Friedrich August von Hayek, Mr. Keynes and War Costs

Friedrich August von Hayek’s short periodical article, originally published in The Spectator on November 24, 1939, and republished in the supplied 1997 version, evaluates Keynes’s proposal for financing the war through compulsory savings. Its central argument combines substantial agreement about wartime policy with reservations about postwar repayment. Hayek accepts the need to restrict civilian purchasing power and endorses blocked savings as a practicable alternative to inflation or politically unacceptable taxation. He questions, however, Keynes’s plan to release the accumulated deposits during a postwar slump. The article moves from explaining the proposal and its economic necessity to examining its political risks, proposing an alternative settlement, and supporting income-tax deduction at source.

Hayek begins by praising Keynes’s ingenuity and explicitly separating agreement on this proposal from their wider theoretical differences. The significance of that opening is substantive: wartime resource constraints can produce agreement among economists otherwise regarded as intellectual opponents. Keynes proposes that, alongside ordinary income tax, the government retain a substantial portion of current incomes in blocked savings accounts. Lower-income households, largely exempt from direct taxation, would contribute temporarily rather than surrender their income permanently. Their postponed purchasing power would finance the war while leaving them with corresponding deposits.

The case for this restriction rests on the distinction between money incomes and available goods. Some productive resources remain unused, but spare capacity is uneven: the existence of reserves does not mean that every material requirement of war can be met without reducing civilian production. Because lower-income households account for a large share of consumption, their demand cannot simply be excluded from the adjustment. Rising wages aggravate the problem by increasing purchasing power when civilian supplies must contract. The reduction in consumption is therefore unavoidable; financial policy determines how it occurs and who bears its costs.

But this inflationary method, while ultimately it will also bring about the necessary reduction of consumption, since the rise of wages will lag more and more behind prices, is indescribably wasteful.

Inflation is not an escape from sacrifice but a disorderly means of imposing it. Hayek anticipates a spiral in which higher wages raise prices and higher prices provoke further wage demands. Eventually wages fall behind prices, reducing workers’ real consumption, but only after production and calculation have been disrupted, additional injustices created, and capital endangered. His support for compulsory savings follows from this diagnosis: the policy restrains expenditure directly while preserving a claim for the contributor, rather than letting inflation erode purchasing power unpredictably.

And if outright taxation of the lower incomes to the required extent is impracticable, or, what amounts to the same thing, is generally regarded as unjust, Mr. Keynes's proposal, or something very like it, appears to be the only real solution.

This endorsement is conditional on the political limits of taxation, yet emphatic about the urgency of action. Hayek also brings out a distributive implication of deferred repayment. If interest and repayment are financed through ordinary taxation, lower-income contributors’ temporary sacrifice will ultimately be met through increased taxation of higher-income groups. Forced saving thus changes the timing and eventual allocation of the burden without abolishing the immediate need to consume less.

The disagreement begins with Keynes’s proposed release of deposits after the war, timed to support expenditure when resources are no longer fully employed. Hayek identifies this as the point where the scheme becomes connected with Keynes’s theory of depressions. He doubts that a wholesale increase in expenditure is necessarily a safe remedy, but does not attempt a full theoretical refutation. Instead, he develops a political objection: accumulated claims would generate pressure for repayment, making the timing of their release difficult to govern by economic conditions alone.

Any scheme which required Parliament to come to a decision about the method of repayment in the years immediately following the war would create really grave political danger.

The danger lies in the gap between economically appropriate timing and politically compelling demands. Hayek compares the prospective controversy to a soldiers’ bonus problem on an enormous scale. His reminder that much inflation after the previous war occurred immediately after hostilities strengthens the warning: the demand to release savings could become most powerful precisely when additional expenditure would be hazardous. A successful wartime restraint could therefore create a destabilizing postwar liability.

Hayek consequently questions cash repayment outside ordinary sinking-fund methods and sketches a different settlement. A capital levy on existing wealth, payable partly in industrial shares, could establish a trust fund resembling a large holding company. Savings holders would receive an equity interest in industrial capital instead of retaining claims against the government.

The ordinary objection to a capital levy, that it means using capital resources for current expenditure, would of course not hold in this case.

Here the levy would transfer ownership claims rather than consume capital to finance current spending. Hayek presents it as a possibility, not a fully worked-out programme: it need not increase the burden on capitalists and could reduce the continuing budgetary weight of government debt. The article closes with a more immediately administrative recommendation, deduction of income tax at source. Earlier receipts would help the government catch up with rapidly mounting expenditure, while taxpayers might welcome receiving income already net of tax. The article’s distinctive contribution is thus its separation of wartime demand restraint from postwar demand stimulus: Hayek supports Keynes’s immediate financing mechanism while insisting that repayment institutions must anticipate political pressure as well as economic conditions.