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.