Paul Krugman on Depression Economics - Democratic Underground

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Sun Jan-10-10 07:03 PM
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Paul Krugman on Depression Economics

It’s crucial to appreciate where we are. We may have avoided a repeat of the Great Depression, but we’re still very much living in a world in which the usual rules of economic policy don’t apply. That is, we’re living in a world governed by depression economics – and our understanding of the logic of depression economics… is our only defense against economic disaster – Nobel Prize winning economist Paul Krugman, from the last paragraph of his book, “The Return of Depression Economics – and the Crisis of 2008”.

The last paragraph of Krugman’s book explains the whole purpose of the book. We can get through this economic crisis if it’s handled properly. But if it’s not handled properly we could end up having a repeat of the 1930s.

In the last chapter of his book, Krugman describes the main gist of our current economic crisis, how we got there and how we can get out. By way of comparison to the Great Depression of the 1930s, he says:

While depression itself has not returned, depression economics – the kinds of problems that characterized much of the world economy in the 1930s but have not been seen since – has staged a stunning comeback. The world economy has turned out to be a much more dangerous place than we imagined.

Depression economics

Krugman explains that depression economics is the failure of the demand side of the economy, i.e. spending by the private sector has stalled. Without any direct reference to Ronald Reagan or his disciples, Krugman takes a swipe at the ideology that brought us to this point:

The specific set of foolish ideas that has laid claim to the name “supply side economics” (Otherwise known as “trickle down” economics) is a crank doctrine that would have had little influence if it did not appeal to the prejudices of editors and wealthy men. But over the past few decades, there has been a steady drift in emphasis in economic thinking away from the demand side to the supply side of the economy.

Krugman sums up the crux of our current situation:

In the short run the world is lurching from (economic) crisis to crisis, all of them crucially involving the problem of generating sufficient demand… One country after another has experienced a recession that at least temporarily undoes years of economic progress, and finds that the conventional policy responses don’t seem to have any effect. Once again, the question of how to create enough demand to make use of the economy’s capacity has become crucial. Depression economics is back.

In the last chapter of the hardback edition of his book, while making comparisons between now and the Great Depression, Krugman makes a point of saying that he doesn’t think this one will be as bad. But in the new paperback edition, he isn’t quite so sure:

By the time this epilogue was written (June 2009) the resemblance had become all too close. Over the past year, by a number of measures, the world has experienced a slump every bit as severe as the first year of the Great Depression… This slump has led to mass unemployment…

He then shows a graph that plots worldwide industrial production over time, for the Great Depression vs. now, to demonstrate the very similar first year trends. It looks a lot like this one:

How we got here

My parents used to tell me that we couldn’t have another Great Depression because the lessons we learned from that tragedy taught us how to prevent similar future occurrences. And that has generally been the consensus of our nation’s economists, ever since we recovered from the Great Depression. But sometimes lessons are forgotten – or they are unlearned when influential elites change the story to further their own selfish interests. Krugman makes that point:

How did this second great colossal muddle arise? In the aftermath of the Great Depression, we redesigned the (economic) machine so that we did understand it, well enough at any rate to avoid the big disasters. Banks, the piece of the system that malfunctioned so badly in the 1930s, were placed under tight regulation and supported by a strong safety net. Meanwhile, international movements of capital, which played a disruptive role in the 1930s, were also limited. The financial system became a little boring but much safer.

Then things got interesting and dangerous again… The growth of the shadow banking system, without any corresponding extension of regulation, set the stage for latter day bank runs on a massive scale. These runs involved frantic mouse clicks rather than frantic mobs outside locked bank doors, but they were no less devastating. What we’re going to have to do, clearly, is relearn the lessons our grandfathers were taught by the Great Depression…

Krugman talks about what he calls the “shadow banking system” (discussed in more detail in this post) – the taking on of investment bank functions by financial entities that are not formally labeled as banks but which actually were banks, in that they functioned as banks. It was all part of the general deregulatory atmosphere that began in the early 1980s with the Reagan Revolution. Krugman states what should have been obvious to all of those who have influenced our nation’s economic policies for the past 30 years:

The basic principle should be clear: Anything that has to be rescued during a financial crisis, because it plays an essential role in the financial mechanism, should be regulated when there isn’t a crisis so that it doesn’t take excessive risks. Since the 1930s commercial banks have been required to have adequate capital, hold reserves of liquid assets… and limit the types of investments they make, all in return for federal guarantees when things go wrong. Now that we’ve seen a wide range of non-bank institutions create what amounts to a banking crisis, comparable regulation has to be extended to a much larger part of the system.

In other words, to hell with the idea that we should rescue our financial elites with trillions of dollars of taxpayer money when they run into trouble (i.e. socialize their risks), while acceding to their wishes to be free of regulation (i.e. privatizing their benefits) when they do well.

On the worthlessness of the bank bailouts

Krugman was quite perplexed about the purpose of the bank bailouts, both under the Bush and the Obama administrations. This is what he said about the Bush administration bailout, in his book:

At first, after the fall of Lehman Brothers, the Treasury Department proposed buying up $700 billion in troubled assets from banks and other financial institutions. Yet it was never clear how this was supposed to help the situation… It’s not clear whether banks will be willing to lend out the funds, as opposed to sitting on them. My guess is that… there will eventually have to be more assertions of government control – in effect, it will come closer to a full temporary nationalization of a significant part of the financial system… Nothing could be worse than failing to do what’s necessary out of fear that acting to save the financial system is somehow “socialist.”

He didn’t have kinder words to say about the Obama administration’s plans to handle the situation. This is what Krugman had to say about Geithner’s bank bailout plan:

The Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt… This isn't really about letting markets work. It's just an indirect, disguised way to subsidize purchases of bad assets.

In other words, this is a gift from the American taxpayers to the banks – in the form of socialized risks and privatized benefits.

How do we get out?

Because the underlying problem is quite similar to the cause of the Great Depression of the 1930s, Krugman proposes a similar solution – the one that FDR utilized, and which worked so well then:

What the world needs right now is a rescue operation… The obvious solution is to put in more capital… In 1933 the Roosevelt administration used the Reconstruction Finance Corporation to recapitalize banks…

He was very critical of the Bush administration’s less than half-hearted efforts in this regard. And though he felt that the Obama administration took more of a step in the right direction, it still fell far short of what was needed:

Mr. Obama’s prescription doesn’t live up to his diagnosis. The economic plan he’s offering isn’t as strong as his language about the economic threat. In fact, it falls well short of what’s needed…. A huge gap is opening up between what the American economy can produce and what it’s able to sell. And the Obama plan is nowhere near big enough to fill this “output gap.”…

Only about 60 percent of the Obama plan consists of public spending. The rest consists of tax cuts – and many economists are skeptical about how much these tax cuts will actually do to boost spending. The bottom line is that the Obama plan is unlikely to close more than half of the looming output gap, and could easily end up doing less than a third of the job.

Where we stand now

Krugman is cautiously optimistic about our current situation. At the end of his book he says:

At the time of writing (June 2009) things seem to be looking a bit better. Or to be more accurate, the rate at which things are getting worse seems to be slowing. For example, the United States is still losing hundreds of thousands of jobs each month – but it isn’t losing jobs as fast as it was earlier this year. The sense that the world economy was plunging uncontrollably into the abyss has eased.

While the risk of total economic collapse seems to be receding, that’s a long way from saying that the crisis is over. Think of the world economy as a patient who was rushed to the hospital and seemed to be at risk of dying. Now the patient is off the critical list but is still very, very ill – with no hint of when a full recovery might happen.

Things haven’t changed that much since Krugman wrote those words, as another 85 thousand jobs were lost in our country in the last month of 2009.

The intersection of depression economics and politics

Paul Krugman’s Nobel Prize in economics speaks for itself. What makes him an especially valuable source of information is that he makes every effort to bring his economic discussions down to the level of people who don’t have a great deal of background in economics. Other books of his that I would strongly recommend include: “The Great Unraveling: Losing our Way in the New Century” – a scalding critique of the George W. Bush administration’s fraudulent economic policies; and “The Conscience of a Liberal” – which dwelt largely with how FDR’s economic policies rescued us from the Great Depression and set the stage for several decades of economic prosperity, until being undone by the Reagan Revolution.

Yet there is one very important dimension that Krugman does not cover in “The Return of Depression Economics”: the political dimension. Nothing better illustrates the omission of this crucial dimension than the last paragraph of the first edition of the book:

We will not achieve the understanding we need unless we are willing to think clearly about our problems… I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men.

True enough as far as it goes. But I think we should ask how obsolete doctrines come to “clutter the minds of men” who ought to know better. With the ballooning of income inequality to obscene and unprecedented levels, some very wealthy people have acquired the means to influence national policy as never before. Gabriel Thompson explains how this power is abused, in an article titled “Meet the Wealth Gap”:

It’s about the vast political power conferred by wealth, which can be deployed to support institutions pushing policies that magnify the wealth divide. (These institutions) subsidize senior fellows who … see something sinister in a living-wage movement… (They) call the movement a “sneaky way of bringing socialist economics to America’s cities”.

In other words, these wealthy elites use their influence to push policies they perceive as benefiting themselves, no matter how destructive they are to the rest of humanity. They disingenuously disclaim the warnings of our best climate scientists, to argue that global warming need not be taken seriously, thus sheltering corporations that continue to pollute our atmosphere and thereby accelerating the warming of our planet, while accumulating immense profits. Naomi Klein explains how this works in “The Shock Doctrine”:

Perhaps part of the reason why so many of our elites are so sanguine about climate change is that they are confident they will be able to buy their way out of the worst of it. The Rapture is a parable for what they are building – a system that invites destruction and disaster, then swoops in with private helicopters and airlifts them… to divine safety.

Al Gore says it as well as anyone, in his book, “Our Choice – A Plan to Solve the Climate Crisis”. Referring to the denial of our global climate crisis, he says:

The decision by powerful ideologues and self-interested corporate advocates to convert “questions of truth into questions of power” has produced lassitude in reaction to genuine, fact-based warnings of an onrushing tragedy with no parallel in all of history.