Krugman's Prescription for Disaster

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Paul Krugman
calls for Obama and his advisors to push an expanded version of
the New Deal (see the link
below by Mark R. Hatlie
). According to Krugman, they should
throw caution to the winds
and “figure out how much
help they think the economy needs, than add 50 percent. It’s
much better in a depressed economy, to err on the side of too much

Obama should
reject this advice. If he listens to Krugman, the likely result
will be a wave of stagflation that makes the experience of the 1970s
look mild by comparison. Such a prescription would both continue
and accelerate Bush’s fiscally reckless policy of propping
up malinvestments through massive increases in spending, deficits,
and easy credit by the Federal Reserve. As the continuing fall of
the stock market and the rise of unemployment indicate, more bailouts
and more “shock socialism” do not work. Obama made a fatal
mistake in failing to oppose the aptly described billionaire bailout.

This call for
a hyper New Deal rests on a flawed view of history. According Krugman,
the only reason Roosevelt failed to bring recovery was because he
spent too little, not too much. At the same time, he tries to have
it both ways by stating that the crisis of the 1930s would have
been “much worse” without the New Deal.

A key problem
with Krugman’s analysis is that it does not adequately explain
why the decade-long New Deal era depression lasted so much longer
than previous depressions. Prior to the 1930s, depressions (as in
the sharp and short downturn of 1921 and 1922) had typically lasted
for two to three years. The predominant anti-depression policy before
Hoover and Roosevelt was to cut spending, balance budgets, and let
prices, profits, and wages readjust to more sustainable levels.
Yet Krugman regards this older approach for curing depressions as
“much worse” than the New Deal. The logical implication
of his argument is that the New Deal, modest as it was, would have
made the Great Depression at least somewhat shorter than previous
downturns. The fact that it did not stands as a stunning indictment
of FDR’s policies.

The unprecedented
duration of the depression also represents an indictment of Herbert
Hoover’s approach. This was because Hoover intervened too much
not, as Krugman would have it, too little. Krugman’s article
neglects the relevant point that Hoover had pursued a mini-New Deal
from 1929 to 1933 via programs such as the Reconstruction Finance
Corporation and the Federal Farm Board. It was Hoover, not Roosevelt,
who was the first president to reject the advice of the “leave
it alone liquidationists.” Instead of letting malinvestments
(or toxic assets in today’s parlance) readjust at a lower level,
he desperately propped them up. In great part because of Hoover’s
high-wage policies, real wages were actually 12 percent higher in
1932 than in 1929! Meanwhile, of course, unemployment advanced to
record levels as businesses saved on payroll costs by laying off
workers. Perhaps if Hoover had listened to the advice of the so-called
“liquidationists,” the depression would have been over
by 1931.

More troubling,
at least for opponents of war, is Krugman’s dubious contention
that “What saved the economy, and the New Deal, was the
enormous public works project known as World War II, which finally
provided a fiscal stimulus adequate to the economy’s needs.”

The evidence does not support the view that that war was beneficial
for the economy. In a seminal article for the Journal of Economic
History, Robert Higgs convincingly
the Keynesian theory of World War II as put forward
by Krugman and others.

While unemployment
disappeared during the war, it was hardly a step forward. Moving
men and women from the unemployment lines to the killing fields
of Anzio did not represent economic progress in any meaningful sense.
During the war, Americans at home suffered from rationing, shortages,
more accidents on the job, longer hours, and many other measures
of economic deprivation. Moreover, as Higgs points out, “real
personal consumption declined. So did real private investment. From
1941 to 1943 real gross private domestic investment plunged by 64
percent; during the four years of the war it never rose above 55
percent of its 1941 level; only in 1946 did it reach a new high.”

According to
genuine prosperity did not begin to return until the last months
of 1945 and 1946. This prosperity occurred under a policy of reverse
Keynesianism which included massive reductions in spending because
of demoblization, rapid steps toward price decontrol, and scaled
back deficit spending.

Higgs sums
it up

World War
II, the so-called Good War, has been a fount of historical fallacies.
One of the greatest – and one of the most pernicious for subsequent
policymakers – is the notion that prosperity prevailed during
the war. Although Americans might have been dying in the Pacific
and European theaters of war, people on the home front actually
benefited from the war, because it propelled the economy at long
last out of the Great Depression. This view of the war would be
sufficiently egregious if it were true, but despite the claims
of historians for the past half century, it is not true.

Obama’s best
hope to bring lasting recovery is to let the economy go through
a short, but sharp, readjustment. He needs to remove the malivestments
not, contra Krugman, perpetuate them. Obama can facilitate this
readjustment to a more sustainable level by cancelling the bailout,
cutting spending, and pruning deficits. Another worthy goal would
be to dismantle the Federal Reserve which helped to create this
mess through its easy credit policies.

Most of all,
however, Obama should end our costly empire by closing down our
overseas bases and bringing home the troops. Only then, can we start
to get our financial house in order and move towards genuine economic
well being.

14, 2008

David T.
Beito [send him mail]
is a member of the Liberty
and Power
group blog at the History News Network.

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