Keynes Suppresses the Study of the Production Structure in the Concept of Aggregate Investment and Excludes Time as a Relevant Variable

From Hayek’s point of view, the major deficiency in The General Theory is that it is not based on a theory of capital. According to Hayek, the market is a network of millions of companies that complement and coordinate with each other intertemporally and synchronically, forming an extremely complex production structure. In order to understand how and why this structure is coordinated or discoordinated, we need to apply a theory allowing us to study the way it works. However, Keynes does not study this production structure, but suppresses it in the concept of aggregate investment. This is why Hayek thought that Keynes was not able to understand the causes of and the solutions to economic fluctuations. 

According to Hayek, the absence of a theory of capital meant that in the model developed in The General Theory, time is not considered as a relevant variable. In the Keynesian world, when demand increases, a parallel increase in the supply of goods appears almost instantaneously. Therefore, for Keynes, the structure of production does not need a significant amount of time to produce the necessary additional final goods to meet additional consumer demand. Thus, The General Theory never considered that a shortage of supply may occur. In Hayek’s opinion, this approach is wrong.

—David Sanz and Juan Morillo, “Hayek’s Hidden Critique of The General Theory,” in “Hayek, Keynes and the Crisis: Analyses and Remedies,” ed. Carmelo Ferlito, special issue, Journal of Reviews on Global Economics 4 (2015): 214-215.

The Microeconomic Approach Shows that the Belief in a Direct Relationship between Aggregate Spending and Employment Is WRONG

 The microeconomic approach shows that the belief that there is a direct relationship between aggregate spending and employment is wrong. Hayek explains that unemployment is usually concentrated in certain sectors, industries and production stages (for example, let us assume that unemployment is mainly concentrated in sectors A, B, C, D and E). For the Keynesian employment policies to be able to create new jobs in those specific sectors of the market, it would be necessary for entrepreneurs and consumers to voluntarily decide to spend the additional revenue received from these Keynesian policies in those sectors that are in crisis. However, Hayek explains that “[i]f expenditure is distributed between industries and occupations in a proportion different from that in which labour is distributed, a mere increase in expenditure need not increase employment.” Hayek thinks that it is an illusion to believe that these policies would solve the unemployment problem, as the holders of the additional money will spend their money where they consider it most appropriate and not necessarily in areas where there is unemployment (for example, they might decide to spend their money in sectors O, P, Q, R, S and T). Indeed, Hayek points out that it is very unlikely for individuals to choose to spend their money in the specific sectors that are in crisis, since these sectors are in crisis precisely because entrepreneurs and consumers are not willing to buy the output offered by these sectors at current prices. 

—David Sanz and Juan Morillo, “Hayek’s Hidden Critique of The General Theory,” in “Hayek, Keynes and the Crisis: Analyses and Remedies,” ed. Carmelo Ferlito, special issue, Journal of Reviews on Global Economics 4 (2015): 216-217.

The Change in Relative Prices Caused by Keynesian Demand Policies Will Encourage a Spontaneous Process of DISINVESTMENT

The second reason [for why there is not a direct connection between aggregate demand and employment] is what Hayek termed the “Ricardo effect”: the permanence of a productive structure requires the permanence of a parallel structure of relative prices. Hayek noticed that Keynesian demand policies have the special feature of modifying the pricing structure so as to promote investments with reduced maturity periods (i.e., less intensive capital investments). Hayek explains that, after applying Keynesian demand policies, this peculiar modification takes place in relative prices, and as a result, many entrepreneurs will modify their production strategies and will try new, less capital intensive (and therefore more profitable in relative terms given the new pricing structure) production strategies. This change in production strategies will result in a change in the composition of the demand for capital goods of those entrepreneurs, and will also reduce the aggregate amount of money devoted to buying higher-order capital goods in the market. Therefore, Hayek notes, many entrepreneurs will stop buying capital goods from their usual suppliers. As a result, these suppliers will lose part of their market and many will be forced to lay off workers or even to cease business. Hayek named this phenomenon the Ricardo effect. Thus, the change in relative prices caused by Keynesian demand policies will encourage a spontaneous process of disinvestment and, therefore, many of the business firms and jobs that were needed before to produce these specialized capital goods (which now will have significantly lower demand) will become useless. Hayek concludes that the demand policies proposed by Keynes will lead to an absolute reduction in the volume of employment. 

—David Sanz and Juan Morillo, “Hayek’s Hidden Critique of The General Theory,” in “Hayek, Keynes and the Crisis: Analyses and Remedies,” ed. Carmelo Ferlito, special issue, Journal of Reviews on Global Economics 4 (2015): 216.

Keynes Does Not Study the Production Structure, But Suppresses It in the Concept of “Aggregate Investment”

From Hayek’s point of view, the major deficiency in The General Theory is that it is not based on a theory of capital (Hayek [1941] 1952). According to Hayek, the market is a network of millions of companies that complement and coordinate with each other intertemporally and synchronically, forming an extremely complex production structure. In order to understand how and why this structure is coordinated or discoordinated, we need to apply a theory allowing us to study the way it works. However, Keynes does not study this production structure, but suppresses it in the concept of aggregate investment. This is why Hayek thought that Keynes was not able to understand the causes of and the solutions to economic fluctuations.

According to Hayek, the absence of a theory of capital meant that in the model developed in The General Theory, time is not considered as a relevant variable. In the Keynesian world, when demand increases, a parallel increase in the supply of goods appears almost instantaneously. Therefore, for Keynes, the structure of production does not need a significant amount of time to produce the necessary additional final goods to meet additional consumer demand (Hayek [1941] 1952). Thus, The General Theory never considered that a shortage of supply may occur. In Hayek’s opinion, this approach is wrong.

According to him, time is a central variable in understanding any production process. The dynamic “balance” of any structure of production depends on an adequate coordination between the “ripening” of investments in the form of final goods and services and the income generated by such investments in the form of final demand. Thus, for Hayek, the biggest economic problem is that consumers should be willing to “wait” long enough to allow the consumer goods to emerge in final markets. Otherwise the phenomenon of inflation will appear, and, as it will be explained later, this phenomenon will seriously endanger the sustainability of the production structure. This is why, for Hayek, savings are so important.

—David Sanz and Juan Morillo, “Hayek's Hidden Critique of The General Theory,” Journal of Reviews on Global Economics 4 (2015): 214-215.