How Hayek engaged Keynes




The greatest debate in the history of economics began with a simple request for a book. In the early weeks of 1927, Friedrich Hayek, a young Viennese economist, wrote to John Maynard Keynes at King’s College, Cambridge, in England, asking for an economic textbook written 50 years before: Francis Ysidro Edgeworth’s exotically titled “Mathematical Psychics.” Keynes replied with a single line on a plain postcard: “I am sorry to say that my stock of ’Mathematical Psychics’ is exhausted.” 

    Why did Hayek, an unknown economist with little experience, approach, of all people, Keynes, perhaps the best-known economist in the world? For Keynes, Hayek’s request was just another item in his bulging postbag. Cambridge’s economics prodigy retained no record of Hayek’s request, even though he was so conscious of the contribution he was making to posterity through his daring approach to the study of political economy that he had taken to hoarding each scribbled note and every last letter. His posthumously published papers, even when edited, fill dozens of volumes. 

    Hayek, meanwhile, seemed fully aware of the significance of his request. He treasured Keynes’s bald reply and preserved it for the next 65 years as a personal memento and professional trophy. The postcard sits today in the Hayek archive at the Hoover Institution on the Stanford University campus in California -- tangible evidence that Hayek had instigated the first contact in what would become an intense duel over the role of government in society and the fate of the world economy.

Scarce Resources

Edgeworth interested Hayek because one of the subjects he explored at length was a topic that would come to engage both Keynes and Hayek: how scarce resources can best maximize the “capacity for pleasure.” The forbiddingly titled “Mathematical Psychics: An Essay on the Application of Mathematics to the Moral Sciences,” published in 1881, was Edgeworth’s best-known work. It anticipated a great number of the debates that would entangle economists over the next century, including notions of “perfect competition,” “game theory” and, most important for the impending battle between Keynes and Hayek, the belief that an economy will reach a state of “equilibrium” with every able- bodied adult fully employed. Edgeworth was also an early expounder of theories about money and the monetary system, which by 1927 both Keynes and Hayek had already addressed at length.

Slender Pretext

There was a pretext, albeit slender, that might have prompted Hayek to reach out to Keynes: Keynes had succeeded Edgeworth as editor of the Economic Journal in 1911. But why Hayek should expect Keynes to possess what Keynes jokingly refers to as “my stock of ‘Mathematical Psychics,’” as if he maintained a secret hoard of Edgeworth’s forbidden works, is hard to fathom.

    Though Edgeworth was little remembered even among U.K. economists, “Mathematical Psychics” was commonly available. While a profound division existed between the British school of economics, centered around the teachings of Keynes’s mentor, Alfred Marshall at Cambridge and the continental variety, which focused on the theories of capital investment (the money invested in a business) expounded in Vienna by Hayek’s mentor, Ludwig von Mises, there was a good deal of contact, and a fair degree of misunderstanding, between the two camps.

Mercantilist Tradition

Marshall’s economics was based on a common-sense understanding of the subject and how business worked in practice, emanating from the mercantilist tradition that had made Britain the most successful commercial nation in history. The notions of the “Austrian School” were more theoretical and mechanistic, deriving from an intellectual, rather than a practical, understanding of how business might work.

    The Austrians mostly read English and were conversant with, if not persuaded by, the English tradition; the English, on the whole, couldn’t read German and largely ignored the works of Austrian and German theorists. But such was the bond between academics that national borders meant little. The trading of books and journals continued throughout the horrors of World War I, even when scholars found themselves on opposite sides of trench-dug borders. The philosopher Ludwig Wittgenstein, a friend of Keynes’s at Cambridge and a distant cousin of Hayek’s, wrote to Keynes while serving in the Austrian army on the Italian front, asking for a new volume by the Cambridge philosopher Bertrand Russell: “Could you possibly send it to me and let me pay for it after the war?” Keynes duly obliged.

Famous Worldwide

Even if Hayek couldn’t find a copy of “Mathematical Psychics” in the University of Vienna’s extensive library, it was a stretch to imagine that his next port of call should be the world-renowned Keynes. Keynes was not merely a fellow of King’s College, Cambridge, teaching economics to undergraduates. At age 42, he was famous worldwide because of his role as a British Treasury negotiator at the Paris Peace Conference, the precursor to the Treaty of Versailles, which brought the cataclysm of World War I to an end. By revealing to the wider public the intense xenophobia and nationalistic spite that had guided the Paris deliberations, Keynes had become a celebrated figure not only in Britain but also in Europe generally, particularly in the defeated nations of Austria and Germany.

Precocious Understanding

Keynes’s precocious understanding of economics and public finance was so considerable that when Britain declared war on Germany in 1914, he was recruited to negotiate an enormous loan from American creditors. The borrowing was vast not only because it funded Britain’s worldwide war effort, in defense of an empire that covered half the globe, but also because American bankers didn’t trust the French and Italians to meet their repayments, leaving Britain to indemnify its allies. Keynes’s efforts were so ingenious, and his charm so effective in cutting through bureaucracy, that when the war ended, Keynes joined the team to advise on how to make the Germans pay for causing so much death and devastation.

    The war was the most destructive in history up to that time. At its root, the struggle between the Central Powers of Germany, Austria-Hungary, Turkey and Bulgaria versus the Allies, made up of the U.K., France, Russia and, eventually, the U.S., was over territory and world trade. The conflict marked the end of a chivalrous age and the dawn of the modern era. Cavalry and bayonet charges slowly gave way to tank battles, chemical- weapons attacks and aerial bombardment.

Four Terrible Years

After four terrible years, the Germans were starved into submission, and by the armistice in 1918 almost 10 million in uniform on both sides lay dead, a further 8 million were “missing,” more than 21 million had been wounded, and about 7 million civilians had perished. A generation of young Europeans had been slaughtered or maimed.

    As Hayek recalled, Keynes was “something of a hero to us Central Europeans” owing to his courageous condemnation of British, French and American leaders for levying crippling reparations on those in the remnants of the defeated alliance. His damning account of the Paris talks, “The Economic Consequences of the Peace,” was published just months after the Versailles treaty was signed, and became an instant worldwide sensation. Keynes’s predictions that the burdensome reparations would lead to political instability and extremist politics, and that they might spark another world war, would turn out to be chillingly prescient.

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