The Big Shill

Readers of this blog know that I believe academic economists ought not to be shills for politicians and bureaucrats and let one's writings and pronouncements be infected with political partisanship. I have made that point many times and try to hold to it myself with everything that I write. (And that includes Ron Paul, even though I agree with him on many things. Nonetheless, academic economists should be willing to keep their distance, even from people they like.)

Second, academic economists ought to be able to differentiate between political "victories" by a politician and the economic outcomes. Unfortunately, Paul Krugman in this column manages to violate to principles and once again identifies himself as a shill, a lowly political operative.

It is no secret that Krugman worships Franklin Roosevelt and the New Deal, holding it to an almost mystical standard. That FDR's New Deal attempted to organize the entire U.S. economy into a series of cartels, destroyed agricultural products despite widespread hunger (the destruction financed by a tax on agricultural products), criminalized the kosher killing of chickens, and unleashed petty bureaucrats to burden entrepreneurs with useless rules is utterly irrelevant to Krugman. In fact, he wants us to believe that the New Deal -- which actually kept unemployment higher than it would have been had FDR just stuck to engaging in his adulterous liaisons -- in essence created an economic miracle: "...the New Deal had a revolutionary impact, empowering workers and creating a middle-class society that lasted for 40 years...."

In other words, Krugman wants us to believe that no U.S. "middle class" existed before the New Deal and that by empowering the state to move well beyond previous boundaries, FDR accomplished what no one ever before was able to do. Now, I have no idea how the New Deal could have done that, except that Krugman thinks that empowering labor unions and vastly expanding what truly is an unproductive bureaucracy managed to increase overall wealth in the U.S. economy.

This defies the imagination. The New Deal, from its inception, openly attempted to throw sand in the wheels of production and, thus, result in less wealth in the form of goods and services. Destruction of crops destroyed wealth; creating and maintaining cartels destroyed wealth. This is fundamental, yet Krugman turns the whole thing upside down by claiming that the use of violence (which enabled unions to gain higher wages for themselves -- at the expense of non-union workers) and the expansion of the bureaucracies, which are funded by taxpayers who are forced to give up some of their own wealth, somehow made all of us wealthier.

Krugman's gives himself away by telling readers that making some people poorer somehow is good for the economy. He writes:

That said, health reform will provide substantial aid to the bottom half of the income distribution, paid for largely through new taxes targeted on the top 1 percent, and the “fiscal cliff” deal further raises taxes on the affluent. Over all, 1-percenters will see their after-tax income fall around 6 percent; for the top tenth of a percent, the hit rises to around 9 percent. This will reverse only a fraction of the huge upward redistribution that has taken place since 1980, but it’s not trivial.

There is a huge problem here; Krugman explains that the new tax laws will make a portion of our population less well-off, but he does not adequately explain how that benefits the rest of us. Yes, ObamaCare allegedly will make it easier for some people to have access to health insurance, but ObamaCare itself, with all of its new rules, regulations, and criminal penalties, will result in less medical care overall being made available. Even Krugman admits that the health care law created a "Rube Goldberg device of regulations and subsidies...."

Is it my imagination, or is Barack Obama a magician? One would think that by adding rules and procedures (which, according to the Law of Opportunity Cost will increase overall costs), the government is going to force the medical care "supply curve" to the left (to use economists' jargon). How this is a "victory" for the economy, I have no idea.

In Krugman's view, making one group of people less-well-off is the same thing as making everyone else better off, yet he offers no mechanism other than pure transfer payments. However, transfer payments only distribute existing wealth and they create no new wealth. This is the classic "Zero-Sum Economy," and if that is Krugman's view of things, then how does he explain the fact that overall standards of living for everyone are substantially higher than they were during the New Deal. For that matter, they are substantially higher for everyone than they were during Ronald Reagan's presidency.

I would ask anyone to explain how Paul Krugman's theory of political economy actually demonstrates any causal relationship between New Deal and "Big Deal" policies and an overall rising standard of living. Krugman never has explained how an economy might grow in the first place, except to claim that inflation somehow creates economic miracles. (But even there, he does not explain a causal relationship between inflation and real economic growth.)

Furthermore, his explanation of "capital theory" really is nothing more than a spending theory. The new Apple iPhone, he surmised, might boost the economy because people will buy new ones. Come again? Does the iPhone do away with the Law of Opportunity Cost?

In the end, what Krugman is reduced to shilling for Barack Obama because he is a Democrat who has vastly expanded the reach of the State. And according to Krugman, an expanded and more powerful State through coercion makes us all richer. I'm not sure how that happens, but maybe Krugman will explain everything in a future column.

Maybe the Stimulus-Bearing Space Aliens will have iPhones

I believe I owe Paul Krugman an apology, for I have written in the past that Keynesians do not have a theory of capital. I was wrong; Keynesians do have a capital theory: it is called More Spending.

Now, this is not a theory of capital like that developed by the Austrian School, beginning with Carl Menger. Instead, it is a theory that says that the construction and addition of capital to the economy is useful mainly in the amount of short-term spending that it brings. Thus, the actual performance of new capital takes a back seat to the fact that when business enterprises purchase the capital, they spend money, and it is that short-term spending that is significant.

For those who might argue differently, Krugman lays out his view in his column that claims the new iPhone will provide "stimulus" to the U.S. economy. True, it seems that others also have drunk the Kool-Aide, and others seem to be even more enthusiastic about this latest rendition of the "Broken Windows Fallacy" than even Krugman (although he does seem to buy into the concept):

A recent research note from JPMorgan argued that the new iPhone might add between a quarter- and a half-percentage point to G.D.P. growth in the last quarter of 2012. How so? First, the report argued that Apple was likely to sell a lot of phones in a short period of time. Second, it noted that although iPhones are manufactured overseas, most of the price you pay when you buy one is domestic value-added — retailing and wholesaling, advertising and profits — all of which counts as part of G.D.P. Finally, it took some plausible guesses about the price of each phone and the number of phones sold, and used those guesses to make an estimate of the impact on G.D.P.

It’s all pretty straightforward. But the implications are wider than most people realize.

The crucial thing to understand here is that these likely short-run benefits from the new phone have almost nothing to do with how good it is — with how much it improves the quality of buyers’ lives or their productivity. Such effects will kick in only over the longer run. Instead, the reason JPMorgan believes that the iPhone 5 will boost the economy right away is simply that it will induce people to spend more.

 Once again, we see the most important element of economic thinking go missing: opportunity cost. The money that people will spend for new iPhones is money that will not be directed in the purchase of other goods. We do not have new "spending" arising from nothing; what we will have is a redirection of how people spend their incomes.

Not surprisingly, Krugman does not end at that point. If you believe in the "iPhone stimulus," he crows, then you believe that more government spending will boost the economy. But, hey, why even stop there?

Why not go whole hog and hope that the invasion of the space aliens comes complete with the Little Green Men stopping at the Apple Stores and elsewhere to buy the iPhones before they set out to destroy the earth. However, if that is their plan, then we should not resist the invasion because doing so would invoke "weaponized Keynesianism," and Mitt Romney supports that, so it must be bad. (Actually, it is bad, but not because Mitt likes it. Yes, Paul, there is more to life than partisan political thinking.)

No, we should not resist because after the Little Green Men With iPhones destroy the earth, we then will have the Ultimate Keynesian Stimulus of rebuilding just about everything. As Krugman writes:

Yet depressions do end, eventually, even without government policies to get the economy out of this trap. Why? Long ago, John Maynard Keynes suggested that the answer was “use, decay, and obsolescence”: even in a depressed economy, at some point businesses will start replacing equipment, either because the stuff they have has worn out, or because much better stuff has come along; and, once they start doing that, the economy perks up. Sure enough, that’s what Apple is doing. It’s bringing on the obsolescence. Good.

The Little Green Men With iPhones could accelerate that process, all to the better. In fact, I will slightly change Krugman's next paragraph to demonstrate exactly what I mean:

But why suffer through years of depressed output and high unemployment while waiting for enough obsolescence to accumulate? Why not have the government Little Green Men With iPhones step in and spend more, say on education and infrastructure, to help the economy through its rough patch? Don’t say that the government Little Green Men With iPhones can’t add to total spending, or that government spending can’t create jobs. If you believe that the iPhone 5 can give the economy a lift, you’ve already conceded both that the total amount of spending in the economy isn’t a fixed number and that more spending is what we need. And there’s no reason this spending has to be private.

So, all it takes for us to experience new stimulus is for E.T. to phone home. If he does it with an iPhone, all the better.

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.

Yes, Paul, Bob Murphy Exists -- and He is a Better Economist than You Are

So, after shunning debate and the like, Paul Krugman finally admits that Robert Murphy exists, although I hardly think that what Murphy wrote constituted as "puerile insults." Yes, this comes from a person who mocks people who disagree with him as "zombies." No immaturity there.

The article to which Krugman refers is this one on capital theory, something that is missing from Krugman's Keynesian analysis as well as from the old Chicago School. (In their view, capital magically appears, as economists simply can assume it into existence. Don't try this at home.)

I think that Krugman and Murphy can argue this on their own without any help from me. Here is Murphy's post on his own blog regarding Krugman's post. Read and enjoy.

(I am back from speaking to the Gulf Coast Economics Club in Pensacola. A great time was had by all, and now it is time to get to work at my day job.)

"Forgive Us Our Debts...."

One of the central working assumptions in Keynesian theory is the homogeneity of all assets. As economist Robert Higgs notes:

This way of compressing diverse, economy-wide transactions into single variables has the effect of suppressing recognition of the complex relationships and differences within each of the aggregates. Thus, in this framework, the effect of adding a million dollars of investment spending for teddy-bear inventories is the same as the effect of adding a million dollars of investment spending for digging a new copper mine. Likewise, the effect of adding a million dollars of consumption spending for movie tickets is the same as the effect of adding a million dollars of consumption spending for gasoline. Likewise, the effect of adding a million dollars of government spending for children’s inoculations against polio is the same as the effect of adding a million dollars of government spending for 7.62 mm ammunition. It does not take much thought to conceive of ways in which suppression of the differences within each of the aggregates might cause our thinking about the economy to go seriously awry.

In fact, “the economy” does not produce an undifferentiated mass we call “output.” Instead, the millions of producers who bring forth “aggregate supply” provide an almost infinite variety of specific goods and services that differ in countless ways. Moreover, an immense amount of what goes on in a market economy consists of dealings among producers who supply no “final” goods and services at all, but instead supply raw materials, components, intermediate products, and services to one another. Because these producers are connected in an intricate pattern of relations, which must assume certain proportions if the entire arrangement is to work effectively, critical consequences turn on what in particular gets produced, when, where, and how.

These extraordinarily complex micro-relationships are what we are really referring to when we speak of “the economy.” It is definitely not a single, simple process for producing a uniform, aggregate glop. (Emphasis mine)

I quote Prof. Higgs to answer Krugman's recent blog post on debt and GDP in which he points out that during the 1930s the debt/GDP ratio fell. In commenting on graphs he has in his post (which you can see on his link -- I'm not reproducing them here), he writes:

Debt actually fell as the economy slumped, through a combination of deleveraging and default. The ratio to GDP spiked only because GDP collapsed. Conversely, as the economy began to recover under the New Deal (before the big mistake of 1937), the debt ratio improved thanks to rising GDP, even though the nominal level of debt also rose.

What all this tells you is how important it is, in dealing with debt, to get the economy moving — and how devastating it is, even if you’re deeply frugal, if contraction and deflation rule.

The problem is that Krugman is operating on the assumption that private and government debt are homogeneous in nature when, in fact, they are not. Most private debt, and especially private debt of that era, is for capital formation and business expansion. Government debt (and especially the federal debt), on the other hand, mostly exists for present spending purposes and it not investment by any stretch of the imagination. (The one exception on the local and state levels is the issuance of capital bonds which are used for roads, bridges, and other physical infrastructure improvements. These bonds usually have pretty specific fees designed for repayment, as opposed to having a general obligation for taxpayers.)

In the Krugman-Keynesian view, however, there is only spending, and debt is useful to the economy ONLY in the fact that it permits more present spending, which supposedly is the grease that gives the economy "traction" and allows there to be future development. As Krugman has noted elsewhere, public debt might be rising, but it only is helping to replace the drop in private debt.

However, it is important to note that the mechanism for repaying private debt (which is undertaken for capital or business expansion) is the sale of goods and services in the future. The debt ultimately is repaid because real wealth is expanded, as opposed to the debt payments coming from the pockets of future taxpayers.

Krugman would argue that government borrowing today simply helps keep spending alive, and that will give the economy some "traction" so that the economy in the future will be stronger. What is lacking in that train of thought, however, is the mechanism for economic growth. In his view, economic growth occurs because people spend more money. End of discussion.

This view, I believe, is extremely shortsighted. In Austrian (and the old standard) views of economics, economic growth occurred because over time, people found ways to create more goods and services by using fewer resources, thus permitting those now-unused resources to be applied to other uses. That seems to be counter-intuitive to today's thinking in which we assume that growth occurs only because we are using more and more scarce resources (and that one day those resources will run out and we will be reduced to poverty via increased scarcity).

Again, this demonstrates a huge misunderstanding of what resources are and how we use them. Many products we now use are made from factors that at one time were not seen as resources at all. Crude oil once was seen as a nuisance product, and the modern silicon for computers is nothing more than something derived from sand.

Capital is useful because it serves as a tool for permitting us to make more goods from fewer factors of production, and especially labor. Contrary to the atavistic belief that capital creates mass unemployment, capital allows labor to be applied to uses to which labor before was too scarce to be used in this way.

Thus, to say that the only economic use of capital is the spending generated to create it (which I doubt even Krugman believes, although his analysis does not permit any other interpretation) is to misunderstand capital and to misunderstand the use and importance of debt. In other words, the guy simply does not "get it."

Consumption and Spending, and Other Links

In my latest column for the Freeman Online, I differentiate (in 700 words) between consumption and spending. The Keynesians (and Krugman groupies) see spending as mechanistic and necessary so we can repeat the circular "economy" in which we make stuff, put it on the shelves, and then "spend" so that we can clear the shelves so that people will have something to do: make more stuff to put on the shelves.

There are a number of other excellent articles as well. Wendy McElroy looks at the attempts by Sen. Harry Reid to effectively "federalize" the local police, thus making them even less accountable than they are now. Sheldon Richman comments on the latest "re-regulation" of the financial sector, and Steven Horowitz examines Austrian capital theory.

Have a great weekend.