"The return of depression economics" (book review)

Paul Krugman's new book argues that the world might be facing a depression again which can only be avoided by returning to Keynesian policies. Phil Mitchinson reviews the book and points out the flaws of Krugman's "solutions".

Paul Krugman's book is the latest in a recent line from academics, economists and investors (John Gray's False Dawn, George Soros' The Crisis of Global Capitalism) which attempts to analyse the recent economic crisis in South East Asia, Latin America and Russia, and propose a policy which might enable Europe and America to avoid plunging into the same catastrophe. While our newspapers and politicians are beguiled by the myth of a permanent boom, these more serious analyses offer a more frightening image of the future for capitalism.

He begins ominously asking the dreaded question "nothing like the Great Depression can ever happen again. Or can it?" His conclusion concisely and entertainingly argued over the next 170 or so pages is that it can, but that it doesn't have to. Funnily enough this is the conclusion reached by other recent publications on the same theme. The crux of all their arguments seems to be a need to return to Keynesianism.

Early on Krugman points out "The kind of economic trouble that the world has recently suffered is precisely the sort of thing we thought we had learned to prevent....No sensible person thought that the age of economic anxiety was past; but whatever problems we might have in the future, we were sure that they would bear little resemblance to those of the 1920s and 1930s. And then came the latest crisis."

The purpose of his book, he tells us, is to answer the questions "How did this crisis happen? How can we turn it around and prevent it from spreading?" His description of how recent economic events unfolded answers the first, up to a point, but his solution to the second falls well short of the mark.

The last period of defeating inflation, he argues, has been too successful, and no longer allows the room for manoeuvre that economies once had to escape recession through deficit financing - the classical method of Keynesianism. Let inflation, at moderate levels return, he argues. This 'managed inflation' would allow countries to enjoy negative real interest rates to encourage investment in a recession and avoid the trap which has suffocated the Japanese economy over the last ten years, a downward spiral into deflation where even zero level interest rates are no benefit. This argument at least has the merit of answering the objection levelled against Keynesianism that it generates inflation, in advance, by welcoming inflation, as a useful economic tool.

In other words, free markets and monetarism are OK in a boom, but once recession strikes we need the old voodoo magic of Keynes. Forgetting in an instant that it was precisely the crisis caused by Keynesian economics in the 60s and 70s that led to the rise of monetarism as the new religion of the economists.

The problem as Krugman sees it is one of a lack of demand. Stimulating and managing demand is the usual argument of Keynesians, what they singularly fail to do, and here I'm afraid Mr. Krugman is no better, is explain why this shortfall in demand occurs. It is true that there is always a shortfall in consumption. Marx explained that underconsumption is a major problem for capitalism since the whole system is based on paying workers less in wages than the value they produce, the surplus being the source of the capitalists' profits. Inevitably since the workers are also the consumers they can't buy back all the goods they produce.

Permanent crisis

The capitalists themselves, although fabulously wealthy are small in number and are therefore unable to consume much of the surplus. The world market is constructed out of exporting this surplus and competing to export. However the system is not in permanent crisis because the capitalists invest not only in the production of consumer goods but also in the production of capital goods, plant, machinery and so on. This is what Marx described as the division of the economy into departments one and two. However in the long run this has its limits too, the production of capital goods eventually leading to the production of more consumer goods. What the proponents of demand management cannot explain is why more goods are produced than there is demand for, ie why there is overproduction. It is this overproduction, inherent in capitalism, which lies at the heart of capitalism's crisis, and therein lies the nub of the problem and the insoluble nature of the system's crisis.

Keynesians like Mr. Krugman provide us with excellent descriptions of events, but offer us little in the way of an alternative. He uses a delightful analogy with a babysitting co-op to illustrate the dynamics of the boom-slump cycle of capitalism, and outlines many treatments for the individual symptoms of the crisis - yet offers no final cure. This is no accident. Economists today, no matter how honest, do not really seek a cure to capitalism's fundamental crisis. They accept tacitly that there isn't one. Instead they look for ways to limit the crisis and thereby limit the political repercussions. In other words their real purpose is to defend the system, not cure the economy. This is flatly admitted toward the end of the book when, with a nod to the all powerful market, Krugman admits "I don't like the idea that countries will need to interfere in markets - that they will have to limit the free market in order to save it. But it is hard to see how anyone who has been paying attention can still insist that nothing of this kind needs to be done"

Amongst many motoring analogies, Krugman compares the recent series of economic crashes with a series of road accidents which happen along one stretch of highway. In each case something can be found to be flawed in the actions of the driver, or the performance of the car. Surely he reflects one is entitled to ask whether there is something wrong with the stretch of road? This is part of his impassioned plea to reject monetarism and return to the old god Keynes. We would simply stretch his analogy to question the entire road network.

In the book's final lines Krugman appeals again that the "only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men." The tried and failed prescriptions of Keynes are just such an obsolete doctrine. What stands in the way of world prosperity, and threatens the return of depression economics, is an obsolete economic and political system - capitalism.