Sunday, July 11, 2010

Krugman and Ferguson: liberal and conservative

On the eve of a massive day of reckoning between the Orangemen and the Iberians with a Catalan spine; a mighty battle that may see the Dutch prevail...if von Bommel and de Jong can stymie Iniesta and Xavi...if Kuyt and Robben can interchangeably outflank the Spanish centre and confuse Xabi Alonso and Puyol...if Latin emotions lose out to Dutch cool...if...a bird's brain has better intuition than the psychic powers of a spineless octopus...

On this eve, I am taking some time out to make some observations on the ongoing pitched verbal battle between Paul Krugman and Niall Ferguson.

Paul Krugman.

Krugman has advocated strongly for further economic stimulus packages to be rolled out to ride over the spectre of a double-dip recession. That is his proposed remedy.

Ferguson believes that further deficit spending will leave governments and nations and economies in tatters and drown in a sea of debt.

Niall Ferguson.

Krugman has, in interviews, hearkened (with a straight face) the historical phenomenon where the Great Depression only truly ended when World War II happened, the War causing the U.S. Government to embark on a massive public spending programme. That was a tad too glib for my liking.

I tend to lean towards Ferguson in this debate.

Instead of further deficit spending I would urge governments to look into two key policy measures.

Krugman and Ferguson are in mutual agreement that the key issue is unemployment. But they differ on the economic policy prescriptions to reduce unemployment.

Being a liberal, Krugman is sceptical that the private sector can voluntarily unlock their savings and start re-investing (and, therefore, start employing).

Krugman, in the same interview that I saw, made another glib remark that the best and most immediate way to reduce unemployment was for governments to employ more people in the public services! As I said, a tad too glib for me. And, coming from a Nobel-winning economist at that! (Though the catty response would be that the Nobel Prize Krugman earned was for trade NOT fiscal policy).

The Krugman prescription leaves too many loose ends in economic policy not the least of which is a huge mountain of debt and, possible hyperinflation from overprinting of money.

First, tweak tax policy

The first policy imperatives that governments should look into to stimulate economic activity and stave off a double-dip is to tweak the tax rates.

Corporate and personal income tax rates should be reduced. This will stimulate private investment for sure. And, consumption spending will tend to increase since taxpayers will have greater disposable incomes unlocked by the reduction of income tax.

In the context of Malaysia, I say again, bring both corporate and personal income tax rates down to a top rate of 18%.

Second, reduce public spending and government size

Commensurate with the reduced tax revenue, governments should reduce public spending. This will be in tandem with the growth of private investment and consumption.

At the same time, the bloated civil service should be downsized to reduce operating expenditure.

I realise that the difficult issue, one which liberals like Krugman are sceptical of, is whether the private sector will rise to the incentive offered by the reduction of income tax or, just sit on their fat tax savings.

It all boils down to confidence.

The capital markets throughout the world are highly concerned about greater deficit spending and more stimulus packages. This must surely be indicative of a fairly rational market environment that will respond positively to the effort by governments to pare down their bloated bureaucracies and profligate spending. The market will also respond positively to the likelihood that consumption will increase as disposable incomes increase.

This creates a virtuous cycle.

In contrast, increased deficit spending which increases public debt and increases the threat of hyperinflation creates a potential vicious cycle.

There, I said it.


hishamh said...

With respect friend de minimis, I have to disagree. Are you refering to this article by Niall Ferguson?

Because despite the massive issuance of debt, yields on 10-yr Treasury have been pretty volatile since the article was written (you can check them here), but generally still around the same level as before.

Despite his credentials and the title of the article, Mr Ferguson has himself misunderstood or misrepresented what was going on. Treasury yields (and the stock market, and the USD exchange rate), have largely been driven by risk aversion, not supply and demand. And quoting just the rise in yields over a six month period is highly misleading, as this coincided with the recovery in the global economy (and thus lower risk aversion, and thus lower demand for "safe" assets).

While I don't necessarily subscribe to Krugman's "savings glut" thesis - it's too much like an excuse for saying it's not our (US) fault - I believe his policy prescription (such as it is) is correct for the US.

There's little evidence that the market cares at all about US debt levels, or the non-risk of hyperinflation. In fact quite the opposite, which suggests expectations of very low inflation, or very low growth, or both.

Not that I think it particularly matters, because I don't see the risk of a double-dip as being very high.

hishamh said...

Interesting reading from RGE:

semuanya OK kot said...

Krugman has explained his views lucidly in at least 5 of his newpaper columns. I have not heard of the other guy. As far as I see, and as reported by Krugman, the opposition seems hell-bent on regaining power at any cost.

None of this will make the Malaysian problem of 1.2 million superannuated, BTN-infected zombies and an Alien-like parasitical strategy go away.

de minimis said...

Bro hishamh

If the threat of a double-dip is too imminent, the kruan prescription may be too compelling for policymakers too ignore. He did say that he believes the situation is almost where the kitchen sink needs to be thrown into the mix. Sounds dire. Krugman is the new "dr doom"???

armela said...

im with the comment of hishamh...