On a Saturday blog entry, Paul Krugman explained “marginal thinking” —or the idea that the rational thinker will only commit to an action where the marginal benefits outweigh the marginal costs. For example, a producer will only sell his or her product if what the producer is getting in return is worth more than the product being sold (interestingly, the same works vice versa, since the purchaser will only pay whatever amount for any given item if the good is worth more than what the consumer is paying for it—it’s called subjectivity). In any case, Krugman applied “marginal thinking” to the stimulus and went on to claim that “when it comes to stimulus, there doesn’t seem to be a lot of marginal thinking going on.”
Current unemployment is now where Braford DeLong put "now", but on the dotted line.
Supposedly, according to Krugman, the marginal benefit of additional stimulus is increased employment. So far the empirical evidence seems to disagree with his position. Indeed, according to Bradford DeLong—another Keynesian blogger, closely followed by Paul Krugman—the administration believed that with the $800 billion stimulus package unemployment would peak at 7.9%. Instead, unemployment is currently at 9.7%. That is quite a difference. Of course, Bradford DeLong claims that without the stimulus unemployment would be “above 10%”, and the graph he provides masquerades the truth (where it says now is not current unemployment figures, but where the administration believed that unemployment would be after the stimulus package—the real unemployment figures are those shown by the dotted line, which is higher than what the administration believed would be with, and without, stimulus). On the other hand, Paul Krugman claims that the stimulus was “obviously” too small—well, how much would be enough?
But, why doesn’t credit stimulus increase employment over the long-run? At first, it might give the illusion that it does (although, so far, this hasn’t proven true). For example, the government gives “Business A” $200 million, which are used to expand a product line which adds two jobs per every store that the business owns. Theoretically, there has been an increase in employment. On the other hand, amidst economic uncertainty and falling sales it’s far more likely that that same business would instead use that money to afford current wages, as opposed to downsizing operations. But, that’s not the real problem. The real problem is that the credit extension offered by the government as stimulus provided false signals on the economic viability of investing in a new product line. That money does not accurately portray consumers’ demand, since the money did not originate from profit. Instead, wherever the money is invested it will be malinvested—the classic problem with all credit expansion that is not backed by real savings. And so, in the long-run, even if there was a slight increase in employment, stimulus will only increase unemployment, because the business was conned into spending money into poor assets. The same is true even had the business just propped current operations. If the business is losing money on current goods and services that it puts on the market, propping these same assets will not guarantee future profits. Indeed, there is no demand for these products. The best course of action would have been for the business to liquidate those goods and services and instead redistribute their capital and resources to where it was profitable.
But, that is not all what Krugman gets wrong. He goes to claim that the marginal cost is the additional debt caused by borrowing. In his own words, “does anyone really think that, say, another $500 billion in borrowing would be the straw that broke the camel’s back?”
Although it’s not clear what he means, the original $800 billion stimulus will already cost much more to the taxpayer—and taxes divert production. Indeed, as economist Henry Hazlitt taught in his book Economics in One Lesson, inflation is the worst form of taxation:
But suppose the public works are not paid for from the proceeds of taxation? Suppose they are paid for by deficit financing—that is, from the proceeds of government borrowing or from resorting to the printing press?[…] Yet when the government comes to repay the debt it has accumulated for public works, it must necessarily tax more heavily than it spends. In this later period, therefore, it must necessarily destroy more jobs than it creates. The extra heavy taxation then required does not merely take away purchasing power; it also lowers or destroys incentives to production, and so reduces the total wealth and income of the country.
Further stimulus may not collapse the dollar, but the claimed marginal benefits obviously do not exist and the marginal costs are much greater than what is suggested by the proponents of credit expansion. There is no long-run increase in employment, only an increase in unemployment, and the cost to the taxpayer will over time be much greater than the original value of the borrowed credit. In other words, Obama’s stimulus packages will only make the depression (yes, we are in a depression) longer and harder.
Krugman concludes that “ratifying what we’ve done… makes very little sense.” Nobody is ratifying what has been done—they are taking the lessons learned (that fiscal stimulus does not actually stimulate the economy) and deciding that any further fiscal stimulus would only worsen the situation. Unfortunately, there are still a large amount of economists and politicians (in the latter case, the majority) who believe that further stimulus is the answer to our woes—my question to them is “how much is enough?” If $800 billion was insufficient, what guarantees that $500 billion will be enough? Take a look at Japan—ask them how much was enough. For all the spending they did and all the debt they have accumulated over the past two decades, their economy never recovered. The folly in artificial fiscal stimulus should be clear enough. It is rather unfortunate that those people with political agendas ignore reality and instead advocate policies that will only deepen the economic trench the government has been digging for us.
