Paul Krugman & the nature of economics

Paul Krugman is being accused of hypocrisy for calling for an extension of unemployment benefits when one of his textbooks says "Generous unemployment benefits can increase both structural and frictional unemployment." I think he can be rescued from this charge, if we recognize that economics is not like (some conceptions of) the natural sciences, in that its theories are not universally applicable but rather of only local and temporal validity.

What I mean is that "textbook Krugman" is right in normal times when aggregate demand is highish. In such circumstances, giving people an incentive to find work through lower unemployment benefits can reduce frictional unemployment (the coexistence of vacancies and joblessness) and so increase output and reduce inflation.

But these might well not be normal times.It could well be be that demand for labour is unusually weak; low wage inflation and employment-population ratios suggest as much. In this world, the priority is not so much to reduce frictional unemployment as to reduce "Keynesian unemployment". And increased unemployment benefits - insofar as they are a fiscal expansion - might do this. When "columnist Krugman" says that "enhanced [unemployment insurance] actually creates jobs when the economy is depressed", the emphasis must be upon the last five words.

Indeed, incentivizing people to find work when it is not (so much) available might be worse than pointless. Cutting unemployment benefits might incentivize people to turn to crime rather than legitimate work.

So, it could be that "columnist Krugman" and "textbook Krugman" are both right, but they are describing different states of the world - and different facts require different models; I fear that Krugman's excessively combatative style is ill-judged in this context.

The question to ask of any model or theory isn't merely: is it internally coherent? It's: does it apply here and now? Here are three other examples of this:

 - You can write some sort of model in which QE is deflationary. The question is: does that model apply to the economy today?

 - Brad De Long has suggested that the "liquidationist" (pdf) theory of recessions - the idea that unprofiatable capital must be destroyed - was a terrible idea during the Great Depression of the 30s, but valid for some previous recessions. Different times require different theories.

 - The idea of expansionary fiscal contraction might have applied in some times and places, but it hasn't applied to the UK recently.

My point here generalizes, I think. In the social sciences, very many hypotheses, models or theories are true of some times, some places and some people. One job of the social scientist is to judge which theory works when. We don't need theories of everything. We need theories of here and now.  

Another thing: economic efficiency isn't the only relevant value here. There's also the principle of luck egalitarianism, which says we shouldn't penalize people for things thery can't control. This argues more more generous unemployment pay in hard times, as it's more likely in such circumstances that people are out of work through no fault of their own.

Comments

[Leigh Caldwell]

Theories in physics are also only applicable in specific times and places - apples don't fall at 10m/sec/sec in space - but the theory usually includes clear enough definitions for the user to be able to know when and how they can apply it. Economic theories can be more general if they include such specifications; then rather than picking a theory ad hoc, our meta-theory can also tell us which sub-theory to use in the current context.

Perhaps a better generalisation is to say that generous unemployment benefits always have an incentive effect (on some people, to differing extents) and always have a demand effect (on some people, to differing extents), but which effect dominates at the aggregate level depends on the presence and strength of other incentives and other demand.

[Neil Wilson]

" In such circumstances, giving people an incentive to find work through lower unemployment benefits can reduce frictional unemployment (the coexistence of vacancies and joblessness)"

That's the marginalist argument that people are fundamentally lazy and prefer 'leisure' to 'work'. People always seek out something to do anyway, because doing nothing is boring. Quits rise in a boom and disappear in a recession.

If you do reduce the cost of labour then you also reduce the incentive on capital to invest to eliminate jobs - as well as reducing demand which makes the full utilisation of existing capital irrational.

And that leads you straight to a low productive economy.

Labour needs to remain expensive to promote the replacement of jobs with machines, and private sector expansion has to be brought to a halt sufficiently early to allow room for that investment spending to happen.

Unemployment benefits (or more preferably a Job Guarantee) give you the policy space to allow that to happen.

[Boffy]

" the idea that unprofiatable capital must be destroyed."

It depends what capital destruction means here. The term has been used by those with a crude interpretation of Marx to mean the physical destruction of capital. So on that basis its argued that the physical destruction of capital in WWII, in some way was useful for capital in providing a basis of more rapid growth after WWII.

A simple consideration that the main problem that developing economies face is a lack of capital is enough to show that such a concept is ludicrous.

When Marx talks about capital destruction he does not mean its physical destruction, but the destruction of capital value. In other words, what capital requires is the continued physical existence of that capital, but for its value to be radically reduced, by some form of "moral depreciation".

On that basis the physical capital is able to be utilised by new owners profitably in a way that its formers owners could not, and even existing owners of are able to utilise surplus value to buy replacement capital at much reduced values, thereby bringing about significant rises in the rate of profit.

So, Marx says,

“When speaking of the destruction of capital through crises, one must distinguish between two factors.” (TOSV2 p 495)

One is the form of physical destruction described above, but it is the second form that is beneficial for capital.

“A large part of the nominal capital of the society, i.e., of the exchange-value of the existing capital, is once for all destroyed, although this very destruction, since it does not affect the use-value, may very much expedite the new reproduction. This is also the period during which moneyed interest enriches itself at the cost of industrial interest. As regards the fall in the purely nominal capital, State bonds, shares etc.—in so far as it does not lead to the bankruptcy of the state or of the share company, or to the complete stoppage of reproduction through undermining the credit of the industrial capitalists who hold such securities—it amounts only to the transfer of wealth from one hand to another and will, on the whole, act favourably upon reproduction, since the parvenus into whose hands these stocks or shares fall cheaply, are mostly more enterprising than their former owners.”

(TOSV2 p 496)

[Ralph Musgrave]

Neil Wilson seems to claim that because “People always seek out something to do..” that therefor what they will do will consist of work. The long term benefit scroungers in my neighbourhood certainly find “something to do”: gardening, going for walks, watching television, etc. But that’s not work is it?

Re Neil’s theory that “Labour needs to remain expensive” so as force employers to create productive jobs, that’s a great theory. So if we quadrupled the minimum wage, the output of the least productive would instantly be quadrupled? Where do I find this new theory set out in more detail? If that theory is valid, its inventor deserves a Nobel Prize.

I accept that in-work benefits are an artificial disincentive to paying decent wages, and that that artificiality probably needs a countervailing artificiality, i.e. minimum wages. But beyond that, I go along with the conventional wisdom, namely that an excessive minimum wage simply destroys the least productive jobs.

[Apps 55753818692 57604852 9cfb5a666c56e52ae2f81297bcf2c9ab]

The textbook says ""Generous unemployment benefits CAN increase both structural and frictional unemployment." It doesn't say it will. It's like saying a useful medication can cause have a harmful side effect. It doesn't mean you never prescribe it. The critics are either terrible readers who don't know the meaning of "can" or hypocrites themselves.

[Anthonyjuanbaut]

This post (inadvertently?) exemplifies the tenuous scientific status of macroeconomics, and argues that macroeconomists as a cohort should be ignored as regards policy advice, etc.

Simply put, science that is "locally and temporally valid" isn't all that useful. Can you imagine a medical study where therapy/intervention demonstrated efficacy only in black males over 50 in the setting of uncontrolled diabetes? The take-away is that the intervention really isn't "generalizable" and therefore not useful in curing human disease. Sadly the same holds for the macroeconomic "therapies".

[Dave Timoney]

@Anthonyjuanbaut, macroeconomics isn't a science (in the modern sense of the word, i.e. having to do with the observation of the physical world). It is often described as a "social science", but that is a clumsy oxymoron. Though science can play a supporting role (e.g. cliometrics in history), the true object of study in economics is human behaviour, hence the inescapable reduction to moral philosophy.

The economy, as an object of study, is a human construct (or gestalt), both in the sense of the aggregate of decisions by individual "utility maximisers" and in the sense of a projected, quasi-religious belief. The urge to interpret it as a science, through mathematical models and "laws", is an attempt to dehumanise and depoliticise it for hegemonic reasons.

There is no economic "law" that cannot be proved or disproved at some time or place, so economics as a discipline fails the falsifiability test proposed by Karl Popper. However, that can also be twisted to suggest we can never know anything with assurance and should therefore cleave to the tried and tested (the reactionary recourse of Hayek, Oakeshott et al).

Economics is politics. No more, no less.

[Anthonyjuanbaut]

@Elbow: Very nicely said.

[Robert Waldmann]

This is an excellent post. Congratulations on the Krugman and Thoma links. Krugman had one criticism and as a total Krugbot I want to explain and pile on.

He said physicists, too, use different models at different times.

I think the particular problem with economics is "models or theories". In the natural sciences, there isn't the concept of "models or theories". Theories are to be tested and rejection by the most obscure data is considered very important. Models are to be used and are known to be false.

Economics has the peculiar pathology of theory, which is known to be false, but is considered important aside from its usefulness (so ad hoc models aren't treated with as much respect as less empirically useful theory based models).

[JSeydl]

Thank you for writing the last paragraph. We need more economists who can think outside of the realm of efficiency every once in a while; especially considering that moral considerations are typically thought, at least among the philosophers, to come *prior* to efficiency considerations.

[Deviation From The Mean]

From Arse to, erm, Arse said,

"Economics is politics. No more, no less."

I admire skepticism and economics needs it but, seriously, you are telling me that economics cannot proceed on scientific terms? Who are you to consign centuries of academic work to the dustbin of history?

More from Arse:

"The urge to interpret it as a science, through mathematical models and "laws", is an attempt to dehumanise and depoliticise it for hegemonic reasons."

I can think of one great leftist who would have found your position very problematic, Karl Marx! His attempts to uncover the inner workings of the economy and establish categories, laws etc should have saved us from many a dead end provided by 'humanists' and 'politicos'. But alas, it didn't!

apologies, but to quote Engels:

"To desire, in a society of producers who exchange their commodities, to establish the determination of value by labour time, by forbidding competition to establish this determination of value through pressure on prices in the only way it can be established, is therefore merely to prove that, at least in this sphere, one has adopted the usual utopian disdain of economic laws."

[weareastrangemonkey]

Krugman (and a large number of other economists before him) has made this point many times before:

When the economy is operating at its full potential unemployment benefits will increase unemployment. When the economy is not operating at its full potential (i.e a recession caused by low demand) then government spending (such as unemployment benefits) can increase demand and thus increase employment.

These are not contradictory points. Its like someone saying "when the road is straight keep going straight. When there is a turn in the road then turn (in the correct direction)." and the gotcha response of the morons is to say "But you said to go straight an hour ago." It is idiotic nonsense, and I think it is disingenuous.

[Keith]

It is a shame Prof Krugman gets no credit for his compassion. He is clearly a nice person ( having never met him ) and it is good to see that he opposes causing suffering to the American unemployed, their friends, and families.

On the other hand unemployment is caused by inadequate demand and poor regional policy. The very abstract models that indicate otherwise are suspect. In the right political conditions developed economies have created full employment such as during big wars.

In that sense it is always a political choice to prefer under employment of assets to their employment.

[Dave Timoney]

@DFTM, Engels (and Marx before him) was criticising the simplistic application of morality to economics, which he discerned in the work of Proudhon and other utopian socialists. This isn't a justification of economics as a science, but the dismissal of a political competitor (which rather proves my point).

Re "Who are you to consign centuries of academic work to the dustbin of history?" I make no claims for myself (other than that I am alive and Engels isn't), but surely that statement could have come from the mouth of every conservative who ever lived?

[Deviation From The Mean]

No Marx and Engels believed that a scientific method could be applied to economics - abstraction, categorisation, modelling, testing etc etc. Engels likened Marx's work in economics to Lavoisier in Chemistry. How any right thinking person can dispute this is beyond me.

Engels again,

"Marx stands in the same relation to his predecessors in the theory of surplus-value as Lavoisier stood to Priestley and Scheele."

Science is more often than not on the side of progress and against reaction. Of course ruthless criticism is part and parcel of any approach, but blanket dismissal is the kind of approach I would expect to see from the evangelical Christians.

I am aware that economics, and other such meta theory disciplines, is very prone to manipulation, bias etc etc but this is why honest and searching criticism is necessary. Countering one falsehood with another gets you nowhere, and more often than not, leads down dead ends.

[Dave Timoney]

@DTFM, the application of the scientific method to economics is no different to its application to history (cliometrics) or music (harmonics). This does not make either history or music a science.

Marx and Engels scientism must be seen in the context of an era when empiricism was routinely invoked in support of progressive causes. However, it was also invoked in support of plenty of reactionary ones too, such as eugenics and race theory. The claim that "Science is more often than not on the side of progress and against reaction" is just liberal cant.

By the way, I am neither an evangelical Christian nor a "right thinking person".

[Deviation From The Mean]

"Marx and Engels scientism must be seen in the context of an era when empiricism was routinely invoked in support of progressive causes."

It was an era when science flourished as it was applied more and more to every discipline of society, with spectacular results. Incidentally, the era of applying that method to these disciplines is still with us. We will have to wait a little longer for the next 'dark' age!

"Science is more often than not on the side of progress and against reaction" is just liberal cant."

Not liberal cant just meaningless bollocks! I have given myself a good slap for that statement!

[Paul Marks]

The idea that economic law is only of "local and temporal validity" was an error of the 19th century German "Historical School" (refuted by Carl Menger). The defenders of Paul Krugman must be desperate indeed if they have to fall to the level of the fallacies of the Historicists.

As for "Keynesianism" (the idea that producing more money and credit is good for long term prosperity) - even Karl Marx (hardly a defender of the free market or private property rights and limited government)mocked this idea (long before Keynes was born) see Hunter Lewis's "Where Keynes Went Wrong". Although modern Marxists appear to have forgotten this - and in such countries as Venezuela and Argentina mix Marxism and Keynesianism in a weird hybrid form.

As for "egalitarianism" - the idea that it is somehow unjust for someone (due to good fortune) to have vastly more income or wealth than someone else, runs totally against the principles of the Constitution of the United States of America. Someone can not claim to, both, be loyal to the limited government principle of the Bill of Rights and to be loyal to the doctrine of egalitarianism. And, to cite the Governor of New York, if conservatives have no business living in New York - egalitarians (i.e. people who reject the principle that government should be limited) have no business living in the United States.

[An Alien Visitor (Who means you no harm)]

"The idea that economic law is only of "local and temporal validity" was an error of the 19th century German "Historical School" (refuted by Carl Menger)."

As long as you are not suggesting that economic laws are applicable universally and at all times. This would be more abusrd.

[Bob Murphy]

This clarification might interest you, Mr. Dillow.

[Bob Murphy]

Hyperlink didn't seem to take, so here it is:

http://consultingbyrpm.com/blog/2014/01/i-was-less-than-clear-on-my-problem-with-krugmans-unemployment-insurance-post.html