07 Apr 2010

Krugman vs. Austrians

Economics 11 Comments

Paul Krugman is a clever fellow. Sensing that I am swamped with other work commitments, he launches an attack on Austrian business cycle theory today on his blog:

My view is that the fatal flaw in Austrian economics is that it can’t explain unemployment — or, worse, that it thinks that it can explain unemployment, but is deluding itself. The Austrian view is that unemployment in a slump results from the difficulty of “adaptation of the structure of production” — workers are unemployed as resources are painfully transferred out of an overblown investment-goods sector back into production of consumption goods.

But this immediately raises the question, why isn’t there similar unemployment during the boom, as workers are transferred into investment goods production?

I’ve asked this question repeatedly over the years, and all I get is one of two things: gobbledygook, or “but during the phase of rising investment, the economy is booming!”, which is of course circular. In practice, Austrians seem to be Keynesians during booms without knowing it; they realize that high demand produces a boom, but don’t realize that this contradicts their own theory of slumps.

And the key to all this, I believe, is that the Austrian abhorrence of explicit models, even for the purposes of clarifying thought, leaves them unaware of the holes in their account.

Fortunately, I have already answered this in depth. Since I didn’t just say, “But the economy is booming during the investment phase!” I deduce that my earlier article was “gobbledygook.”

11 Responses to “Krugman vs. Austrians”

  1. Daniel Hewitt says:

    Here is the comment I left on his blog, which is awaiting moderation.

    Both consumption and investment are (artificially and unsustainably) increasing during the boom; this is the crux of the Austrian Business Cycle Theory. Both investment goods and consumption goods are competing for finite resources, including labor, during the boom. The logical result is a low rate of unemployment.

  2. Allen says:

    Daniel, this was also my thought as I read the post.

    I am far from an expert in ABCT–my limited knowledge comes almost exclusively from the youtube video of Garrison’s lecture–but my immediate reaction to Krugman’s comment is that the thrust of the ABCT is that artificially low interest rates lead to increased production in both investment goods and consumer goods simultaneously, which is entirely consistent with a result of no unemployment during a boom. So to answer Krugman’s question, there is no unemployment during the boom because at that time there is (artificially) high demand for workers in all phases.

    It seems impossible that someone could spend any amount of time learning about ABCT and not grasp this central point–Krugman’s intellectual dishonesty is infuriating (though not surprising). And it’s ironic that Krugman dismisses Austrians as model-haters while discussing a theory that Austrians have actually developed a well-conceived model to explain.

  3. Sean A says:

    I have an uncle in Tuscon that left his job at a large firm to start a business drafting the plans of various new construction projects. He was baited to do so because he saw immediate opportunities to gain business as he had gained somewhat of a reputations for doing quality work. Their was no time of unemployment since he had already established a line of prospects with the abundance of new construction projects going up–in fact, if had not been promised business by clients, its doubtful he would have left his job since at the time his son was about 1 year old. He profited with the boom, but now can find virtually no work. A similar thing happened to my uncle whose in construction in Vegas. There will always be entrepreneurs to follow the profits. The problem was, they weren’t real. When I visited my uncle in Tuscon in January, he explained to me his dilemma and I told him a brief version of ABCT; his response was, “that’s exactly what happened.” Many of the construction projects he designed the layout for (and luckily had been paid for), purchased and cleared land, and some had been constructed, but most were forced to stop in their tracks. Those that had been constructed were doing poorly. Drive down a main street in Phx or Tuscon (or anywhere in AZ) and you’ll see an abundance cleared plots of land and even building foundations with no workers or equipment around them. It was all artificial.

  4. LWH says:

    Let’s take up a collection for Paul Krugman to attend Dr. Murphy’s upcoming Mises Academy class. I’m in for $10.

  5. Richard says:

    I left this comment on PK’s blog, not nearly as technical in nature as your response, but this seems like such a silly objection to ABCT, only an academic with no common sense could make it:

    This is really simple Paul, when things are booming, people voluntarily leave their jobs for higher paying jobs.

    Anyone familiar with the Internet boom in the late 1990’s saw this first hand. There was so much investment money flowing into the tech sector that many thousands of people who had minimal or no skills in that industry were hired into companies and given on the job training. Why would there need to be unemployment during growth?

    Malinvestments in the tech sector were not identified as such until later. Once they were, many of the people who were marginally qualified were the first to be laid-off, and unable or unwilling to go back to their previous work ended up unemployed.

    I saw this first hand, Deputy Sheriffs, Navy Weapons Specialists, History Majors, and economists with no real marketable skills outside their narrow professions became Network Consultants, System Administrators, etc…

    It was so much easier for people to swing a hammer or pour concrete during the housing boom than manage IT systems. Is this really that hard to see?

  6. Teqzilla says:

    It is almost impressive how Krugman has compressed so many weird arguments into such a small space. His whole claim that Austrians are closet Keynesians is especially bizarre. As far as I can see it is based on nothing more than his inexplicable belief that talking about how changes in the structure of production result in changes to the aggregate demand for labor somehow demonstrates a need for, or secret belief in, the particular Keynesian conception of ‘Aggregate demand’ and its implications.

    It is the non-logic of the dogmatist and I think it is a kind of dogma which arises not so much from Krugman’s inability to question Keynesian theory but his inability to relinquish Keynesian definitions. His spat with Amity Shales was a good example of this. He ‘answered’ her claim that the large scale and persistent unemployment in the great depression was a result of high relative wages by doing post after post on what would occur if there were a general cut in wages. He didn’t even seem to realize that they were talking about different things.

  7. Teqzilla says:

    Came back because I remembered a point of history that is quite relevant here.

    In January 1937 writing for The Times Keynes held that “We are in more need today of a rightly distributed demand than of a greater aggregated demand”. He explained why earlier in his article ‘How to avoid a slump’ by noting that “I believe we are approaching, or have reached, the point where there is not much advantage in applying a general stimulus at the centre. So long as surplus resources were widely diffused between industries and localities it was no great matter at what point in the economic structure the impulse of an increased demand was applied. But the evidence grows that – for several reasons which there is no space to enter here – the economic structure is unfortunately rigid…”

    It is interesting that in less than year after the publication of the general theory the evidence had grown enough for its author to conclude that the ‘right distribution’ of demand was of significant importance. Sadly, many decades after the publication of the General Theory has not been enough time for Keynes’ disciples to catch up to even their dear leaders foggy understanding of what is wrong with the ‘Keynesian’ approach. Far from Austrians being self loathing Keynesians it appears Keynes was a self loathing Austrian.

  8. Bob Roddis says:

    Prof. Murphy said it all in his “Austrians Can Explain the Boom and the Bust” article:

    It is much harder for workers to switch jobs and take a pay cut versus quitting a job in order to take a better one that pays more.

    How hard is it to get a good job in booming industries in booming towns?

    As opposed to taking a massive pay cut to work in a dying town?

    Well, duh!

    • Sean A says:

      Thinking about it, I’m not so sure Keynesians can think in non-aggregated terms; thus, it is difficult to deduce the situation down to logical human action. He’s set on explaining the Boom in holistic terms, and applying a universal standard of frictional unemployment. The problem is this isn’t frictional unemployment of displaced workers, it is the movement from later to earlier stages of production. People are not leaving their jobs for temporary unemployment; they are leaving them for the more propitious opportunities in the intermediate goods where the new credit has entered. I can’t explain Krugeman’s argument in any other terms other than he just doesn’t get Austrian capital theory and the structure of production as affected by either savings/investment (voluntary divergence from consumption) versus increased credit entering through the loan market (artificial). Thus, he simplifies the seemingly obvious claim that people will act on the more propitious opportunities to “well the economy is booming during the investment phase.”

  9. Mike says:

    I think a key point is capital consumption is what is going on during the so-called boom. Phrased more generally Krugman’s point kind of makes sense: “Why aren’t things also bad during the boom if they are so bad during the bust?” The answer is they are – as soon as the artificial boom begins more people may be employed but they are getting poorer because the boom isn’t fueled by increased production, it occurs because people are suddenly, and unknowingly, consuming capital.

    When Robinson Crusoe becomes deluded into believing he’s entered a land-o-plenty he throws all of his food rations into a stew pot, builds a wonderful bon-fire with the boards of his shelter, and sits back in awe of how wonderful life is going to be from here on out. Unfortunately, when the fire burns out and all the victuals are eaten, reality sets in and things can’t just go back to the way they were. He has mistakenly consumed capital and the only way to get back to normal is through hard times and saving. I think I heard Sean Corrigan use a similar explanation once.

  10. Jeremy says:

    Odd. They posted my comment on Keynesian ignorance of capital theory but they didn’t post my comment asking why he refuses to debate an Austrian rather than firing shots from his blog…………….