An old Polish soldier who had settled in London after World War II exposed me to the teachings of Hayek when I was sixteen years old. He had fought the Nazi machine as a member of the Royal Air Force. An equally nasty totalitarian force subsequently occupied his country: the Stalinist Communists. After the war, he settled in my neighborhood, and I got talking to him. He was adamant that I read Hayek as Hayek could show me all that was wrong with totalitarianism. The book offered was The Road to Serfdom. I did. I dedicate this reproduction to all those people who have suffered untold hardship under various totalitarian regimes.
Setting my sights on the London School of Economics, where Hayek had taught for twenty-plus years in the 1930s through the 1950s, as a place to study, to my great pleasure, we could study, as part of our political theory course, The Constitution of Liberty. Although Hayek had taught at the LSE in the economics department, none of his economic works were taught. Indeed, I was totally ignorant, up until my mid-twenties (i.e., post-university) of his economic works, which needless to say were the works cited in the awarding of his Nobel Prize. Further, it was Hayek who led me to the works of Ludwig von Mises, about whom I am certain that I would have otherwise known nothing.
Just as my Polish friend sparked my social and political interest in Hayek, I hope this volume can do the same for others concerning his economic work. This volume intends to revitalize Hayek’s contribution to the study of economic fluctuations (more commonly now called business cycles) and monetary theory. Hayek demonstrated an entrepreneurial and empirical attitude toward his work. Just as his social, political, and legal work is rich with warning about too much well-meaning government interference, so too are his neglected economic works.
After his time at the Institute for Business Cycle Research in Vienna, he funded his own trip to the United States to interview economists and develop his work. Hayek understood the importance of statistical verification but was also committed to getting the theory right rather than counting on empirics to generate their whole result. His legacy should be to complement theoretical quibbles with hard facts, and these essays contain rich avenues to pursue.
One particular area I would like to draw the reader to is his works contained here on the business cycle, which was the work that grew from Mises’s initial work on the matter in 1912, which has become known as the Austrian theory of the business cycle. Most contemporary economists have dismissed this work as not being in accordance with the observable facts and thus not worthy of being taught; hence, perhaps why I never saw sight nor sound of his teachings as an undergraduate.
In brief Hayek contends that an artificial manipulation by government of the interest rate creates a subsidy of credit that causes entrepreneurs to bring forth projects that were hitherto marginal. In reality, the consumers do not want the goods of these projects, so there is a misallocation (malinvestment) of resources. A careful reading of these early Hayek essays preempts the modern debate over rational expectations and shows that the cluster of errors can be avoided by his steadfast commitment to methodological individualism. Entrepreneurs are neither lemmings nor computers because they are heterogeneous.
If we extend the assumption of heterogeneity from capital to entrepreneurs, the question is, which type of entrepreneur is creating the cyclical activity of interest? Standard economic theory suggests that it is the marginal entrepreneur who moves the market, and Hayek points us in a direction that very few scholars have acted upon. I would find great value in subjecting this point to empirical evidence, to see who these marginal entrepreneurs are (the ones who are exposed when their credit subsidy is removed in a monetary contraction), and the conditions of their entry and exit. Perhaps moral hazard is not the greatest problem created by subsidized credit, and the effects of adverse selection create even larger inefficiencies.
Hayek stressed the role of relative price movements and focused attention on the interest rate. But he also provided a rich and accomplished critique of the use of abstract, aggregate variables. This presents a temptation for theorists to overemphasize interest rate changes, despite the fact that they only affect the risk of highly leveraged firms. In many cases the volume of credit, raw money creation by the Central Bank, seems a more realistic variable than the rate of interest.
Hayek’s faculty position at the LSE (1931–1950) not only raised the profile of the Austrian School, but also elevated capital theory to one of the key economic issues, by highlighting (and translating) the key Swedish and Austrian insights for the English-speaking orthodoxy. During this period the LSE was the frontier of the continental tradition, and Hayek, Keynes, Robinson, Sraffa, Shackle, Robbins, et al. were at the peak of their discipline. This volume reminds us of a time when Austrian theory sat at the top of the table of debate, and offers us the way to return there.
Hayek was writing in a tradition where economists were conscious of the practical relevance of their work. To be sure, Hayek utilized grand thought experiments and abstraction, but his theoretical work always sought to understand the real world. Since then a divergence has occurred between self-referential academics and a generation of business consultants who lack the rigor of price theory. I am sure that a reassessment of the likes of Hayek is of fundamental importance to any young economist seeking to bridge these two spheres and return to a science of commerce.
In fact, the critical problem of how individuals coordinate is the thread that runs throughout Hayek’s work, and the monetary aspect returns with his late attention to the nationalization of money. In these works we see Hayek as a price theorist, and as a facilitator of economic inquiry. As an entrepreneur I recognize deep insights throughout Hayek’s work, but also several points that have to be expanded and verified. This volume should not be seen as an example of preservation, but an engine of discovery.