Paul Krugman is something an unusual: a brilliant economist who can be relied upon to throw economic reasoning out the window whenever it gets in the way of toeing the Democratic party line. Here, in an attack on the Blue Dogs, he supports a key argument for the public option:
Finally, there would be a public option: a government-run insurance plan competing with private insurers, which would help hold down costs...
There has been a lot of publicity about Blue Dog opposition to the public option, and rightly so: a plan without a public option to hold down insurance premiums would cost taxpayers more than a plan with such an option.
This argument is framed in terms that mimic the appeal of standard free market arguments. Competition is good, right? You can't hurt people by giving them more choices.
But there already is competition in the health insurance industry: Aetna, Blue Cross Blue Shield, CIGNA, UnitedHealth Group, and WellPoint, to name the top five. It is an abuse of the theory of competition to treat the entry of a new supplier into an industry that is already competitive as necessarily a good thing. If there are increasing returns to scale, as there typically are in insurance, it may be more efficient to have a small number of firms rather than a large number. If the health insurance industry is competitive already, which the number of suppliers suggests that it is, premiums are already held down to marginal cost, and the entry of a new supplier could not force current suppliers to lower premiums.
If the health insurance industry is not competitive, one of the following situations must obtain: (a) health insurance is a natural monopoly, or (b) there is some kind of collusion going on. The idea that health insurance is a natural monopoly is hard to reconcile with the existence of multiple suppliers. In any case, it would be absurd, under that supposition, to introduce another supplier, because the definition of a natural monopoly (think of an electricity distribution network) is that it is inefficient to have more than one supplier (to have two sets of power lines running to the same house). If health insurance is a natural monopoly, the government should either take over or regulate the premiums for the entire industry. If there is collusion, the Department of Justice should break it up. Under no set of assumptions is it a reasonable policy for the government itself to enter the industry as a supplier and compete with private insurers.
The silliness of this argument becomes immediately evident if we think about some other industry, say, restaurants. Suppose people are complaining that restaurant prices are too high, and a politician proposes to start a government restaurant chain that will compete with the private sector restaurants and bring down prices. I think it's obvious enough what's wrong with that. If the government restaurant chain somehow has completely separate finances from the government-- in which case it's not clear in what sense it is a government restaurant chain-- then perhaps there is no objection to the policy except that it is very odd. But presumably the government restaurant chain will get some kind of taxpayer subsidy or other privilege (e.g., an implicit guarantee of its debts, or favorable treatment by regulators) that gives it an unfair advantage over the private sector restaurants. It will then become a means of redistribution, from the general taxpayer to the patrons of the government restaurants. Presumably state eateries will be less efficient, as theory and practice tell us (theory tells us that the absence of market discipline takes away the incentive to exert effort and make sound decisions). So there will be losses to society as a whole, as well as redistribution. Non-patrons of state restaurants, and private restaurateurs, will suffer, while frequent patrons of state restaurants may benefit, although their gains may not be enough to offset losses from higher taxes and crowding out of private restaurant options. The objections to a "public option" in health care are exactly the same.
But isn't health care different? Doesn't free-market economics somehow fail to apply to health care? Maybe so, in some ways. The reasons to think health care is different are basically three. (1) The high degree of uncertainty about health care needs means that payment systems, to be efficient, probably need to involve insurance, and insurance markets create special kinds of agency problems. In this respect, health care resembles auto repairs or disaster relief. (2) Patients are unusually ignorant, relative to doctors, about their needs in health care markets: my stomach pain (say) might, for all I know, require treatment by a $1 box of pills or a $100,000 surgery. In this respect, health care might resemble any kind of consulting service or, again, auto repair. (3) Health care is considered by some to be a merit good, which everyone "deserves" (whatever that means) regardless of ability to pay. Few would object if poor people don't have access to jet skis or Hawaiian shirts or iPods or pineapples, but some feel it is wrong for anyone to die just because they cannot pay the doctor's bill. None of these peculiarities of health care have any bearing on the market structure of the industry or give the argument for the public option as competition any of the validity that it so obviously lacks in the case of the restaurant industry.
There are many questions in economics that are to a large extent unresolved or mysterious, where there is large scope for valid differences of opinion. If I were to ask why some countries are so much richer than others, you could give many different and contrasting, to some extent even contradictory answers, and it would count as good economics. The validity of the Krugman/Obama argument for the public option is not one of those questions. It IS WRONG. The argument is a simple fallacy. An attempt to clarify its logic with a model would have laughable results. If a student were to make this argument on an exam it would be a professor's duty to mark him down, on the grounds that he doesn't understand the basics of how markets work. It is the kind of argument the absence of which defines the writings of a great economist, at least when he is not degrading his intellect to peddle propaganda.
What is especially sinister about this argument is that it mimics free-market language in order to appeal to people who are vaguely sympathetic to the free market without understanding it. There are sensible grounds for supporting a public option. One might want it as a means to subsidize cheap, low-quality health care for the poor and indigent while leaving the existing system in place for the middle class. Or, one might want to subsidize the state system in order to drive private health insurance companies out of business and move to socialized medicine. To state those reasons, though, would make enemies. The Krugman/Obama argument is a way to trick people who don't want a health welfare program or socialized medicine into thinking of the public option as a way to improve efficiency and lower costs while leaving the current system in place. Krugman at least is surely aware that the argument is spurious.
How long will the public tolerate the economics profession when our Nobel laureates choose not to avoid the most elementary fallacies?
"History lessons for economists in thrall to Keynes" (Niall Ferguson, FT)
On Wednesday last week, yields on 10-year US Treasuries – generally seen as the benchmark for long-term interest rates – rose above 3.73 per cent. Once upon a time that would have been considered rather low. But the financial crisis has changed all that: at the end of last year, the yield on the 10-year fell to 2.06 per cent. In other words, long-term rates have risen by 167 basis points in the space of five months. In relative terms, that represents an 81 per cent jump.
Most commentators were unnerved by this development, coinciding as it did with warnings about the fiscal health of the US. For me, however, it was good news. For it settled a rather public argument between me and the Princeton economist Paul Krugman.
It is a brave or foolhardy man who picks a fight with Mr Krugman, the most recent recipient of the Nobel Prize for Economics. Yet a cat may look at a king, and sometimes a historian can challenge an economist.
A month ago Mr Krugman and I sat on a panel convened in New York to discuss the financial crisis. I made the point that “the running of massive fiscal deficits in excess of 12 per cent of gross domestic product this year, and the issuance therefore of vast quantities of freshly-minted bonds” was likely to push long-term interest rates up, at a time when the Federal Reserve aims at keeping them down. I predicted a “painful tug-of-war between our monetary policy and our fiscal policy, as the markets realise just what a vast quantity of bonds are going to have to be absorbed by the financial system this year”.
De haut en bas came the patronising response: I belonged to a “Dark Age” of economics. It was “really sad” that my knowledge of the dismal science had not even got up to 1937 (the year after Keynes’s General Theory was published), much less its zenith in 2005 (the year Mr Krugman’s macro-economics textbook appeared). Did I not grasp that the key to the crisis was “a vast excess of desired savings over willing investment”? “We have a global savings glut,” explained Mr Krugman, “which is why there is, in fact, no upward pressure on interest rates.”
Keynes had some genuine, albeit marginal, contributions to make, but where he posed as an antagonist of traditional economics, tradition was generally vaguely right and Keynes was generally guilty of logical or empirical errors. That economists made Keynes the most influential economist of the 20th century was just a mistake on their part. Yes, deficits do raise interest rates.
Just turned this in...
Why are there monks and nuns? Why do some men and women under the influence of this motive take vows of poverty, chastity (celibacy) and obedience? Why do communities of such people adopt peculiar economic arrangements which prohibit individual private property? And why have such institutions been so successful historically, lasting for generations, sometimes under such adverse circumstances that few or no other institutions have been able to survive, and made wide-ranging contributions to learning and law, agriculture and architecture, and technology? Clearly, the quintessential motive for a monk or nun is to worship God. But simply to say monks and nuns exist because people want to worship God is an incomplete explanation, for two reasons.
First, that human beings desire to worship is not a phenomenon that can be readily explained in terms of biological motives, as for example, human desires for food, sex, or shelter, can be. So one might ask: Why do humans want to worship God? That, however, is not a question for an economist. Economists generally treat what people want as an exogenous factor. Since the desire to worship God, or some other supernatural entity or entities, is not limited to monks and nuns but is felt (applying the method of “revealed preference”) by most human beings, we may take it as a given part of the human “utility function.” Following Becker and Stigler (1977), differences in taste for worship can be accounted for in terms of different endowments of a special kind of “capital,” which can be called “spiritual capital.”
The second problem is that, granting that people want to worship God, it is far from obvious what connection there might be between the worship motive and the monastic lifestyle. Why do some adopt celibacy for God’s sake, while other people, in some cases probably just as devout, choose to marry instead? Why is celibacy correlated with the practice of eschewing worldly occupations, even as devout religious householders pursue them? And why do celibate religious communities adopt economic constitutions which internally abolish private property? Questions like these deal with the links between “micro-motives and macro-behavior,” and thus seem especially suited to economic analysis.
Some readers may think there is an obvious non-economic explanation of monasticism: religious authority. People adopt the monastic lifestyle because the Church tells them that God wants them to. By this account, monasticism would have its origins in the religious doctrines and hierarchies that tell the faithful what God wants, and the individual’s role would consist not so much of choice but obedience. The appropriate mode of explanation would consist of an examination of the theology and doctrine of the Church to see why the monastic lifestyle was adopted as an ideal, and/or a psychological study of why people believe in and submit to religious authority. By this account, to treat monks and nuns as rational agents, faced with choices, maximizing utility, subject to cost and opportunity constraints, like consumers in a market, would be to misconceive the problem.
There are (at least) two problems with a theory of this kind. First, religious people often fail to do what the Church tells them, and they (say they) believe, is God’s will, when faced with incentives to do otherwise. There are Mormons who drink alcohol, Amish who drive cars, Hindus who eat beef, Muslims who eat pork, and Catholics who divorce or abort babies. Given the infinite promises (Heaven) and threats (Hell) that religions offer to motivate believers, one might expect believers to have what economists call ‘alphabetic preferences’ for doing God’s will, but it appears that at least many of them do not. And given that religious people sometimes break the rules, it seems legitimate to take into account normal economic factors of cost and benefit as potential influences on whether and when they do so. A man who believes God forbids him to hire a prostitute may still be more likely to hire her if her price is low than otherwise. Likewise, a man who believes that entering a monastery is his surest way to salvation may still be more likely to do so if by doing so he gets some of the things that ordinary men value in life: adequate food, music, study, sleep, economic security, and easy labor.
Second, at least if we focus on the Christian case, the monastic way of life was not originally imposed by Church authorities or present ab initio in sacred scripture. Nothing like a plan for a monastery appears in the Bible, although monasticism did emerge from the efforts of devout people to live by Gospel teachings. Nor did popes or bishops invent the monastic life and prescribe it to their flock. Odd as it may sound, given monks’ reputation for hierarchical organization and rigid discipline, monasticism is a case of what the Austrian school of economics calls spontaneous order. It emerged in Egypt in the 3rd century B.C. when hermits like St. Anthony fled to the desert and attracted followers, then it evolved and spread throughout the Christian world and beyond. Monasticism was first lived, then codified, most famously but not only in the Rule of St. Benedict, and thereafter remained dynamic, with new monastic orders appearing and competing with each other. No one planned monasticism. It was a pattern emerging without design from individual choices, as a price emerges in the marketplace.
Some features of monastic life, especially the absence of internal private property, resemble the ideas of modern socialism. That is not to say that monasteries resemble Communist states like the Soviet Union, but rather that they bear some resemblance to small, voluntary socialist communes, like the utopian experiments at Brook Farm and New Harmony in the United States, or the Israeli kibbutzim. This similarity is puzzling, because secular socialist communal experiments have generally been transient, dissolving within a few years or at most after a generation. Monasteries, by contrast, have exhibited a durability which virtually no other human institution, apart from the Christian Church itself, can match, often lasting for centuries, with some stretching back more than a millennium.
The perennial irony of monasticism is that monks are always fleeing the world, while the world is always following them. Or, to state the point more tendentiously, monasticism is frequently corrupted by the prosperity which its piety creates, and then reformed from within by zealots who want to recover pristine ideals. For example, the late medieval Cistercians, who sought agricultural self-sufficiency by fleeing ‘the world’ into the uncultivated wilderness, ended by acquiring large holdings of land, and became some of Europe’s leading sheep farmers, viticulturalists, and builders and operators of water-mills, the great power source of that time. They engaged in international trade and even developed a reputation for wealth and greed. To an economist, this is a record to inspire admiration. To historians sympathetic to the pristine ideals to which the early Cistercians aspired, as well as to some later monastics in the Cistercian and other orders, the same process may seem like a sad story of decline. However it is evaluated, monasticism’s capacity both to endure, to achieve success in almost every field of human endeavor, to preserve and advance civilization in manifold ways, calls for explanation.
A further characteristic of monasticism is of special interest. Political philosophers for centuries, especially John Locke, Thomas Jefferson, and James Buchanan, have imagined a “social contract” as the basis for the legitimacy of government, and the virtue of “consensual” government is habitually acknowledged by modern liberalism. Yet no modern democracy actually asks the consent of its subjects (individually, that is) to govern them; no one really signs a social contract. Citizenship in a modern democracy, and subordination to its laws, is not based on consent; but membership in a monastery, and subordination to its rules, is, being a result of an explicit vow made by a consenting adult. It is interesting, therefore, to contrast the real social contracts of monasticism with the fanciful ones of the philosophers.
That's the intro...
"A talent for missing trends" (Richard Rahn):
Did you notice that the major economic forecasters, both private and government, totally missed the global credit crisis and size of the recession?
The mainstream consensus economic forecasts made in December 2007 for the year 2008 for the United States, Europeand Japan predicted roughly twice as much growth as actually occurred. You may recall that a year ago, when oil prices were racing toward $147 per barrel, the high-paid wizards at Goldman Sachs were projecting it to go over $200 per barrel - it is now $40-something a barrel. A few economists claim to have forecast this great recession, but most have been pessimists for years, and predicting nine out of the last three recessions is not really an example of forecasting brilliance.
The foreign policy/political forecasts were even worse. A year ago, as the presidential nominees of both parties were being selected, the widely held belief was that the great issue would be Iraq. The Democratic establishment believed Senate Majority Leader Harry Reid's words, "the war is lost."
Because of that belief, the Democrats selected their most antiwar candidate, Barack Obama. The Republicans nominated John McCain, who was the champion of winning the war, in part, through the "surge," which indeed did work.
Each candidate had essentially sewed up his respective party nominations before the extent of the economic problems became clear. In retrospect, it is unlikely Mr. Obama and Mr. McCain would have become the nominees given what we know now about the economic situation. Each party had other candidates with stronger economic credentials who would have been more credible.
In the mid-1990s, when the fear of global warming was first becoming fashionable, the global warming theorists said we had only 10 years to make fundamental changes with carbon dioxide (CO2) emissions or the planet was doomed (i.e. the "hockey stick" thesis).
Well, it has now been more than 10 years. and the planet has actually been getting cooler over the last decade, which was not forecast by a single major climate model (oh, well). Also the polar ice cap has not disappeared, and the polar bear population is getting bigger, not smaller! It seems those who claim the variable output of the sun (sun spot theorists) has more effect on Earth temperature than CO2 might just be right.
Matt Yglesias tries to explain the "paradox of thrift," a key concept in Keynesian economics:
[I]t’s probably worth attempting a layman’s explanation of “the paradox of thrift” in the current situation. So here goes:
I get a paycheck direct deposited into my bank account every two weeks, which is my salary less deductions for taxes and less money diverted into retirement savings. And every month, about as much money comes out of that account—to pay the mortgage, to pay utility bills, to pay credit card bills, and as ATM withdrawals for cash that I spend. I also have coming in a less-regular flow of checks for various freelance assignments I pick up here and there. Those freelance assignments don’t come with taxes deducted, so I always winding up owing money when I do my taxes so I try to make sure I have money saved to pay that off when April comes around. Beyond that, I’m usually saving up some money to take a trip (to Spain, for example) or to buy something somewhat expensive (a new Macbook, for example). But those kind of savings are a pretty small portion of the overall pie. The money I’m not saving for taxes or MacBooks gets spent on goods and services. That spending provides jobs for other people around the world. And those people, in turn, probably spend most of the money they make on other goods and services thus providing more jobs.
So what happens if I decide to cut back and save more, maybe because I want to buy a car or just because I feel a bit nervous and want to build up a cushion? Well, if there’s some particular business that depends crucially on my patronage, that might be bad news for them. But even though the economy as a whole depends on consumers like me spending me, my personal decision to cut back shouldn’t particularly have any macroeconomic impact. And not just because the amount of money is small. It won’t have much impact because if I increase the amount of money I have in my savings account, the bank can increase the amount of money it lends out. And just as my spending led to economic activity and jobs, whatever it is other people borrow money from the bank to do will also generate economic activity.
Why is it that the bank can lend out more money when Matt saves more? It has the cash, yes, but where does the borrower come from? Implicit here-- take note-- is an assumption of some kind of capital market, where prices, namely in this case interest rates (which is a kind of price), or perhaps some kind of credit rationing, equalize supply and demand for loanable funds. Yet the next step in the argument is to assume that this market breaks down:
But now suppose a bunch of people lose their jobs in the construction business and start spending less money. And also a bunch of people in finance lose their jobs and start spending less money. And some restaurants and bars that catered to the finance crowd start having less business so they employ staff for fewer hours and those guys all start spending less money.
Now it’s not just me looking to build a bigger cushion by cutting back on spending, it’s a whole bunch of people looking around and feeling nervous and deciding to cut back. Well, with all that cutting back there’s a lot less stuff flying off the shelves. So retailers start laying off workers (who need to reduce spending and whose friends start feeling nervous and reducing their own spending) and discounting the merchandise. Maybe the sales are so impressive that everyone changes their mind, decides that the bargains are too good to pass up, and goes and buys a bunch of stuff rather than increasing savings...
Well, yes. That's how the price mechanism works: prices rise or fall to whatever point equilibrates supply and demand. What's needed to make the story work here is an ad hoc assumption that for some reason the price mechanism doesn't work well here. But if you adopt ad hoc assumptions like that there are a lot of stories you can tell.
If so, the economy just had a minor hiccup and life goes on. But maybe the accelerating wave of discounts just makes people feel more nervous. And maybe I see all this discounting and decide not to buy that new MacBook after all, because it’s not on sale yet and I’m betting it will be soon.
Now we’ve entered “paradox of thrift” territory. People are saving more. And the increased saving isn’t being cycled back into the economy as new investment...
This assumption that savings does not get cycled back into the economy as new investment is crucial. If banks will lend out the new money to entrepreneurs, who invest it, there is no paradox of thrift, just a re-allocation of resources from consumption to investment. So it's important to figure out why this crucial market mechanism is supposed to fail.
In part, that’s because of problems in the financial system...
It occurs to me that the banks are simultaneously being berated for making bad loans before and for not lending out more money now. It's not surprising that they're reluctant to lend when not only has their past lending worked out badly, but they're being blamed for it on all sides. I suspect the banks are being excessively scapegoated here. It's not their fault that housing prices were allowed to soar to unsustainable levels and then allowed to drop. And it's not exactly their fault, either, when sub-prime borrowers walk away from their homes. To compel people to honor their contract agreements is generally thought to be the government's job. If anti-bank populism makes the banks especially risk-averse, it's doing harm to the economy.
But in part, it’s because with short-term demand slumping so much, there’s not a lot of worthwhile investing to be doing...
STOP! What does short-term demand have to do with it? Investment is often or even typically geared towards the long term. Few investments pay off in the next year, or the year after. It's not clear why an investment project that is expected to pay off over the course of, say, the next thirty years, should care about a slump in short-term demand. If they do, it's for other reasons. For example, businessmen might be confident that demand will come back, but be unsure what customers, after regaining their confidence, will want to buy. Or businessmen might be concerned about increased expropriation risk due to a sudden vogue for economic populism resulting from the recession-- or perhaps the possibility of pro-union legislation which will make it easy for organized labor to steal or destroy any value streams that investors create.
To say that slumping short-term demand means there's no worthwhile investing does not, in itself, make sense. To make it make sense would require some other theory, which would likely have quite different policy implications. If investors are wary because of an increase in perceived political risk, government would be wise to minimize uncertainty by either doing nothing, or by doing things that were clearly temporary and wouldn't change anything in the long run-- and the worst thing politicians should do is to talk about unspecified but seemingly radical "change." If investors are wary because they rely on short-term demand as an indicator of the trajectories of long-run demand and don't know what to invest in when short-term demand is slumping, the best policy might be to put money into consumers' pockets fast-- doesn't much matter whose-- and let them buy whatever they now think most worthwhile, to signal to business to make more of it. Matt continues:
The economy needs someone to decide to borrow some money and start a new firm that employs these newly unemployed people. But with the volume of consumption going down so rapidly, nobody’s really in the mood to start a new business...
"In the mood." This is the problem with Keynesianism: it alternates between rational rigor and ad hoc behavioralism. What do "moods" have to do with it? If money's cheap because everyone's scrambling to save, and meanwhile there are lots of unemployed workers to hire, that's a great time to do your long-term investment. If you're expecting Project X to pay off starting three years from now, and to go on paying off for another thirty, you don't care if demand will be weak in 2009-2010. You'll invest now and make money later. As long as you assume people behave rationally, you can at least develop the logic of your models pretty rigorously, with well-defined and well-motivated, if not 100% realistic, assumptions about the roots of human action. When your theory is relying on moods (or "animal spirits," as Keynes said) to explain phenomena, you're on much shakier ground.
And existing businesses are busy scaling back production, not interested in borrowing money to ramp it up. The result of this is an overall fall in the average level of income. And that means that even with the share of income being saved going up, the actual level of savings can be going down and we can truly end up in the toilet.
It's not clear why Matt thinks it's a problem that the level of savings is falling if it can't be channeled into investment anyway. But if the price mechanism does its work, even if the dollar value of savings does fall, it should be able to buy a lot more of certain key inputs, say labor, or gasoline.
The ultimate point of a fiscal stimulus policy is to avoid that toilet scenario. To get money flowing in the economy again, so that savings gets translated into investment which gets translated into jobs which pay salaries which, in turn, are spent and saved in ways that create jobs.
But of course, a fiscal stimulus policy also involves the government borrowing a lot of money, and the government is competing with private corporations for the same stock of loanable funds. That stock of loanable funds isn't necessarily fixed: government spending could feed back into the supply of loanable funds positively (e.g., if an unemployed worker gets a government job and decides to save more) or negatively (e.g., if the increased government debt spooks some investors and causes them to abandon projects, and not pay workers, who then don't have money to save). So it's not a logical impossibility that government spending might occur without crowding out private investment. But if it does crowd out private investment-- and it seems very likely that it will, and to me not at all unlikely that it will crowd it out on a more than one-for-one basis-- the stimulus will boost GDP in the short run, if at all, only at the expense of making us poorer in the long run. (Hat tip: Tyler)
"How Government Prolonged the Depression" (Wall Street Journal)
The goal of the New Deal was to get Americans back to work. But the New Deal didn't restore employment. In fact, there was even less work on average during the New Deal than before FDR took office. Total hours worked per adult, including government employees, were 18% below their 1929 level between 1930-32, but were 23% lower on average during the New Deal (1933-39). Private hours worked were even lower after FDR took office, averaging 27% below their 1929 level, compared to 18% lower between in 1930-32.
Even comparing hours worked at the end of 1930s to those at the beginning of FDR's presidency doesn't paint a picture of recovery. Total hours worked per adult in 1939 remained about 21% below their 1929 level, compared to a decline of 27% in 1933. And it wasn't just work that remained scarce during the New Deal. Per capita consumption did not recover at all, remaining 25% below its trend level throughout the New Deal, and per-capita nonresidential investment averaged about 60% below trend. The Great Depression clearly continued long after FDR took office.
Why wasn't the Depression followed by a vigorous recovery, like every other cycle? It should have been. The economic fundamentals that drive all expansions were very favorable during the New Deal. Productivity grew very rapidly after 1933, the price level was stable, real interest rates were low, and liquidity was plentiful. We have calculated on the basis of just productivity growth that employment and investment should have been back to normal levels by 1936. Similarly, Nobel Laureate Robert Lucas and Leonard Rapping calculated on the basis of just expansionary Federal Reserve policy that the economy should have been back to normal by 1935.
So what stopped a blockbuster recovery from ever starting? The New Deal. Some New Deal policies certainly benefited the economy by establishing a basic social safety net through Social Security and unemployment benefits, and by stabilizing the financial system through deposit insurance and the Securities Exchange Commission. But others violated the most basic economic principles by suppressing competition, and setting prices and wages in many sectors well above their normal levels. All told, these antimarket policies choked off powerful recovery forces that would have plausibly returned the economy back to trend by the mid-1930s.
The most damaging policies were those at the heart of the recovery plan, including The National Industrial Recovery Act (NIRA), which tossed aside the nation's antitrust acts and permitted industries to collusively raise prices provided that they shared their newfound monopoly rents with workers by substantially raising wages well above underlying productivity growth. The NIRA covered over 500 industries, ranging from autos and steel, to ladies hosiery and poultry production. Each industry created a code of "fair competition" which spelled out what producers could and could not do, and which were designed to eliminate "excessive competition" that FDR believed to be the source of the Depression.
These codes distorted the economy by artificially raising wages and prices, restricting output, and reducing productive capacity by placing quotas on industry investment in new plants and equipment. Following government approval of each industry code, industry prices and wages increased substantially, while prices and wages in sectors that weren't covered by the NIRA, such as agriculture, did not. We have calculated that manufacturing wages were as much as 25% above the level that would have prevailed without the New Deal. And while the artificially high wages created by the NIRA benefited the few that were fortunate to have a job in those industries, they significantly depressed production and employment, as the growth in wage costs far exceeded productivity growth.
These policies continued even after the NIRA was declared unconstitutional in 1935. There was no antitrust activity after the NIRA, despite overwhelming FTC evidence of price-fixing and production limits in many industries, and the National Labor Relations Act of 1935 gave unions substantial collective-bargaining power. While not permitted under federal law, the sit-down strike, in which workers were occupied factories and shut down production, was tolerated by governors in a number of states and was used with great success against major employers, including General Motors in 1937.
The downturn of 1937-38 was preceded by large wage hikes that pushed wages well above their NIRA levels, following the Supreme Court's 1937 decision that upheld the constitutionality of the National Labor Relations Act. These wage hikes led to further job loss, particularly in manufacturing. The "recession in a depression" thus was not the result of a reversal of New Deal policies, as argued by some, but rather a deepening of New Deal polices that raised wages even further above their competitive levels, and which further prevented the normal forces of supply and demand from restoring full employment. Our research indicates that New Deal labor and industrial policies prolonged the Depression by seven years.
By the late 1930s, New Deal policies did begin to reverse, which coincided with the beginning of the recovery. In a 1938 speech, FDR acknowledged that the American economy had become a "concealed cartel system like Europe," which led the Justice Department to reinitiate antitrust prosecution. And union bargaining power was significantly reduced, first by the Supreme Court's ruling that the sit-down strike was illegal, and further reduced during World War II by the National War Labor Board (NWLB), in which large union wage settlements were limited by the NWLB to cost-of-living increases. The wartime economic boom reflected not only the enormous resource drain of military spending, but also the erosion of New Deal labor and industrial policies.
The real explanation of the Great Depression rather pulls the raison d'etre out from under Keynesian theory.
Krugman doesn't make enough concessions here:
Yes, an increase in government demand could be offset by a fall in private demand because people expect their future taxes to be higher. Private demand could also fall because an employer who would have hired those workers finds that they're already employed by the government. Or private demand could fall because the money they would have borrowed to finance a project is instead used to buy government bonds. There are lots of ways that government spending can crowd out private-sector activity.
And here he seems to suggest that too many tax cuts were part of what caused the Great Depression:
In the United States, the Republican party remains committed to a belief in that old tax-cut magic, with no willingness to rethink its doctrine in the face of catastrophe... So yes, we can have another depression — because those who refuse to learn from history may be condemned to repeat it.
Herbert Hoover didn't want to run deficits, so he raised taxes: "in 1931-1932 Hoover had proposed -- and a Democratic-controlled Congress had enacted -- a massive tax increase in a desperate effort to balance the federal budget." I believe the standard Keynesian line has usually been that Hoover's fiscal austerity during a depression was a disastrous mistake.
With respect to most prominent economists, I accord them a certain form of professional courtesy, namely that even when I disagree with them, I regard their opinions as held in good faith, even when I disagree with them, and even when there seem to be some pretty obvious reasons why they can't be right. Perhaps in some cases they are arguing in bad faith and I'm unduly generous, but I'd rather do that than accuse the innocent.
There is only one exception to that rule: Paul Krugman. I'd hesitate to say the name if it weren't for this NY Times column ("Bad Faith Economics") in which he basically calls half the profession liars.
As the debate over President Obama’s economic stimulus plan gets under way, one thing is certain: many of the plan’s opponents aren’t arguing in good faith. Conservatives really, really don’t want to see a second New Deal, and they certainly don’t want to see government activism vindicated. So they are reaching for any stick they can find with which to beat proposals for increased government spending.
It's true that it would be quite confusing if government activism were suddenly vindicated in the way Krugman is thinking of, contrary to both reason and past experience. The New Deal didn't work. Combined with Hoover's interventionism, it turned what could have been a V-shaped recession into an L-shaped recession, making the whole decade of the 1930s a lost decade. It's true that the economy grew-- a dead cat bounce-- during FDR's first term, but it never regained 1929 levels or came near full employment, and came crashing back down in 1937-8. Only the war, which forced us to return to some kind of economic rationality just to make bombers and tanks, got us out of it, and by the end of it FDR was dead. It's not for the sake of our ideology or class interests or whatever that most economists, especially conservative ones, don't want a rerun of the 1930s. It's because they were disastrous times for humanity.
Some of these arguments are obvious cheap shots. John Boehner, the House minority leader, has already made headlines with one such shot: looking at an $825 billion plan to rebuild infrastructure, sustain essential services and more, he derided a minor provision that would expand Medicaid family-planning services — and called it a plan to “spend hundreds of millions of dollars on contraceptives.”
And why is the government spending so much on Medicaid family planning? Condoms are cheap. Better to give poor people the money and let them buy condoms themselves-- or something else. Particularly since milions of respectable voters have moral objections to contraceptives. Boehner is right.
But the obvious cheap shots don’t pose as much danger to the Obama administration’s efforts to get a plan through as arguments and assertions that are equally fraudulent but can seem superficially plausible to those who don’t know their way around economic concepts and numbers. So as a public service, let me try to debunk some of the major antistimulus arguments that have already surfaced. Any time you hear someone reciting one of these arguments, write him or her off as a dishonest flack.
First, there’s the bogus talking point that the Obama plan will cost $275,000 per job created. Why is it bogus? Because it involves taking the cost of a plan that will extend over several years, creating millions of jobs each year, and dividing it by the jobs created in just one of those years.
It’s as if an opponent of the school lunch program were to take an estimate of the cost of that program over the next five years, then divide it by the number of lunches provided in just one of those years, and assert that the program was hugely wasteful, because it cost $13 per lunch. (The actual cost of a free school lunch, by the way, is $2.57.)
The true cost per job of the Obama plan will probably be closer to $100,000 than $275,000 — and the net cost will be as little as $60,000 once you take into account the fact that a stronger economy means higher tax receipts.
OK, I'll skip this one because I'm not up on the accounting-- JustOneMinute has what seems to me a devastating takedown though. I'd want to ask: Is the government going to be creating net jobs, or attracting employees out of the private sector, crowding out private employment? I don't believe that anyone really has any idea.
Next, write off anyone who asserts that it’s always better to cut taxes than to increase government spending because taxpayers, not bureaucrats, are the best judges of how to spend their money.
Here’s how to think about this argument: it implies that we should shut down the air traffic control system. After all, that system is paid for with fees on air tickets — and surely it would be better to let the flying public keep its money rather than hand it over to government bureaucrats. If that would mean lots of midair collisions, hey, stuff happens.
The point is that nobody really believes that a dollar of tax cuts is always better than a dollar of public spending...
This is ludicrous. Obviously we're going to finance critical functions like air traffic control in any case. Stimulus spending, by its nature, is going to be on discretionary things. And there is a reason to presume that, not in every case but as a rule, a dollar of tax cuts/private spending is better than a dollar of public spending. Krugman adds:
Meanwhile, it’s clear that when it comes to economic stimulus, public spending provides much more bang for the buck than tax cuts — and therefore costs less per job created (see the previous fraudulent argument) — because a large fraction of any tax cut will simply be saved.
This suggests that public spending rather than tax cuts should be the core of any stimulus plan. But rather than accept that implication, conservatives take refuge in a nonsensical argument against public spending in general.
Earth to Krugman. This is a reasonable Keynesian argument. But a lot of economists just don't believe in Keynesianism. There has been a counter-attack against Keynesianism for the past thirty years or so. Have you heard of "the rational expectations revolution?" If you're skeptical about, but do not completely dismiss, Keynesianism, to advocate a tax-cuts-only stimulus is an application of the "first, do no harm" principle. Government spending, especially discretionary spending undertaken fast, is often/usually wasteful. Even if you do stimulate aggregate demand you're destroying some aggregate supply in the process, and if you don't stimulate aggregate demand-- for example, because people see the budget deficit and get even more scared about the future-- then you're still in a recession and have dug yourself a deeper hole. If you cut taxes, at least whatever the money is spent on passes the test that somebody thought it was worth it to them, for their own money. This "argument against public spending in general" is not only not nonsensical, it is absolutely central to welfare economics and the theory of constrained maximization, to the extent that the discipline of economics is inconceivable without it. But don't worry, Krugman understands it perfectly well. It's just not in his interest to admit that right now.
Finally, ignore anyone who tries to make something of the fact that the new administration’s chief economic adviser has in the past favored monetary policy over fiscal policy as a response to recessions.
It’s true that the normal response to recessions is interest-rate cuts from the Fed, not government spending. And that might be the best option right now, if it were available. But it isn’t, because we’re in a situation not seen since the 1930s: the interest rates the Fed controls are already effectively at zero.
That’s why we’re talking about large-scale fiscal stimulus: it’s what’s left in the policy arsenal now that the Fed has shot its bolt. Anyone who cites old arguments against fiscal stimulus without mentioning that either doesn’t know much about the subject — and therefore has no business weighing in on the debate — or is being deliberately obtuse.
Not at all. The Fed can always print money. Krugman understands this because that's what he was telling the Japanese to do in the 1990s, when they were in a long slump which Keynesian-style fiscal stimulus only exacerbated. It can print money and buy assets, as it's been doing, or we could just print money and send it out to regular citizens. Krugman has made a strange argument that you can fall into a liquidity trap where newly-printed money just gets saved. I didn't read the model carefully enough to say whether it's right, or whether its assumptions are plausible, though it would have the odd implication that in the equation of exchange, MV=PY, V would have to be a function of M such that V=1/M-- exactly! In any case, many economists can believe in quite good faith, either (a) that Krugman's liquidity-trap model is wrong and liquidity traps cannot occur, or (b) that we're not in one now. It doesn't seem that even the Japanese in the 1990s were in one, because when they did try "quantitative easing" of the money supply, it worked. The claim that "the Fed has shot its bolt," i.e., that monetary policy can do no more and we're in a liquidity trap, is at best a plausible hypothesis. To claim that this is THE verdict of economic theory and that to deny it is bad faith, is itself bad faith. Krugman is being, so to speak, "deliberately obtuse."
These are only some of the fundamentally fraudulent antistimulus arguments out there. Basically, conservatives are throwing any objection they can think of against the Obama plan, hoping that something will stick.
But here’s the thing: Most Americans aren’t listening. [No polls are cited in support of this claim.] The most encouraging thing I’ve heard lately is Mr. Obama’s reported response to Republican objections to a spending-oriented economic plan: “I won.” Indeed he did — and he should disregard the huffing and puffing of those who lost.
If Obama does take Krugman's advice and rams through a big stimulus bill over the opposition of Republican "losers" and against the professional judgment of much of the economics profession, his behavior will be a notable contrast to that of George W. Bush in 2005. Bush ran and won on Social Security reform twice. Unlike Obama, Bush won by laying out a well-thought-out platform at the Republican National Convention, which swung enough voters to create a generally stable pro-Bush majority (though a poor performance in the first debate caused his support to dip briefly). Voters gave him a solid mandate for this platform by re-electing him with increased margins throughout the country and electing 55 Republican senators and an increased majority in the House. Bush, accordingly, set out to reform Social Security. He wanted to do so, however, in a bipartisan fashion with Democratic support, and invited the Democrats to discuss options. The Democrats refused to do so, choosing instead a bitter scorched-earth policy. So Social Security reform did not pass. That was unfortunate for the country, but one must still Bush with a certain political good sportsmanship.
Obama did not run as a big-spending liberal. "I will cut taxes - cut taxes - on 95 percent of working people," is surely the best-remembered line in his campaign, and his ads in the last month of the campaign thundered over and over again, "We just can't afford John McCain," as if John McCain were going to be the bigger spender of the two candidates. Against this, McCain claimed over and over again that Obama was going to raise taxes, but the claim ultimately fell flat. I think people decided, not necessarily that Obama was too honest to break his promises - he's a politician, after all - but that he'd committed himself so heavily to be a tax-cutter that he'd pay too high a political price for backing away from that. And of course, he also claimed to be a "uniter," which suggests trying to find consensus with the opposition. To give credit where it's due, the stimulus is said to be about half tax cuts, so Obama doesn't seem to be breaking promises yet.
UPDATE: Krugman writes in a blog post:
I think, is that we’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed... I’m tempted to go on and say something about being overrun by barbarians in the grip of an obscurantist faith, but I guess I won’t. Oh wait, I guess I just did.
History lesson: the barbarians were not "in the grip of an obscurantist faith." If Christianity is the "obscurantist faith" in question, it was the Romans who were in its grip. And that obscurantist faith preserved Greco-Roman learning through the Dark Ages and got us out of them.
Here's an abstract way to think about stimulus, crowding-out, and unemployment. Let's assume that the economy has 100 workers. Each can produce $100 if employed in the private sector, or (since government is less efficient) $80 if employed in the public sector. There is a proposal to try to boost the economy by having the government run projects that create jobs. What will be the effect?
First, suppose the unemployment rate is 2%. Suppose further that the government programs can do targeted hiring so that they pick up exactly the workers that the private sector would not hire. A stimulus program hires two workers, and GDP rises from $9,800 to $9,960.
It is unlikely, though, that stimulus jobs will hire exactly the people who wouldn't have been employed by the private sector. In general, the same kinds of people who were good at getting private-sector jobs are likely to be good at getting public-sector jobs. Of course, highly paid private workers may not want to work for the government, but since (a) there is a lot of "job churn" anyway, with people constantly going in and out of jobs, (b) stimulus programs may out-bid the private sector, intentionally or inadvertently, and (c) if the stimulus programs are actually supposed to do something useful rather than pure make-work they'll have to hire people with skills, who will frequently be attractive candidates for the private sector as well, it is likely that many workers who will end up in stimulus jobs would have found jobs in the private sector.
So let's adopt the opposite assumption, that when the stimulus programs create a job, that worker is selected randomly from the population.
Now suppose that the unemployment rate is 25%. The government passes a stimulus program that creates 20 jobs. Of these we can expect 5 employees (25%) to be attracted from the ranks of the unemployed, and 15 to come from private-sector employment. Pre-stimulus GDP: 75 * $100 = $7,500. Post-stimulus GDP: (75 - 15) * $100 + 20 * $80 = $7,600. In this case, the stimulus does "work," in the sense of raising GDP. But $2,000 worth of "stimulus" spending only raises GDP by $100, and the unemployment rate falls only from 25% to 20%.
Finally, suppose that the unemployment rate is 7%. The government proposes a stimulus that creates three jobs. The odds are:
Less than 0.1% that all three of the stimulus workers come from the unemployed. So it is almost certain that there will be some crowding-out of private-sector activity. Indeed, it is far more likely than not that the stimulus will only crowd out private-sector activity and have no effect on unemployment. Of the two likeliest outcomes, if the government hires no workers who would have been unemployed, the stimulus reduces GDP by $60. If it hires one worker who would have been unemployed, the stimulus raises GDP by $40. Since pure crowding out is more likely than crowding out with a little bit of stimulus, the expected output effect of the stimulus is to reduce GDP.
Less than 0.1% that all three of the stimulus workers come from the unemployed.
So it is almost certain that there will be some crowding-out of private-sector activity. Indeed, it is far more likely than not that the stimulus will only crowd out private-sector activity and have no effect on unemployment.
Of the two likeliest outcomes, if the government hires no workers who would have been unemployed, the stimulus reduces GDP by $60. If it hires one worker who would have been unemployed, the stimulus raises GDP by $40. Since pure crowding out is more likely than crowding out with a little bit of stimulus, the expected output effect of the stimulus is to reduce GDP.
Only use a payday cash advance as a last resort.