Monday, September 6, 2010

Krugman Unleashed: Economics as Though the Non Sequitur Means Something

Following with his thematic writing (in following recent blog posts, including this one, along with my response), Paul Krugman continues to insist that if the Obama administration decides to really crank up the borrowing and spending, we, too, can experience a wonderful boom, just as Americans did in the 1940s.

Now, I find interesting that Krugman now has decided that World War II, a time when at least 50 million people met horrible deaths, really was a wonderful time of plenty and happiness, or at least it gave us an "economic boom," and Krugman believes booms are good. Lest anyone think I am exaggerating, read Krugman's own words:
From an economic point of view World War II was, above all, a burst of deficit-financed government spending, on a scale that would never have been approved otherwise. Over the course of the war the federal government borrowed an amount equal to roughly twice the value of G.D.P. in 1940 — the equivalent of roughly $30 trillion today.

Had anyone proposed spending even a fraction that much before the war, people would have said the same things they’re saying today. They would have warned about crushing debt and runaway inflation. They would also have said, rightly, that the Depression was in large part caused by excess debt — and then have declared that it was impossible to fix this problem by issuing even more debt.

But guess what? Deficit spending created an economic boom — and the boom laid the foundation for long-run prosperity. Overall debt in the economy — public plus private — actually fell as a percentage of G.D.P., thanks to economic growth and, yes, some inflation, which reduced the real value of outstanding debts. And after the war, thanks to the improved financial position of the private sector, the economy was able to thrive without continuing deficits.
As I have noted before, Robert Higgs, who actually is an economist who knows something about history (and is not simply a partisan political operative like a famous faculty member from Princeton), lays out the reality of the World War II home front quite well. Furthermore, there is the little problem of Krugman's non sequitur: How in the world can we say that World War II created a "boom" that "laid the foundation for long-run prosperity"?

First, the economy was tuned to war goods, not goods that people actually would want or need in normal life. Much of the capital that was developed during the war was not easily turned toward civilian production.

Second, there is no causality here. Krugman notes that the government went into huge deficit spending during the war, and then "long-run prosperity" just naturally followed. How, I ask, does that follow?

No doubt, Krugman would argue that the economy had "gained traction" during that time, but that is a circular argument at best. In that view, the economy booms because, well, it booms.

Finally, is Krugman demanding that the government expand the way it did during World War II, and that somehow, that will create long-term prosperity? If enough of us get jobs raking leaves and digging holes, and then filling them up again, will that magically make goods appear on the shelves and give us the Horn of Plenty?

Prof. Higgs has a much better handle on the subject. In this paper on "Regime Uncertainty," he not only lays out what happened during the 1930s and the war, but also what happened afterward. The difference is that his paper actually uses believable causal mechanisms, not Krugman's "Hair of the Dog" economic theories.


ruralcounsel said...

Somehow I doubt deficit spending during WWII worked so well for the Japanese or German governments.

William L. Anderson said...

Surely you jest. I mean, the Germans had such a labor shortage (jobs, jobs, jobs) that they had to "import" "guest workers" (read that, slaves from occupied countries) to fill their factories.

Full employment!! And everyone knows that "full employment" is the same as prosperity. I remember hearing a Marxist economics professor claim in 1982 that Romania had a better economy than ours because "there is no unemployment."

So, Romania might have been just this side of Hell, but there you have it: Paradise!

jgo said...

"I mean, the Germans had such a labor shortage (jobs, jobs, jobs) that they had to "import" "guest workers" (read that, slaves from occupied countries) to fill their factories."

That sounds much like what the last 4 US presidential admins have been doing. We may have hundreds of thousands of US STEM workers who are unemployed and under-employed, and they may be the best in the world by any measure, but, they keep telling us, we have to bring in more gastarbeiteren, and more foreign students, and "staple green cards" to every diploma... (in order to drive down compensation) because we neeeeeed the skills they picked up in the USA.

Anonymous said...

You have nothing on Krugman. Stop talking him!

Edward said...

I'm going to quote your pal Higgs as to why the war helped us out of the Depression:

"So why, apart from historians and economists misled by inappropriate and inaccurate statistical constructs, did people—evidently almost everyone—think that prosperity had returned during the war?

The question has several answers. First, everybody with a desire to work was working. After more than 10 years of persistently high unemployment and the associated insecurities (even for those who were working), full employment relieved a lot of anxieties. Although economic well-being deteriorated after 1941, civilians were probably better off on the average during the war than they had been during the 1930s. Second, the national solidarity of the war effort, though decaying after the initial upsurge of December 7, 1941, helped to sustain the spirits of many who otherwise would have been angry about the shortages and other inconveniences. For some people the wartime experience was exhilarating even though, like many adventures, it entailed hardships. Third, some individuals (for instance, many of the black migrants form the rural South who found employment in northern and western industry) were better off, although the average person was not. Wartime reduction of the variance in personal income—and hence in personal consumption—along with rationing and price controls, meant that many people at the bottom of the consumption distribution could improve their absolute position despite a reduction of the mean.49 Fourth, even if people could not buy many of the things they wanted at the time, they were earning unprecedented amounts of money. Perhaps money illusion, fostered by price controls, made the earnings look bigger than they really were. In any event, people were building up bank accounts and bond holdings; while actually living worse than before, they were feeling wealthier.

Which brings us to what may be the most important factor of all: the performance of the war economy, despite its command-and-control character, broke the back of the pessimistic expectations almost everybody had come to hold during the seemingly endless Depression. In the long decade of the 1930s, especially its latter half, many people had come to believe that the economic machine was irreparably broken. The frenetic activity of war production—never mind that it was just a lot of guns and ammunition—dispelled the hopelessness. People began to think: if we can produce all these planes, ships, and bombs, we can also turn out prodigious quantities of cars and refrigerators."

Higgs also makes the point: "They were earning unprecedented amounts of money" The Keynesian and monetarist explanation of the war is that by replenishing the private sectors' cash savings, the deficit spending during the war enabled the repair of private sector balance sheets harmed during the depression,and after the war ended households and corporations (GM was churning out tanks and the government was paying it) had enough money to spend on investment goods AND consumption goods.'

And you have to explain the key point. why did the equivalent deficit spending of twice gross domestic product not crush the economy afterwards? Instead of crushing America, America experienced a postwar boom. Public debt was high but private savings and incomes were also very high, and we essentially grew our way out of debt.
(And by the way, you really have to stop making fun of krugman using the "traction" word again and again. it was cute at first, but now its pathetic- and embarrassing. I think the monetarist explanation of "traction" is increased monetary velocity, nothing too weird about that)

William L. Anderson said...

Hey, Krugman is the one who uses the word. I'm just repeating what the guy says.

So, all the government has to do is to print a bunch of money, fill our savings accounts with it, and then we can have pent-up demand!

jason h said...

Don't forget rationing, price controls, and bombing the rest of the world's factories to keep inflation under control.

Steven said...

War did not create prosperity. The government significantly cutting spending and easing regulations in 1946-1947 did the trick.

Bob Roddis said...

These Chartalists are misusing the term "savings". Savings should refer to the situation where a private person or entity decides to forego immediate consumption of private income for future consumption/investment. The Chartalists seem to be referring to a situation where the government blows money on a harebrained scheme, borrows the money to pay for it, and then allows people in the private sector to purchase the debt securities resulting from blowing money on the harebrained scheme with the opportunity for the private party to earn interest off the sweat of future taxpayers.

That is not “savings”.

Steve said...

"If enough of us get jobs raking leaves and digging holes, and then filling them up again, will that magically make goods appear on the shelves and give us the Horn of Plenty?"

Actually, Krugman did say that about digging holes. Listen to this CNBC video excerpt -

Original here -

Unknown said...

My wife lived in Communist Poland. One of the things she remembers about those times was "Everybody had lots of money...there just wasn't anything to buy." This sounds to me to be a lot like the war time economy here in the United States. Higgs was right. The war did not end the depression.

Anonymous said...

The whole WW2 ended the Depression is an outright lie. WW2 did not stimulate the economy nor did it end the Depression. The facts indicate that it made the Depression worse, But the war did give the folks in the USA a heightened sense of accomplishment. There was rationing and complete government management of the economy, not exactly a wealthy paradise.

It was not until 1946 and all the returning laborers that these new entrepreneurs without foreign competition could finally after 16 years begin to bring the country out of the depression.

But don't be too quick to give Truman a thumbs up. The Dow Jones did not recover to its 1929 high until November of 1953. That was 24 years after the crash and 17 years after the New Deal. It was also 9 years after the bomb.

Anonymous said...

"Much of the capital that was developed during the war was not easily turned toward civilian production."

If you take the tour of America's largest/most famous/still existing manufacturer, you'll hear them tell you how WWII changed them from old fashioned build one at a time into assembly line production.

Another Anonymous said...

Krugman for once is right.

Kudos to Edward above.

Everybody believed then and still believes the war finally ended the depression - after the New Deal nearly ended it by FDR's wise policies - because it is capital T True. All the economists in the world ideologically twisting the facts doesn't change that. WWII didn't stimulate the economy - don't make me laugh.

Of course the rational comparison is peacetime economy to peacetime economy. All that war effort was going toward a singular purchase of a unique invaluable good - a world without Nazis etc. And lo and behold - if you compare the postwar economy to the prewar economy - it grew by an unprecedented amount during the war, just as if the war prosperity was real, because it was.

If not for the people of the US spending their money on this invaluable good, Chuck's wife, unless she was one of the 10% of Poles recognized as Aryan, would be enjoying her happy existence as a dead person. Ever hear of Generalplan Ost?

Yeah, right about turning toward civilian production - so hard to turn factories turning out lend-lease trucks for Uncle Joe Stalin, to trucks for American people and businesses. To turn bomber factories into ones making civilian airplanes based on the warplane designs. All the oil refineries, steel mills etc ad infinitum were a waste.

Whoop-de-doo about the Dow. That just shows how crazy bull markets can get. A lot of the Roaring 20s came from Florida real estate speculation. There were big headlines in Florida a few years ago about how real estate had finally gone up enough so that you wouldn't have lost money after 80 years. Wonder if that is still true?!

To be even blunter than usual - anybody who thinks the US war effort didn't end the Depression, stimulate the US economy and wasn't worth it to the US and the rest of the world understands nothing of history and economics and is entirely insane.

Anonymous said...

WWII ended the New Deal. That is why it ended the depression.