with the general Ricardian overlay that remained in British economics. Most generally, Marshallian economics is clearly not especially methodologically individualistic (compared to either the Lausanne or Austrian schools), and is almost anti-subjectivist in tone.
In Marshallian economics we have the genesis of the division between microeconomics and macroeconomics of modern economic theory, because it is here that Ricardian economics continued, albeit in modified form. (For instance: The Marshallian theory of costs is more Ricardian than not.) The microeconomic approach to monetary theory really postdated Marshall's tour de force. The Cantabrigian hostility to a Wicksellian microeconomic theory of capital, interest and business cycle theory, and to the Misesian theory of money is thus seen to be no accident. For a radically microeconomic approach to these questions was simply foreign to the Marshallian tradition.
The Marginalist Revolution, conceived of as a general microeconomic revolution, was never completed; and it was almost immediately met in Britain by a very effective counter-revolution. It consequently advanced least in Britain, and least of all in Cambridge. It is questionable to what extent Keynes was acquainted with non-Marshallian thinking. We have his own word that German economic writings were closed to him, if the writings were not on a subject about which he already knew.15 For Keynes to have broken out of the Marshallian framework, he would have had to read German more fluently, as did Lionel Robbins. Keynes knew of Jevons, of course; but while Jevons in spirit was against all manifestations of Ricardianism, he did not to my knowledge push the microeconomic approach to the frontiers of monetary theory. And he was surprisingly classical on cost theory.
Keynes returned to a classical, macroeconomic mode of thinking in The General Theory. Viewed by a radical microtheorist and subjectivist such as Hayek, Keynes's new work was not so much revolutionary as counter-revolutionary. Hayek was opposed to the macroeconomic formalism and nascent Ricardianism of The General Theory. His disagreement with Keynes was now more fundamental and methodological, rather than particular and technical. This state of affairs surely made a formal review of Keynes's new work most difficult, particularly since Hayek probably did not work out his own thoughts immediately upon publication of The General Theory.
Hayek's change of interests may also be thus explained. For he fairly abruptly ceased writing on monetary theory proper. He saw that his dissatisfaction with the New Economics (which to him was Very Old Economics) could only be brought out in work on the fundamentals of economics. Accordingly, he began a project on scientific methodology in the early 1940s, and he has moved further in this direction in his interests ever since. His Nobel Laureate lecture represents the culmination of this intellectual phase.16 Nowhere else has he more clearly spelled out his disagreement with macroeconomic thinking as fundamental and methodological.
Viewed historically, this Gestalt-conception, which, to repeat, I think is Hayek's, has great merit. We do not have a consistent microtheoretic discipline. We would have had if the Lausanne and Austrian schools had maintained a natural intellectual alliance. But ironically the very figure who brought Walrasian and Paretian economics to the attention of Anglo-American economists also provided us with an apparent synthesis of macroeconomic (i.e., Keynesian) and general equilibrium economics. This is no place to consider in detail Sir John Hicks's role in the evolution of modern economic thinking.17 But it is the place to pose a problem that is suggested by the previous historical analysis, an analysis, to repeat, that also aids in our understanding of Hayek's response to the publication of The General Theory.
The problem concerns the recent endeavors to provide microfoundations for macroeconomics. The results have been none too impressive so far, despite the otherwise impressive credentials of those engaged in this search. It may all be a matter of time; there is no denying the possibility. But if the historical view presented here is correct, then the recent macroeconomic research program is all a futile effort. In the view offered here, the microeconomic mode of analysis is radically opposed to the macroeconomic. A coherent economic theory could only be developed by the unqualified acceptance of one mode and the concomitant rejection of the other. The protagonists of Cambridge (U.K.) understand this fact, I believe. It is not clear that their counterparts among the neoclassicals do also. Friedrich A. Hayek and Piero Sraffa, who have perhaps never agreed on anything else before, may both be in error. But the possibility that they are correct certainly should give one pause.
This historical analysis should not be completely new to one who has read Prices and Production. For the analysis is presented there in a very summary form. Of course, the analysis presented in Prices and Production could make no reference to the Keynesian revolution and such later developments. But Hayek had said much of what I am now repeating here in dealing with the monetary theory then most representative of Ricardian thinking—the quantity theory, particularly the Fisherian version. Some of the relevant passages have been quoted earlier in this book in the course of developing Hayek's criticisms of the quantity theory. There I focused the technical aspects of his dissent. Here I wish to emphasize the methodological aspects.
Hayek argued that:
For so long as we use different methods for the explanation of values as they are supposed to exist irrespective of any influence of money, and for the explanation of that influence of money on prices, it can never be otherwise [that progress in monetary theory will be hindered]. Yet we are doing nothing less than this if we try to establish direct causal connections between the total quantity of money, the general level of all prices and, perhaps, also the total amount of production. For none of these magnitudes as such ever exerts an influence on the decisions of individuals; yet it is on the assumption of a knowledge of the decisions of individuals that the main propositions of non-monetary economic theory are based. It is to this “individualistic” method that we owe whatever understanding of economic phenomena we possess; that the modern “subjective” theory has advanced beyond the classical school in its consistent use is probably its main advantage over their teaching.
If, therefore, monetary theory still attempts to establish causal relations between aggregates or general averages, this means that monetary theory lags behind the development of economics in general. In fact, neither aggregates nor averages do act upon one another, and it will never be possible to establish necessary connections of cause and effect between them as we can between individual phenomena, individual prices, etc.18
Hayek need have altered little in the above in order for it to serve as his criticism of Keynesian economics. Indeed, the similarity between the quantity theory and Keynesian economics leads us to a related topic.
KEYNES AND THE CLASSICS: THE FALLACY OF THE NONEXHAUSTIVE DILEMMA
Several generations of economics students have been brought up on the “Keynes and the Classics” argument, as it is presented in virtually every macroeconomics textbook. The analysis of this chapter, indeed of the whole book, casts doubt on this two-fold division in monetary theory. The reasons for this doubt are likewise two-fold. First, as we have seen, there is a similarity between the Keynesian and quantity-theory traditions in their fundamentally classical and Ricardian bent. This similarity is being increasingly recognized in textbooks, as the propositions of one “theory” are being couched in terms of the other. Thus, while economists have for a long time emphasized that MV=Y and C+I+G=Y are tautologies, the textbook writers have only recently begun to draw the logical conclusions: any Keynesian proposition can be cast in quantity-theory language and vice versa.19
Second, Keynesianism and the quantity theory (or Keynes and the Classics) represents a non-exhaustive choice.20 As is always true of such fallacious choices, the arguer is thereby given great license with the facts. While Keynesian economic theory can be expressed in terms of the quantity theory and vice versa, the tradition represented by Hayek can be expressed in terms of neither theory. For the variables of neither theory encompass those of Hayek's theory; and the variables of these other theories do not even enter directly into Hayek's analysis. In fact, one could argue that the choice in monetary theory is between premarginalist Ricardian thinking and a consistent marginalist and subjectivist approach. This is not to deny that a good deal of marginalism and subjectivism is present in modern monetary theory; but so too is a good deal of Ricardian macro-formalism. For one who doubts this, I can only suggest reading Hayek's Monetary Theory and the Trade Cycle, or Monetary Nationalism and International Stability, and comparing it with almost any modern treatise on money. The best comparison here might even be between Mises's Theory of Money and Credit (the locus classicus in this tradition) and modern monetary thought.
I would emphasize once again that many of Ricardo's insights in capital theory and some even in monetary and value theory play an important role in Hayek's own analysis. Many have noted the Ricardian or classical roots of Austrian capital theory. What I have endeavored to juxtapose is Ricardian macro-formalism, or Ricardian methodology, and consistent methodological individualism and subjectivism. The Cambridge rediscovery of Ricardo has focused precisely on what are to economists in the Austrian tradition the most objectionable features of Ricardianism (for example, analysis by social classes rather than individuals and manipulation of aggregate variables rather than attention to the relevant micro signals). Insufficient attention is thereby paid to the interesting (to Austrian economists) Ricardian insights on capital (for example, the importance of the period of production) and value theory (for example, see chapter 5 on the Ricardo effect).
There are real points of disagreement in monetary analysis. But as Leijonhufvud has recently argued, these have more to do with questions of the existence of a self-regulating mechanism of a market economy21 ; and this truly fundamental difference has no logical connection with the presumed values of various elasticities that might lead one to be a Keynesian or a quantity theorist.
To discuss intelligently substantive disagreements, one must first recognize their nature. I have been arguing that differences among macrotheorists and monetary theorists are often misperceived and are consequently persistent. These differences are not narrowly technical in nature, though the debates are carried on in technical terms. Consequently, the issues are more easily muddled than solved. The differences are at root methodological, and broadly political-economic. This chapter has dealt with the former source of controversy. The latter would take us beyond the scope of this book, though I have touched on some of the issues in the second chapter. But then I did not set out to solve problems in this chapter, but only to identify them. I hope that I have done this.
See Hayek, “Reflections on the Pure Theory of Money of Mr. J. M. Keynes,” part 1, Economica 11 (August 1931): 270.
Hayek, The Pure Theory of Capital (Chicago: University of Chicago Press, 1941), pp. 369–76.
See Hayek, The Pure Theory of Capital, p. 3;also, verbal communication.
See Hayek, “Reflections,” part 1, 277–80.
Don Patinkin, “Keynes Monetary Thought: A Study of Its Development,” History of Political Economy 8 (Spring 1976): 57.
Some of the issues involved in this subject are covered in Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (New York: Oxford University Press, 1968), pp. 157–85.
On Keynes's treatment of capital, see Leijonhufvud, Keynesian Economics, pp. 187–314. Noteworthy is Keynes ambivalence on Austrian capital theory: “It is significant that whereas Keynes (like Cassel) was quite critical of Böhm-Bawerk, his ‘observationsș on capital stress the roundaboutness notion of the Austrians” (Leijonhufvud, Keynesian Economics, p. 250n).
See Harcourt's remarks on Solow's approach in G. C. Harcourt and N. F. Laing, eds., Capital and Growth (Baltimore: Penguin Books, 1971), p. 17.
See Ludwig M. Lachmann, Capital and Its Structure (London: London School of Economics, 1956).
See Emil Kauder,A History of Marginal Utility Theory (Princeton: Princeton University Press, 1965), pp. 15–57.
“Classical economics is essentially macro economics” (Robert Eagly, The Structure of Classical Economic Theory [New York: Oxford University Press, 1974], p. 21).
Thomas Sowell, Classical Economics Reconsidered (Princeton: Princeton University Press, 1974), p. 33. The dynamic problems of macrotheory were the chief focus in classical economic theory. This is in contrast to contemporary macrotheory.
John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace & World, Harbinger Books, 1965), p. 32.
Mark Blaug, “Was There a Marginal Revolution?” in The Marginal Revolution in Economics, eds. R. D. Collison Black, A. W. Coats, and Craufurd D. W. Goodwin (Durham: Duke University Press, 1973), p. 14.
Keynes acknowledged this in the Treatise, reprinted as Moggridge, ed., The Collected Writings of John Maynard Keynes, 25 vols. (London: St. Martin's Press, 1971) 5: 178n.
Hayek, “The Pretence of Knowledge,” in Full Employment at Any Price? (London: Institute of Economic Affairs, 1975), pp. 30–42.
Two recent attempts to begin this much-needed reassessment are Ludwig M. Lachmann, “Sir John Hicks as a Neo-Austrian,” South African Journal of Economics 41 (1973): 195–207; and Robert Clower, “Reflections on the Keynesian Perplex,” Zeitschrift für Nationalökonomie 35 (1975): 1–24; esp. 5–12.
Hayek, Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), pp. 4–5.
An explicit example of such an argument is Charles W. Baird, Macroeconomics (Chicago: Science Research Associates, Inc., 1973), pp. 176–80.
On this point, see also the editorial introduction in Sudha R. Shenoy, ed.,A Tiger by the Tail (London: Institute of Economic Affairs, 1972), p. 8.
Axel Leijonhufvud, “Effective Demand Failures,” Swedish Journal of Economics 75 (1975): 28–29.