Krugman, Causality, and the Irish Financial Crisis

Whenever I read one of Paul Krugman's columns, I don't expect to be in agreement, so I am pleased when he makes points that I believe are spot on. However, somewhere through the column, he suddenly makes a turn in which the entire thing is turned into a giant non sequitur that leaves me scratching my head to his logical progressions.

For example, in 2003, he wrote a column in which the theme was the "Lump of Labor Fallacy," which tends to be the underlying theme that labor unions present in their worldview. Throughout the column, he lays out the intellectual case debunking this fallacy, but then writes this:

Since 2001, sensible economists have been pleading for federal aid to state and local governments so schoolteachers and police officers needn't be laid off because of a temporary fall in revenues. They've also urged the administration to stop dragging its heels on much-needed homeland security spending, not just because such spending is needed to make the country safer, but also because it would create jobs and put more income into the hands of Americans likely to spend it. (And if you're worried about spending's leading to increased deficits, why not cancel some of those long-run tax breaks for upper brackets?) Until we've done the obvious things, there's no reason to despair about job creation.

I remember my reaction the first time I read it: Say what? The intellectual basis behind calling the "Lump of Jobs Fallacy" a fallacy is that we apply theories of division of labor and marginal utility and, yes, the Law of Scarcity. Krugman, on the other hand, tied it to a Keynesian notion that more spending creates jobs and prosperity.

(In fact, Krugman's view of "jobs" is that a "job" is something we do and its main purpose is for an avenue of income to boost spending. He does not tie the production aspect of work to production of goods themselves as the basis for our purchasing power. Instead, we get an amorphous view of "spending" that has only a loose connection to production.)

Thus, it is today in Krugman's "Eating the Irish" column. He begins on a strong note, but then veers off the Keynesian cliff in a way that leaves me scratching my head.

First, I begin with the sound part:

The Irish story began with a genuine economic miracle. But eventually this gave way to a speculative frenzy driven by runaway banks and real estate developers, all in a cozy relationship with leading politicians. The frenzy was financed with huge borrowing on the part of Irish banks, largely from banks in other European nations.

Then the bubble burst, and those banks faced huge losses. You might have expected those who lent money to the banks to share in the losses. After all, they were consenting adults, and if they failed to understand the risks they were taking that was nobody’s fault but their own. But, no, the Irish government stepped in to guarantee the banks’ debt, turning private losses into public obligations.

I fully agree and hold that there should have been NO bailouts, but that also includes the bailouts that occurred in this country. Not only do I believe that Wall Street should have been on the hook for its role in creating and sustaining the Housing Bubble, but I also believe that had the Bush and Obama administrations permitted that to happen, we would not have had the Great Implosion that everyone (including Krugman) predicted.

Yes, it would have been difficult as the markets sorted out which firms had solid assets and which had worthless paper, and some CEOs would have lost their mansions in Connecticut. However, it would not have taken long to liquidate the malinvested assets, and we would be well on our way to a real recovery instead of the stagnation that we have now.

Unfortunately, after this paragraph, Krugman veers off into, well, Krugmanism. He writes:

Before the bank bust, Ireland had little public debt. But with taxpayers suddenly on the hook for gigantic bank losses, even as revenues plunged, the nation’s creditworthiness was put in doubt. So Ireland tried to reassure the markets with a harsh program of spending cuts.

Step back for a minute and think about that. These debts were incurred, not to pay for public programs, but by private wheeler-dealers seeking nothing but their own profit. Yet ordinary Irish citizens are now bearing the burden of those debts.

Or to be more accurate, they’re bearing a burden much larger than the debt — because those spending cuts have caused a severe recession so that in addition to taking on the banks’ debts, the Irish are suffering from plunging incomes and high unemployment. (Emphasis mine)

So, while taking on the obligations that the government should not have taken on in the first place, the Irish government then should have increased spending? With what? Tax revenues fell and the Irish government could not print Euros, so all it could have done was to borrow, and somehow I doubt that the world was anxiously awaiting the acquisition of more Irish government debt.

Furthermore, his contention that spending cuts "caused" the recession is utterly laughable. Is Krugman claiming that had Ireland continue to spend at current levels or even boost spending (With what?), that Ireland would not have experienced a recession? Krugman's statement is a classic non sequitur, something that a competent economist should not be pursuing. He goes on (unfortunately):

In early 2009, a joke was making the rounds: “What’s the difference between Iceland and Ireland? Answer: One letter and about six months.” This was supposed to be gallows humor. No matter how bad the Irish situation, it couldn’t be compared with the utter disaster that was Iceland.

But at this point Iceland seems, if anything, to be doing better than its near-namesake. Its economic slump was no deeper than Ireland’s, its job losses were less severe and it seems better positioned for recovery. In fact, investors now appear to consider Iceland’s debt safer than Ireland’s. How is that possible?

Part of the answer is that Iceland let foreign lenders to its runaway banks pay the price of their poor judgment, rather than putting its own taxpayers on the line to guarantee bad private debts. As the International Monetary Fund notes — approvingly! — “private sector bankruptcies have led to a marked decline in external debt.” Meanwhile, Iceland helped avoid a financial panic in part by imposing temporary capital controls — that is, by limiting the ability of residents to pull funds out of the country.

And Iceland has also benefited from the fact that, unlike Ireland, it still has its own currency; devaluation of the krona, which has made Iceland’s exports more competitive, has been an important factor in limiting the depth of Iceland’s slump. (Emphasis mine)

First, I doubt that Iceland is exactly wallowing in prosperity at the moment. The imposition of capital controls hardly is a solution, no matter what Krugman thinks. It is a statement that the government owns one's property, period. The only reason that governments impose capital controls is that those in power want to steal property of others and the only way to do it is to keep it in the country where government agents can find it.

This is the financial version of the Berlin Wall, and it is theft, pure and simple. Why am I not surprised that Krugman endorses this action?

As for the currency issue, there is some truth in that matter, but Krugman leaves out something important: Iceland may be able to repudiate some of its obligations via currency devaluations (which really is a sophisticated way of saying it is printing more money and impoverishing anyone whose wealth is held in Kronas), but it is less likely to attract future investment from outside the country. In other words, it trades a temporary fix for future problems.

However, since Keynes himself declared that "In the long run, we all are dead," I guess that even if short-term actions hold long-term consequences, we should not worry. That will be someone else's problem.

Will "Austerity" Doom Us? Or Is It a Plot By Bond Buysers?

Paul Krugman is a guy on a mission, and when he writes all of his columns and blogs on a single theme -- "Austerity" is Bad, Really Bad -- then one can tell he is serious about his message. His column today falls into that category (again), but now he also presents the problem as being caused both by ignorance (not agreeing with Krugman is being ignorant) and A Sinister Plot By Bond Buyers To Destroy The World.

Riding in on his steed, Krugman declares:

For the last few months, I and others have watched, with amazement and horror, the emergence of a consensus in policy circles in favor of immediate fiscal austerity. That is, somehow it has become conventional wisdom that now is the time to slash spending, despite the fact that the world’s major economies remain deeply depressed.

This conventional wisdom isn’t based on either evidence or careful analysis. Instead, it rests on what we might charitably call sheer speculation, and less charitably call figments of the policy elite’s imagination — specifically, on belief in what I’ve come to think of as the invisible bond vigilante and the confidence fairy.

Bond vigilantes are investors who pull the plug on governments they perceive as unable or unwilling to pay their debts. Now there’s no question that countries can suffer crises of confidence (see Greece, debt of). But what the advocates of austerity claim is that (a) the bond vigilantes are about to attack America, and (b) spending anything more on stimulus will set them off.

But the 2008 Nobel Laureate has declared that the USA can and should continue on its spree of borrowing, printing money, and spending. (Thus, we can pretend we prosperous and rich even when we are broke, since printing money creates wealth, according to this Keynesian acolyte.)

Krugman's poster child for "austerity" is Ireland, which according to him is in the Very Throes of Permanent Destruction:

And current examples of austerity are anything but encouraging. Ireland has been a good soldier in this crisis, grimly implementing savage spending cuts. Its reward has been a Depression-level slump — and financial markets continue to treat it as a serious default risk.

However, according to Financial Times, Ireland is not doing as badly as Krugman claims, and seems to be moving in the right direction:

Ireland climbed out of recession on Wednesday with the economy returning to growth in the first quarter, after suffering one of the deepest downturns of any advanced industrialised economy.

Ireland’s return to growth, in spite of having undertaken a huge fiscal retrenchment over the past two years which prolonged the downturn, will provide encouragement to other European economies facing up to tackling rising public deficits.

Furthermore, FT notes Krugman's recent criticisms of Ireland's policies:

Paul Krugman, the Nobel-laureate economist, argued last week that Ireland had seen little reward for its brave fiscal measures. “Virtuous, suffering Ireland is gaining nothing,” he wrote in the New York Times. He was referring to the reaction in the bond markets, where Ireland is still paying 3 per cent more than Germany to finance its budget. But Irish ministers argue they had little choice but to tackle the deficit.

“Had we not done so, the deficit would have ballooned towards 20 per cent of GDP – a level at which the very financial survival of this country would have been at risk,” Mr Lenihan said at the time of the December budget.

Ireland has slashed public sector salaries by about 15 per cent. Welfare has been cut, including 10 per cent off child benefit. New income and health levies have also been imposed.

The return to growth reflects a buoyant performance by the export sector, particularly the foreign-owned multinationals, who have benefited from the euro’s decline and from Ireland’s falling cost base. Ireland sells close to 60 per cent of its exports outside the eurozone – to the UK, US and other economies.

Now, FT is not claiming that Happy Days Are Here Again on the Emerald Isle, but it is clear that after chasing the same housing bubble as much of the rest of the world, Ireland is putting its house in order, unlike the USA. Krugman's entire analysis depends upon the notion that governments should spend and spend until the economies "recover," but with government continuing to prop up malinvestments and discouraging private investment in healthy sectors due to what economist Robert Higgs calls "regime uncertainty," there is not going to be a recovery in the private sector, period.

In Keynesian analysis, the "end game" is the magical recovery of the private sector. Yet, FDR's New Deal (which Krugman generally praises) clearly did not bring recovery, and it created a huge regime uncertainty. However, given the Obama administration's attacks upon productive people and its attempts to force high-cost, low-output things like "green jobs" upon us, not to mention Obama's own anti-entrepreneurial rhetoric, government spending is likely to be the only game in town.

It won't bring recovery, but it does permit people like Krugman to claim that the state really is our savior when, in reality, it is anything but.

(Hat tip to Chris Westley for the FT article)