The high priest of interventionist economics

From his perch at the New York Times, Professor Krugman has been dispensing economic and political advice for many years. Unfortunately, he is to economics somewhat similar as Ben ('you have to buy financials here') Stein is to investments, in short, he is potentially capable of causing a lot of damage. For this reason alone, his views must be challenged from time to time, even though we poor bloggers do certainly not have his reach. My fellow blogger and friend Mish has recently done so,  in a blog entitled 'Krugman still wrong after all these years'. He certainly is, and I want to take the opportunity to add a few complementary thoughts to Mish's ruminations on the topic. First of all, I would recommend this paper (pdf) by Daniel Klein and Harika Bartlett, in which Krugman's editorials have been analyzed statistically and then interpreted by the authors.


The verdict is clear: Krugman is propounding a social-democratic ethos, even though he curiously never admits it outright. On the contrary, he presents himself as somehow being 'above ideology', while at the same time managing to be one of the most vocal and well known advocates for statism and interventionist policies in the economics profession today. As the paper notes, if one thoroughly looks at e.g. his concern for the poor, it turns out that this concern is trumped by his support for statist intervention – this is to say, when the choice is between a policy of liberalization that clearly helps the poor and a continuation of a regime of regulation harmful to their interests, he will always favor regulation (by simply remaining silent on the topic). His record of favoring markets apparently consists of a single assertion in one of his editorials which he purports 'not to be against the market' – a statement that is then thoroughly contradicted in almost every paragraph of the hundreds of articles he has written. He has come out in favor of liberalization in exactly two cases in his writings for the NYT from 1997 to 2008, which comprised 645 editorials as of January 2008.

Krugman's political ethos is also marked by the 'social compact' chimera – he strongly supports democracy, because the act of voting in his mind legitimizes state coercion. After all, you have a choice, so this theory goes. If you're not happy with the status quo, vote against it. We all know however that this is not how it works in reality. You can not opt out, or vote against the status quo, because that choice is simply not presented in elections. In the US specifically, the two party system is akin to a one party system with only slight shades of difference in emphasis regarding the types of statist policies that are supported. In this context read Albert Jay Nock's very interesting and entertaining essay 'What the American votes for', in which he explains why he decided to abstain from voting, respectively only voted for people that were already dead.

Criticism without basis

Occasionally, Krugman will criticize the Austrians (whom he doesn't name – he calls them the 'liquidationists' instead – presumably short hand for everyone who thinks the state should not intervene to stem the bust), who in turn frequently criticize right back. Curiously, Krugman does his utmost to ignore the Austrian school's arguments – it is as if he is aware he's being criticized, and given that the views of the Austrian school are lately gaining a certain degree of credence with the public, finds it necessary to publish an occasional criticism, but at the same time is studiously avoiding to actually read what they have written. In his recent article on what he calls the 'Hangover Theory', which can by implication only refer to Austrian Business Cycle Theory (ABCT), he once again roundly ignores arguments that have been sent his way quite some time ago already.


This can only mean one of three things:


A) he doesn't grasp the arguments (unlikely).

B) he didn't read any of them, nor any of the classical works (possible I guess).

C) he has read them, but now makes as if they didn't exist, thereby misrepresenting them by omission.


As Robert Murphy shows here by means of a little economic anecdote, Krugman simply ignores the role of capital (a failing of Keynesianism in general), and its intertemporal structure. Now, he has either read Murphy's piece or he hasn't, but he sure does ignore it completely. Most importantly he ignores the point that during the boom, resources will be misallocated, which in turn leads to consumption of capital.

I urge everyone to read Murphy's article, as it lucidly explains why the view of the economy as an agglomeration of 'aggregates' is wrong – and how in an artificial boom, misallocation of capital along the production structure leads to capital being consumed and falling into disrepair. As Murphy correctly remarks, it is vital to understand this part of the ABCT if one wants to sensibly contribute to the debate. It is the process of capital consumption – respectively consumption of the pool of real funding, or put in other words, previously accumulated wealth – that creates the illusion of the boom.


The master builder

Ludwig von Mises had numerous little common sense quotes and anecdotes in which he tried to paint an easy to understand picture illustrating such concepts. With regards to capital consumption, he referred to consumption without preceding production (which is a side effect of the fiat money system's 'money out of thin air' creation) as akin to 'burning the furniture to heat one's home.' One can do that for a while, and the house will be nice and warm for some time, depending on the amount of furniture available to burn. One day though, one will perforce run out of heating material, and voila – the home will grow cold (as a metaphor for the inevitable bust resulting from capital consumption). Another von Mises anecdote that illustrates scarcity and the importance of correct – i.e., market-based – information in guiding entrepreneurial decision making, is the one about the master builder. Imagine the Pharao charges you with building him a palace. At the outset, you are informed how many pieces of wood, hows many bricks, nails, glass panes, shingles and other building materials will be at your disposal. In short, you seemingly have perfect information about the resources available to you.

However, someone made a mistake – there are in fact 20% fewer bricks available than you were led to believe. Some of the crew discover the mistake, but given that building the palace means a good time for everyone – they all have jobs, they're building a nice palace, everybody, including the builder seems happy – they decide to keep you in the dark about it. You will of course succeed in erecting the foundation, and perhaps in building up to say, the first floor. However, the building you have planned on the basis of this incorrect information will forever remain unfinished – at some point, the bricks will run out prematurely. It follows that the earlier in the process you learn of the error, the better the outcome will be. If you learn of it while still drawing up your plans, you can plan anew, and only some of everybody's time will be lost. If you learn of it after having built the foundations, there may still be time to change plans for a somewhat smaller, but still doable palace. If you learn of it one day before the bricks actually run out, it will simply be too late – a monument to malinvestment will have been erected – an unfinished palace. The resources that have been used up in erecting this unfinished building have been used up, and while everybody had a 'good time' (the boom) while doing that, they are now faced with the fact of an unsalvageable and uneconomic project standing before them.


Relevance to the economy at large

The problem presented by an artificial credit boom to the whole economy is akin to this master builder problem. In this case, the artificially low interest rate is what creates a fata morgana – i.e. a crucial piece of misinformation – that leads businessmen astray, namely the illusion that more savings are available than there really are. It is the conceptual difference between money and real resources that trips up Krugman. He thinks if only someone – preferably, in his view, the state – were to spend money in the teeth of the bust, everything would be alright again. This ignores what has happened in the boom – scarce resources were misallocated due to false information on the true state of savings, and thus capital ended up being malinvested and consumed. If we look at the policies enacted since the bust began, we see that they are all geared to keeping the disinformation that the boom was based on alive.

Once again, interest rates are being suppressed to an artificially low level. The state meanwhile is set to spend more money than at any time before in such a brief time span in peace time, on the idea that more spending is going to cure what too much spending has wrought. However, the state can not add one iota to the pool of scarce economic resources that need to be optimally allocated if the economy is to recover. We must always come back to the fact that the state does not have any economic resources of its own – it does not produce any. Instead, it must take them from those who do produce them.

Listening to Krugman, you'd think Austrians were a bunch of sourpusses begrudging everyone the good times of the boom, and then making things worse by being especially dour party-poopers with regards to the remedies thought to be necessary 'fix' the bust. However, it is just realism and rigorous a priori reasoning that leads to their conclusions. Once the economy's pool of real funding has been damaged on account of an artificial credit boom, the priority must be to allow the production structure to readjust to reality, and that process, while painful, is also necessary. The efforts of a coercive redistribution agency (the government) can not change that, and the printing of more fiat money can not either. What the introduction of these factors does is to upset the market process. They are deliberately used to induce booms (booms are politically popular until they go bust), in the hope that someone else will have to deal with the consequences (as is indeed the case; Bernanke gets to deal with Greenspan's legacy, and Obama with Bush's), and when those consequences inevitably arrive, they are used again in a futile attempt to keep those consequences at bay.

As long as the pool of real funding hasn't been damaged too excessively during a boom, a dose of monetary pumping can be expected to revive the illusionary boom – as has indeed happened several times in the past, most recently after the technology bubble flamed out. The problem is that this only stores up even bigger problems for the future. We can all clearly see now that Greenspan's attempt to prevent the previous correction/bust from doing its work has led to an even bigger, more intractable bust in the present, but the interventionist caste still insists that we have to do the same thing all over again, only in larger dosage!


Once a boom turns to to bust, there are a number of facts that need to be faced:


  1. there were not as many savings as thought, so capital was misallocated;
  2. what the economy needs is as little interference as possible, since otherwise the danger is that even more capital will be misallocated.
  3. the process of realigning the capital structure to reality is not painless, since it requires far fewer workers than are are needed when everything is humming.
  4. the less interference there is, the faster it will be over.
  5. to interfere means de facto to burden an already weakened economy even more – therefore, the more intervention, the less desirable the likely outcome (and it's not as if we didn't have any examples for that)


The pretence of knowledge

Lastly, look at how Krugman argues in favor of state intervention and spending to 'mitigate the bust'. His argument in favor of increased fiscal spending in Europe is summed up as follows:

dY/dD = (1-m)/[1 – (1-t)(1-m)c – t(1-m)]

Read the linked article for an explanation of the formula.

This is what Hayek referred to as the 'Pretence of Knowledge'. Modern day economists seem to think that if it can't be put into a formula, then it can't be science. Economics is however a social science, not a natural one. It is about human beings, and the interactions of millions, nay billions, of human beings can not be pressed into neat little formulas. This is not to say that one must completely abandon a formulaic approach to certain economic concepts (a graphic representation of a supply-demand curve surely has its place for instance), only that the 'ceteris paribus' type equilibrium which these formulas assume to be in place is not present in the real world. The science of economics must proceed from sound a priori reasoning, otherwise it can not present the proper conclusions and provide policy recommendations. It is this latter point that should worry us all. Krugman and other supporters of interventionist dogma are self-styled advisers to the political class, which in turn likes to hear nothing better than advice that prods it to intervene. The courtier economists are thereby apt to doing a lot of damage, as mentioned in the opening paragraph.

Naturally, few economists would be prepared to admit that they actually don't know what to do. In this, the Austrian school is quite different. It essentially says: 'The entity that knows best what is to be done is the free market. Let it work'. In other words, they have no 'policy recommendation' except – 'do nothing'. When Ludwig von Mises was once asked what his first action would be if he were to be appointed 'minister of economics' he answered: 'Resign'. It's not the type of advice one can easily make a living from. The interventionist courtier economist of Krugman's type on the other hand is asked to draw up plans, has the ear of the powers-that-be, gets to feel important, and gets paid nicely for his efforts.

Furthermore, as has been shown over and over again, the fact that intervention does not work is never seen as a reason to abandon it, but rather to come up with new, additional interventions purportedly designed to fix the unintended consequences of the old ones. In this manner, the power of the state grows and grows – which is to the advantage of both the political class as well as its 'advisors' and everyone feeding at the state's trough (including many corporations; contrary to what one would think, most corporate entities are not in favor of a free market either – rather, they seek protection from competition in the form of anti-competitive regulations, respectively seek a slice of the tax payer pie that is doled out by the political class in its favors and vote buying activities). What is to the advantage of the political class and its advisors and hangers-on is however as a rule to the disadvantage of everyone else. If we want a sound economic policy, we must oppose Krugman's call for more intervention.




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