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The last-minute negotiations over the
debt ceiling have brought the economic pundits out in force. In the midst of
a terrible recession, the contrast between Austrian and Keynesian analysis is
striking. The Austrians recommend the virtues of saving and investment, while
Keynesians preach the opposite. Things are so topsy-turvy that in this
article, I'm actually going to defend President Obama from Paul Krugman's barbs.
Krugman Pounces on
Obama
In a blog post earlier this week, Krugman first quoted from President Obama's press
conference on the budget negotiations:
I do think that if the country as a whole
sees Washington act responsibly, compromises being made, the deficit and debt
being dealt with for 10, 15, 20 years, that that will help with businesses
feeling more confident about aggressively investing in this country, foreign
investors saying America has got its act together and are willing to invest.
And so it can have a positive impact in overall growth and employment.
Seems like boilerplate rhetoric. Who
could object to the president of the United States explaining that there are
bad consequences for economic growth if investors perceive the country as a
banana republic, or (what is equivalent) that there are good
consequences if investors think the long-term fiscal crisis has been solved?
The only reason to complain is that these platitudes are phony; the
Republican and Democratic "statesmen" in Washington will at best
engineer a short-term fix that allows us to limp along until the next
emergency arises in a few months.
Ah, but Nobel laureate Paul Krugman is a clever writer, and he can come up with
reasons to complain about Obama's statement:
OK, so that's the confidence fairy at the
beginning. But the "foreign investors" thing is actually worse.
Think about it: U.S. interest rates are
low; there's no crowding out going on; we are NOT suffering from a shortage
of saving.
So if foreign investors decide they love
us, what does it do? It drives up the value of the dollar, which reduces
exports, which leads to fewer jobs.
Does this sound familiar? It's closely
related to the reasons Chinese accumulation of dollar reserves
unambiguously hurts the U.S. economy when we're in a liquidity trap. And what
we just learned is that the White House still doesn't get it.
In this short passage, Krugman not only contradicts basic Austrian analysis, but
in his treatment of foreigners he even bungles Keynesian analysis.
I'll deal with each issue separately.
The Confidence
Fairy
Krugman's mocking
reference to a "confidence fairy" is a running gag on his blog. In Krugman's view, the obvious problem with the world
economy today is insufficient aggregate
demand. Businesses aren't hiring workers or investing in their
operations because sales are so weak. But because of a debt overhang in the private sector, total
spending from consumers and businesses will be depressed for some time.
That's why it's up to the government to fill the gap through extensive
deficit spending.
But many policymakers and analysts draw
back from Krugman's recommendations. They think
that major governments already tried massive "stimulus" efforts,
and that the world economy is still stuck in a rut. Contrary to Krugman, these advocates of "austerity" recommend
reining in deficits and even propose cutting government spending. In order to
explain why fiscal austerity should actually promote economic recovery,
austerity proponents often claim that fixing the government's long-term
budget outlook will restore confidence. Krugman
thinks this is a nonsensical theory for which there is no evidence, hence his
running joke about the "confidence fairy."
Here we see the huge gulf between
Austrian and Keynesian analysis. According to the Austrians, a recession was
inevitable because real capital resources were misallocated during the
housing-bubble years. The massive government and Fed interventions since then
have only served to delay the economy's adaptation to the new
realities.
Because everyone — including Krugman — admits that Americans in both the private
sector and the government were consuming too much during the housing-boom
years, the Austrians naturally conclude that the solution is to
increase savings and live within our means. That goes not only for
households, but for the government, too. There is nothing magical about government
spending. In fact, resources allocated via the political process are much
less likely to satisfy consumer preferences than resources allocated via
market processes.
On the specific issue of the confidence
fairy, Krugman is in a bit of a pickle. For one
thing, it's hard to see how the austerity talk of "confidence" is
any less rigorous than John Maynard Keynes's famous discussion of "animal spirits" when it comes to
explaining business investment.
Even more troubling for Krugman is that he himself admits that private investors
have been acting on the (alleged) myths of the anti-Keynesian economists.
During his talk on Keynes, Krugman
alludes to an investment bank making an apology for its erroneous predictions
on interest rates (where the bad prediction was due to ignoring Krugman's analysis). Several times, Krugman
has criticized Pimco's Bill Gross for saying that interest rates
will rise because of the end of QE2, and Krugman
often ridicules Peter Schiff and others for warning clients of hyperinflation. More
generally — and I don't remember if Krugman
himself has done this — progressives have mocked the ads for gold
pushed on conservative talk radio.
Krugman et al. can't
have it both ways. It can't be the case that the world is (a) full of
imbeciles who lose boatloads of their clients' money because they listened to
a Chicago School or Austrian economist give advice, while (b) investors
aren't influenced by their fears over Obama and Bernanke's policies. Krugman and the other Keynesians need to pick one story
and run with it.
Say's Law
Furthermore, the "explanation"
that the problem with the economy is a lack of spending was exploded long ago by J.B. Say. Although
there are some subtleties in the analysis, I would still put the classical
wisdom of Say's law up against the elegant
mathematical models coming out of Princeton any day.
This is the present context for the
dispute: Right now we have very low private business investment, high
unemployment, low consumer spending, and low growth rates in total output.
The Austrian proposal is to take off the shackles on entrepreneurs and to
stop interfering with price signals in the capital markets so that the
"real" problems with the economy can be fixed. Once that happens,
businesses will begin hiring again, unemployment will drop, real output will
grow, and spending will take care of itself.
The Keynesians deny that there is any
"real" structural problem at all. This comes from their aggregated
view of the economy, in which the structure of production can't get distorted
as it can in the Austrian theory. Instead, someone like Paul Krugman sees the same amount of tractors, real estate,
and skilled workers on the eve of the bust as he does on the day after, so he
can't understand why "real GDP" should fall at all. The economy
must not be living up to its potential if it isn't cranking out stuff as fast
as it (apparently) was at the peak of the housing bubble. Krugman's
model literally can't handle the possibility that the economy was in an
unsustainable position during the bubble, and that Bernanke's policies have
only made things worse.
Is Foreign
Investment Harmful?
As I mentioned in the beginning of the
article, when Krugman turned his attention away
from the confidence fairy and focused on foreign investors, he actually
repudiated even standard Keynesian analysis. Recall that Obama had argued
that foreign investment in the United States would help our economy. To this,
Krugman replied, "So if foreign investors
decide they love us, what does it do? It drives up the value of the dollar,
which reduces exports, which leads to fewer jobs."
Hold on a second. Krugman
has told us repeatedly that the problem with the world economy right now is
that some people want to save more than others
want to invest. (Specifically, the market-clearing interest rate "wants"
to be negative, but alas that's impossible, and hence we're stuck with a glut
of savings.) This is why Krugman thinks that it
would help the United States if China stopped buying so much Treasury debt.
But Obama (or rather, his speechwriters)
presumably weren't talking just about foreign investors buying IOUs from
Uncle Sam. If someone is thinking about setting up, say, a car factory in
another country, he will hesitate if that country is running the printing
press like mad, or if it might have to jack up income tax rates in a few
years because of mushrooming debt. But in that uncertainty, if the political
leaders of the country agree to long-term budget cuts and so forth, then the
investor might bite the bullet and spend the funds.
To repeat, this is exactly what
Keynesians say needs to happen in order for the economic recovery to become
self-fulfilling and for the government to gracefully leave the scene. Private
investment needs to expand. But Krugman is so
hostile to the idea that "right-wing" policy measures might achieve
this outcome that he went so far as to rail against foreign investment per se
in the United States.
Even on Keynesian terms, foreign
investment in the United States would be a good thing, at least if it
directly contributed to higher expenditures. For example, if a Japanese
investor wanted to build a car factory in South Carolina, he would first need
to sell yen for US dollars. That would indeed push up the value of the
dollar, and hurt US net exports (other things equal). But so what?
Unemployment would still go down and US wage income would go up as the
Japanese investor used his newly acquired dollars to hire American workers to
build the new factory and to begin operations.
To see the big picture, we can drop money
for the moment. Suppose the Japanese investor literally sent clothes, food,
and other goodies across the ocean to previously unemployed US workers. In
exchange for these items, the US workers would assemble the new factory on
behalf of the Japanese man. In this scenario, it's true that US imports would
have risen, thus making the dreaded "trade deficit" worse. But the
previously unemployed workers who now had earned
some food, clothes, etc., would probably not see the problem with a change in
the trade statistics.
Conclusion
Austrians have a commonsense approach to
booms and busts. After a period of massive overconsumption and malinvestment, the proper remedy is for households to
save and businesses to invest in lines indicated by the proper market rate of
interest. In contrast, the Keynesians as led by Paul Krugman
excoriate savings and even occasionally throw out the investment baby with
the bathwater too.
Robert P. Murphy
Essay originally
published at Mises.org
here. With authorisation
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