How’s that for an obscure post title? I’m referring to Krugman’s accusation that right-wingers are hypocrites. (I hope you were sitting down for that one.) Their latest abomination refers to their claim that people with high incomes are engines of job creation and therefore we don’t want the government to drop the hammer on them. What’s the problem? Krugman argues that this standard right-wing line contradicts basic micro, if you think markets work:
The Romney fundraiser in the Hamptons continues to inspire much justified hilarity. Matt Yglesias has fun with whining rich people complaining that they are the engine of the economy, pointing out that quite a few of the whiners make their money in ways that arguably does very little for growth…
There is, however, an even broader critique of the whole keep taxes low on jobcreatorsenginesoftheeconomy [sic–RPM] thing — it doesn’t make sense even when the rich really earn their money….
So, imagine a Romney supporter named John Q. Wheelerdealer, who works 3000 hours a year and makes $30 million. And let’s suppose that he really does contribute that much to the economy, that his marginal product per hour — the amount he adds to national income by working an extra hour — really is $10,000. This is, by the way, standard textbook microeconomics: in a perfectly competitive economy, factors of production are supposedly paid precisely their marginal product.
Now suppose that President Obama has reduced Mr. Wheelerdealer to despair…So Wheelerdealer decides to go Galt. Well, actually just one-third Galt, reducing his working time to just 2000 hours a year so he can spend more time with his wife and mistress.
According to marginal productivity theory, this does in fact shrink the economy: Wheelerdealer adds $10,000 worth of production for every hour he works, so his semi-withdrawal reduces GDP by $10 million. Bad!
But what is the impact on the incomes of Americans other than Wheelerdealer? GDP is down by $10 million — but payments to Wheelerdealer are also down by $10 million. So the impact on the incomes of non-Wheelerdealer America is … zero. Enjoy your leisure, John!
OK, there’s a catch: Wheelerdealer pays taxes, and when he chooses to work less, he pays less taxes. So there is in fact a welfare loss to the rest of America, but it comes only through the fact that revenue falls.
So there’s a huge contradiction in the whole position of the self-regarding rich — a contradiction that I’m quite sure bothers them not at all. More champagne?
I get where Krugman is coming from here, but is this right? Is it really the case that standard micro suggests–in the absence of externalities and other frictions–that whether you live in a society of Thomas Edisons and the Beatles, or in a society of Billy Madisons and Herman’s Hermits, the only change you’d notice is in the amount of services the government could afford to provide you?
It seems to me this can’t be right, but I don’t know if Krugman is making a basic mistake, or whether there actually is a contradiction in standard micro (or at least the way we think about it). Three things come to mind:
(1) Even in the standard framework, if every factor gets paid its marginal product, it’s still the case that adding one more unit of factor X can raise the marginal productivity and hence the return to factor Y. E.g. it would be wrong to say, “Lots of people think workers are richer because of the introduction of more tools and equipment, but this is silly. The producers of hammers and forklifts get paid their marginal product, so obviously workers don’t see higher wages because of their existence.”
Now I remember vaguely from Kirzner’s history of economic thought class that this was a big deal back in the day, because you had to worry about whether the total incomes to factor owners in this approach would exhaust / exceed total output. But for sure, I think Krugman is glossing over this crucial part of the argument.
(2) What about consumer surplus? That doesn’t seem to be getting its due regard here. If Bill Gates had never existed, Krugman is arguing that the rest of us would have the same real income (except for lower government services). Even if that were true (which I’m not sure it is), we wouldn’t have the same utility right?
(3) Moving away from standard neoclassical models and into Austrian territory, one way of thinking about what entrepreneurs do is that they create new production functions. I.e. they use their brilliant minds to discover/create opportunities that previously didn’t exist. How in the world can we say that this insight forces us to say that either (a) the market fails or (b) entrepreneurs don’t shower benefits on others?
In any event, it is standard in Human Action for Mises to say that the capitalists/entrepreneurs reap the initial gains of their actions, but that eventually competition showers those blessings on the rest of humanity. I sort of understand the way in which Krugman could argue, “Ah, so you guys believe in market failure,” but that seems like a really odd way of putting things from an Austrian perspective.