He’s doing a victory lap, but shouldn’t be.
By Michael Tanner
Paul Krugman has never been shy about
proclaiming that he is right and everyone else is wrong — and not just
wrong, but “knaves and fools.” Lately, however, one begins to worry that
he might actually hurt himself, so vigorously has he been patting
himself on the back for his opposition to “austerity” (defined as any
cut in government spending, anytime, anywhere).
On his latest
victory lap, Krugman is celebrating two things. First, a group of
researchers from the University of Massachusetts Amherst discovered a
small error in a widely cited paper by Carmen Reinhart and Ken Rogoff
that showed economic growth was lower in countries with higher debt
loads. Many of those who favor reduced government spending (including
me) have cited Reinhart and Rogoff positively. Therefore, Krugman
declares, the entire idea of austerity has been “sold on false
pretenses.”
Second, European economies have sputtered. Krugman
blames this on sharp spending cuts, which would be the opposite of the
Keynesian stimulus spending that he favors. If only European governments
had listened to him, Krugman suggests, instead of to all those knaves
and fools, and spent more, their economies would be humming along by
now.
Professor Krugman should pause briefly from congratulating himself to take a look at a few unfortunate facts.
Let’s deal with the Reinhart and Rogoff kerfuffle first.
For
all the attention it has received, the Amherst researchers did not
actually disprove Reinhart and Rogoff’s conclusion. Reinhart and Rogoff
found that economies grew slower during periods of high debt (defined as
government debt greater than 90 percent of GDP) than they did during
times of lower debt.
The researchers from UMass, on the other
hand, found that — wait for this — economies grew slower during periods
of higher debt than they do during times of lower debt.
The UMass
researchers did find a smaller difference in growth rates (one
percentage point versus 1.3 points for the preferred median rates in
Reinhart and Rogoff), but that hardly suggests that we are in dire need
of more debt.
Besides, Reinhart and Rogoff’s model always provided
a sort of faux precision to the debt argument. While the UMass
researchers agreed that higher debt is correlated with lower growth,
they found no evidence of Reinhart and Rogoff’s assertion that growth
drops off dramatically above 90 percent of GDP. Did anyone really
believe that debt equal to 89 percent of GDP was fine, while 91 percent
of GDP sent the economy into a free fall? The point is that governments
cannot amass an unlimited amount of liabilities without economic
consequences.
Numerous studies besides Reinhart and Rogoff’s have
shown this, including ones by the European Central Bank, the IMF, and
the Bank for International Settlements. No doubt knaves and fools all.
More
important, however, debt has never been the most important measure of
government’s burden on the economy. As Milton Friedman pointed out, the
real burden of government is spending, regardless of whether that
spending is financed through debt or taxes. Too much debt is clearly
bad, but substituting taxes for the debt does not make the problem
substantially better.
Which brings us to the question of European
“austerity.” Krugman continues to insist that European countries’
austerity has been devastating, and that spending cuts must therefore be
resisted. The “case for keeping [the U.K] on the path of harsh
austerity isn’t just empirically implausible, it appears to be a
complete conceptual muddle,” he wrote this week, and “austerity policies
have greatly deepened economic slumps almost everywhere they have been
tried.”
But there have actually been few spending cuts in Europe,
so it makes little sense to blame them for poor performance. A new study
by Constantin Gurdgiev of Trinity College in Dublin compared government
spending as a percentage of GDP in 2012 with the average level of
pre-recession spending (2003–2007). Only three EU countries had actually
seen a reduction: Germany, Malta, and Sweden. Not surprisingly, two of
those three, Germany and Sweden, are among those countries that have
best weathered the economic crisis. Those countries that have suffered
most, Greece, Italy, Spain, and Portugal, have all seen spending
increases.
And what about Great Britain, which has been Krugman’s
No. 1 exhibit for the dangers of austerity? Compared with pre-recession
levels, British government spending is up by 2.5 percent of GDP, a 29
percent increase in nominal spending.
Krugman belittles those who
cite countries such as the Baltic nations or Switzerland, whose
governments really have cut spending and seen robust economic
recoveries. But how does he account for Iceland, considering he himself
once called it “a post-crisis miracle?”
Iceland actually slashed
spending from 57.6 percent of GDP in 2008 to 46.5 percent in 2012, a
nearly 20 percent reduction. Yet, while Iceland was one of the countries
hardest hit by the international banking crisis of 2008 and the
recession that followed, the economy started growing rapidly again in
2010.
What most of Europe has seen in abundance is tax increases —
exactly the sort of thing Krugman has advocated in the United States.
In fact, overall, European countries have raised taxes by $9 for every
$1 in spending cuts.
One might conclude that it was these tax
hikes, rather than nonexistent spending cuts, that are responsible for
Europe’s economic slowdown. Something to keep in mind the next time Paul
Krugman — or President Obama, for that matter — calls for yet another
tax hike on the rich.
None of this makes Krugman either a knave or a fool. But it does make him wrong.
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