Monday, June 7, 2010

Is Fiscal Sanity the Inflicting of "Pointless Pain"?

Paul Krugman is a popular fellow in many circles because he both represents the "Progressive" political views of liberal Democrats (and some Republicans, let's face it) and also gives very clear explanations of what economist Robert Higgs calls "vulgar Keynesianism." And, as I have explained in previous posts, the Keynesian view holds that an economy is little more than a perpetual motion machine that needs to be greased with newly-printed government money in order to keep running smoothly.

Thus it is that Krugman has become the champion of "stimulus," and given the set of assumptions under which he operates, what he says makes perfect sense. If assets are homogeneous, which means that there are no real economic fundamentals to fall out of balance, then all it takes to keep the economy going is an infusion of new money. In fact, as Krugman writes in this blog post, to pull back on "stimulus" now would be an act of madness, the infliction of "pointless pain."

He writes:
And even this figure conveys a misleading impression of the importance of stimulus spending. First, since cutting stimulus would weaken the economy, it would reduce revenues — that is, a substantial part of the debt growth the IMF attributes to stimulus would have happened even without stimulus, through lower revenue. Second, for the US at least the core reason for long-run budget concern is rising health care costs — in fact, health cost control is the sine qua non of long-run solvency — which has nothing whatever to do with how much we spend on job creation now.

So how much we spend on supporting the economy in 2010 and 2011 is almost irrelevant to the fundamental budget picture. Why, then, are Very Serious People demanding immediate fiscal austerity?

The answer is, to reassure the markets — because the markets supposedly won’t believe in the willingness of governments to engage in long-run fiscal reform unless they inflict pointless pain right now. To repeat: the whole argument rests on the presumption that markets will turn on us unless we demonstrate a willingness to suffer, even though that suffering serves no purpose.

And the basis for this belief that this is what markets demand is … well, actually there’s no sign that markets are demanding any such thing. There’s Greece — but the Greek situation is very different from that of the US or the UK. And at the moment everyone except the overvalued euro-periphery nations is able to borrow at very low interest rates.

So wise policy, as defined by the G20 and like-minded others, consists of destroying economic recovery in order to satisfy hypothetical irrational demands from the markets — demands that economies suffer pointless pain to show their determination, demands that markets aren’t actually making, but which serious people, in their wisdom, believe that the markets will make one of these days.
If one wishes to find a quick study in modern Keynesian thinking, here it is. The entire operation is circular -- if governments want more revenue, they need to borrow and print money and it will come back to them in, well, revenue.

Yet, let us step back for a second and examine the larger picture. Krugman is saying that the the only way for governments to pay back their debts in the future is, well, to get into more debt. This is most interesting and deserves a harder look. First, debt comes with interest, so any newly-acquired debt will mean that principal AND interest payments will be in our future, so the debt will grow automatically.

Second, if there really are no economic basics and if assets are homogeneous, then there is no way for the economy to grow or improve. The Keynesian viewpoint is not intellectually or theoretically positioned to explain how an economy can grow, except to say that more spending has a magical effect upon economic processes that miraculously enable the factors of production to create more goods.

However, such a "miraculous" process cries out for an explanation. If factors are homogeneous and their output increases only when spending increases, then how can these assets produce more goods and services from more spending? Should more spending somehow enable entrepreneurs to change the productive processes to where producers can make more goods and services from the same amount of resources, then the Keynesian argument no longer holds.

That is because the Keynesian viewpoint has no mechanism for this extra burst of production, except to say that somehow before there was "enough" spending, that assets were not operating at "full capacity." In other words, that the only thing that can enable these "underused" or "underutilized" assets to operate at "full employment" is for government to print lots and lots of money.

While the Keynesian might think that the "capacity" example explains economic growth, it actually explains nothing. How did the "capacity" get there in the first place? What made entrepreneurs and producers arrange resources to create the particular means of production?

In the Keynesian view, this simply "happens." It is random, and it involves no real purposeful behavior, yet that makes no sense. Production does not simply happen, and an economy does not just appear out of a new blizzard of paper money.

No, the Keynesians don't have an answer, so for Krugman to claim that cutting back on stimulus would simply inflict "pointless pain" is to misunderstand what his happening. Instead, if one sees assets, resources, and factors of production as being heterogeneous, and if one holds that the structures of production within an economy matter, then this "hydraulic Keynesianism" in which politicians and bureaucrats simply pull and push levers is no explanation of the economy at all.

I doubt that the policymakers of the G20 really understand what I have pointed out, but they do realize that something is amiss. If they really did understand what was happening, not only would they demand governments pull back on this reckless spending, but that their bureaucrats and politicians get out of the way of entrepreneurs and let them find those assets that are profitable, and let them go to work.

The current Keynesian prescriptions are leading to disaster, just as they led to disaster during the 1930s. If we want years and years of high unemployment and no economic growth, then all we have to do is to follow what Krugman is demanding. While I have no confidence in the "austerity" of the G20, I have even less confidence in Krugman's Keynesianism.


alison said...

Krugman and other "vulgar Keynesians" already have the explanation for the cause of the Japanese type situation that probably will develop in the next months/years: the insufficient stimulus and very timid interventions to correct for maket failures.

Bob Roddis said...

Does anyone else find it strange that the "progressive" Keynesians want the government to artificially induce the maximum utilization of "capacity" possible and then complain about the free market causing "unsustainable growth" (which, of course, causes global warming) which must be tamped down and suppressed by yet more brilliant government oversight?

I detect a personality defect here somewhere. Or maybe just a defect in character.