"On Krugman"

Robert Levine of Rand emails this reaction to Paul Krugman's essay on the state of macroeconomics:

On Krugman, by Robert A. Levine, Rand: Being a saltwater economist, by ideology and a bicoastal education and career, I of course think that Paul Krugman’s “How Did Economists Get it So Wrong?” made some major points that needed making, and as usual made them very well.

But he also left two major omissions, inclusion of which may change the states of both theory and the economic outlook. Neither has either appeared in the commentaries I have seen.

The first omission is of Joseph Alois Schumpeter.¹ Krugman did mention the name in two sour asides; it apparently does not appear in any of the commentaries. Schumpeter is remembered by many of his colleagues as an unpleasant man as well as a political reactionary. I was not in a position, as an undergraduate in one of his courses shortly before he died, to judge the former. The latter was certainly true: he was a royalist.

He was also one of the seminal economists of the 20^th century. He was a rabid anti-Keynesian, but in fact his central concepts of innovation and entrepreneurship integrate well with Keynes and fill in a major gap. Keynes’s discussion of investment provides a complex analysis of the relationship of profits and interest rates; it says little about where the profits come from. That is what Schumpeter is about: not the routine buying and replacing of capital goods, strongly influenced by the close profit/interest relationship, but the “autonomous” investment stemming from doing new things in new ways. Such investment then invokes the Keynesian multiplier, the Keynesian (but post-Keynes) accelerator, and business cycles endogenous to the narrow profit/interest relationship but exogenously induced.

In particular, Schumpeter’s emphasis on innovation-induced “long waves” (which he named after their discoverer, Nicolai Kondratieff), starting with the industrial revolution and continuing through railroads, the telegraph, the telephone, automobiles, aircraft, radio, and—after Schumpeter—television and computers and the “information revolution” fills a crucial gap in the saltwater/freshwater debate. Much of the causation for the really major macroeconomic movements since World War II simply lies outside of that debate as now waged..

Schumpeter’s emphasis on the regular periodicity of Kondratieff and other shorter cycles has been generally and properly criticized; in the last century such regularity if it existed at all was interrupted at least by the two World Wars. But the concept of innovation, with creative destruction and all that goes with it, stands; it is widely accepted by economists—and then ignored as a macroeconomic factor, e.g., in the current debate.

This leads to the second omission, the failure to treat with the fundamental causes of the dreadful decade of the 1970s. Krugman covers it as a cause of the major parting of the waters between salt and fresh, which it is, but in fact the major cause of the dismal economy and the consequent dismal economics lay outside of both; rather, it was in the fundamental global redistribution led by consolidation of OPEC and the oil boycotts stemming from the Yom Kippur war and then the Iranian revolution. The oil sheiks took control of a crucial portion of world product. Oil consumers had to adjust, cutting back on their own portion either by slowing growth and increasing unemployment, or bidding for what was left, thus engendering inflation. Economists adjusted by inventing, and then arguing about, rational expectations. Stagflation brought about no good responses either in the real world or the economics stratosphere.

The 70s can be looked at as a Schumpeterian wave in reverse: instead of growth-engendering structural change, the assertion of power by the oil-producers was a growth-inhibiting (at least for the major developed economies) structural change—with consequences yet to be analyzed.

The developed economies, and the rest of the world, recuperated from the 70s via a true Schumpeterian wave created by computers and information technology, and ending, as Schumpeterian waves do, in the bursting of the IT bubble in the late 1990s.

Whether the housing/financial bubble has anything to do with Schumpeter is arguable: the attempt to spread home ownership through financial innovation might be treated as an example of useful entrepreneurship gone bad, or the pervasive financial devices themselves might be classed in the same genre.

Underlying much of the current malaise, however, is another real-economy factor not mentioned in the current debate, the rise of the developing economies, led by China and India. Like the oil producers of the 70s, they are claiming increasing portions of world product. Unlike the sheiks, however, they are producing more rather than rather than grabbing existing product. The needed adjustments for the developed world may nonetheless be traumatic, including stagflation as the world economy (apparently already led by China and India) returns to growth.

Whether this is “negative Schumpeterianism” is probably not worth worrying about. What we should worry about instead is coping with the consequences—to Us—of major economic restructuring. Financial reform and short-run monetary or Keynesian stimulus, necessary for short-run melioration have little to do with the long run. We may have to await the onset of another truly Schumpeterian technological wave, whenever that occurs.

A term of the 1930s, long-since forgotten, was “secular stagnation”; when the Great Depression was ended not by technology but by deficit spending to finance World War II, the fears that growth had ended until an unforeseeable future were forgotten. One hopes that this time the turnaround will be based on technology, not war or even indefinite peacetime deficits, with positive change beginning soon.

In my grandmother’s version of Keynes’s most famous statement, “We should live so long.”

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¹ Another; name, completely omitted, is that of John Kenneth Galbraith, but his semi-institutional economics remains, of course, beyond the pale.

(Much of this commentary is based on Robert A. Levine, “Adjusting to Global Economic Change: the Dangerous Road Ahead”, RAND OP-243-RC)