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:

...one 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."