Krugman and depression economics

Paul Krugman

by Michael Roberts

Paul Krugman’s latest book, End this depression now!, is easy reading (http://www.amazon.com/End-This-Depression-Paul-Krugman/dp/0393088774).  In this well-written piece, the Nobel prize winner and guru of Keynesian economics outlines many of the arguments that he has been making in his much followed New York Times blog (http://krugman.blogs.nytimes.com/).  He says this book is not really about the causes of the Great Recession and ensuing long depression, but what to do about it.  And Krugman reckons there are things that we can do.

But first he reminds us of how damaging this major slump in capitalist production has been for America.  One-third of Americans have either suffered from job loss or had family members who had and another third knew somebody who had been made jobless.  Around 40% of families had suffered reduced working hours, lower wages and benefits.  There are now four job seekers for every job opening.  Six million Americans, almost five times as many as in 2007, have been out of work for more than six months; four million for more than a year.  Many of those still in work have had to accept a drop in wages because they must take lower paying jobs compared to their education or skills.  It’s an even worse story in southern Europe.

Krugman makes an estimate of the likely permanent loss of value in potential GDP from the Great Recession and the subsequent depression of about $5trn.  This is fairly close to my own estimate made on this blog recently (The long depression – the waste of capitalism, 3 May 2012).  That’s an accumulated staggering 40% of current US real GDP.  The recession has not led to a quick recovery as in some previous slumps because businesses are not willing to increase investment.  Krugman’s response is firm.  If the private sector is not willing to invest, the public sector must step up to the plate.  But policy in the US, Europe and elsewhere is the exact opposite: austerity rules along with the savaging of public investment.

For Krugman, this solution is simple and would work if it were not for the pigheaded, ideological insanity on the part of the majority of economists and policy makers who want to see government spending cut, not increased.  You see, for Krugman, the crisis is not caused by any fundamental flaw in the capitalist mode of production,  No, it is as Keynes once put it, like a magneto problem in a car: “the point is that the problem is not with the economic engine, which is as powerful as ever.  Instead, we are talking about what is basically a technical problem, a problem of organisation and coordination – a ‘colossal muddle’ as Keynes described it.  Solve this technical problem and the economy will roar back into life”.

Really?  Does the weak economic growth that the mature capitalist economies have experienced even in the ‘booms’ of the 1990s and 2000s and which came to an end in a humongous slump in 2008, really indicate an economic engine as powerful as ever?  Krugman thinks so: the capitalist mode of production is fine: all it needs is a new electrical part, not a totally new engine.  But the new part is not being supplied because of the ‘colossal muddle’ on policy that economists and politicians have got themselves into.

For Krugman, it is obvious what is wrong:“we are suffering from severe lack of overall demand”.  So it’s obvious – just create some more demand.  I have discussed this Keynesian view of crisis in previous posts (see Effective demand, liquidity traps and debt deflation, 27 April and Paul Krugman, Steve Keen and mysticism of Keynesian economics, 21 April 2012). The Keynesians present a description of a slump as the cause, but they are not the same thing.  To use Krugman’s Keynesian metaphor, the magneto is bust: but why is it bust?

According to Krugman, in his baby coop example, again resurrected in this book, it is due to the hoarding of money.  Instead of people spending their coupons on babysitting services, they start to save them up.  Similarly, instead of businesses investing their money or households spending, they start saving for some unknown subjective, irrational reason, and that is what creates the lack of demand. “Collectively, world residents are trying to buy less stuff than they are capable of producing to spend less than they earn.  That’s possible for an individual but not for the world around us.  And the result is the devastation around us”.  It’s bleeding obvious, isn’t it?  And the solution is also: “big economic problems can sometimes have simple easy solutions.”  We can get out of this mess by increasing the supply of money.   To do that, governments and central banks must act to break the ‘liquidity trap’ (money hoarding).  In his interview in the Financial Times with Britain’s Keynesian journalistic guru, Martin Wolf, Krugman proposes yet more quantitative easing (QE), or more money injected into the US economy to the tune of another $2trn, doubling the ineffective QE already injected by Fed Reserve governor Ben Bernanke.  It may not be working, but keep trying is the message.

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But then it is apparently not as simple as Krugman first tells us in the book.  There is a problem with capitalism beyond simply a sudden lack of demand.  It is the growth of excessive debt in the private sector of the economy “that is arguably at the root of our slump”.  So there is more to this than meets the magneto.  Leaning on the ideas of Hyman Minsky, Krugman brings in the problem of the financial sector: financial agents take more and more risk to make money and they borrow more and more to do it.  This is inherent in an unregulated financial sector, which becomes vulnerable if things go wrong.  So the economy at some point can then have a ‘Minsky moment’, when borrowers can’t pay their bills and lenders stop lending.  Krugman says that “anything can trigger this”.  But once the slump has begun and capitalists and households try to reduce their debts, or deleverage, they drive the economy further down by not spending (baby coop again).  The economy contracts faster than the debt can be reduced and we enter ‘debt deflation’ (as explained by 1930s economist Irving Fisher).  Then debtors can’t spend and creditors won’t spend.

So it was not quite as simple as we first were told.  In fact, it is quite complicated now. The Austerians claim that the depression cannot be overcome by more borrowing, on the contrary, you will only make things worse.  This view now sounds plausible.  But Krugman says it is a paradox (of debt), because, although “the root of the crisis” was excessive debt, now we must borrow even more, not deleverage, otherwise we shall remain in a long depression, as in the 1930s.

You can see that, although Krugman says he wants to discuss what to do now to get out of the depression, he cannot escape talking about how we got there in the first place.  His causal factors can be summed up: the deregulation of the US banking system under successive administrations, which led to excessive risk-taking, speculation and a credit binge.  But interestingly, he rejects the sharply rising inequality of income and wealth over the last 30 years as the cause of the eventual slump, contrary to the current fashion among left economists and some Marxists (see my recent post, Inequality: the cause of crisis and depression?, 21 May 2012).  As Krugman says: “there’s no reason to assume that extreme inequality would necessarily lead to economic disaster.”  Krugman prefers the Minsky cause: financial deregulation and instability, turning the “capital development of a country into a by-product of a casino” (Keynes).

Krugman scathingly exposes the complacent apologetics of the dominant neoclassical economists and the sad failure of the Obama administration to resist their rejection of Keynesian solutions.  For Krugman, the Obama administration has failed to get rid of the depression because it has cut government investment and discretionary government spending and has not stimulated the economy nearly enough.  He points out that the neoclassical warning that inflation will result from too much government spending has turned out to be crying wolf.

So the answer to the current depression is more government spending.  What turned things round in the Great Depression was a massive rise in government arms spending before Pearl Harbour.  As Krugman noted “in the summer of 1940, the US economy went to war.  Long before Pearl Harbour, military spending soared as America rushed to replace ships and armaments… and army camps were quickly built to house the millions of new recruits…military spending created jobs and family incomes rose…as businesses saw their sales growing, they also responded by ramping up spending”.
But can more government spending take the capitalist economies of the US, Europe and Japan out of this long depression?  You see, if we assume that the capitalist mode of production is to remain dominant and state-controlled production will not replace the private sector, then more government spending will only succeed in ending the long depression if it raises the rate of profit in the capitalist sector and thus kick-starts investment.  Even though corporate profits have recovered in the US from their trough in mid-2009, the rate of profit is still below the most recent peak of 2005 and the ‘neoliberal’ peak of 1997.  So corporations continue to hoard their cash and business investment growth is too weak to restore jobs and incomes to pre-crisis levels.

In the years leading up to Pearl Harbour and the subsequent war, government spending not only rose massively, government took over the control of production as civilian goods production was switched to armaments.  Wages did not fall but workers saved (buying war bonds) and consumption was curbed (rationing and lack of credit).  Thus extra government spending went directly into raising the profitability of a war-driven capitalist sector.

In an appendix in his book, Krugman considers the evidence that government spending on armaments is the way out of depression. He notes that World War 2 military spending was actually ‘disappointing’ in boosting growth because of “rationing and restrictions on private construction” while the Korean war was also less than effective because of “sharply raised taxes”.  But are wars the only way to get big government spending implemented? According to Krugman, “the answer, unfortunately, is yes. Big spending programs rarely happen except in response to war or the threat thereof.”   So more government spending does not really seem to be a promising solution to the depression, after all.

Marxist economics can explain why.  Capitalists only invest more if it is profitable to do so, not because it might be in the ‘national interest’.  The role of profitability is totally missing in Krugman’s nicely written book.  For him, profit is irrelevant: what matters is incomes, spending and saving.  And yet Marx’s law of profitability best explains why there will be recurring slumps caused by the tendency for profitability to fall.

The only way to revive that profitability is through slumps that destroy the value of accumulated capital, so that profitability (relative to remaining value) will then rise and allow the process of accumulation to resume.  After a period of a huge buildup of both tangible and fictitious capital over the last 20 years, capitalism went into a Great Recession.  But, as in the Great Depression, it cannot get out of this long slump without a massive destruction of dead capital.  World War 2 eventually managed to do that.  In the 1880s and 1890s, it took a series of major slumps before sustained growth resumed.  That is more similar to now.  Just more government spending designed to ‘stimulate’ the private sector will not do the trick.  Only the replacement of capitalist accumulation with state-planned investment as the dominant mode of production would do so.  Otherwise, we can expect another slump down the road, whether Krugman’s policies or those of the Austerians predominate.