Economists' duel

Don't Be So Aggressive, Mr. Krugman

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Dueling economists.
  • Why it matters

    Why it matters

    Economists disagree strongly over whether and how Greece should pay back its debts to its international creditors.

  • Facts


    • New York Times columnist Paul Krugman has strongly criticized Germany’s opposition to a further debt haircut for Greece.
    • Mr. Krugman and other left-leaning economists, such as Thomas Piketty and Joseph E. Stiglitz, have been critical of austerity in Europe.
    • Even John Maynard Keynes saw value in the kind of supply-side reforms that Germany is now demanding of Greece, the author argues.
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In a column for the New York Times this week, Paul Krugman strongly criticized Germany’s “morality-play economics”; he said the demands of the Eurogroup were “madness,” and said the suggestion that Germany’s demands mask a coup d’état mentality were “exactly right.”

The demands of the Eurogroup constituted an offer which Greece should not accept under any circumstances, Mr. Krugman wrote. But even if Greece were to accept the offer, it would mark “a grotesque betrayal of everything the European project was supposed to stand for.” 

Is this a case of somebody finally telling it like it is, without worrying about the diplomatic niceties of the job? Is an eminent expert – Mr. Krugman is a Nobel Prize winner in economics – revealing for us the dark side of international politics?

Far from it, unfortunately.

It is true that columnist Mr. Krugman has done a great deal for economic theory, but his contributions to economic policy in practice are nearly always polemical and sometimes highly aggressive.

His tirades against the group of euro states, Germany in particular, regularly cross the line of personal decency and are right up there with criticisms by other left-leaning economists like Thomas Piketty and Joseph E. Stiglitz. Speeches by German left-leaning Social Democratic politicians like Oskar Lafontaine are often based on the thoughts of Mr. Krugman & Co.

Expansive monetary policy leads to a fall in real wages. This fact is frequently not mentioned by Mr. Krugman, Mr. Piketty, Mr. Stiglitz.

What all these people have in common is that in terms of economic policy, they’re neo-Keynesians – their ideas are based on the influential economist John Maynard Keynes.

But in his seminal work, “The General Theory of Employment, Interest and Money,” Mr. Keynes very clearly saw value in improving supply-side conditions – the implementation of competition-stimulating reforms – and said this should take priority over measures to stimulate demand. On this point, Mr. Keynes was no different from classical economists like Adam Smith and David Ricardo, or neo-classicists like Paul A. Samuelson and Alfred Marshall.

Only in extreme crisis situations such as liquidity and investment traps – which, in reality, are extremely rare – did Mr. Keynes favor demand-stimulating measures. And even then, he preferred expansive monetary policy to expansive fiscal policy.

In his opinion, demand-stimulating measures could only work under very restricted conditions, for example, in an environment of fixed exchange rates. But the euro currency area doesn’t have fixed exchange rates against major global currencies such as the U.S. dollar, yen, pound sterling and Swiss franc. Moreover, there is no liquidity or investment trap in the whole of the euro area.

Another point: expansive monetary policy leads to a fall in real wages. This fact is frequently not mentioned by Mr. Krugman, Mr. Piketty, Mr. Stiglitz and Mr. Lafontaine. Mr. Keynes, whom they so like to quote, specifically envisaged a reduction of real wages in the case of a crisis – to unburden companies and enable them to invest again.

These left-wing economists are instead guided by models founded by the neo-Keynesians John Hicks and Alvin Hansen in the 1940s and 1950s, and which were further developed by various neo- and new Keynesians, both of which are different schools of thought. What these models have in common is that they ignore either completely or partially the conditions which Mr. Keynes formulated for expansive policies to be effective.

That means as a consequence, economists like Mr. Krugman, Mr. Stiglitz and Mr. Piketty can be accused of working without a clear theoretical foundation and ignoring central tenets of Mr. Keynes, whom they regularly invoke. The objective of an expansive monetary policy in particular amounts to a bottom-to-top redistribution – firstly, by the above-mentioned decreases in real wages, and secondly by asset price effects.

Thomas Piketty likes to remind Germany of the London debt agreement in the early 1950s, when around 60 percent of Germany’s foreign debt was canceled. This is what he suggests the European Union now do with Greece.

In this context, Mr. Piketty does not mention the debt reduction for Greece in 2012 amounting to €107 billion owing to private creditors, about 50 percent of the total debt burden at the time.

In addition, interest rates on Greece’s residual debt were reduced twice and repayment schedules moved back, in most cases by decades. That had the effect of reducing the discounted cash value of the state’s debt by a further 10 percent.

Above all, Mr. Piketty does not mention that after World War Two, German Economics Minister Ludwig Erhard had resolutely implemented wide-ranging competition-boosting reforms in the Federal Republic of Germany – starting in 1948, and even against the will of the U.S. High Commissioner of the time, Lucius Clay.

Thanks to Mr. Erhard, state management of prices, consumer goods, raw materials and resources was lifted, product and labor markets were liberalized, an anti-trust authority was installed, an independent central bank was created, capital flow controls were reduced, first free-trade agreements concluded, an efficient federal administration was created, an investment-friendly tax system introduced and executive state and local authorities were set up.

Paul Krugman takes the biscuit for polemics with his aggressive criticism of the federal government in the past few days.

He achieved all this despite initial resistance from Chancellor Konrad Adenauer, who was a traditional Rhineland Christian Democrat and only eventually supported Mr. Erhard’s social market economy when he realized it could win him votes and create jobs.

Such resolute growth initiatives are nowhere to be seen in Greece. So debt reduction without reforms to boost competitiveness will achieve little to nothing – they just play for time at best. Reforms to improve competitiveness are a precondition for Greece returning to growth – only then it would make sense to talk about further debt relief. Not vice versa.

Mr. Piketty also likes to remind Germany of the post-war U.S. Marshall Plan and calls for the European Union to finance a similar program. What Mr. Piketty does not say is that the Marshall Plan constituted only some 4 percent of German GDP at the time. In contrast, Greece – even without the debt reduction in 2012 – has received more than 400 percent financial aid from the E.U., or more specifically from the European Central Bank and IMF plus money from various E.U. funding pools for structural programs.

Mr. Stiglitz and Mr. Krugman make largely the same arguments, also demanding further steps from European monetary policy, as well as, needless to say, increased state expenditure. But they ignore any kind of competitiveness-boosting reforms. If asset prices rise as a consequence of these additional debts, both will presumably be quick to warn of asset price bubbles and over-indebtedness. And probably predict the bursting of future bubbles, despite this being the result of their own recipes. It’s a recipe for remaining the eternal admonisher and critic, no matter what happens.

But Paul Krugman takes the cake for polemics – with his aggressive criticism of the federal government in recent days. Does he really believe there is even one creditor out there prepared to risk another €20 billion with Greece, without demanding bigger efforts to implement competition-boosting reforms? It’s difficult to believe.

It remains unclear to the reader what is behind Mr. Krugman’s hate-filled tirades. But you could get the impression that he consciously uses the title of Nobel Prize winner as a weapon – to impose on the world his own ideas of morality and politics.


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