Tag: Paul Krugman

Estonia and Austerity: Another Exploding Cigar for Paul Krugman

I have great fondness for Estonia, in part because it was the first post-communist nation to adopt the flat tax, but also because of the country’s remarkable scenery.

Most recently, though, I’ve been bragging about Estonia (along with Latvia and Lithuania, the other two Baltic nations) for implementing genuine spending cuts. I’ve argued that Estonia is showing how a government can reignite growth by reducing the burden of government.

Not surprisingly, some people disagree with my analysis. Paul Krugman of the New York Times criticized Estonia yesterday, writing that the Baltic nation suffered a “Depression-level slump” in 2008 and has only managed an “incomplete recovery” over the past few years.

He blames this supposedly weak performance on “austerity.”

I have a positive and negative reaction to Krugman’s post. My positive reaction is that he’s talking about a nation that actually has cut spending, so there’s real public-sector austerity (see Veronique de Rugy’s L.A. Times column to understand the critical difference between public-sector and private-sector austerity).

This is a sign of progress. In the past, he launched a silly attack on the U.K. for a “government pullback” that never happened, so what he wrote about Estonia at least is based on real events.

My negative reaction is that Krugman is very guilty of cherry-picking data. If you look at the chart that accompanies his post, Estonia’s economic performance isn’t very impressive, but that’s because he’s only showing us the data from 2007-present.

The numbers are accurate, but they’re designed to mislead rather than inform (sort of as if I did a chart showing 2009-present).

But before exposing that bit of trickery, there’s another mistake worth noting. Krugman presumably wants us to think that the downturn coincided with spending cuts. But his own chart shows that the economy hit the skids in 2008 - a year in which  government spending in Estonia soared by nearly 18 percent according to EU fiscal data!

It wasn’t until 2009 that Estonian lawmakers began to reduce the burden of spending. So I guess Professor Krugman wants us to believe that the economy tanked in 2008 because of expectations of 2009 austerity. Or something like that.

Returning now to my complaint about cherry picking data, Krugman makes Estonia seem stagnant by looking only at data starting in 2007. But as you can see from this second chart, Estonia’s long-run economic performance is quite exemplary. It has doubled its economic output in just 15 years according to the International Monetary Fund. Over that entire period - including the recent downturn, it has enjoyed one of the fastest growth rates in Europe.

This doesn’t mean Estonia is perfect. It did experience a credit/real estate bubble, and there was a deep recession when the bubble burst. And the politicians let government spending explode during the bubble years, almost doubling the budget between 2004 and 2008.

But Estonia reacted to the overspending and the downturn in a very responsible fashion. Instead of using the weak economy as an excuse to further expand the burden of government spending in hopes that Keynesian economics would magically work (after failing for Hoover and Roosevelt in the 1930s, Japan in the 1990s, Bush in 2008, and Obama in 2009), the Estonians realized that they needed to cut spending.

And now that spending has been curtailed, it’s worth noting that growth has resumed.

What makes Krugman’s rant especially amusing is that he wrote it just as the rest of the world is beginning to notice that Estonia is a role model. Here’s some of what CNBC just posted.

Sixteen months after it joined the struggling currency bloc, Estonia is booming. The economy grew 7.6 percent last year, five times the euro-zone average. Estonia is the only euro-zone country with a budget surplus. National debt is just 6 percent of GDP, compared to 81 percent in virtuous Germany, or 165 percent in Greece. Shoppers throng Nordic design shops and cool new restaurants in Tallinn, the medieval capital, and cutting-edge tech firms complain they can’t find people to fill their job vacancies. It all seems a long way from the gloom elsewhere in Europe. Estonia’s achievement is all the more remarkable when you consider that it was one of the countries hardest hit by the global financial crisis. …How did they bounce back? “I can answer in one word: austerity. Austerity, austerity, austerity,” says Peeter Koppel, investment strategist at the SEB Bank. …that’s not exactly the message that Europeans further south want to hear. …Estonia has also paid close attention to the fundamentals of establishing a favorable business environment: reducing and simplifying taxes, and making it easy and cheap to build companies.

Good policy makes a difference. But it also helps to have rational citizens (unlike France, where people vote for economic illiterates and protest against reality).

While spending cuts have triggered strikes, social unrest and the toppling of governments in countries from Ireland to Greece, Estonians have endured some of the harshest austerity measures with barely a murmur. They even re-elected the politicians that imposed them. “It was very difficult, but we managed it,” explains Economy Minister Juhan Parts. “Everybody had to give a little bit. Salaries paid out of the budget were all cut, but we cut ministers’ salaries by 20 percent and the average civil servants’ by 10 percent,” Parts told GlobalPost. …As well as slashing public sector wages, the government responded to the 2008 crisis by raising the pension age, making it harder to claim health benefits and reducing job protection — all measures that have been met with anger when proposed in Western Europe.

It’s worth noting, by the way, that government is still far too big in Estonia. The public sector consumes about 39 percent of economic output, almost double the burden of government spending in Hong Kong and Singapore.

But, unlike certain American politicians, at least the Estonians understand the problem and are taking steps to move in the right direction. I hope they continue.

P.S. The President of Estonia, a Social Democrat named Toomas Hendrik Ilves, used his twitter account to kick the you-know-what out of Krugman yesterday. For amusement value, check out this HuffingtonPost article.

P.P.S. A few other nations, such as Canada and New Zealand, also imposed genuine spending restraint in recent decades and they also got good results.

Note to Larry Summers: The Government Borrows for Transfer Payments, Not Investment

“It is time for governments to borrow more money,” according to former treasury secretary Larry Summers.  He is not peddling this advice to Greece and Spain, but to countries like the United States and Japan that can still sell long-term bonds at very low interest rates. Summers urges the United States, in particular, to borrow more for “public investment projects” that are presumed to raise the economy’s future output. He offers the hypothetical example of “a $1 project that yielded even a permanent 4 cents a year in real terms increment to GDP by expanding the economy’s capacity or its ability to innovate.”

Even if such promising projects were easy to find, however, that is not the way the current government has been inclined to spend borrowed money. Despite all the rhetoric about “shovel-ready projects,” about 95 percent of the 2009 stimulus bill consisted of government consumption (salaries), refundable tax credits, and transfer payments which, as Robert Barro notes, “dilute incentives to work.”

Summers says, “Any rational chief financial officer in the private sector would see this as a moment to extend debt maturities and lock in low rates — the opposite of what central banks are doing.” Locking-in low borrowing costs would indeed make sense if the money from selling long bonds were used to retire short-term Treasury bills, but that would not involve borrowing more as Summers proposes.

For both government and households, it is certainly more prudent to use borrowed money to finance investments that will yield a stream of income in the future—either actual income (such as toll roads) or implicit income (the benefits from living in a mortgaged home).

Apostles of the Keynesian doctrine, such as Larry Summers, Paul Krugman, and Alan Blinder, invariably use hypothetical public works examples to make the case for more and more national (taxpayer) debt. Keynesian forecasting models, used by the Congressional Budget Office (CBO) to warn of the looming fiscal cliff and defend the fiscal stimulus of 2009, likewise assume the highest “multiplier” effect from tangible government investments.

In the real world of politics, however, Congress and the White House use borrowed money to placate constituencies with the most political clout. Federal spending on investment projects has essentially nothing to do with the huge 2009-2012 budget deficits (only 29 percent of which can be blamed on the legacy of recession, according to the CBO).

The Table shows that transfer payments and subsidies account for 63.8 percent of estimated spending in 2012, while federal purchases account for 28.4 percent. Also, most federal aid to states is for transfer payments like Medicaid.  Within federal purchases, only 7.6 percent of the spending ($152.5 billion) was counted as gross investment in the first quarter GDP report, and two thirds of that was military equipment and buildings. Net investment, minus depreciation, is smaller still.

If borrowing more for investment was a genuine political priority, rather than an academic conjecture, the government could do that by borrowing less for government payrolls, transfer payments, and subsidies.  At best, Larry Summers has made an argument for spending borrowed money much differently, not for borrowing more.

Paul Krugman and the European Austerity Myth

With both France and Greece deciding to jump out of the left-wing frying pan into the even-more-left-wing fire, European fiscal policy has become quite a controversial topic.

But I find this debate and discussion rather tedious and unrewarding, largely because it pits advocates of Keynesian spending (the so-called “growth” camp) against supporters of higher taxes (the “austerity” camp).

Since I’m a big fan of nations lowering taxes and reducing the burden of government spending, I would like to see the pro-tax hike and the pro-spending sides both lose (wasn’t that Kissinger’s attitude about the Iran-Iraq war?). Indeed, this is why I put together this matrix, to show that there is an alternative approach.

One of my many frustrations with this debate (Veronique de Rugy is similarly irritated) is that many observers make the absurd claim that Europe has implemented “spending cuts” and that this approach hasn’t worked.

Here is what Prof. Krugman just wrote about France.

The French are revolting. …Mr. Hollande’s victory means the end of “Merkozy,” the Franco-German axis that has enforced the austerity regime of the past two years. This would be a “dangerous” development if that strategy were working, or even had a reasonable chance of working. But it isn’t and doesn’t; it’s time to move on. …What’s wrong with the prescription of spending cuts as the remedy for Europe’s ills? One answer is that the confidence fairy doesn’t exist — that is, claims that slashing government spending would somehow encourage consumers and businesses to spend more have been overwhelmingly refuted by the experience of the past two years. So spending cuts in a depressed economy just make the depression deeper.

And he’s made similar assertions about the United Kingdom, complaining that, “the government of Prime Minister David Cameron chose instead to move to immediate, unforced austerity, in the belief that private spending would more than make up for the government’s pullback.”

So let’s take a look at the actual data and see how much “slashing” has been implemented in France and the United Kingdom. Here’s a chart with the latest data from the European Union.

I’m not sure how Krugman defines austerity, but it certainly doesn’t look like there’s been a lot of “slashing” in these two nations.

To be fair, government spending in the United Kingdom has grown a bit slower than inflation in the past couple of years, so one could say that there’s been a very modest bit of trimming.

There’s been no fiscal restraint in France, however, even if one uses that more relaxed definition of a cut. The only accurate claim that can be made about France is that the burden of government spending hasn’t been growing quite as fast since the crisis began as it was growing in the preceding years.

This doesn’t mean there haven’t been any spending cuts in Europe. The Greek and Spanish governments actually cut spending in 2010 and 2011, and Portugal reduced outlays in 2011.

But you can see from this chart, which looks at all the PIIGS (Portugal, Italy, Ireland, Greece, and Spain), that the spending cuts have been very modest, and only came after years of profligacy. Indeed, Greece is the only nation to actually cut spending over the 3-year period since the crisis began.

Krugman would argue, of course, that the PIIGS are suffering because of the spending cuts. And since there actually have been spending cuts in the last year or two in these nations, does that justify his claims?

Yes and no. I don’t agree with the Keynesian theory, but that doesn’t mean it is easy or painless to shrink the burden of government. As I wrote earlier this year, “…the economy does hit a short-run speed bump when the public sector is pruned. Simply stated, there will be transitional costs when the burden of public spending is reduced. Only in economics textbooks is it possible to seamlessly and immediately reallocate resources.”

What I would argue, though, is that these nations have no choice but to bite the bullet and reduce the burden of government. The only other alternative is to somehow convince taxpayers in other nations to make the debt bubble even bigger with more bailouts and transfers. But that just makes the eventual day of reckoning that much more painful.

Additionally, I think much of the economic pain in these nations is the result of the large tax increases that have been imposed, including higher income tax rates, higher value-added taxes, and various other levies that reduce the incentive to engage in productive behavior.

So what’s the best path going forward? The best approach is to implement deep and meaningful spending cuts, and I think the Baltic nations of Estonia, Lithuania, and Latvia are positive role models in this regard. Let’s look at what they’ve done in recent years.

As you can see from the chart, the burden of government spending was rising at a reckless rate before the crisis. But once the crisis hit, the Baltic nations hit the brakes and imposed genuine spending cuts.

The Baltic nations went through a rough patch when this happened, particularly since they also had their versions of a real estate bubble. But, as I’ve already argued, I think the “cold turkey” or “take the band-aid off quickly” approach has paid dividends.

The key question is whether nations can maintain spending restraint, particularly when (if?) the economy begins to grow again.

Even a basket case like Greece can put itself on a good path if it follows Mitchell’s Golden Rule and simply makes sure that government spending, in the long run, grows slower than the private economy.

The way to make that happen is to implement something similar to the Swiss Debt Brake, which effectively acts as an annual cap on the growth of government.

In the long run, of course, the goal should be to shrink the overall burden of government to its growth-maximizing level.

Paul Krugman’s Distorted Views on Inequality in Latin America

When it comes to discussing Latin America, Paul Krugman has a tortuous relationship with facts. Let’s take a look at a post he wrote last week on inequality in the region. Krugman claims that Latin America’s decline in inequality in the last decade is due to the region “partially turning its back on the Washington Consensus” (a term that has misleadingly become short hand for free market policies). Is that the case?

First, note how the graph in Krugman’s post actually shows inequality going up in Latin America during the 1980s, before the implementation of policies related to the Washington Consensus (which for most countries begins in the early 1990s), and then sharply declining before the arrival of what he calls the “new policy approach” of left-of-center governments. The rise of inequality in Latin America in the 1980s coincides with the periods of hyperinflation that crippled the economies of Argentina, Brazil, Nicaragua, Peru, and Bolivia. Central banks in Latin America were all too busy in those years financing the acute fiscal imbalances of their central governments through the emission of money. And Latin American countries were deep in the red precisely because their bloated public sectors became unsustainable, leading to the serious debt crisis of 1982. Thus, it was an inflationary spree, caused by the crisis of big government, that exacerbated inequality in the region. Of course, Krugman fails to mention this.

Can we assign the recent decline in inequality in Latin America to any specific ideology? A recent study by Kenneth Roberts of Cornell University on the politics of inequality in Latin America looked at inequality trends from 2000 to 2010 and found that “countries that experienced net declines in inequality were governed by diverse administrations of the left, centre, and right, including non-leftist governments in Colombia, Mexico, Peru, Paraguay, El Salvador, Guatemala, and Panama.” According to Roberts, “there was no strict correspondence between declining inequality and either the ideological profile of national governments or any specific set of redistributive initiatives.”

Second, it’s quite a stretch to state that Latin America as a region moved away from the Washington Consensus. I’m not going to dwell here on the virtues of all the policy recommendations identified by John Williamson back in 1989 or discuss the extent to which they were actually implemented by the various Latin American governments. However, even though some countries such as Venezuela, Ecuador, Bolivia, and Argentina have turned their backs on responsible macroeconomic policies in the last few years, most governments in the region, including those called “left of center,” still implement macroeconomic policies related to the Washington Consensus such as freer trade, fiscal and monetary discipline, and attraction of foreign direct investment.

It is telling that despite the serious deterioration in economic freedom in countries such as Venezuela, Ecuador, and Argentina economic liberty has actually increased—slightly—in Latin America as a region in the last decade. According to the Economic Freedom of the World , Latin America went from a regional average grade of 6.56 (out of 10) in 2000 to 6.62 in 2009. Implying that Latin America has somehow turned its back on market-friendly policies is misleading.

Third, Krugman looks at the economic performance of Latin American governments based on their ideological affiliation, suggesting that social democratic regimes have a better record than non-left-of-center governments. However, the study on which he bases his post relies too heavily on analyzing governments by their ideological labels, rather than looking at their actual economic policies. This can be very misleading. For example, during the period covered by the study (2000s), Chile is ranked as left of center, even though during that decade the country increased its level of economic freedom, moving up in the ranking of the Economic Freedom of the World index from 28th place in 2000 to 5th in 2009.

Finally, Krugman finished his post questioning Chile’s free market model and private pension system (even though the study he was referencing categorizes Chile as “left of center” and thus credited that ideological camp for Chile’s healthy economic indicators). Krugman doesn’t provide evidence to substantiate his criticism other than making a presumable reference to the recent student protests in Chile. If he looked at the facts, he would see a different picture. He would find that Chile is the country with the most impressive record in poverty reduction in Latin America (the poverty rate fell from 45 percent in the mid-1980s to just 15 percent in 2011), that it has tripled its income per capita since 1990 to $16,000 (the highest in Latin America), and that it is set to become the first developed nation in Latin America within a decade. What is it about this record that Krugman finds so annoying?

Is Obama Really Going to Propose Another Keynesian Stimulus?

Just last week, I made fun of Paul Krugman after he publicly said that a fake threat from invading aliens would be good for the economy since the earth would waste a bunch of money on pointless defense outlays.

Yesterday, there were rumors that Krugman stated that it would have been stimulative if the earthquake had been stronger and done more damage, but he exposed this as a prank (though it is understandable that many people – including me, I’m embarrassed to admit – initially assumed it was true since he did write that the 9-11 terrorist attacks boosted growth).

 But while Krugman is owed an apology by whoever pulled that stunt, the real problem is that President Obama and his advisers actually take Keynesian alchemy seriously.

And since President Obama is promising to unveil another “jobs plan” after his vacation, that almost certainly means more faux stimulus.

We don’t know what will be in this new package, but there are rumors of an infrastructure bank, which doubtlessly would be a subsidy for state and local governments. The only thing “shovel ready” about this proposal is that tax dollars will be shoveled to interest groups.

The other idea that seems to have traction is extending the current payroll tax holiday, which lowers the “employee share” of the payroll tax from 6.2 percent to 4.2 percent. The good news is that the tax holiday doesn’t increase the burden of government spending. The bad news is that temporary tax rate reductions probably have very little positive effect on economic output.

Lower tax rates are the right approach, to be sure (particularly compared to useless rebates, such as those pushed by the Bush White House in 2001 and 2008), but workers, investors, and entrepreneurs are unlikely to be strongly incentivized by something that might be seen as a one-year gimmick. Though I suppose if the holiday keeps getting extended, people may begin to think it is a semi-durable feature of the tax code, so maybe there will be some pro-growth impact.

In any event, we will see what the President unveils next month. I’ll be particularly interested in how his supposed short-run jobs proposal fits in with his long-run plan for dealing with red ink. He has been advocating for a “balanced approach” and “shared sacrifice” - but that’s Obama-speak for higher taxes, and we know that’s a damper on job creation and new investment.

As you can tell, I’m not optimistic. The best thing for growth would be to get the government out of the way. The Obama White House, though, thinks bigger government is good for the economy.

This stimulus video was produced last year and was designed for another jobs plan concocted by the Administration, but the message is still very appropriate.

Paul Krugman Meets E.T.

I’ve poked fun at Paul Krugman for his views on health care and British fiscal policy, and I’ve semi-defended him about unemployment subsidies and housing bubbles.

Now it’s time for some more mockery.

Back in 2001, Paul Krugman received some much-deserved criticism for stating that the 9/11 terrorist attacks would be stimulative for the economy.

He committed the “broken-window” fallacy, explained more than 150 years ago by a famous French economist, Frederic Bastiat.

Breaking a window at the local bakery, Bastiat explained, might generate business for the town glazier, but only at the expense of some other merchant, like a tailor, who would have benefited if the baker didn’t have to spend money on a new window.

In other words, the destruction of wealth is not good for an economy. At best, it makes us poorer and then shifts how current income is allocated. This is why Bastiat wrote (perhaps predicting the emergence of Krugman):

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

But we have to give Krugman credit for a bizarre form of ideological consistency. He is willing to advocate bigger government, no matter how sloppy the reasoning or how quirky the rationale.

His latest outburst was to say on CNN how wonderful it would be for the economy if the people of earth mistakenly thought we were on the verge of an alien invasion, which would lead to lots of military spending.

He even cited an episode of Twilight Zone to justify his assertions. I’m surprised he didn’t also mention the 1996 film, Independence Day.

As I wrote in a previous blog post, this is one of those moments when your only response is to say “wow.” This is even worse than when Keynesians assert that it would be stimulative to pay people to dig holes and fill them in again.

For those who want more info on why government spending does not boost the economy in the short run, here’s my video on Keynesian economics.



And if you want to know why government spending does not boost the economy in the long run, here’s a video looking at some empirical evidence about economic performance and the size of the public sector.



Misunderstanding Nozick, Again

Someone called Stephen Metcalf writes at Slate of his horror at finding in “an otherwise quite groovy loft” in New York’s SoHo “not one but two copies of something called The Libertarian Reader.” Given that he manages to lump not just Paul Ryan and South Park but Sarah Palin into the libertarian basket, you can appreciate his dismay.

Metcalf puts Robert Nozick at the center of his argument, understandably enough. My colleague Tom Palmer says that academic critics almost always cite one chapter of one book, Nozick’s Anarchy, State, and Utopia, and declare that they have grappled with libertarian ideas. Still, it’s a good book and worth grappling with, and it did have an impact, as Metcalf notes:

I like to think that when Nozick published Anarchy, the levee broke, the polite Fabian consensus collapsed, and hence, in rapid succession: Hayek won the Nobel Prize in economics in 1974, followed by Milton Friedman in ‘75 [1976], the same year Thatcher became Leader of the Opposition, followed by the California and Massachusetts tax revolts, culminating in the election of Reagan, and … well, where it stops, nobody knows.

I’ll leave it to my more learned colleagues to analyze how successfully Metcalf actually deals with Nozick’s arguments. I just want to note one thing here. Like many other critics of libertarianism, Metcalf triumphantly announces:

How could a thinker as brilliant as Nozick stay a party to this? The answer is: He didn’t. “The libertarian position I once propounded,” Nozick wrote in an essay published in the late ’80s, “now seems to me seriously inadequate.”

Yes, yes, yes. It gets repeated a lot: “Even Nozick renounced libertarianism.” If it were true, it’s not clear what it would mean. Libertarianism is true, or not, whether or not Paul Krugman or Russell Kirk believes it, and whether or not Robert Nozick believes it. The idea stands or falls on its own. But as it happens, Nozick did “stay a party” to the libertarian idea. Shortly before his death in 2002, young writer Julian Sanchez (now a Cato colleague) interviewed him and had this exchange:

JS: In The Examined Life, you reported that you had come to see the libertarian position that you’d advanced in Anarchy, State and Utopia as “seriously inadequate.” But there are several places in Invariances where you seem to suggest that you consider the view advanced there, broadly speaking, at least, a libertarian one. Would you now, again, self-apply the L-word?

RN: Yes. But I never stopped self-applying. What I was really saying in The Examined Life was that I was no longer as hardcore a libertarian as I had been before. But the rumors of my deviation (or apostasy!) from libertarianism were much exaggerated. I think this book makes clear the extent to which I still am within the general framework of libertarianism, especially the ethics chapter and its section on the “Core Principle of Ethics.”

So Nozick did not “disavow” libertarianism. Indeed, Tom Palmer adds a point that

David Schmidtz told at a forum about Schmidtz’s book from Cambridge University Press, Robert Nozick, held October 21, 2002 at the Cato Institute. According to David, Nozick told him that his alleged “apostasy” was mainly about rejecting the idea that to have a right is necessarily to have the right to alienate it, a thesis that he had reconsidered, on the basis of which reconsideration he concluded that some rights had to be inalienable. That represents, not a movement away from libertarianism, but a shift toward the mainstream of libertarian thought.

Metcalf’s criticisms of libertarianism will have to stand on their own, as will libertarianism itself. He doesn’t have Nozick on his side. As for Metcalf’s final complaint that advocates of a more expansive state have been “hectored into silence” by the vast libertarian power structure, well, I am, if not hectored, at least stunned into silence.

P.S. Matt Welch notes that if Metcalf doesn’t have Nozick on his side, at least he has Ann Coulter.