Krugman and "economic fallacies"

Friday, July 8, 2011
Krugman and "economic fallacies"
William Anderson

With the job numbers today looking dismal, I figured that the Paul Krugman would call for more borrowing and spending, and he did not disappoint. However, as an added bonus, Krugman also declares certain things to be "economic fallacies," which not only turns upside down any meaning of "economics," but also is built upon that Mother of All Economic Fallacies, the "Fallacy of the Broken Window."

Krugman writes:

One striking example of this rightward shift came in last weekend's presidential address, in which Mr. Obama had this to say about the economics of the budget: "Government has to start living within its means, just like families do. We have to cut the spending we can't afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs."

That's three of the right's favorite economic fallacies in just two sentences. No, the government shouldn't budget the way families do; on the contrary, trying to balance the budget in times of economic distress is a recipe for deepening the slump. Spending cuts right now wouldn't "put the economy on sounder footing." They would reduce growth and raise unemployment. And last but not least, businesses aren't holding back because they lack confidence in government policies; they're holding back because they don't have enough customers ­ a problem that would be made worse, not better, by short-term spending cuts.

Notice what Krugman is saying: Government magically can do away with opportunity cost by spending. (Yes, I know, his argument is that government spending will transform "idle resources" and then give the economy "traction" to move on its own.)

Furthermore, he is not listing anything close to an "economic fallacy." Instead, he is dealing with policy issues, while having economic implications, are not economic theories themselves. An "economic fallacy" deals with a violation of either premises or what we might call a "law" of economics.

Perhaps the most famous of the fallacies is about which Frederic Bastiat wrote in "What is seen, and what is not seen" when he described the view that "broken windows" are necessary to keep an economy going:

Have you ever been witness to the fury of that solid citizen, James Goodfellow, when his incorrigible son has happened to break a pane of glass? If you have been present at this spectacle, certainly you must also have observed that the onlookers, even if there are as many as thirty of them, seem with one accord to offer the unfortunate owner the selfsame consolation: "It's an ill wind that blows nobody some good. Such accidents keep industry going. Everybody has to make a living. What would become of the glaziers if no one ever broke a window?"

Now, this formula of condolence contains a whole theory that it is a good idea for us to expose, flagrante delicto, in this very simple case, since it is exactly the same as that which, unfortunately, underlies most of our economic institutions.

Suppose that it will cost six francs to repair the damage. If you mean that the accident gives six francs' worth of encouragement to the aforesaid industry, I agree. I do not contest it in any way; your reasoning is correct. The glazier will come, do his job, receive six francs, congratulate himself, and bless in his heart the careless child. That is what is seen.

But if, by way of deduction, you conclude, as happens only too often, that it is good to break windows, that it helps to circulate money, that it results in encouraging industry in general, I am obliged to cry out: That will never do! Your theory stops at what is seen. It does not take account of what is not seen.

It is not seen that, since our citizen has spent six francs for one thing, he will not be able to spend them for another. It is not seen that if he had not had a windowpane to replace, he would have replaced, for example, his worn-out shoes or added another book to his library. In brief, he would have put his six francs to some use or other for which he will not now have them.

What Krugman advocates, of course, is something like the "Broken Window Fallacy" (all in the name of claiming that the BWF is a fallacy in itself), for unless government spending via taxation, monetary creation, and borrowing can create wealth where there was none before, government simply is transferring resources or it is blocking the transference of resources from lower-valued to higher-valued uses.

Now, it is true that if government cuts spending, it will create more unemployment in the short run, but to Krugman, there only is a short run. Because the Keynesian viewpoint holds that resources (for economic purposes) are homogeneous, it does not matter where spending is directed, just as long as "new jobs" are created.

Yet, it DOES matter where spending is directed and it is not a fallacy to emphasize that point. For the past three years, the government has engaged in policies of bailouts, "stimulus" spending, new regulations, and throwing huge amounts of money at "green" energy projects, and we are further away from an economic recovery than when we started.

Yes, Krugman can claim that government spending is falling and that the government already is engaging in "austerity." That is nonsense, but nonsense is what prevails in Washington.