Stiglitz vs Krugman

A very interesting front is opening up regarding the current state of America.

Some economists believe that the main problem in America is a lack of demand, defined as the desire to buy, the willingness to buy, and the ability to pay for it

From Paul Krugman:

There is nothing — nothing — in what we see suggesting that this current depression is more than a problem of inadequate demand. This could be turned around in months with the right policies. Our problem isn’t, ultimately, economic; it’s political, brought on by an elite that would rather cling to its prejudices than turn the nation around.

The implication here is that people just don’t have the money in their pockets to spend at the levels they were five years ago, and the solution is (through whatever means) giving them that money.

As well as the obvious (and accurate) Austrian retort that demand in 2006 was being pushed skyward as part of a ridiculous and entirely artificial debt-financed bubble, other economists believe that a lack of demand is just a symptom of other underlying symptoms. I myself believe that the three main problems are a lack of confidence stemming from high systemic residual debt, deindustrialisation in the name of globalisation (& its corollary, financialisation and that sprawling web of debt and counter-party risk), and fragility and side-effects (e.g. lost internal productivity due to role as world policeman) coming from America’s petroleum addiction.

Now Joe Stiglitz has weighed in in a lengthy and essential Vanity Fair piece:

The trauma we’re experiencing right now resembles the trauma we experienced 80 years ago, during the Great Depression, and it has been brought on by an analogous set of circumstances. Then, as now, we faced a breakdown of the banking system. But then, as now, the breakdown of the banking system was in part a consequence of deeper problems. Even if we correctly respond to the trauma—the failures of the financial sector—it will take a decade or more to achieve full recovery. Under the best of conditions, we will endure a Long Slump. If we respond incorrectly, as we have been, the Long Slump will last even longer, and the parallel with the Depression will take on a tragic new dimension.

Many have argued that the Depression was caused primarily by excessive tightening of the money supply on the part of the Federal Reserve Board. Ben Bernanke, a scholar of the Depression, has stated publicly that this was the lesson he took away, and the reason he opened the monetary spigots. He opened them very wide. Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level. Today it is $2.8 trillion. While the Fed, by doing this, may have succeeded in saving the banks, it didn’t succeed in saving the economy.

Reality has not only discredited the Fed but also raised questions about one of the conventional interpretations of the origins of the Depression. The argument has been made that the Fed caused the Depression by tightening money, and if only the Fed back then had increased the money supply—in other words, had done what the Fed has done today—a full-blown Depression would likely have been averted. In economics, it’s difficult to test hypotheses with controlled experiments of the kind the hard sciences can conduct. But the inability of the monetary expansion to counteract this current recession should forever lay to rest the idea that monetary policy was the prime culprit in the 1930s. The problem today, as it was then, is something else. The problem today is the so-called real economy. It’s a problem rooted in the kinds of jobs we have, the kind we need, and the kind we’re losing, and rooted as well in the kind of workers we want and the kind we don’t know what to do with. The real economy has been in a state of wrenching transition for decades, and its dislocations have never been squarely faced. A crisis of the real economy lies behind the Long Slump, just as it lay behind the Great Depression.

At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century—better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

What this transition meant, however, is that jobs and livelihoods on the farm were being destroyed. Because of accelerating productivity, output was increasing faster than demand, and prices fell sharply. It was this, more than anything else, that led to rapidly declining incomes. Farmers then (like workers now) borrowed heavily to sustain living standards and production. Because neither the farmers nor their bankers anticipated the steepness of the price declines, a credit crunch quickly ensued. Farmers simply couldn’t pay back what they owed. The financial sector was swept into the vortex of declining farm incomes.

The cities weren’t spared—far from it. As rural incomes fell, farmers had less and less money to buy goods produced in factories. Manufacturers had to lay off workers, which further diminished demand for agricultural produce, driving down prices even more. Before long, this vicious circle affected the entire national economy.

The parallels between the story of the origin of the Great Depression and that of our Long Slump are strong. Back then we were moving from agriculture to manufacturing. Today we are moving from manufacturing to a service economy. The decline in manufacturing jobs has been dramatic—from about a third of the workforce 60 years ago to less than a tenth of it today. The pace has quickened markedly during the past decade. There are two reasons for the decline. One is greater productivity — the same dynamic that revolutionized agriculture and forced a majority of American farmers to look for work elsewhere. The other is globalization, which has sent millions of jobs overseas, to low-wage countries or those that have been investing more in infrastructure or technology. (As Greenwald has pointed out, most of the job loss in the 1990s was related to productivity increases, not to globalization.) Whatever the specific cause, the inevitable result is precisely the same as it was 80 years ago: a decline in income and jobs. The millions of jobless former factory workers once employed in cities such as Youngstown and Birmingham and Gary and Detroit are the modern-day equivalent of the Depression’s doomed farmers.

The consequences for consumer spending, and for the fundamental health of the economy — not to mention the appalling human cost—are obvious, though we were able to ignore them for a while. For a time, the bubbles in the housing and lending markets concealed the problem by creating artificial demand, which in turn created jobs in the financial sector and in construction and elsewhere. The bubble even made workers forget that their incomes were declining. They savored the possibility of wealth beyond their dreams, as the value of their houses soared and the value of their pensions, invested in the stock market, seemed to be doing likewise. But the jobs were temporary, fueled on vapor.

So far, so excellent. Stiglitz first shovels shit over the view of Fisherian debt-deflation as the main cause of the slump in demand — debt-deflation is a symptom, and a very nasty one, but not really a cause. Second, Stiglitz also correctly notes that today’s ailments are the result of social, infrastructural and productive upheaval in the real economy. He correctly identifies the leading trend here — manufacturing (and, it should be added, primary industry) has been ripped out of America by the forces of globalisation, and the powerful pull of cheaper wages. This is a strong explanation of why Krugman’s view — that the only thing missing is demand, and that government can fix that in an instant — is nonsense.

As I wrote earlier this month:

The point here is that economic health — and real industrial output, measured in joules, or in “needs met” — and money circulation are in reality almost totally decoupled. Getting out of a depression requires debt erasure, and new organic activity, and there is absolutely no guarantee that monetary easing will do the trick on either count. Most often, depressions and liquidity traps are a reflection of underlying structural and sociological problems, and broken economic and trade systems. Easing kicks the can down the road a little, and gives some time and breathing room for those problems to be fixed, but very often that just doesn’t happen. Ultimately, societies only take the steps necessary (e.g. a debt jubilee) when their very existence seems threatened.

Stiglitz continues:

What we need to do instead is embark on a massive investment program—as we did, virtually by accident, 80 years ago—that will increase our productivity for years to come, and will also increase employment now. This public investment, and the resultant restoration in G.D.P., increases the returns to private investment. Public investments could be directed at improving the quality of life and real productivity—unlike the private-sector investments in financial innovations, which turned out to be more akin to financial weapons of mass destruction.

Now, I don’t really have a problem with the idea that government can do some good. If people in a democracy choose to solve problems via public spending, well, that’s part of the bargain in a democratic state. Even Adam Smith noted that government should fund “certain great institutions” beyond the reach of private enterprise.

But here we reach the great problem with Stiglitz’s view:

The private sector by itself won’t, and can’t, undertake structural transformation of the magnitude needed—even if the Fed were to keep interest rates at zero for years to come. The only way it will happen is through a government stimulus designed not to preserve the old economy but to focus instead on creating a new one. We have to transition out of manufacturing and into services that people want — into productive activities that increase living standards, not those that increase risk and inequality.

The United States spent the last decade (arguably longer) and trillions of dollars embroiled in wars aimed at keeping oil cheap, and maintaining the flow of global goods precisely because America is dependent upon those things. America does not play global policeman out of nicety or vanity — she does it out of economic necessity. That is precisely because America let globalisation take away all of her industry, making her dependent not only on the continued value of her paper dollar, but on the flow of global trade in energy and goods.

Investing more money in services will leave America dependent on these contingencies. And dependency is fragility — and the more fragile America becomes, the more aggressive she becomes in maintaining and controlling the flow of global goods.

Any stimulus package ought to instead be focussed on making America energy independent, and encouraging innovative new forms of manufacturing (e.g. 3-D printing) that can undercut Chinese labour.

So while Stiglitz must be commended for seeing through the haze, it is rather puzzling that his alternative is services, rather than self-sufficiency.

While America is dependent on foreign goods and energy, she is prone to not only waste huge amounts of productive capital on war and weapons, but she also risks serious economic damage from events such as oil shocks, geopolitical shocks, regional wars, and — well — anything that might slow down or endanger global trade. Her need to police the world makes her even hungrier for oil, which means she spends more money on the world, which makes her hungrier for oil.

48 thoughts on “Stiglitz vs Krugman

  1. I see a civil war in Saudi Arabia within the next 10 years. Whether we are involved or not, the price of oil will sky-rocket. The silver lining: other energy technologies become economically viable for the private sector. For better or worse we are dependent on technology and cheap energy. The transition will be wrenching and very disruptive, but it is coming. It may not be through war, just the peak of “easy” oil production. Only the free market can make the transition in an efficient manner.

    I cannot see any “service” area jobs that will bail us out. High level services, like financial analysis, can be done just as easily in China as in the U.S. If one can perform the service using a computer, it can be done anywhere the labor is cheapest. I cannot see clearly any answer to our loss of jobs. I would suggest we scrap “rigged” trade in favor of real fair trade and that we do all we can to make this the best country for manufacturing through infrastructure and tax treatment to stimulate investment in highly automated manufacturing facilities.

    The United States relationship to the rest of the world is like the Great Lakes. When the locks between the lakes are destroyed, the water level will tend to equal out. Only time will add more water, more demand for goods in China and elswhere. The wild cards will continue to be another massive world war or major technological break-throughs, especially in energy.

    • Agreed. I earn my income from the service economy, and I have seen over the last 10 years, IT, and Outsourcing to the Third World (India. Phillipines) make my income earning potential a lot tougher. So a service economy is not the answer. Countries need to have fair trade where health and labour laws are acceptable in a modern world. Agriculture, Manufacturing and Service sectors need to be balanced to allow the full spectrum of human abilities to be utilised. This prevents depression and skill loss among structurally unemployable and untrainable citizens. The government sector needs to be more efficient, so that welfare in the form of 100,000 dollar salaries is not justified because of a few “White Papers”.

      I agree a debt jubillee is required. This will allow a reset. However debt financing will reflect increased risk profiling. You will have to work and save for your next non essential trinket. Like it used to be. If you have capital you will not lend it will nilly!

      2012 will be a very very very interesting year, from a historical and economic history standpoint.

  2. I cannot see any “service” area jobs that will bail us out. High level services, like financial analysis, can be done just as easily in China as in the U.S. If one can perform the service using a computer, it can be done anywhere the labor is cheapest. I cannot see clearly any answer to our loss of jobs. I would suggest we scrap “rigged” trade in favor of real fair trade and that we do all we can to make this the best country for manufacturing through infrastructure and tax treatment to stimulate investment in highly automated manufacturing facilities.

    Nailed it.

  3. I am just a lay observer of the human world. I think we have been led by over-educated fools for too long, time we broke out from their ways. There are many alternatives that could be explored, we do not all have to work like crazy all our lives just to make ends meet. We could work shorter weeks, shorter days and still save enough for a comfortable retirement. We do not have to work in Dickensian ‘dark satanic mills’, nor in mediocre mind numbing service sector jobs. There are possibilities that would enrich us all, we just need to stop the theft and robbery carried out by the elites, remove them and their ways and it will open up the potential for great things. America became corrupted after its Civil War, when the Jeffersonian economic model was rejected in favour of the Hamiltonian model.

    • I believe that the coming technological revolutions will free a huge swathe of the population from the yoke of “Dickensian ‘dark satanic mills’”, and “mediocre mind numbing service sector jobs”. Specifically, decentralised automated energy production, and decentralised automated manufacture (3-D printing, molecular assembly). If we produce our own energy and goods we can do whatever we want with the balance of our time. That could be music, travel, writing, design, etc. This decentralisation would very much be neo-Jeffersonian, which to me is politically preferable.

      The real tests are geopolitical: can the current global infrastructure sustain us to the point where we can implement this new industrial revolution?

      I hope so. But war hawks love a good war…

      • I think the whole “slow money” movement, local production, local demands, paired with access to new technologies and many of these great works that the government should be doing anyway (see for how badly we’re really doing).

        We could also really use a smart grid, bringing energy competition to the individual level.

        More on slow money:

        • 1.Hand made leather shoes clothes that represent real quality and workmanship, including artistic flair and diversity or plastic Nike shoes and Tracksuit, Tshirt, Business Suit style?
          2. Organic seasonal food, cooked using a tried and tested family recipe, sold from a local home or McDonalds?
          3. Local Solar, Wind and Biogas powered generators or Fukashima style Genrators?
          4. Electric cars/bikes for local travel connected via public transport (Rail/Bus) or Ford F650 Pickups?
          5. Microfinancing based on local knowledge and mutual understanding of debtor/creditor situation or TBTF Banks?

      • A lot of what gets in the way of the Jeffersonian model is beyond our control. The one that pops into my mind is planned obselesence (not sure if I spelled that right). Things are made to break down after a certain amount of time. We can make things that last far longer, such as dish washers that are energy efficient and last as many as 40 years, but manufacturers don’t. Our commodities are on an international market, which is why oil production in the US brings little upside to local populations. Even the incorporation laws won’t allow too much grass roots financing and structure. Too much of the system is geared towards waste and large, structured institutions. It’s not merely a matter of our current choices, but decades of social structure.

  4. Uh, so it seems that it takes a Nobel laureate to say what an amateur like me has been saying all along: that you should actually look at what’s going on in the underlying “economy” (quoted so as to avoid giving the idea that I believe there’s actually an existing entity by that name).

    With regards to Krugman’s views, I can only quote Doug Casey who said that “the idea of stimulating demand shows how bankrupt economic theory has become” – as if people will not spend on things they need and can afford. Perhaps after the demand has been stimulated I will want 5 Ferrari cars instead of just 3.

    Ultimately though Stiglitz sounds reasonable (up to a point) and I don’t really see where the difference lies between yours and his views of government spending – which you both seem to advocate; I understand you’re saying he wants to spend on bad things but you have better ideas for directing govt. spending.

    As for America’s wars being out of necessity and not vanity, I feel you’re underestimating the effects of human psychology. My personal conviction (influenced heavily by Bill Bonner and John N. Gray) is that vanity and self-delusion did play a very important part in the conduct of USA’s external policy – from the lowliest commoners to the POTUS.

    • Of course America’s wars are a product of vanity. The real economic necessity is to allow the free market to build an American economy that doesn’t need its government to act as petrodollar hegemon. The “necessity” is a delusion, but a powerful one.

      • And of course, the point where I am really diverging from Sitglitz is that he retains full faith that government is the only way out of this mess — I see government as one of a number of possible routes out, and given the current state of macro not one that is likely to be taken.

    • Since the Nobel five pick the ‘weiner’ { mispelling intentional} with only modest intellect.. it is fair to say the ‘prize’ isn’t really based on merit. Case in point: the president of a country who doesn’t even know the date of his actual birthdate.. the proof of his birthplace being in Kenya easily proved, but the most damning is that he is just an evil, war mongering, hate filled nincompoop who will pay the price for helping the previous freemason presidents destroy a country.
      I was born during WWII, and I am not one to swallow lies, which is all this government dishes out, and always has. Consumerism is a sin, a human fault, in my opinion, which leads people to spiral out of control in all aspects. War is never the end means to peace. It only leads to egotism, power hungry and completely mad with the love to destroy…. they love to kill.. simply put, and I defy anyone to look back in the sorry history of this country and prove any different. They spin their webs of lies, with a smattering of semi truth, which is hidden from most people who are busy with ‘life’… Andreis’ last statement is so right on… there is a small percentage of the population who cannot stomach the deceit and destruction that has been going on since before I was born.. I could read the comments of these persons who posted here, all day…. alot of wisdom and perception that I crave…. thank you each..
      I believe this act that barry is about to complete, could well put the final nail in the proverbial coffin … we know the dollar is artifically high…it takes an instant.. one blink of the eye, to crash this house of cards… this may be it.

        • I will say that I don’t think that the end of the dollar “bubble” (The Great Treasury Crash as I have called it in the past) will be this week, or this month. There’s an outside chance it will be in 2012, but it really could be much later. I think back to Spruce Goose’s comment yesterday about China calling America a paper tiger in the 60s. The house of cards hasn’t fallen yet. Yeah, there are cracks appearing. The fundamentals have got worse, sure. But whatever brings the sequence of events leading to the end will surely be a black swan, a straw that breaks the camel’s back, and we can only guess what that will be.

        • I have lived for almost 7 decades.. traveled extensively, majored in I may not agree with your opinions, but the opinions that I do choose to share, are as valid as anyones. I very much enjoy different opinions and if being a ‘nut’ is what it takes, at least I have time on my side.. and who knows…. what if what I say does happen… it is bound to eventually, we have never been closer to the end of an era as ever before, and we just get closer and closer to the beginning of what is to come… depending on what that end is, of course, is our own speculation and beliefs. The end has been happening since the beginning of this planet, and since no one ever dies, we will all know what is to come. According to Quantum Physics Theory, time flows backwards as well as forward and the leftover of all energies are called organized chaos, so obviously we have a very complex world…and again, my own opinion, that the end of this era will be beyond our wildest imaginations.

          You state: “you don’t think”….. and I state “I believe”… so we are both just speculating.. which is what a healthy blog should be about… don’t you think? We are sharing our ideas in a polite manner, and neither of us has said it is written in stone. I don’t think it enhances anything to ridicule someone and to imply that someone else is less than them…. often times those who have the gift, or misfortune, however one chooses to view it, is the one who has a great deal of insight.. I don’t have to defend what I say, and I don’t think anyone else does either. We are sharing different ideas and most of the remarks are the result of living a life.. long or short, good or bad. We can all learn to co-exist on this blog and treat others with respect. Isn’t this something that neighbors, schools, towns, cities, states, nations have trouble with doing? Lashing out in hatred never solves anything. Whatever is going to happen will happen with or without our opinions… but thank you Aziz for your answer… I thank you for your articles and hope that you can ‘tolerate’ me if I want to express my opinions in the future. The only truism that we can absolutely count on is this: God is in control, and it will all work out for all those who love Him….and indeed, even His enemies will get what they want also.. however twisted that is.

        • You are free to express whatever opinions you like, but don’t expect them to go unchallenged. I am not into censorship. The only things I will censor are spam, illegal material, and material designed to incite violence, none of which I could possibly accuse you of. This is a forum for honesty: people can share their views, challenge others’ views, exchange ideas, and hopefully learn from the experience.

          Speculation is what we all do when we predict the future, whether we are using mathematical models, or historical or fundamental analysis, or something else.

        • That’s ridiculous. Everyone knows coffee doesn’t go with nuts. Beer goes much better. Or am I missing the point?

        • Now you’re talking, Two dogs…. no… you got the point, I’m sure of it… come on over.. I have the beer AND the nuts…. 🙂

  5. I like Spiritwomens comments. It gives me food for thought like all contributors here. I mean she is part of the “Economy” therefore is relevent in some way.

    I don’t agree with all comments, but I don’t ridicule. Ridicule went out in Grade school. Trolls are insecure types who need attention, because after they leave home, there mothers are not around to give them attention.

    I am running out of economic qustions and answers. I think it is time to ditch economics for the new age after 2012. Perhaps “slow finance” linked above is the next model to look into.

    • I would think the only reason to express ones thoughts about things as important as the future in this time of uncertainty, would be seriously taken, as with your posts.. I read your thoughts in other places and you are consistent in your viewpoints.. no one can misconstrue your intent. As with mine. I have been in almost total seclusion for more than 8 years… plenty of time to delve into the spiritual world. The unseen world is the only world that is real… if you know anything about physics… you know. Buddy, and Aziz.. if everyone on this planet were as wise as you are, it would be Heaven. As we are quite aware, it is not. I only want to help those who don’t know what I know… and I am helped by you, who know what I don’t know.. that is what it is all about. helping each other get to where we need to be. That’s all. Simple. Love. And respect.

      • Spiritwomen. Check this out. I have used.

        I have practiced deep meditation, using theta sound waves and optical stimulation, and have broken through to the other side of reality. Think of it as a kalidescope, with fluid images and visions.

        It beats watching “Dancing with the Stars.

        • Thanks Buddy… looks pretty interesting… have you tried to converse with someone just through your mind?? Now THAT is cool… some communicate with me also.. just to proove it can be done with anyone, I asked a guy, through mental communication, to see if he could fix my gun… a few days later he came over to fix my gun Later I asked him to bring me something the next time he went to the store.. a few days later, he came over with what I wanted, I told him I had only thought it, never said a word out loud to him… he just looked at me, confused… but he drinks an awful lot….There are alot of fun things to do with the mind…my fiance, who went to heaven in early 2005, taught me how to do it..{we still communicate that way..} it was almost more fun than using the phone…:) if you do get into it, there can be many voices, who you will be able to identify, and you might have to limit them.. it can get quite discombobulating …..dancing with the stars?? No thanks.. a mind is a terrible thing to waste… TV is not my thing.. it drives me crazy. again…. thanks for the link.. I will check it out…if you have anything else that is different.. please let me know.. so much to learn.. so little time.

        • I have seen the human mind control a video game through electrical diodes attached to the skull, so the possibility of mind control or conversations to others is possible.

          One day science may prove it.

        • Read Mein Kampf by Hitler. The UNCENSORED edition.

          Then read history and cross reference to Mein Kampf

          Then look at today’s events.

          I had a Grandmother in a concentration camp, and the book gave me perspective.

  6. Who the f**k is long US Dollars now? The US doesn’t manufacture that much, she doesn’t create new organic value, all she does is printing dollars in exchange for oil and goods. Then why is USD surging so much? My gold bought at summer is -25% YTD and silver 50% YTD……

    • Gold has been bid up by ETF’s and Hedge funds.

      Anything that ramps up to parabolic levels is bound to return to the mean growth or trend.

      Investing 101. It is human greed fear which causes prices to fluctuate.

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  11. IMHO The problem is much larger. I believe that there simply are not enough jobs to go around for over 7 billion people. Cheap energy and tax incentives can’t compete in slave wage markets of which there are plenty, and renewable engergy technology can be used in those markets as well as our own. You can’t monopolize the sun or the wind. We have to find a new system of living that provides some sort of security to people so that they’re not desperate and destitute, but one that also figures out a way to engage the human drive for improvement and purpose. Work sharing and a stronger social safetynet would be good start, but you need to direct human energy as well resources. Globalized capitalism in a world where the prevailing wage doesn’t cover the basics of survival for a person and their family is inherently an unstable world. This is the big issue we as a society need to tackle.

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  16. Hi there! This is my first comment here so I just wanted to give a quick shout out and say I genuinely enjoy reading through your posts. Can you suggest any other blogs/websites/forums that deal with the same topics? Many thanks!

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