Thursday, June 7, 2012

Krugman v. the Austerians

Almost sounds like a Godzilla movie, doesn't it?

Anyway -- here's the video:

Here's how the BBC described the footage at this link:
Jeremy Paxman is joined by Nobel Prize winning economist Paul Krugman, venture capitalist Jon Moulton and Conservative MP Andrea Leadsom to discuss whether austerity is always the best method for resolving a country's national debt problem.

0 - 1:26: Krugman notes that experience over the last few years indicates that austerity does not work. It’s been tried in the UK, Greece, Ireland and to a certain extent the US.  It does not work.  In addition, austerity makes the long-term fiscal situation worse by lowering growth, thereby lowering GDP and increasing the debt/GDP ratio at the macro level.

1:26 – 2:05: Ms. Leadsom makes two arguments. More spending doesn’t solve the problem; it’s really simple math.  In addition, we should be implementing a far more aggressive austerity program to sharpen the hit and get it over with.

Bonddad: The “simple math” argument works just as strongly when you consider the GDP equation (C+I+X+G), doesn’t it?  So why not increase spending, especially when consumption and investment is down?  In addition, the “we’re not doing it properly argument,” is pure garbage.  The MP sidesteps the simple fact that austerity hasn’t worked as advertised.  Instead, she says, “let’s try it again, but do it more aggressively.  There is no data to back-up this claim; it’s pure faith.

2:05-3:05: Krugman notes that when everyone is trying to cut spending all at once, you cut yourself into a depression – an observation noted by Irving Fisher in the 1930s.  There is a circular nature of the economy; your spending is my income and my spending is your income.  When everyone is slashing spending at the same time, income drops at the macro level.

3:10-3:52: Mr. Molton makes two arguments.  First, that the public sector is too big (according to him, The UK government sector accounts for 50% of GDP) and that there is a moral argument about passing on too much debt.

3:52-4:30: Krugman responds that the real moral crime is there are no jobs for college graduates right now; they’re graduating with degrees and they have no jobs available.  In the scheme of things, a high unemployment rate is in fact more “immoral” than too much debt.

Bonddad’s note: something that is missed here is that in borrowing to build the economy, you create jobs and growth.  Eventually, there is enough growth from the public sector to hand off growth to the private sector.  This growth increases GDP, which eventually lowers the debt/GDP ratio. In addition, properly implemented Keynesian policy leads to a hand-off from government to the private sector.

4:40-4:50: Mr. Molton and Ms. Leadsom respond that growth will return as people leave the public sector and join the private sector.  Ms. Leadsom also argues that the government should be lowering taxes and, in general, creating an environment for entrepreneurs to start businesses etc..

4:50-5:42: Krugman responds that most people won’t start businesses.

Bonddad’ note: this is a very important point, and one that is often not fully developed.  Inherent in the idea of supply-side economics is that the government should create an entrepreneur friendly business climate.  First, being an entrepreneur myself, I couldn’t agree more.  But, just as importantly, most people aren’t entrepreneurs; most people work for other people. Consideration must be made for the far larger number of people who aren't entrepreneurs.

In addition, Krugman notes that the real agenda of the conservatives is to cut the size of government; that their agenda isn’t fiscal, but political.

5:40-6:24: Cross talk between Molton and Krugman regarding the size of the state and economic growth.  Mr. Molton references a study (I believe by “Alfonso”) which demonstrates that larger public sectors slow growth.  Krugman responds that this is not true and uses Sweden as an example.

6:24-7:20: Ms. Leadsom argues that taking money from the private sector for the public sector is not the way to create jobs; that, in fact, either public sector expands or the private sector expands.

Krugman states she is missing the point.  The real problem is that the economy is in a depression; there are a vast number of resources that are not being used.  At this time, the government and the private sector are not competing for resources.  As such, government spending isn’t going to crowd out investment.

7:20-8:20: Ms. Leadsom argues that lowering taxes and deregulation are in fact the most effective way to stimulate the economy. 

Krugman notes that in survey after survey, businesses are saying lack of demand is the real problem.

8:20-8:40: Mr. Molton argues there have been some austerity success stories.  Krugman responds that those worked because interest rates were high and could be lowered or that the country could devalue their currency, which no one can do right now.

And that’s the end.

Bonddad’s commentary:

Basically, supply-side policies work best when there is pent-up private sector demand. By lowering the cost of investment, you can unleash a self-reinforcing cycle. The bigger the pent-up demand, the bigger the payoff to an improvement in expectations. Without that pent-up demand, resources freed from supply-side measures and austerity get saved, not spent, and no self-reinforcing cycle is triggered.

The world of 1980 had tons of pent-up demand and gale-force tailwinds. Inflation and interest rates were coming down from high levels, household leverage was very, very low, financial innovation non-existent, consumption had been deferred, and demography was coiled as the baby boomers were just coming on line. On the government side, unions were powerful, price and wage controls were a reality, and tax rates were high. This was the ideal set up for supply side reforms.

Fast-forward to post-2008. Whatever the opposite of pent-up demand is, that’s what we have. Inflation and interest rates are already low, household leverage is a major burden, consumption was pulled forward during the boom, and demography is no longer our friend. Plus, we have globalization acting like a supply shock to our labor pool, holding down wages. In short, the tailwinds are now headwinds. On the government side, unions are far less powerful today, there are no price and wage controls, and tax rates are low. It seems next to impossible to make the case that supply-side policies can have anywhere near the effect today that they had in the 80s.

The conservative representatives were really politicians and not economists.  As such, they were at a disadvantage when answering and dealing with economic questions.  I think a fairer debate would have been to have someone like John Taylor represent the conservative view – someone who is more versed in economics and could have responded in appropriate terms.  Put another way, this debate was between two politicians and an economist.

At no point did any of the conservatives talk about unemployment.  There was no mention of how many people are out of work and something should be done about that.   They obviously felt no need to to get people to work in any way.  And that, in and of itself, is a big problem.