You might have seen this clip from CNBC’s Squawk Box on Wednesday. It features Nobel Prize-winning economist Paul Krugman fielding bush-league questions about the role of government in the American economy, principally from co-host Joe Kernen.
After hilariously telling Krugman, “I view you almost like a unicorn,” Kernen said he was “confounded” by Krugman’s writing and that he hoped to spend the segment having a “philosophical argument.”
As arguments go, viewers got a lot more dogma than philosophy. Krugman set out to push his new book End This Depression Now! Kernen couldn’t have cared less.
Krugman made the point that when an economy is doing well, it is incumbent upon the government to pay down its debt. A hike in spending, or for that matter a cut in taxes, is counterproductive if you’re a running a deficit while the economy is healthy. That changes during a slowdown or recession. Government spending is appropriate then because it stimulates the economy. The last thing you want to do during a period of negative or slow economic growth is cut government spending.
Some – clearly Kernen is in this camp – argue that this logic doesn’t apply to the U.S. today because its debt is too high. That in fact austerity, or an effort to cut government spending so that debt levels come down, is the necessary next step.
But austerity can have unintended consequences in a downturn. Cutting government spending has a negative effect on economic growth. That’s not an argument; it’s a simple point of fact. Reduce spending in a soft economy and you will make it a whole lot softer. It triggers a rise in unemployment and a drop in consumer spending, both of which mean lower tax revenues.
Furthermore, there is little evidence that the U.S.’s national debt is in fact too high. The yield on 10-year Treasury notes is near a record low, well below the rate of inflation. If bond holders are so convinced that the U.S. government is at risk of not meeting its financial obligations (à la Greece), then why are they prepared to lend the government money for so little in return?
The big question came at about the 10-minute mark. After pinning Krugman down on an acceptable level of government spending (he said anything north of 50% would cause him to “start to wonder”), Kernen asked about the relative efficiency of government. Isn’t the private sector more effective?
Krugman talked about healthcare as an example of where that’s not true. He might also have said that governments are uniquely positioned to stimulate a stalled economy.
Imagine you’re a U.S. business-owner right now. Unemployment remains above 8%. Europe is threatening to drag the global financial system into its second crisis in five years. And emerging economies such as China, which have been among the few sources of global growth, are slowing down. Are you more likely to add or cut staff? Are you thinking about investing in your business or stockpiling cash?
The U.S. government, on the other hand, has the resources to support the economy. It can spend to stimulate growth, knowing that when times are better it can pay the added debt back down. At least that’s what Macroeconomics 101 teaches us.
It’s unrealistic in the extreme to expect the private sector – companies and/or consumers – to soften the effects of an economic downturn. Only governments have the resources to execute stimulus programs that minimize both the length and depth of a recession.
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