Krugman, Cartels, and the Brave New Economy

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Paul Krugman is an angry man. In his Friday, April 11, column in the New York Times, he claimed that "thousands" of people die each year because they don’t have medical insurance. (Unfortunately, he gives a very questionable anecdote and then extrapolates that example into "thousands" dying. In other words, he spoke ex cathedra, especially and since it first appeared, the Times had to issue a correction saying Krugman was wrong.)

His solution for this "crisis"? Empower the state. He writes:

Look, I know that many progressives have their hearts set on seeing Barack Obama get the Democratic nomination. But politics is supposed to be about more than cheering your team and jeering the other side. It’s supposed to be about changing the country for the better.

And if being a progressive means anything, it means believing that we need universal health care, so that terrible stories like those of Monique White, Trina Bachtel and the thousands of other Americans who die each year from lack of insurance become a thing of the past.

That means a state-run system, period. Yet, Krugman hardly wishes to stop with outlawing entrepreneurship in medical care; in fact, he wishes to criminalize entrepreneurship across the entire economy.

How do I draw that conclusion? As I have read Krugman’s work over the past several years and especially this past year, I have seen him constantly call for a new rendition of the New Deal, and its subsequent attempts to organize the entire economy into a series of cartels. Read the following from his most recent column:

The question is, can the next administration end America’s malaise?

Some of the causes of poor economic performance since 2000 are probably beyond any administration’s control. Raw materials were cheap in the 1990s, but in the years ahead the rise of China and other emerging economies will place increasing pressure on world supplies of oil, copper and so on, no matter what the next president does.

But reinvigorated regulation could help restore confidence to the financial system. A return to pro-labor policies could help raise real wages. Pro-competitive policies — which are not the same thing as giving powerful businesses whatever they want — could help America regain its leadership in information technology. In other words, there’s a lot that could be done to perk up our sagging confidence.

The system of what he speaks is the New Deal, so if one is to understand what Krugman is saying, one first must understand the nature of the New Deal and its regulatory policies. The first and most important thing is that it was based upon the old "Progressive" notion of organizing the entire system into a series of cartels.

The "Progressives" held that private competition was wasteful and ultimately responsible for periods of unemployment, given that competition would lead producers to "overproduce," and then they had to shut down their businesses and factories until their inventories cleared. Thus, they reasoned, if one wished to end periods of involuntary unemployment, then one did so by holding back production in order to keep businesses from engaging in "overproduction," which then would also create the twin problem of "underconsumption." (Yes, Krugman believes in that, too.)

New Deal initiatives like the Agricultural Adjustment Act and the National Industrial Recovery Act were modeled after Mussolini’s Italian "experiment," or what then was called "Fascism." After the U.S. Supreme Court struck down the AAA and NIRA in 1935, the economy rallied briefly, but then the Roosevelt Administration decided to empower labor unions. In 1937 and 1938, the economy was wracked by a series of government-encouraged strikes, and in 1938, the economy suffered a "depression within a depression" as unemployment surged to nearly 20 percent.

An appeal to logic would bring one to realize that one does not "create jobs" and employment opportunities by using government to hold back production at "monopoly" levels, yet that is what people like Krugman are trying to tell us. For example, he says the following about the banking and financial cartels that the government created during the 1930s:

Congress tried to make sure it (the Great Depression) would never happen again by creating a system of regulations and guarantees that provided a safety net for the financial system.

And we all lived happily for a while — but not for ever after.

Wall Street chafed at regulations that limited risk, but also limited potential profits. And little by little it wriggled free — partly by persuading politicians to relax the rules, but mainly by creating a "shadow banking system" that relied on complex financial arrangements to bypass regulations designed to ensure that banking was safe.

For example, in the old system, savers had federally insured deposits in tightly regulated savings banks, and banks used that money to make home loans. Over time, however, this was partly replaced by a system in which savers put their money in funds that bought asset-backed commercial paper from special investment vehicles that bought collateralized debt obligations created from securitized mortgages — with nary a regulator in sight.

Elsewhere, Krugman has written that deregulation of the financial sector (and deregulation of other aspects of the economy like transportation and telecommunications) came about because of Ronald Reagan and free-market ideology. While such statements no doubt play well to the poorly-educated and uninformed New York Times crowd, they hardly square with reality.

Most of the deregulation initiatives came during the administration of Jimmy Carter, who was and is not known for any particular sympathy to free markets and private enterprise. (Indeed, some of his most visible appointments to government posts were fire-breathing socialists like S. David Freeman of the Tennessee Valley Authority.)

Indeed, since Krugman has decided to re-write history, perhaps it is time to revisit those wonderful days of yesteryear. According to Krugman, the financial cartels were a safe and wonderful mechanism for financing capital development in the economy — except that was not the case. Krugman conveniently leaves out that people abandoned those "tightly regulated savings banks" because of Regulation Q (which he would bring back), which limited banks and S&Ls on what interest they could pay.

Thus, people who were facing inflation rates of 10 percent and more decided that five percent interest on savings accounts wasn’t cutting it. The drive to put money in the "non-bank" sector was not motivated by ideology, as Krugman would have us believe, but rather because government-caused inflation was destroying the savings of individuals. (I should add that Krugman, being a True Believing Keynesian, holds that savings are not good, anyway, since they mean people are not spending money at a rate that will bring about "full employment.")

Furthermore, entrepreneurs were bringing the computer age into the marketplace, and the old banking cartel was not equipped to provide them with funds. For example, when MCI began to challenge the AT&T monopoly on long-distance telephone service, Michael Milken underwrote the venture with his famed "junk bonds." Likewise, when Ted Turner launched his fledgling Cable News Network in 1980, Milken underwrote that venture, too, as the banking system was not about to touch a risky venture like CNN.

Krugman conveniently leaves out this bit of financial history, and I suspect he either would appeal to the standard neo-classical viewpoint that takes the introduction of new capital and technologies as a "given" (don’t worry about their origins, as they just magically appear in KrugmanWorld), or would ignore this altogether, as it does not fit his narrative. Nor does he tell us of the very destructive role that government-created mortgage entities like "Fannie Mae" and "Freddie Mac" have played in this current bubble. Neither of those institutions are "free-market" creations, yet Krugman wants us to believe that the bubble was caused by free-market ideology. Right.

What does all of this mean in the real world? It means that Krugman believes we can have a thriving economy without entrepreneurship. After all, under heavily-regulated regimes, the first thing to go is the entrepreneur. For example, when the Southern Railway in 1964 developed the Big John grain car, other railroads demanded the Interstate Commerce Commission, which served as the central regulating entity in the railroad cartel, to outlaw the car. The ICC did just that. That is how regulated regimes operate.

Time and again, we have seen regulatory agencies step in to block the application of new technologies and innovations because they bring in new forms of competition, which will kill a cartel. Now, Krugman would argue that regulated forms of the economy are safer, providing a "safety net" against risk. One cannot have entrepreneurship without risk, but Krugman apparently believes that an economy without innovation is just fine, or that innovation will happen without the intervention of entrepreneurs.

The results of such a cartelized system are not a mystery. During the New Deal, the rate of unemployment stayed at more than 10 percent from 1931 through the end of 1941. While Krugman has written elsewhere that this was a golden economic period because the perceived "gap" between rich and poor shrank (yes, everyone became poorer), one should recall that the worst recession since World War II brought supposedly intolerable unemployment rates of about 10 percent.

If we are to have what Krugman is demanding — a cartelized regime — there is no way around both high rates of unemployment and the inevitable stratification of society that has become so common in the heavily-regulated European economies. Yet, there is another way, one that Krugman ignores, but would provide a way out of the current financial mess.

First, and most important, the authorities simply need to let the financial chips fall where they should fall. Stop trying to bail out the system, as it only compounds the problems. Herbert Hoover and later Franklin Roosevelt attempted to bail out the system, and only created havoc.

Second, dispense with the Federal Reserve safety net. Krugman constantly refers to the "safety net" of regulation, but ignores the fact that the Fed for years has hinted it will bail out just about anyone with its vaunted stores of "liquidity." (Don’t forget that on the evening of "Black Monday," October 19, 1987, Alan Greenspan promised Wall Street plenty of "liquidity" after the stock market melted down that day.)

I do not fear the recession nearly as much as I fear the government intervening in the economy to stop what is inevitable. Most, if not all, Austrian economists say the same thing. However, the loudest voices are those that are giving the prescription for disaster, not only in the coming year, but the coming decade. And the loudest voice happens to be that of Paul Krugman.

April 16, 2008

William L. Anderson, Ph.D. [send him mail], teaches economics at Frostburg State University in Maryland, and is an adjunct scholar of the Ludwig von Mises Institute. He also is a consultant with American Economic Services.

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