Krugman (Sort Of) Responds to "Regime Uncertainty" Arguments

Although Paul Krugman does not want to use the term "regime uncertainty," nonetheless, he seems to be referring to that argument in a July 7 post on business investment. He writes:

Truly, we live in a time of mass delusion — or maybe make that elite delusion — where there are lots of things that everyone believes, without a shred of evidence to back that belief. Here’s one more: everywhere you go, you encounter the claim that businesses aren’t investing, they’re just sitting on piles of cash, because they’re worried about future government policies.

There is, of course, a much more prosaic alternative: businesses aren’t investing because they have lots of excess capacity. Why build new structures and buy new machines when you’re not using the ones you already have?

So is there anything in the data suggesting that we need to invoke fear of government to explain low investment? Not a bit.

He goes on to present a graph that contrasts business investment with the CBO's estimate of the gap between potential GDP and real GDP. Since the pattern of the investment follows the CBO's "gap," according to Krugman, that is the end of the argument.

Krugman's argument is based upon the following sets of questions and answers:

Q: Why is the economy bad?

A: Because businesses and individuals are not spending as much as they used to spend.

Q: Why aren't businesses and individuals spending like they used to spend?

A: Because the economy is bad.

Q: What would make the economy recover?

A: Businesses and individuals have to start spending again.

As you can see, this is a circular argument, and Krugman bases much of his analysis upon such "logic," yet he claims that people who disagree with him are suffering from "mass delusion." Now, I don't doubt that businesses as a whole are going to invest less during a recession, but Krugman is leaving out some important matters.

The "capacity" argument is not really an economic argument at all. First, it operates on what Austrian economists call the view that factors of production (for analytic purposes) are homogeneous. Second, "capacity" is a theoretical term for the capability of a firm to create output provided that all factors were operating at "full employment."

The idea behind the Keynesian emphasis on "capacity" is that government can "stimulate" the economy to a point where all firms are operating at full capacity, which then signals that we have arrived at a full-employment Nirvana. Of course, this argument contains the assumption that "stimulus" spending affects all sectors of the economy equally, as though an economy is a homogeneous mass of factors.

I have read a number of Robert Higgs' articles and papers, and never once have I seen him resort to the straw man characteristic of Barack Obama as a "socialist." For that matter, he did not call FDR a "socialist" in his "regime uncertainty" paper published 13 years ago.

If, indeed, government spending is what drives a successful economy, then why was there not a "Great Depression of 1946-48" following the end of World War II, when real prosperity returned. Higgs writes:

Finally, this way (regime uncertainty interpretation) of understanding the Great Duration meshes nicely with a proper understanding of the Great Escape after the war. The Keynesians all expected a reversion to depression when the war ended. Most businesspeople, in sharp contrast, “did not think that there was any threat of a serious depression” after the war (Krooss 1970, 217). The businesspeople forecasted far better than the Keynesian economists: the private economy blossomed as never before or since. Official data, which understate the true increase because of mismeasurement of the price level, show an increase of real nongovernment domestic product of 29.5 percent from 1945 to 1946 (U.S. Council of Economic Advisers 1995, 406). Private investment boomed and corporate share prices soared in 1945 and 1946 (Higgs 1992, 57–58). None of the standard explanations can account for this astonishing postwar leap, but an explanation that incorporates the improvement in the outlook for the private-property regime can account for it.

From 1935 through 1940, with Roosevelt and the ardent New Dealers who surrounded him in full cry, private investors dared not risk their funds in the amounts typical of the late 1920s. In 1945 and 1946, with Roosevelt dead, the New Deal in retreat, and most of the wartime controls being removed, investors came out in force. To be sure, the federal government had become, and would remain, a much more powerful force to be reckoned with. But the government no longer seemed to possess the terrifying potential that businesspeople had perceived before the war. For investors, the nightmare was over. For the economy, once more, prosperity was possible.

One does not have to believe Obama is a socialist to understand that the anti-business rhetoric coming from the White House and Congress is having a chilling effect upon long-term business investment. For example, Obama's claim that his administration would "create 700,000 'green' jobs" does not point out that government subsidies to companies not capable of turning a profit ultimately must come from the hides of presently "healthy" companies, and one can be assured that this "plan" actually would destroy more wealth (and jobs) than it would create. 

Yet, instead of trying to understand a differing point of view, we see vengeful politicians now being urged to seize the funds of individuals and businesses in order that government "may better spend it." No doubt, that will create real prosperity.