Don Boudreaux's latest take on Krugman's "austerity" claims

I'm letting Don Boudreaux provide the answer today to Paul Krugman's claim that Great Britain's government is following a policy of "austerity." (By the way, "austerity" is nothing more than government not engaging in reckless borrowing and spending. I guess if I am not trying to get as many credit cards and maxing out of them, then my household is in an "austerity" pattern, and all of us know about the dastardly Paradox of Thrift of which Krugman warns.)

Take it away, Don.

Jobs, jobs and wealth creation

Mainstream economists like Paul Krugman have an administrative view of an economy, as though it can be managed centrally. All that matters in this viewpoint is the number of "jobs" that are created, and to Krugman and others like him, a hundred jobs "created" by government borrowing would be equivalent (and probably superior) to jobs created by a profitable business firm.

(And, since we are in a "liquidity trap," there is no opportunity cost, at least where government is concerned. One dollar of wealth creation is a dollar of spending, and so goes the circle.)

Furthermore, because he holds that an economy is basically a circular mechanism, he really cannot see beyond the number of employees a company might have employed in this country to see the value of what a firm produces. In his latest column, Krugman makes the point that Apple does not create many jobs, which is very, very short-sighted. He writes:

A big report in The Times last Sunday laid out the facts. Although Apple is now America’s biggest U.S. corporation as measured by market value, it employs only 43,000 people in the United States, a tenth as many as General Motors employed when it was the largest American firm.

In other words, in Krugman's view, Apple has no usefulness as a firm beyond how many people it employs. Its economic contribution stops at that point.

Firms do not exist to employ people; people are employed in the process of creating goods that are useful to others, and if one were to gain a sense of the real economic contribution of Apple, it would be safe to say that the company has created hundreds of billions of dollars of wealth, and Apple products and the technologies they have spun off have impacted the lives of billions of people. That's right, billions.

As for the point about "clusters," Krugman is correct at that point. Unfortunately, he shows his Keynesian colors here:

The point is that successful companies — or, at any rate, companies that make a large contribution to a nation’s economy — don’t exist in isolation. Prosperity depends on the synergy between companies, on the cluster, not the individual entrepreneur.

ut the current Republican worldview has no room for such considerations. From the G.O.P.’s perspective, it’s all about the heroic entrepreneur, the John Galt, I mean Steve Jobs-type “job creator” who showers benefits on the rest of us and who must, of course, be rewarded with tax rates lower than those paid by many middle-class workers.

In other words, entrepreneurs don't matter in the Krugman view of an economy. Of course, he forgets that one of this country's most important places of synergy, Silicon Valley, came about because of the vision of a few entrepreneurs who turned their ideas into the creation of huge amounts of wealth. Furthermore, he seems to forget that most of the great entrepreneurs of recent times have been...Democrats. From Steven Jobs to Bill Gates to Michael Milken to the founders of Google, liberal Democrats have made a huge economic impact because they had great ideas and how to put them together to create new products.

So, what is Krugman's idea of a Really Big Economic Success? The auto industry bailout. He writes:

...this vision helps explain why Republicans were so furiously opposed to the single most successful policy initiative of recent years: the auto industry bailout.

The case for this bailout — which Mr. Daniels has denounced as “crony capitalism” — rested crucially on the notion that the survival of any one firm in the industry depended on the survival of the broader industry “ecology” created by the cluster of producers and suppliers in America’s industrial heartland. If G.M. and Chrysler had been allowed to go under, they would probably have taken much of the supply chain with them — and Ford would have gone the same way.

Fortunately, the Obama administration didn’t let that happen, and the unemployment rate in Michigan, which hit 14.1 percent as the bailout was going into effect, is now down to a still-terrible-but-much-better 9.3 percent. And the details aside, much of Mr. Obama’s State of the Union address can be read as an attempt to apply the lessons of that success more broadly.

First, Krugman assumes that there are no other auto producers in this country, and I am sure that many of the assets of Chrysler and GM would have been put to good use. Second, Krugman forgets that the bailout did not occur in order to save "clusters," but rather to force taxpayers to pony up to save the United Auto Workers.

The reason that GM and Chrysler were bankrupt was that they were producing goods that consumers were not willing to purchase, and neither company was willing to do what was necessary to turn around the situation. Yes, they had intransigent unions and delusional managers, but that did not mean that the rest of us should have been forced to cover for them. Chrysler and GM were destroying wealth, not creating it, and by rewarding their actions, the Obama administration sent a strong message that the only thing that matters in this economy is a political connection.

Krugman has no idea how markets work and he certainly does not understand a price system. (Sorry, aggregate supply and aggregate demand models have nothing to do with price systems or even economics.) Once again, we see that he really does not know what wealth creation means and cannot differentiate between a job that creates wealth and a job that destroys it.

Krugman changes his tune (in time to shill for Obama)

I have said many times that Paul Krugman is much more a political operative than an economist, and while that makes people mad, it also is true. And the day before President Obama's State of the Union Speech, suddenly the gloomy, "We-Are-Practicing-Austerity" Krugman was singing the praises of Obama the Great.

Yes, this is the same Obama that recently Krugman was claiming was not spending enough and was going to throw us into another downturn because of his policies of "austerity." But now that we are in a political campaign, Krugman is singing, "Happy Days are Here Again."

He claims that he was abused when he pointed out the housing bubble, and I find it interesting that in his blog posts and elsewhere, he has attacked Peter Schiff, yet it was Schiff who was the most vocal about the bubble and its meaning. Furthermore, Mark Thornton in 2004 had made the point about the bubble, and Ron Paul was playing Paul Revere on the subject in 2003. However, since Krugman thinks Austrians are idiots and don't know any economics, he throws the Austrian warnings down the Orwellian Memory Hole.

(Now, don't forget that Krugman's good friend Ben Bernanke also missed the bubble, but Krugman isn't about to jump on his ally for being wrong. No, Krugman is much too smart a political operative to do that.)

Yet, there are a couple things in this column that are puzzling. First, he claims that somehow we can revive the economy with...more housing:

But the economy is depressed, in large part, because of the housing bust, which immediately suggests the possibility of a virtuous circle: an improving economy leads to a surge in home purchases, which leads to more construction, which strengthens the economy further, and so on. And if you squint hard at recent data, it looks as if something like that may be starting: home sales are up, unemployment claims are down, and builders’ confidence is rising.

And why might housing be a bright spot in the future? He writes:

Furthermore, the chances for a virtuous circle have been rising, because we’ve made significant progress on the debt front.

That’s not what you hear in public debate, of course, where all the focus is on rising government debt. But anyone who has looked seriously at how we got into this slump knows that private debt, especially household debt, was the real culprit: it was the explosion of household debt during the Bush years that set the stage for the crisis. And the good news is that this private debt has declined in dollar terms, and declined substantially as a percentage of G.D.P., since the end of 2008.

Krugman is talking apples and oranges. No one has claimed that government debt brought about the recession; instead, they are saying that adding trillions of dollars of government debt only exacerbates the problem. Moreover, he is saying that housing has bottomed and maybe things will get better.

Why didn't housing bottom sooner? It did not bottom because Krugman and others argued that the government should continue to pump huge amounts of money into those failing sectors in order to prop them up, as though higher prices bring prosperity. So, the government did just that and housing fell, albeit more slowly, but it fell, so the pain was stretched out.

So, in order to avoid a worse recession, the government created a depression. But now that Obama is up for re-election, suddenly he is Mr. Job Creator. Yes, the man who has pumped hundreds of billions of dollars into "green energy" and other such boondoggles suddenly is responsible for bringing back prosperity. Somehow, I doubt that is happening, but political operatives are not exactly known for their truth telling.

As for Krugman's claim that more inflation and more government debt will give us recovery, Frank Shostak, who is a much better economic analyst than Krugman, says that recovery will come only when the government ends its jihad against savings. No, Shostak doesn't have a Nobel, but he does actually understand economics.

Should capital gains tax rates reflect ordinary income tax rates? Maybe in Wonderland

[Update]: In his column today, Krugman continues the theme that capital gains taxes should be higher, although he does not say HOW high. His reference toward Ronald Reagan invokes another logical fallacy, as though whatever Reagan did regarding taxes always should be acceptable to people who hold to free-market principles.

Krugman also fallaciously assumes that wealthy people pay ONLY 15 percent of their entire income in taxes. However, this interesting chart appeared today in the Wall Street Journal that lists ALL federal taxes paid by people in different income groups, and it tells a much different story. (Of course, Krugman is well-known for making up history, whether it be tax or regulation history. One might expect such behavior from a political operative.)

Now, why would Krugman try to be deceptive here? Why is Krugman nearly always deceptive? It is because he has traded whatever academic integrity he had to be a political operative. It is one thing to argue about tax rates and quite another to present a false picture of a situation -- when accurate information is available. [End Update]

In his post on the post-war history of capital gains taxes, Paul Krugman points out that the rates have been higher in the past than they are now. That obviously is true, but it opens up other arguments. For example, he declares this:

Here’s how Romney’s low taxes will be defended by smarter conservatives (the less smart ones will just shout “class warfare”): they’ll claim that there are compelling reasons to have low taxes on capital gains, and that there is therefore nothing wrong with having very high-income people paying lower tax rates than the middle class.

Like Barack Obama, he is slippery with his language, for even with lower rates, people who gain most of their income via investment are going to pay significantly higher amounts in taxes than others. Unfortunately, in a speech the other day, Obama first mentioned tax rates and then he claimed that the wealthy thus pay "lower taxes" than do people in the middle class. That simply is false, but a president who claims that paying unemployment benefits will "create more jobs" than the construction of an oil pipeline (and, by insinuation, more wealth) simply is delusional about the economy. Keynesianism will do that to people. The U.S. economy did well relative to the rest of the world (which was recovering from World War II) at this time, so does Krugman also believe, in the name of "fairness," that the capital gains rates also should have been 91 percent? I don't know, but I don't see, using his own logic, how he can argue against that modest proposal.

In fact, during that time, even some of the LOWEST rates were higher than 25 percent or slightly under 25 percent. Thus, will Krugman and Obama complain that the capital gains rates in the 1950s were unjust because they were lower than tax rates that people earning small incomes were paying? I don't know, although it seems that Krugman seems to be fixated on the current situation while claiming that the 1950s were prosperous years, and I suspect he believes that the high tax rates were part of the reason for the prosperity.

(He certainly has not made any statements in public to the contrary except to tell me in a 2004 Q&A at the Southern Economic Association meetings that the 70 percent rates of 1980 were "insane." I have not seen him making any similar statements in any of his writings since then.)

If Paul Krugman believes that capital gains taxes always should be at the top rate, since it would be unfair for investors to pay the same rates (or less) than the middle class, perhaps we need to look at the various marginal rates of income taxation to see if Krugman is trying to pull a fast one. For example, during the time in the 1950s when capital gains rates were 25 percent, the top income tax rate in the USA was 91 percent.

The following table that lists inflation-adjusted income tax brackets since 1913 might make things a bit more clear:

Partial History of Marginal Income Tax Rates Adjusted for Inflation
	Income	First	Top Bracket
Year	Brackets	Bracket	Rate	Income	Adj. 2011	Comment
1913	7	1%	7%	$500,000	$11.3M	First permanent income tax
1917	21	2%	67%	$2,000,000	$35M	World War I financing
1925	23	1.5%	25%	$100,000	$1.28M	Post war reductions
1932	55	4%	63%	$1,000,000	$16.4M	Depression era
1936	31	4%	79%	$5,000,000	$80.7M
1941	32	10%	81%	$5,000,000	$76.3M	World War II
1942	24	19%	88%	$200,000	$2.75M	Revenue Act of 1942
1944	24	23%	94%	$200,000	$2.54M	Individual Income Tax Act of 1944
1946	24	20%	91%	$200,000	$2.30M
1954	24	20%	91%	$200,000	$1.67M
1964	26	16%	77%	$400,000	$2.85M	Tax reduction during Vietnam war
1965	25	14%	70%	$200,000	$1.42M
1981	16	14%	70%	$212,000	$532k	Reagan era tax cuts
1982	14	12%	50%	$106,000	$199k	"
1987	5	11%	38.5%	$90,000	$178k	"
1988	2	15%	28%	$29,750	$56k	"
1991	3	15%	31%	$82,150	$135k
1993	5	15%	39.6%	$250,000	$388k
2003	6	10%	35%	$311,950	$380k	Bush era tax cuts
2011	6	10%	35%	$379,150	$379k

In the end, I don't think Krugman is making much of an argument. For example, as one who was in college in the early 1970s and then being in the workplace for more than half the decade, the 40 percent capital gains rates also coincided with an era of high inflation and high unemployment. If Krugman believes that capital gains rates should reflect normal income tax rates, then he is saying that we need 40 percent capital gains rates again.

For that matter, the 1970s were a time of economic stagnation, not unbridled prosperity, as Krugman wants us to believe. He might hate the 1980s, but that also was a time of huge private investments in the high-tech sector and telecommunications, and Daniel Henninger of the Wall Street Journal has an excellent column about that era, including the corporate raiders that Krugman claims did so much damage. The article deals with the actual state of business entrepreneurship at that time, something that Krugman is incapable of understanding, since all of his economic analysis is done with the crude aggregates of the Keynesian models, and there is no way to fit entrepreneurship into those contraptions.

There is a larger issue, however, and that is private investment as a whole. Krugman, being a good Keynesian, holds that economically speaking, government "investment" is just as good as private investment, so it doesn't matter if the government is building nuclear weapons or a farmer is growing crops. If the GDP numbers of both are equal, then both are equal in their wealth component.

Is this a ridiculous example, since even Krugman would admit we cannot eat nuclear weapons? In one way, yes, but in the Keynesian structure, it is not ridiculous. And given that Krugman has given us his "confidence fairy" ditty numerous times, it is clear that he does not hold private investment to be anything but another form of spending, and if government can spend in equal amounts, then it is just as well and perhaps better, since in Wonderland, State Power equals freedom and prosperity.

Higher taxes on investment income = more investment, Krugman claims

In reading Paul Krugman for more than a decade, I have come to the following conclusions about his economic beliefs:

• State-sponsored investment is both morally and economically preferable to private investment;

• Higher tax rates on investment return will result in more private investment;

• These are mutually-exclusive beliefs, but nonetheless he expresses them both, but if there is to be a choice, it always is in favor of more state power.

Of course, Krugman also seems to believe that the greater the scope and scale of government police power, the freer people will be, at least if the Democratic Party controls the apparatus of government. In other words, the Police State in which government tells us what we can eat, what we should think, where we should live, what income we are permitted to keep, the form of transportation we should have, and so on, is a State of Freedom. (And if any dissenters can point out where Krugman publicly has stated otherwise, please let me know, but for now, I cannot say honestly that I ever have seen Krugman complain about the expansion of the Police Powers of the State.)

Krugman's recent blog post which I want to examine is the one on taxes on investment income, where he writes:

As Ezra Klein says, the real issue raised by Romney’s maybe-revelation — are we sure that his tax rate is even as high as 15 percent? How much is shielded in tax havens? We need the returns — is the way our system allows those with very high income to pay substantially lower taxes than the upper middle class. If capital gains and other investment income didn’t receive special treatment, we’d be getting substantially more revenue. Why does our political elite talk only about cuts to social insurance, and not at all about raising more revenue from the upper tail of the income distribution? (Emphasis mine)

Given that Krugman and President Obama have called for a return to the 39.6 percent upper-income tax brackets (and Krugman on many occasions has intimated that it should be even higher), one can assume that Krugman also wants a near-40 percent levy on investment income. Now, given that his Keynesian beliefs permit him to assume that the Law of Opportunity Cost does not exist when government is involved, we safely can assume that Krugman believes that if investment income were taxed at about 40 percent, then there would be exactly the same amount of overall investment income that would be taxed.

In other words, a 40-percent tax rate would not discourage investors from putting even a penny less of investment, and that investment returns would not change. My sense is that Krugman believes that even if private investment were to fall, government could make up the difference with investing. Of course, everyone knows that government investments are made in "wise" things like "high-speed rail" in California (a true boondoggle if ever there was one), Solyndra, corn-based ethanol, electric windmills, auto industry bailouts in order to prop up the United Auto Workers, and so on. By moving resources from higher-valued uses to lower-valued uses, government works is "magic," making us poorer, but apparently that is what Krugman believes is morally and economically preferable to anything that might advance private investment.

Furthermore, Krugman deftly changes "tax rates" to "taxes" themselves, which is what Obama also has been doing. No, Warren Buffet does not pay less in taxes than his secretary, and Mitt Romney does not pay less in taxes than do I. For that matter, I am sure that Krugman himself pays more taxes than do most of us. But there is a difference in tax rates and taxes, even if Krugman wants to confuse us on that subject.

The more I read of Krugman, the more I realize that he is just a pure statist. The corporatism that he espouses (government funnels money to politically-connected firms, with the financial markets essentially carrying out state-sponsored directives) has been seen before, whether in Mussolini's Italy, Hitler's Germany, and Peron's Argentina. We know how those regimes went down, and ours will fare no better, and in the end, Krugman will blame private enterprise and call for even more statism.

Do savings really cause depressions?

One of the constant themes in Keynesian (and Krugmanian) economics is the evil of savings, and how government must manipulate the currency and the banking system in order to discourage people from saving money. On a number of occasions in his columns and blog posts, Krugman has invoked the hoary "paradox of thrift" which uses the Fallacy of Composition to declare that while it might be OK for a few individuals to save a few bucks here and there, it is disastrous if everyone saves at once.

In a recent blog post, Krugman once again claims that if the rate of savings goes up, GDP automatically goes down and the economy plunges into recession. (The post is primarily about the methodology of comparative statics, which all economists use in one way or another, but nonetheless his example is very telling. It is one thing to use comparative statics to demonstrate the effects of a tax on coffee and quite another to use the same method for savings and GDP, as they are not the same thing even though Krugman wants us to believe that we examine these things in exactly the same way.)

This example "proves" that if people save money, then GDP must fall. When people save money, Keynesians argue, not all of it is invested immediately, so when some current spending is eliminated but is not immediately spent as investment, there is a lull in which the economy is dragged down. Furthermore, they argue, once the economy starts to plunge, unless government immediately disrupts the pattern by spending and also inflating (which undermines savings), then aggregate demand will fall and investors will fail to create new capital, since they don't anticipate demand for the products it will help produce.

The Keynesian Multiplier, along with graphs such as what Krugman trots out, are shown as "proof" of this point. The Multiplier is expressed as 1/savings rate (Marginal Propensity to Save) which also can be expressed as 1/(1 - Marginal Propensity to Consume).

For example, say the MPC is 80 percent (or 0.8) and the MPS, then would be 20 percent (or 0.2). In other words, people in an economy would spend 80 percent of their income and save 20 percent. Thus, the Multiplier would equal 1/0.2 or 5. However, if people saved only one percent of their income, then the Multiplier would be 1/0.01 or 100, which "proves" that the less we save, the more prosperous we will be.

(I must admit that this reminds me of the saying we had when I was in high school, which began with "The more you study, the more you know," and finally was able to end, after some "logical" progressions, to "The less you study, the more you know. So why study?")

An obvious questions arises: If savings is bad, why not have a zero savings rate, which then would give us a multiplier of infinity? Keynes, when faced with that same question, declared that at that point, inflation would skyrocket, although he did not explain why that would be a bad thing, given that Keynesianism is based upon the "magic" of inflation, anyway.

This economic viewpoint, however, is based upon a nuanced view of capital, that it is homogeneous AND that the value of capital formation is in the spending that takes place, not with capital itself. And, Keynesians argue, because increased savings lower the value of the Multiplier, that the "solution" is for people not to save (or save as little as possible) and depend upon government or the central bank (or both) to manufacture the money needed for capital investment out of thin air.

All of this crashes, however, if capital is heterogeneous. Furthermore, if capital can be malinvested -- and Austrians argue that will be the case when capital is created via inflation -- then the Keynesian scheme is destined to end in disaster.

That is what we are seeing now. For more than two decades, the government has followed the pattern of inflating, running into malinvestments, inflating the economy into "recovery," and then dealing with future crashes that are larger. We have seen the Tech Bubble and collapse, the Housing Bubble and collapse, and now the governments around the world have created the Sovereign Debt Bubble which is destined to collapse.

Krugman can use all of the graphs and math that he wants, but he cannot get around the sticky problem of heterogeneous capital, nor does he have an answer for malinvestments. His M.0. has been to state his case and then attack anyone who disagrees, claiming that their disagreement is based upon their fundamental desire for people to suffer and to be out of work. That is not economics, but then Keynesianism is not economics, either.

Jonathan Macey schools Krugman on private equity

There is life imitating art, art imitating life, and then there is make-believe. Not surprisingly, Paul Krugman chooses the third option, at least when it comes to his belief that Oliver Stone's "Wall Street" gave an accurate picture of how private equity firms work.

(I do agree with Krugman's contention that government is not a business and that a businessman is any more capable of being an effective president than a career politician. Nonetheless, Krugman then wants us to believe the same tired song that government creates prosperity by spending, while businesses create recessions by becoming more efficient and by employing more capital. I can see a politician making such a statement, but an academic economist is supposed to understand something about the Law of Opportunity Cost.)

In his most recent column, Krugman quotes Gordon Gekko's famous "greed is good" speech as though that actually were accurate economics -- that corporate raiders could make money by buying healthy firms and then destroying their value.

What Krugman wants us to believe is that companies like Bain Capital would target successful, healthy, profitable firms, purchase them, and then make money either by running them into bankruptcy and then selling their assets. Now, perhaps at Princeton University, they teach that firm owners become wealthy by driving their firms into insolvency, but I would like to know how the market value of a company would INCREASE when it is careening into failure.

In an excellent article in the Wall Street Journal, Yale law professor Jonathan Macey explains how the private equity system actually works (as opposed to how Krugman says it works). (I don't have the full article available, and if I am able to do it later, I will post it.)

Macey's point is simple; a firm like Bain Capital purchases a firm that is underperforming relative to similar companies, restructures it, and then sells it. In order to profit, the private equity firm must be able to sell the firm (or its assets) for more than it paid for the company at the beginning.

Some common sense is in order, as Macey notes. A company cannot purchase a healthy company, run it into the ground, and then sell it for more than for the purchase price. While Krugman might believe that business people are utterly stupid (as opposed to professors and politicians), they are not so stupid as to buy high and sell low and do it consistently -- and remain in business.

If the Bain Capitals of the world are going to make profits, then they have to sell businesses or their assets (or both) for more than what they paid for the company, and they are NOT going to be able do that by looting a company. That simply makes no sense, which is why I hardly am surprised that both Krugman and Newt Gingrich seem to share the belief that businesses can profit by buying healthy companies, destroying them, and then getting even more value from their sale.

None of this means I am endorsing Mitt Romney for president. I hardly am enamored with his candidacy, but when people like Krugman and Gingrich demonstrate that they are utterly ignorant of how the leveraged buyout process works while condemning the whole practice, I'm going to speak up for the simple reason that someone needs to be able to explain some of the simple yet profound tools of economics without the political baggage.