It seems to be a season in which lots of people want to call attention to themselves by disagreeing with Prof. Paul Krugman. I have no doubt that I won’t succeed in attracting any attention at all; but the whole thing sounds like fun. Especially the part where you actually manage to get Prof. Krugman to pay attention and then point out why you’re totally, devastatingly wrong.
So here are two ways in which I disagree with my understanding of Prof. Krugman’s economics. I should note that I am not a professional economist, and so my two points of disagreement are about what I think is important, not necessarily what economists think is important. Oh, yes, it also means that I may not know what I’m talking about. However, I have been reading Prof. Krugman, along with an eccentric collection of other writers on economics ranging from Thurow to a British economic historian’s history of the world’s economy from ancient times, since the late 1980s. So I do have some vague idea of what he has been saying.
Disagreement 1: Climate Change Economics
Prof. Krugman is surprisingly well informed on climate change science, for an economist – it was he who pointed me in the direction of a superb resource, Joe Romm at www.climateprogress.com. However, there is little consideration in his work of the medium-term effects of our present disastrous “business as usual” (see my last two blog posts, among others). Specifically, Prof. Krugman assumes that the food and energy portions of the CPI have fluctuated widely up and down in the past but over the long run have paralleled more stable prices, so that using a “core” CPI without these gives a better picture of inflation and therefore of such things as how close we are to a liquidity trap or the likely real rate of growth of the economy, not just now but in the next 2-3 years.
However, some preliminary research suggests that climate change already is costing the economy 0.1% per year in coping with disasters, and this should be expected to grow exponentially every decade or two, since the violence of storms and other related factors will do so as well. Since infrastructure spending continues to “fight the last battle”, we may anticipate that we will not decrease disaster costs by pre-adaptation. And so, Prof. Krugman should be anticipating a significant drag on the world’s economy as well as the US’ within the next 2-3 years.
More importantly, droughts of Dust Bowl proportions should be anticipated over the next few years as the antecedent to worldwide droughts over much of the arable land 35 years from now. This constitutes a much larger and permanent effect on food prices. Less food, higher prices, a divergence of food from the rest of the CPI are the minimum things that it seems to me will happen at some point in the next 5 years, and they may very well happen this year.
It’s not enough to say that Krugman is more aware of climate change than most economists -- he implicitly says that economic theories do not need to change much to accommodate climate change. I respectfully (well, not really, but it sounds good) disagree.
Disagreement 2: The Income Effect on Labor and “Spending One’s Time on Leisure”
Briefly, the income effect on labor, as Prof. Krugman has quoted it approvingly several times, is that when you raise someone’s wages, they choose to “spend” part of the added income on “leisure”, so the productivity of the employee goes down, hastening the point where increasing pay decreases profit. There is also a variant that says that the employee responds by working more hours, but those hours are less productive, hence it makes more sense to start up a new firm with new people at lower wages. This is the microeconomic view.
Where it comes into play in macroeconomics appears to be in relation to things like the minimum wage, and why employers often seem to think it maximizes profit to drive down typical wages below the “living wage”. That is, both the neoclassical and neoKeynesian views appear to feel that there is merit in “labor supply/demand” terms to such a business approach, and that at a certain point there is a tradeoff between wage floors and unemployment.
My first point of disagreement is that I have never, in my 30-plus years of working in all sizes of firms, seen “spending on leisure”. On the contrary, most employees I know see the world as one of steadily ratcheting expectations for the same amount of pay, added work that is not refusable because there is a thin line between having a job and being fired for someone else who will work those extra hours, and pay that has no clear relation to productivity. It is, in fact, pay that is determined by “what everyone else is paying” with an emphasis on the downside (because surveys are typically of last year’s pay), fixed budgets, and the urge to reengineer to reduce headcount. When employees get a raise in pay, they spend it on work – because they have to. If you want to take a reduction ad absurdum, take a CEO or Executive VP, and see if they work less because they make more money. I don’t say that these are productive; I just say that, at least for show purposes, they put in long hours compared to most other employees.
All right, then, does it matter in macroeconomic terms, since it is now apparently agreed that much of microeconomics is fiction, but it does provide useful approximations to drive macroeconomic analysis and forecasting? Well, in this case, I would argue that an approach more like what Piketty and Saez appear to be groping towards is useful, and the income effect theory isn’t. That is, one distinguishes between workers with negative wealth, those with growing positive wealth, and the top 0.1% or so who have wealth enough that they can live off investment income for the rest of their lives. Which of the three is impacted most determines the effect of increasing wages. A negative-wealth person, if this tips them into positive wealth, will be far more productive than otherwise. A growing-wealth person will be marginally more productive, since that person will be able to spend less time on basic-needs spending (handling a mortgage). For the top-wealth person, a higher income has no effect at all.
In other words, I suspect that the income effect is a poor approximation of what’s really going on, and leads to policy conclusions on what to do about wages vs. unemployment that are the opposite of what really should be done. Prof. Krugman, I respectfully (or whatever) disagree with you on that one.
Well, I had fun with this one, even if no one else did. And I didn’t even include some of the nitpicks, such as whether there’s a way to make interplanetary trade pay if it doesn’t involve actual transport of goods, but rather communication via quantum physics of the specs of the desired goods, to be produced via transmuters on site – something like leGuin’s vision. Maybe if someone actually reads this …