Wednesday, June 16, 2010

Does Unlimited Government Spending Bring Prosperity?

Paul Krugman still is on his anti-austerity kick, which I guess is his economic flavor-of-the-week. His blog post on "austerity" and Ireland (among other countries), while clever, really does not answer the question he is asking, plus he inadvertently paints himself into a corner. Let me explain.

First, let us look at what Krugman writes: the cause is fiscal austerity — and we keep hearing about supposed examples of countries that experienced a boom after tightening fiscal policy, supposedly demonstrating that austerity is good, not bad, for employment. First was Canada in the 1990s, which turns out to be a quite different story. Now we’re hearing about Ireland in the 1980s.

So, time for a little research. And whaddya know: this story is also not at all the way it’s being told (pdf). Yes, Ireland had fiscal austerity — but it also benefited from a devaluation and an inflationary boom in the UK.

Oh, and Irish interest rates fell sharply, which was possible because they were very high to begin with; that’s not much of a precedent for the United States today, which starts with very low rates.

So yes, you can boost your economy with fiscal austerity, as long as you also devalue your currency and sharply reduce interest rates; also, incantations will destroy a flock of sheep, if administered with a sufficient portion of arsenic.
We have to remember that Krugman is demanding that governments can bring back prosperity by (1) borrowing trillions of dollars for which there is no appreciable way to pay back the money unless they (2) repudiate the debt by printing money, which is what Krugman wants them to do.

There is nothing surprising here, when one is beholden to Keynesian orthodoxy. When interest rates (as set by the central bank) are at what Krugman calls "zero-bound," then the only entity that can spend freely is government, since it has a legal monopoly on "creating money."

However, Krugman's economic logic in this passage is wanting. First, what does he mean by an "inflationary boom," and why should he care? In Keynesian thinking, inflation is NECESSARY for bringing an economy to "full employment," at least until the economy reaches its highest levels of "capacity." Thus, when one holds to this way of thinking, ALL booms are necessarily "inflationary," as inflation is required for the boom to occur in the first place (and Krugman holds that booms are good).

Second, why did Ireland's interest rates fall? Krugman gives no causality; they just fell. Third, none of this explains why Ireland in the 1980s had a fundamental economic change in which the country went from a quaint, but poor nation that mostly exported people to a place that attracted new investment AND people who wanted to be part of what was happening.

With Krugman, the change just happened, but lots of places have currency devaluations and even lower interest rates, yet do not have paradigm shifts in the economy. In other words, Krugman really has no causality theory for what happened.

James Burnham in a 2003 paper in the Independent Review wrote about the Irish boom, and gives much more detail into what happened. Yet, Krugman, holding to his Keynesian orthodoxy, simply gives us one more example of post hoc ergo propter hoc.

Again, we are dealing with two very different paradigms. In the Keynesian way of thinking, spending is everything. This is very different than "demand" as we know it, economically speaking, in which demand reflects what people want and what they are willing to give up in order to obtain it. In other words, demand cannot be separated from opportunity cost.

In the Keynesian view, however, "demand" really means "aggregate demand," which exists when people have "purchasing power" fueled by money. Thus, when government prints more money, it creates new "purchasing power" and, therefore, new "aggregate demand." There is nothing purposeful about this whole scenario; in fact, there really is nothing economic about it, for real economics deals with opportunity cost, something that pretty much is missing in Keynesianism.

So, we really are arguing two very different views of the world, and I believe that the Austrian view, while hated by the Krugmans of the world, better explains economic phenomena than does Keynesianism. However, don't forget that the very first line of Carl Menger's ground-breaking Principles of Economics makes the important point: "All things are subject to the law of cause and effect." In other words, to Austrians, causality really matters.

We are left, then, with the question that I asked in the title of this post. Krugman assumes that government spending financed via borrowing and printing really exacts no opportunity cost. I cannot accept that view under any circumstances. The fundamental building block of economic thinking is opportunity cost, and to ignore it is to jettison economics in the whole.


These Are The Times said...

With depression at the doorstep, it is time to fire the Federal Reserve. Western economies are on the brink of total collapse; only prompt, decisive and radical measures can prevent complete world economic ruin. Ironically, Russia and China are in a much better position to weather this up-coming storm than western countries.

The American rescue plan plodded through Congress and the world was hopeful when the $700 billion package went through. Alas, any relief was very short-lived and the package sent the share markets into even more pronounced gyrations.

Despite the whole rescue package being ill conceived, the pundits foolishly applauded the upward surge in the share markets. The recent rescue package was designed to give the ruling elite back money they used to artificially prop up the share markets. The package is a short-sighted, band-aid measure that helps secure the seats of incumbent politicians. But, the main beneficiaries of all these are the ruling elite and their Federal Reserve.

The failed rescue package was immediately followed by piece-meal assistance for certain individual banks. This gave the market a temporary boost. Again, it was short-lived. These volatile market swings should offer no comfort to anyone except speculators, who are becoming richer at the expense of everyone else.

The band aids will not help the economic crisis. There is a systemic problem. The Federal Reserve and all the central banks in the world that are designed on its model are defrauding the people of the world.

Daniel said...

Could you explain what you mean by opportunity cost being missing in Keynesian economics? That was integral in my education - how do they teach Keynesianism at Frostberg?

Daniel said...


Justin Murray, CFO said...


They may talk opportunity costs, but it is always done in that sort of quaint fashion in Keynesian economics where, somehow, there is this distinctive difference in macro and micro economics, that both are two mutually exclusive beasts and one can't impact the other. When it comes to individual businesses, Keynesians are more than willing to admit that resources are limited, obtaining more resources increases proportionately with the amount already held, and that the resources must be used in their most efficient method.

However, once the system moves between a magical, undefined line between micro and macro, resources suddenly become unlimited. All we need to create total prosperity is run printing presses 24/7 and give away money. In Keynesian economics, opportunity costs simply do not apply to the macro system or to governments. Resources are infinite and opportunity costs are merely a problem when there are finite resources, but a non-issue to infinite resource creatures like government.

The reality is that economics is only separated between macro and micro for the convenience of learning the system as a whole. There is no such thing as an operational micro system and macro system. There is just economics and opportunity costs apply no matter how big the component gets or what the identity of the actor is. Resources are finite, no matter how much money gets dumped into the system. Adding a new Dollar won't cause iron ore to pop into existence from nothing.

Where Keynesian economics fails is that acting as if money itself is the source of all value and the only way to return prosperity is to maintain spending, no matter what, is that all it does is destroy the ability to notice the opportunity costs. When opportunity costs are ignored, resources are haphazardly utilized and, ultimately, everyone is worse off because we lost the important information (price fluctuation) that tells us when it's time to back off consumption and production of a particular good or service.

You'll have to realize that, at the end of the day, Keynesian economics is just a group of quickly slapped together "hypotheses" that are carefully chosen not because it has any bearing in reality, but because it will benefit the individual proposing the system.

All we have to do is ask a simple question. At what time in history has what Mr. Krugman (I refuse to call him a doctor, he didn't earn anything but a piece of paper) just proposed actually worked? The answer is never, which is why they always argue that it was never enough. And it will never work.

William L. Anderson said...

Keynesians teach that the "aggregate supply" curve is flat until the economy starts pushing toward the end of its "capacity." In other words, in the relatively early stages, the economy can expand without prices rising (when the government stimulates it through spending).

That only can happen if opportunity cost takes a powder. Furthermore, the theory does not explain adequately WHY these resources are idle. It just states that people have stopped spending.

Anonymous said...

The last 10 years have made it impossible for me to take any reference point as viable save for a birds eye view.

Now given the fact that though 1) one might not know the cause one can still testify that they have stomach pain, 2) it's not only obvious that there is extreme tension in the imaginary global unified magic blob economy, but also 3) that those with wizard powers (thieving directors of Iceland's banks) will feast when the elephant rises and when it crashes, given these known and expected conditions it's time to stop playing this silly disjoint (faux synthesis) Hegelian game and admit we are either being pulled apart at both ends or crushed.

Anyone arguing the finer points of one or the other is either a morbid opportunist or really not a serious contributor to the debate.

Austerity and stimulus are crass code words for two sides of the same coin. Neither responsibility nor investment is associated with either of those words, at least what they mean in recent practice.

Before I expose Kagan next week, I will take both the Mises corner and the Keynes corner to task though I'll probably land squarely in the Mises corner by the end.

Enjoyed the blog so far.