Saturday, January 10, 2009

Economic Penance

I'm a big fan of Paul Krugman (hence my second post in a row about him).  The Princeton economics professor, New York Times columnist and recent Nobel laureate is a bit of a lefty folk hero which, of course, makes him a big target of the right.

I was reminded of this the other day when I noticed a post by George Lightbourn at the Wisconsin Policy Research Institute, attacking Krugman's advocacy of a super-massive federal stimulus package to stem the incoming tide of economic disaster.  While Professor Krugman doesn't have the time to respond to every conservative's misconceptions, a post on his blog a few days later provides a neat contrast between Krugman's broad-based number crunching and Lightbourn's blind adherence to conservative ideology.

Lightbourn's argument is based on the supposition that the current recession is the result of an over-lavish lifestyle over the past few years.  During the days of wine and roses we over-spent and over-borrowed.  The recession is the inevitable fall back to earth after the housing bubble burst under our feet.  If the government were to take out still more debt in the people's name to prop up federal and state spending based on unrealistic economic growth, we'd simply find ourselves further in the hole. 

It's a compelling argument but thankfully (the last few years were hardly lavish), it isn't true. Krugman's post is based, among other things, on this figure from the Congressional Budget Office.

The small type underneath the image explains that the horizontal line in the middle is an estimation of the country's potential gross domestic product, what our economic output would be if we effectively used our resources, labor and capital.  The plot line is the actual level of GDP and that vertical dotted line indicates where we are now, with real GDP projected to keep falling well into this year.

The difference between projected GDP and actual potential GDP indicates that, without stimulus, economic output over the next couple of years is going to fall well below capacity. Krugman is suggesting that the Federal Government take the necessary steps to bring economic output back up to where it ought to be.

The significance of this is that stimulus advocates are not, as Lightbourn claims, trying to use government spending to continue an unsustainable level of economic output.  They're trying to nudge output back up toward its natural level.  The spending shouldn't have to continue as a recovering economy should start to return to capacity on its own.  

It's also worth noting that this graph discredits the notion that the previous few years were somehow unsustainably extravagant.  The housing bubble was unsustainable but rampant speculation in real-estate only ever pushed GDP to just at potential in 2006, the height of sub-prime.  Otherwise, the economy was somewhat abysmal by historical standards. A real boom looks like the late 1990s where economic output soared well beyond projected capacity then crashed down to . . . well, the Bush era.

Hopefully, with solid stimulus and needed reforms of our regulatory and tax structures, we can create a balanced economy that keeps output at or near capacity based on the production of actual goods, ideas and services, not speculative bubbles.  In the meantime, there are trillions of dollars in needed infrastructure repairs to keep us busy. 

Or we could could follow conservatives like George Lightbourn who want to boldly stay where we are.

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