Robert Higgs versus Paul Krugman

Because Paul Krugman is the most visible spokesman for the Keynesian economic viewpoint (or, at least what Robert Higgs calls "vulgar Keynesianism"), I tend to deal with his statements from the New York Times, as it is convenient to do so, and Krugman clearly does a good job of stating his viewpoints from there. (I tend to avoid statements by James Galbraith, which are like Krugman's, although Galbraith does not do as well in squeezing the concepts into small spaces.)

One prominent economist who also understands the modern Keynesian orthodoxy is Higgs, who edits the Independent Review and who has been an eloquent voice against what Krugman and others promoting. Today, I examine a couple of articles that Higgs wrote in which he clearly lays out why it is that Krugman's orthodoxy is destructive.

In this article published on Lew Rockwell's page almost a year ago, Higgs goes to the heart of the differences between the Austrians and the Keynesians, writing:

The root problem, I believe, lies in the aggregative character of contemporary thinking about macroeconomic fluctuations. In this view, rising aggregate real output is good, no matter what the composition of the newly produced goods and services. A recession, which most analysts understand as a sustained decline of aggregate real output, is bad, and, in their view, it should be combated by fiscal "stimulus" and by expansionary monetary policy in order to reverse the decline in aggregate demand. They do not worry about – indeed, they rarely even pay much attention to – the makeup of the aggregate output that is added during business expansions, lost during business recessions, or brought into being by the government's compensating fiscal and monetary actions. Output is output; spending is spending. In fact, the whole idea of using government spending to offset reduced spending by investors or consumers turns on this assumption that a dollar spent is a dollar spent, regardless of what it is spent for.

However, that thinking, writes Higgs, is wrong because of its insistence upon the homogeneity of investment and output:

In today's vulgar Keynesian environment, investors and economists do not appreciate how the seeds of macroeconomic busts are sowed by artificially created credit that is employed to finance investments that would not be undertaken if they had to be financed by real savings – investments known in economic theory as malinvestments. When a large volume of malinvestments has been undertaken during a boom (e.g., much of the investment in residential housing and commercial real-estate development between 2002 and 2006), and when for whatever reason the pace of new credit creation slows, causing interest rates to rise, then the unsustainability of these malinvestments becomes increasingly apparent. More and more of them are terminated, often in unfinished condition, and many such projects go bankrupt for want of buyers willing and able to pay for them in the market. (Emphasis Higgs')

A "recovery" created by such means is no recovery at all, as Higgs explains:

If the government and the central bank use their fiscal and monetary policies to prop up these malinvestments, they do not solve the basic problem; they only paper it over for the time being. The vast assistance given recently to financial institutions embarrassed by investments in bad real-estate-related securities, for example, has allowed these institutions to delay the write-offs and other balance-sheet adjustments that would reflect the errors they have made. The bailouts have created a large number of zombie financial institutions, much like the ones that caused the Japanese economy to stagnate during the 1990s and later. Owners and managers of financial firms laden with rotten securities have been holding out for government rescues of various sorts, rather than carrying out the required restructuring, which in many cases must include bankruptcy proceedings.

Just as the malinvestments were made possible in the first place by effusions of artificially created credit and hence artificially depressed interest rates, so now the Treasury and the Fed are keeping the owners of these malinvestments afloat by further effusions of artificially created credit. But so long as these inherently unsustainable projects continue, they constitute a huge legion of the living dead. They may look viable, but their viability hinges entirely on de facto subsidies via the government's various bailout schemes. Such projects will remain unsustainable unless continually propped up at the expense of the general public, who will suffer because of increased ordinary taxes or a mounting inflation tax on their dollar-denominated assets. If the government goes forward in this fashion, it will be sustaining an economy rife with malinvestments kept in operation only by constant transfusions of other people's wealth channeled to the zombie projects by the Treasury and the Fed – a permanent policy of robbing prudent, responsible Peter to pay imprudent, irresponsible Paul. No sound, long-run economic development can be based on such productivity-sapping transfers of wealth into projects that are not worth the expense of keeping them going and which misallocate resources to the overall economy's detriment so long as they continue.

In this article, published in March, 2009, Higgs goes into more detail explaining why the aggregation of economic activity into the Y = C + I + G + (X-M) equation is just plain wrong and ultimately destructive. Writes Higgs:

This way of compressing diverse, economy-wide transactions into single variables has the effect of suppressing recognition of the complex relationships and differences within each of the aggregates. Thus, in this framework, the effect of adding a million dollars of investment spending for teddy-bear inventories is the same as the effect of adding a million dollars of investment spending for digging a new copper mine. Likewise, the effect of adding a million dollars of consumption spending for movie tickets is the same as the effect of adding a million dollars of consumption spending for gasoline. Likewise, the effect of adding a million dollars of government spending for children’s inoculations against polio is the same as the effect of adding a million dollars of government spending for 7.62 mm ammunition. It does not take much thought to conceive of ways in which suppression of the differences within each of the aggregates might cause our thinking about the economy to go seriously awry.

In fact, “the economy” does not produce an undifferentiated mass we call “output.” Instead, the millions of producers who bring forth “aggregate supply” provide an almost infinite variety of specific goods and services that differ in countless ways. Moreover, an immense amount of what goes on in a market economy consists of dealings among producers who supply no “final” goods and services at all, but instead supply raw materials, components, intermediate products, and services to one another. Because these producers are connected in an intricate pattern of relations, which must assume certain proportions if the entire arrangement is to work effectively, critical consequences turn on what in particular gets produced, when, where, and how.

These extraordinarily complex micro-relationships are what we are really referring to when we speak of “the economy.” It is definitely not a single, simple process for producing a uniform, aggregate glop. Moreover, when we speak of “economic action,” we are referring to the choices that millions of diverse participants make in selecting one course of action and setting aside a possible alternative. Without choice, constrained by scarcity, no true economic action takes place. Thus, vulgar Keynesianism, which purports to be an economic model or at least a coherent framework of economic analysis, actually excludes the very possibility of genuine economic action, substituting for it a simple, mechanical conception, the intellectual equivalent of a baby toy.

Compare this to what Krugman claims: that all that is needed for the government to "create prosperity" is for the central banks to print money and the government to borrow and spend. Yet, the profession claims that Krugman is the better economist? Somehow, I doubt it.