The Super Secret, Mystical Recession Cure

For some reason, I found myself reading through Paul Krugman’s recent NY Times material. Perhaps it was a desire for a little mental vaunting, what with the direction the elections seem to be taking, and if so I should have come away quite satisfied as Mr. Krugman is in full Chicken Little mode. A GOP takeover of congress will be a disaster, and we should all be very afraid. Stupid people are allowing their emotions to run away with them and will destroy the world economy through getting all moralistic about debt. And of course, the reason why the entire world doesn’t see things Krugman’s way is because macroeconomics is too hard for them to understand.

Well, I’m certainly prepared to admit that Krugman’s expertise in macroeconomics is greater than my own — and I’ll even stretch and say that my understanding probably goes farther than that of the average bear. However, I can’t escape the feeling that Krugman is somewhere between singing:

The intelligent lot, the intuitive lot,
The infallible lot we are.

and

The marvellous mugs, miraculous mugs,
The mystical mugs we are.

But since he’s rather less exuberant than Chesterton he says it like this:

The greatness of Keynes is illustrated by the trouble people who consider themselves well informed have, to this day, in understanding the basic principles of how a depressed economy works.

It’s true that most people are not very good at understanding complex systems with many, interdependent moving parts. This is why most people are confused by macroeconomics, or come to that microeconomics at the theoretical level. But then, it’s also why even terribly clever people who think that they have a solid grasp of macroeconomic theory get themselves in trouble by believing that they understand all the factors in play and drawing up charts which demonstrate that unless we pass the President’s recovery plan, unemployment might go as high as 9%.

Don’t get me wrong, macroeconomics is indeed different from everyday business experience, as Krugman touches on:

Businesses are open systems; the world economy is a closed system, with feedback effects that are crucial but play no role in ordinary business experience. In particular, an individual businessman, no matter how brilliant, never has to worry about the fact that total income equals total spending, so that if some people spend less, either someone else must spend more, or aggregate income must fall.

But when the explanations become too mystical, I can’t help (perhaps because it’s just my simplistic, middle brow, self) cocking an eyebrow:

The years leading up to the 2008 crisis were indeed marked by unsustainable borrowing, going far beyond the subprime loans many people still believe, wrongly, were at the heart of the problem. Real estate speculation ran wild in Florida and Nevada, but also in Spain, Ireland and Latvia. And all of it was paid for with borrowed money.

This borrowing made the world as a whole neither richer nor poorer: one person’s debt is another person’s asset. But it made the world vulnerable. When lenders suddenly decided that they had lent too much, that debt levels were excessive, debtors were forced to slash spending. This pushed the world into the deepest recession since the 1930s. And recovery, such as it is, has been weak and uncertain — which is exactly what we should have expected, given the overhang of debt.

The key thing to bear in mind is that for the world as a whole, spending equals income. If one group of people — those with excessive debts — is forced to cut spending to pay down its debts, one of two things must happen: either someone else must spend more, or world income will fall.

Yet those parts of the private sector not burdened by high levels of debt see little reason to increase spending. Corporations are flush with cash — but why expand when so much of the capacity they already have is sitting idle? Consumers who didn’t overborrow can get loans at low rates — but that incentive to spend is more than outweighed by worries about a weak job market. Nobody in the private sector is willing to fill the hole created by the debt overhang.

Now, as a stand-alone economic model, this makes a great deal of mathematical sense — and that’s hardly a surprise as Krugman is a smart guy with an ability to understand complex mathematical models. Yet it’s a model, it’s not the real world. And as such, it’s only as useful as its resemblance to the real world.

Mathematically speaking, if demand is not coming from one source (businesses and individuals spending money which they have or which they have borrowed) then you can make up for that demand from another source (the government spending money it has borrowed) and the effect will be the same. The two main problems I see, however, have nothing to do with the mathematics of the model — they have to do with the relation of the model to reality.

First off, however much it clearly annoys Krugman that this is the case, voters simply do not like the idea of the government spending endless amounts of borrowed money on projects which might not otherwise be funded because it’s important to “prime the pump” of the economy. People can’t escape the idea that this is their money, as taxpayers, which is being spent, and that they’re going to have to pay it back. During a recession, people are particularly troubled by their own debts and bills — and since one of the bills that they see every so often is a tax bill, they don’t like thinking about the government racking up endless debts which they are going to have to pay back later. So while in theory government spending could make up for a private demand shortfall and keep the economy up, it seems to me that in practice it’s simply not sustainable in a situation where that public spending would have to be financed through massive borrowing, because since people would be thinking “that’s borrowed money” they would continue to be afflicted by economic anxiety and to sit tight on their savings. Knowing that the public money being used to “prime the pump” was “fake” demand would keep people from recovering their confidence and prolong the lack of private demand.

The second big issue that comes up, it seems to me, it the question of what the government should spend its money on in order to stimulate demand. This was comparatively easy during the New Deal programs of the Great Depression — a significant percentage of the country was employed in manual labor, and many major public works projects required large numbers of manual laborers, so it was easy to start up a big project, pay the workers, and expect that money to filter out into the economy. Today’s workforce is much more heavily focused on skilled/specialized labor, and so even if we assume that the government could use deficit spending to employ lots of people through public spending, this brings up the question of what the government should spend on which wouldn’t cause mal-investment in capital and labor training.

Say, for instance, the government were to announce a major project of putting up wind farms. Huge amounts of money are spent, lots of new wind turbine making factories are built and wind turbine makers and installers are trained. All this spending helps get the economy back on track, as those wind turbine installers head down to Wal-Mart and spend their paychecks. After two years the program is a success, and so the wind turbine program ends. Now what happens to those workers and the capital investments in those factories? How easily are they turned to other work, and how long are they unemployed in the interim? Do we simply end up with another economic slowdown as a result of massive unemployment in the windfarm industry?

The problem is, even a wonderfully complex economic model dreamed up by an intelligent lot, and intuitive lot, and infallible lot of marvelous, mystical mugs will end up being simpler than the actual world. And as a result, it’s not always as easy to get the real world to do what you want as it is to get a model to do so.

15 Responses to The Super Secret, Mystical Recession Cure

  • Here is what is so very difficult for this idiot (moi) to understand: why a man with a PhD that knows there is to know about economics is not a multi-billionaire?

    Posted at Instapundit: “They’ve spent the past 18 months calling you names and questioning your sanity and patriotism. But today you get to vote, and that’s all that matters.”

  • I don’t think a formerly unemployed person who gets a new government job is going to sit on his money because of some mystical economic anxiety that wouldn’t exist if it were a private sector job. A well-designed stimulus works in theory and in reality.

    After two years the program is a success, and so the wind turbine program ends. Now what happens to those workers and the capital investments in those factories? How easily are they turned to other work, and how long are they unemployed in the interim? Do we simply end up with another economic slowdown as a result of massive unemployment in the windfarm industry?

    Same could be said of the public works projects of the Great Depression. If it’s successful, the economy would pick up and there would be more demand for unsubsidized jobs.

    The way I see it, the problem with stimulus is almost entirely about your second point. The government is unlikely to create many jobs that don’t replace private sector jobs. What percentage of the unemployed can weatherize homes and make wind turbines?

    Ideally, we would’ve had a high skill jobs program in place so the unemployed can tutor kids or patrol streets. But there’s no chance of that happening now.

  • I didn’t read your article, DC, because then I’d have to read excerpts of Krugman, and that’s not going to happen. But I hope your article was good anyway.

  • I certainly don’t think that a formerly unemployed person who gets a government job won’t spend more money than they did while unemployed — but in order for the theory to work they need to not only spend more than while unemployed, but that spending needs to make the private sectore become so encouraged that they decide good times are here again, ramp up capacity, hire a bunch of people, etc. That seems pretty hard to do.

    To be honest, I would think that in our modern economy the best approach (though it doesn’t have the virtue of allowing congress to spend like a drunken sailor on all their favorite programs) would be to stick with a stimulus which consists of payroll tax relief for businesses and extended (and perhaps more generous) unemployment benefits for those actually out of work. There are those who argue that even this slows the reallocation of resources, but I’d think it’s an acceptable risk because of the human benefits.

  • Extended more generous unemployment benefits = Government jobs without the benefits of work

  • I thought you made some really good points. Particularly, that the spending needs to be focused much different in this economy than in the 1930s and that people are scared to spend b/c they’re worried about the bill they’re going to be hit with in the future. I know I am expecting taxes to be have to be raised sometime soon, so I’d be preparing if I have any money to save.

  • Paul Krugman is, to put it as nicely as possible, an idiot. Keynesian economics is a failure.

    The private sector employs the most people. The private sector is the engine of creation and ideas. Government is not. Stimulation of the private sector through lower personal income tax rates, lower corporate income tax rates, and lower taxes on investment and capital gains is what successfully stimulates an economy into recovery and increased employment. The subsequent economic growth results in increased tax revenues.

    Krugman is far too stupid to understand this. So are the Democrats and far too many Republicans.

  • Keynes was particularly annoyed that in a depression people tend to save and not spend. Guess why?

    Mr. Krugman is a product of the academy; his ideas are academic.

    Try Belloc’s ECONOMICS FOR HELEN, as a simple but accurate explanation of the public economy. As J.K. Galbraith noted, economics is not that difficult to understand – unless you burden it with unnecessary and superficial mathematics.

  • Associating current Keynesian economics with JM Keynes does the man a disservice. He was a pragmatic man who espoused government spending when it could have helped. I doubt that he would have endorsed the the policies of his noisier followers.

  • “Extended more generous unemployment benefits = Government jobs without the benefits of work”

    The difference is that unemployment pays people less than they would make working to look for a job — a government job turns someone from a job seeker into a job holder. Thus, leaving someone looking for work doesn’t involve a top down decision on specialization, it leaves emergent order to work out what sort of jobs people should train for and take.

  • RR is kidding, right?

    About the “Extended more generous unemployment benefits = Government jobs without the benefits of work?”

    That’s a joke, right?

  • Oh, sorry, he said, “…without the BENEFITS of work.”

    Perhaps it’s because it’s 1 AM, but something made me think he was saying something like, “…without the DRAWBACKS of work.”

    Never mind.

    (Of course, it isn’t just “without the benefits of work”; it’s “with the additional drawbacks of a marginal increase in the incentive for joblessness.”)

  • Te Deum laudamas . . .

  • What was Reagan’s definition of an economist? Someone who tells you why something that works in practice won’t work in theory?

  • I don’t think it’s economics as a whole that’s the problem — Krugman just happens to be one of those people who, in regard to politics, believes that if you fail at something it’s because you didn’t do more of what he wanted.

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