11 Dec 2008

"Paul Krugman Is Not an Economist"

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So says Bill Anderson. I used to think that was an over-the-top cheap shot, but the more I read Krugman, the more I think Bill is right. In a recent article on deficits, Krugman gives us this gem (amidst all kinds of other basic mistakes):

Should the government have a permanent policy of running large budget deficits? Of course not. Although public debt isn’t as bad a thing as many people believe — it’s basically money we owe to ourselves — in the long run the government, like private individuals, has to match its spending to its income.

It is just stunning to me–though I should stop being continually surprised; my expectations are clearly not rational in the mainstream sense–how casually Krugman repeats throw-off remarks that I used to critique as a fun little exercise when teaching undergrads.

I was going to refute this notion from scratch, but in reviewing the proofs of my Study Guide [pdf] to Human Action, I realized that Mises blew it up 60 years ago. Here he is:

The trumpery argument that the public debt is no burden because “we owe it to ourselves” is delusive. The Pauls of 1940 do not owe it to themselves. It is the Peters of 1970 who owe it to the Pauls of 1940. The whole system is the acme of the short-run principle. The statesmen of 1940 solve their problems by shifting them to the statesmen of 1970. On that date the statesmen of 1940 will be either dead or elder statesmen glorying in their wonderful achievement, social security.

When the government runs a deficit today, it takes real resources from the private sector, in exchange for IOUs. So the total damage is done today; e.g. if the government pays for a bunch of chicken dinners, then that food is gone. The politicians don’t have a time machine to literally steal from our grandchildren.

But what happens is that the people who relinquished their purchasing power to the government today expect to be compensated down the road, when the Treasury debt is paid off. So the taxpayers at that time are forced to bear the brunt of the fact that the economy has fewer resources (because government deficits today lead to less capital accumulation).

So there are two separate things going on. On the one hand, there is the simple transfer. Some people get government handouts today, and those lending to the government to finance it have to reduce their consumption. (I.e. these people have less money to spend, because they bought government IOUs.) Then later on, the taxpayers make a net transfer to the holders of government debt.

So yes, “we owe it to ourselves,” but it’s not much consolation for the average taxpayer to know that at least he is getting ripped off so that another American can live on the government teat. But even on its own terms, Krugman’s analysis is wrong because government deficits tend to crowd out private investment. Thus, the overall pie in 30 years is smaller, and then the transfer occurs on top of it.

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