keynes hayek

Global warming is not a hoax, that’s what I believe. It is a very real danger which our civilization confronts and for that precise reason it is very important to understand the primary drivers that feed it and the possible approaches to handle it.

The scientific aspect is well understood and agreed upon worldwide. Yes, too much human activity introduces too much carbon dioxide in the atmosphere resulting in the greenhouse effect which traps heat near the earth and increases the average temperature. But what causes this? What are the economic causes of the problem? What are the economic aspects of common solutions proposed?

The discovery of fossil fuels and the industrial revolution

The discovery of fossil fuels was a major landmark in the history of human civilization. It gave us lots of both, pollution and progress. Fossil fuels are the second densest source of power after nuclear fuels today. You cannot imagine many of our space crafts and aircrafts without one of these two sources of power. Neither the Porsches which accelerate to 100 km/h within 3 seconds. Nor the factories which produce so much of the stuff we use every minute.

The industrial revolution which rode on the back of fossil fuels was instrumental in improving the living standards of millions of people worldwide. It gave common people access to facilities and opportunities only the rich and privileged could think of in the feudal age. And it came with its own set of problems, one of which we are discussing here – pollution and global warming.

Both industrialization and environmental degradation go hand in hand, has been the experience. The real world problem is to find the right balance because zero pollution requires zero human activity and hence is not an option. Neither is no concern for pollution an option. Yes scientific improvement to find ways of sustaining human activity without damaging the environment is a good path to follow, but what are the economic impacts of a government led approach instead of a market led approach?

So how much pollution is ok?

What is the right balance? Environment is one of the prime examples of issues which demonstrate the problems with collectivism. What incentives do I as an individual have to care for the environment? Most actions I can do for improving the environment result in the rewards being shared. Most actions I can undertake to degrade the environment result in the punishments being shared. So good intentions aside, an individual might personally want clean air but has no individual incentive to care for the environment. This is a very real problem with all forms of collectivism.

Collectivists generally blame this problem on the profit motive. Their solution is illegalization of profits and institutionalization of collectivism. That illegalization of profits does not solve the problem is a fact, well borne out by economic experiments throughout the last century, was a foregone conclusion for some because they correctly identified collectivism to be the problem rather than the profit motive.

Yet, environment is one of those cases which are not easily amenable to a departure from collectivism. Air and water – it’s difficult to identify how much O2 and CO2 each individual or factory is taking in and giving out, it will be a shared. A real problem. Let’s park this problem with the understanding that a section proposes the solution to be more collectivism! We will analyze the collectivist solutions later on in this piece.

So what is the right amount of pollution which does not stifle growth while keeping the environment relatively clean? The short answer is let the people decide. I know this answer will be misconstrued by many to mean democratic control of environment. That’s not what I mean. I mean free markets. Its free markets which can decide what people actually want, not democratic control. The difference is profound.

Democratic control in all instances means imposition of majority wishes on minorities, whatever way you might define majority and minority. A free market allows majority and minority to live together cooperating while pursuing their own individual self-interests.

The great depression and unemployment

It raises many eyebrows when you talk about free markets when discussing environment. The reason is a basic misunderstanding about what free markets actually mean. Many understand it to mean no rules, whereas it actually is a system of constraining greed. Anyways let’s move ahead to understand why that is relevant here.

The US Federal Reserve was created in the early 1910s with the intention of preventing the frequent bank collapses which used to happen before that time. It was said that bank collapses were a sign of an unstable economy and something needs to be done to fix this ‘problem’. Actually the banks which used to collapse were those who lent out a very large fraction of what they were custodians of, in expectation of too much profit but went bust when depositors wanted their money back. The market used to kill those banks which did too much gambling with their depositor’s money.

This also was a check on depositors to go for more trustworthy banks even when they didn’t get that high an interest rate. So the mechanisms of the free market were considered to be ‘problems’ by some and the idea of a central bank made its way into USA ,which could serve as ‘the lender of last resort’ for banks who had gambled too much.

So we had a central bank and it had sweeping effects on the country. The most conspicuous of those was an increased growth rate in the American economy and this was considered to be a major achievement of the new way of managing the economy. This is how it works, when you have a central bank backing you, you can afford to risk more! You can lend out more at lower interest rates. People can get more loans to try out their business ideas. More production in the economy. More consumption thereafter and everything look awesome. So we see that the government just with the stroke of a pen, legislated acceleration towards prosperity! Everybody was better off! Or was it? Did someone pay for this prosperity? Actually Two entities paid for it.

One was the Future in the form of the Great Depression. The other victim was the Environment which paid a price for this accelerated growth.

Government stimulated growth increases consumption above what the free market would allow along with accelerating environmental degradation above what the free market will allow. Government stimulated growth also increases inequality because the relatively well-off are the primary beneficiaries of government stimulated growth.

By the end of the 1920s, the American economy started seeing the effects of stimulated economic growth. USA entered the great depression. Misallocation of resources produced due to easy credit was trying to fix itself. Along with fixing the inflated consumption patterns the depression as a side effect was also trying to slow down the environmental degradation of the past decade. But this was deemed a ‘problem’ by the collectivists, despite the actual cause of the problem being the couple decades preceding the great depression. Anyways Dr. Keynes rose to embrace the challenge.

How Keynes introduced us to economic ‘drugs’

The celebrated economist John Maynard Keynes, in 1933, studied the problem of unemployment and inflation. He conclusively proved that a free market cannot consistently produce full employment due to cases of insufficient aggregate demand. He was right. The state of unemployment during the great depression, he said, cannot be corrected by letting the market function. And then Dr. Keynes also provided us the solution. The government should create a bubble to increase aggregate demand, is basically what his solution was. An economic bubble.

But what when the bubble burst after sometime, he was questioned! Why care about the long run, in the long run we are all dead, he explained. Satisfied with his answer, Franklin Delano Roosevelt set himself onto the task of creating the Keynesian bubble.

The free market was trying to fix the elevated consumption and environmental degradation caused due to the Federal Reserve. Keynesianism prevented that from happening by regenerating the artificial consumption and the inherent environmental degradation. The idea that government stimulating aggregate demand in the economy above the market level is ok is at the root of the problem.

Keynes basically discovered new drugs for us, economic drugs which allow us to remain high. But what happens when the effect of the drug wanes? According to Keynes, either of two things could happen. Either you are dead and there is no problem left to solve. If you are not as yet dead you could blame the free market for the hangover and take another set of drugs.

Keynesianism has had such a profound effect on world politics; it is showing its ill effects till the present date. I regard Keynes to be second only to Marx in creating misery for the masses. But in a way Keynes was more dangerous than Marx because he worked under the garb of optimizing the market, an idea which catches the imagination of those who have a superficial understanding of what a free market is. Marxism, the ultimate form of collectivism, can be rejected even with a superficial application of the mind.

But superficial application of the mind draws you to Keynesianism and that is the real danger. Keynesianism has been used as a political tool by politicians throughout the world, throughout the decades, to provide transient bliss to the people and win elections. When the effects of Keynesianism show up with time, they are blamed onto ‘inherent instability’ of the free market which the politician is ‘fixing’ with Keynesianism.

And this stimulated consumption has summarily destroyed the environment which the American left feigns so much love for.

Even the ‘great’ Indian ‘economist’ Dr. Manmohan Singh has spoken in favor of a Keynesian stimulus as recent as in 2009. The state of the Indian economy under Marxist Sonia Gandhi and Keynesian Manmohan Singh could evidently have not been any better than it is now.

It is said by some that Friedrich August von Hayek, our protagonist here, lost the debate to Keynes. The Keynesian revolution was too much for him to handle. This conclusion reflects more on the economic illiteracy of the masses rather than anything else.

Monetary policy and its dangers

The primary tool of Keynesianism is monetary policy especially post the dismantling of the gold standard, though even fiscal policy can be substituted for qualitatively similar effects. Why monetary Keynesianism is much more dangerous than fiscal Keynesianism is because fiscal Keynesianism receives a pushback from people due to the increased taxation involved, whereas the monetary variant can be done under the hood, and the resulting inflation tax can be conveniently blamed on the ‘greedy’ capitalist.

But for the sake of our discussion let’s focus on the ill effects of inflationary monetary policy on the environment. How does inflationary monetary policy work? The central bank of a country artificially reduces the interest rate below the market rate. The resulting elevated demand and reduced supply for credit is handled by creating fiat money by the monopolistic central bank. Cheap credit accelerates economic activity above what the free market allows. And the resulting byproduct is environmental degradation. And when you keep doing this for more than half a century throughout the world except for brief recess, you will surely create a lot of degradation. A whole load of it.

And then you can demand more governmental spending to solve the new problem you have created. That’s the primarily ‘business model’ of the American Democrat party though neither the Republican Party is blameless on this. One of the most fatal blows to the free market actually came from Richard Nixon when he completely dismantled the gold standard which could have kept politicians on a leash.

Let’s not cheat the poor

Monetary expansion is not only detrimental to the environment, it is unethical. To understand this let’s look at the idea which Nobel prize winning economist Joseph Stiglitz has popularized in his documentary explaining why laissez faire won’t work:

“A bank is a place that will lend you money if you can prove that you don’t need it.”

That’s absolutely correct. So what happens when you artificially reduce the rate of interest below the market rate? Due to the precise idea that Stiglitz popularizes, the newly created fiat currency lands in the hands of those who already have a lot of money! I hear you guys whispering that this sounds like ‘trickle down’ economics and you are absolutely right. It precisely is and its distinctive characteristic is that it does not trickle down.

The hypocrisy of the century unfolds when you hear Stiglitz justifying monetary expansion and denouncing trickle-down economics in the same sentence. I know what Stiglitz’s excuse will be. Tax reduction is trickle-down economics whereas monetary expansion is not. I will let the reader decide which of the two, leaving the money you earned in your hands or giving the rich money they never earned, is trickle-down economics.

Keynesianism is one of the major contributors to wealth inequality and it’s not difficult to understand why.

How the GDP race is blinding us

Countries generally measure their economy’s health with Gross domestic product. But is a higher GDP necessarily better overall when we include environment in the picture? Will a 50% GDP growth rate per annum be awesome for the society? This will of course give us lots of products and services to consume! Do we want to get there? What is the right number?

First let’s look at a few facts. All economic crashes have been preceded by periods of higher than average GDP growth. Environmental degradation generally matches the rate of production and consumption in the economy. So does that mean a lower GDP growth rate is better?

Actually all facts above are true. And the only system known to man which can work when multiple opposing motivations exist is the market mechanism of dispersed decision making.

Why not reduce GDP growth rate below the free market rate and save the environment?

Theoretically Yes. But in the real world, you will require governmental action and governmental monopolistic power to achieve this reduced level of productivity than the voluntary market. Welcome to the Marxist heaven. This is precisely what Marxists are trying to do worldwide though with other stated intentions.

Who in the biggest sufferer of government actions to reduce GDP growth disguised as egalitarianism? It is the poorest because the relatively well-off cozy in towards the government and can scrape through the reduced productivity.

Are we ok with making our air cleaner by killing off the poor? I am not.

Governmental action on global warming

More contemporary non-Marxist governmental action to reduce pollution comes in two forms. One is environmental regulation. The other is the ‘pay as you pollute’ model. When they work as intended, both are mathematically same.

The environmental regulation model is the most common solution presented. It will improve the environment for sure. But at what cost? At the surface it seems this solution is going to prevent the greedy capitalists from degrading our environment for their profit motive. But is it that simple? Let’s see. Regulation which prevents activities which cause pollution will move capital from industries which come under the ambit of this regulation to industries which don’t. In effect, increasing investment in eco-friendly technologies and that’s good.

What else will it cause?

It will increase the price of many commonly used products. As an example, it will increase the price of plastic manufacturing. Plastic is used by poor and rich alike but what happens when the price of plastic increases. The rich will need to spend more and their savings will decrease without reducing their overall standard of living because by definition the rich’s income far exceeds their spending and the difference is called savings. But what happens to the poor. Poor by definition has an income barely equaling their spending. What happens when the poor needs to increase their spending due to government regulations. He is forced to reduce his standard of living so that his spending match his income, his savings in all cases stays close to zero.

Are you ready to sacrifice the poor for cleaner air? For me it’s a very difficult question for which I don’t have an answer. But one thing I can say for sure that we first need to dismantle Keynesianism.

Scientific advances on environment preservation

Won’t it be great if we use science to develop technologies which produce less pollution than existing technologies? Totally! But what’s important is how you do that. If this happens through the private market, everything is well and good. But what if no private player is ready to venture into this for whatever reason may be due to high costs. This is the standard argument used by socialists to justify governmental control of capital. Let’s see what it means.

When government spends taxpayer money to promote and develop green technologies, who benefits and who pays?

Everybody benefits equally and everybody pays equally. Sounds nice right? So Mr. Bill Gates pays 10 cents and gets some amount of fresh air and a poor villager also pays 10 cents and gets the same amount of fresh air.

If you think this is justified, you need to grow out of the Marxist theory of objective value. The same product has different value depending on who you ask. Bill Gates will be quite ok with paying these 10 cents for another breath of clean air. But will a poor person who is not sure where his next morsel comes from be ok with this deal?

Someone might say that the poor guy is not paying anything, he does not pay taxes and so this argument is absurd. Who do you think owns the tax money after it has been paid to the government?

The Keynesian seduction

Keynesianism is just another seductive ideology on the lines of Marxism which promise prosperity without productivity. Both are collectivist; with Marxism relying on dismantling the market through suspending property rights while Keynesianism dismantling the market by suspending honest accounting.

It is quite evident that increased prosperity cannot be obtained by redistribution because this distorts the incentives for production. Yet Keynesians are steadfast on the idea that spending what you don’t have is the path to prosperity. A celebrity justification for Keynesian monetary expansion comes from Nobel Prize winning economist Paul Krugman, who follows a variation of the Keynesian idea which these people call ‘New Keynesian economics’.

Sure it is new, but it still is Keynesian. I vaguely remember some story about the devil changing its form when people started recognizing it but cannot exactly recollect the details, so let’s forget that.

When told that its quite obvious that consuming more will not solve a problem caused due to overconsumption and you can consider any family to understand this simple idea, this is what Krugman responds with. A family and the economy are different coz in an economy one person’s expenditure is another person’s income whereas this is not the case with a family.

Let’s for argument sake agree that Krugman makes sense. Let us say that the head of the family starts a coupon mechanism in the family which are exchanged among the family members. So the son gives her mother a few of the coupons when she prepares breakfast for him. He gives a few coupons to his dad when he drops him to school. And the father gives his son a few coupons when he mows the lawn. So we have now removed the difference pointed at by Krugman.

Now if the head of the family starts producing more of these coupons will it make the family more prosperous? If it does in the short run, will that be sustainable?

Krugman will take refuge in some arguments about the size and complexity of the system while evading the specific question as to what exactly is the difference! The biggest con job here is to totally ignore the reasons which brought you into this state of high debts in the first place.

The Keynesian seduction is so intense that even brilliant minds like Milton Friedman while realizing this is not the best approach, have succumbed to the idea that a system of centralized monetary expansion can be made to work. Monetarist ideas, to whatever extent, tried by Alan Greenspan have backfired due to the inherent contradictions of the idea.

Theft is bad. But most of these economic ideologies try to somehow prove we can live with it. Austrian Free market ‘fundamentalists’ are clear. Theft is bad and if you steal you must pay. But these other ideologies try to paint the picture differently. Keynesians say that if your theft is caught, steal from someone else and repay and enjoy life!

The Marxists would say the government should steal everything so that there is nothing left to steal and this way the problem of theft is solved! Monetarist are slightly saner advising thieves that they should steal predictably like for example only on odd days of the month so that people can manage their finances accordingly by taking into account the losses they will face on odd days.

What should we do right now to tackle global warming?

Step One, stop Keynesianism in any form.

Step Two, Let the people form non-governmental organizations which use voluntary contributions from people for green activities, unhindered by government.

Step Three, Convince people that this is an issue which needs their attention in any form possible but don’t use the coercive government for this convincing activity.

Any governmental involvement needs to be thought through keeping in mind the effects on the least privileged among us. Using tax money for green causes is not such a good idea as some people want us to believe. Free markets don’t solve all problems for you but they at least don’t create new problems like Keynesianism does.

Citations

1. P Vaidyanathan Iyer, “PM warns G20 fiscal stimulus is too small” Indian Express, April 2 2009, accessed June 29 2014
2. Big Ideas That Changed the World, Season 1, Episode 6 – Capitalism
3. Paul Krugman, “The Austerity Agenda” The New York Times, May 31, 2012, accessed June 23, 2014,

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Gaurav Sinha

Gaurav is a Software Engineer currently employed with Amazon.com in USA. Gaurav graduated from IIT Delhi in 2007 with an Integrated Masters degree in Mathematics and Computing. He is deeply interested in physics and economics and spends most of his free time reading and thinking about these topics. He closely follows political developments in both India and USA and has strong views on both.