Krugman’s Still Wrong

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.