Available Now! (click cover)

America's Counter-Revolution
The Constitution Revisited

From the back cover:

This book challenges the assumption that the Constitution was a landmark in the struggle for liberty. Instead, Sheldon Richman argues, it was the product of a counter-revolution, a setback for the radicalism represented by America’s break with the British empire. Drawing on careful, credible historical scholarship and contemporary political analysis, Richman suggests that this counter-revolution was the work of conservatives who sought a nation of “power, consequence, and grandeur.” America’s Counter-Revolution makes a persuasive case that the Constitution was a victory not for liberty but for the agendas and interests of a militaristic, aristocratic, privilege-seeking ruling class.

Tuesday, January 20, 2009

Krugman Flunks Capital Theory

Paul Krugman is said to have beat up on George Will during this joint appearance on ABC's "This Week" back in November. But all Krugman really did was show that he, like Keynes, holds an unrealistic Play-Doh model of capital, as opposed to the heterogeneous, multistage, intertemporal structure-of-production model of the Austrian school. When Will notes that there was negative net investment during the 1930s, Krugman responds that, of course, there was negative net investment: "Because when . . . all the factories are standing idle, who wants to build a new one?"

Point for Krugman? Wrong.

If Krugman took the Mises-Hayek trade cycle theory seriously he'd realize that the idle factories in the 1930s represented malinvestment induced by Federal Reserve credit expansion in the 1920s. This policy, by lowering the interest rate and falsely signaling an increase in real saving (i.e., a preference for future over present goods), shifted resources from later stages of production (closer to the consumer) to earlier stages of production. Unfortunately, those who think of capital as a heap of homogeneous, monochrome Play-Doh aren't sensitive to this point. Capital is capital is capital. That's why Krugman can't understand why someone would want to invest when factories stand idle.

When the inflationary boom ended, as it had to because it was artificially induced and there weren't enough resources for both the early stages and the later stages (where consumers wanted them), the malinvestments had to be liquidated. But since capital consists not of Play-Doh but of discrete things -- buildings, machinery, tools materials -- with particular characteristics, those that were the products of malivestment were not necessarily suitable for other purposes. They couldn't simply, costlessly, and instantly be moved and employed in later stages of production. Hence, the idle factories. This was wasted capital brought about by the credit expansion. This was the depression.

If the economy was to recover, new investment consistent with consumers' actual preferences had to be undertaken. But that required time and saving, i.e., deferred consumption. It also required a stable political environment in which investors could be confident that their property was safe from the government. Unfortunately, thanks to tax increases, unending interventionist programs, and threatening antibusiness rhetoric, FDR's government failed to provide that environment.

Krugman's flip remark to Will is a perfect illustration of what is wrong with Keynesian economics.

Cross-posted at Anything Peaceful.


liberranter said...

I never cease to wonder how F.A. Hayek ever managed to win the Nobel Prize. Considering the transparent economic illiteracy of every other recipient in that prize's history (Krugman being only the latest example), the decision to award it Hayek must have been either a grotesque error in judgment on the part of the Nobel committee, or an early example of intellectual "Affirmative Action."

Depending on one's point of view, Hayek's status as a Nobel laureate either lends that prize an unearned veneer of legitimacy or stains his otherwise impeccable professional reputation. Krugman's interview with Will, added to the volumes of verbal vomitus he has left all over the NYT's OpEd pages for the last several years, should make the Nobel Prize a kiss of death to the professional reputation of any economist.

Sheldon Richman said...

Of course he had to share it with someone who disagreed with him on nearly everything, Gunnar Myrdal.

Russell Hanneken said...

Excellent post, Sheldon. Krugman ought to be able to appreciate your point even if he doesn't subscribe to the Austrian narrative about the causes of the Depression.

I wonder if he would say involuntary unemployment is impossible while there are still help wanted ads in the newspaper.

liberranter said...

I wonder if [Krugman] would say involuntary unemployment is impossible while there are still help wanted ads in the newspaper.

That would be perfectly in keeping with the sort of nonsense he's published so far. Look for this very theory to appear in the NYT at a future date. Just give him time.