Paul Krugman has been ranting in the New York Times about the need for more stimulus. He's been doing this on a weekly basis for, well, it seems forever. In his recent column, "Easy Useless Economics," he lambasts economists who think the economy's job problems are structural -- too many people trained to work in the declining industries, like construction and finance. He's also taken on economists who think the economy has suffered a productivity shock.
Paul says the jobs shortages range across all industries and the idea that worker productivity nosedived precisely on September 15, 2008, when Lehman Brothers collapsed and U.S. firms began firing close to a half million workers each month, is simply silly.
Paul thinks that structural and productivity shock explanations are not only "useless," but cruel because they divert attention from what he knows to be the problem -- lack of demand, for which there is a clear solution -- have Uncle Sam print or borrow more money and spend it, presumably on goods and services produced by American workers.
I appreciate and share Paul's consternation and outrage that we have still have 27 million Americans out of work or short on work five years after the economy turned south. I also think the productivity shock explanation is ridiculous and that there is structural unemployment, but that it's the byproduct of the economy's failure, not its cause.
What I have trouble grasping, though, is the precise reason Paul thinks the economy has settled into its current unemployment and underemployment trap.
Paul's saying there is too little demand is not particularly edifying even when he quotes Keynes to back himself up. The structural unemployment economists would say there is too little demand for workers in declining industries. The productivity shock economists would say a drop in worker productivity has lowered the demand for their services.
So "too little demand" does not distinguish Paul's views about the labor market from others.
Traditional as well as New-Keynesian economists argue that there is too little demand because a) firms set their prices too high, so they get too few customers and, therefore, lay off workers or b) workers require wages that are higher than firms can afford to pay, so firms lay off workers until having so few workers raises the productivity of the ones they retain by enough to pay what's required.
There's not a lot of strong evidence in favor of price rigidity. Wage rigidity has more empirical support. Yet, just as it's silly to assume labor productivity dropped suddenly starting precisely on September 15, 2008, it's silly to believe that prices and wages suddenly became too high on that day.
And if either of these were the explanation, Paul should be calling for firms to cut their prices or workers to cut their wage demands. Yet, he's not doing this. He does want the Fed to engineer an inflation, which would make rigid prices and wages low in real terms, but I don't really think Paul believes in either price or wage rigidity.
I say this because I wrote a Bloomberg column awhile back suggesting the President put Paul and Jaime Galbraith in charge of finding markets with price and wage rigidities and telling the perpetrators to change their behavior. Both Paul and Jaime instantly and angrily blogged that they didn't believe in these rigidities and that I didn't understand Keynes.
Frankly, I don't know if Keynes understood Keynes. But, anyway, let me accept that Paul doesn't believe that price and wage rigidity are the reason for too little demand for labor.
(I must interject, though, that if Paul doesn't believe in price rigidity, he shouldn't be yelling at the Chinese for manipulating their exchange rate since with price flexibility, the real rates at which U.S. and Chinese goods swap -- the real terms of trade, won't depend on the rate at which the exchange rate is set.)
So what then is left for Paul's explanation of too little demand? Perhaps it's what we economists call coordination failure -- the proposition that economies can come to rest in multiple places (have multiple equilibriums), some with high and some with low employment. Such coordination failures arise because real world, as opposed to textbook, economies don't have anyone coordinating supply and demand.
There is no one to get suppliers (firms) and demanders (households) on the same page, where the suppliers know what and how much the demanders will want to buy and the demanders know exactly how many of them the suppliers will employ.
Hence if employers come to believe that other employers aren't hiring (and, therefore aren't producing customers), they won't hire (produce customers), and if they believe the opposite, they will hire.
Economists have written down mathematical models of coordination failures for decades. It's certainly something Keynes put his finger on (There, I'm referencing him too!) when he raised the sensitivity of the economy to "animal spirits."
But if coordination failures are what Paul thinks is the too-little-demand problem, it would be nice for him to say so instead of keeping his readers guessing all these years. His readers might be more willing to accept his prescription if they understood fully his diagnosis.
I'm pretty sure that it's coordination failure that Paul's worried about. He says in the column that we got out of the Great Depression in 1939 when the military started hiring for its needs. The important point about that hiring is that in so doing the military knew there was a demander (a customer) for the military services it would produce, namely itself -- the military.
One thing about that episode is clear. Everyone agreed that we definitely needed the military services that the military purchased. Without those services, we would have lost the war.
But aren't there things that the government, today, definitely needs to produce? What about having the government build and give away tens of thousands of new homes in our blighted inner cities for which it could hire the million-plus construction workers who need work? Doing so would assure there was a demander, Uncle Sam, for the supplier, Uncle Sam.
But would everyone agree that having Uncle Sam hire otherwise unemployed construction workers to do good things for bad cities is a great idea? Would people living in the suburbs, for example, want to pay higher taxes to rebuild Camden, N.J.?
Probably not, which is why Paul is pushing for the government to borrow or simply print the money. This way it's not so clear who will pay for the government's direct or indirect hiring. With borrowing, it will be us in the future, our kids, or our grand kids who'll pay the taxes to service the new debt. And if Uncle Sam just prints money to rebuild Camden, prices will eventually rise and everyone with nominal assets, like cash or regular bonds, with see the purchasing power of these assets drop.
In not spelling out what's really wrong with the economy or whom he really expects to pay to fix it or pretending the costs will be minor because they can be deferred or obscured via inflation, Paul's being disingenuous.
We know that Paul would love to force the rich to pay more taxes to hire construction workers to build new houses to give to Camden residents for free. My dad and his brothers had the first and last department store in Camden, so I'd love the rich to also pay more taxes to refurbish Kotlikoff's and give it back to my family for free.
Trouble is that the rich aren't necessarily up for this arrangement. They don't want to be taxed directly or indirectly, via inflation. They also don't want to see their kids taxed down the road. And the middle class, realizing that the rich are powerful enough to avoid being taxed, may not be up for this arrangement either.
So when Paul rails on about the need for more stimulus and doesn't tell us who will pay for it, he must think that his readers don't care about future taxes and inflation.
But maybe I'm being unfair to Paul. Maybe he real thinks that, thanks to the government's intervention, the economy will psyche itself up, coordinate on good times, produce good times, and, therefore, produce the extra revenue needed to rebuild Camden.
This is demand-side, as opposed to supply-side, magic. But is this magic for real? And if it's for real, can we access it more cheaply than Paul seems to recommend?
The coordination failure models do contain this magic as a real possibility. By coordinating beliefs on good times -- where all firms know that all other firms are hiring and thus producing more customers (namely the people being hired), the government can flip the economy from a bad to a good equilibrium in which everyone is fully employed and output and tax revenues are higher.
The question then is how, precisely, can the government coordinate beliefs on good times?
I guess Paul would say that if the government very publicly spends a lot of money on things, that act alone will coordinate the beliefs of millions of individual firms on good times. Maybe this is what Keynes (There I go again!) had in mind when he said even paying workers to dig ditches and refill them could fix the economy.
It might or might not. It might lead the public to think times must really be bad if the government is spending so much money trying to fix things.
Psychology, particularly mass psychology, is a tricky thing to orchestrate, particularly for economists. Maybe this is why Paul hasn't admitted that he thinks coordination failure underlies the economy's failure. Doing so would show he's trying to play psychologist, and a very expensive one at that.
Where do I come down?
I agree with Paul or at least with what I think Paul thinks. I think we are experiencing a massive coordination failure and that there is economic magic available to fix it. But unlike Paul I think that that magic can be had for free.
Let's go back to September 15, 2008. Suppose the 8.5 million American workers fired in the subsequent 19 months had all been fired on September 15th? What would we have concluded? We'd have concluded that something, namely panic, coordinated the massive firing.
Now what if President Bush had gone on the tube and explained to everyone that they had panicked over nothing fundamental, that the Fed was going to be our temporary banking system as needed, and that he was ordering every firm to immediately rehire everyone they had just fired and keep them on for the next year until the panic subsided?
Yes, that would have been illegal, but put legality aside for the moment. My guess is that this would have worked. The reason is that the millions of different employers in the country would have realized that the same customers they had on September 14th would be there on September 16th.
Note that ordering firms to retain workers wouldn't have entailed borrowing money, printing more money, or spending more money. I.e., it wouldn't have involved stimulus at all. It would have involved manipulating mass psychology to calm a hysterical economy at a very low price, namely zero.
It's not September 15, 2008 any more. But coordination failure still afflicts us. Uncle Sam has spent massively to both change economic perceptions and, in raising future taxes, force future taxpayers to pay for (demand) more current output that they, themselves, won't get to enjoy. Yet, Paul says Uncle Sam hasn't spent enough.
I say, let's coordinate a mass rehiring of workers on a voluntary basis by asking all large and medium-sized employers to increase their employment by 5 percent.
As those of you who follow my blog know, I'm running for President as described at www.kotikoff2012.org. And I say on that site and I've said elsewhere in print that on day 1 as President I would bring together the CEOs of the country's 1,000 largest employers and exhort them to all hire 5 percent more. Day 2, I'd meet the next 1,000 largest employers, and continue either in person or via my staff down the line.
Again, we have 27 million Americans today out of work and short on work. If all our large- and medium-sized firms voluntarily hired 5 percent more workers they would magically find they had collectively produced more customers, namely these 27 million people they just hired.