Paul Krugman Sallies Forth to Save France from Austerity
Courtesy of Pater Tenebrarum, Acting Man
Too Much Government? Not In Paul Krugman's World
From his perch at the NYT, Paul Krugman informs us that he has detected a 'Plot Against France', because credit rating agency S&P has dared to downgrade the government's debt to 'AA' from 'AA+'. Keep in mind here that in France, government has the largest share of spending in the economy of all industrialized nations: it amounts to 57% of GDP. One might well say that it is on the verge of becoming a full-scale command economy. Admittedly that would be a bit of an exaggeration, since GDP omits all spending on raw and intermediate capital goods, with the exception of 'durable' capital. It therefore ignores a huge chunk of economic activity.
However, it is not an exaggeration to state that under the Hollande government, France has begun to adopt features of a 'Zwangswirtschaft' (literally: a 'coerced economy'), in which the government decides who may produce what, when, how, in what amounts, and so forth. The most recent evidence in this regard is that the government is now forcing companies to operate at a loss rather than fire workers, thereby further tightening what is already the most sclerotic and repressive labor legislation in Europe. Regime uncertainty in France has never been higher, and it is therefore no surprise that the country is in a seemingly inexorable economic downward spiral.
Krugman's solution to this problem is apparently that the government should increase its size even more by adding to its already out-of-control spending. Anyone doubting the wisdom of such a course is held to be “using debt fears to advance an ideological agenda.” Krugman of course is a completely impartial observer, who has no ideological agenda at all. He writes:
“On Friday Standard & Poor’s, the bond-rating agency, downgraded France. The move made headlines, with many reports suggesting that France is in crisis. But markets yawned: French borrowing costs, which are near historic lows, barely budged.
So what’s going on here? The answer is that S.& P.’s action needs to be seen in the context of the broader politics of fiscal austerity. And I do mean politics, not economics. For the plot against France — I’m being a bit tongue in cheek here, but there really are a lot of people trying to bad-mouth the place — is one clear demonstration that in Europe, as in America, fiscal scolds don’t really care about deficits. Instead, they’re using debt fears to advance an ideological agenda. And France, which refuses to play along, has become the target of incessant negative propaganda.
Let me give you an idea of what we’re talking about. A year ago the magazine The Economist declared France “the time bomb at the heart of Europe,” with problems that could dwarf those of Greece, Spain, Portugal and Italy. In January 2013, CNN Money’s senior editor-at-large declared France in “free fall,” a nation “heading toward an economic Bastille.” Similar sentiments can be found all over economic newsletters.”
Well, France definitely is a 'time bomb at the heart of Europe'. Its economy is performing very badly – unemployment is hitting record highs and industrial production is continually coming in below forecasts, in spite of the widely reported 'recovery' in euro-land (which in turn is a lagged effect of monetary pumping having increased true money supply growth in the euro area to 8.8% year-on-year between early 2012 and early 2013).
Time Bomb
Although we doubt that France's debt problems will 'dwarf those of Greece and Spain', the country's well-being is more important for the euro area, given that it is the second-largest economy in continental Europe and considered an important part of the euro zone's 'core'. In fact, Krugman is deliberately misquoting what the Economist article actually states: it is notsaying that France's economic problems could dwarf those of Greece, it is saying that the problems France could cause for the euro may dwarf those Greece has caused. Meanwhile, government spending in France has risen to new record highs. Frances's total debt-to-GDP ratio is by now a full 50% above the Maastricht treaty limit. Could it be that S&P was getting worried about this?
France's public debt-to-GDP ratio is exploding into the blue yonder – click to enlarge.
French government spending is at a new record high – click to enlarge.
France's industrial production (total, including services). Manufacturing production looks a great deal worse – click to enlarge.
According to Paul Krugman, the only thing that matters are the interest rates on French government debt that currently prevail in the markets. They 'prove' that nothing can go wrong and that France should spend even more. However, one could have applied the very same reasoning to Greece's government debt as recently as December 2009:
The yield on Greece's two year government note. According to Krugman's reasoning, we knew for certain in December of 2009 that Greece's government should 'spend more' in order to revive its economy, and that there would be no risk associated with such a policy – click to enlarge.
Note that we are not saying that French government debt will suffer a collapse akin to that seen in Greek government debt. That strikes us as rather unlikely. We merely want to make a point about what current market interest rates are telling us about the risk of incurring even more debt, which is absolutely nada.
Paul Krugman evidently doesn't quite understand the term 'time bomb'. Allow us to help. A time bomb is a bomb that hasn't gone off yet. Before it does, it may well look perfectly harmless, but that is a state of affairs that is potentially subject to change. Such change usually happens suddenly and unexpectedly.
Everything is Hunky-Dory in France
Krugman then compares one lame economy (France's) to the lame economies of other European countries such as that of the Netherlands, to make the point that 'France doesn't look all that bad' and wonders why curiously, the Netherlands are still rated 'AAA'. The nearly 11% of the workforce that are unemployed in France (Netherlands: 8.6% – not much to write home about either, but a lot better) would probably disagree with that 'it's not so bad' comment, but there is a solid reason why the Netherlands have a better credit rating. Here it is:
Netherlands, public debt-to-GDP ratio. This is also above the Maastricht limit of 60%, but it is a lot lower than France's debtberg – click to enlarge.
So now we are looking things up for Krugman he was either too lazy to check, or more likely doesn't mention because they don't fit his narrative. By the way, we don't think the Netherlands deserve an AAA rating either, the only point we want to make is that there is nothing 'strange' about why the country has a better credit rating than France.
Krugman then continues:
“Meanwhile, French fiscal prospects look distinctly nonalarming. The budget deficit has fallen sharply since 2010, and the International Monetary Fund expects the ratio of debt to G.D.P. to be roughly stable over the next five years.”
This is assuming that the IMF's forecasts are worth anything. They usually aren't, as evidenced by the constant stream of revisions the IMF is forced to make to its forecasts on just about anything. Once the current echo boom collapses – and it will, because it is an artificial recovery bought with monetary inflation – all these assumptions regarding the 'non-alarming fiscal prospects' of France will go out of the window post-haste.
Krugman sees nothing amiss though:
“By the numbers, then, it’s hard to see why France deserves any particular opprobrium. So again, what’s going on?”
It depends on what numbers one considers. A debt that is 50% higher than the Maastricht limit is of great concern to all other euro area members, since the euro's construction implicitly guarantees that France is living beyond its means at the cost of everybody else.
The Spending versus Taxation Error
Krugman of course has his own explanation, which we would call a major non-sequitur garnished with grave economic error:
“Here’s a clue: Two months ago Olli Rehn, Europe’s commissioner for economic and monetary affairs — and one of the prime movers behind harsh austerity policies — dismissed France’s seemingly exemplary fiscal policy. Why? Because it was based on tax increases rather than spending cuts — and tax hikes, he declared, would “destroy growth and handicap the creation of jobs.”
In other words, never mind what I said about fiscal discipline, you’re supposed to be dismantling the safety net.
S.& P.’s explanation of its downgrade, though less clearly stated, amounted to the same thing: France was being downgraded because “the French government’s current approach to budgetary and structural reforms to taxation, as well as to product, services and labor markets, is unlikely to substantially raise France’s medium-term growth prospects.” Again, never mind the budget numbers, where are the tax cuts and deregulation?
You might think that Mr. Rehn and S.& P. were basing their demands on solid evidence that spending cuts are in fact better for the economy than tax increases. But they weren’t. In fact, research at the I.M.F. suggests that when you’re trying to reduce deficits in a recession, the opposite is true: temporary tax hikes do much less damage than spending cuts.”
Readers know that we generally disdain using economic statistics to prove points of economic theory – mainly because anything can be used to 'prove' anything. However, this is a prime example of Krugman's slippery method of cherry-picking data and studies that suit his agenda. First of all, the source for his claim is an article posted by an 'economic advisor to the trade union movement' at a site called the 'Social Europe Journal'. In other words, socialists are called upon to provide Krugman with his talking points – which is perhaps no surprise. More damning though is Krugman's complete silence on the wealth of countervailing studies that have found the exact opposite to be true.
Evidence Contradicting Krugman's Assertions
In a monthly bulletin published in 2010, the ECB points out (see page 85 ff., 'Lessons from the Past', which provides links to the supporting evidence):
“Past experience suggests that creating signi?cant primary surpluses through fiscal consolidation will be pivotal to reducing the very high debt ratios for many euro area countries and thereby limiting their dampening impact on output growth. Moreover, case studies conducted for Belgium, Ireland, Spain, the Netherlands and Finland found that fiscal consolidations based on expenditure reforms were the most likely to promote output growth, especially when combined with structural reforms.
Overall, it appears that expenditure-based fiscal consolidations are more successful and have more beneficial effects on long-run economic growth than revenue-based ones. With tax burdens already high, the scope for revenue-based consolidation may be limited as many euro area countries may already be close to their revenue-maximising levels of taxation, i.e. the peaks of their Laffer curves.
The empirical literature offers diverse results as to whether fiscal consolidations in the euro area have had expansionary effects on economic activity in the short run. With reference to the periods of sizable government debt reductions mentioned above, expansionary fiscal consolidations are suggested in Ireland, the Netherlands and Finland. Looking at a broader range of experiences, it is found that around half of the fiscal consolidations in the EU in the last 30 years have been followed by an improved output growth performance in the short term relative to the initial starting position.
Finally, it is also shown that fiscal consolidations have had negative but limited short-term implications for real output growth in a number of countries. Although fiscal consolidation may imply costs in terms of lower economic growth in the short run, the longer-run bene?cial effects of fiscal consolidation are undisputed.”
So yes, if it is empirical evidence that Krugman is looking for, we do not have to rely on the 'Social Europe Journal' – Olli Rehn indeed appears to be basing his assessment on plenty of peer-reviewed studies. Robert Murphy notes that the notion that hiking taxes is far more harmful to the economy than cutting spending is the subject of what is by now a vast economic literature – ironically, this literature has in part been produced by people who are today arguing the opposite (like Krugman's fellow Keynesian Christina Romer). Murphy writes:
“The theoretical case for "supply-side economics" is straightforward: People respond to incentives. By allowing entrepreneurs, investors, and workers to keep a smaller fraction of their last dollar earned, hikes in marginal tax rates discourage business start-ups and investment and reduce labor supply. This is the logic behind conservative and libertarian warnings about proposals to address the long-run U.S. fiscal imbalance through large tax-rate increases on high-income people.
Although the basic theory is unassailable, it remains to test the practical significance of such supply-side effects. Fortunately, scores of peer-reviewed studies do just that. Far from the impression that Christina Romer gives, many economists find that taxes do matter.
Padovano and Galli (2001), for example, used data for 23 OECD countries from 1951 to 1990 and found that high marginal tax rates and tax progressivity were negatively associated with long-term economic growth. In a 2002 follow-up study, these same researchers estimated that an increase of ten percentage points in marginal tax rates decreased the annual rate of economic growth by 0.23 percentage points.
Engen and Skinner (1996) found a relationship twice as strong. They surveyed more than 20 studies looking at tax rates and economic growth in the United States and abroad. They concluded that "a major tax reform reducing all marginal rates by 5 percentage points… is predicted to increase long-term growth rates by between 0.2 and 0.3 percentage points."
Young Lee and Roger Gordon (2005), concentrating on corporate taxes, reached a similar conclusion. Using data for 70 countries for the period from 1970 to 1997, they found that a reduction of ten percentage points in corporate tax rates raised a country's growth rate by one to two percentage points. This finding is striking. A one-to-two-percentage-point increase in growth does not add up over time: it compounds over time. An additional percentage point in growth, compounded over 20 years, increases a country's real GDP by 22 percent.
Ironically, one of the strongest findings—published in the prestigious American Economic Review—came from none other than Christina Romer and co-author David Romer. In a 2010 paper that developed a new measure of fiscal shocks, the Romers classified every major tax-change episode from the U.S. postwar period and listed their conclusions:
Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent. Third, investment falls sharply in response to exogenous tax increases. Indeed, the strong response of investment helps to explain why the output consequences of tax changes are so large. Fourth, the output effects of tax changes are highly persistent. (Romer & Romer 2010)
This comparison of statistical studies actually also shows the problem with such studies: while they may come to the same basic conclusion in the cases Murphy presents (all firmly contradicting Krugman), they all produce slightly different numbers. In any case, all one needs to do is to apply is a smattering of economic logic. To us the fact that the 'basic theory is unassailable' is what is most important. We nevertheless urge interested readers to read Murphy's article in toto, as it also contains a very interesting chapter on 'expansionary fiscal consolidations'.
Naturally, the term 'structural reform' is a red flag for Krugman. He writes:
“Oh, and when people start talking about the wonders of “structural reform,” take it with a large heaping of salt. It’s mainly a code phrase for deregulation — and the evidence on the virtues of deregulation is decidedly mixed. Remember, Ireland received high praise for its structural reforms in the 1990s and 2000s; in 2006 George Osborne, now Britain’s chancellor of the Exchequer, called it a “shining example.” How did that turn out?”
This is yet another of Krugman's countless non-sequiturs. Are we to believe that regulating the economy to death is going to produce better economic outcomes than leaving it alone? Ireland's crisis was not a result of economic deregulation; it was the result of a credit bubble. Credit bubbles are produced by the fractionally reserved banking system aided and abetted by the central bank. We have never seen or heard Krugman utter a single critical remark about this system. On the contrary, whenever he discusses central banks, we find him pleading for more monetary pumping. He demanded that the Fed should 'act irresponsibly' on several occasions. Most damning in this context is his agreement with Paul McCulley in summer of 2002 that 'Alan Greenspan needs to create a housing bubble'. In other words, Krugman agitated for the very policy blunder that produced the bubble and subsequent crisis that in the end also laid Ireland low. Here is the exact quote:
“To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”
This is an example for what William Anderson once referred to as 'Krugpot economics'. It certainly goes to show that following economic advice from Krugman and his fellow Keynesian charlatans (Paul McCulley is a prominent one) can be downright dangerous.
Conclusion:
There is no 'plot against France'. That exists only in Paul Krugman's fevered mind. If anything, the 'AA' rating S&P sees fit to grant France is still way too high (we would actually call it 'daring'). Krugman's ideas on government spending and taxation are contradicted both by economic logic and empirical evidence. Moreover, the people running France right now sure don't need his input when it comes to tax & spend policies – they are firmly wedded to big government ideas, and the outcomes are there for all to see. Anyone with entrepreneurial drive or wealth to protect is trying to flee France, with the result thatLondon is now the 6th largest French city. Even Obelix has decided he would rather be a Russian than a Frenchman.
Paul Krugman has joined the conspiracy theorists and thinks a 'plot against France' is underway.
(Top Photo via frontpagemag.com / Author unknown)
