Can Krugmanomics Be Saved?

Paul Krugman recently penned a 6000 word essay for New York Times Magazine provocatively titled “Can Europe Be Saved?”(January 16, 2011) Coming from anyone else than a Nobel Prize winning economist, such a title questioning the survivability of the largest economy in the world, with more Fortune 500 companies than the United States and China combined, would be laughably dismissible. Imagine an essay titled “Can America Be Saved?” Or “Can China…” or India or Brazil or planet Earth be saved, and you can grasp the hubris of the framing.

So I presume that Professor Krugman did not write the title, probably it was written by some bleary-eyed copy editor at 3 AM who did not even notice that the article is not even about “Europe” but about the “euro.” A title of “Can the Euro Be Saved?” is a better fit for the article itself and is worth discussing. Asking “can Europe be saved?” is cataclysmic thinking on the silliest order.

In his New York Times column and bestselling books, Professor Krugman has done yeoman’s work in educating millions and being a commonsensical center-left voice in a fairly narrow American political landscape. He is one of a rare American breed, a public intellectual that reaches a mass audience. The last time I heard, he also is still teaching a course load at Princeton University, in addition to writing a blog, appearing frequently on TV and giving public lectures. He is clearly putting his heart and soul into his work, and for that we owe him our gratitude, even when we don’t agree with him.

Unfortunately, Professor Krugman also has his blind spots, and they are laced throughout his essay. Krugman lays out familiar arguments regarding the challenges of the euro zone and its 17 member states; there really is nothing new here that Krugman and others haven’t covered extensively before. But the more revealing aspect of Krugman’s essay is what he left out. As such, it reveals much about the fallacies of his thinking regarding international economics, and to some degree about the economics profession in general. The European and U.S. economies have diverged in fundamental ways and had been leaving different tracks in the sand well before the economic crisis. But the boilerplate of Krugmanomics, applied in a one-size-fits-all fashion, prevents Krugman from being as astute a commentator on either Europe or international economics as he is on U.S. domestic politics.

In a nutshell, Professor Krugman argues the following in his essay: The euro was always a dubious idea because it did not combine a monetary union with a fiscal union. But European leaders “engaged in magical thinking” and pretended the downsides didn’t exist. Chief among those downsides is that individual eurozone nations have lost their monetary flexibility, so when a country like Ireland has a crisis it can’t devalue its currency in an attempt to boost its competitiveness, exports and employment, because it now shares that currency with 16 other nations. Instead, it must cut government spending and workers salaries to increase competitiveness, relinquishing the chance for Keynesian type stimulus spending to jumpstart the economy, further deepening its economic crisis and enduring painful deflation.

Of course, deeply troubled U.S. states can’t devalue their currency either, since all share the use of the dollar, but Krugman says they benefit from a key difference: a “transfer union,” led by a central federal government that can bail them out when the going gets tough. Also, the U.S. has a more mobile workforce that can move when jobs are scarce to where jobs are more plentiful. European nations, Krugman says, have neither—language and cultural barriers discourage migration, and strong countries, especially Germany, have been refusing to help weaker ones sufficiently. But Germany’s selfishness must change, Krugman argues, if the eurozone is going to survive. “Odds are the current tough-it-out strategy won’t work. … Europe’s stronger nations will have to make a choice.” Yet Krugman hints at his own doubts that Europe will make the correct choice. His piece has all the drama of an oracle predicting an economic disaster in the making.

But the first crack in Krugman’s thinking is revealed at the end of his very first paragraph, when he writes: “Europe’s gross domestic product might have fallen as much as [in the U.S.], but the Europeans weren’t suffering anything like the same amount of misery [as Americans]. And the truth is that they still aren’t.”

Instead of spending a few paragraphs exploring why it is that Europeans are suffering less than Americans – for example, exploring how Europeans have introduced elements of worker democracy into their social capitalist economy via practices like works councils, partially worker-elected boards of directors of major corporations (codetermination), a more robust cooperative system, short work and a culture of consultation which helps spread the pain around; or how Europe manages to provide quality, universal healthcare to all its people for about half the amount of money that Americans pay per capita for healthcare, even in the midst of an economic crisis; or how Europeans provide more support for families and workers than Americans can even imagine – is it due to better institutions, practices and policies? Is it better leadership? Is it dumb luck? Or is it just a matter of time before they are doing as poorly as Americans? — instead Krugman gives us 6000 words of macroeconomic boilerplate about how, as he says in his very next line, “Europe is in deep crisis.”

Certainly some countries in Europe, including the notorious PIGS (Portugal, Ireland, Greece and Spain), as well as the smaller Baltic republics and Great Britain, are having difficult times. But others – Germany for one, but also the Scandinavian countries, France, the Netherlands, Denmark, Switzerland, Poland and others in central Europe – are doing remarkably well. In fact, 14 of the 23 European countries that are members of the Organization for Economic Cooperation and Development have lower unemployment rates than the U.S., including Germany, Britain, Sweden, Italy and Belgium; France, which American ideologues typically like to skewer, has an unemployment rate the same as in the U.S. An article exploring why some countries in Europe are doing well and others not so well, and why most of them are doing better than the U.S., truly would have been a valuable contribution to the discussion. Instead, Krugman goes on to rattle off the well-traveled narrative about the lack of a fiscal union to go along with a monetary union that has been much discussed for months in numerous publications and websites.

The reason it’s important to point this out is because Krugman’s article unfortunately shares much in common with a long trail of gloomy and distorted American media reportage about Europe. Well before the economic crisis of 2008–9, the European economy (and especially the economies of Germany, France, and Italy) were regarded as in a state of perpetual crisis, written off by most American eurosceptics as a clumsy, sclerotic basket case, a “sick old man” condemned to long-term decline. Starting in 2003 and lasting until late in 2006, gloom and doom headlines predating Krugman’s prevailed in the U.S. media, such as “The End of Europe”; “The Decline and Fall Of Europe”; “Is Europe Dying?”; “Why America Outpaces Europe” and dozens more until —surprise, surprise—it was discovered that the European economy actually was surging and had equaled and then surpassed the U.S. economy during those years. In fact, an article published in theinternational version of Newsweek on November 20, 2006, blared the headline “The Great Job Machine: Despite Its Laggard Reputation, Europe Continues to Grow Faster, and Create More Jobs, than America”—yet that story never appeared in the domestic version of Newsweek. To this day, the patriotic U.S. media continue to shield Americans from injections of reality that are badly needed to understand our country’s relative standing in the world.

Krugman has contributed his share over the years to his readers’ confusion about international economics. For example, no one has been more influential in defining a misleading narrative about Japan being an economic basket case than Paul Krugman. Recall that in the early 1990s, in the wake of a recession, economists predicted that Japan’s surging, export-driven economy would eat America’s lunch and the U.S. would be looking at huge government deficits for years to come (indeed, deficit obsession gave Ross Perot his political rise in the 1992 presidential election). Then, by the end of the decade, the U.S. budget showed a sizable surplus and the schizophrenic economics profession did an about-face and concluded instead that the land of the Rising Sun had been mired in a “lost decade,” economically speaking. Krugman wrote a series of gloom-and-doom articles, with titles like “Japan’s Trap” and “Setting Sun,” bluntly stating: “The state of Japan is a scandal, an outrage, a reproach. It is operating far below its productive capacity, simply because its consumers and investors do not spend enough.” (italics mine)

But let’s look at some of the Japanese metrics during that time. Throughout the alleged lost decade the Japanese unemployment rate was a mere 3%, about half the U.S. unemployment rate. The Japanese also had universal healthcare, one of the lowest rates of inequality, higher life expectancy than Americans, and lower rates of infant mortality, crime, and incarceration. In other words, Americans would have been so lucky as to experience a Japanese-style lost decade.  Even today, Japan’s unemployment rate is about 5% –a bit over half the U.S. rate –and it still has healthcare for all its people, low income inequality, crime, incarceration, homicides and is one of the world’s leading exporters to boot. It also has been doing far more than Obama-led America to reduce its carbon emissions which contribute to global warming. While Japan certainly has its challenges – what economy doesn’t – doesn’t it sound like a country from which Americans might learn a thing or two about how to get out of the mud hole in which we are stuck?

Not according to Paul Krugman. In Krugman’s theoretical world, “consumption” and “aggregate demand” are crucial components and any country like Japan that falls short in those categories is portrayed as suffering from a disease. Indeed, the Japanese situation has been called “Japan syndrome,” sounding like a sickness to warn policymakers, as in “you don’t want to end up like Japan.” Experts like Krugman consistently have chosen to emphasize their own preferred measuring sticks, seeing the glass as half-empty rather than half-full (to be fair, recently Krugman has slightly retracted some of his earlier views on Japan in the face of his glaring oversights).

So Professor Krugman, unfortunately, has been part of this disquieting American tradition in which the media and leading thinkers have been so wrong about international economics and have misled Americans about our country’s relative standing in the world. It is important to keep that in mind as one reads Krugman’s NYTM article. Like his Japan narrative, Krugmanomics applied to Europe uses the wrong measuring sticks and results in a flawed understanding of Europe’s situation.

The transatlantic ideological divide

Professor Krugman’s article contains several inaccuracies in its rendition of the challenges and dilemmas faced by Europe. First, the author has manufactured his own version of recent European history. He writes:

“The tragedy of the Euromess is that the creation of the euro was supposed to be the finest moment in a grand and noble undertaking:  the generations-long effort to bring peace, democracy and shared prosperity to a once and frequently war-torn continent. But the architects of the euro, caught up in their project’s sweep and romance, chose to ignore the mundane difficulties a shared currency would predictably encounter…Instead, they engaged in magical thinking, acting as if the nobility of their mission transcended such concerns.”

In actual fact, European leaders were quite aware of the potential landmines of having a monetary union without a fiscal union. There was no “magical thinking,” just a pragmatic recognition of the compromises one has to accept sometimes to move an ambitious project forward. Europeans on both the left and the right, such as Jacques Delors, who as President of the European Commission (the closest thing Europe has to a U.S. president) laid the groundwork for the introduction of the euro, warned about the difficulties resulting from having a monetary without a fiscal union. Indeed, Delors considered fiscal federalism an eventual by-product of monetary union, once these defects manifested themselves. But the fact is, the disparate nations of Europe were not prepared to agree to the whole package at one time. Remember, this is a continent that not that long ago had fought brutal wars against each other, going back centuries.

So it was necessary to construct their union in stages (much as Obama is doing with his ambitious healthcare overhaul). A monetary union, a single European market, a European Parliament and some other common institutions and laws was the most they could get agreement on initially, knowing full well that at some point the defect of lacking a fiscal union would rear its gnarly head. Nevertheless, any steps taken toward creating a more unified Europe were broadly seen as having important political as well as economic advantages that helped to unite the European continent. So this was a compromise of necessity, not unlike the one that the American founders had to make in the Big State vs. Little State compromise over political representation (which resulted in every state, regardless of population, receiving two senators, a compromise that haunts the most populous states like California to this day since they are saddled with a transfer union that increasingly drains their state economies, as we shall see).

Indeed, Krugman doesn’t even bother to reflect on our own nation’s history, and how we came to become more of a union. Under the first government of President George Washington in 1789, the U.S. not only did not have a common fiscal policy from state to state, it didn’t even have a monetary union. Different currencies and scripts were used in the 13 different states. The situation was abysmal, causing the first Secretary of the Treasury, Alexander Hamilton, to embark on an ambitious project to create just such a fiscal and monetary union. His efforts were opposed mightily by none other than Thomas Jefferson and James Madison, who feared too much central government power, attesting to the complexity and controversy of these issues that is evident in Europe today. Would Krugman say about those early American efforts, as he has about Europe’s, that the elimination of the thirteen different colonial currencies for one unified dollar without a strong fiscal union was “magical thinking”?

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