Paul Krugman wonders why, while an economic restructuring during a period of “bust” requires “massive” unemployment, restructuring during a period of “boom” does not. Krugman, in his post, refers specifically to a piece by Schumpeter (quoted from Essays: On Entrepreneurs, Innovations, Business Cycles, and the Evolution of Capitalism). He somehow ties Schumpeter’s theories (as well as those of contemporary “neo-classical” macroeconomists) with fiscal spending, and the effect the latter may have on unemployment. He ties his comment in with Schumpeter’s theory based on the so-called “hangover theory” (a term coined by Paul Krugman, not the economists he is criticizing). Whether or not Schumpeter is right (which, admittedly, he is not entirely correct in his economic theories, but that is beside the point), Krugman shows a tremendous amount of short-sightedness in his comment. Surely, a Nobel laureate and a scholar should be able to factor in the influence of the necessity to liquidate malinvestment.
Let us use the Austrian theory on the trade cycle to portray the “neo-classical” argument (it should be assumed though that other neo-classical schools of economic thought agree with the Austrian theory). Simply put, the theory suggests that government-induced (through the Federal Reserve) monetary inflation caused a variety of malinvestments. In the case of the current recession these malinvestments took place principally in the housing sector (both individual and commercial), although there were malinvestments elsewhere. These malinvestments were relevant to the capital-goods industry, but since the
re was also an extension of consumer credit the consumer-goods industry also saw an array of malinvestment. Krugman is correct in stating that the expanding sectors of the market necessarily drew labor from one sector to theirs. It would follow that there is a restructuring of the employment market, and therefore if the “hangover theory” is correct then Krugman holds that there should have been “massive” unemployment during the economic boom.
But, Krugman does not consider that while a time of economic boom there is no liquidation of malinvestment because monetary inflation continues to make certain lines of investment seem profitable, during a bust this no longer holds true. In other words, it is not the restructuring of the labor market which in and of itself creates unemployment. The origins of unemployment come from the liquidation of malinvestments. During a time of boom a laborer can quickly and immediately move (if the laborer possesses the right skills) to a new sector because that sector is immediately available. During a bust there is no alternative job immediately available, and so the laborer is forced into unemployment.
Although Krugman has repeatedly been caught making elementary macroeconomic mistakes in his analyses, this one should have come as a surprise. This was not an elementary mistake of economic theory. This mistake came out of a failure to objectively take into account all the factors, and instead blindly (and foolishly) criticize sound economic theory without any real argument.
If one asks why there is no alternative form of employment immediately available during a recession, then another would respond that during a recession there is a psychological impediment to investment. Recessions which are allowed to take place without government interference (or at least minimal government interference) usually are relatively short (take for instance the recession of 1921 and 1922, which in many ways was worse than the recession turned depression of 1929, but lasted for a much shorter period of time), which shows that the restructuring of industry can take place rather quickly. But, when government interference casts further shadows on the investment sector and produces economic uncertainty then that restructuring will take much longer, as people prefer to hold on to their money instead of investing it. This is why, despite the stimulus package, unemployment has continued to increase.
I think that sometimes Paul Krugman does not think things through before he says them, and he commits basic mistakes. We all do them, but I think that if one is to publish work on a blog read by tens of thousands daily then one should put a greater effort into proof reading and making sure that it is all theoretically correct. Even in this case small errors are explainable, but this was no small error.