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NEW YORK — Does this sound familiar?
Central bankers who are so concerned about the threat to their currency that they demand that austerity be imposed upon angry citizens. Political leaders who, facing a deep recession that has led to large-scale unemployment, insist that the only route to recovery is to cut public spending, pay off national debt and impose higher taxes.
How about this? Economists, doubting the wisdom of bankers and lawmakers, argue that the best way to avoid a decade of lost jobs and economic stagnation is to borrow and spend to promote economic growth. They are ignored in favor of a creed that deems government intervention damaging to business confidence and the self-restoring effects of the market.
Eighty years ago, the coalition government of the British prime minister, Ramsay MacDonald, faced an almost identical set of choices to those now confronting the policy makers who run the euro zone, not to mention the slightly different circumstances challenging U.S. and British economies today.
MacDonald, caught in a world recession and saddled with defending an ailing world trading currency "” the pound sterling "” clung to what came to be known as The Treasury View, a program of deep public spending cuts and a belief that the market would eventually restore economic growth. The policy didn't work and its legacy was a lost generation unable to find jobs.
Chief among the critics of the British government was John Maynard Keynes, the economist from King's College, Cambridge, of whom the philosopher Bertrand Russell said, "?"?When I argued with him I felt I took my life in my hands, and I seldom emerged without feeling something of a fool.''
Keynes proposed a revolutionary way of reviving a flagging economy. He argued that the Bank of England should keep interest rates low so businesses could borrow cheaply, and that taxation should be sharply cut to promote spending. He also advocated putting the unemployed "” at the time, 11.4 percent of the labor force "” to work building roads and housing projects.
To the faint hearts afraid that such measures would run up crippling government debt, Keynes said there would be time enough to pay down the borrowing when the economy was booming again. There was no need to worry about the long term, he famously wrote, for "?"?in the long term we are all dead.''
In the autumn of 1931, Keynes was confronted by a bold and articulate foe, Friedrich Hayek, a young Viennese economist summoned by the London School of Economics to counter the potent ideas emanating from Keynes. Hayek was a member of the hard-headed Austrian School led by Ludwig von Mises, who argued that the market was self-correcting and that any interference by governments would end in disaster.
In broken English backed by intricate triangular diagrams, Hayek described why he believed that any attempt to trick the market into creating jobs would prove futile. Factories that expanded with cheap money may for a while take on extra workers to meet the artificial demand, he said, but unless the cheap rate continued indefinitely, plants would close and the new jobs would be lost.
Before long, Keynes and Hayek set out on an intellectual duel that came to define the debate still raging today about whether governments should intervene in the economy. At first through learned journals, then in private letters, the two men thrust and parried. Hayek came out punching, setting off a caustic, vituperative, unforgiving scrap in which Keynes, 16 years older than Hayek, felt he was not being treated "?"?with that measure of "?good will' which an author is entitled to expect of a reader.''
The dispute was so venomous that older hands rushed to pry the dueling dons apart. Arthur Pigou, a renowned professor of economics at Cambridge, scolded them for employing "?"?the method of the duello'' and clawing at each other "?"?in the manner of Kilkenny cats.''
After gallons of ink had been expended, Keynes grew bored and the dispute petered out without a clear conclusion. But the battle continued by proxy, with Keynes's disciples, the "?"?Cambridge Circus,'' relishing their bruising scuffles with the "?"?Austrians'' at the L.S.E., who raised Hayek's standard aloft.
Each of the two economists vowed to expand on his philosophy. Keynes published his magnum opus in 1936, "?"?The General Theory of Employment, Interest and Money,'' a complex and often incomprehensible work that inspired young American economists, including Milton Friedman and John Kenneth Galbraith (who eventually ended up on opposite sides of the intellectual and ideological divide), to apply the new creed in Franklin D. Roosevelt's New Deal.
Hayek's efforts at a masterwork fared less well, and he failed to find the perfect riposte to "?"?The General Theory.''
While Keynes felt he had won the argument, he remained doubtful that politicians would try his ideas on the grand scale he prescribed except in dire circumstances, like a world war. As it turned out, of course, he did not have to wait for long. In response to Hitler's expansionism, in the mid-1930s the democracies borrowed heavily to rearm before the Nazi storm broke over Europe.
World War II appeared to prove Keynes's contention that if, at the bottom of the business cycle, governments borrowed and spent on a huge scale they could make sure that unemployment did not rise to painful heights. From 1945 to 1975, with the help of Keynesian spending, the Western world enjoyed unprecedented prosperity.
Undeterred by Keynes's success, Hayek kept plugging away and in 1944 his book "?"?The Road to Serfdom'' opened a second front against his rival. Chilled by the lessons of Hitler's Germany and Stalin's Russia, Hayek concluded that the larger the size of the state, the more likely it was that individual rights would be trammeled.
In the mid-1970s, when Western economies were plagued by the debilitating combination of inflation and stagnation that came to be known as stagflation, Keynesianism appeared to have run its course. Hayek's ideas were lifted from the bookshelf, dusted off and looked at afresh. The result was monetarism "” conceived by Milton Friedman, who had fallen under the spell of Hayek and agreed with his fiscal conservatism and belief in keeping government small "” in which inflation was to be contained by only incrementally and predictably increasing the supply of money.
Fast forward to the financial crisis of 2008-9, when, as in the early 1930s, the world economy again faced an existential threat and the imminent collapse of the financial system. Without a second thought, George W. Bush and his G-20 allies reached not for Hayek but for Keynes. They supported ailing banks with giant government loans and headed off a calamitous recession with a trillion-dollar Keynesian economic stimulus.
But no sooner had the measures been put in place than there was buyers' remorse from angry voters, most notably the Tea Party protesters in the United States, who demanded that the debt be paid off without delay. It was if a starving man had been served a square meal, only to have his stomach immediately pumped.
The argument over whether to stimulate the economy or let the markets clear on their own continues to dominate politics on both sides of the Atlantic. The battle lines remain the same as those drawn by Keynes and Hayek, and the tone is just as sharp.
Leaders face the same choices: to cure unemployment or risk inflation; to introduce a stimulus or impose austerity; to borrow and spend or tax and repay debt.
One side still hankers after a traditional Keynesian stimulus. President Barack Obama's stillborn Jobs Act is a thinly disguised $500 billion stimulus to create employment largely through spending on infrastructure. The other side echoes Hayek's two-pronged attack on Keynes: that stimulus doesn't work and wastes taxpayers' money; and that government takes up too large a share of the country's income.
In Britain, Hayekians in the Conservative/Liberal Democrat coalition of Prime Minister David Cameron "” inspired by Margaret Thatcher's championing of their hero in the 1980s "” relish the reduction of public spending in the name of economic prudence. In Europe, the German-French pact to keep European political integration on track demands that the price for continued euro zone membership for countries that ran up big public and private debts "” Portugal, Spain, Ireland, Italy and Greece "” be a smaller state sector and balanced budgets.
In this rematch of Keynes and Hayek, Hayek is at the moment in the ascendant. Europe has set out upon a decade of painful austerity, promising to slowly repay debt and force swollen governments to shrink. In the United States, all the Republican candidates back Hayek's message of fiscal rectitude and smaller government. So has Hayek won the 80-year-long contest?
It's too early to tell. There is a significant political price to pay for reducing the size of the state and paying off public borrowing. Economic growth slows and already high unemployment increases. Disillusionment with the political leaders who preside over such a mess may drive the voters to the extremes. In Europe in particular, these are treacherous times.
Keynes first found fame when he resigned in 1918 from the Allied team planning to impose crippling reparations upon the defeated Germans in the Treaty of Versailles. His "?"?Economic Consequences of the Peace'' was a masterpiece of invective that warned that deliberately impoverishing an advanced industrial country would encourage extreme political movements that might provoke a second world war.
He was right. Weimar Germany was buffeted by civil unrest and revolutions; its tenuous democracy was discarded in favor of Nazism. It is just such a risk that Angela Merkel and Nicolas Sarkozy run today when they preside over the deliberate beggaring of their weaker European neighbors.
Nicholas Wapshott is the author of "?"?Keynes Hayek: The Clash That Defined Modern Economics.''
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