I Just Don’t Get Paul Krugman
James Hanley on Dec 29th 2008
Here’s how I see it: the opponents of a strong stimulus plan don’t really have an alternative to offer. They don’t even have a really coherent critique; as Brad DeLong points out, if you believe that a surge in private spending would raise employment — and even the critics agree on that — it’s very hard to explain why a surge of public spending wouldn’t have the same effect.
Perhaps because it matters what the money is spent on? Sure, public spending will create some employment, but the real question is whether it adds to the sum total of investment in the economy or whether it simply diverts investment from private to public. In the latter case, it will create employment that will simply be offset by the loss of other employment. But even worse, because public investment tends to be less efficient than private investment, it could actually reduce the sum total of employment.
In either case, Krugman and the supporters of fiscal stimulus would claim victory by pointing at the highly visible jobs created, while ignoring the much harder to discern jobs that are lost (harder to discern because it would be impossible to say just which jobs were lost). We’re simply back to Bastiat’s discussion of “What is seen and what is not seen.” Simply looking at gross employment figures won’t help much, either, as we would expect the economy to recover and create new jobs, regardless of any fiscal stimulus, so discerning the signal among the noise is difficult, if not simply impossible.
Krugman is acting as if Friedman never critiqued Keyenes. In fact Krugman is among the minority of economists who still prefer Keynes fiscal theory to Friedman’s monetary theory, but he’s being disingenous dishonest to claim his critics don’t have an alternative. He just doesn’t like the alternative–government standing still and not overreacting–because he’s still intellectually wedded to an active Keynesian government. From his book Peddling Prosperity:
I just made an outrageous assertion: that Keynesianism is basically right…The prestige that gave conservative economics its sense of intellectual leadership, that convinced even moderates that the right was the party of ideas, rested largely on the brilliance and persuasiveness of macroeconomists like Friedman and Lucas. When their noisy attack on Keynes turned into a quiet retreat, the whole conservative claim to be the wave of the future lost its plausibility.
Now there’s two big lies built into that claim. The first is that Friedman’s economics are “conservative” economics. Friedman’s critique of Keyenes was built on on an intellectual dispute about whether recessions resulted from a decline in people’s willingness to spend money they actually had (Keyenes) or from a decline in the amount of spendable money available (Friedman). That’s hardly a political critique, yet Krugman can’t resist sticking partisan labels on it, simply because the logical consequence of Friedman’s claim is that fiscal policy won’t work.
The second big lie is that the intellectual attack on Keynes has become a quiet retreat. That, I’m sure, is news to Paul Volcker, Alan Greenspan, and Ben Bernanke–monetarists all, as well as to Marginal Revolution’s Tyler Cowen and Alex Tabarrok, Cafe Hayek’s Don Boudreaux and Russell Roberts, and to all these guys.
But let’s use another Krugman quote, from the same source, to investigate this just a little further.
…the monetarists say that wages and prices will fall, increasing the real value of cash in circulation and curing the recession. But will wages and prices really adjust?
Good question. Empirical, just like I like them. We can only be anecdotal here, but let’s see whether the current anedcotal evidence suggests that prices and wages are adjusting.
- Gasoline prices have fallen by more than 60% from their midsummer high. The Detroit Free Press reports that consumers are saving $1 billion per day on gas. That’s an annual stimulus of $365 billion–close to half of what President-elect Obama’s proposing.
- The Bureau of Labor Statistics reports that the Consumer Price Index for November fell by 1.7%, after falling by 1% in October, remaining steady in September, and having fallen by 0.1% in August. That’s evidence of falling prices, folks.
- Retailers are running huge sales. MSNBC reports that
The bargains before Christmas were already unheard of. But on the day after the holiday, it is even better.
And in England they predict that “the bargains will continue for at least another 12 months. “
- FedEx has made a small splash with its wage-cutting measures. Senior execs are taking pay cuts of 7.5% to 10%, all other salaried non-union employees are taking a 5% cut, and the company is suspending matching contributions to 401(k) plans for at least one year (an effective wage cut).
- Not nearly so noticeable as Fed Ex, all the employees at Adrian, Michigan’s, Croswell Opera House are currently reduced to half-time status (with commensurate pay reductions).
No economist I know of would argue that this process occurs smoothly or instantaneously. There’s always stickiness in an economy. But it does in fact happen, and Krugman’s denial of it is a startling bit of empirical ignorance. But to the extent he’s right, the problem may not be the normal workings of a free-market economy, but something else entirely. From the Toledo Blade comes this revealing report:
Eighty-two nonunion city of Toledo workers spent their day after Christmas on an additional holiday from work - albeit unpaid - as the budget-crunched city enacted its second mandatory furlough of the year to save money.
Friday’s furlough applied only to nonunion workers per an arbitrator’s decision this week that blocked Mayor Carty Finkbeiner’s earlier effort to furlough all nonessential employees for three days this year (emphasis added)
Toledo’s effort to do exactly what Friedmanites predict they will do–and Krugman predicts they will not–is blocked not by the natural workings of the market, but by their city workers’ unions. Union contracts create exactly the kind of stickiness that prevents the market from reacting properly to a recession. Surely Krugman gets that? They did just give him a Nobel Prize after all, and by most reports a well-deserved one. But, for the record, it was for his work on international trade theory, not for any alleged refutations of monetary theory or explanations of the cause of recessions.
Filed in The Boardroom
Good post James H, but before anyone else wades in I’d like to add a prebuttal for anyone who wants to say “well he has a Nobel and you don’t so how dare you criticise him”
1) Nobel != infallible. See: Long-Term Capital Management.
2) Krugman’s Nobel is for his work in trade theory (and his contributions are definitely worthy of respect here), not fiscal policy. Its not like he has special leet Nobel skillz that apply in this area.
3) Friedman had a Nobel too, and his was focused on this area (more monetary policy than fiscal, but still economic stimulus was his thing).
The sad thing is, I do get Krugman. He, like Galbraith before him, is enamoured of the “Camelot” school of political philosophy, where all the bad things that a government does are due to stupidity or cupidity on the part of the leaders and if the right person is in charge then little things like perverse incentives, institutional failure or the law of unintended consequences just don’t matter.
This regrettable belief seems to be very resistant to contrary evidence.
Mr. Hanley,
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OK, call me one of those mushy, do-gooder liberals, but aren’t you working on the assumption that there would be some if any gain in employment in the short term if the government didn’t pump some money into the system say on infrastructure or public works projects? I mean, you may be right that there is some unkown loss in employment from the private sector, but the question might better be asked, “When would that employment appear and how much worse would things get before it did?”
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As one of Mr. Babka’s beloved amateurs, I’m obviously no economist but it seems that if there were a reason that private money thought that now would be a good time to start investing and creating jobs, wouldn’t they be doing it? And, doesn’t the fact that most people are struggling right now have something to do with the fact that, if no one is in a position to buy anything, why would folks spend money producing it if it will not sell? Does that make sense?
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In other words, and this is where the do-gooder, mushy liberal part comes in, is it not better to do something to create employment–any employment–in order to stave off a further downward spiral? At least one can guarantee in the short term that people will be working and therefore be demanding goods and services. In other words, use the government to get the ball rolling so that the private sector which is strictly concerned with bottom lines will feel comfortable enough to jump back in and start investing in things that further the upward spiral?
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I guess the reason I’m so skeptical about standing aside to see what happens is that things could quite possibly get a whole lot worse, which in a hypothetical world with no consequences to actual people might be an interesting study, but I’m not sure how well that plays in real time.
James K,
Good point about Friedman’s Nobel (which I’d quite stupidly forgotten). I agree with you that Krugman is enamored of the Camelot theory of government; I just don’t get why. Apparently he’s never read Buchanan or Tullock.
M. Boggs,
Oh, I wouldn’t be so insulting as to call you that. ;) There’s some mild confusion in language in your first question that requires me to answer carefully. You speak of government “pumping in money on public projects.” But the question at the heart of the Keynes/Friedman debate is whether such public spending actually does “pump in” money. Both agreed money needs to be pumped in during a recession: Keynes said government spending could do that, while Friedman said it could not, because it only displaced private spending (whether government raises taxes to get the money to spend or borrows it, it is taking money that is no longer available to private spenders/investors, and so it merely displaces them, rather than adding to the net total of spending). Friedman argued that spending needed to be increased by actually making more money available to the private sector to spend. That’s where the Federal Reserve comes in–they actually put money into, or pull money out of, the economy, so they can definitely add to the net amount available for spending.
So, yes, I believe government should pump money into the economy in a recession, which creates employment. No, I don’t think a trillion dollar spending plan financed by borrowing money that is then no longer available to private borrowers pumps more money in–it just shifts that trillion dollars from private spending to public spending.
Second, you ask whether employment increases would naturally happen in the short term. I guess that depends on the definition of the short term. In economicese, the short run is the time it takes to do easily implemented business changes, like hiring more workers to add an extra shift at a factory. I would not expect that to happen in the short run of a recession unless the Fed added money to the economy. I would expect it to happen shortly after the Fed adds money.
But note that these public works projects are, mostly, not short run prospects. The time it takes to start up a large public works or infrastructure project automatically takes it out of the short run (if we’re speaking economicese) or the short term (if we’re speaking more casually).
So is it better to do something, anything, to create employment and prevent a downward spiral? Well…as noted above, the primary critique of Keynesianism is that in fact it won’t do that, because it’s just shifting spending, not adding to it. The secondary critique is that even if it does work, timing is everything, and planning to put people to work 6 months-18 months hence not only doesn’t prevent a downward spiral now (unless it creates confidence–that unpredictable commodity that all by itself can boost an economy), but may come on line when the economy is already picking it up, leading to overheated growth.
I guess my major objection would be your final contrast, which is unfairly biased by assuming the best about government action and the worst about government inaction. Once you stack the deck like that, you’ve predetermined your conclusion, but not on a sound basis.
In fact we do have at least one example where government did nothing, 1992, when G. H. W. Bush took minimal action while Clinton played on everyone’s economic fears. As it turned out, the economy was recovering even before Clinton won the election on the basis of it sucking. (Full disclosure: I voted for Clinton on that basis; now I think Bush’s non-response was the right policy.)
Finally, you ask, if I may paraphrase, why would anyone invest now if no one can afford to buy. Although that question’s a bit of a hoary classic, it’s still a good one because most people haven’t heard the answer. Which is: now’s a good time to get stuff cheap. Want to buy new equipment for your business? Buy now. (And, although it wasn’t your purpose, put some people to work.) Been planning to open a restaurant, and it will take you 3-6 months to fix a place up, etc? Properties are available at a good price right now, and we’ll probably be coming out of recession around the time you open up. It really is the reduction in prices that helps the economy self-correct.
But if no one is lending money, how can I get the loan to open a restaurant?
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And, is there a canon of hoary classics? And just what is a hoary classic question? I can only assume, based on a quick self-assessment that it is a sharp, well-reasoned, and insightful question based on amazing intellect and superior hygiene?
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But seriously, what’s a hoary classic? I’ve heard of classy whores, but…
I think its a variation on the Fundamental Attribution Error (the tendency to treat the adverse outcomes of your actions as due to circumstance and the adverse outcomes of others’ actions as due to intent).
If a politician does something and bad things happen, it must be because they’re a bad politician. Obviously we must put a good politician in their place and if they screw up too then they must be bad as well, how dare they trick us like that!
Thus the quest for King Arthur begins. I suspect this is actually the default model for human thought. It actually takes training to overcome this.
Mr. Hanley says,
[quote]Been planning to open a restaurant, and it will take you 3-6 months to fix a place up, etc? Properties are available at a good price right now, and we’ll probably be coming out of recession around the time you open up. It really is the reduction in prices that helps the economy self-correct.[/quote]
Doesn’t this assume I’ve got the cajones to take the risk to open the place up “hoping” the economy will come back in the time frame you suggest?
Mr. Hanley,
And what would happen if the government simply pumped money towards private contracters to do the works projects? Wouldn’t this short circuit the claim that the government was taking away the investment opportunites available to the private sector?
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I know I’m a pain in the butt, but I don’t seem to get why the certainty of one pump is so much worse than the uncertainty of another.
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It just seems that government doesn’t have the same “constraints” that private sector industry does in that it has no profit motive to dictate behavior and could take a loss in the short term to benefit the system as a whole in the long term. I get the feeling though that you would argue that what I’ve described above might possibly be the root of the whole problem in that it allows the government to behave (spend) irrationally and with no constraints…ever.
M. Boggs,
I’ll try to answer your questions, to the best of my ability.
1. “Hoary:” very old; aged. That is, I meant to say that it’s a question that’s been asked for a long time, and yet it still needs to be answered.
2. Regarding having the cojones to take a risk: Most of us don’t, and most who do will fail within a short time. It’s those who do take the risk and who succeed who really drive the economy–the entrepreneurs. Quite frankly, I’m in your camp. I’ve been offered numerous business opportunities over the years (I seem to have a knack for coming up with business ideas that at least one person with access to capital likes), but I’ve always turned them down. I don’t really have the entrpreneurial drive, as I’m too risk-averse (but only on financial matters) and don’t like to work too hard. But there are always people looking for opportunity.
3. ” what would happen if the government simply pumped money towards private contracters to do the works projects?” If the money came from Congressional appropriations, it would–according to Friedman–simply displace private investment, and there’d be no net gain. That is, there’d be no more money at play than before–it would just be government spending instead of investors and entrepreneurs. If the money actually came from the Federal Reserve, it would new money–a real for sure addition to the money supply in the economy–and would presumably increase employment. The two problems then are (1) does it actually go to work fast enough to help, and (2) it creates a risk of inflation. I think (1) is the real issue–if the money doesn’t go to work for more than half a year, it’s probably too late because we’ll probably be coming out of the recession regardless. So then it would just be pointless spending (unless it’s actually going toward otherwise desirable public works projects). I don’t think some temporary inflation is a major concern during a recession. But that’s not what Congress and Obama have been talking about–they’ve been discussing borrowing more money (taking it out of the private sector) to spend; so they’re just discussing displacing private spending with government spending. (And Keynesians believe that works, because they think the private spenders/investors are in fact not spending and investing now. If they’re right, the policy will work.)
4. ” might possibly be the root of the whole problem in that it allows the government to behave (spend) irrationally and with no constraints…ever.” That is a fear. But more specifically I’ve just been questioning whether the Keynesian approach–fiscal policy–will work. I have real doubts, so I think it becomes a lot of wasted effort, frequently wasted spending, and reinforces the myth that government is the primary solution to all problems.
5. “But if no one is lending money, how can I get the loan to open a restaurant?” OK, I’ll admit it. I simply ducked that issue before, because it’s the one part of this particular recession that has me very puzzled. By most reports I’ve seen, there actually is plenty of credit available–that is, there’s plenty of money in the economy, so having the Fed pump in more isn’t as obvious a solution. The problem seems to be fear among lenders, They do in fact have money to lend, but have been bitten so regularly lately by defaulters that they’re no longer confident they can predict who they should lend to. If that’s the case, I think it’s a problem that will work itself out within a quarter or two. They’ll get tired of not making money and will start loaning again, and are probably spending their time right now looking at how to better assess potential borrowers. That’s not a wholly satisfactory answer, so I hope James K is still reading and can chip in on this.
“it will take you 3-6 months to fix a place up … and we’ll probably be coming out of recession around the time you open”
As best I recall, James, I’ve heard/read recently few if any credible estimates of a turnaround this soon (say, by mid-2009). What is the basis for this projection (other than your own apparently irrepressible - and enviable - optimism)?
As suggested by Mr. Boggs, the obvious problem with assuming that there will be a timely turnaround due to “natural” forces (a position seemingly viewed with considerable skepticism by several prominent economists) is that if there isn’t, those with neither jobs nor resources will be in extremely bad shape by the time a recovery is in full force.
Which is not to champion a stimulus or any other specific plan, which I am not competent to do. But whatever course is chosen, I’d like to see a primary objective be minimizing and broadly distributing the inevitable pain that will be attendant to correcting for decades of irresponsibility by a large proportion of the US population.
This is inflationary which is a hidden tax, and it will consume valuable resources.
“No profit motive to dictate behavior” means that valuable resources might be being used for less valuable outputs. In the short run this “may” help GDP figures, but in the long run you have a less efficient economy. It also means the prices of those resources are being bid up which makes it harder for private businesses to compete.
Your example about having the cajones to open a restaurant is interesting, but let me turn it back on you. What if I want to open a restaurant (or construction business), but I find that to attract workers I have to pay more than I can afford because government projects have bid up the price of labor in my area?
Charles,
6 months from now is the middle of 2009.
And while this is merely anecdotal, in my town, a Mexican restaurant that never did very well (good food, too pricey, not fun enough) closed down recently, but now has a sign up saying “under new ownership–reopening soon. Also, while driving by a Fazoli’s restaurant that closed down about a year ago, I saw some people inside looking it over. No idea if they closed a deal or not, but obviously someone’s looking for a place to open up another restaurant.
As I noted, most of us will think like you do (heck, on a personal level, I do, too–I’m not that optimistic, at least about my own entreprenurial skills). All that makes me optimistic is (a) history, and (b) the knowledge that there are in fact people more adventurous–perhaps more crazy–than Mark, Charles and James.
Keep in mind what I noted in my post–costs are cheaper now. So if you’re thinking about opening a restaurant, an auto body repair shop, etc., etc., it could be a better business decision to get started now, while you might be able to buy a building cheap, or lock in a cheaper lease, than to wait for the economy to heat up again. As Mr. Boggs noted, it takes cojones. But some folks really do have them.
Mr. SixString,
I agree it’s inflationary. And while I am a religious devotee of Paul Volcker for having clamped down on the inflation of the 1970s, I think we often have to pick our poison. Something being, in general, bad does not mean we can automatically reject it, since our alternatives may be worse. In the case of a recession, a little inflation seems to me a reasonable price to pay. But reasonable people can disagree on that.
As to the question of whether my business costs are increased due to government competition, that is among the general set of reasons I’m not a fan of fiscal policy. (Although, in the specific case, a restaurant owner and a government contractor constructing, say, a road or dam, are probably not bidding on the same labor pool.)
James -
Being fairly good at abstract math, I was in fact able to add six months to today and get mid-2009 (frustratingly, I recognized the potential ambiguity when I wrote that and still left it - my bad). The estimates I’ve heard/read tend to be late 2009 at the earliest, often into 2010. Taking into account that many of the currently unemployed have been so for months already, that could mean more than a year of waiting for things to get better. In any event, people in the situation to which I allude aren’t in a position to open new businesses, and as you note, anecdotes don’t address my issue. (Not to mention that given the general public’s demonstrated economic acumen over the last few decades, I don’t see that a wave of new businesses necessarily portends a robust economy - that might just be just the latest show of financial foolishness and/or desperation. One does need customers.)
The economists to whom I refer make their estimates based on expertise and data - the same way some of them foresaw the problems we now face. Ie, they have a track record, so in the absence of contrary opinions formed similarly, I’m inclined to accept theirs.
Charles,
The estimates I’ve seen tend to cluster around mid-2009. Since our dueling experts are all trying to predict the future, we’ll see.
I agree that the currently unemployed aren’t likely to open up new businesses. I just don’t think it’s particularly relevant who opens up the businesses, as long as some do. And historically we know that it has happened in the past, so there’s no compelling reason to think it won’t happen this time. I do bend my libertarian principles enough to support unemployment benefits–unless they’re ridiculously generous, I believe the good clearly outweighs the harm. So I’m–at the least–not arguing for ignoring those who are currently unemployed.
I hope my comment about 6 months/mid ‘09 didn’t come across as too snarky. It honestly wasn’t meant that way. (In my head it sounded gently humorous–on the page it looks a little blunt.)
James -
Not at all. Despite our somewhat rocky start together, I now consider you in the category of “drinkin’ buddy”, complete with occasional friendly digs. But in this instance, as indicated above I recognized the potential misunderstanding and failed to make the appropriate clarification; any consequences are my own fault.
I should note that the stock market clearly is voting for the shorter time frame. However, I generally consider the market a contrary indicator, am keeping my powder dry, and will be very disappointed if the bottom is already in. As you say, we shall see.
Charles,
Drinkin’ buddies are the best type, next to buddies who will drive you to the airport.
Re: the stock market. Perhaps I should have more faith in them (rational expectations theory and all), but I generally don’t. In the long range of stock movements, yes, but not in the short range. So if they’re pointing toward my prediction, as you say, I’ve just gotten more nervous.