Friday, November 26, 2010

Krugman, Causality, and the Irish Financial Crisis

Whenever I read one of Paul Krugman's columns, I don't expect to be in agreement, so I am pleased when he makes points that I believe are spot on. However, somewhere through the column, he suddenly makes a turn in which the entire thing is turned into a giant non sequitur that leaves me scratching my head to his logical progressions.

For example, in 2003, he wrote a column in which the theme was the "Lump of Labor Fallacy," which tends to be the underlying theme that labor unions present in their worldview. Throughout the column, he lays out the intellectual case debunking this fallacy, but then writes this:
Since 2001, sensible economists have been pleading for federal aid to state and local governments so schoolteachers and police officers needn't be laid off because of a temporary fall in revenues. They've also urged the administration to stop dragging its heels on much-needed homeland security spending, not just because such spending is needed to make the country safer, but also because it would create jobs and put more income into the hands of Americans likely to spend it. (And if you're worried about spending's leading to increased deficits, why not cancel some of those long-run tax breaks for upper brackets?) Until we've done the obvious things, there's no reason to despair about job creation.
I remember my reaction the first time I read it: Say what? The intellectual basis behind calling the "Lump of Jobs Fallacy" a fallacy is that we apply theories of division of labor and marginal utility and, yes, the Law of Scarcity. Krugman, on the other hand, tied it to a Keynesian notion that more spending creates jobs and prosperity.

(In fact, Krugman's view of "jobs" is that a "job" is something we do and its main purpose is for an avenue of income to boost spending. He does not tie the production aspect of work to production of goods themselves as the basis for our purchasing power. Instead, we get an amorphous view of "spending" that has only a loose connection to production.)

Thus, it is today in Krugman's "Eating the Irish" column. He begins on a strong note, but then veers off the Keynesian cliff in a way that leaves me scratching my head.

First, I begin with the sound part:
The Irish story began with a genuine economic miracle. But eventually this gave way to a speculative frenzy driven by runaway banks and real estate developers, all in a cozy relationship with leading politicians. The frenzy was financed with huge borrowing on the part of Irish banks, largely from banks in other European nations.

Then the bubble burst, and those banks faced huge losses. You might have expected those who lent money to the banks to share in the losses. After all, they were consenting adults, and if they failed to understand the risks they were taking that was nobody’s fault but their own. But, no, the Irish government stepped in to guarantee the banks’ debt, turning private losses into public obligations.
I fully agree and hold that there should have been NO bailouts, but that also includes the bailouts that occurred in this country. Not only do I believe that Wall Street should have been on the hook for its role in creating and sustaining the Housing Bubble, but I also believe that had the Bush and Obama administrations permitted that to happen, we would not have had the Great Implosion that everyone (including Krugman) predicted.

Yes, it would have been difficult as the markets sorted out which firms had solid assets and which had worthless paper, and some CEOs would have lost their mansions in Connecticut. However, it would not have taken long to liquidate the malinvested assets, and we would be well on our way to a real recovery instead of the stagnation that we have now.

Unfortunately, after this paragraph, Krugman veers off into, well, Krugmanism. He writes:
Before the bank bust, Ireland had little public debt. But with taxpayers suddenly on the hook for gigantic bank losses, even as revenues plunged, the nation’s creditworthiness was put in doubt. So Ireland tried to reassure the markets with a harsh program of spending cuts.

Step back for a minute and think about that. These debts were incurred, not to pay for public programs, but by private wheeler-dealers seeking nothing but their own profit. Yet ordinary Irish citizens are now bearing the burden of those debts.

Or to be more accurate, they’re bearing a burden much larger than the debt — because those spending cuts have caused a severe recession so that in addition to taking on the banks’ debts, the Irish are suffering from plunging incomes and high unemployment. (Emphasis mine)
So, while taking on the obligations that the government should not have taken on in the first place, the Irish government then should have increased spending? With what? Tax revenues fell and the Irish government could not print Euros, so all it could have done was to borrow, and somehow I doubt that the world was anxiously awaiting the acquisition of more Irish government debt.

Furthermore, his contention that spending cuts "caused" the recession is utterly laughable. Is Krugman claiming that had Ireland continue to spend at current levels or even boost spending (With what?), that Ireland would not have experienced a recession? Krugman's statement is a classic non sequitur, something that a competent economist should not be pursuing. He goes on (unfortunately):
In early 2009, a joke was making the rounds: “What’s the difference between Iceland and Ireland? Answer: One letter and about six months.” This was supposed to be gallows humor. No matter how bad the Irish situation, it couldn’t be compared with the utter disaster that was Iceland.

But at this point Iceland seems, if anything, to be doing better than its near-namesake. Its economic slump was no deeper than Ireland’s, its job losses were less severe and it seems better positioned for recovery. In fact, investors now appear to consider Iceland’s debt safer than Ireland’s. How is that possible?

Part of the answer is that Iceland let foreign lenders to its runaway banks pay the price of their poor judgment, rather than putting its own taxpayers on the line to guarantee bad private debts. As the International Monetary Fund notes — approvingly! — “private sector bankruptcies have led to a marked decline in external debt.” Meanwhile, Iceland helped avoid a financial panic in part by imposing temporary capital controls — that is, by limiting the ability of residents to pull funds out of the country.

And Iceland has also benefited from the fact that, unlike Ireland, it still has its own currency; devaluation of the krona, which has made Iceland’s exports more competitive, has been an important factor in limiting the depth of Iceland’s slump. (Emphasis mine)
First, I doubt that Iceland is exactly wallowing in prosperity at the moment. The imposition of capital controls hardly is a solution, no matter what Krugman thinks. It is a statement that the government owns one's property, period. The only reason that governments impose capital controls is that those in power want to steal property of others and the only way to do it is to keep it in the country where government agents can find it.

This is the financial version of the Berlin Wall, and it is theft, pure and simple. Why am I not surprised that Krugman endorses this action?

As for the currency issue, there is some truth in that matter, but Krugman leaves out something important: Iceland may be able to repudiate some of its obligations via currency devaluations (which really is a sophisticated way of saying it is printing more money and impoverishing anyone whose wealth is held in Kronas), but it is less likely to attract future investment from outside the country. In other words, it trades a temporary fix for future problems.

However, since Keynes himself declared that "In the long run, we all are dead," I guess that even if short-term actions hold long-term consequences, we should not worry. That will be someone else's problem.

13 comments:

AP said...

"However, it would not have taken long to liquidate the malinvested assets"

AT&T could not roll CP for several days during October 08. Had another counter party heavily involved in the capital markets like C or BAC failed, or had programs like the CPFF not put in the place, a company like AT&T would not have met their obligations. No doubt..

So would you chalk that up to correcting malinvestment? The breaking down of capital markets (which was occurring in March of 08) impacts more than a bunch of irresponsible banks.

http://www.businessweek.com/magazine/content/08_42/b4104000808352.htm

And to be clear, I'm not endorsing the bail out of irresponsible banks. But the bail out of the banking SYSTEM had to take place.

"The only reason that governments impose capital controls is that those in power want to steal property of others and the only way to do it is to keep it in the country where government agents can find it"

Really? This is an extreme interpretation. The capital controls were temporary, the Berlin Wall was not. And nobody got shot for taking capital out of Iceland, and nor did the Iceland government cover the boarder with armed guards with shoot to kill orders. You make it sound as if the President of Iceland was bouncing around the country, storming into people's houses, taking their televisions, and having his way with the women.

William L. Anderson said...

Capital controls are a Berlin Wall for capital, and they are enforced by the implied and actual violence of the state. No, they are not as blatant as was the Berlin Wall, but nonetheless they send the message of state power.

Hope everyone had a great Thanksgiving. I just watched the Auburn-Alabama game. What a comeback!

Lord Keynes said...

So, while taking on the obligations that the government should not have taken on in the first place, the Irish government then should have increased spending?

You bet they should have.

With what? Tax revenues fell and the Irish government could not print Euros

The Euro zone system is insane. The Irish should have left it, restored their own currency and recovered monetary independence, either borrowing from their own citizens in the new domestic currency or by having the central bank purchase bonds indirectly or directly.

Is Krugman claiming that had Ireland continue to spend at current levels or even boost spending (With what?), that Ireland would not have experienced a recession?

By leaving the Eurozone and engaging in fiscal stimulus, they could have avoided recession, just as Australia did by its early and large Keynesian stimulus.

The only reason that governments impose capital controls is that those in power want to steal property of others and the only way to do it is to keep it in the country where government agents can find it.

Your statement is false. Capital controls do not confiscate wealth: they control its movement.
Capital controls work both ways too: either to control the flow of money out of a country or control the flow of money in.
E.g., one of the major purposes of capital controls is to prevent the destabilizing inflows of hot money that cause asset bubbles: this is why China never experienced the East Asian financial crisis.
No “theft” of money is going on. All that’s going on is that the government refuses to let overseas investors to bid up your domestic assert prices.

Bala said...

Hey bandit,

"Your statement is false. Capital controls do not confiscate wealth: they control its movement"

Only the owner of property may decide what it done with and to it. In the case of movable property, that includes where to keep it. If the government may decide that it may not leave the borders of the country, it is pretty much claiming ownership over the piece of property. It's simple, but how is a bandit to ever understand this?

"just as Australia did by its early and large Keynesian stimulus."

How about explaining how correlation implies causation? What is the theory behind making such a claim?

Lord Keynes said...

Only the owner of property may decide what it done with and to it.

Nonsense.
If I own a chemical factory that spews toxic clouds into the air killing people, I have created a moral conflict already between my use of the property and its effects on other people. In this case, the principle that human life is more important than property rights would take precedence, and even force used in stopping my immoral use of my property would be justified.

In the case of movable property, that includes where to keep it.

Also rubbish.
If I choose to move a massive amount of explosives (which I own) next to someone's house and fail to store them properly, my behavior is immoral, by the reckless risks I have caused to others' lives.
My "property rights" do not take precedence over the need to removal an unnecessary and immoral threat to human life.

Richard said...

"My "property rights" do not take precedence over the need to removal an unnecessary and immoral threat to human life."

Great. Replace "property rights" above with "central banks"and I think you are on to something. Let's get rid of the source of all the 'hot money' and ultimate threat to human life - central banks and the fractional reserve banking systems they subsidize.

(Gov't supplied Fiat Money and subsidized fractional reserve banking = toxic clouds = explosives. Bit of a stretch but all are definitely a threat to our well being).

Bala said...

Hey bandit,

How quickly you prove that you have the intellectual capability of a jellyfish. The statement

"Only the owner of property may decide what it done with and to it."

does not mean that whatever I choose to do with my property is OK. It is OK as long as I do not violate the person and property of another person. Therefore, property rights are self-limiting. Exercise of property rights is not a legitimate excuse for the violation of the rights to life and property of another individual.

In the case of the emission of toxic fumes, the person and property of other people are adversely affected, something that is not justified by my property rights. In fact, it is a violation of the victim's rights to life and property. The fact that I own a club gives me the right to swing it as long as I do not hit you or damage your property in the process. If I do, you would be right in initiating legal proceedings against me and my ownership of my club will not protect me.

In the case of storage of explosives, frankly, I don't see by what standard you are calling it immoral. It has the potential for harm but the storage per se does not constitute damage to the life and property of others. So, you have no case yet.

"My "property rights" do not take precedence over the need to removal an unnecessary and immoral threat to human life."

A threat to human life that does not constitute an instance of violation of RIGHTS to life and property is not sufficient justification to violate the rights to life and property of the people from whom such a threat may be felt to originate.

What a freaking retard!!

Lord Keynes said...

does not mean that whatever I choose to do with my property is OK. It is OK as long as I do not violate the person and property of another person. Therefore, property rights are self-limiting. Exercise of property rights is not a legitimate excuse for the violation of the rights to life and property of another individual.

That is a devastating and astonishing concession - well done.

Bala said...

Hey bandit,

"That is a devastating and astonishing concession - well done."

That was not a concession, you moron. That was to point out how stupid your examples were.

In any case, I have said nothing inconsistent with the libertarian (or Objectivist) concept "property".

Anonymous said...

@the bandit: If you're so detached from the conversation to interpret that as a concession, one seriously has to question your mental health.

burkll13 said...

im beginning to think LK is Steven Colbert. i used to think you argued like a typical pundit but you have officially crossed the absurdity line.

Pirate Rothbard said...

"Hope everyone had a great Thanksgiving. I just watched the Auburn-Alabama game. What a comeback!"

TCU may not be as good as Auburn. But they are the undoubtedly the best private university in the country.

Which means TCU is capitalism's team.

Go Frogs!

Anonymous said...

I am constantly astonished by the method of discussion used by two particular commenters here, who will always invent useless, irrelevant, hypothetical situations to make a generalized point out of casuitry.

Of course, it is typical of today's discourse that we discuss anything by first disregarding all facts, but this unconvincing technique of debate is even backed by the amazing lack of manners shown by the two.

Anyway, Mr. William Anderson, would you say these capital controls in Iceland resemble the suspensions of specie payment that have been imposed during financial panics in 19th century United States and in the recent Argentinian crisis? Only, these are done abroad, and not domestically? It is a pretty crude way of handling panics as it is, and in the past has seemed to backfire in restoring any faith in the financial health of a country. If I were ever told not to withdraw my funds from a bank in a given point of time, I'd only make sure to withdraw my money later and never put it in that bank again. That's how I have always treated businesses that cause me hassles; just imagine what professional institutions would do.