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.