Hayek’s “Profit, Interest and Investment” (1939) Is a Theoretical Explanation of the High and Persistent Unemployment of the 1930s

It is usually assumed that, while John Maynard Keynes developed a theory of chronic unemployment, Friedrich August Hayek did not. Indeed, a theory like this one was never explicitly explained by Hayek. 

However, we defend “Profit, Interest and Investment” (1939a) was written as a theoretical explanation of the high and persistent unemployment of the 1930s. We believe that the assumptions chosen by Hayek reveal that intention: “We shall start here from an initial situation where considerable unemployment of material resources and labor exists, and we shall take account of the existing rigidity of money wages and of the limited mobility of labor. More specifically, we shall assume throughout this essay that (. . . ) money wages cannot be reduced (. . . )and finally, that the money rate of interest is kept constant.” These assumptions are similar to the institutional and macroeconomic conditions of the British economy in the late 1930s. Besides, these assumptions are radically different from those chosen in Prices and Production (1931). In that book, Hayek assumed as a starting point in his discussion, a) full employment, b) labor mobility, c) flexible wages and d) flexible rate of interest. Thus, we believe that Hayek tried to adapt his model to the new circumstances. 

We will argue in this paper that this essay could be interpreted as a theory of chronic unemployment and economic stagnation. Also, it will be defended that this phenomenon has its explanation in a dynamically inefficient design of some of the institutions that rule the market.

—David Sanz and Juan Morillo, “The Hayekian Theory of Chronic Unemployment,” Procesos de Mercado: Revista Europea de Economía Política 15, no. 1 (Spring 2018): 14.