Monday, March 8, 2010

Krugman's Methodenstreit

The longest continuing battle in economics is not between socialists and free-marketeers but rather between historicists and those who believe that the laws of human action are immutable throughout time. Perhaps the most famous battle between these two groups came between Gustav Schmoller of the German Historical School and Carl Menger, the founder of the Austrian School of Economics, the battle taking place during the late 1800s and aptly being named the Methodenstreit, or the debate over epistemology.

Given the lack of philosophical training among modern economists, who seem to believe that all they need to know are mathematical algorithms, I doubt that many newly-minted econ Ph.D.s even can define "epistomology" and certainly know nothing about the Methodenstreit, given that most doctoral programs in economics no longer include History of Economic Thought. (Why bother with history when everything we need to know is contained in the latest edition of American Economic Review?

Yet, the Methodenstreit lives on, whether or not economists and others recognize it. While Marxism, which is based upon both Historicism and the Labor Theory of Value (which also was debunked by Menger and other Austrians) dominates the U.S. academic professions of English, History, and the various "Identity Studies" programs that pretty much run academics in the larger and more "prestigious" universities, it has relatively small impact on U.S. economics departments.

However, nearly every department engages in historicism whenever someone presents the various Keynesian models of the economy, and especially list the Keynesian "solutions" for economic downturns. Thus, we see Paul Krugman unwittingly (Or maybe wittingly, who knows?) engaging in historicist arguments when he claims that economic rules are changed during recessions and depressions.

The latest incident involves what I pointed out last week on the blog about Krugman contradicting, well, Krugman. Not surprisingly, Krugman has an answer (I include it in its entirety):
I hear through the grapevine that the usual suspects at the WSJ have put out something along the lines of “Krugman says that unemployment benefits won’t raise unemployment, but in his textbook he says they will, neener neener.” Are they really that stupid? Probably not — but they you think that you, the reader, are that stupid.

But anyway, maybe this is a good time to explain the difference between determinants of the NAIRU — the minimum rate of unemployment consistent with a stable inflation rate — and the determinants of the unemployment rate at a point in time.

So: there are limits to how hot you can run the economy without inflationary problems. This is usually expressed in terms of a non-accelerating-inflation unemployment rate; yes, there are some questions about whether the concept is quite right, especially at very low inflation, but that’s another issue.

Everyone agrees that really generous unemployment benefits, by reducing the incentive to seek jobs, can raise the NAIRU; that is, set limits to how far down you can push unemployment without running into inflation problems.

But in case you haven’t noticed, that’s not the problem constraining job growth in America right now. Wage growth is declining, not rising, and so is overall inflation. A wage-price spiral looks like a distant dream.

What’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant. That’s why comments by the likes of Sen. Kyl are so boneheaded — anyone who thinks that high unemployment in the first quarter of 2010 has anything to do with workers getting excessively generous benefits must not get out much.

This is Historicism at its purest; when the rate of unemployment is high, economic incentives no longer matter, as all that matters is spending. However, when unemployment is low, then we really can have too much spending.

In other words, incentives matter only part of the time, as to be determined by Krugman.

However, the statement, "What’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant," is pure socialism, which also is a Historicist construct. This is another term for what socialists say is the chronic problem under capitalism is the inability of workers to "buy back the products" they create.

In other words, there is no real connection between production and consumption. The ability of people to consume comes from money, which must be supplied by the state, since production and consumption are independent of one another.

Fortunately, economists dealt with this issue long ago, although we can see that this socialist fallacy continues to rear its head. The problem is not the inability to "buy back the products." Instead, it is the problem of malinvested factors of production during the previous boom that either must be liquidated or changed to uses that fit with the time preferences and desires of consumers.

In modern Krugman-speak, the problem is chronic underconsumption or overproduction (two sides of the same coin). Austrians, however, see the issue as revolving around malinvestments that cannot be sustained. As I have written many times before, Keynesians (and all Historicists) believe that factors of production are homogeneous and that they will operate no matter what as long as government provides enough money so workers can "buy back the products." Such a contention should be false on its face, but as we can see, the Historicist myths live on...and on.

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