Friday, June 1, 2012

Krugman Solves Another Mystery! And Breaks More Windows!

In his column on why he believes austerity is the wrong policy, Paul Krugman manages to play the part of both a psychologist AND an advocate of Broken-Window Economics, which is a pretty big accomplishment when one is limited to 750 words. But, then, Krugman is an exceptional person and he was up to this mighty task.

Broken Window Fallacy, Again (and Again)

It is hard to know where to begin, but I think I'll start with his newest version of why breaking windows is good economics, and leave the psychology until the end. In a move that is like hurling a one-ton boulder through a huge plate-glass window, Krugman writes:
The bad metaphor — which you’ve surely heard many times — equates the debt problems of a national economy with the debt problems of an individual family. A family that has run up too much debt, the story goes, must tighten its belt. So if Britain, as a whole, has run up too much debt — which it has, although it’s mostly private rather than public debt — shouldn’t it do the same? What’s wrong with this comparison? 

The answer is that an economy is not like an indebted family. Our debt is mostly money we owe to each other; even more important, our income mostly comes from selling things to each other. Your spending is my income, and my spending is your income. 

So what happens if everyone simultaneously slashes spending in an attempt to pay down debt? The answer is that everyone’s income falls — my income falls because you’re spending less, and your income falls because I’m spending less. And, as our incomes plunge, our debt problem gets worse, not better.
 I admit that this sounds good, and I am sure that the Really Brilliant People at Princeton and the NY Times will be his Amen Chorus, but Krugman actually manages to pile up one fallacy after another, and in the process he also demonstrates his belief that factors of production really are homogeneous. Now, if that really were the case -- one set of assets is just like another -- then maybe the Keynesian argument would make sense, but in an economy made up of heterogeneous labor, resources, and capital, Krugman really is pursuing circular logic.

Austrians argue -- correctly, I believe -- that the real problem that becomes manifest during the boom is that investors are led down the wrong paths into investments that cannot be sustained, period. Take housing, for example. Since the Housing Bubble burst in 2007-08, the government has poured billions and billions of dollars into trying to reflate the bubble, yet overall housing prices are continuing to fall.

Keynesians have no answer for this, because in their view, if the government or private consumers continue to throw money at an asset, then it automatically should be sustained. Yet, it is obvious that the housing market it not behaving according to Keynesian dictates.

Nowhere is the dichotomy between Austrians and Keynesians more clear than in those three paragraphs. With Krugman, it is all spending all of the time, and if government slashes spending on things like "green energy" subsidies, then it is making EVERYONE poorer. Austrians, on the other hand, correctly note that these kinds of subsidies themselves enrich those who are politically-connected at the expense of everyone else. Malinvestments don't even enter the picture, at least not in Wonderland.

Yes, Yes, Advocates of "Austerity" Hate Poor People

Krugman next turns to his psychological skills, ferreting out what he says is the REAL reason that "austerity" advocates continue to push their views:
...the austerity drive in Britain isn’t really about debt and deficits at all; it’s about using deficit panic as an excuse to dismantle social programs.
In the world of Keynesianism, spending on social programs creates wealth. For example, when President Obama announced that he was killing the Keystone Pipeline, he also added that the payment of additional unemployment benefits actually would help the economy more than would the building of a pipeline because it would bring about more spending than would occur in the construction of the line.

To put it another way, Obama believes that oil is not an asset, only a cost. In that regard, he is being a good Keynesian when he claims that profitable ventures are a drain on the economy but paying out welfare benefits adds to wealth.

I believe this demonstrates a huge point of difference between Austrians and Keynesians. Keynesians like Krugman hold that by spending on social programs, the government is generating new wealth and can help build an entire economy upon such actions.

Austrians, on the other hand, believe that social programs must rest upon the back of an economy that has created real wealth elsewhere. Fiscally speaking, these programs are a cost, not a generator of net wealth. This is not an argument against such programs, but rather just a statement of economics.

In other words, the arguments reflect fundamental views of economics. Unfortunately, Krugman has decided to claim that since "everyone knows" that social programs on their own are wealth-generating, that the only reason one might argue that they should be cut back is because one hates poor people.

Economies are not self-generated from government spending. Cranking up the government printing presses and then directing the newly-created money to those who are politically-connected does not give the overall economy a boost. Instead, it enriches some at the expense of others.

Now, I am not jumping in with the "austerity" crowd that holds that governments must jack up tax rates in order to pay banks that took risks when they threw loans at dubious "investments." However, Krugman's "we owe it to each other" is not sound economics on any level, period. Furthermore, his view that government spending alone will boost the economy into a real recovery is just plain wrong. His is not a prescription for recovery; it is a prescription for a continuing depression.

19 comments:

Mike Cheel said...

"So what happens if everyone simultaneously slashes spending in an attempt to pay down debt? The answer is that everyone’s income falls — my income falls because you’re spending less, and your income falls because I’m spending less. And, as our incomes plunge, our debt problem gets worse, not better."

All but the last sentence describes a contraction which is a result of holding too much debt due to excessive malinvestment and excessive consumption (meaning living beyond your means or living right on the edge with no savings where any kind of disruption would cause you to nose dive).

As for the last sentence, if the bulk of the debt one holds is not malinvestment and negative trends are taken into account then there is no serious debt problem under most circumstances.

Hiram J Goldstein II said...

"So what happens if everyone simultaneously slashes spending in an attempt to pay down debt? The answer is that everyone’s income falls — my income falls because you’re spending less, and your income falls because I’m spending less. And, as our incomes plunge, our debt problem gets worse, not better."

What exactly does Krugman think it means to "pay down debt?" Apparently, he believes there is not a person on the other side of the debt transaction, but that debt payments go into some kind of hole of nothingness. If I cut my spending on potato chips to pay my credit card debt, Frito-Lay's income goes down, but Mastercard's income goes up by exactly the same amount. It's zero-sum.

Even within a Keynesian framework, Krugman's math is shady.

Dennis said...

Someone's debt payment is someone else's income. If you stop making debt payments, that means that the income of your creditors falls. Economies don't grow if everyone stiffs their creditors.

Mike M said...

Since Krugman has put the broken window strategy back on the table (on steroids this time), I believe I have identified a business opportunity.

I’m going to open up a rock store. The rocks I sell will be the perfect size and shape to throw through windows. I’m going to make a fortune! Maybe I can get a government contract to supply rocks. We can dust off the CCC days and have a government program to pay people to throw them. Now I don’t want any of you criticizing my business plan by saying that my rock retail outlet doesn’t add creative value to the economy. I’m a critical facilitator to creating macro demand. Besides, your expense of buying my rocks is offset at the “aggregate” level because it’s my income.

Anonymous said...

I did not learn anything from your reply to Krugman. Another waste of my time...

Mike M said...

Anonymous; It must nice to be omnipotent. Thank you for gracing us with you wisdom and insight.

Publius said...

"Economies don't grow if everyone stiffs their creditors." - Dennis

How is repaying debt "stiffing" your creditor? Only in a Keynesian world is repaying debt seen as stiffing. If repaying debt is stiffing your creditor what is defaulting called?

Dan said...

Hey Publius,

Go back and re-read Dennis's post. Slowly.

He's on your side.

Tel said...

It is patently impossible for everyone to owe money to everyone else.

Anyone saying, "we owe it to ourselves" should explain how such a thing can be achieved.

Michael Duff said...

In the distant past, when credit was limited, a person paying off debt would not reduce the total amount of money circulating in the economy because the debt payment would become capital that could be lent out again.

If a whole bunch of people paid off their debt at once, the bank would end up with a surplus of capital and lower interest rates.

It's only now, in our world of infinite debt and centrally-planned interest rates that reductions in debt are seen as a "problem."

Bob Roddis said...

Only 20% of young people age 18-9 agree government spending is an effective way to economic growth.

http://www.forbes.com/sites/johnzogby/2012/05/02/libertarian-bent-of-young-voters-tests-obama/

Average people don't buy this Keynesian nonsense. That's why Romney has to pretend he thinks deficits are immoral. Because they are and people know it. However, average people are so disengaged that they don't even know that deficits and funny money dilution are purposeful government programs enacted by a bunch of nitwits known as Keynesians.

In a fair and open fight, the Keynesians will never convince average people of their idiotic policies. It's our job to alert average people to the truth.

Lord Keynes said...

"Now, if that really were the case -- one set of assets is just like another -- then maybe the Keynesian argument would make sense, but in an economy made up of heterogeneous labor, resources,"

His statement does not require any assumption of homogeneous financial or capital assets. You're making it up, Anderson.

"Since the Housing Bubble burst in 2007-08, the government has poured billions and billions of dollars into trying to reflate the bubble, yet overall housing prices are continuing to fall."

The government did not engage in stimulus to reflate the housing bubble: it did so to boost investment and consumption spending.

Again, it is only your straw man argument at work.

"Keynesians have no answer for this, because in their view, if the government or private consumers continue to throw money at an asset, then it automatically should be sustained"

No, they don't.
There are plenty of Keynesians who say that housing prices are overvalued and need to correct, e.g., Steve Keen.

Their concern is that this process will cause debt deflation, and how this latter unnecessary effect on real output and employment can be mitigated.

Anonymous said...

What exactly does Krugman think it means to "pay down debt?" Apparently, he believes there is not a person on the other side of the debt transaction, but that debt payments go into some kind of hole of nothingness. If I cut my spending on potato chips to pay my credit card debt, Frito-Lay's income goes down, but Mastercard's income goes up by exactly the same amount. It's zero-sum.

The slack in the economy comes from to much debt in both the private and public sector. Krugman is suggesting to have an orderly draw down on debt while keeping incomes stable so debt can be paid off faster. The real job creators are the middle class household buying up inventories and since there is an excess of capital to invest the government should pick up the slack and then when the economy improves pay down on public debt. It amazes me that people on this blog refuse to see the ideas that have been in place have been completely wrong. Austerity in time of depression is just plain stupid. Instead of attacking the real problem now you are worried about what might become a problem later. (inflation) It would be nice to debate the issues on this blog instead of attacking one of the few economist who has actually gotten right. Anderson how about stating needs to be done for a change. Lets see if they hold water.

Zachriel said...

Michael Duff: If a whole bunch of people paid off their debt at once, the bank would end up with a surplus of capital and lower interest rates.

That works until interest rates drop to zero. In a deflationary economy, the signal is lost.

Hiram J Goldstein II said...

Anonymous, I don't believe you actually read the paragraph you quoted. Try again, and explain how paying down debt causes a net loss in incomes in the economy.

Pulverized Concepts said...

The concept that unemployment insurance is stimulative is an insult to logic. UI is actually mortgage/rent/car payment insurance, existing contractual obligations, not new purchases. Finance companies and banks are very much in favor of UI extensions.

Tel said...

Anonymous: "Austerity in time of depression is just plain stupid."

Can you even provide a definition of what "Austerity" actually is? Krugman cannot do this. Sometimes "Austerity" means reduced government spending (although why exactly government spending should be subject to special consideration is beyond me), sometimes "Austerity" means reduced government spending as a percentage of GDP (and then we get into all the arguments about what GDP really does measure).

Lately, Krugman has been plotting government spending as a percentage of "Potential GDP". Hang on a moment, surely that must be a misprint, I mean since "Potential GDP" is a completely imaginary figure, we should rightly be dividing "Potential government spending" by "Potential GDP" to get a final percentage which approximately means, "Potential for disbelief".

Steven said...

"Paul Krugman is not an economist." - William L. Anderson

Anonymous said...

"Our debt is mostly money we owe to each other"

No it's not. We are not some homogeneous Borg collective. We are in fact a nation of highly various and disparate groups with opposing ideas, goals, values and agendas. In fact the group called net tax producers owes the tax liability to the group known as net tax consumers.

To put it more colloquially, tax payers owe the money to tax takers like welfare queens, crack whores, bankster operatives, Solyndra executives, government employees etc. We the producers owe the national debt to the parasite class that Krugman and his ilk lionize. The man is without a doubt the greatest waste of brain power in human history.