The Return of Depression Economics and the Crisis of 2008
By Paul Krugman (New York and London: W.W. Norton & Co., 2009)
Paul Krugman is arguably the most-read economist in the world today. A Princeton University Professor of Economics and International Affairs, a Nobel Prize laureate in Economics, and a twice-weekly New York Times columnist, his reach extends far beyond academia, into government and public discourse. He obviously has very high-level contacts in government—Ben Bernanke, the Chairman of the US Federal Reserve is a former colleague, and the person who hired Krugman from MIT. Krugman’s writing is accessible—at least his public writings—and he is even witty at times. And, he is not afraid to go after the right-wingers when necessary. In short, he brings an understanding of economics to a public that is largely considered economically ignorant, and makes “the dismal science” not.
As a long-time global labor activist turned sociology professor at a regional campus of Purdue University in Indiana, I turned to Krugman’s new book, along with other resources, for help in preparing for a course on “The Sociology of the Current Financial Crisis” that I am teaching this summer. What I read in Krugman’s book shocked me—and in more ways than might be immediately expected. Let me give an overview of Krugman’s book, and then I’ll comment.
Krugman seeks to share his understanding of the current financial crisis, and he takes things up to October 2008, making this an extremely up-to-date book. (An earlier version of this book examined the 1997-98 “Asian Financial Crisis,” and he now extends his analysis to see what was learned from it that is guiding the responses to the current crisis.) His methodology is to report and discuss financial crises particularly since the Great Depression of the 1930s, but even some before that, in order to help pull out commonalities and differences. Importantly, his scope is global as well: he discusses financial crises in Latin America in the 1980s, with a particular examination of Mexico and Argentina; Japan in the 1990s and on to 2003; the “Asian financial crisis” of 1997; and Argentina (again) in 2002. He examines these crises to try to learn what happened, and to see what the economic profession has learned from them.
From looking at these particular cases, he also looks at policy responses to these crises. He certainly is critical. However, he writes as a Keynesian, which obviously colors his perspective. [Quickly, Keynesians focus on creating demand to get an economy out of economic slowdowns, and take the position that macroeconomic intervention through cutting interest rates or increasing budget deficits, as needed, “could keep a free market economy more or less stable at more or less full employment” (p. 102).] Interestingly, he also writes from a particular Keynesian position, not common to all Keynesians—surprisingly, and I comment further below, he all-but-ignores the real economy of production and consumption.
Krugman points out the economics profession—of which he is a full-fledged member—has basically claimed that they know enough to prevent any future repeats of the Great Depression. Yes, there are still recessions, but the response is simple: cut interest rates to restimulate the economy and, if necessary, cut taxes and raise spending. This approach has been used in the United States in 1975, 1982, and 1991.
However, in talking about the financial crisis that began in Asia in 1997, he observes “the policies those countries followed in response were almost exactly the reverse of what the United States has done in face of a slump” (102). Many of the affected Asian countries raised their interest rates and cut their budgets drastically. How to explain that? He notes that the Asian countries’ economic policies had been “largely dictated” by the US Treasury and the International Monetary Fund (103).
Here he turns to the issue of international currency speculation, arguing that the policies designed for East Asia were intended to thwart speculators—thus, he sees the crisis as a financial crisis only. Krugman points out that speculators seek situations where they can prey on weakened—or apparently weakened—currencies, benefiting from and sometimes even stimulating currency crises. Therefore, to keep the speculators at bay, the solutions proposed were designed to maintain market confidence at all costs, even though much of the problems that emerged were from the private sector and not the public sector. Hence, interest rate hikes and drastic budget cuts were proposed so as to discourage currency speculation. Obviously, this takes us into the realm of social psychology:
… because crises can be self-fulfilling, sound economic policy is not sufficient to gain market confidence—one must cater to the perceptions, the prejudices, the whims of the market. Or, rather, one must cater to what one hopes will be the perceptions of the market.
… international economic policy ended up having very little to do with economics. It became an exercise in amateur psychology, in which the IMF and the Treasury Department tried to persuade countries to do things they hoped would be perceived by the market as favorable (114).
And then, to his credit, Krugman asked if the IMF actually made things worse. He concluded it had done two things wrong—the IMF was wrong to demand fiscal austerity, and it was wrong to demand structural reform as a precondition to getting new money—and avoided one problem (demanding that these countries defend their currency values at all costs) by creating another (demanding that they raise their interest rates so as to try to persuade investors to keep their money in the country).
Nonetheless, Krugman continues onward to argue there simply were no good choices in this situation, concluding “And so it really was nobody’s fault that things turned out so badly” (118); i.e., “stuff happens.” I wonder if the millions of workers who lost their livelihoods, the children who were forced out of school because their families could no longer pay education expenses, and everyone else whose life was disrupted would agree with Krugman on that. (And actually, Malaysia rejected IMF prescriptions and emerged much less damaged than the countries that accepted them.)
Krugman stays on the tracks of the speculators, seeking “bad guys” cause obviously it could not be the economic system itself. He specifically focuses on George Soros and his efforts. He notes that Soros had created a financial crisis for Britain in 1990. He critiques Mahathir Mohamad, then prime minister of Malaysia, for blaming speculators and especially Soros for Malaysia’s financial crisis in 1997-98. But then Krugman talks about efforts by speculators—rumored to include Soros—to create a currency crisis in Hong Kong, but were turned back only by deft action by governmental officials. Hummm … maybe Mahathir wasn’t as crazy as he first seemed….
Krugman continues this approach. He talks about Long Term Capital Management (LCTM), a hedge fund whose collapse in 1998 threatened to cause a full-scale global financial panic. And, helpfully, he explains to the reader the real idea of a hedge fund: instead of helping to make sure that market fluctuations do not affect one’s wealth, as is often suggested, Krugman points out that “What hedge funds do, by contrast, is precisely to try to make the most of market fluctuations” (120).
In other words, hedge funds try to profit off of small variations in valuation between different (usually) international markets, shifting money back and forth across the globe with computer keystrokes. And because they can often operate with large amounts of money, they can make immense profits off of small changes—or they can loose immense amounts of money if they guess wrong. LCTM guessed wrong—and a global financial system calamity was barely averted.
Here, though, Krugman says something very interesting. After the New York Federal Reserve intervened to get a group of investors to buy out the management of LTCM, and surmount the crisis, Krugman points out that, “even now, Fed officials are not quite sure how they pulled this rescue off” (138).
Speaking of the Fed, he shifts to discussing Alan Greenspan’s stewardship of the US Federal Reserve. Krugman is quite critical of Greenspan, and points out that on Greenspan’s watch, two economic bubbles were allowed to emerge—in stocks related to the dot-com world in the late 1990s and the housing crisis of the mid-2000s—and Greenspan basically did nothing about them.
Along with the two bubbles, however, Greenspan did nothing while a “shadow banking system” emerged, which basically functioned as a banking system only without the regulation with which the established banking system had to contend (albeit with little interest to regulate by the George W. Bushies). By June 2008, the combined balance sheets of the five major investment banks reached over $4 trillion, while the total assets of the entire banking system was only $10 trillion. It was the failure of this shadow banking system that Krugman claims caused the current financial crisis, which began in the summer of 2007. He calls this “The Mother of All Currency Crises” (176):
… in the short run the world is lurching from crisis to crisis, all of them critically involving the problem of generating sufficient demand. Japan from the early 1990s onward, Mexico in 1995, Mexico, Thailand, Malaysia, Indonesia, and Korea in 1997, Argentina in 2002, and just about everyone in 2008—one country after another has experienced a recession that at least temporarily undoes years of economic progress, and finds that the conventional policy responses don’t seem to have any affect (emphasis added) (184).
Krugman doesn’t present any “solutions” to the crisis. All he can come up with is the need “to approach the current crisis in the spirit that we’ll do whatever it takes to turn things around; if what has been done so far isn’t enough, do more and do something different, until credit starts to flow and the real economy starts to recover” (188).
This shocks me. Here is one of the most highly respected and well-trained economists in the world telling us to do “whatever it takes to turn things around.” I’m sorry: a high school student could give this kind of advice. You don’t need a Ph.D., etc., to come up with this.
And this comes after almost 190 pages of historical examples, and clear discussions of what happened and/or should have happened. And this is the best he can come up with…?
However, in his defense, he does suggest “vigorous monetary expansion” earlier in the book to end recessions, the tool which was used to end recessions of 1981-82, 1990-91, and 2001, as he notes (68). But Krugman does not differentiate between short-term financial stimulation—such as vigorous monetary expansion—and the long-term economic stimulation provided by plentiful, well-paying jobs that provide means for people to support themselves and their families. His concern only extends to the short-term response. And this illuminates a key weakness of the Keynesian approach: as long as sufficient demand can be generated—no matter how—then apparently any recession can be overcome. Krugman doesn’t have to be concerned about jobs, because his particular type of Keynesian does not require this consideration, and thus, he doesn’t.
Beyond this, there are two things in the book that caused my jaw to drop, at least metaphorically. First, Krugman shows that finance officials have seen the problems we’re facing in the US and the world again and again—most certainly in 1997-98 as the “Asian financial crisis” spread around the world, almost taking down Russia, Brazil and the United States—and they have no understanding of the causes of these crises and, hence, no realistic solution.
He refers to this several times throughout the book: the problem is “deleveraging,” “involving plunging prices and imploding balance sheets” (135). In other words, great amounts of money are invested—by “regular” investors such as investment banks as well as speculators—in the hopes of making great profits, and when things go bad—for whatever reason—this “herd” flees like a bat out of hell, destroying economic value and leaving economic and social devastation that affects millions of people in their wake. And it’s on to the next “opportunity.”
Yet Krugman cannot explain why investors pulled out of Asia the way they did in 1997. He focuses on Thailand, suggesting it was because an over-supply of credit (i.e., in this case, foreign investment): “Soaring investment, together with a surge of spending by newly affluent consumers, led to a surge of imports, while the booming economy pulled up wages, making Thai exports less competitive…” (81). So, supposedly export growth slowed down, creating a huge trade deficit. And the problem was “crony capitalism.”
Krugman’s got a problem here. He asserts—giving no evidence for the claim—that Thai wages were being pulled up by the expanding economy. Yes, generally speaking, research has shown that workers make more money in multinational corporation’s subsidiaries and/or subcontractors than they do in corporations run by Thai capitalists (i.e., “national” capital) or than they did in their former lives as peasants. However, once the jump has been made into the MNC-related factories, there is nothing to push up wages. Unlike Filipino workers in the 1980s, Thai workers never created a labor movement strong enough to force MNC-related factories to keep raising wages. And without that, and especially in the face of competition from countries like the Indonesia, Malaysia and the Philippines, it is all but certain Thai wages did not increase, and certainly nowhere near with the importance Krugman suggests.
The larger problem of Krugman’s analysis here is that he leaves out the development strategy pushed by the International Monetary Fund (IMF) and the World Bank (WB): export-oriented industrialization. In other words, recognizing the low levels of consumption in these countries, along with the cheap cost of labor, the IMF/WB encouraged each of the “developing countries” in Asia to focus their economy toward providing imports for the developed countries, such as the US. And when each industrializing country in the region did this, ultimately there became an overproduction of goods, which forced prices downward, and investors were not prepared for the reduction of growth. And as overproduction forced prices down, governments devalued their currencies to try to maintain their respective economy’s competitive positions. And the result was about $105 billion dollars of investment withdrawn from East Asia in little more than a year. This economic problem then shifted to Russia, to Brazil and, finally, to the US.
As I wrote in an article in Canadian Dimension in mid-1999, “It became a crisis because investors around the world were making heavy bets that the economies in East Asia would continue to expand as they had been since the mid-1980s, and they were unprepared—intellectually or emotionally—to have the Asian ‘economic miracle’ collapse. After all, by the mid-1990s, Asia (including Japan) had been producing one-third of the manufacturing value in the world.” In short, I showed it was an economic crisis—based on overproduction—and a financial crisis rather than just a financial crisis as Krugman alleges.
Along with this, however, is something even more shocking than his not understanding the cause of the “Asian financial crisis”: I don’t know about Krugman’s academic writings, but in this book, he shows almost zero interest in or knowledge of what he calls “the real economy” in the United States, the economy of production and consumption, and the lives of working people. His total focus on this, in any concentrated form, is on pages 179-180.
Now maybe this is not uncommon among economists, but this utterly astounds me. In this book, he gives no idea of the changes that are going on in the real economy. However the global economy is getting more and more competitive, jobs are being destroyed by businesses through technological displacement and by off-shoring of production to respond to this increased global competition; companies are restructuring; corporate bankruptcies are throwing even more and more workers on the scrap heap, etc., which, in turn, reduces these displaced workers’ ability to support their families, to consume products, to live. (For details of this, see my recent “Neo-liberal Economic Policies in the United States: The Impact of Globalization on a ‘Northern’ Country” at http://www.zmag.org/znet/viewArticle/21584.)
And while things are getting worse in the United States, the financial crisis has already wrecked untold misery on people in the “developing countries.” In a global economic system dependent on selling to the “developed countries,” the economic contraction in this country is an unmitigated disaster for hundreds of millions around the world.
In short, what Krugman doesn’t understand—and more importantly, what the people who share Krugman’s viewpoint and the people they advise don’t understand—is that there is a difference between the economic system and the well-being of working people in this country and around the globe. Not understanding that difference is the reason, I believe, that we’re gotten the particular response of the Obama Administration, pushing trillions of dollars to the banks, and much, much less to support the rest of us. The refusal of the government to bail out the State of California, to give an extreme case, only illustrates this difference much more clearly.
Krugman, who so smugly dismisses alternatives to capitalism in his first chapter, spends the rest of his book giving us considerable reasons for requiring an alternative. Capitalism has caused great misery around the globe over the past several centuries, and a small number of us (relative to the world’s population) have done well over the past 100 years (give or take). Now, as this financial crisis continues, the benefits are becoming even more restricted.
Not only is a better world possible, it is required.
Kim Scipes, Ph.D., is an Assistant Professor of Sociology at Purdue University North Central in Westville, IN. He has been episodically writing on changes in the global economy and how they have affected Americans over the past 25 years, and is the author of KMU: Building Genuine Trade Unionism in the Philippines, 1980-1994 (Quezon City, Metro Manila: New Day Publishers, 1996). His web site is at http://faculty.pnc.edu/kscipes, and he can be reached directly at email@example.com.