Who is to blame for the continuing financial chaos?
 
In a recent post on Baseline Scenario, Simon Johnson and Peter Boone make a strange argument:  "According to Friedrich von Hayek, the development of welfare socialism after World War II undermined freedom and would lead western democracies inexorably to some form of state-run serfdom.  Hayek had the sign and the destination right but was entirely wrong about the mechanism.  Unregulated finance, the ideology of unfettered free markets, and state capture by corporate interests are what ended up undermining democracy both in North America and in Europe. "
The post goes on to detail how they think the European crisis will work out -- continued fiscal crises and collapses, with massive defaults and lower living standards on the horizon.  They are probably not far off target; the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) problems are not problems of liquidity that can be "bailed out," but problems of insolvency.  Someone will bearing massive losses, and the fight over who this will be will generate continuing political turmoil.
 
But Johnson and Boone headline their piece with this strange reference to Hayek, and as Hayek was more or less an advocate of unfettered markets, I gather they are laying some of the blame on him.  I guess they don't see the irony in: "Unregulated finance, the ideology of unfettered free markets, and state capture by corporate interests are what ended up undermining democracy both in North America and in Europe. "
 
Regulatory capture is exactly one of the things Hayek explicitly warned of.  He called it "corporatism," and recognized it as destructive of liberty and prosperity.  Furthermore, Hayek's work in business cycle theory specifically addressed the kinds of monetary and fiscal manipulations that led to our current crises.  These are not examples of the "unfettered free market" nor "unregulated finance," but of government intervention and so-crony capitalism (better called corporatism or mercantilism).  Hayek's work was so heavily focused on these issues that one can only assume Boone & Johnson haven't read any of Hayek at all.  It's shameful to misrepresent him this way.
 
It's hard to understand why this smear of Friedrich Hayek was tacked onto their essay.  But if they want to take a poke at a "defunct economist," they'd do better to take on John Maynard Keynes, the man who invented the modern macro policy that has brought PIIGS, and much of the rest of the world, to the brink of bankruptcy.  It was Keynes who taught us that spending creates prosperity.  It was Keynes who assured us that productivity doesn't matter -- just spend and let the multiplier create wealth.  It was Keynes who chided "The long run is a misleading guide to current affairs. In the long run we are all dead."
 
There's more to the financial crises than just Keynesianism.  But Keynes did indeed preach the kinds of fiscal and monetary irresponsibility that have crucial factors.  And none of what has happened would have surprised Hayek, had he seen it.  It's surprising that Johnson, who usually is careful in his analysis, would make such a bad argument.  If the idea was to blame "free market fundamentalism" for the crisis, it falls entirely flat.  Fiscal irresponsibility by governments, burgeoning and unsustainable welfare states, currency manipulations by central banks, and control fraud by a protected financial system are not the free market.  They are exactly the things Hayek warned us against.