Monday, January 2, 2012

Krugman, yet again...

Yes, another post on Krugman. Apologies.

This time he is claiming that nobody understands debt. Apparently, he does.

The first actual point he makes is this:

People who get their economic analysis from the likes of the Heritage Foundation have been waiting ever since President Obama took office for budget deficits to send interest rates soaring. Any day now!
And while they’ve been waiting, those rates have dropped to historical lows. You might think that this would make politicians question their choice of experts — that is, you might think that if you didn’t know anything about our postmodern, fact-free politics.
 I think I covered this point in my last post. He goes on to discuss the analogy with family debt, and says:

First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.
And a family just needs to grow it's income faster than the growth of debt. Just as with a family, if income is not growing fast enough, then the debt becomes a crippling burden. He then goes on to compare the debt levels after the World War II, and correctly claims that the US had substantial rises in income, despite the huge debt levels accrued during the World War II. This is true, but what has it to do with today. In World War II the debts accrued because the productive capacity of the US was turned over to destructive capacity. At the end of the war, the economy returned to productive capacity. Where is this huge switch going to come from today? There is no possibility of such a switch around today, because the circumstances are completely different.

Even more worrying is that this is the current account of the US, taken from Econbrowser:


This is a historical view of the US current account (from here), that includes the 1950s, and gives the current account as a percent of national income.

So, Professor Krugman. The current situation and post World War II are comparable in exactly which way? When you are running large current account surpluses, it is not so difficult to get out of debt. However, the US is going in the opposite direction. Again, think of the family and whether they are growing their income. No, the current account deficits are being funded by debt.This brings me neatly onto the next part of Krugman's analysis:
It’s true that foreigners now hold large claims on the United States, including a fair amount of government debt. But every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners. And because foreigners tend to put their U.S. investments into safe, low-yield assets, America actually earns more from its assets abroad than it pays to foreign investors. If your image is of a nation that’s already deep in hock to the Chinese, you’ve been misinformed. Nor are we heading rapidly in that direction.
The charts seen above show that this is irrelevant. The US economy is borrowing and consuming more than it produces overall. This is what a current account deficit represents. He does at least concede that debt is not entirely harmless:

Now, the fact that federal debt isn’t at all like a mortgage on America’s future doesn’t mean that the debt is harmless. Taxes must be levied to pay the interest, and you don’t have to be a right-wing ideologue to concede that taxes impose some cost on the economy, if nothing else by causing a diversion of resources away from productive activities into tax avoidance and evasion. But these costs are a lot less dramatic than the analogy with an overindebted family might suggest.
So the danger with higher taxes is that it causes avoidance and evasion? That's it? If that is the case, then higher taxes must be assumed to have no negative impact upon the economy, provided that the system prevents avoidance and evasion. Why not then, raise taxes to 80% of all income, and some of the new tax revenue to absolutely prevent evasion and avoidance. With sufficient resource thrown at the problem, then it would be impossible to evade or avoid the tax. Is this what he is saying; that the only problem with high taxation is avoidance and evasion? Really? What does Krugman mean by 'if nothing else'? This is simply fatuous.

Krugman then goes on to suggest that history shows that countries can live with high levels of debt, but does nothing to compare levels of debt with the ability to service debt. And this is exactly the point, and what modern Greece illustrates. Compared with some historical examples, Greece's debt looks relatively benign. However, it was not benign because Greece was, like the family going too far into debt, unable to service the debts it was accumulating. The growth in debt was exceeding growth in income, with ongoing and growing current account deficits rooted in debt:

Yes, Professor Krugman, it is always possible to give examples from history of high levels of debt. But are they applicable to the current situation of the US, or of other economies whose overall circumstances are different from the examples given.

Why do I pay so much attention to Krugman? It is because he is influential, and because he is an exemplar of how black can be turned into white. He has a great ability to mix up examples and illustrations which do not have applicability to the current situation. For example, in the post-WWII scenario, there was no direct equivalent of the hyper-competition that comes from the BRIC economies. The US position as the world's leading and largest economy saw no similar challenge. However, apparently, the situation post-WW II is comparable to now. It is a view that will give false comfort, and lead to complacency. Such muddle headed thinking needs to be challenged.

Note: Regular readers will know that I do not believe that governments of developed economies have any reason to borrow in the first place, but I will leave that to one side for this post.


  1. What about Krugman's point that we owe this debt to ourselves? I don't think you addressed that? If we are paying off others (mostly) then obviously thats bad, like a mortgage - but if we are paying off ourselves as he says?


You are more than welcome to comment on the posts, but please try to stay on topic....I will publish all comments, excepting spam and bad language, and my moderation of the comments is just to exclude these.

Please allow up to two days for the comment to appear.

I have had a request for an email address for the site and have created the following:


I have ommitted the @ symbol to avoid spam....

For general purposes I would suggest using the comment form, but will occasionally look at this email account. Please be clear what is for publication and what is not, though I will also not guarantee publishing of email comments, unlike the comments through the form! Thanks.