Krugman Paints an incomplete Picture
I was reading today Paul Krugman’s article, Why Weren’t Alarm Bells Ringing? He is painting a picture of how the crisis formed and secular stagnation followed. It seems that he is trying to paint a complete picture so that anyone could understand the crisis completely just from reading his post.
However, he is missing an important part of the picture. I point to a sentence…
“Even if you believe that financial excess set the stage for the slump that followed—and despite my sympathy for the secular stagnation view, I guess I mostly do—there was still no good reason why the slump had to be as terrible as it was. Containing the fallout from a financial crisis isn’t nearly as easy as Milton Friedman misled economists into believing, but it’s not impossible.”
Do you believe the bolded words? Is there really no good reason for why the slump was so terrible? Do you accept his view without question? Do we dare say that the master missed something?
Well, there is a good reason why the slump became terrible. It is important to note that fiscal and monetary policies lose effectiveness against this reason. Labor’s share of income dropped precipitously from its historic range. There are good reasons for this drop. Countries far and wide are dropping their labor share to compete globally with the likes of China and Germany. The drop in labor share has turned into a death spiral for the global economy. Effective demand is tight everywhere now. Fiscal policy fell short to reverse this drop in labor share by not focusing on job & labor income creation. Monetary policy became ineffective lost effectiveness to counteract the drop in the liquid flow of consumer demand.
In a post yesterday about Pavlina Tcherneva, we see that the bottom 90% of incomes has progressively received less and less of the gains during recoveries for decades. Until finally, the bottom 90% is losing in this recovery. This fact has created a deeper and more sluggish recovery. Eventually it will be understood that potential output has been reduced because of labor losing economic strength.
If you add this critical aspect to the picture that Paul Krugman is painting, you get a more complete picture.
You write “Fiscal policy fell short to reverse this drop in labor share by not focusing on job & labor income creation.” So if fiscal policy had focused on job and labor income creation (and the stimulus had been larger), then wouldn’t the slump have been less terrible than it was (maybe a lot less)?
Krugman writes “…that stimulus could easily have been bigger and gone on longer. What we got instead, however, was a wrongheaded obsession with deficits and unprecedented fiscal austerity…” And I don’t think he would argue against “focusing on job & labor income creation” to make the stimulus more effective (although I don’t know that – I’m more of a follower of Dean Baler than I am Krugman).
Edward,
First, thanks for the link to Paul Krugman’s article “Why Weren’t Alarm Bells Ringing. I expected an opinion piece but it is a review of “The Shifts and the Shocks” by Martin Wolf. It is a little longer and really gives some insight into what the reviewer is thinking.
Second, your third paragraph is an out of the park home run. It is laden with ideas which I have been pondering. As an example I have been wondering if by implementing Global Free Trade and thus indirectly reducing our own labors’ share and thus damaging our own economy, have we actually damaged the global economy since we are one of the largest consuming nations. That has become even more apparent with the current news in Europe. (I view Japan as a special case.) As another, I still have some hope that the ‘powers that be’ will recognize the continuing damage to our economy but if not I fear some version of your “death spiral”.
Third, Krugman’s last 3 paragraphs seem to show how far economists still are from distilling the data and getting to the base cause. He recognizes debt as having “helped set the stage for disaster”, but adds other unimportant factors which tend to dilute the truth. That debt should have been a deafening alarm that consumers were very stressed. Instead it was taken as a reason for condemnation of the morality of the middle and lower classes.
It seems to me Krugman always agreed that the stimulus, besides being too small and too short-term, did not focus enough on job creation. Several million Davis-Bacon jobs, pulling that many out of the surplus labor pool and reducing the size of that pool available to other employers, would have done wonders for labor share.
While writing my second paragraph above, something kept nagging at me but I could not figure out why. Later I found this.
From Robert Waldmann in his post:
http://angrybearblog.strategydemo.com/2014/10/read-jeff-madrik.html
“I think this is the key to the near unanimity among mainstream economists. Egalitarian mainstream economists support low barriers to imports to first world countries, because we care most about the poorest — third world workers.”
This rings true to me. It is ironic that in attempting to help the third world workers, they brought on an economic disaster for the first world economies. (And indirectly perhaps an economic disaster to third world workers.)
Moderation seems to be the key to life. I read somewhere that anything can be a poison if taken in large enough quantities.
Mike B. and Urban Legend,
There is a subtle but important difference in the way Krugman views fiscal stimulus and the way I view it. He sees the government providing the demand. I see the objective of fiscal stimulus to improve labor share, in other words, improve consumer demand.
The government could do fiscal stimulus, but if labor share does not change, all the fiscal stimulus simply multiplies through the economy with the same high share going to capital. Thus fiscal policy would not change the real weakness of labor income.
But as Urban Legend says, “would have done wonders for labor share.” That is the real hope with fiscal stimulus… that labor share has a chance to rise by making the labor market tighter.
Krugman points to the fiscal stimulus of WWII but we also need to realize the labor share rose greatly from that fiscal stimulus. The rise in labor share during WWII was the real key to empowering consumer demand.
JImH,
Exactly… Tibetan doctors have the tradition that anything is a medicine or a poison depending on the dosis.
The key is moderation. My view is that free trade and capital movement should have had more controls over the last 20 years, like shock absorbers on a car. The transition would have been made less dramatic.
Great post, Edward. Let me point to something that Krugman said in his review of the Wolf book, but buried deeply, near the end: “what we need urgently are policies to support demand on a continuing basis.” He should be shouting such advice. Occasionally he seems almost shy about offering some of his best, most useful policy conclusions.
Hi,
“The drop in labor share has turned into a death spiral for the global economy. Effective demand is tight everywhere now.”
What is the link between effective demand and the financialization of the economy ? It seems to me that the capacity to recycle capital income into consumption by the labor class (exemple : subprime lending) through credit creation has postpone the effect of the drop in labor share.
If so, shouldn’t a calcul of the effective demand limit encompass a estimation of the total debt carrying capacity of an economy ?
PJR,
My sense is that when Krugman calls for more demand, he is calling for government fiscal stimulus, instead of direct policies to increase labor income and labor share. The problem is that you could have fiscal stimulus and labor share still fall. The key is to make increasing labor share the priority of the message. He isn’t saying that at all.
Reminds of the Krugman Algorithm.
1). Krugman is right.
2). I think Krugman is wrong
3). Go to 1
A. Matthey
Are you saying that labor is spending capital income?