Wednesday, 30 September 2009

Krugman Still Believes In A Free Lunch

There are so many things wrong with the above analysis.

The article is about how, in times like these, when we are ‘living is special conditions’, crowding out happens in reverse. That is, the government spending our money, when we don’t want to, actually makes us better off, not just now but also in the future. ie more consumption now leads to more consumption later. Of course this is not and cannot be true because it violates the first rule of economics: There is no such thing as a free lunch.

Regardless of whether or not he/she has a PhD or not, always be wary of an economist who tries to say that the 'it’s different this time' with regards to economic theory. True (Austrian) economic theory does not change, and when Keynesians use words like ‘crowding in’, ‘liquidity trap’, ‘paradox of thrift’ and ‘animal spirits’ it’s usually because they don’t understand what is really going on.

Krugman’s second point really sums up his lack of understanding:

(2) Crowding out: when it runs deficits, the government competes with the private sector for funds, so deficits crowd out private investment, which reduces potential growth.

It isn’t just funds that the private sector competes with the public sector for. When the public spends our money it uses up resources, (land, labour, capital), which prevents the private sector from employing them more efficiently. For a more in depth analysis of why public sector stimulus is no free lunch visit here:

Without fiscal spending, investment does take place, just at a lesser rate than is needed to make use of all the idle resources. It’s not only that the productivity of government-sponsored investments are below what could be hypothetically achieved by the private sector, it is that these ‘investments’ (more like consumption in reality) would hinder investment by the private sector now and in the future. Assuming that there is no crowding out in the present period (i.e. assuming that private demand does not fall as people expect higher taxes in the future and that Treasury yields do not rise due to the excess saving), I have no issue with the claim that higher fiscal spending makes a country better off in the present by raising demand. As an example, having masses of unemployed workers who could be contributing in some way makes no sense in the present. It’s obvious that the more we spend right now the better off we are right now, we don’t need Krugman to tell us this. The problem is we do not live in just one period. While I know that my ‘excess’ saving is not improving my wellbeing in this period, I am doing it because it will improve the discounted net present value of my future wellbeing. This is as true for an economy as it is for an individual.