Ebeling Schools Krugman, Again

Richard Ebeling emails:

Dear Bob,

Krugman, again on his "New York Times" blog, tries to rebut Hayek's argument, and make the case that trade protectionism did nothing of significance to extend or make worse the Great Depression.

http://krugman.blogs.nytimes.com/2010/07/10/hayek-trade-restrictions-and-the-great-depression/

And, again, I've submitted a reply, which hopefully will be added eventually to the comments section.

Just in case, once more, if it is not posted, here is what I've said:

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There is a peculiarity in Dr. Krugman's argument that the problem in the Great Depression was not a misallocation of labor or other resources, but mass unemployment.

And that peculiarity is that there must be a causal explanation as to how the economy got into this position, and the answer to that should offer an insight as to how to get out of that situation.

First of all, and contrary to most Keynesian reasoning, there is no such thing as
"aggregate demand" and therefore there cannot be a "failure" of aggregate demand.

There is the demand for shoes, and hats, and bananas, and houses, and . . .

But there is no such thing as a demand for "output as a whole." After all, there is no such "demander" in the market place Thus, we must ask why there can arise mismatches, imbalances, disequilibriums between a variety of individual market demands and supplies, which, it is true, can feed on each other, with microeconomic distortions feeding on each other and bringing about a cumulative decline in employments, productions and outputs.

The "Austrians" see the cause of the depression or recession usually arising from monetary mismanagement that has distorted essential market price signals -- in this case, market rates of interest -- that generate over time imbalances between savings and investment, and a misallocation of labor, capital and other resources among the sectors of the economy.

It is these imbalances in the demands and supplies, and resulting distortions in the structure of relative prices and wages, that eventually set the stage at some point for a necessary correction in the market.

But when "boom" has burst there is no escaping the necessary realignments in the structure of relative prices and wages; reallocations of capital and labor to reflect the post-boom patterns of supplies and demands, and the writing down or writing off of various investment projects begun during the boom period, and found now to be unprofitable in the post-boom correction period.

If there are superimposed on this correction process inflexible or "rigid" prices and wages that resist or significantly lag behind the necessary realignment in the price-wage structure and supply-demand adjustments, then there will be additional unemployment and reduced production in various sectors. And these will then put greater downward pressure on other individual demands and supplies, do doubt.

But what is crucial, may I suggest, is not that there is that some imagined "aggregate demand" deficiency. Rather, the problems are on the supply-side, in the failure or resistance or delays in the appropriate price and wage and resource allocational adjustments.

This would be understood more easily and clearly, it seems to me, if presumed "macro"-economic problems were looked at more often and consistently though a microeconomic chain of logic. It would make the policy issues and answers seem different, as well. They would point more in the direction suggested by Friedrich Hayek in the 1930s and the decades following.

It also means that whatever other criticism may be raised against deficit spending and growing debt burdens, this more "Austrian"-type micro analysis enables us to see that government stimulus or stimulated "aggregate demand" spending is not not spending on "output as a whole," because as I suggested there is no such demand.

The government's spending or the spending induced by government fiscal "activism" are always, by micro necessity, demands for particular goods or services in particular sectors or corners of the market. And their sustainability is limited to how long government continues to spend or stimulate spending in particular ways and in a particular directions.

If or when that "stimulas" spending is slowed down or ended, the patterns of demands and the structure of prices dependent on it, and the resource and labor employments derived from it, must decline. And a new layer of necessary adjustments and realignments are now required in the economy.

That is, such "demand management" activity runs the risk of setting the stage for a future downturn as an result or product of the ways the government had earlier tried to move the economy out of the recession.

Thus, the Austrian argument is not an argument of resignation or despair or insensitivity to the hardships of those unemployed in the downturn. Rather, it is a positive conception of what is needed to be allowed to work within the market, itself, so that rebalance and recoordination can come about for real and sustainable recovery without making a future downturn inevitable.

Dr. Richard Ebeling
Professor of Economics
Northwood University
Midland, Michigan