Britain can’t afford to fall for the charms of the false economics Messiah

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...Britain can't afford to fall for the charms of the false economics Messiah

Krugman

Superstar economist Krugman wants us to change course, but his solutions

are simplistic.

By Warner | Telegraph – Thu, May 24, 2012 21:21 BST

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Nobel Prize winning economist Krugman (Image: REUTERS/n

McDermid)Superstar economist Krugman wants us to change course, but his

solutions are simplistic.

For the latest on the eurozone debt crisis, visit our Live Blog

What does the future hold as Europe (Chicago Options: ^REURUSD - news) slides,

ever more hopelessly, towards the abyss? As Cameron has pointed out, there

have been 18 EU summits since he became Prime Minister little more than two

years ago, and none of them has produced anything remotely resembling a

solution.

The stand-off got a whole lot worse this week. France and Germany are now in

open conflict over the way forward, if indeed there is one. For the UK, already

bleeding badly from the after-effects of the financial crisis, the situation

could scarcely look more threatening.

The fiscal consolidation chosen by the Coalition was always likely to have a

negative impact on output, at least in the short term. To make it work, the

Government needed the following wind of decent growth elsewhere in the world

economy. Instead, it's facing a hurricane. We look set to be broken by the

storm.

But fear not salvation is at hand. Next (Xetra: 779551 - news) week, there comes

to these shores a Messiah, a prophet of great wisdom and understanding whose

teachings promise to vanquish despair and " end this depression " . He is Prof

Krugman, a superstar polemicist who has been described by The Economist as " the

most celebrated economist of his generation " . Actually, " celebrated " is not

exactly the right word, for Krugman divides opinion like no other. To his

followers, he's a saint; to his detractors, he's a false prophet with satanic

intent.

I've been a little misleading here. He's not really coming to Britain to save

us, but rather to promote his latest book, End This Depression Now! Krugman is

an economist with attitude, and he thinks Britain is in the midst of a " massive

blunder " in economic policy. The UK is the very worst example of austerity

economics, he believes, for unlike the poor beleaguered nations of the eurozone

periphery, we've not had this misery forced on us by the ghastly euro, but have

opted for it as an unnecessary penance for the sins of the boom. If only we

could be persuaded to forsake " Osbornomics " and tread the path originally set

out by our dearly beloved former leader, Gordon Brown that of spending our way

back to growth then all would be well again.

Put like that, of course, it sounds ridiculous, but the fact that Krugman is a

Nobel prize-winning economist gives Labour's calls for a U-turn on the economy

an intellectual credibility they would otherwise struggle to attain.

All the great economists from Adam to Maynard Keynes were as much

moral philosophers as dispassionate analysts of events, and Krugman is no

exception, preaching his message with all the passion of the religious zealot.

He feels our pain and begs us to let him help. " The road out of depression and

back to full employment is still wide open, " he insists. " We don't have to

suffer like this. "

Krugman may appear loud and radical, but he follows a fairly standard Keynesian

text. By his own admission, the social cost of the present downturn doesn't come

anywhere close to the Great Depression of the interwar years, or not yet. None

the less, there are parallels, and we already meet Keynes's classic definition

of a depression as a " chronic condition of subnormal activity for a considerable

period without any marked tendency either towards recovery or towards complete

collapse " .

In such circumstances, monetary policy can help, but only up to a point. In a

depression, even those with the balance sheet strength to spend and invest won't

do so, whatever the encouragement offered through ultra-low interest rates. It

follows that governments should step into the breach and do the job instead, as

a kind of spender of last resort. They can worry about the accumulated debt

later, once output has picked up again.

To Krugman, it's understandable that policymakers screwed up so monumentally in

the Great Depression; they didn't understand what was going on and there was no

template for the circumstances they found themselves in. To his mind, there is

no excuse this time around; it's textbook stuff, which is being wilfully

ignored.

But haven't we already tried borrowing to stimulate? And what did it deliver

other than fiscal ruin, which in the eurozone periphery is so serious that

markets have stopped lending altogether? Krugman has an answer for these

questions, too. It's not the policy that was wrong, merely that the stimulus

wasn't big and sustained enough. As for the eurozone, again, it wasn't the

policy, but the euro. Countries with their own currencies and central banks

won't run into this kind of problem. In extremis, they can always print the

money.

Easy peasy, then. What's not to like? Well, I'm sorry, but I just don't buy it.

It may or may not be possible for a vast, largely internalised economy such as

the US, with its reserve currency status, to run double-digit deficits into the

indefinite future without adverse consequences, but for the UK it is a much more

questionable policy.

True, Britain has lived with much higher debts relative to GDP in the past, but

this has nearly always coincided with major wars. With demilitarisation, much of

this borrowing to spend falls away and domestic consumption comes roaring back.

No such get-out-of-jail-free card exists this time around. Further, the

demographic is completely different from that of the post-war baby boom

generation, where growth and therefore debt erosion were more or less

guaranteed. Today, the unfunded liabilities of an ageing population stretch

menacingly into the long-term future.

As it is, government spending in the UK is already approaching 50 per cent of

GDP. Just how high does Prof Krugman propose it should go? It's all very well to

say " jobs first " and worry about the deficit later, but once government spending

becomes entrenched, it's very difficult to get rid of it. Even Reagan and

Thatcher struggled to make significant inroads.

In any case, the picture Krugman presents of wrong-headed British austerity is a

caricature of the reality, though one admittedly encouraged by the Coalition's

rhetoric. Yesterday's revised GDP figures, showing that the country is even

deeper in recession than we thought, would appear to support the mocking tone in

which Krugman condemns the idea of " expansionary austerity " . But where is this

austerity? In fact, one of the few positive contributors to output in the last

quarter was government spending, which grew by 1.6 per cent. Krugman seems to

have forgotten the automatic stabilisers, which because of our welfare state are

considerably bigger than in the US. In America, much current UK spending would

count as a discretionary fiscal stimulus of the sort End This Depression Now!

advocates.

As Raghuram Rajan, a former IMF (Berlin: MXG1.BE - news) chief economist, has

argued, today's troubles are not simply the result of inadequate demand, but of

major changes in the world economy brought about by globalisation. The old

monopoly of knowledge and expertise once enjoyed by advanced economies has been

swept away. For decades, we compensated for the jobs and income lost to

technology and cheaper foreign competition with unaffordable government spending

and easy credit. Much of the growth enjoyed in these pre-crisis years was simply

unsustainable.

Krugman's message is seductive, but it's also unrealistic. If only the

solutions to our plight were as simple as he thinks.