Conscience of a Keynesian

The Return of Depression Economics and the Crisis of 2008

Paul Krugman is the country’s most prominent liberal critic of Barack Obama’s economic policy. His twice-weekly New York Times columns have recently excoriated the administration’s response to the economic crisis for bearing too close a resemblance to George W. Bush’s.

Obama’s latest moves, he says, have been too slow and not sweeping enough to get credit flowing, while they protect the rich at a moment when they should really ensure that ordinary people have money to spend.

Krugman’s support for greater social equality puts him at odds with the “supply-side” neoliberal policies that have dominated elite policy in recent decades. This is not just a moral stance. With characteristic humor, he recently told Newsweek: “I’m not overflowing with human compassion. It’s more of an intellectual thing. I don’t buy that selfishness is always good. That doesn’t fit the way the world works.” This stance places Krugman in the “Keynesian” camp, which emphasizes the need to support consumer demand as a tonic for the overall economy. As John Maynard Keynes did in the 1930s, Krugman advocates free markets because they can produce high economic growth, but also like Keynes, he believes that markets go wrong in ways that are predictable—and fixable, given the right policies.

Krugman’s latest book originally appeared in 1999 to explain the Asian crisis of the late 1990s, Japan’s decade-long stagnation, and crises of Latin America dating back to the 1970s. The new edition, released last December, updates the account to the point last fall when the financial crisis was clearly turning into a major global slowdown in the “real economy.”

Because of its scope, the book forms an invaluable chronicle of the crises of the neoliberal period. In many cases, Krugman also exposes the crucial links between successive crises. For example, he explains clearly how the Asian financial crisis was followed in 2000 by the deflation of a bubble in Western tech stocks and a recession in the United States. The Federal Reserve then loosened credit to stimulate the economy, and kept rates low, in part, because employment was slow to recover. Low rates fed a boom in mortgage lending and helped create the housing bubble that only began to burst in 2006.

Along the way, Krugman provides useful plain-language explanations of topics

that often get people confused: the difficulties in adjusting national monetary policies in a multipolar world economy; how hedge funds operate, how they profit from market volatility, and how they aggravate that volatility; what banks really do, and how an unregulated, high-risk “shadow” banking system grew worldwide until it was exposed—and largely demolished—because of the mortgage crisis.

The internationalization of finance meant that no economy was “decoupled” from the crisis in the U.S.:

A large part of the increase in financial globalization actually came from the investments of highly leveraged financial institutions, which were making various sorts of risky cross-border bets. And when things went wrong in the United States, these cross-border investments acted as what economists call a “transmission mechanism,” allowing a crisis that started with the U.S. housing market to drive fresh rounds of crisis overseas. The failure of hedge funds associated with a French bank is generally considered to have marked the beginning of the crisis; by the fall of 2008, the troubles of housing loans in places like Florida had destroyed the banking system of Iceland.

If Krugman has an analytic strong point, it is in understanding international economic connections. He won a Nobel Prize, after all, for his challenges to mainstream theories of world trade. Nevertheless, Krugman’s default standpoint seems to be national, not global. He often considers how one national economy compares to other economies, or how it relates to other economies, but not how it may form an integrated system with them. He seems, for example, to lack a concept of an imperial world order, in which advanced economies compete over which will capture the profit opportunities that come from dominating the resources, markets, and labor power of the less-advanced.

More to the point in the current discussion, Krugman makes practically nothing of the fact that the crisis among Asian exporting countries in the late 1990s was resolved by adjusting the world system so that the U.S. would borrow money to act as the “importer of last resort.” This “solution” forms the background to the massive trade imbalance between the U.S. and China and the skewed global financial picture of the 2000s—in which foreign holdings of U.S. government debt exploded at the same time that corporations and individuals worldwide were also piling up debt.

This shortcoming in Krugman’s analysis comes directly from his Keynesian standpoint. He approaches crises as policy problems, not as systemic problems. The book concludes with an emphatic denial that the problem of the world capitalist system is really structural. Krugman suggests that the real links among the crises of the past decade come from a string of policy mishaps that can be blamed on mistaken supply-side theories.

Krugman’s bashing of neoliberal orthodoxy is quite welcome, but he’s also attacking those, including Joseph Schumpeter and Karl Marx, who have said that crises are endemic to capitalism and actually perform a function, in Schumpeter’s phrase, of  “creative destruction.” Krugman quotes and rejects Schumpeter’s view that crises adjust capitalism to its real profit potentials. He thus also rejects the idea that government responses to a crisis might merely reshape and postpone the crisis to a later date—a point made, before Schumpeter, by Polish Marxist Rosa Luxemburg.

Krugman’s view comes out sharply in his briefest diagnosis of the world crisis:

What does it mean to say that depression economics has returned?… [F]or the first time in two generations, failures on the demand side of the economy—insufficient private spending to make use of the available productive capacity—have become the clear and present limitation on prosperity for a large part of the world.

Krugman is correct to locate the problem in the mismatch between productive capacity and the broad public’s ability to buy, but his emphasis on consumption misses the possibility that capital itself has been overproduced to the point that it is unable to find a profitable outlet—and eventually moves from one bubble to the next.

In Marx’s version of crisis theory, the market mechanisms of crisis—which Krugman explains so ably—are sometimes an expression of such an underlying general crisis of profitability, a “structural” problem if ever there was one. In this view, neoliberalism as a theory may be full of mistakes, but it was a historic response to a real problem of global slowdown in the 1970s. The ensuing decades of redistribution of wealth from workers to bosses—to the “supply side”—actually had the effect of restoring lost profitability. In other words, it was functional for the system, even while it was dysfunctional for most people on Earth.

This criticism shouldn’t stop anybody from reading this enlightening book, or checking out Krugman’s New York Times blog to keep current. Just pick up a copy of Luxemburg’s Reform or Revolution while you’re at it.

Issue #63

January 2009

Politics and struggle in a new era

Issue contents

Top story



Critical Thinking