Friday, May 20, 2011

OK, Krugman really is a mercantilist

One of the supposed great triumphs in economics was the development of an intellectual argument for free trade and against the "mercantilist" doctrines of the day which emphasized the belief that wealth consisted of the money in the government's treasuries. Unfortunately, mercantilist beliefs never quite died, and we see Paul Krugman resurrecting them in his recent column on "making things."

Krugman touts the recent rise in manufacturing employment to the falling dollar and Obama's industrial bailouts, and he may be right. After all, if the government forces Americans to pour resources into certain economic sectors, we should not be surprised when those sectors, at least on paper, are doing better. However, the economic analysis should not be aimed at output, per se, or even employment. No, we in economics, we look at the opportunity cost of the policies that are spurring manufacturing growth to see if they are making us poorer.

Henry Hazlitt, in his classic "Economics in One Lesson," noted that the difference between "good" and "bad" economics was the following:
"The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences. The bad economsit sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups."
Indeed, one of the constant themes in Krugman's columns has been that only the short-term effects matter. I never have seen him even ask the larger question of whether or not certain policies move resources from lower-valued uses to higher-valued uses, or if we see the opposite occurring.

From what I can read in this column, Krugman really believes that a government can bring an economy into prosperity through financial tricks such as money debasement and industrial subsidies. He writes: potential disaster has been avoided: the U.S. auto industry, which many people were writing off just two years ago, has weathered the storm. In particular, General Motors has now had five consecutive profitable quarters.

America’s industrial heartland is now leading the economic recovery. In August 2009, Michigan had an unemployment rate of 14.1 percent, the highest in the nation. Today, that rate is down to 10.3 percent, still above the national average, but nonetheless a huge improvement.

I don’t want to suggest that everything is wonderful about U.S. manufacturing. So far, the job gains are modest, and many new manufacturing jobs don’t offer good pay or benefits. The manufacturing revival isn’t going to make health reform unnecessary or obviate the need for a strong social safety net.
Furthermore, the GM and Chrysler bailouts, he claims, gave us "net" benefits:
...there’s the matter of the auto industry, which probably would have imploded if President Obama hadn’t stepped in to rescue General Motors and Chrysler. For those companies would almost surely have gone into liquidation, closing all their factories. And this liquidation would have undermined the rest of America’s auto industry, as essential suppliers went under, too. Hundreds of thousands of jobs were at stake.

Yet Mr. Obama was fiercely denounced for taking action. One Republican congressman declared the auto rescue part of the administration’s “war on capitalism.” Another insisted that when government gets involved in a company, “the disaster that follows is predictable.” Not so much, it turns out.
Not surprisingly, Krugman is taking a very narrow approach: the bailouts helped the unions, and with government help, GM is making a comeback, so the move by the government must have been a net benefit to the economy. The problem is that there is a much larger picture that we need to understand.

At the time of bankruptcy, GM and Chrysler were hopelessly in the red. In economic terms, consumers saw them as moving resources from higher-valued to lower-valued uses. Just because the Obama administration declared that GM was to be viable again did not make the consumers' judgment wrong; it just forced consumers and taxpayers to put resources into GM that they would not have made voluntarily.

No doubt, the shuttering of GM and Chrysler would have caused hardships in Michigan, Indiana, and Ohio, but those also are the states (especially Michigan) that have shown themselves to be hostile to capital investment and reasonable business practices. Like New York, Michigan's government actively has driven firms out of the state or tried to regulate them to death, and when the results of their actions become apparent, those same governments then demand that taxpayers from elsewhere bail them out.

We also see manufacturing "growth" in subsidized "alternative or green" energy sectors, yet all of the firms in those sectors basically are wards of the state. The excuse to subsidize them has been that we must keep them alive while they "innovate" and experiment with new capital and ways to deliver their products, yet historically subsidized industries generally have lagged behind those that did not need or seek government largess.

Then there is the situation with the dollar, a currency that Krugman claims must be further debased. He writes:
First, what’s driving the turnaround in our manufacturing trade? The main answer is that the U.S. dollar has fallen against other currencies, helping give U.S.-based manufacturing a cost advantage. A weaker dollar, it turns out, was just what U.S. industry needed.

Yet the Federal Reserve finds itself under intense pressure from the right to make the dollar stronger, not weaker. A few months ago, Paul Ryan, the chairman of the House Budget Committee, berated Ben Bernanke for failing to tighten monetary policy, declaring: “There is nothing more insidious that a country can do to its citizens than debase its currency.” If Mr. Bernanke had given in to that kind of pressure, manufacturing would have continued its relentless decline.
This falls into the Keynesian prescription that government through the monetary authorities can inflate us into prosperity. Now, I have no doubt that Krugman partially is correct; debasing the dollar does make American exports more attractive while raising the costs of imports. I'm even willing to give him the argument that if the Federal Reserve System actually were to end its current policy of deliberate inflation, American manufacturing exports might even fall.

Yet, that is not the larger issue. The larger issue is whether or not entrepreneurs will be able to have the freedom to invest and direct resources from lower-valued to higher-valued resources, and seek investment projects that are economically sustainable.

Subsidies require that government cannibalize healthy sectors in order to prop up unhealthy sectors. That is the bottom line in economic analysis here, yet Krugman continues to insist that if the unhealthiest of manufacturers like GM and Chrysler are kept afloat by government intervention, that the overall effect MUST be good. After all, Michigan's rate of unemployment is falling.

In Krugman's world, there is no such thing as opportunity cost, especially if the economy is in what he calls a "liquidity trap." Yet, economic laws are immutable, and they apply to a world of scarcity, and not even the august Princeton University economics faculty can change that simple fact.

I'm sure that more than two centuries ago, Krugman would have been welcomed by the mercantilists and monetary cranks. Today, it seems that the economic faculties of our most prestigious universities once again are open to those very things Adam Smith and others debunked. I guess that is why these faculty members often refer to themselves as "Progressives."


ayassos said...

To put Krugman's analysis in perspective, we first have to refer to the blog post which preceded his column. The blog is where he tries out his ideas, of course, particularly when he's trying (on rare occasions) to do something "original." He came up with his own means of measuring the manufacturing trade deficit by using "non oil, non ag" numbers which are not actually available in the "pure" form he has concocted. So the first question is whether the stats he uses are even accurate; Krugman has a well known penchant for cherry picking stats, to put the matter politely. The comparison is then done over some time period as a "percentage of GDP." However, as Krugman admits elsewhere, when he's arguing the dollar decline is really not such a big deal because it goes up and down, Krugman does not tell us how the graphed trade balance matches up against the up-and-down of the dollar's value. Also left out of this sketchy analysis is the fact that the trade balance is affected by a general decline in American purchasing, and since a great deal of our purchasing of manufactured goods is of foreign goods, the effect of this fall-off is of course a variable. In other words, this is the usual shoddy work of Paul Krugman.

tonyhawk said...

Krugman is right. When a liquidity trap exists govt investment does not displace private investment so no healthy sectors are being affected by extra spending. To turn the question back to you...what are the opportunity costs of letting a potentially profitable company like gm dissolve due to outside factors that were not entirely their own the 08 financial crisis?

James E. Miller said...


Who ever said GM would have dissolved? The truth is bankruptcy saved GM, not the bailout. Bailing out was a clear political maneuver on part of the Obama administration (would he have bailed out Wal-Mart, the largest employer in the U.S., if for some reason they went bankrupt?)

Lord Keynes said...

"One of the supposed great triumphs in economics was the development of an intellectual argument for free trade and against the "mercantilist" doctrines of the day which emphasized the belief that wealth consisted of the money in the government's treasuries."

Modern, serious arguments for industrial policy are not based on mercantilism, but on the infant industry argument, as made, most notably, by Alexander Hamilton.

And the US is the most obvious example of the success of infant industry protectionism: the US in the 19th century was one of the most protectionist nation on earth, but also one with the most usccesful industrialization and fast economic growth (Paul Bairoch, 1993. Economics and World History: Myths and Paradoxes, University of Chicago Press, Chicago. pp. 32-37).

Why was that? We know why:

"high tariffs only have a positive relation with growth if they protect those sectors which generate positive externalities in the economy in general. So, in the relation between trade policy and growth what is significant is not just average tariffs, but the structure of tariffs. The causal mechanism between tariffs and growth is better explained by the structure of tariffs."

Antonio Tena, “Tariff Structure and Institutions in the Late 19th Century. New Perspectives on the Tariff Growth Paradox,” 2007

Japan, South Korea, and Taiwan are exmaples of extremely sucessful industrial policy as well.

Chinese industrialization also has a lot to do, not just with cheap wages, but with industrial policy:

One of the US's major problems is incompetent and poor industrial policy.

In world of agressive inetrventionists using industrial policy, America manufacturing will be slaughtered.

The Austrian laissez-faire, "do-nothing" approach is sheer madness.

Lord Keynes said...

"most succesful industrialization"

callahan auto said...

LK - again, since you don't understand the secondary effects, none of those studies demonstrate or provide any sort of remotely conclusive proof what would have happened in the absence of those tariffs. try again.

US manufacturing has been slaughtered so bad that the total value of manufactured goods in the US has been on a steady upward climb over the past 30 years in the face of a "disastrous" industrial policy.

you would be better off keeping your ill-informed, simpleton "observations" to yourself.

callahan auto said...

LK - no need for the second post to still makes no sense. what is sheerly "madness" is your faith in a bunch of useless government officials' ability to pick winners and losers, notwithstanding the immorality of doing that in the first place.

Lord Keynes said...

"again, since you don't understand the secondary effects,"

Total rubbish. The whole point of recent research into the effects of industrial policy has been precisely to look at secondary effects, such as returns to scale and synergies.

"US manufacturing has been slaughtered so bad that the total value of manufactured goods in the US has been on a steady upward climb over the past 30 years

And that output would have been higher had a better industrial policy been implemented.

And no one denies output has increased, but output is only ONE measure of the state of your manufacuturing sector:

The manufacturing share of the USA economy dropped from 21% in 1980 to 18% in 1990, 16% in 2000 and 13% in 2008. Still as previous posts show the USA manufacturing output has grown substantially: over 300% since 1980, and 175% since 1990. The proportion of manufacturing output by the USA (for the top 14 manufacturers) has declined from 31% in 1980, 28% in 1990, 32% in 2000 to 24% in 2008.

Anonymous said...

Lord Keynes, have you considered the potato chip vs. microchip argument?

You are making an argument for protecting manufacturing, without first justifying why manufacturing should be protected.

Either way, imagine America as a country producing potato chips and Arbitraria as a country producing microchips. The American worker sells the potato chips, buys a microchip for his computer, builds his knowledge base with a computer, and expands his human capital. The Arbitrarian worker sells the microchips, buys a bag of potato chips, and eats it in front of the television while cutting into his IQ instead of learning. In short, the benefit to the living of the American and the Arbitrarian is determined not by what they produce but by what they consume. The American works easy, and gains something really useful, while the Arbitrarian works hard to produce a complex microchip and gains very little for it.

Also, agriculture has fallen as a percentage of GDP and number of workers employed in America. Nobody argues for policies to raise agricultural output, especially given that US produces so much food that it has to destroy half of it.

Why should US use industrial policy to divert capital in capital markets from high-return, high productivity, high salary sectors such as IT solutions and towards low margin, low productivity, low wage sectors such as automobile components? Especially given that the latter includes things that can be purchased from abroad? Did you know that Facebook earns $400,000 per employee, while Ford earns $50,000 per employee?

callahan auto said...

LK - those studies don't prove anything related to what would have happened in the absence of those tariffs. if anything is rubbish, it is the conclusions you are trying to draw.

your second point here perferctly illustrates the denseness of your argument. who cares if the manufacturing sector makes up a smaller slice of the total pie.

in your infinite wisdom, what is the optimal share for manufacturing in our total economy? you should lobby your elected federal representatives to make sure that they pass a constitutional amendment that freezes the manufacturing sector's share at that optimal amount. that will bring us riches. people like you never cease to amaze me.

Lord Keynes said...

"those studies don't prove anything related to what would have happened in the absence of those tariffs."

Wrong. E.g., in the absense of tariffs, a major part of the US industrial revolution in New England would have been stopped in its tracks:

"Cotton textiles constituted nearly two-thirds of value added in large-scale manufacturing in New England in the 1830s. The removal of the tariff, according to my results, would have reduced value added in textiles by, at a minimum, three-quarters. The implication is that about half of the industrial sector of New England would have been bankrupted."

Mark Bils, “Tariff Protection and Production in the Early U.S. Cotton Textile Industry,” Journal of Economic History 44 (December 1984): 1033–1045.

If you bother to look at the specialist literature, you would find other examples of what would have happened in the absence of tariffs.

"who cares if the manufacturing sector makes up a smaller slice of the total pie."

When the collapse is due to faulty neoclassical economic policy and incompetent industrial policy, there are many reasons to care.

Not least of all people made long-term unemployed by the collapse of manufacturing employment in the labour force.

Also, there is an obvious national security argument.

Contrary to Austrian fairy tales, the world isn't filled with benevolent and kind people just interested in selling you things: you give up your strong manufacturing base, you become dependent on foreigners for defense purchases and have the inability to produce what is needed if (god forbid) there is ever a serious military threat.

callahan auto said...

LK - i think you need to bone up on your reading comprehension. i never said that those studies didn't "claim" anything, I saide those studies don't "prove" anything. where is the analysis in those studies where he studies the alternate use for the capital that was diverted to textiles and the welth that would have been created.

I'll ask again, what is the optimal amount of the manufacturing share? you need to post a number to have any credibility. also, you are now moving the goalposts by now getting into the "national security" argument which is a bit odd since we produce a much higher amount of manufacturing goods so we seem to be fine on that front.

you now seem to be making a manufacturing employment argument which is something different. i guess your point is that producing more with less somehow contracts our wealth. that would be a new discovery in the field of economics. it is funny watching you change your arguments to fit whatever point you are trying to make. i know it is very difficult to move away from the senseless dogma that you have clung to for your entire life, but try and muster up the courage to do it.

again, this is hilarious.

Lord Keynes said...

"i guess your point is that producing more with less somehow contracts our wealth"

LOL.. Stupid straw man argument. Quite the contrary:

But we are long way from the time when productivity increases through automation mean that manufacturing employment falls to the same level of agriculture.

At the moment there is a serious problem of long-term unemployment through loss of manufacturing and outsourcing.

The case for free trade based on comparative advantage in a world where capital and capital goods are extremely mobile just doesn't work:

At the moment, the wealthiest economies of the world, the US, Japan, UK, other Western European nations, have manufacuring as a fundmamental part of their economies.

If you are a poor developing nation, it is industrialization that makes you rich, just as South Korea, Taiwan got rich through radical industrial policy.

callahan auto said...

LK - i will take your refusal to state the appropriate % of our economy that should be comprised of manufacturing as an admission on your part of the stupidity of your original argument. you also have backed of your "national security" argument since our manufacturing production steadily increases.

now, all we are left with is the classic subjective "long term undemployment" argument that can be used to support just about any statist policy one desires. that is a shocker.

you have been shown to be full of incoherent, goal-post moving arguments. think my work is done here.

Anonymous said...

Lord Keynes does not seem to acknowledge the service sector "frogleap" or jump that has taken place across the Third World, without industrialization taking place first.

India's government, for example, used import substitution industrialisation policies and the most radical usage of infant industry protectionism along with generous subsidies for Small-and-Medium Enterprises (SMEs).

And it did so across 60 years.

It is still a largely agrarian region, and its manufacturing has been pathetic. Its capital equipment production is minimal.

What has afforded many former slum-dwelling Indians a new, rapid social mobility in the urban regions?

The service sector.

And only from the massive gains of the service sector has enough capital been generated for India's manufacturing to start rising significantly at all, after 2006.

Manufacturing and industrialization as a means for turning the poor world rich? Pure confirmation bias.

Lord Keynes said...

Nobody said that you can’t have failed industrial policy. The reasons why India’s industrial policy failed, but why, say, South Korea’s was enormously successful, are fully explained in Vivek Chibber, 2003. Locked in Place: State-Building and Late Industrialization in India, Princeton University Press, Princeton, N.J. and Oxford.

Your statement is akin to pointing to an incompetent doctor who misdiagnoses a patient and administers the wrong drug, and then claiming that all scientifically-based medicine must be wrong, just because of one failure through error.

Anonymous said...

Isn't calling economic laws "immutable" a pretense of knowledge?