Saturday, June 2, 2012

Yes, but ...

Paul Krugman is hammering away again today, pointing out that Britain's budget-cutting moves are based on bad metaphor and ulterior motives. The hidden agenda is the dismantling of social programs: for politicians who never liked the social safety net in the first place, the budget deficit is an opportunity to put some more holes in it.  The bad metaphor is the old chestnut of the family budget: when a household has run up debts, it has to cut back, and a government is no different.

Except that, as PK points out, a government is different--or rather, an economy as a whole is different from a single household. "Our debt is mostly money we owe to each other; even more important, our income mostly comes from selling things to each other. Your spending is my income, and my spending is your income."

It's an important point, and one worth making again and again, even if it never seems to get through. (It was my sister who originally pointed me to the column, adding, "Doesn't this poor guy ever get tired of having to say the same thing over and over?" Which immediately made me think of this motivational poster.) And in principle I agree. But I have a concern with it as well.

"Income" has two meanings in economics. One is essentially the same as in everyday English, money you have coming in, for whatever reason. The other meaning is useful economic production, the creation of a good or the provision of a service. This is "income" because it's what ultimately accounts for the money coming in. We're not merely "selling things to each other." We're making and doing things that other people want to buy. We're creating value. We're doing real work.

In normal times, it's a reasonable simplification to gloss over this "doing" and focus on the "selling." High unemployment and stagnant output mean that the economy has the ability to create more value. Under those circumstances, the only reason it doesn't create more value is that not enough people are willing to pay for it. If we could all just agree to be a bit less thrifty, we'd all find ourselves doing more work, creating more value, having more wealth. And government is the only entity that can "agree" to be less thrifty in a coordinated way, on behalf of all of us.

The catch is that I don't think these are normal times. Sure, part of this Great Recession / Lesser Depression is the housing bubble and credit debacle that gets all the attention. A combination of debt forgiveness and fiscal stimulus would be good medicine for that.

But the other part of our mess is resource constraints.

This chart plots the daily rate of oil production against the price per barrell, from January 1999 to February 2012.
If you live to be 100, you're unlikely to see a better real-world example of a kinked supply curve. The flat part of the curve is where the world's oil wells can increase output pretty easily, so the price doesn't have to go up much to get them to do it. The vertical part, to the right of a production rate of about 72 million barrells per day, is pretty steep. The simplest interpretation of these data is that it's really difficult to produce much more than 72 or 73 million bpd, and so far we've never produced more than 76 million bpd. At lower quantities, increased demand means increased output. Above 73 million bpd, increased demand mostly means higher prices. (The chart is a recreation and update of one I saw a few years ago on The Oil Drum, though I don't know if I could still find the specific post that used it.)

So what does this have to do with Krugman's column? If I'm going to sell to you, and you're going to sell to me, then we should both actually be doing something. And in a modern economy, "doing something" almost invariably involves using some fossil fuel, including at least some petroleum.

Here's my fear for the sensible, mainstream policy PK is pushing. Say it works, so we each try to buy stuff from each other, which means we each try to do stuff for each other, so we each (indirectly) go off to buy some oil in order to do that "something." And everyone else is buying from each other, and going off to do stuff for each other, and buying oil to each do their "something." But there just isn't that much oil. So how do we actually get things done? And if we can't get things done, what good will stimulative policy do?

For the past 200 years it was relatively straightforward to pay for investments--things like building canals, railroads, factories, oil wells, coal mines, computers. Investments made you richer, able to do more than you could before. It was relatively easy to borrow, because you could promise to pay back the loan out of the wealth your investment created. And it was fine if the government did it, because the new bridge or airport would make the economy richer, so tax revenue would go up, so the government could repay what it had borrowed. The financial tools we have--things like bonds and stocks--are ways of divvying up that future wealth.

In our current situation, it's not that there's no work to be done--there's plenty, restructuring our built environment so we can have a decent life while using less energy than today. But how do we pay for it? Because the investments we need might not make us richer than we are today; maybe the best they can do is to make us less poor in the future than we would be without them.

We don't yet have the financial tools to divvy up that kind of future. Until we do, I'm not sure how much good traditional stimulative policy will do.

Which doesn't mean we should be pursuing self-defeating austerity and using this crisis as a pretext to weaken a social safety net that's only going to get more important.


  1. So how do we pay for it? (or did you answer that in another post?)

  2. Hi Karl,
    Interesting take. However, I would worry that your position might turn you into one of those structural economists Krugman lampoons in Easy Useless Economics.

    I would challenge you on two points. First, is the 1999-2012 crude oil price really an example of a "kinked supply curve," or is it equally a reflection of geopolitics, especially with regard to Iraq? We should of course be pointing to resource limitations, but the danger is that if Oil output soars as Iraq retools, then all those naysayers will point to that as evidence for their position.

    Second, if there is plenty of work to do toward "restructuring our built environment so we can have a decent life while using less energy than today" then the question is not "how do we pay for it?" but "can we borrow?" and really "can we afford not to?" If we can do it, then it will reduce long-term resource use while employing people today--part of Krugman's argument is that employing people today will also increase their long-term earnings and the tax base necessary to pay for those restructurings.