In his column in the NYT this morning Paul Krugman urges a large fiscal stimulus to jump-start the economy:
The idea that tight fiscal policy when the economy is depressed actually reduces private investment isn’t just a hypothetical argument: it’s exactly what happened in two important episodes in history.
The first took place in 1937, when Franklin Roosevelt mistakenly heeded the advice of his own era’s deficit worriers. He sharply reduced government spending, among other things cutting the Works Progress Administration in half, and also raised taxes. The result was a severe recession, and a steep fall in private investment.
The second episode took place 60 years later, in Japan. In 1996-97 the Japanese government tried to balance its budget, cutting spending and raising taxes. And again the recession that followed led to a steep fall in private investment.
Just to be clear, I’m not arguing that trying to reduce the budget deficit is always bad for private investment. You can make a reasonable case that Bill Clinton’s fiscal restraint in the 1990s helped fuel the great U.S. investment boom of that decade, which in turn helped cause a resurgence in productivity growth.
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One more thing: Fiscal expansion will be even better for America’s future if a large part of the expansion takes the form of public investment — of building roads, repairing bridges and developing new technologies, all of which make the nation richer in the long run.
Should the government have a permanent policy of running large budget deficits? Of course not. Although public debt isn’t as bad a thing as many people believe — it’s basically money we owe to ourselves — in the long run the government, like private individuals, has to match its spending to its income.
There are several things that concern me about this prescription. For one thing I’m concerned that Dr. Krugman is overestimating the effects of fiscal stimulus, which I’ve recently heard analogized to filling a swimming pool by taking water from the deep end and pouring it into the shallow end. The money must ultimately come from somewhere whether from higher taxes which will further reduce private consumption and investment or from higher interest rates which will further reduce private consumption and investment.
Additionally, while there’s a long term argument to be made for the kinds of spending that Dr. Krugman advocates, I don’t believe those will provide near term stimulus. Additionally, there’s the issue of deadweight loss: at least some “highways to nowhere&148; are the norm in a representative system rather than aberrations.
Most of all I think that our economic problems are much more concentrated and a national spending plan would avoid dealing with the problems we have today in order to address the problems we might have some day inefficiently.
The biggest problem with this kind of government spending is that we have seen over time that it does not work very well. At best, it’s “filling a swimming pool by taking water from the deep end and pouring it into the shallow end” — that’s brilliant and I am going to steal it —, but more often it’s worse than that. More often, it’s taking money from the pool and putting it into glasses, then giving those glasses to those favored by the government, and asking them to fill the pool rather than using the water for themselves. Fundamentally, the government — not just ours, any governing institution that includes a bureaucracy, including very large corporations — is very good at doing inefficient or ineffective things quickly, so that “something” can be said to have been done, while being very poor at being either efficient or effective.
Consider this, had the government not forced city customers of telephone and electric companies to give money to potential rural customers, where the price of bringing electricity or phone service was prohibitive due to low population density, would electricity or phone service have come as quickly to rural areas? Clearly not. However, that price differential would have been a huge incentive to entrepreneurs, and maybe we would have seen innovative solutions to small-capacity electrical generation or voice communications. For example, where there was no mandate, in cable TV, it was not long before there were satellite TV providers, and that has provided competition even in markets where there are monopolies for cable TV service. If there were no monopolies, so that prices were driven down or viewer options increased in the cities, the satellite companies would be forced to follow suit. Government creates problems; it does not solve them, except by creating bigger problems.
I meant to say “taking water from the pool.” Bah. Preview is for wimps!
Keep in mind that it’s not just that fiscal stimulus transfer money (although they do); the reason why you get things like $1+ in consumption for $1 in spending in a number of programs is that it loosens up private sector spending, so the total amount goes up.
Brett, the problem is that the Keynesian multiplier is based on an “all other things being equal” line of reasoning. That’s most likely in the case of extending unemployment benefits or food stamps which is why I support increased government spending in those areas.
However, there’s more going on. In most other cases the increased government spending will just cause people to pay down their debts (which won’t stimulate the economy). Additionally, there’s the deadweight loss of taxation. If you get $.15 of stimulus for every dollar of spending and $.15 of deadweight loss for every dollar, you get no benefit at all, all other things being equal. The actual numbers matter.
However, things aren’t equal. In the case of fiscal stimulus every dollar spent must be taken from somewhere else, either through taxation or borrowing. If it’s taxation, there’s a sort of reverse stimulus effect (plus deadweight loss). If it’s borrowed the interest must be paid off, presumably forever.
Finally, the world is a lot more complicated than it was 80 years ago. How much do you have to appropriate in 2008 to get $1’s worth of spending on, say, roads in 2008. Road-building projects take years to plan and execute not to mention litigate. We don’t just round up a crew and start building a road.
Just to bludgeon the bloody obvious…Krugman poisons the opposition argument and then pretends it never happened. Note bolding:
The idea that tight fiscal policy when the economy is depressed actually reduces private investment isn’t just a hypothetical argument: it’s exactly what happened in two important episodes in history.
The first took place in 1937, when Franklin Roosevelt mistakenly heeded the advice of his own era’s deficit worriers. He sharply reduced government spending, among other things cutting the Works Progress Administration in half, and also raised taxes. The result was a severe recession, and a steep fall in private investment.
The second episode took place 60 years later, in Japan. In 1996-97 the Japanese government tried to balance its budget, cutting spending and raising taxes. And again the recession that followed led to a steep fall in private investment.
We’re not supposed to notice that in the Krugmanesque universe tightening spending does all the damage while raising taxes has no effect at all. This is classic Krugman conflation. If you’re not for what Krugman wants, you’re automatically for cutting spending and raising taxes and causing recession.
What are you talking about? Krugman hardly said that raising taxes has “no effect at all”; he specifically pointed out that part of the damage was done by raising taxes in an effort to balance the budget, although his main point was about fiscal policy (“tight” fiscal policy – meaning that he was criticizing efforts to balance the budget in a recession).
To add, Dave – isn’t that the point of deficit spending in a recession? You borrow the money in the recession, spend it on various projects designed to promote longer-term economic growth, provide some jobs, and help out (unemployment insurance and food stamps). Then, when your economy picks up, you use the extra tax revenues caused by economic growth (and Keynesian theory actually says that you ought to raise taxes in a boom while cutting spending for this reason) to pay down the debt you incurred. Nobody’s talking about relying on tax revenues to pay for greater spending in a recession; in fact, Keynesian theory says that cutting taxes (in addition to government spending) are the way to go during a downturn.
I’m not criticizing your criticism of the validity of the multiplier; for the record, I think extending unemployment insurance and food stamps are the best way to go. The main reason why I’m in favor of other forms of spending, like greater infrastructure spending, is because this is stuff that ought to be done anyways, so if done properly you’re getting a long-term economic benefit from it while pumping money into the type of business you want to promote (especially if you are trying to promote greener power).
Brett–he’s arguing against tight fiscal policy that no one has proposed, and touting massive deficit spending as the only cure. Yes, it’s dishonest, as those are far from the only paths available.
And yes, he blithely dismisses the effect of taxation after bringing it up. If he had meant to make any points at all about taxation he sure didn’t follow through, as those are the only two places he mentions taxation at all before going on to ignore it entirely in the rest of his polemic. If he wants it counted on one side as a factor he should address it on the other–as you yourself note, what about lower taxes? But Krugman doesn’t want lower taxes, and the subject vanishes.
So we have Krugman essentially blaming recession on reduced government spending (which no one has proposed) and higher taxes (which he then drops) in order to bolster his own case for much greater government spending. Given his history of endorsing wealth redistribution through increased and progressive taxation, the omission of the contra argument is telling.