A Sick Economy or Creative Destruction?

I’m skeptical of the claim that Paul Krugman makes in his column today:

Wages are falling all across America.

Some of the wage cuts, like the givebacks by Chrysler workers, are the price of federal aid. Others, like the tentative agreement on a salary cut here at The Times, are the result of discussions between employers and their union employees. Still others reflect the brute fact of a weak labor market: workers don’t dare protest when their wages are cut, because they don’t think they can find other jobs.

Whatever the specifics, however, falling wages are a symptom of a sick economy. And they’re a symptom that can make the economy even sicker.

First things first: anecdotes about falling wages are proliferating, but how broad is the phenomenon? The answer is, very.

He continues by noting that according to the BLS the average wage rose two-tenths of a percent in the first quarter of this year. How that translates into a broadbased decline in wages is unclear to me. Further, as Dr. Krugman surely knows, making a claim based on the average wage is specious. A reduction in pay on the part of a few thousand financiers or stock traders who made $500,000 a year each is certain to drive down the average wage. That isn’t a sign of a sick economy any more than the quarter a few years back when the GDP rose .1 percent solely on the basis of the appreciation of Microsoft stock was the sign of a healthy economy. Contrariwise, it is a sign of creative destruction: assets are being moved from less productive areas into more productive ones.

Dr. Krugman’s prescription for our problems is more fiscal stimulus:

There has been a lot of talk lately about green shoots and all that, and there are indeed indications that the economic plunge that began last fall may be leveling off. The National Bureau of Economic Research might even declare the recession over later this year.

But the unemployment rate is almost certainly still rising. And all signs point to a terrible job market for many months if not years to come — which is a recipe for continuing wage cuts, which will in turn keep the economy weak.

To break that vicious circle, we basically need more: more stimulus, more decisive action on the banks, more job creation.

Presumably, the fiscal stimulus he want is more spending. I’ve asked the question before but I’ll ask it again. Does anyone have any empirical evidence that the Keynesian multiplier is now or has ever been greater than 1? I.e. that the economy is actually stimulated by fiscal stimulus in the form of government spending?

My concerns about greatly increasing the deficit (which is what fiscal stimulus means) include high inflation, crowding out, the likelihood that any counter-cyclical spending won’t be matched by pro-cyclical reductions in spending, the prospect that the spending will in fact be pro-cyclical (which isn’t what we need), and the propensity of the government to pick winners and losers which IMO is what got us into this pickle in the first place.

What I think we’re seeing is that areas of the economy in which we’re enormously over-invested, e.g. the financial and automotive sectors, are contracting and wages are contracting in them, too. That’s the sign of a healthy economy, not a sick one.

6 comments… add one
  • Drew Link

    Given that the “multiplier” is bandied about so cavalierly, you would think the data would be readily available.

    However, if you just scan this report by the Romer’s on the tax multiplier:

    http://www.econ.berkeley.edu/~cromer/RomerDraft307.pdf

    you can see how complex it can get.

  • It doesn’t help that even among economists the way a multiplier is calibrated differs. For some a multiplier of 0 is no net increase in economic activity as a result of increased spending and a multiplier of 1 means a doubling of economic activity while among others a multiplier of 0 means a reduction of economic activity in the amount of the increased spending and a multiplier of 1 means no net benefit as a consequence of the subsidy. I use the term in the latter sense. Consequently, as I understand a .8 multiplier it means an actual net reduction in economic activity and a multiplier of 1.5 as an increase in the amount of 50% of the spending increase.

  • Drew Link

    Now you’ve got me thinking. I’ll see if I can find some discussion of this. My understanding has always been that a .2 meant that a dollar of spending resulted in 1.2 dollars.

  • Drew Link

    Truth!

    http://www.newyorkfed.org/research/staff_reports/sr241.html

    http://gregmankiw.blogspot.com/2009/03/are-fiscal-multipliers-now-big-or-small.html

    http://barrdear.com/john/2009/01/25/the-fiscal-multiplier/

    http://www.cepr.org/pubs/new-dps/dplist.asp?dpno=5839

    Or maybe not. Spending multipliers from .15 to 3.4 !! Take yer pick.

    I think you have also seen Kevin Murphy’s model, taken from a UofC seminar. He didn’t put a number on it, but explained why he thinks its low.

    Enjoy.

  • As Pontius Pilate put it, what is truth?

    Note, BTW, that the definition put forward by John Barrdear supports my use of the term.

  • Drew Link

    I think we all know what “truth” is: its what a smooth talking politician can make a relatively uninformed and gullible public – supported by a friendly and propagandistic press – believe……….

    But I digress…..

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