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Tuesday, November 11, 2008

Krugman's Prescription for Disaster

Paul Krugman calls for Obama and his advisors to push an expanded version of the New Deal (see the link below by Mark R. Hatlie). According to Krugman, they should boldly throw caution to the winds and “figure out how much help they think the economy needs, than add 50 percent. It’s much better in a depressed economy, to err on the side of too much stimulus.”

Obama should reject this advice. If he listens to Krugman, the likely result will be a wave of stagflation that makes the experience of the 1970s look mild by comparison. Such a prescription would both continue and accelerate Bush’s fiscally reckless policy of propping up malinvestments through massive increases in spending, deficits, and easy credit by the Federal Reserve. As the continuing fall of the stock market and the rise of unemployment indicate, more bailouts and more “shock socialism” do not work. Obama made a fatal mistake in failing to oppose the aptly described billionaire bailout.

This call for a hyper New Deal rests on a flawed view of history. According Krugman, the only reason Roosevelt failed to bring recovery was because he spent too little, not too much. At the same time, he tries to have it both ways by stating that the crisis of the 1930s would have been “much worse” without the New Deal.

A key problem with Krugman’s analysis is that it does not adequately explain why the decade-long New Deal era depression lasted so much longer than previous depressions. Prior to the 1930s, depressions (as in the sharp and short downturn of 1921 and 1922) had typically lasted for two to three years. The predominant anti-depression policy before Hoover and Roosevelt was to cut spending, balance budgets, and let prices, profits, and wages readjust to more sustainable levels. Yet Krugman regards this older approach for curing depressions as “much worse” than the New Deal. The logical implication of his argument is that the New Deal, modest as it was, would have made the Great Depression at least somewhat shorter than previous downturns. The fact that it did not stands as a stunning indictment of FDR’s policies.

The unprecedented duration of the depression also represents an indictment of Herbert Hoover’s approach. This was because Hoover intervened too much not, as Krugman would have it, too little. Krugman’s article neglects the relevant point that Hoover had pursued a mini-New Deal from 1929 to 1933 via programs such as the Reconstruction Finance Corporation and the Federal Farm Board. It was Hoover, not Roosevelt, who was the first president to reject the advice of the “leave it alone liquidationists.” Instead of letting malinvestments (or toxic assets in today’s parlance) readjust at a lower level, he desperately propped them up. In great part because of Hoover’s high wage policies, real wages were actually 12 percent higher in 1932 than in 1929! Meanwhile, of course, unemployment advanced to record levels as businesses saved on payroll costs by laying off workers. Perhaps if Hoover had listened to the advice of the so-called “liquidationists,” the depression would have been over by 1931.

More troubling, at least for opponents of war, is Krugman’s dubious contention that “What saved the economy, and the New Deal, was the enormous public works project known as World War II, which finally provided a fiscal stimulus adequate to the economy’s needs.” The evidence does not support the view that that war was beneficial for the economy. In a seminal article for the Journal of Economic History, Robert Higgs convincingly challenged the Keynesian theory of World War II as put forward by Krugman and others.

While unemployment disappeared during the war, it was hardly a step forward. Moving men and women from the unemployment lines to the killing fields of Anzio did not represent economic progress in any meaningful sense. During the war, Americans at home suffered from rationing, shortages, more accidents on the job, longer hours, and many other measures of economic deprivation. Moreover, as Higgs points out, “real personal consumption declined. So did real private investment. From 1941 to 1943 real gross private domestic investment plunged by 64 percent; during the four years of the war it never rose above 55 percent of its 1941 level; only in 1946 did it reach a new high.”

According to Higgs, genuine prosperity did not begin to return until the last months of 1945 and 1946. This prosperity occurred under a policy of reverse Keynesianism which included massive reductions in spending because of demoblization, rapid steps toward price decontrol, and scaled back deficit spending.

Higgs sums it up:

World War II, the so-called Good War, has been a fount of historical fallacies. One of the greatest—and one of the most pernicious for subsequent policymakers—is the notion that prosperity prevailed during the war. Although Americans might have been dying in the Pacific and European theaters of war, people on the home front actually benefited from the war, because it propelled the economy at long last out of the Great Depression. This view of the war would be sufficiently egregious if it were true, but despite the claims of historians for the past half century, it is not true.

Obama's best hope to bring lasting recovery is to let the economy go through a short, but sharp, readjustment. He needs to remove the malivestments not, contra Krugman, perpetuate them. Obama can faciliate this readjustment to a more sustainable level by cancelling the bailout, cutting spending, and pruning deficits. Another worthy goal would be to dismantle the Federal Reserve which helped to create this mess through its easy credit policies.

Most of all, however, Obama should end our costly empire by closing down our overseas bases and bringing home the troops. Only then, can we start to get our financial house in order and move towards genuine economic well being.

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Blogger Paulanz said...

Right on - it seems to me that basic common sense tells us increased government spending cannot lead to real wealth creation or increased prosperity.

But the idea that we were NOT rescued from the Great Depression by government spending seems to be an unheard of idea outside of economic circles...So I don't hold out much hope that the politicians will be able to resist their own impulses and a majority of public opinion in favor of the myth...

At least we DO have hope that he'll get us out of Iraq, however a reduction in defense spending is questionable - just look at the size and power of the defense industry and the % of people with an interest in it!

4:14 PM  
Blogger David T. Beito said...

Thanks! Reduction of defense spending can happen if Obama wants it to happen. Unfortunately, he shows no inclination to do so. If the financial crisis continues, however, he may have no other choice.

4:48 PM  
Blogger Sukrit Sabhlok said...

It's extremely unlikely that Barack Obama or anyone affiliated with his administration is reading this blog. Hence, we can expect that your sound advice will be ignored, and the Obama administration will follow in the "New Deal" footsteps of Roosevelt, prolonging the agony and causing an inflationary recession.

Although this might sound bad, the ability of libertarians to predict the coming economic calamities can only work in our favour. Remember how Milton Friedman's ideas rose to prominence during the 1970s? The same can happen again, if we are ready.

8:15 PM  
Blogger Per Paterson said...

Very good article indeed. Now we have the two main alternatives on how to handle the economic crises.

How should banks be dealt with?

And what about gold and silver as a new world currency so no government or central bank can increase the amount of money?

8:47 PM  
Blogger Economics of Contempt said...

You make a couple glaring logical mistakes in this post. First, you write:

"According Krugman, the only reason Roosevelt failed to bring recovery was because he spent too little, not too much. At the same time, he tries to have it both ways by stating that the crisis of the 1930s would have been 'much worse' without the New Deal."

That's not trying to "have it both ways." The claim is that the New Deal made the Great Depression better than it would have been without a New Deal, but was nevertheless too small to end the Depression. Mitigating an economic downturn and ending an economic downturn aren't the same thing.

Second, you write:

"The logical implication of [Krugman's] argument is that the New Deal, modest as it was, would have made the Great Depression at least somewhat shorter than previous downturns. The fact that it did not stands as a stunning indictment of FDR’s policies."

No, the logical implication of Krugman's argument is that the New Deal would have made the Great Depression at least somewhat shorter than it would have been had we followed the old approach for curing recessions. How do you know that the old anti-recession policy would have made the Great Depression shorter than it actually was? How do you know that in the absence of the New Deal, the Great Depression wouldn't have been longer than the Long Depression? You don't.

Also, comparing the Great Depression with the recession in 1921-1922 is ridiculous. Output in 1929 alone contracted more than twice as much as output contracted in the entire 1921-1922 recession. And 1929 was before Hoover started his expansionary fiscal policy (which I agree Hoover never gets credit for, although you'd probably call it "blame" rather than "credit"!).

2:28 AM  
Blogger Per Paterson said...

I think "Economics of Contempt" has some good points in his text.

The 1921-1922 recession was not of the same cycle degree, we need to go further back in history to find one of similar magnitude, there was one around 1860 if I remember correctly.

A modern example of banking crises is in Sweden and Japan in 1990-1994 and how it was dealt with. Sweden came out of it quickly and Japan is still in recession 18 years later after numerous stimulus packages.

We need more information.

5:31 AM  
Blogger David T. Beito said...

I try answer some of the questions all of you have raised here

11:52 PM  
Blogger Dave Collins said...

Basically I am wondering if anyone in the world is actually an economist. Or is everyone a bunch of stupid idiots with big titles and completely no sense. I am not an economist but I do know a few things. 1. To improve an economy you have to be able to produce more with less input. 2. Any policies that help this will help everyone. 3. Any policies that hurt this will hurt everyone. So with that simple definition what do wars do that will increase economic output. Almost nothing, except some research and development spin-offs. For the most part they utilize large amounts of resources, men and materials and you get nothing to eat or improve your life with. So any reduction in war or defense spending will ultimately help the economy. Trade agreements that move jobs from highly automated equipment to highly unskilled labor, ie more workers less equipment is bad for the economy. Why, because you are producing less with more people, dumb (*&^!! So all this stuff we buy from China and Indian and Mexico is a complete bunch of baloney that ruins the economy. So you get really three simple ways to fix the economy in about 2 months. 1. End the war and slash military spending. 2. End any trading with countries who do not have the same minimum wage laws we have. 3. Loan any money to business's who are very likely to become highly automated, ie less people more output.

So if you notice economic stimulus packages to people do not help anything because they buy more Chinese junk and then run out of money! Bailouts to banks do not help because they put more money into buying existing homes or keeping homes which means absolutely nothing to improving economic output, ie eating or creating anything. Bailing out industries that are highly automated is an end run around doing what is right which is legislating that we do not do business with countries that are not highly automated and use basically slave or underpaid labor and no automation.

If you want to talk about the earth and environment again everyone is a bunch of idiots that talk on this matter. 1. Gasoline pollutes. 2. Electric or propane cars are pollution free compared to gasoline.

Everything in the world runs off of electricity except the most logical item which is an automobile. The people which say this can not be done, are either liars or complete idiots. When you charge your laptop take a look at the battery and the amount of power it provides do the math and convert it to horsepower and realize that a automobile with 200hp only has about 75hp at normal operating speeds and accelerations. Then you will realize that any truck in the world has five times the amount of hauling capability to be an electric car and you can still have half the room left over to haul wood!! Not to mention there is an overabundance of propane in the US alone and every car in the US can run today on propane!!! So again more bullshit from oil companies who pushed there prices up to $4 and then lowered them to $2 in less than six months!!!! If more people start demanding the above and saying and repeating so the idiots and liars in the world will get out of the way we will not have to go through the DEPRESSION we are about to go through!!!!!!!!

By the way I would love to hear a response to the above or is everyone afraid?

7:49 AM  
Blogger Paulanz said...

Why should we reply, David, when you clearly already know it all and the rest of the world is full of idiots. Not exactly a post inviting discussion. Sorry you're so angry at all us dum dums.

4:41 PM  
Blogger Dave Collins said...

Ok, I am no longer angry. I am calm and rational. A depression is something worthy of getting a little angry at based on the fact that we are more technologically advanced than having to go through a depression. I posted this after watching a MIT professor say on CNN that we should do nothing at all about the economic problems we currently have. And if that is what you get by being supposedly the best at something then, it is time we all get angry and say enough is enough. I do not claim to be the brightest person but I will tell you that doing nothing may be better than doing more of the same bad things, war, investing in manufacturing in China and India to utilize Slave labor or almost slave labor. But come on..... A MIT economist must have a little better sense than that and know that by investing in creating more with less people here in the US or anywere with the same minimum wage laws by increasing automation is how you increase economic output and help everyone. And before I get to far out in left field with ideas I will tell you what I have seen in 20 years. An automobile plant in Wixom Michigan building less than 20 lincolns an hour with over 3000 people per shift go to being able to produce over 70 lincolns per hour with less than 2000 people per shift and over 1 billion dollars worth of equipment get shut down so people in america could buy luxury vehicles produced in China with over 10,000 people producing less than 20 vehicles per hour. And yes the vehicles from China cost more and the Lincolns last longer, did you know that lincoln continentals have not been made since 2002 and that is the most commonly recoginized luxury limo on the road. But I could have used other assembly plant in the US for the same demostration, or lumber plants or paper plants or textile plants or....(all shut down for cheap basically slave labor in other countries) That is not economic improvement that is the kind of economic downward spiral that causes a depression. Because again more people creating fewer things in the end leads to less for everyone. So what, a few fat cats get rich, everyone else gets poor. That is not being angry that is calm rational and what is really going on in America. You could point to oil, you could point to housing you could point to any sector, including health. The addition of more people at cheaper wages with a few on the top making spectacular money with no real relationship to improving the economic output of producing more with less people and less waste and less of an environmental inpact. All of this eventually adds to an economic depression. Yet we are increasing our technological prowess every day at lightning speed throughout the world to include China and India. So again I will say that we need to make the system work for economic inprovement which means reward those who make more with less people and less materials. Stop bailing out those insurance and banking companies who create nothing. And the insurance and banking companies reward those who create nothing and profit off of taking a piece of profit like a mofia hit man off of everyone slave laborors included.

I realize I rambled a bit but it was not angry. Stop sending money overseas for oil we have enough electricity and natural gas to run automobiles on and we could pump more if we wanted to but we do not want to. If you do not believe that take a ride along the west coast of Michigan or Pensylvania or anywere and you will find oil wells not pumping unless oil goes over $100 a barrel or $150 per barrel. Oil comes out of the ground for free so watch the price drop because there are real alternatives out there and nobody wants to see the golden goose of oil get killed. The next thing to run automobiles could be electric and not as easily controlled by a few very rich individuals.

So again I am not angry I just think it is a shame that we are not going through an economic boom like nothing we have ever seen before because we are going through a technology boom like none ever before on the face of this earth and that is what creates economic expansions. Not stimilus checks and bailing out insurance companies.

Thank you for reading!

9:12 PM  
Blogger Nasrin Afshar Azadeh said...

I think war chemistry allows possibilities for policy makers to enact many restrictions with no unwanted consequences and harsh reaction from the people. It also diverts production from butter to armement - that works well for sometime to create some space into a saturated market!!! is this so odd analysis??

However, new technologies could do just that - similar to all the wealth IT created for the US economy during 90s - it was a blessing!

12:35 PM  

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