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Krugman’s Tax-Enhanced Economic Recovery Fantasy

Politics / Economic Theory Jun 11, 2012 - 05:35 AM GMT

By: William_Anderson


Best Financial Markets Analysis ArticlePaul Krugman apparently believes that he has struck the mother lode: He has declared that Ronald Reagan actually was more "Keynesian" than Barack Obama. Why? He writes:

O.K., by now many readers have probably figured out the trick here: Reagan, not Obama, was the big spender. While there was a brief burst of government spending early in the Obama administration – mainly for emergency aid programs like unemployment insurance and food stamps – that burst is long past. Indeed, at this point, government spending is falling fast, with real per capita spending falling over the past year at a rate not seen since the demobilization that followed the Korean War.

He then goes on:

Why was government spending much stronger under Reagan than in the current slump? "Weaponized Keynesianism" – Reagan’s big military buildup – played some role. But the big difference was real per capita spending at the state and local level, which continued to rise under Reagan but has fallen significantly this time around.

And this, in turn, reflects a changed political environment. For one thing, states and local governments used to benefit from revenue-sharing – automatic aid from the federal government, a program that Reagan eventually killed but only after the slump was past. More important, in the 1980s, anti-tax dogma hadn’t taken effect to the same extent it has today, so state and local governments were much more willing than they are now to cover temporary deficits with temporary tax increases, thereby avoiding sharp spending cuts.

Actually, there is a mother lode of confusion here, something that Krugman is good at creating with his sleight-of-hand use of statistics, not to mention a total refusal to examine the substance of the economic recovery that occurred after the recession of 1982. First, the notion that "revenue sharing" programs by the federal government actually helped lead the recovery is a True Krugman Howler. The actual amounts of money that was distributed in the form of block grants with minimal federal regulatory oversight (something that Krugman no doubt would claim was evil) was a pittance in terms of overall state budgets.

Second, and even more important, Krugman is claiming that temporary tax increases by state governments played an important role in bringing about economic recovery. In other words, money taken from private citizens and businesses and given to state employees and businesses contracting with the state somehow turned around a nasty recession.

Unless Krugman wants to appeal to the silly "balanced budget multiplier," I am not sure that his "logic" makes sense. (The "balanced budget multiplier" is based upon the belief that government will spend all of the money taken from households instead of just part of it, so a tax increase will bring about stronger economies. Obviously, this "logic" ultimately leads to the Mother of All Prosperity Schemes: a 100 percent tax.) To claim that robbing Peter to pay Paul would bring about economic recovery simply does not pass the laugh test.

Krugman grasps at more straws with his statement that "weaponized Keynesianism" also helped bring about economic recovery. It is true that Reagan did push through spending increases for the Pentagon, and no doubt that made military contractors and their employees better off, but if ramping up military spending truly were a pure benefit rather than a cost, then I guess the key to prosperity today would be for the USA to invade yet another hapless Third World country.

(As in his statement that tax increases in the states played a strong rule in bringing economic recovery, Krugman would be hard-put to complain about American military adventures abroad, since they do result in more government spending, and as every good Keynesian knows, more government spending means more general prosperity.)

There is something that Krugman does not address in this article, and that is the amount of liquidation and economic shifting that took place during the 1980s. Since Krugman and I were born in the same year, both of us remember some of the things that occurred during the recession of 1982 – and the claims that were being made at the time.

A lot of farmers that had piled up debt (at the urging of federal agriculture officials) in anticipation of inflation and a permanent increase in crop prices found themselves watching their farms being sold at auction after crop prices fell in the wake of the Federal Reserve System's efforts (under Paul Volcker) to cut back money growth. I distinctly remember Dan Rather beginning one of his broadcasts at a farm auction, and Hollywood produced a spate of movies decrying the demise of debt-ridden farmers.

A large number of older iron and steel foundries were abandoned, giving rise to Billy Joel's hit song, "Allentown," and places like Pittsburgh, Pennsylvania, underwent fundamental economic changes as whole industrial sectors that were the basis of the economies in those places shut down. Likewise, a number of U.S. automobile plants shut down permanently (and the way was paved for automobile companies from other countries to build non-unionized plants in the USA, plants that have performed much better than their American counterparts).

There also were fundamental changes in transportation, as the Interstate Commerce Commission regulatory schemes that created cartels in trucking and railroads were changed drastically and the ICC actually was phased out altogether. Entire new high-technology industries grew rapidly during this time, as changes in the rules governing telecommunications ultimately paved the way for the modern use of the Internet.

In other words, Reagan actually permitted huge portions of the economy to liquidate, a term that is anathema to Keynesians like Krugman. Despite the demands by members of Congress to adopt "industrial policies" that would prop up failing industries and create huge new subsidies for sectors favored by congressional Democrats, there actually was substantial free-market growth in the economy, and by the beginning of 1984, it was clear that the economy was in strong recovery mode.

Now, according to Krugman, what happened then actually was impossible. Yes, there was some growth in government, but certainly nothing like the massive spending that Keynesians claim would have been necessary for real economic recovery to have occurred. Furthermore, Keynesians would have us believe that the amount of liquidation that happened in 1982 and beyond would have dragged the U.S. economy into oblivion, but that clearly is not what happened.

People trained in statistical methods know that there always are clever ways to present numbers, and Krugman is playing that game. A number of people already have dealt with his numbers trickery and I won't join them. Instead, I wish to deal with Krugman on the basis of theory.

According to Paul Krugman, the economic recovery of 1983-84 could not have happened, given the liquidation that accompanied the recession, yet it did. Thus, he is forced to make up the fantasy story that "revenue sharing," "weaponized Keynesianism," and state tax increases really were the secret to prosperity. Oh, and the rate of inflation fell sharply during that time, something that Keynesians would argue is not possible during a recovery.

Unfortunately, a lot of people buy into this nonsense – and it is nonsense – and it gives Washington the excuse that taking more of our money and blowing it on "green energy" boondoggles and worse will hasten economic recovery. No, these schemes hold back whatever recovery we might get.

William L. Anderson, Ph.D. [send him mail], teaches economics at Frostburg State University in Maryland, and is an adjunct scholar of the Ludwig von Mises Institute. He also is a consultant with American Economic Services. Visit his blog.

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    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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