Friday, July 09, 2010

Krugman sees Spending as Spending

Paul Krugman sees hypocrisy when fiscal conservatives bemoan the lack of investment spending:
There’s now a lot of talk about the fact that U.S. corporations are sitting on a lot of cash, but not spending it. I don’t find that particularly puzzling: with huge excess capacity, why invest in building even more capacity. But almost everyone seems to agree that if we could somehow get businesses to spend some of that cash, it would create jobs.

Which then raises the question: how can you believe that, and not also believe that if the U.S. government were to borrow some of the cash corporations aren’t spending, and spend it on, say, public works, this would also create jobs?....

I have never seen a coherent objection to this line of argument.

Here's the difference. If a company spends money investing, it expects to create more value than it spends. That is, if the NPV of spending is greater than 0, meaning not merely via some multiplier, but the spender himself expects to garner more money than he spends, otherwise the NPV is less than zero. Businesses may make mistakes, but surely this is their expectation, and generally they are correct, as profits, on average are positive (in spite of Marx's prediction in Book 3 of Das Kapital).

So, having GOOG spend $1B creates more than $1B in wealth via a virtuous circle of self-interested exchange. In contrast, if the government spends $1B on a light-rail environmental impact study and Global Warming research, the payback is much less than the $1B. You can say such spending creates $1B+ in wealth through the multiplier, but many of us fiscal conservatives are skeptical of such multipliers, especially given the political context in which such spending decisions are made.

When businesses invest it is not merely that they are writing checks that makes it productive, it is that they are spending money where they by definition expect to create value. Decentralizing investment decisions, relying on individuals to create wealth, is the Invisible Hand. When government spends, this is hardly ever the case. It's a distinction with a difference, one that a true Keynesian simply can't understand.


  1. I like your commentary on financial matters a great deal. But I think your macro commentary is usually rather irrelevant. I suggest spending some time reading Scott Sumner's blog; I suspect his perspective would appeal to you.

  2. Ricardo3:10 PM

    Rather irrelevant? Nothing could be more relevant than this post, right now. Krugman and his ilk would like to squander economic value building bridges to nowhere, without considering that creating value is what improves society for all classes in the long run, not "creating jobs". This needs to be told to him, and the rest of the Keynesians, and repeated until it gets through their thick skulls.

    Eric, keep up the good work.

  3. If the government wants to encourage cash-rich companies to spend money now, why not offer them a 50% tax credit on new equipment purchases (or other capital spending) made before a certain deadline (e.g., within the next year)? To the extent that $1 of tax credits would encourage $2 of business spending, that ought to have a positive multiplier, no? And since it would be profit-seeking businesses, and not government, making the spending decisions, presumably, the spending would go in more productive directions.

  4. najdorf6:07 PM

    Eric - right on. I think it's pretty safe to disregard anyone whose opinions begin with "aggregate demand is good regardless of sustainability or quality of investment". That sort of thinking leads right to the idea that a Tulip Bubble is a Good Thing, because you have lots of demand meeting lots of supply and therefore the economy is strong.

    Dave: The history of stimulus via enormous tax credits is not exactly glorious. It's pretty much the same as the government spending to create demand, except with added possibility of clever folks gaming the tax code to derive positive risk-free returns at government expense from negative NPV investments. To the extent that the credit helps purchases that would have been made anyway, it just gives free money to corporations in exchange for accelerating their capex (which is then reduced in years with less attractive tax benefits). To the extent that the credit helps purchases that were not even close to economic, it has the problem Eric talked about. To the extent that the credit helps lift 5% return projects to 10% projects and pushes them over someone's cost of capital, we're just competing China in the application of massive stimulus to create enormous capacity in minimally profitable industries. Good luck with that.

  5. Drewfus5:58 AM

    In Australia, a first term Prime Minister has just been dumped (in favor of his deputy), partly due to the mismanagement and rorting associated with Keynesian stimulus projects. This is in a country that suffered the mildest of recessions at worst, and now has a 'headline' unemployment rate of 5.1%.

    The electorate do not seem to have bought the line that the waste is ok, "because its all stimulus", no matter how much politicians and the mainstream media attempt to 'educate' them. So as usual, what seems uncontroversial to the point of banality to economists like Krugman, still fails to convince the public.

  6. I suppose I should have been more specific. I think Falkenstein (and several commenters) are confused about monetary economics. It is difficult to say anything true and interesting about macroeconomics without understanding monetary economics. There are proper responses to arguments for fiscal policy (fiscal policy is certainly not my first choice for fixing today's problems), but Falkenstein's point, though true, is mostly besides the point.

  7. jsalvati: That I might disappoint you by arguing what you think is bad idea X while also promoting good idea Y, is just one of those unavoidable problems. Just remember, geniuses have bad ideas, madmen and evil monsters have good ones. You can't expect your friends, let alone your enemies, to be consistent in your epistemology. One way to solve the problem is to be a partisan, say a standard Democrat, Republican, Socialist, and follow the party line. Most popular blogs, in fact, follow this pattern (DeLong, Thoma, Krugman).

    But, I don't see how monetary policy's relative importance to fiscal policy relates to the Krugman comment. Krugman seems to think G=I as far as its effect, a claim I find ridiculous, but a Keynesian staple.

  8. "In Australia, a first term Prime Minister has just been dumped (in favor of his deputy), partly due to the mismanagement and rorting associated with Keynesian stimulus projects."

    I thought the proximate cause was the resistance to his mining Super Tax proposal. Gillard promptly walked it back and and worked out a less confiscatory proposal after discussions with the major miners.

  9. Najdorf,

    Is there any form of fiscal stimulus you (or Eric) would approve of? I can't tell from this post if Eric is against government infrastructure spending per se, or just against pointless spending. It seems to me that there are some forms of infrastructure spending that could both stimulate the economy in the mid term while increasing productivity over the longer term (e.g., building more nuclear power plants to ensure a plentiful supply of low cost energy for industry).

    But if you want to bring demand forward and have a fiscal stimulus that will have an impact in the near term, tax credits of the sort I mentioned would seem to be a reasonably efficient way of doing that. I could be wrong, but I find it hard to believe that most cash rich companies would invest in otherwise uneconomic equipment because of the credits; it seems more likely that they'd try to accelerate already-planned purchases instead.

    Another fiscal stimulus program that seemed to have a pretty big bang for the buck was the cash-for-clunkers programs, in Germany and (later) here in the U.S.

  10. Drewfus2:35 AM

    The tax on mining super profits (defined as profit above the long-term bond rate) was important, yes - it made the leadership situation critical rather than just problematic. But speaking of epistemological differences, your point reminds me to always keep in mind - "its more complicated than that".

    Besides, the mining tax was itself designed to help return the federal budget back to surplus asap, after the Keynesian 'spendathon' had turned a 1-2% of GDP surplus into a 3% of GDP deficit, in quick time.

    Of course, the big spending was credited with having saved the Oz economy from recession - the technical definition of two quarters of negative growth was just avoided. However, that many other countries employed the same Keynesian spending strategy to minimize the economic downturn, with mixed results at best, is apparently of very little interest. People like to feel in control of their destiny - therefore it worked.

  11. Anonymous10:26 AM

    @Dave --- "Another fiscal stimulus program that seemed to have a pretty big bang for the buck was the cash-for-clunkers programs, in Germany and (later) here in the U.S."

    Spend $3bn to destroy $4bn of productive capacity; you consider that "stimulus"? Why not just knock down and rebuild Manhattan?

  12. Anonymous4:24 PM

    Eric, I agree that Spending for the sake of spending is bad.
    But are you saying that public goods never have an economic value then their investment? Are you arguing that public investment never has a positive return for society?
    By your logic, we should we close all the schools, since they reduce wealth. And we close all the parks, since they reduce wealth?

  13. "Spend $3bn to destroy $4bn of productive capacity; you consider that "stimulus"? Why not just knock down and rebuild Manhattan?"

    If you're going to go for the Bastiat/broken windows tack, better to use his example than spout nonsense about knocking down and rebuilding Manhattan. Even better, you could justify the numbers you pulled out of your hat and address the specific examples I offered, of the cash for clunkers programs in Germany and the U.S., and explain why you think they were ineffective forms of fiscal stimulus, despite evidence to the contrary.

  14. dsquared1:58 AM

    A bit curious to use Google as your example of a private company here; if I was trying to make the point that government spending didn't create positive NPV investments, I'd try to draw people's attention away from the Internet.

  15. Anonymous8:13 AM

    "explain why you think they were ineffective forms of fiscal stimulus, despite evidence to the contrary."

    because they simply pulled forward consumption from the future.

    what would you term "effective" fiscal stimulus?

  16. Good post, and something that hearing Krugman on the radio was getting me to talk about. I was just last week discussing with a colleague about how an economy is like a multitude of (hopefully) positive NPV projects over time. A company or economy can create a lot of activity (which is all that static GDP measures) by engaging in a big wave of new negative NPV projects. But over time, such projects shrink the value of the entity in question.

    Krugman, fixated on static snapshots of activity, using a framework that doesn't consider the long run (see Keyne's famous quote about it), of course thinks there's no difference. Krugman's model assumes an infinite supply of fish, so why bother teaching people how to fish, when you can just give it to them?

  17. "because they simply pulled forward consumption from the future."

    That was sort of the point. You could argue that after monetary policy has shot its bolt government shouldn't use fiscal stimulus to ameliorate recessions, but it's hard to argue that fiscal stimulus of the cash-for-clunkers sort was ineffective in ameliorating a recession.