Krugman's "Spending Agenda"

In a recent column entitled "The Austerity Agenda", Paul Krugman has once again trotted out his favorite quote from Keynes:

"The boom, not the slump, is the right time for austerity." So declared John Maynard Keynes 75 years ago, and he was right. Even if you have a long-run deficit problem — and who doesn’t? — slashing spending while the economy is deeply depressed is a self-defeating strategy, because it just deepens the depression. ... When the private sector is frantically trying to pay down debt, the public sector should do the opposite, spending when the private sector can’t or won’t. By all means, let’s balance our budget once the economy has recovered — but not now. The boom, not the slump, is the right time for austerity.

Krugman's solution to our current economic malaise, then, is that the government, for whom interest rates now are exceptionally low, should borrow money and spend, spend, spend.

Let us consider what is wrong with this argument. To help us do that, let us first look at one of my favorite passages from Daniel Yergin's book The Quest: Energy, Security, and the Remaking of the Modern World, in which the author describes the fate of what he calls the "petro-state:"

When [oil] prices soar, governments are forced by society's rapidly-rising expectations to increase their spending as fast as they can -- more subsidies to hand out, more programs to launch, more big new projects to promote. ... But when world oil prices go down and the nations' revenues fall, governments dare not cut back on spending. Budgets have been funded, programs have been launched, contracts have been let, institutions have been created, people have been hired. Governments are locked into ever-increasing spending. Otherwise they face political and social explosions.

(For further commentary on this passage, see my blog post We are all "Petro-States" Now.)

The gusher of spending that Yergin describes petro-states unleashing is not unlike the gusher of stimulus spending that Krugman would have our Federal government unleash. The only difference is that in the case of the petro-state, the spending is funded by soaring oil prices, whereas in the case of our federal government, the spending would be funded by increased debt. According to Krugman, this increased debt is not a problem because interest rates are currently so low. That is, instead of soaring oil prices to fund its spending our government has plunging interest rates. In essence, our most precious natural resource is nothing more than the fickle willingness of others to lend us money.

But, these interest rates won't remain low forever, just as oil prices don't remain high forever. When interest rates reverse and begin to rise, then, according to Krugman, the federal government will cut back on its spending. But, what will have happened in the meantime is that "Budgets will have been funded, programs will have been launched, contracts will have been let, institutions will have been created, people will have been hired. Governments will be locked into ever-increasing spending." Many of the people who will have been hired will have organized themselves into public service employee unions. Other people will be receiving pensions or subsidized health care or food stamps or some other kind of benefit from the government. All these people will resist any effort to cut government spending. Furthermore, one of the reasons why interest rates will be rising, presumably, is because the economy will be doing better, boom times will have returned. But, during boom times there will be even less of an incentive to cut spending. The end result will be that we will have reached the next permanently higher plateau of government spending and indebtedness.

Then, this process will repeat itself all over again. That is, at some point, the boom times will end, recession will rear its ugly head again, and we will hear renewed cries for government stimulus. Given the new permanently higher plateau of indebtedness, however, our government will be in an even more precarious position and even less able to borrow and spend. As this process repeats itself over and over again, eventually our indebtedness will reach such a level that lenders will not be willing to lend money to the United States. We will have arrived at the point where a.) much of the population is dependent on governmental largesse and will riot if that largesse is withdrawn through austerity measures, but b.) the government can no longer borrow to provide such largesse because they have already run up such massive debts. This is the state Greece currently finds itself in.

Krugman writes: "By all means, let’s balance our budget once the economy has recovered — but not now. The boom, not the slump, is the right time for austerity." The problem is that "the right time for austerity" never arrives. This is one of the major conceptual weaknesses of Keynesianism: Keynesians always talk about how the government will cut back on spending in countercyclical fashion once the good times have returned; but they neglect the fact that all their government spending will have created constituencies that will resist these spending cuts and that politicians will pander to in order to gain their votes.

Krugman tries to argue that the austerity programs being pursued in Europe and the United States are really strategems being used to eliminate the welfare state:

So the austerity drive in Britain isn’t really about debt and deficits at all; it’s about using deficit panic as an excuse to dismantle social programs. And this is, of course, exactly the same thing that has been happening in America.

In reality, it is Krugman's drive for ever-increasing spending -- government stimulus spending during recessions and unabated government spending during boom times -- that is designed to make the people of America ever more dependent on their government. This may be able to go on a while longer. But eventually the government will exhaust itself and collapse beneath a mountain of debt.