The Return of Depression Economics

Paul Krugman argues that the idling of productive capacity in the world economy makes investment in public goods more likely to pay off now than at other times. While in good economic times credit is rapidly transferred to speculative growth opportunities, in bad economic times credit contracts, and much more production can be achieved with the same amount of wealth. Krugman calls this ‘Depression Economics,’ because it is true in bad economic times only.

Economist’s View: Krugman: What to Do
What to Do, by Paul Krugman, NY Review of Books: What the world needs right now is a rescue operation. The global credit system is in a state of paralysis, and a global slump is building momentum as I write this. Reform of the weaknesses that made this crisis possible is essential, but it can wait a little while. First, we need to deal with the clear and present danger. To do this, policymakers around the world need to do two things: get credit flowing again and prop up spending.

I believe not only that we’re living in a new era of depression economics, but also that John Maynard Keynes—the economist who made sense of the Great Depression—is now more relevant than ever. Keynes concluded his masterwork, The General Theory of Employment, Interest and Money, with a famous disquisition on the importance of economic ideas: “Soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”

We can argue about whether that’s always true, but in times like these, it definitely is. The quintessential economic sentence is supposed to be “There is no free lunch”; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work. The true scarcity in Keynes’s world—and ours—was therefore not of resources, or even of virtue, but of understanding.

However, the market, not the government, picks winners through the savage mechanism of creative destruction. The government is not able to perform this role effectively.

Simply spending money on neat toys like new schools or bridges to nowhere is not the answer, because such project generate nothing and leave us with costs we will have to pay once the economy comes back.

Rather, we should focus on infrastructure spending that changes the system in ways favorable to us. The most obvious bad aspect of the system is that economic growth leads to greater consumption of oil and natural gas, which enrich bad states like Venezuela and Russia. Spending projects should focus on breaking this link, so that we can become wealth without them becoming powerful.

Projects like Solar Los Angeles, Windy Maine, and a million electric cars are part of the solution.

Heck, even the CEO of Poet Ethanol will be addressing a forum together with Tom Daschle and Jim Woolsey. The time to weaken the chains that bind us to Gap states like Russia and Venezuela is now.