Hayek on Eurozone Crisis - Economics Help

This is an article published in the LSE about the Austrian view of the Eurozone crisis ‘The Work of Hayek shows why EU governments can’t spend their way out of problems‘

I’ve attempted to summarise the article, but I advise reading it for yourself:

The recent boom and bust was caused by artificially low interest rates and capital flows which caused an inefficient use of resources.
The current period of high unemployment and low interest rates means there is much idle capital and labour unused – waiting to work out how best to be used. (analogy use of jigsaw pieces waiting to be put together by the market)
Governments always lack the knowledge of how to efficiently make use of these resources, but instead will choose the most electorally popular types of government spending. Therefore, if the government spends money it will inevitably go on the wrong areas of the economy and just make things worse. Therefore, the government shouldn’t intervene.
So what can we do? Allow private enterprise to decide how to use these idle resources. The only thing we should do is remove barriers to enterprise and competition, e.g. cut regulation, taxes and state intervention. In a free market, the price signals of profit, loss and prices will enable a return to market equilibrium and full employment. It may take time, but it will happen eventually.
‘Before the advent of Keynesianism, most recessions were very short lived as producers were left free to shuffle the jigsaw pieces into better combinations’

Some things struck me about the article.

There is a lack of specific examples relating to the current crisis. It is hard to find any examples of a country where government spending has fallen and there has been impressive economic recovery. In fact, the opposite seems to happen, with the deepest recession in those countries with harshest austerity policies.
The main argument seems to be the unwavering faith in the inevitable failure of any type of government intervention.
The idea that before the advent of Keynesianism most recessions were very short lived is highly dubious (to be polite). It inconveniently ignores (for example):

The Great Depression (1929-37) The great depression did last a long time. The Great Depression only really ended when countries embarked on Keynesianism (mostly in form of military spending). Those countries who embarked on military spending ended recession earlier than others.

The recession of 1815–1821. widespread

foreclosures, bank failures and negative market sentiment.

The tendency to lump all government intervention together is lazy. Keynesianism doesn’t advocate tariff barriers. To impose tariff barriers can contribute to an economic downturn, but just because tariffs can be harmful doesn’t mean it is wrong to pursue countercyclical fiscal policy. It is a very different type of government intervention.
Keynesianism isn’t about bigger government. A feature of the Keynesian fiscal policy is that it should be countercyclical. For example, in this piece Simon Wren-Lewis argues that EU fiscal policy was too loose in the run-up to the 2008 crisis.

” In my view, fiscal policy in many Eurozone countries outside Germany was insufficiently tight before 2008, but for most not because it implied a build-up of government debt. The problem was that private sector demand was too strong, encouraged by large capital inflows from abroad and real estate bubbles

It is not just disciples of Hayek who argue that there was a speculative bubble in the build up to the crisis of 2008.

Is government spending doomed to be inefficient? UK business has frequently argued the UK lacks key infrastructure – lack of housing, lack of airport capacity – lack of train and road capacity. UK business argues that this lack of investment is holding back the long term capacity of the economy. Yet, these public goods will not be provided by the free market. In the UK’s double dip recession the sector with the largest fall was construction – helped by significant cuts in government capital expenditure.
The UK has a lack of investment in transport and housing and a double dip recession caused by a declining construction sector; would government spending on construction really make things worse?
Multiplier effect and confidence. Has government austerity encouraged private sector confidence? No. see: Confidence fairy Government spending could cause a positive multiplier effect which helps stimulate the private sector.
The long run. Hayek’s theory argues that eventually, the free market will provide an efficient outcome and full employment. But, how many years are we prepared to wait? When you have unemployment of 25% as in the case of Spain, does it matter if government intervention is less than optimal? Does it matter if spending projects are politically popular, as long as you tackle the fundamental lack of aggregate demand in the economy? When you are in a deflationary spiral, there is no guarantee the free market will turn everything around and start investing.
Since 2008, the Eurozone has been an experiment in rejecting Keynesianism. There has been no effective counter-cyclical fiscal or monetary policy. The result has been a rise in unemployment and double dip recession.
There is a fair criticism of Eurozone labour market being too highly regulated. EU unemployment was high before the crisis hit. But, labour market deregulation alone will not solve the more fundamental problems of declining output and prolonged recession. If you look at the US, with a much more deregulated labour market, unemployment has risen much faster. In a recession, there is a role for supply side policies, but they are not a panacea for the economy.

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