Sunday, November 30, 2008

Depression Economics

A spectre is haunting the world - the spectre of Depression.  With it depression economics is at hand, as economists dust off their textbooks and look for lessons from the Great Depression.  And what is depressing, is how little economics know, and how little economists are willing to admit it.

It would seem that every Anglo-American economist believes that a big stimulus is needed, to get the economy moving.   In America we are to spend upwards of 1 trillion dollars -  a huge sum.

Now when you are about to spend a truly important amount - money which the American nation does not have - it would seem that there should be some evidence that it will do what one wants.  Is there any evidence that stimulus really gets a nation out of depression?  That is, economists have a model which shows that it does.  Is there evidence from the real world that shows this model is valid?

Paul Krugman writes:  
"Some readers may object that providing a fiscal stimulus through public works spending is what Japan did in the 1990s—and it is. Even in Japan, however, public spending probably prevented a weak economy from plunging into an actual depression."
So, apparently the real world did not do what the models said stimulus should have done.  And Krugman's answer is:  but our models show that things would have been even worse.    Of course they would - if your models tell you to do something, and you do it, then no matter what really happens, your models will tell you that things would have been worse had you not done what you did.  That's what models do.  But what is still lacking is confirmation of the model by reality.  

Well, didn't at least the Great Depression prove that Keynesian stimulus worked?   Let's quote Krugman again:

Now, you might say that the incomplete recovery [of the American economy in the late 1930s] shows that “pump-priming”, Keynesian fiscal policy doesn’t work. Except that the New Deal didn’t pursue Keynesian policies. Properly measured, that is, by using the cyclically adjusted deficit, fiscal policy was only modestly expansionary, at least compared with the depth of the slump.

Okay, fair enough, but then why do we know that Keynesian fiscal stimulus works? Again Krugman:

What saved the economy, and the New Deal, was the enormous public works project known as World War II, which finally provided a fiscal stimulus adequate to the economy’s needs.
Now there are many things I would call World War II, but one of them would not be a "public works project".   In World War II, we weren't building bridges; we were building weapons  and bombs to blow up other peoples' bridges.  But with World War II, the U.S. got lucky; it won the war, and ended up with half of the world's productive capacity.  People often say military spending is non-productive.  But World War II was an exception, at least for America.  All that military spending turned out to be productive, indeed exceptionally productive, a truly wonderful investment on the dollar - for America at least -, because it was used to wipe out the competition.  

So, if World War II is the example in the real world that Krugman thinks corroborates the model of Keynesian stimulus, then it would seem that it was a very particular case, and that other, unique factors could have played a role.  England, for instance, had the same war stimulus, but endured rationing until 1954.

But let's quote Krugman a fourth time
We can argue about whether that's always true, but in times like these, it definitely is. The quintessential economic sentence is supposed to be "There is no free lunch"; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work.

Yes, mass unemployment defines a depression, and it would be better for the unemployed to be doing something productive, rather than nothing. But surely the devil is in the details: "if we can only figure out how to get our hands on it." Krugman doesn't explain how we are to get our hands on it. He doesn't even consider the ontological question: can we get our hands on it?  All we get is hope.  Hope that stimulus will work.  But hope is crappy policy.

I'm not opposed to all economic ideas.  Just the dumb ones.

No comments: