If there had been no Great Depression in the 30s, there would have been no Keynesian Revolution.
The world of economists was thrown into a state of crisis as a result of the economic
collapse of that time.
The prevailing paradigm of English neoclassical economics was better suited for the analysis
of long-term problems of economic growth rather than problems of discoordination.
In today's conventional wisdom, it is customary to assert that the analysis of the English
This neoclassical school led to the conclusion that recessions could not occur.
Know this to be gross oversimplification, but it is not at all unfair to claim that
the prevailing orthodoxy of the English neoclassical school established a thought framework that
was incompatible with disturbances other than those of short duration, wherein self-correcting
mechanisms would quickly be apparent and effective.
The depression of the 1930s did not cause a crisis for theory because it was severe.
The crisis arose because the contraction appeared to exhibit no self-correcting tendencies.
In short, the economies of Europe and America were not only depressed, but appeared to be
in a state of equilibrium to the economists of that day.
This appearance of equilibrium was what created the dissonance between the apparent state
of the world and perceptions engendered by the prevailing orthodoxy.
Keynes and those who listened to them were in search of an explanation of how such a collapse could take place and what could be done about it.
Keynes offered such an explanation, but more importantly, the analytical apparatus that he offered led to some simple and direct conclusions as to what could be done in the way of collective action to remedy the depression.
After a while, the Keynesian vision of the way in which an economy functions became the prevailing orthodoxy.
Over the succeeding five decades, the depression economics of Keynes has created an unconscious depression myopia that has constrained the abilities of mainstream economists in their analyses of the workings of the economy and it has led to substantial failures of misguided policies.
Just as Keynes once envisioned himself as trying to free economists from what he saw as the intellectual straight jacket of the pre-Keynesian worldview,
Econimists are now faced with the necessity of unshackling themselves from a Keynesian
world view that is unsuited to the analysis of the functioning of the real world economy
in which we live. Granted that the Great Depression was the event that spawned the Keynesian world
view, the ascendancy of Keynesian economics was by no means inevitable. The early twentieth
century development of what we now call macroeconomics in the hands of the Austrian School, most
Those particularly, Ludwig von Mises and later Friedrich Hayek, provided an analytical apparatus
that could have been the source of answers for which the profession was searching. This
outcome might have come to pass, one can speculate, had Anglo-Saxon economics not evolved so much
in isolation from the very rich development of the Austrian tradition, particularly with
respect to capital theory. It is indeed the case that most students of economics of the
in the last four decades are unaware of what John Hicks reminds us, that in the early 1930s,
the new theory of Hayek rivaled the new theory of Keynes, and that it was by no means clear
which perspective would prevail. Of course, Austrian cycle theory was a lot newer to British
economists than to European economists. Whereas much of Keynes' theory was slapped together
in response to the economic collapse, the theories of Mises and Hayek, as elucidated
during the 1920s were built upon the earlier works of Wichsel and Boehm-Bawerk and were
capable of predicting the collapse of the 1930s before the fact. Even Keynesian economists
must admit that the theory of Keynes can at best explain why a depressed economy cannot
recover quickly, but cannot even pretend to explain why the collapse of aggregate demand
takes place. Explaining a depression by a collapse of aggregate demand is to use a depression
to explain a depression. It is very circular type of reasoning. Resort to speculative market
collapses and animal spirits is an intellectual refuge. Ironically, the epicentricity of Anglo-Saxon
economics rendered the simplistic Keynesian mechanisms easier to understand for economists
reared in the Marcellian tradition than the richer, much more complete Austrian analysis,
despite the fact that Austrian analysis was much more consistent with the basic microeconomic
Principles that form the basis of pre-Keynesian neoclassical economics.
That the lack of familiarity with the Austrian mode of analysis made the contest difficult
for Hayek seems clear, but the most important reason for the eventual prevalence of the
Keynesian perspective is more fundamental.
The psychological trauma associated with the collapse led to an intense desire for a policy
prescription, a collective action that would end the depression.
Office and politicians intensely wanted intellectual support for their desire to direct the economy.
Keynes provided the academic respectability to governmental actions such as the New Deal
that were already underway and that office holders would have wanted with or without
academic respectability. Austrian cycle theory could not possibly rationalize Keynesian-type
Policy Prescriptions. As Schumpeter put it, there cannot be any doubt that it, that is
the general theory, owed its victorious career primarily to the fact that its argument implemented
some of the strongest political preferences of a large number of modern economists. Politically,
Hayek swam against the stream. The contention, such as Schumpeter's, that there is a demand
for Keynesian Theory that is derived from a demand for Keynesian conclusions is an important
one. It is important not only as an explanation of how Keynesianism came into its original
dominating position, but also as an explanation of much of the subsequent history of twists
and turns in the development of Keynesian reasoning. It is particularly important in
explaining the reaction of Keynesian economists to their own intellectual crisis during the
1970s and 80s, and that reaction is at the core of much of what follows in this assessment.
In Keynes, Keynesian economics developed along two lines that although linked by a common
ancestry to Keynes, have evolved so distinctly as to be incompatible with one another. One
of these is the school that in time came to label itself post-Keynesian. Because that
school of thought essentially rejects marginalism, its evolution has been cut off and isolated
from virtually all of the rest of subsequent development of economic thought, as the acceptance
The second line of development is that which most American students of economics are familiar.
As that second line of development emerged, different labels were attached to it as it
went through various phases. Stemming from Hick's development of the ISLM analysis,
the second line has sometimes been labeled neoclassical, other times as bastard Keynesian.
I would prefer to use the label Orthodox Keynesian to distinguish it from the most recent evolutionary
strain of Keynesian economics to which the label Neo-Keynesian or New-Keynesian applies.
The Orthodox Keynesian approach is characterized by an adherence to the ISLM apparatus, an
inflation-unemployment trade-off, i.e. the Phillips curve, and an intertemporally persistent
structure of the economy that permits the use of monetary and fiscal policies as devices
for Stabilizing or Fine-Tuning the Economy. Orthodox Keynesianism is also associated with
the notion of quantity adjustments and thus income as the principal equilibrating mechanism
of the economy. More importantly, it is associated with the potentiality of a macroeconomic equilibrium
of less than full employment. A distinction needs to be made between Orthodox Keynesianism
and the Neo-Keynesian school now emerging as the dominant strain. The essential distinction
is that while the neo-Keynesian school maintains an essentially Keynesian flavor, it is very
much influenced by the challenge raised in the 1970s by the rational expectations or
new classical critique of orthodox Keynesianism. At one and the same time, neo-Keynesian analysis
incorporates some aspects and reacts against other aspects of the new classical economics.
For example, the neo-Keynesians accept the long-run non-exploitability of an inflation
unemployment trade-off, unlike earlier Keynesians.
On the other hand, despite its influence by the rational expectation school, neo-Keynesian
analysis maintains a stabilizing role for monetary and fiscal policy.
It is probably safe to say that orthodox Keynesianism is in a state of eclipse, but that the Keynesian
and policy conclusions have re-emerged through the neo-Keynesian response to the intellectual
demise of orthodox Keynesian analysis. However, there's an obvious geographic dimension to
the current state of Keynesian economics. Post-Keynesian method seems to dominate as
it has for some time in Great Britain and to a degree in Europe, whereas neo-Keynesianism
is developing almost entirely in the United States. To be sure, there are American adherents
to the post-Keynesian paradigm. Eichner and Galbraith are obvious examples, but their influence
among academicians is quite small on this side of the Atlantic. I suspect that one reason
for this geographically based difference has to do with the fact that post-Keynesian analysis
revolves around the distribution of income, and European economists, the British in particular,
seem always to be obsessively concerned with distributional issues. At least in technical
Analysis, Efficiency is the primary focus of neo-Keynesian economists. While the most
modern of neo-Keynesians rejects the standard ISLM apparatus, it is clear that the primary
agenda of neo-Keynesian economists is to rationalize some of the ad hoc mechanisms of more primitive
Keynesian forms in order to preserve the major policy conclusions. The earlier Keynesian
chain of logic was most vulnerable in its analysis of the labor market wherein workers
The post-Keynesian solution was to deny the existence of a labor market, but the neo-Keynesian
and Solution is to try to portray the appearance of sticky wages and other Keynesian aspects
of the labor market as the result of individual optimizing behavior which is nonetheless inconsistent
with a social optimal, in other words, full employment. In other words, it is the outcome
of a market failure and market failure always provides the statist with all the justification
that he deems necessary for government intervention.
The identification of acceptance of the ISLM apparatus with Orthodox Keynesians but not
with the most recent collection of Neo-Keynesians is, I believe, correct but potentially confusing.
The ISLM apparatus was accepted by Friedman and like-minded monetarists after all, but
it was thoroughly rejected by the new classical economists. It is just as thoroughly rejected
by Post-Keynesians.
For someone wanting a way out of this taxonomical confusion, I recommend the book by Warren
Young.
Besides, I don't want to trespass too far into the territory that has been assigned
to others in this symposium.
A bit more trespass is necessary, though, in order to complete the historical setting
of the present state of the Keynesian episode, which for now has come to reside in the schools
of post-Keynesian and neo-Keynesian economics.
For this purpose, I find the classification of each of the five decades since the general
theory by Peter Sinclair to be highly useful, though I interpret much of the historical
detail differently. Sinclair labels the first decade after Keynes, that is 1936 to 1946,
as the decade of distilling. This is the decade of the mechanization of the Keynesian model
in the mislabeled neoclassical synthesis that produced the ISLM apparatus as the main tool
of analysis of orthodox Keynesianism. The years 1946 to 56 are identified as the decade
of data and dispute. Much of what went on during this decade dealt with the empirical
realization that the Keynesian consumption function could not hold as a long-run proposition.
Eusenberry's Relative Income Hypothesis, Modigliani's Life Cycle Hypothesis, and Friedman's Permanent
Income Hypothesis all emerged as alternatives to the primitive Keynesian consumption function,
although Friedman did the best job of reconciling the short-run Keynesian function with the
statistical relative constancy of the long-run average propensity to consume.
None of this caused any crisis for Keynesian economics, although it did bury the stagnation
thesis of Alvin Hansen, which thesis took the Keynesian consumption function as a
as a serious long-term proposition. Otherwise, these developments were seen as refinements
of the basic Keynesian model. And to this day, macroeconomic textbooks tend to employ
the primitive Keynesian consumption function in their expositions, relegating Friedman,
Modigliani and Duesenberry to separate and quite separable chapters or appendices.
The next decade, that is 1956-66, is labeled by Sinclair as the Decade of Dynamics. It
It is this decade that Keynesian economics begins a process of mutation, one eventually
leading in the post-Keynesian and the other in the neo-Keynesian direction.
Solow's so-called neoclassical growth model brought relative factor prices into play and
gave a place for capital labor substitution within a one-sector model.
In significant contradistinction to Austrian capital theory, capital was treated as homogeneous,
much as it was by Knight.
Knight, however, did not conceive of an aggregate production function, which in Austrian analysis is a logical impossibility.
Impossible or not, the aggregate production function has become a mainstay of mainstream dynamic economics.
They developed another strain of growth models in the Cambridge-England tradition that formed the basis of post-Keynesian dynamics.
These include the models of Kaldor and others who share a common ancestry going back to Kalecki.
Issuing any role for substitution, these models are driven entirely by income effects and they render determinate the distribution of income between the owners of capital and labor.
The absence of substitution effects from these models makes the concept of an aggregate production function meaningless in post-Keynesian analysis, and post-Keynesians have remained true to this concept.
But the rejection of the concept of an aggregate production function is based on the alleged nonexistence of factor markets, as conventionally perceived,
not on problems of aggregation over homogeneous capital goods, which problems form part of the basis for the Austrian rejection of an aggregate production function.
In any event, this is the decade in which Keynesian economics splits into mutually contradictory paradigms and which has produced a distinction today between post-Keynesians and neo-Keynesians.
The ten years of 1966-76 are labeled by Sinclair as the decade of disillusion. The disillusion
stems from the inability of the orthodox Keynesian model to explain what was going on in the
world at the time. The most primitive Keynesian models assumed fixed prices, hence the models
were inapplicable to questions about inflation, accepted full employment, beyond which the
so-called classical model involving a crude quantity theory of prices held as a so-called
Special Case. The introduction of the Phillips curve in the early 60s, at first as a Deus ex machina,
supposedly provided the missing link between the real sector and the price level. In time,
Phillips-type phenomena were incorporated into the most sophisticated Keynesian-based econometric
models, some of which ran into hundreds of equations. Even with the assistance of the
Phillips curve, however, the existent varieties of orthodox Keynesian models were utterly
The Uncompatibility with Stagflation was perhaps the key issue leading to the crisis for Keynesian orthodoxy and the demise of its mechanistic worldview.
The seeds of this intellectual crisis were sown by Milton Friedman's well-known presidential address, in which he described the transitory nature of the Phillips curve.
His depiction of labor market processes argued that money illusion, the key ingredient in Cain's weakest link, was a disequilibrium phenomena,
the effects of which would dissipate so that in the long run there could be no inflation-unemployment trade-off.
Now there were several responses among mainstream economists to the intellectual crises associated
with the demise of orthodox Keynesianism. One response was a growing popularity of post-Keynesian
economics. In many respects, this response was a return to the most primitive version
of Keynesian economics, wherein output determination is the subject of economic analysis, but money
wage and price level movements are seen as sociologically determined in a tussle over
for the Distribution of Income.
Hence, the crisis in Keynesian theory
over the incompatibility of rising inflation
coupled, at least sometimes, with rising unemployment
was resolved by in effect ignoring it
through seeking refuge in what is really
a non-economic theory of inflation.
The most dramatic mainstream response to the crisis
in Keynesian economics was the development
of the rational expectations approach to macroeconomics.
In the hands of Lucas, Sargent and Wallace, Barrow and others,
and others, the rational expectation story was at one and the same time a critique of
orthodox Keynesian reasoning as well as an alternative to it. The grounds on which the
early rational expectations proponents criticized orthodox Keynesian models were quite sound.
In its simplest form, their argument was that Keynesian models, particularly Keynesian policy
conclusions, were based on the illogical proposition that economic agents, in reacting to fiscal
and Monetary Variable Changes will make systematic errors. Rather than learning from the experience
of past policy, they will react the same way each time to say counter-cyclical changes
in the money supply. It would be impossible to gauge the amount of stimulus or restraint
needed in a given situation if agents react differently with learning, but orthodox Keynesian
models, even the most complicated, were based on assumptions of an intertemporally stable
School, behavioral structure of the economy.
As Roger Garrison and I have pointed out elsewhere, this basic truth of the Rational Expectation
School was anticipated by Mises as early as 1953.
The response of Orthodox Keynesian economists during the decade of disillusion was essentially
defensive.
The presidential address of Franco Medigliani, presented at the end of that decade, is a
good example of that response.
The best way to get the flavor of the response of the established Orthodox Keynesians is
to read the sections on Tobin and Solow in our Joe Klamers' conversations with economists.
What comes across quite clearly in that is a belief on their part that the rational expectations
or new classical approach is entirely too abstract and over-mathematically formalized,
but highly unrealistic in its basic assumptions.
Allegedly, it is the mathematical elegance of the new classical economists that accounts
for their widespread appeal to the mainstream of technically trained young economists.
This observation is entirely correct, but how ironic it is.
The cult of admiration of economic models for their mathematical elegance, after all,
is the product of the so-called Keynesian Revolution.
Rivals to Keynesian orthodoxy have always been scuffed at because they lacked such mathematical
rigor.
It seems now that orthodox Keynesianism has died upon the sword by which it once lived.
To Austrian economists, of course, the irony is hardly comforting. The rational expectation
school may have beaten the orthodox Keynesians at their own game, but the game was not worth
playing. Moreover, the game itself is a distraction from the serious task of building an understanding
of economic events. Sinclair labels his last period, which I believe can be extended to
The Decade of Debt, Doubt and Deflation
I'm not here concerned with the debt or deflation aspects, and in any event, disinflation would have been a more appropriate term.
The doubt to which Sinclair refers is the exceedingly unsettled state of affairs in macroeconomic analysis,
particularly the present disagreements between the new classical and neo-Keynesian economists.
Economists. This last period is also characterized by the coalescence of the
Neo-Keynesian, or as its adherents like to label it, New Keynesian school.
Neo-Keynesians, particularly during the 1980s, have not been content to
defensively react to the new classicals, but have in a sense gone on the
offensive. They have incorporated what they can of the rational expectations
perspective, and they have attempted to derive from individual maximization, the
and behavioral postulates that were just ad hoc mechanisms in Keynes.
Most significantly, they have directly confronted the policy and effectiveness conclusion of the new classical economists.
So at present, the Keynesian paradigm no longer commands the adherence that it once did.
And that paradigm is now represented by two schools, post-Keynesian and neo-Keynesian,
which are analytically distinct from one another and from Keynes.
However, these two subspecies of Keynesianism, like their predecessor species, continue to
provide the academic rationale for government control and manipulation of the economy, based
on a nearly religious belief in an inherently unstable private economy, and in the ability
of central authority to improve its workings.
Thus these schools and their associated cast of characters mirror to closer inspection.
So I'd like to turn first to the post-Keynesians. The post-Keynesian model has several distinctive
critical elements. The first of these is what I would call a Leontief view of production.
In this perception, fixed technical coefficients connect labor and capital, and this technical
fixity removes any possibility of varying the proportions in which inputs are used.
Hence, relative prices of capital and labor have no role in post-Keynesian analysis in determining the techniques of production.
Moreover, as a consequence of this view of production, per-unit variable costs do not increase as output expands.
Thus, the standard conception of an upward-sloping marginal cost curve and the derivative concept of an upward-sloping industry supply curve is seen by post-Keynesians as mythical.
The post-Keynesian view of production is most comprehensively stated by Piero Schraffa,
and his work on this topic has become the standard reference for the paradigm.
He has taken this view of production to its logical conclusion and value theory.
That conclusion is that relative product demand has no effect on relative prices.
Relative prices of inputs and the techniques of producing various products determine relative product prices.
The value theory that emerges is very much like the early 19th century labor theory of
value except that a composite called the basic commodity replaces labor as the origin of
all value. Perhaps it is this connection that leads some post-Keynesians to describe themselves
as neo-Bracardian. While the story of production of commodities by means of commodities, to
use their phrase, cannot be simply told within a limited space, the details of the story
are not necessary for a general overview of post-Keynesian economics.
It is sufficient to note that Shroff's contribution makes national output independent of wages
and prices. Wages and prices determine the distribution of income, and that distribution
depends on the struggle between organized labor and capitalists, government efforts
to alter that distribution, and on the rate of private investment. Thus, John Stuart Mill's
Post-Keynesians can pursue their grandest redistributive
schemes without any fear, on their part anyway, of its consequences for the well-being of
mankind.
is also subscribed to a markup theory of pricing. Having determined that price has nothing to
do with demand, they contend that the oligopolistic firms that dominate the economy determine
prices not in response to demand conditions, but rather in order to achieve a targeted
level of profits. That targeted level is determined by whatever amount of funds are necessary
in order to undertake the firm's investment plans, which in turn are determined by their
are perceptions of the capital necessary to meet future product demands.
The post-Keynesian perception of production and pricing also divorces inflation from any
demand considerations. Most particularly, the basic truth of the quantity theory is
emphatically denied. With markup pricing, inflation is all of a cost-push variety and
it is determined, nebulously, by the struggle over the distribution of income. Money is
is seen as endogenous, but in a peculiar way. The causal relationship between money and
prices that is seen by monetarists is reversed by post-Keynesians. As costs rise, businesses
apply their markup to prices. The higher prices may create a higher demand for credit, which
causes the banking system to expand the money supply out of excess reserves. If these excess
reserves run out, there are other sources of credit, such as expanding the repayment
Term. In most situations, this won't be necessary, as the central banking systems will usually
expand the system's reserves. If it doesn't, a liquidity crisis may result, but even then
the effect is on output exclusively. Within very broad limits though, monetary policy
really doesn't work at all in this view. As I mentioned before, the post-Keynesian view
The view of the labor market, as conventionally defined, is that it does not exist.
In the words of one post-Keynesian, neither the demand for labor nor the supply of labor
depends on the real wage.
It follows from this that the labor market is not a true market, for the price associated
with it, the wage rate, is incapable of performing any market clearing function, and thus variations
Money Wages in the Wage Rate Cannot Eliminate Unemployment
Money Wages, on the other hand, are determined by the relative power of unions and oligopolistic
corporations. This relative power can be affected somewhat by the degree of slack in the labor
market, but public policy and social custom are seen as much more important determinants
of that power. In any event, markup pricing dictates that prices will move with money
Wages. With wages, both money and real, as well as prices playing no role in employment
determination, it is simply aggregate demand variations, usually investment variations,
that given fixed proportions determine the level of employment. There's a great deal
more of course to post-Keynesian economics than can even be touched upon here. There
are two important surveys by post-Keynesians that are fairly comprehensive. One is an article
by Eichner and Kregel in the 1975 Journal of Economic Literature and another book edited
by Eichner. The articles in that book by Peter Kenyon, by Kregel, Applebaum and Bazelmore
are particularly useful. An important source of particulars of the post-Keynesian framework
are contained in articles published over the years in the Journal of Post-Keynesian Economics
which began publication in 1978. While there is an internal consistency in the post-Keynesian
model, it is clearly built on a set of ad hoc assertions and ideological jargon. As such,
post-Keynesian economics appears as a collection of non-sequiturs to most other economists,
even other Keynesians. In one sense, the development of post-Keynesian thought is stark apology.
It has no microeconomic foundations except for primitive pre-marginalist ones, and it
serves mostly to rationalize a collectivist control of the division of income according
to Class. With Marxism falling in credibility, the post-Keynesian effort to justify government
control of investment decisions and perpetual wage and price controls provides the next
best hope for those who just cannot accept economic individualism.
I'd like to turn now to an examination of the neo-Keynesians. Now post-Keynesians like
to think of their perspective as a direct outgrowth of the line of thought initiated
and the General Theory intend to view Orthodox Keynesianism as a distortion of Keynes' message.
There have been so many interpretations of what that message was that it is no simple
matter to determine the correctness of the post-Keynesian ancestral claim. What is easily
established is that the post-Keynesian system is quite distinct from Orthodox Keynesian
thought. The distinction between Neo-Keynesian and Orthodox Keynesian strains is far less
For one reason or another, some economists that I think of as Orthodox Keynesians are
sometimes referred to, without their objection, as New Keynesian, such as Tobin and Modigliani.
My basis of distinction is the identification of certain characteristics that mark a distinct
Neo-Keynesian strain. These characteristics are individual optimizing behavior, implicit
contracting, asymmetric information in the labor market, and efficiency wages. All of
These elements, when put together, are used to arrive at Keynesian conclusions, persistent
involuntary unemployment, and an effective role for demand management.
Put in the simplest terms possible, the task that Neo-Keynesians see themselves facing
is to explain equilibrium in markets, particularly labor markets, without market clearing.
The principal device for doing so is reliance on the concept of implicit contracting and
the related concept of efficiency wages.
The basic notion of implicit contracts is that both firms and workers would prefer wage stability
to employment stability. Hence a firm will respond in the short run to economic disturbances
by reducing output and employment rather than wages. To reduce wages in response to transitory
demand decreases would weaken the long-run profitability of the firm in this view. Moreover,
the firm may find that paying higher than market wages, and by inference that does not
The notion of higher than market clearing wages, called efficiency wages, seems to be one of the major empirical preoccupations of the most popularly known neo-Keynesian, Lawrence Summers.
Even when firms regard a change in demand as permanent, their workers do not know this.
Due to this asymmetric information, the only way labor, especially if organized, can be convinced to accept the wage reduction over the long run is for the firm to not attempt an immediate wage cut, but to first cut output and employment.
I guess anything kinder and gentler won't be believed.
And the workers displaced by the imperfection of asymmetric information in one firm won't find employment at lower wages elsewhere because other firms have implicit contracts with their own workers which prevent absorption.
Because these propositions are derived from models of utility maximizing workers and profit maximizing firms, subject to rational expectations,
Neo-Keynesians see themselves as having completed the task of providing a sound microeconomic foundation to Keynesian notions of how the world works.
Moreover, Keynesian rigidities, as explained by imperfect markets with asymmetric information,
are easily extended to other markets.
Joseph Stiglitz, one of the most important neokanesians, has done so for product and
credit markets.
Neokanesians perhaps should be applauded for their efforts at undermining the equilibrium
always mindset of the rational expectations or New Classical School.
The neo-Keynesian mindset seems to suggest that if they can convincingly argue that markets
do not clear continuously and that unemployment is not necessarily a disguised form of voluntarily
chosen vacation, then they can conclude that the basics of Keynesian economics, including
its policy prescriptions, are maintained intact. But that conclusion does not follow. The literature
on implicit contracts, at the basic level, provides some insights into the complexity
of Real World Labor Markets.
But the contention that a perpetually inefficient labor market results is simply erroneous.
In the real world, workers face an array of implicit contracts, offering a wide range
of opportunities to trade off earning stability for employment stability.
The existence of such a range is welfare enhancing, not a market imperfection.
The implicit contracting idea may be quite incompatible with the continuous market clearing
Hayek's thoughts on the evolution of rule-following behavior are quite amenable to the basic notions
of implicit contracting theories.
Yes, we know that we live in a world of uncertainty and imperfect information, and that this affects
behavior.
If some want to label the resulting behavior as a mark at imperfection, so be it.
But to conclude that a case is thus made that government intervention into markets can improve
the overall performance of the economy is just wrong. It is a conclusion that does not
follow from the fact that we live in a complex, uncertain world. The whole thrust of modern
Austrian analysis points to the conclusion that complexity and uncertainty make it impossible
for government to improve the coordinating tendencies that underlie market activity.