Krugman's Malpractice

Let me start this by first saying that I have a great deal of respect for Mr. Krugman, and read him very frequently as I consider him to be the leading economic thinker on the left and a one of the leading leftist intellectuals at the moment. That being said, Krugman is very good at properly diagnosing the problem, but then will totally manipulate the cause to whatever agenda he is promoting. His usual tactics are ignoring the long term, and looking for the slightest hint of anything anti-Keynesian to assign all fault with.

In "Pain Without Gain" he starts by really laying out how terrible the recession is in Europe, all true since he is just describing current conditions. So far, honest. Then this:

Worse yet, European leaders — and quite a few influential players here — are still wedded to the economic doctrine responsible for this disaster.

Read Stephen's rebuttal after the jump...

First, let's be honest, Greece in the years leading up to the 2008 crisis was not pursuing anything resembling what Krugman blasts as "Austerity". Why? Well, they were failing terribly at what he calls austerity, but what rational people call responsible spending since they were paying government employees 14 months worth of wages, and ran their debt up to 120% of GDP. Yep, nothing there resembling austerity.

No, what Krugman is calling the failed economic doctrine responsible for this "new" disaster is the austerity that was imposed after 2010. He continues that austerity was supposed to return confidence to the bond markets, but this has failed "Even austerity's star pupils, Portugal and Ireland, have done everything that was demanded of them, still face sky-high borrowing costs". Notice he doesn't mention Italy, where a new budget with (pick your choice of word) austerity/responsibility, was able to drive borrowing costs back under 7% (I claim this since in the offering immediately following the austerity budget, yields dropped). Instead he claims this was due to the ECB expanding credit. Except, this too is false since the bond holders didn't demand less in terms of yields, the ECB just tipped the scales and demanded more bonds at lower rates -- effectively adding enough demand to push out of the mix any bond buyers who would demand greater than 7%. Then he throws out a stupid argument that Japan and the US didn't fall into this austerity trend and see low bond yields (yet, this is because investors are flocking to safety...look at Great Britain and Germany who do have responsible/austerity budgets and are being paid by investors to hold their money).

What Mr. Krugman is really doing here is telling this guy (Greece) to take an Advil and put on a band-aid (continued government spending) for this fall (crisis). Now that the aspirin has worn off, and the band-aid is getting worn, Mr. Krugman is blaming all the pain on the lack of aspirin in his system. And don't pull off the band-aid now! No that would hurt, leave it on, he says, not realizing that it's only going to worse if not treated now.

But why is austerity the only way to fix the problem? Well, its the only way to have a sound economy that is not improperly inflated, burdened with too much debt (which requires high taxes which reduce free market growth). Further, there are only two ways Greece can continue to spend. 1- It borrows more -- which IS what got them in this mess. But since it can no longer go to the free market (bonds are going for 300+% yields in the private secondary markets), it would require further injection of cash from the ECB, which would be forced to raise that money from the EU countries that have it (Germany). This would put heavier taxes on the Germans, and stifle their innovation (which is the only bright spot of the entire EU). 2- It inflates its way out. To do this, the EU would have to inflate the Euro, which would destroy its purchasing power against the dollar and increase the costs to borrow of other troubled nations, or it leaves the EU and inflates its way out. Either way, the people who were responsible and saved in whatever currency they inflate will be screwed, which isn't all that fair.

Finally, yes "austerity" may be more painful today, like surgery for a broken face, it's a much better prescription than an Advil and a band-aid. For, even if you take another Advil with a broken face, one day you have to look in the mirror and realize you fucked up.


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Posted by Matt (2/22/12):

I actually don't agree with Krugman here on the Greece question. Your last analogy, Stephen, I think sums it up well.

Essentially, Greece and their troubled European counterparts got themselves into trouble by buying a lot of nice things for their people on foreign credit that was completely blown out by the 2008 financial crisis. The problem, of course, was that these countries were spending money that they never really had, so when the bills came due, they had absolutely no way to pay them. To use another analogy: it's kind of like a spoiled child that spent as if she had a trust fund, but was really just running up sky-high bills on her parents credit card. Eventually, the parents lost a lot of money in the stock market and could no longer sustain the child's profligate ways. They cut off the account, leaving the child with a bunch of unpaid obligations.

The child appealed to a wealthy uncle for relief, but in exchange the uncle insisted that the child trim her expenses dramatically and cut back on her luxurious lifestyle. The child, confused at how she could live any other way, reacted angrily. That's basically what's going on right now in the Eurozone with Greece (the child), the money it spent before the financial crisis (parents' credit card) and Germany and its fiscally stable EU counterparts (the wealthy uncle).

So I don't have a problem with forcing Greece to pay. Its economy will not recover quickly, and things will probably get worse before they get better. But as Stephen said, Greece is so upside down right now that this needs to happen for it to make any kind of legitimate turnaround in the long term.

What I do have a problem with, however, is those who would use the tale of Greece to try and make a similar case for immediate austerity here in the United States. Is Greece a cautionary tale about piling up debt with no real way to pay for it? Yes. Does its situation bear any real resemblance to what's currently going on with the US economy? No.

Greece's economy, with a GDP of $3.12 trillion, is the 32nd largest in the world. The American economy, with about $15 trillion in GDP, is five times as large. We have more people, more industries, and much stronger fundamentals. We are running a large budget deficit right now, but unlike Greece, our debt is not the result of foreign sources of credit drying up; it was mostly caused by our massive recession, which blew a gigantic hole in federal, state, and local tax revenue as people lost jobs or saw their incomes decline precipitously. Deficits were further increased by the need for government, as in all economic downturns, to provide more services (such as unemployment and other forms of social insurance) to keep the economy from totally collapsing. Imagine you have a big group project that needs to be done by a certain deadline, but more and more people in your group keep getting sick. Someone still needs to do the work.

The central problem in our budget situation is not that there simply isn't enough money to go around, as is the case with Greece (though I mostly agree with Paul Krugman, he'll have a hard time convincing me that a country with debt at 120% of GDP doesn't need to cut back). It's that there is a lack of middle class demand to fuel economic activity. Businesses are sitting on historically high pools of cash, but are skittish about investing it because there are still no guarantees that the average person out there has enough money (or even a job) to want to buy what they are selling.

This is why austerity in the United States is so dangerous.
Our economic recovery will depend on people going back to work, earning higher incomes, and being able to buy what we know the economy is capable of producing. Cutting spending dramatically right now would harm the nascent recovery because the impacts of such policies would fall dramatically on the poor and middle class, who without good-paying jobs have been forced to turn in increasing numbers to government assistance. Take money out of their pockets and you only deepen the crisis by hurting demand, which makes it harder for businesses to sell things, which forces them to lay more people off.

We do have long-term budget problems in the United States. We need to find a way to reconcile the commitment we have made to Medicare and Social Security with the challenges of a population that is about to use those services in record numbers. And any sensible approach needs to also raise some money from the folks at the top of our economic pyramid whose taxes have been lowered steadily over the last 30 years, at no real benefit to anyone else.

But the first step in getting long-term deficits under control is in getting the economy growing again (more people making more money = higher tax revenue across the board, and fewer government services needing to be provided). That requires us, not for moral reasons but for economic ones, to refrain from taking money out of the hands of the poor and middle class, who are the most likely to spend it.

Greece may need strict austerity right now. Their assets and resources, however, total a fraction of ours, and it is both unnecessary and unwise for the United States to follow austerity policies back into an economic hole we are just beginning to dig out of, for no real reason other than to satisfy the appetites of those who don't want to ever see government do anything, and can't admit that there are some times when it's pretty important.