Monday, September 6, 2010

Paul Krugman's Blind Eye: 1938

Paul Krugman's September 5, 2010 New York Times Op Ed, 1938 in 2010, turns a blind eye on many of the economic and political realities of both 1938 and 2010. I don't think this is because space in an op ed column is short, and the realities were (and are) two complex to cover completely in a short essay. He ignored what contraindicated the pie he is selling. Paul Krugman is a pretty astute guy, even the Nobel Prize committee thinks so, so let's take a look at his blind side.

Krugman's basic thesis in 1938 in 2010 is that in 1938 the Great Depression had a comeback because of lack of federal deficit spending. He goes on to say that the massive deficit spending during World War II (the U.S. officially entered the war in December, 1941, but began re-arming seriously in 1939) led not only to the end of the Depression and prosperity, but also to the long-term success of the U.S. economy during the second half of the 20th century.

Economic cycles are not really simple downward or upward slopes. Even in aggregate (on the macroeconomic level) they exhibit short-term changes of speed and direction. If you look at sectors (for example housing, or medical services, or steel production) they are typically not fully synchronized, and each sector has its ups and downs on a monthly or even weekly basis.

In the 1930s two command and control economies were growing: the communist economy of the U.S.S.R. and the German economy under National Socialism. Franklin Delano Roosevelt's New Deal failed to produce similarly spectacular results mainly because it was not as centralized or as well thought out. Of course command economies do not always do well; sometimes they fail spectacularly. Same for capitalist free-market economies, and even for mixed economies. But in the late 1930's the global economy was reviving mainly because of the expanding German and Russian economies, which were about as command-control as you can get.

Germany was also re-arming. Eventually other European nations felt they also had to re-arm, and eventually even the U.S. re-armed. This stimulated the economies of the re-arming nations. But the nation that benefited most was the United States. The British Empire, that cruel monster, borrowed money from the U.S. and bought armaments or the makings of armaments (steel, in particular). This external stimulus, plus the fact that the U.S. economy was already in a late-Depression natural economic upswing, is what caused the U.S. economy to be clearly in an up cycle in 1940.

Of course the massive U.S. debt run up during World War II stimulated the economy. But the debt was not what was responsible for postwar prosperity. Our global imperialist-industrialist rivals had their factories bombed to smithereens. Or in the case of Japan, vaporized.

If anyone in the world wanted to buy anything made of metal, after World War II essentially the only source would be the U.S. Even to rebuild their own factories Japan, Germany, Italy, and France had to buy machine tools and steel from the United States. Only the U.S.S.R. retained significant industrial capacity at war's end, and they had lost 20 million people in the war, which knocked back their economy but good.

If Mr. Krugman wanted to engage in historical re-enactment arguments, he could urge Obama to bomb factories in Germany, China, Japan, Korea ... That would be a lot more effective than even greater deficit spending.

Krugman used a false historical analogy, but he still could be right when he says the U.S. economy would benefit from more federal stimulus. On the other hand, maybe when you have economic rivals that are not prostrated by war, stimulus backfires because it almost always uses resources inefficiently. The argument will go on. But using 1938 as a 2010 comparison is comparing two very different situations.

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