On the Political Economy of Eurozone Bailouts – The curious bargain of Greece’s Hayekian neoliberals

Following the Crash of 1929, an epic debate began between liberals who believed in capitalism’s automatic stabilisers and John Maynard Keynes who did not. Today, in Bailoutistan (Greece and the other fallen eurozone countries), this debate has taken an interesting, sad, twist.


Hayek vs Keynes

In the aftermath of the Crash of 1929, Keynes famously criticised the conventional wisdom of his time (the so-called Treasury View) which held that, given sufficient time, the economy would adjust to any recession by letting wages and interest rates fall until the entrepreneurs’ animal spirits’ are stirred sufficiently to stimulate both the additional employment and investment necessary to end the recession. Keynes’ objection was that, following a massive financial crisis that manages to infect the ‘real’ economy, it is highly likely that the large diminution in output, investment and income will lead to a ‘bad’ equilibrium. To a situation where unemployment is sustainably high (and unresponsive to wage reductions that cause labour to become dirt cheap), investment is rarer than snow in the desert (even after interest rates have crashed to zero; the so-called liquidity trap) and, generally, to an economy stuck in a new underemployment equilibrium from which it will not escape even if prices are free to adjust to their heart’s content. Under those circumstances, thought Keynes, to target government budget deficits, by means of government spending cuts, is precisely wrong. His proposition was that, once an economy finds itself locked into an underemployment equilibrium, any attempt to try to “cut itself out of the slump” is tantamount to cutting one’s nose to spite one’s face. No, for Keynes the trick was to “grow out of the depression”.

At the time, the Treasury View (i.e. that automatic stabilisers would do the trick) seemed increasingly pie-in-the-sky and vulnerable to Keynes’ quip that “in the long run we are all dead”. It took an outsider’s intervention to articulate (a) the strongest critique of Keynes, and his advocacy of government intervention during a slump, and (b) the most powerful defence of the market’s superiority as a resource allocation mechanism which government meddling can only stunt and harm – with long term detrimental effects for all. That ‘outsider’ was none other than Friedrich von Hayek.

Just like Keynes, Hayek began with a diagnosis of the problem: a treatise on what caused recessions in general and the Crash of 1929 in particular. Hayek suggested that the main cause of recessions was the excessive credit creation that preceded them, leading to investments that could not possibly prove profitable in the long run. The sequence of events was, according to Hayek, as predictable as it was catastrophic: Good times generated optimism, optimism begat investments, higher investment led to higher incomes and profligate consumption, interest rates fell as bankers competed against one another to give loans to people/firms/states that lacked the capacity to repay their loans in case of the slightest of downturns, etc. The bust was thus a necessary outcome of the boom. It was, in essence, the only cure for the irrational exuberance that caused it. In one of Hayek’s famous jibes, the boom is the illusion while the bust is the reality call. And what should be done once the bust hits? Simple: Let the recession do its work; let it liquidate the bad debts by allowing them to be written off, since they can never be repaid. If this means pain for the multitude, so be it. Just like the drunk must suffer stoically the symptoms of his hangover, so must a capitalist economy wait out the recession. It hurts but its function is divine as it shrinks the mountain of uncreditworthy credit previously built up in the system. Bankruptcy is, during this phase of consolidation, unpleasant but highly necessary. A little like Hell in its symbiotic relationship with Christian dogma.

At this point it is of great interest and significance to juxtapose the Treasury View (which Keynes disparaged) with that of Hayek. Seemingly, both the Treasury apparatchiks and Hayek converged on their opposition to Keynes-inspired fiscal stimuli and on a commitment to the task of reducing government debt. In response to Keynes, both Treasury officials and Hayek jested that his proposal for curing debt by means of more debt was ludicrous. But what of the difference between Hayek and the Treasury? Was there one?

Yes, there was. And an important one to boot: Whereas the Treasury was arguing that wage and interest rate drops would restore the economy to where it was before the bust, Hayek made no such promises. To Keynesian prognoses that the liquidation of bad debts, and the general shrinkage that would follow, may never lead the economy to the state it was at before the Crash, Hayek would shrug his shoulders and say: C’est la vie. Since the boom was ‘unnatural’ anyway, it would be silly (and perhaps unethical) to expect the bust to take us back to where we were before it all went belly up. Where will it take us? Hayek’s answer was: We are damned if we know! But wherever it takes us, it will be better than where we shall land following government fiscal stimuli and more debt. Let the system be cleansed of all bad debt, via wholesale bankruptcies, and then let the market system do what it does best: produce the best of all possible available futures.

In this article, I shall desist pitting further Hayek vs Keynes. Nor will I pursue further the pros and cons of Hayek’s thinking. For my objective here is to focus on the peculiar effect eurozone bailouts (with the Greek one as my main case study) has had on the mindset of neoliberals whose inspiration has traditionally been Friedrich von Hayek.

Hayek on Greece

Were von Hayek to send us a missive from the ether regarding the Greek bailout, what would he have conveyed? He would certainly not think twice before pinpointing two major causes of the tragedy that are recently turning Greece into a wasteland.

The first cause of Greece’s predicament

The first cause that Hayek would pinpoint is, of course, the bubbles that had been building up through excessive bank credit (to both the private and the public sector of Greece) in the realms of the stock market, the real estate market, the government and, of course, the labour market. The rivers of credit that flowed into Greece had caused all ‘prices’, in each of these realms, to become massively inflated thus causing a boom which, just like night follows day, had to turn to bust. And since the boom was exorbitant, in relation to the country’s real productive capacity, the bust was terribly catastrophic.

So, Greeks must accept (I can hear Hayek pontificating) that there is no alternative to liquidating unsustainable stocks (i.e. learning to live with very low share prices in the Athens stock exchange), liquidate the farmer whose produce has never really had a market (at least not one that did not rely on the kindness of the European tax payer), liquidate real estate prices (noting the pre-2009 absurdity of Kolonaki apartments costing New York prices), liquidate government (i.e. shut down most of its departments) and, of course, liquidate labour (i.e. get rid of jobs that do not produce a value equivalent to their cost to the employer).

The second cause of Greece’s predicament

Let me now turn to the second cause of Greece’s current predicament that, in my view, Hayek would highlight: The calamitous intention of the bailouts to avert a Greek default within the eurozone. Since all bad debts ought to be liquidated, according to Hayek, the Greek public debt (arguably the worst of bad debts) ought to be the first to be written off. Is this an insight that does not apply within the eurozone? Before answering, it is useful to look at Hayek’s rather ambivalent relation with the idea of a European currency union to be administered by a European Central Bank. A known sceptic of Central Banks (indeed, in a famous 1974 paper Hayek had proposed the privatisation of money; (i.e. allowing private banks to issue their own currencies, which would then compete for the public’s trust), in 1978 he had this to say about some future euro:

“[T]hough I strongly sympathise with the desire to complete the economic unification of Western Europe by completely freeing the flow of money between them, I have grave doubts about doing so by creating a new European currency managed by any sort of supra-national authority. Quite apart from the extreme unlikelihood that the member countries would agree on the policy to be pursued in practice by a common monetary authority (and the practical inevitability of some countries getting a worse currency than they have now), it seems highly unlikely that it would be better administered than the present national currencies.”

Nevertheless, Hayek extended a grudging acceptance of a euro-like currency while warning that “unchecked party politics and stable money are inherently incompatible” (italics in the original).[1] Whatever Hayek would have thought of Mrs Merkel’s, Mr Sarkozy’s and Mr Draghi’s attempt to ‘save’ the euro in a manner utterly subservient to Germany’s, France’ and Italy’s “unchecked party politics”, one thing is beyond dispute: Friedrich von Hayek would have lambasted Europe’s attempt to create new forms of toxic debt (see the EFSF bonds that are financing the bailouts) in order to ensure that boom-created, wholly unsustainable, old debts (like those of the Hellenic Republic), are preserved for as long as possible and at whatever human and economic cost.

In short, while not at all clear on whether Hayek would have recommended the preservation, disbandment or partial disbandment of the eurozone, it is beyond serious doubt that he would have campaigned vigorously for the liquidation of Greece’s (bad) debts. Fully fledged default would have been, in Hayek’s eyes, the sole course of action not in conflict with his vision of what is at stake in the eurozone today. A view that would cause him to clash with the raison d’ être of all bailouts in Europe (not to mention Mr Draghi’s LTRO that would incite him into an unending rage).

The curious case of Greece’s neoliberals

Since the crisis erupted, I have found myself in various panels opposite representatives of Greece’s tiny but highly influential community of Hayek-inspired neoliberals. It took little time to realise a most peculiar dichotomy typifying them; one which I think is instructive on the damage that the bailouts are doing to Europe’s intellectual life within but also beyond the borders of Greece. It is this: While Greek neoliberals maintain Hayek’s rage regarding the first cause of Greece’s current predicament, they are in deep (and non-intellectual) denial regarding the second one.

On the one hand they are keen to spread Hayek’s message that, within Bailoutistan (with Greece being the most prominent province of this new ‘nation’), there is no alternative to liquidating stocks, farming values, real estate prices, most government departments and much of still employed labour. However, in sharp contrast, the only one thing that they are not prepared to see liquidated is Greece’s public debt to the banks which, according to Hayek himself, created the problem in the first place! Why the exemption of Greek public debt from the list of bad debts/assets to be liquidated? And why the dearth of explanation as to why this exemption is recommended?[2] Two possible answers explain the Greek neoliberals’ schizophrenia.

First, perhaps they misunderstood what their libertarian gurus meant, possibly due to limited analytical power. Or, secondly, the Greek case is special and requires that Hayek is listened to when it comes to liquidation of everything but not of public sector debt. While not the sharpest knives in the cupboard, I do not believe that Greece’s neoliberals simply failed to understand Hayek’s message. Rather, I am of the view that it is Greece’s special circumstances that lead them to exempt public debt from the list of assets that must be liquidated. Were we to ask them to explain what these ‘special circumstances’ are, I think that, after a long discussion, we would surmise that they are driven to the exemption of public debt from the assets to be liquidated for one, simple, depressing reason: they have lost faith in the capacity of Greek national elites to see through the process of liquidation. They have lost faith in the capacity of the Greek authorities, of Greek entrepreneurs, even of themselves, to steer Greece, via Hayekian liquidation, along the path to a libertarian state of affairs. And since they do not think that Greek elites can do this, they put all their eggs in the basket of hope that Northern European elites (perhaps with the assistance of the IMF) will do it for them. And to ensure that this will happen, they are happy to sacrifice a basic Hayekian tenet in order not to antagonise Northern European partners who, for reasons of their own, are keen to keep piling unsustainable new loans on the Greek state (rather than liquidating the existing ones).


A Faustian Bargain seems to have been struck between Bailoutistan’s Hayekian neoliberals (with Greece’s variety the most striking example) and the statist ECB-EE-IMF bailout approach. This explains partly what I shall term the European Periphery’s Neoliberal Anomaly: neoliberals that are happy with the idea of huge new taxpayer-funded loans on insolvent state entities. However, this explanation is only partial as it fails to explain an important observation. Recalling Sherlock Holmes infamous ‘dog that did not bark’ inference, the question arises (regarding Greek but also Irish Hayekians): Why have they said nothing about the need to liquidate the nation’s bankers? (Or Irish bank bondholders for that matter?)

My point here is that, even if we accept the Faustian Bargain hypothesis above (namely that local elites have lost faith in themselves and want the troika to supervise their own odd ‘Road to Serfdom’), there is nothing in the neoliberal manual that can explain their total silence on the national (e.g. Greek or Irish) banks which played a huge, and hugely negative, role in causing the boom that led to the bust. Whereas Hayek would recommend that these bankers are liquidated forthwith (in order to teach all a lesson about the consequences of excessive credit creation), Greece’s and Ireland’s neoliberals are utterly silent on this. Why is that? In the case of Greece the answer is evident: Because of the extremely cosy relationship between the said neoliberals and the bankers. Period.

In conclusion, the eurozone’s bailouts have taken another, hidden toll: they have gutted the intellectual honesty of the very school of thought on which many of Europe’s elites supposedly rely upon for inspiration.

[1] Friedrich von Hayek, “Market Standards for Money”, Economic Affairs, April-May 1986.

[2] The best they can do is to argue that if Greece defaults it will not be able to return to the money markets; a pretty absurd argument since (A) Greece will not be returning, in any case, to the markets and (B) Hayek’s argument would be that this is a splendid thing (as it will force the Greek state to live within its means and to restore its reputation through frugality and prudence).