Krugman on Austerity

I rarely comment on Paul Krugman.  Austrian school economists often like to analyze Krugman and go after him.  I think they give him too much credit for popularity.  It is because he is a Nobel prize winner and a New York Times columnist.  But this doesn't mean much anymore.  Does Krugman really influence that many people?  Alex Jones, Matt Drudge, Lew Rockwell, Sean Hannity, and the latest American Idol winner each influence more people to a greater degree than does Paul Krugman.

With that said, I can't resist today.  I rarely read anything he says unless someone with a contrary point of view quotes him.  So I saw Bob Murphy's post on him today.  I read Krugman's post.  Krugman is either completely ignorant or he is a liar, or perhaps both.  He is loved by the establishment for his advocacy of big government.

In his latest post, he puts up a chart showing various countries with their change in employment percentages vs. their change in structural balance (what he calls austerity).  You can clearly see that Ireland and Greece have the worst change in employment.  Krugman is indicating that austerity leads to a depressed economy and higher unemployment.

First, I would like to point out that it is a bit of joke to say that Ireland and Greece are implementing austerity.  While the governments in those countries have been forced to cut back in certain areas, or at least forced to stop expanding the welfare state to such a great degree, they are both still massive welfare states.  It is not like they have gone to some kind of a limited government approach.  The taxes and spending in both countries are incredibly high, even by today's standards.

But even if Krugman were right and both of those countries had implemented massive austerity (spending cuts), does that really prove anything?  This should really be one of the most elementary things for an economist.  Correlation does not mean causation.  A wet sidewalk does not cause rain.

Take a family that makes $50,000 a year and has credit card debt that is $250,000.  At a certain point, just the minimum monthly payments become so great that that alone will exhaust most of the income.  If the family doesn't file for bankruptcy, then it must make drastic cuts to its budget.  That doesn't make the $250,000 in debt disappear.  The interest payments alone will make this family poor for many years to come, assuming no bankruptcy and no major increases in income.  The family will be in a recession for years to come.

While this isn't exactly a perfect analogy, it is enough to get the point across.  Of course Ireland and Greece are in depressed states.  Even if they had implemented major spending cuts in government, it will take time to recover.  The welfare states there are a giant misallocation of resources.  These resources must be reallocated by the market.  Then there must be savings and investment, which will eventually lead to increases in production.  When the government has messed things up that much, the economy cannot recover instantaneously.  It has to go through a correction.

Unfortunately, that is not even what is happening in Ireland and Greece.  They have just gotten to a point where big government has completely devastated their economies.  It means a dramatically lower standard of living for the people living there.  The governments, through their policies, discouraged saving and encouraged consumption.  It caused a total lack of savings and investment that has severely decreased production.  It has made virtually everyone living there poorer.

There should be a chart showing what happens to countries that follow Krugman's advice.  Greece and Ireland can be at the top of the list.  They would still follow Krugman's advice if it were possible, but it is impossible to spend something that is not there.  Socialist policies eventually don't work any more because there is no more wealth to be distributed.