Krugman, Japan and the definition of insanity

The belief in Keynesian stimulus spending is the perfect example of Albert Einstein's definition of insanity

Will it work this time?
Guy Bentley
On 21 January 2013 13:54

Recently the beleaguered government of Japan announced they would be embarking on a programme of fiscal stimulus totalling the equivalent of £72 billion. It is hoped this new programme of government spending will raise economic growth by 2 percent and create 600,000 jobs.

Unsurprisingly the world’s favourite Keynesian, Paul Krugman, welcomed this move by the Japanese government and showered praise on the Prime Minister of Japan: 

"In short, Mr. Abe has thumbed his nose at orthodoxy, with excellent results."

In Krugman's eyes Japan is abandoning the 'failed orthodoxy' of austerity and is turning to policies that will promote jobs and growth. He has also been supportive of moves to pressure the bank of Japan to seek higher inflation to help Japanese exporters.

The problem is we have been here before. In the 2009 the New York Times reported that "during nearly two decades Japan accumulated the largest public debt in the developed world totalling 180% of its $5.5 trillion economy while failing to generate a convincing recovery".

Between 1992 and 1995 Japan introduced six stimulus programs totalling 65.5 trillion yen. Before the decade was out another four stimulus packages were introduced. By the end of the 90s ten stimulus packages, totalling over 100 trillion yen, had been thrown at the Japanese economy with little to show for it in terms of economic growth.

The belief in Keynesian stimulus spending is the perfect example of Albert Einstein's definition of insanity - doing the same thing over and over again, expecting different results.

It is interesting to observe Krugman's attitude towards the effectiveness of stimulus spending in Japan when in 1999 he wrote:

anyone who believes that temporary fiscal stimulus will produce sustained recovery is implicitly endorsing a rather fancy economic model, the sort of model that finance ministries would under normal circumstances regard as implausible and disreputable…

…What continues to amaze me is this: Japan's current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe

Krugman appears to justify government spending regardless of any other factors including vast government debt, deficits, and previous failures. He seemingly rejects any notion that cuts in government spending can ever lead to a positive outcome, explaining away every example to the contrary including Canada 1994–1998, Denmark 1982–86, Finland 1992–2000, Ireland 1987–89, and Sweden, 1992–2000.

He has moved to such an extreme position, denying almost any evidence that large amounts of government debt could be a problem. A paper written by Carmen Reinhart and Kenneth Rogoff titled 'Growth in a time of debt' shows that once a nation's debt-to-GDP ratio reaches 90 percent median growth, rates fall by 1 percent; Krugman also rejects this. 

As his arch nemesis Robert Murphy points out: "Krugman and his allies have been backed into a corner, having to explain away (at least) nine historical episodes that contradict their theories."

The fundamental flaw in the Keynesian analysis is that if you ask the wrong questions you will get the wrong answer. As the economist Benjamin Powell points out, neither the Keynesian nor Monetarist explanations provide a compelling account of why the Japanese economy has stagnated since the early 1990s.

In marked contrast the Austrian perspective provides a compelling account of the crisis. The origin of the crisis was the unsustainable boom during the 1980s in large part due to the expansionary policy of the bank of Japan. Consistent with Monetarist theory the recession came due to the contraction of monetary expansion. But Austrians see this as a necessary process to rebalance the economy.

During the artificial boom in Japan and the subsequent government interventions that were meant to deal with the inevitable bust, the structure of production has been further distorted. As with most government interventions in the economy Japan's numerous spending packages have been based around political decision making processes favouring certain groups and preventing the restructuring the economy needs to grow and satisfy consumer preferences.

Krugman's stance should not surprise anyone. Debates around government spending have moved far beyond the realm of whether the economics is right and wrong. The point is an ideological one; it is no surprise that Krugman's column is called 'conscience of a liberal' rather than something like 'notes of an economist'.

For those who wish to expose the factual failure of the arguments advanced by Krugman and his allies this must be coupled with a message countering the moralistic arguments that a nation’s compassion is measured by how much its government spends or an individual’s morality is measured by how much tax they pay.

When governments preside over a stagnating economy or an inflationary crisis it is the poorest and most vulnerable who are hit are hardest. The Keynesian fantasy leads to nothing more than economy based on cronyism and a society based on envy.

Guy Bentley is a Libertarian blogger and a former editorial assistant at the Commentator

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