This blog post examines why Hayek considered government intervention dangerous and explores the philosophical and economic background behind his views.
Depression and inflation strike simultaneously
While Keynes was triumphantly advocating for government intervention, there was someone who held diametrically opposed views on the causes of the crisis and how to overcome it. That person was Friedrich von Hayek, a professor at the University of London. In 1944, he published his book, The Road to Serfdom, outlining his arguments. Hayek diagnosed the depression as stemming from excessive investment and excessive spending. He argued that we must trust the market’s ability to adjust, even if it takes time. Let’s hear from Robert Skidelsky, a British peer and Emeritus Professor at the University of Warwick.
“Hayek launched another critique. He was an opponent of Keynesianism. He argued that if the government intervenes too much in the economy, the government grows larger and larger. It makes the economy inefficient.”
This means that excessive government intervention restricts the autonomy of the market, leading to an inefficient system. However, the world, enjoying prosperity under Keynesianism, paid little heed to Hayek’s arguments. Mark Pennington, Professor of Public Policy and Political Economy at the University of London, described Hayek’s situation at the time:
“Hayek wasn’t respected as much as Keynes. Economists thought he had given up economics. He didn’t receive much attention for about 20 years.”
Hayek later appeared on TV and said, “In the early days, I was treated as an outsider by most economists.”
Meanwhile, by the 1970s, a crisis struck the seemingly endless boom. But this crisis unfolded in a completely different way than before. It marked the beginning of ‘stagflation’—a simultaneous occurrence of economic recession and inflation. This phenomenon was utterly inexplicable by Keynesian theory.
Up until World War II, it was generally accepted that prices fell during recessions and rose during booms. But now, the established rule was broken, and the opposite phenomenon occurred. The most representative case was the situation in the United States in 1969. Despite being in a recession, prices continued to rise. While factors like policies prioritizing economic stimulus over price stability and monopolies by a few large corporations could contribute to this phenomenon, the crucial point was that situations began to arise that were far removed from Keynes’ explanations. Ultimately, the prevailing trend in economics was shifting back from Keynes to Hayek.
Let’s continue listening to Professor Mark Pennington’s account.
“Hayek’s central theory is that humans are not rational beings. Human behavior is based on imperfect knowledge. Even the smartest individuals are only a part of their society and are relatively ignorant. Hayek’s main theory stems from this fundamental insight. His core argument is that ‘central economic planning is prone to failure due to the planner’s lack of knowledge.’ Hayek argues that it is better to make decisions in an environment where many decision-makers make diverse choices through competitive processes. Through the process of striving, learning, and evolving, we can discern which decisions are correct and which fail. However, when the government, rather than individuals or businesses, makes all decisions, the likelihood of error increases significantly. Such errors have profound consequences. This is the core of Hayek’s thought. Hayek’s ideas explain why large-scale central planning systems, like the Soviet Union, failed to function effectively. They did not achieve the economic growth or general prosperity that many people desired.”
For his work “The Theory of Money and Credit,” Hayek received the Nobel Prize in Economics in 1974, late in his life, and his ideas were accepted as important in political theory or political philosophy. When Margaret Thatcher became leader of the Conservative Party in Britain, she slammed Hayek’s book on the table and declared:
“This is what we must believe in.”
Why did Margaret Thatcher place such trust in Hayek? In 1979, the year of the election, Britain was enduring a winter of discontent. The economy was mired in a severe recession. The British people chose Thatcher’s Conservative government, and Thatcher, who became Britain’s first female Prime Minister, championed Thatcherism, based on Hayek’s neoliberalism. Thatcherism reduced the scope of state and government activity across the board. It privatized a significant number of state-owned enterprises previously run by the government and cut public spending on welfare. It also guaranteed the free activity of businesses and restricted the activities of trade unions that could hinder this. With the adoption of Thatcherism, Adam Smith’s free market economic system began to revive, and the curtain rose on the so-called ‘era of neoliberalism’. Let’s hear from Robert Skidelsky, Emeritus Professor at the University of Warwick.
“Keynesian scholars didn’t have a good theory about inflation. Meanwhile, inflation kept rising. Perhaps they overlooked the importance of money creation and management. In economics, this is called ‘excess demand’. The solution to correct this was proposed by Milton Friedman. In his famous 1968 lecture, he argued, ‘Excessive money supply causes inflation. Employment must be reduced below the level Keynes demanded.’ There was a strong perception that Keynesianism created big government. The government kept growing. This was one of Hayek’s predictions. Government expansion during the Keynesian era was quite substantial. Before Keynes, governments used at most 20% of national income. But during the Keynesian era, it kept rising to 30%, 40%, 50%, and Sweden even reached 70% at one point.”
Trust the power of the market, even if it hurts
The situation was similar in the United States. When the second oil shock hit in 1979, deregulation began, but the recession persisted. They followed Keynes’s teachings, but it had little effect. The U.S. elected Reagan, who shared Thatcher’s approach, and Reagan implemented Reaganomics based on the theories of Milton Friedman, a Chicago School market fundamentalist like Hayek. Key elements included sound finance, deregulation, appropriate tax rates, and limited government spending. But changing the system wasn’t easy, and good results didn’t come quickly. The pain persisted for three years, and public anger only grew. Ultimately, millions of Americans faced significant hardship.
Amidst this, Britain initiated and won the Falklands War, which became the decisive turning point. The surviving Thatcher government could continue its previously unproductive policies, and finally, the economy began to grow again. This is according to Steve David, Director of Education at the Centre for Economic Studies.
“Hayek provided crucial insights into how the world operates. His theories are more diverse, broader, and more accurate than the Keynesian model.”
Meanwhile, entering the 1980s, within the communist world, as the Soviet Union lost its leadership, the idea began to surface that the solution to the economic crisis might lie not in Marxism, but in the market. With economic conditions showing little improvement, the communist system gradually collapsed. Ultimately, on December 25, 1991, the Soviet Union dissolved. The collapse of communism stemmed above all from ‘growth’ reaching its limits. When growth stalled in industry, consumer goods became scarce; when growth stalled in agriculture, grain became scarce. As society faced shortages of both food and necessities, public discontent steadily grew. The nation lost its competitiveness due to outdated manufactured goods, and its international balance of payments continued to deteriorate.
In the long-standing confrontation between communism and capitalism that had divided the world, capitalism emerged victorious. As a result, the influence of the market became even more dominant. From this point onward, neoliberalism—prioritizing growth over welfare and the market’s role over government intervention—swept across the global economy. The United States and the United Kingdom began advocating globalization and pressuring numerous countries to open their markets. The logic of ‘free markets’ and ‘free trade’ gained even greater prominence.
The Global Economy and the Domino Effect of Crisis
Consequently, the world entered a global economic system. Furthermore, the United States and the United Kingdom successfully globalized using the financial industry as their weapon, ultimately giving birth to a new form of capitalism: financial capitalism. However, almost no one predicted that this financial capitalism could itself trigger another global financial crisis.
The first wave struck Mexico. Until the early 1990s, Mexico had been on a winning streak, reducing its annual inflation rate from 140% to under 10% and boosting its economic growth rate from a mere 1-2% to around 4%. However, in 1994, Mexico was forced to open its markets completely under pressure to join the OECD and with the launch of the WTO following the Uruguay Round agreement. The problems began then. The current account balance deteriorated sharply, the peso’s value plummeted, and an economic crisis ensued. The repercussions of opening up to foreign markets began to spread like wildfire. As imports increased and exports faltered, the country suffered chronic deficits, and foreign exchange reserves began to run dry. Ultimately, the Mexican economy was swept into a vortex where it could not see even an inch ahead. This event starkly demonstrated the crisis that comprehensive capital and financial liberalization, undertaken without sufficient preparation, could unleash.
The subsequent chain of financial crises that struck Asian nations in 1997 followed a similar pattern. Countries like Thailand, Malaysia, South Korea, and Indonesia all experienced rapid growth after embracing financial capitalism, but this was merely inflation fueled by bubbles, ultimately just one step in a process leading to sharp deflation. Ultimately, even the United States, once considered an impregnable fortress, was engulfed by the financial crisis in 2008, and by 2010, the flames of the financial crisis had spread to Europe. People began to despair, but the world had now reached a state beyond anyone’s control.
Of course, globalization did bring unprecedented prosperity. But it is also true that as globalization began, the polarization between wealth and poverty accelerated, and inequality grew even larger. Then Keynesians began criticizing that the cause of this crisis was because neoliberalism had nurtured ‘monstrous finance’. This is the story of Professor Geoffrey Ingham from the Department of Sociology at the University of Cambridge in the UK.
“Keynes thought finance wasn’t bad, but it was dangerous. Keynes consistently doubted the destructive power of finance. He felt the same way about the stock market, where violent fluctuations and speculation ran rampant. Keynes even wrote about speculation.”
Meanwhile, Hayek’s followers countered this. They argued that excessive government spending was the primary culprit behind this financial crisis. They contended that the cause was not the free market, but rather flawed government policies and political forces attempting to manipulate the market. This is the view of Steve David, Director of Education at the UK’s Institute of Economic Affairs.
“I counter that the cause is not the free market, but flawed government policies and political forces attempting to manipulate the market. This holds true for the Great Depression of the 1930s as well as the financial crisis we are experiencing now.”
Neither side’s criticism and rebuttal can be considered entirely accurate. While they reflect certain aspects of reality, they also fail to provide precise diagnoses of the situation or effective countermeasures. Ultimately, Keynesianism and Hayekianism remain sharply opposed to this day.
The problem is that neoliberalism has caused today’s severe income polarization and insecurity in life. Core areas of life—employment, housing, education, childcare, healthcare, and retirement—have become far more unstable than in the past, amplifying crises across society. Particularly alarming is the rapid rise in household debt driven by deepening polarization.
According to the Bank of Korea and the Bank for International Settlements (BIS), South Korea’s household debt-to-disposable income ratio stood at approximately 204% as of the end of 2024, significantly higher than that of the United States (about 100%) or Japan (about 110%). Total household debt amounts to approximately 1,900 trillion won, or about 1.4 trillion USD, posing a serious burden on the Korean economy. As household debt burdens grow, private consumption is contracting, exerting downward pressure on the overall economy. Experts analyze this trend as the initial stage of deflation and warn that if the current situation persists, Korea could fall into a prolonged stagnation without growth, similar to Japan’s ‘Lost Decade’.
We have now reached the point where we must move beyond existing economic ideologies like Keynes and Hayek and establish a new economic paradigm that simultaneously pursues the resolution of polarization and sustainable growth.
