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How to (Really) End This Depression: a Response to Paul Krugman

In the May 24 New York Review of Books, Paul Krugman writes, “The truth is that recovery would be almost ridiculously easy to achieve; all we need is to reverse the austerity policies of the past couple of years and temporarily boost spending.” He continues, “… The strong measures that would all go a long way toward lifting us out of this depression should include, among other policies, increased federal aid to state and local governments, which would restore the jobs of many public employees; a more aggressive approach by the Federal Reserve to quantitative easing (that is, purchasing bonds in an attempt to reduce long-term interest rates); and less timid efforts by the Obama administration to reduce homeowner debt.”.

Krugman supports his case for a big increase in spending chiefly by looking at wartime spending. He also cites an estimate, based on comparing military spending across states, that “a dollar of spending actually raises output via around $1.50.”

In short, Krugman makes what he calls the “textbook” Keynesian case for big government spending, no matter on what, financed by borrowing and easy money.

As a liberal economist myself, I favor increased public spending—but only on the right things, and especially not on the military. We should increase spending for public services like health, education, pensions, local infrastructure like water and sewer systems. And we should pay for these programs by high progressive income taxes, loophole-free corporate taxes, and property taxes at the local and state levels. (Property taxes are truly the best tax we have on personal and corporate wealth—see “Restore the Original Wealth Tax.”)

So how does the Krugman/textbook-Keynesian argument go wrong? It goes wrong because it ignores both the distributional and the marginal incentive impacts of public policy.

Start with military spending. Military spending is notoriously intensive in natural resources and capital, which means per dollar spent it creates very little employment—while diverting funds from more productive possibilities. In the May 28 Nation Robert Pollin and Heidi Garrett-Peltier of The Political Economy Research Institute of U Mass Amherst show “How Cutting the Pentagon’s Budget Could Boost the Economy”. Mason Gaffney has been making the same argument for many years.

Krugman rests much of his case for military stimulus on the dramatic recovery before and during World War II. But so much else was going on at the same time: the economy was surely recovering anyway from the Great Depression; there was a tremendous public investment in health, education, and training of millions of young men, and simple patriotism brought out volunteers in droves.

Military spending is just an extreme example of the kind of resource and capital- intensive spending that damages the economy. Other examples include bridges and highways to nowhere, high-speed rail in low-density regions, or the notorious Keystone oil pipeline from Canada’s tar sands to the US Gulf.

Now look at taxes. Something else happened during World War II: a huge increase in progressive income taxes. In the New York Review article, Krugman notes but dismisses as secondary a connection between high taxes and high employment rates. Not so fast! High progressive taxes on personal incomes or corporate profits create what’s called an income effect. By putting the squeeze on those who have previously enjoyed if not a life of ease at least a life of luxury—taxes on high incomes and high profits encourage people and corporations to find more productive uses for their assets. Krugman also calls the current payroll tax credit “not an ideal stimulus”. In my view, the payroll tax is a major discouragement to hiring, especially the hiring of low-wage workers by small business, because it has a powerful marginal effect. That makes the payroll tax credit an excellent stimulus—one which should be increased further.

So how do we pay for the right kind of public spending? Krugman rejects tax increases as part of a solution. Rather, he would rely on borrowing and expansionary monetary policy. What’s the problem? Here, the conservatives are correct, though often for the wrong reasons.

What’s wrong with borrowing? Well, it does raise the annual deficit and national debt. It does “crowd out” private lending, especially to small business. Meanwhile lenders—whether wealthy individuals, corporations or foreign governments like China—get to enjoy nice low-return but super-safe investments that do nothing for the US economy. It is the opposite of the income effect of progressive taxes!

What’s wrong with expansionary monetary policy, as in quantitative easing? Conservatives claim it will cause inflation. I don’t think there’s much inflation risk, so long as the big banks’ vaults remain stuffed with garbage. But precisely for that reason, the big banks won’t lend the money to risky but productive, employment-generating small business. They’ll lend it back to the US government, or worse—like JP Morgan of late—gamble with it in the international financial markets.

No, recovery will not be “ridiculously easy”. Not until Americans rise up to challenge Grover Norquist and his tax cut henchmen. That’s a long, tough, political battle with no easy textbook answers.

10 comments to How to (Really) End This Depression: a Response to Paul Krugman

  • Hi Polly,
    Bice work.

    But I guess I would only add one point: We are already out of recession. This is the richest country in the worl. Corp. Profits have never been higher.

    We have a garrison state policy framewprk to simply protect the pillored gains from other nations AND to politically enfeeble local political attempts at distributing those gains beyond the one tenth of the one percent who are reaping them. I know Krugman has wriyyen about this. Another economist in the nyt Op Ed recently wrote that 88% of the aggregaTed recovery GDP we to 11% of our pop!

    (I think this is old news. Martin L K made the same connection as did Eisenhower and I think Washington may refered to it as well-both in farewell adresses I think)

    This is an inxomes-distributionalissue. Krugman has written about this as well.

    I also thought I read an article of his on paying down consumer debt and or mortgages. I Think you both agree on that

    I think you and he lso agree on this point of income redistribution, i.e., higher taxes on rich and redistributional incomes policies.

    Tax the rich. “Nation Building” is long overdue here. I did not read his book review article, and must say I find it out of my understanding of his political-economic thought-as I have come to understand it.

    He actually endorses building a war machine over building hospitals and schools???????

    I think it is an easy financial solution. It is an (possibly) impossible political one.

    Be well
    Paolo

  • Unfortunately, it doesn’t matter, because the USA does not formulate economic policy, it scores political points. Other countries see the economic value in incentives, unemployment insurance, healthcare, infrastructure and the like. But look at this week’s headlines: Boehner already planning to block debt ceiling increases next Xmas, Republicans champing at the bit to renew Bush tax breaks for millionaires seven months early (ie in time for the elections)…..
    In China, support for the Party comes before the law. In the USA, politics comes before economics. It’s not all that different. The result is pure folly.

  • One effect of a high income tax is to divert labor from productive activity to finding loopholes. Another is to raise labor costs for highly-skilled in-demand workers far above their effective wages.
    Why do you think that a tax solely on the economic rent of land and other privileges would be insufficient to fund needed public services and infrastructure?

    • I do think a tax on economic rent of land would be quite sufficient. But if we must start from where we are, we can collect more rent by heavier taxes on high incomes.

  • Ben Howells

    And here I thought you were a Norquist disciple!——

  • Adele Wick

    WELL Done, Polly. Once again, concise and precise. Thank you.

  • ezra abrams

    thanks
    If I may, as a non economist, two points
    “ignors the distributions and margianal…”
    econ gibberish – the rest of your article is so nice, wonderful plain old sturdy anglo saxon prose, why do you ruin it with this econ gibberish ?

    this (below)seems kinda contradictory, and esp the crowding out phrase seems contrary to fact: if money is available to the US gov’t at 1-2% (i think the current 10year tnote is 1.5); the problem is not lack of money, it is lack of..I dunno. But how on earth can you hve crowding out when people are giving hte US money at neg real (inflation adjusted rates ???)
    quote”Well, it does raise the annual deficit and national debt. It does “crowd out” private lending, especially to small business. Meanwhile lenders—whether wealthy individuals, corporations or foreign governments like China—get to enjoy nice low-return but super-safe investments that do nothing for the US economy. It is the opposite of the income effect of progressive taxes!

    What’s wrong with expansionary monetary policy, as in quantitative easing? Conservatives claim it will cause inflation. I don’t think there’s much inflation risk, so long as the big banks’ vaults remain stuffed with garbage. But precisely for that reason, the big banks won’t lend the money to risky but productive, employment-generating small business. They’ll lend it back to the US government, or worse—like JP Morgan of late—gamble with it in the international financial markets.”

  • Thanks for the inspiring post as usual, I’ve been reading up on this subject for a few months now so this is a relief.

  • I’m amazed, I must say. Seldom do I come across a blog that’s equally educative and amusing, and let me tell you, you have hit the nail on the head. The problem is something that too few people are speaking intelligently about. Now i’m very happy I came across this during my hunt for something concerning this.