Of all the insights that Friedrich August von Hayek bequeathed to us, one in particular shines out today. It is that running through the ideological and political divisions of human history are two distinct and different ways of looking at the world. One Hayek called constructivist rationalism; the other evolutionary rationalism.
Hayek spent a lifetime arguing that constructivist rationalism is economically and philosophically flawed because it assumes that ‘all social institutions are, or ought to be, the product of deliberate design’. He later called this The Fatal Conceit.
Those who follow this route believe they have it within their power to build, organise and mould society so that it conforms to their concept of what is just and efficient. But it leads, argued Hayek, to economic decline, poverty, social regression and, in extremis, famine, starvation and the collapse of civilisation. Historic examples, said Hayek, included Sparta, Revolutionary France, Soviet Russia, Nazi Germany — and all the tyrannies that blighted the 20th century. Constructivist rationalism is The Road to Serfdom.
Hayek favoured ‘evolutionary rationalism’ which understands that there ‘exists orderly structures which are the product of the actions of many men [and women] but are not the result of human design’. He believed this was the right approach because it is compatible with the teachings of economic science and goes with the grain of human nature; for these reasons, he thought, it leads to prosperity, progress and the flourishing of humanity.
Evolutionary rationalists such as Hayek argued that the liberal market economy — for all its apparent duplication, unfairness, inequalities and instability — leads to wealthier, freer and fairer societies than all the great plans of constructivist rationalism. Indeed, he argued, it was the only way to run and sustain a successful advanced economy, a matter of some relevance, we shall see, as Europe struggles to cope with the rise of Asia.
Hayek was a liberal in the classical, British sense of that word. He had no truck with those who sought to preserve the status quo, and he relished Schumpeter’s ‘creative destruction’. Progress occurred when an unpredictable market was allowed to proceed unimpeded; progress was halted when politicians and planners pretended to know the future and to mould society and the economy accordingly.
An early and influential proponent of the alternative, constructivist view was René Descartes, the 17th-century French philosopher. The problem with the Cartesian view when applied to political organisation and economics, said Hayek, is that it gives the green light to unlimited, hubristic social engineering and ignores the fact that much information is simply not knowable in advance. Nobody accurately predicted, for example, the rise of the internet 20 years ago, which only underlines the futility of trying to pick winners.
The ‘right’ price for a product doesn’t exist in any objective way, argued Hayek. Prices emerge from supply and demand, reflecting a myriad of ever-changing variables that can never be known to a central planner. Only a decentralised society with property rights, the rule of law and a competitive market economy can compute this information. The market, said Hayek, is the only institution capable of co-ordinating the actions of millions of human beings in a way which leads to progress and prosperity.
Today, of course, everybody — apart from the new Marxists of the radical environmental and anti-globalisation movements — broadly accepts that societies should be largely market economies. But if Hayek were alive today, he would be deeply concerned at the way the major European economies, including that of Great Britain, have succumbed to the allure of constructivist rationalism, with its concomitant inexorable rise in the size and power of the state.
Hayek took much comfort from the manner in which Europe emerged from the ruins of the second world war as an economic powerhouse. But he would be dismayed by how, over the last few decades, it has turned its back on many of his principles, and paid the inevitable price in terms of lower growth, fewer jobs and less wealth creation. Hayek would consider today’s levels of European public spending, tax, red tape and state intervention to be in the red zone that is dangerous to economic health.
The rise of the European Union, on which so many of us pinned our hopes for so long, was rumbled as a grandiose project by Hayek long before Euroscepticism became fashionable. To a Hayekian, there are few starker instances of his fatal conceit than the EU’s hubristic launch of a single currency.
The euro’s supporters, of course, were hardcore Cartesians. They devised what they thought was a purely rational currency, abstracted from history, experience, culture or even economics. Their aim was to get rid of the messy, seemingly irrational patchwork of different currencies across Europe, all irritatingly lacking uniformity and harmony.
It is now widely accepted among economists that the single currency has helped keep Germany and Italy in recession or near-recession, while fuelling an inflationary boom at the periphery of the euro zone, in Spain and Greece. Hayek would not have been surprised; it is the stiff price you pay for abandoning evolutionary rationalism: the creation of a one-size-fits-all monetary policy in an area which is far removed from what economists call an optimal currency area.
Yet, as Europe finds itself in a Cartesian bind which is dragging it down, things are stirring on the other side of the world, where Hayek’s principles have found new and powerful disciples.
China has been gradually moving in a more Hayekian direction over the past two decades, after learning at incalculable cost in human lives and resources that communism does not work. By unleashing its people and adopting at least some market-based institutions, the Chinese government — for all its continued attachment to totalitarianism, a truly horrible human rights record and worrying military ambitions — has bowed to reality in one crucial respect. It has ditched its rigid adherence to constructivist rationalism. It has accepted the main insight of Hayek’s evolutionary rationalism: that the only way to unleash the potential of human beings is for the government to focus on defending and enforcing the key institutions of the market economy, allowing what Hayek called a spontaneous order to flourish.
Beijing, of course, still controls its people, prevents them from reading or watching or thinking what they like, all of which Hayek would have abhorred. But it no longer tries to direct or organise all economic activity, as it did during the terrible days of Mao, when tens of millions died. The result of China’s embrace of the market — slow and incomplete though it is — has nevertheless been the greatest and fastest explosion in economic growth, creativity and human ingenuity in the history of the world.
China has a long way to go to meet Hayek’s demanding criteria of a free and prosperous society. This is still a country whose leaders cannot even bring themselves to tell their own people about a massive environmental disaster. Huge economic distortions remain, including a deeply defective banking system plagued with bad debts. Inflation is too high, corruption endemic. Nor can there be any proper market economy or individual freedom in the absence of the rule of law and entrenched property rights, two democratic necessities that dictatorships always deny, China’s included. But at least China is moving in the right direction.
With each step away from communist constructivism to Hayekian capitalism, China has been richly rewarded. It is n ow the world’s number one producer of LCD screens and TVs; it makes 90 per cent of the world’s toys, 70 per cent of its photocopiers, 50 per cent of its cameras, 40 per cent of its microwaves, 30 per cent of its handbags and suitcases and 16 per cent of its clothing.
The pace of growth has defied all predictions: in 2004, the World Energy Council forecast that China would consume 1.3 billion tons of oil equivalent by 2010; it managed that before 2004 was out and now stands as the world’s number two consumer of energy after the United States, hence the current upward pressure on world energy prices.
China’s rise has only just begun. It has yet to become a proper market economy and what capitalist institutions it enjoys are still largely confined to the booming south. China should really be viewed as an amalgam of five zones, only three of which are booming: the Pearl River Delta which borders Hong Kong, the Yangtze River Delta near Shanghai and the Bohai Rim. Think what will happen to the global economy and the geopolitical balance of power if all of China continues to move closer to a Hayekian view of the world, with a growing middle class and all the trappings of wealth, science and technology.
Even the partial embrace of Hayek has allowed China to enjoy the fastest pace of poverty reduction in its long history — perhaps in the history of the world. Numbers in absolute poverty, defined by those living on less than $1 a day, have collapsed from 64 per cent to 17 per cent of the Chinese population. With annual growth averaging 8 per cent for the next 20 years — far from an impossible rate — China will be ranked among the world’s richer middle-income countries within the next decade.
Economists tell us that, in dollar terms, the Chinese economy will overtake the German economy by 2009, the Japanese by 2015 and the American by 2039. India’s economy, in the grip of its own Hayekian reforms, could be larger than all but the American and Chinese within 30 years.
I have no idea if these long-term predictions will come true in that timescale: trees do not grow to the sky; political turmoil could easily delay or even derail the Chinese economic miracle. But whatever the scale and pace of growth in China, India and other economies embracing market-led reform and growth, one thing is pretty clear: of the current G6 (America, Japan, Germany, France, Italy, Great Britain) only the US and Japan are likely to be among the six largest economies in US dollar terms by the middle of this century.
So not a single European economy will be in the top six. This is a seismic change in the global economic balance of power and it is not just a matter of economics. Europe’s demographics also point to its continuing demise as a global economic player. From 2010, Europe’s indigenous population will start to decline as deaths outnumber births; it is only through immigration that its population will continue to grow, and the headline figures conceal a collapse in the working-age population, which will fall from 67 per cent today to 57 per cent in 2020. By then, one in 10 Europeans will be an octogenarian.
The contrast between Europe and China is most dramatic in cross-border capital flows, especially foreign direct investment flows (FDI). We are in the middle of a massive gravitational pull of plant and capital away from Europe’s high-cost economies. These flows are rewriting the economic map of the world, changing the balance of economic, political, military and cultural power. They are a Hayekian revolution: the collective vote of thousands of companies, the one vote that really counts in economics, the voting of corporate wallets, stampeding to Asia.
Consider the following: in France, the outflow of direct investment abroad shot up from $16 billion in 1994 to almost $50 billion last year; in Italy it has gone up from $5 billion in 1994 to $19 billion last year; inward FDI to Germany and France fell sharply last year. In France the inflows almost halved. In the case of Germany the figures seem to have dropped off the bottom of the scale: foreign investors withdrew about $39 billion from the country last year.
No prizes for guessing who are the main recipients. Inward FDI to mainland China keeps hitting new records. It reached $55 billion last year, the highest level on record and well above what even Japan enjoyed in its heyday. The sucking sound of capital being pulled out of Europe and into East Asia is almost deafening. Slowly but surely, economic and demographic pressures, combined with a decline in scientific and educational achievement, will condemn Europe to becoming first a military, then an economic, then an educational backwater, and finally even a cultural backwater. Remember, academic and scientific excellence soon follow economic prowess and China already produces 3 million graduates a year, 250,000 in engineering. In Britain, we can’t even find enough people to teach physics in our schools.
Beijing University this year found its way on to the Times Higher Education Supplement’s list of the top 10 universities for engineering and computing. British universities expand their courses in media studies. No Continental European university is in the world’s top 20. Europeans still collect Nobel Prizes for research, but largely at American universities.
With growing economic prowess comes, of course, military power. The Pentagon believes Chinese military spending is $90 billion today, and will double by 2015. It regards China as the biggest military spender after Russia, though the US easily outspends the two of them combined. European governments continually slash defence budgets, effectively abdicating any global military role, preferring instead the nebulous concept of soft power.
Even Europe’s cultural power and influence is on the wane. There was a time when dining out in French or Italian restaurants was considered the daring and refined thing to do, especially in London and New York. Today Asian and Latin American influences are at the cutting edge of global cuisine, while the dominance of traditional European food has waned. French wine producers, once the epitome of all that was best in wine, have already been seriously hurt by the onslaught from New World producers.
It is now clear that in our lifetimes we will witness the eclipse of Europe. The 19th century was Europe’s century of dominance, the 20th century was when Europe lost its dominance, forced to rely on America’s help to save it from itself. The 21st century will be the Asian-American century, with only the US rivalling China and India in economic, military, educational and cultural power.
So where does this leave Britain? Hayek would say that we have a fatal conceit of our own. That we can continue muddling along, mentally half in, half out of Europe, with an economy that is gradually becoming more Europeanised. No one can be in any doubt that Britain is becoming more like Europe, though few in an increasingly economically illiterate media seem to realise it.
The most recent figures from the OECD show that British public spending has surged from almost 38 per cent of GDP in 2000 to a predicted 44 per cent this year; and a European-style 45 per cent in 2006. In terms of tax-and-spend and regulation, which research published recently shows have added almost £40 billion to the cost of doing business in this country since 1998, Britain can now be regarded as close to the mainstream European social model.
It is not easy to have a sensible debate about this. The British establishment view is still parroted by politicians on the Left and Right and unquestioned by a broadcasting establishment which shares their world view. It is that the UK has no credible alternative to the EU, that the European Project, blessed by historical inevitability, will produce economic growth and political tranquillity.
A slightly more sophisticated addendum to this view is that it is just a matter of time before the EU finally embraces a version of Hayekian liberalism. If ever there was a fatal conceit, it is this. For over 30 years, politicians as diverse as Ted Heath, Robin Cook, Douglas Hurd, Tony Blair and Michael Heseltine have assured me we were ‘winning the arguments’ in Europe. There were times when I even believed them, just as a wee lad I believed Scotland could win the World Cup. Through bitter experience I now suspect there is more chance of Scotland winning the World Cup than of Britain winning the arguments in Brussels!
And I suspect that the radical in Hayek would force him to the unfashionable conclusion that the entire EU project has become a giant and unaffordable distraction. In the grand scheme of things, he would have regarded most European discussions as trivial and parochial, with no relevance to any of the great challenges facing Europe in the 21st century.
Consider, he would have said, the inordinate amount of Britain’s political and intellectual capital which has been diverted and squandered into dealing with European matters — including the 100,000 or so pages of the acquis communautaire — when the rise of China, India and East Asia is what requires our attention.
He would have had the guts to say the emperor has no clothes. Hugely expensive farm subsidies are here to stay. Protectionist sentiment will, if anything, get stronger. Supply-side reforms will remain elusive. Second-rate military capabilities — armies that can’t fight, weapons that don’t work — seem inevitable. These, Hayek would say, are the givens of the European firmament for the foreseeable future. Even Europe’s ten newest members, which are supposedly more market-minded, have failed to shift the balance of power in any real way.
Hayek would be in no doubt that if Britain was to meet the challenge of Asia in the 21st century, its future could not lie in ever greater integration with a European continent in economic, social, cultural and geopolitical decline. Nor is becoming the 51st state of America, as some like to sneer, the only alternative to Europe.
Hayek would have been blunt: Britain should regain its right to set global trade and military alliances, building on its position as an international trading nation and a financial and business crossroads to the world. Government policy should not respond to China as such, he would say, but strive to make Britain a low-tax, high-skilled, well-educated, high-productivity vibrant nation-state just offshore from the highest-taxed, increasingly low-skilled, sclerotic set of rich nations in the world. The ability to compete with China would follow naturally.
All this, of course, would require a Hayekian cultural revolution that our political system is not yet capable of contemplating, and a reorientation of British foreign policy away from Europe towards Asia and Latin America; unilateral free trade, regardless of the policy in Brussels; a radical programme to liberalise the British economy; a radical reduction in tax and public spending as a share of the economy; a flat tax to remove the poorest from tax altogether and encourage entrepreneurial flair; the injection of choice and competition into the public sector on a scale not yet contemplated; a radical programme of welfare reform, accompanied by a transformation in policing to re-establish the rule of law in our inner cities; excellence in schools with vouchers for all, so that merit rather than money determines the quality of education, producing a genuine meritocracy that ends the current scandalous waste of talent that blights our education system; the rescue of British universities from the dead hand of a miserly state which cannot fund them properly and the creation of a UK Ivy League.
Such a Hayekian programme for the 21st century is a tall order; I am not sure we have the stomach for it. But Hayek would have seen it as a stark choice. Either continue with the fatal conceit and totter towards inevitable decline and eventual oblivion. Or make the radical embrace of change and dynamism to ensure a prosperous future in the 21st century.
This is an edited version of the 14th Annual Hayek Lecture delivered by Andrew Neil on 28 November.