Krugman Gets (a Little) Something Right

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It’s not uncommon for presidential candidates to tout their business experience, often claiming that they know “how the economy works.” Surprisingly, in a recent post, Krugman correctly shot this idea down, noting, “The idea that what America needs now is an executive type is just foolish.”

Unfortunately, Krugman does not arrive at this conclusion through sound economic reasoning. He notes that it’s efficient when a businessman is able to produce the same output with half the input. But he argues that an economy-wide scenario like this one would result in a recession. Evidently something that is efficient on a micro level becomes catastrophic for Krugman when it is amplified. Krugman is subscribing to the Keynesian doctrine of “idle resources” or “unutilized capacity.” For an excellent illustration of just what is wrong with Krugman’s thinking, see here.

As always, we must seek to understand the root cause of any economic phenomena. What might cause a sudden, economy-wide “under-utilization” of resources? This can only come about through an artificial lengthening of the structure of production. This structure is a heavily intertwined chain of goods that stretches from raw materials recently mined all the way to the new TV that you see on the shelf. When interest rates are artificially suppressed, businessmen invest more heavily in production processes that are farther and farther removed from the TV on the department store shelf. Unfortunately, consumers don’t currently desire investment in stages of production which are far removed from consumption. Resources are being tugged in two directions—towards producer goods by the entrepreneurs and towards the consumer goods by consumers themselves. This tug-of-war eventually shows the unprofitability of many entrepreneurial endeavors. When bankruptcy comes, factors go unutilized. The answer is not more intervention, but less.

We’ve seen how Krugman’s analysis is faulty (despite arriving at an accurate conclusion). Still, many think that a president with business experience is best because they expect him to be “pro-business.” In reality, the president should not be “pro-business,” only “pro-property.” As we explain here, businesses themselves are often the most ardent opponents of the unhampered market economy. The only “pro-business” policies that the president should advocate are one’s that protect private property. Only in this climate will business be able to arrange their assets in such a way that scarce societal resources are not squandered.

This gets to the heart of why business experience for the president is next to irrelevant. Entrepreneurs are in charge of assets that can be traded. Ownership claims to assets tell us how the market values them, and it prevents the entrepreneur from using them in a wasteful manner. Government also has assets, but there are no market claims to these. It is simply impossible to tell whether they have been configured in an efficient manner. After all, outside investors cannot buy these assets and put them to use in a different line of production (as is the case on the market). This is precisely why the “businessman-president” will find himself steering a rudderless ship.

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2 Responses to Krugman Gets (a Little) Something Right

  1. Tom January 18, 2012 at 9:54 pm #

    When a candidate says he is “pro-business,” it does not necessarily mean he (or she) is so. It often means “pro-business-government.” Large corporations and the Federal Government has become so intertwined, they are indistinguishable. I don’t trust big business candidates anymore. I would like to hear your views on this from an Economists viewpoint.

  2. libertas January 18, 2012 at 10:38 pm #

    You are quite right. When voters think “pro-business,” they are often imagining policies that create an environment of healthy competition, the eventual result being lower and lower prices for consumers. This is clearly favorable from the perspective of consumers. Of course, like the post noted, these “policies” *should* really only be an enforcement of property rights.

    However, this hands-off approach to business, while favorable to consumers (the lower prices, better quality, etc…) is less than favorable to businessmen and entrepreneurs *themselves.* This is precisely because businesses are now forced into rivalrous competition with one another in order to secure economic profits–and this is can be painful.The only other way to secure economic profits is by leveraging the power of the government in one form or another.

    Subsidies are one way that corporations/businesses benefit from being intertwined with government. The subsidy allows the business to sell at a price that would be unprofitable in the absence of the subsidy. The consumer/the economy as a whole is hurt in multiple ways: the taxes that are levied to pay for the subsidy are obvious, but a malinvestment also occurs because that particular business is squandering resources in a line of production that consumers have not deemed productive (else the business would be able to reap a profit at that same price, but without the help of the subsidy).

    Another popular way for corporations to secure government privilege is, ironically, through anti-trust legislation. Though billed as consumer friendly, most anti-trust cases are not brought by consumers themselves, but by competitors who are less efficient. This allows the less efficient producer to handicap his more efficient rival, and consumers are again the losers. If the larger firm is broken up, it may not be able to take advantage of economies of scale, and the result is higher prices for consumers. Again, malinvestment occurs because the less-efficient firm should probably have liquidated–freeing up its resources for other uses. Instead, it lumbers on with support from the government.

    These are two popular ways that business secures government privilege (there are others), but this is a good starting point for understanding why corporations are often diametrically opposed to the free market.

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