Paul Krugman, Nobel-prize winner in economics, and a regular columnist for The New York Times is an outspoken critic of austerity policy. His style is urgent, insistent and occasionally angry, but he is also wonderfully capable of imparting complex knowledge in plain English.
His new book End this Depression Now! (Norton 2012) is a useful guide to the causes of the present economic crisis and provides a practical outline of how to deal with it. Krugman’s main argument is that overcoming the crisis is a matter of urgency—hence also the title of the book—but also relatively straightforward, provided we stop treating “economics as a morality play.”
According to Krugman, both the American and the European economies are in a state of depression, defined, following Keynes, as ‘a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards collapse.’ Business investment is low, likewise overall demand, while unemployment is high. Besides, there is a loss of confidence in monetary and fiscal policies. This is making it harder for governments to borrow money—presently an especially acute problem for Southern European countries.
The Federal Reserve and, as of recently, the European Central Bank have been good with conventional monetary policies consisting of buying assets or making direct loans to bank—what in modern times represents the equivalent of printing money. These are crucial measures, especially with respect to coping with the financial crisis. But they will not suffice for ending economic depression.
This is because both economic areas are caught into a liquidity trap brought about by high leverages, that is to say “the buildup of debt relative to assets.” High leverages are the result of reckless borrowing, facilitated through deregulation and the loosening of governmental oversight mechanisms.
Still the answer to the problem of high debt is not austerity, but the opposite, namely government spending in conjunction with higher inflation. The main argument in favor of increased government spending is threefold: job creation, debt relief for individual households, and the stimulation of private demand. According to Krugman the widespread belief that government spending displaces private spending is a misconception which is not borne by empirical data.
Insofar as inflation is concerned, Krugman recommends a moderate reorientation towards four per cent. Inflation is an easier way to bring about a decrease of wages in those countries which have witnessed a steep increase in this respect without corresponding productivity gains or trade surpluses: “workers are much less willing to accept, say, a 5 percent cut in the number of their paycheck than they are to accept an unchanged paycheck whose purchasing power is eroded by inflation.” In addition, “higher expected inflation, other things being equal, makes borrowing more attractive: if borrowers believe that they’ll be able to repay loans in dollars that are worth less than the dollars they borrow today, they’ll be more willing to borrow and spend at any given interest rate.”
Solving the European crisis might be a bit more difficult given the absence of a political union, hence also of a federal budget. Krugman compares Nevada to Ireland and has the following to say:
“in the case of Nevada, these shocks are buffered, to an important extent, by the federal government. Nevada is paying a lot less in taxes to Washington these days, but the state’s older residents are still getting their Social Security taxes, and Medicare is still paying their medical bills … Meanwhile, deposits in Nevada’s banks are guaranteed by a federal agency … Ireland by contrast, is mostly on its own, having to bail out its own banks, having to pay for retirement and health care out of its own greatly diminished revenue.”
Add to this that as a member of the European monetary union, Ireland does not have the option of devaluing its currency thus reducing the value of its debts and increasing its competitiveness.
And yet again, the immediate answer to EU’s troubles should not be austerity for its own sake. Krugman agrees there is no way around a relative reduction of wages in Southern Europe. However, the way this is currently being brought about, that is to say through ‘internal devaluation’ using austerity policies and high unemployment, is both slow and inhumane. One could add it will only result in more macro-economic misery by forcing these countries in the equivalent of a poverty trap.
What remains incomplete in Krugman’s book is the content of stimulus packages towards the creation of new jobs, as opposed to the recovery of those jobs which were lost as a result of budget cuts. In the case of the U.S. the recovery of lost jobs might be enough, not so perhaps in the case of the European Union.
The obvious answer to this question is infrastructure, but that alone won’t do the trick given the long planning process of most infrastructure projects and their frequent contested nature.
But infrastructure need not always be physical. Perhaps the key to growth in the twenty-first century are those areas engaged in the production of public service goods such as education, health care, food and chemical safety, environmental protection, energy and RTD. These are all sectors which have an expansion potential also in terms of job creation, but which require support in the form of incentives and/or subsidies. It might even be worth exploring whether the way forward is not, in fact, to be found in the growth of the welfare state through public-private partnerships rather than its retrenchment.