Markets

What's Wrong With the Latest German Attack on Paul Krugman (and Keynesian Economics)

By Carter Dougherty

Updated on: June 24, 2010 / 6:00 PM EDT / MoneyWatch

English-speaking readers can be forgiven if they missed a prominent German economist's recent attack on Paul Krugman -- and much of Keynesian economics. After all, Wolfgang Franz issued his broadside against the Nobel laureate in German. Which, it turns out, I happen to read, so here's a serious look at what Franz wrote and why it still comes up short relative to Krugman's assault on Old Europe orthodoxy.

Franz, the head of a quasi-official German organization often called the "Wise Men" (though there is a woman on it), recently took Krugman to task in the German business daily Handelsblatt with a sassy piece entitled "How about some facts, Herr Krugman?" Krugman, of course, has been arguing that Germany's determination to cut its government budget at a time when it should be spending more to bolster the global economy is effectively insane. Franz, as you might expect, took issue.

So far, Krugman has only responded to a brief snippet of Franz's diatribe that was excerpted in the WSJ's Real Time Economics blog -- one in which Franz essentially accused the United States of causing the financial crisis, an argument that takes real chutzpah. But Franz spends much more ink on other, equally specious arguments. So as someone who knows German, Germany and the Germans well, here's the rest of the story.

First, a little background. Establishment German economists are not in the habit of having to defend themselves against anyone who is willing to consider Keynesian ideas. They have, with a few exceptions you could count on one hand, chased neo-Keynesians out of government posts and key research institutions -- a fact that explains the piqued tone here. How dare they challenge us! They act this way vis-a-vis German dissenters as well -- it's nothing personal.

1. Franz complains that Krugman's repeated arguments about German austerity helping to prolong economic weakness in the United States and elsewhere misses a key point: only 8 percent of German imports go to the United States, only 4 percent of its imports come from there. So how can we Germans be the source of the problem?

This is a straw man. Krugman has tirelessly made the case over and over that countries who can afford it should be contributing to global demand, not subtracting from it. Germany has a gilt-edged credit rating and a huge trade surplus, so it qualifies. And anyway, German exports go into the same global pot, regardless of what goes to the United States. For example, Germans make machines that Chinese companies use to manufacture goods for the American market -- creating a reliance on American demand greater than implied by simple bilateral import/export statistics. Construed narrowly, Franz's argument sorta makes sense. But to the broader point, score one for Krugman.

2. Then Franz complains that arguments about at least delaying fiscal consolidation make no sense because you might have growth of about 2 percent in Germany, he implies.

Laying aside the massive downside risks to growth scenarios these days, 2 percent is squat. Hardly enough to make a dent in unemployment, especially in Europe. Maybe it's just culture at work here, but Americans are never going to be satisfied with 2 percent growth. Germans shouldn't be either.

3. Then Franz complains about delaying fiscal austerity:

When should we start budget-cutting, if not next year? Medium-term, as President Obama likes to say? Based on my experience, "medium-term" can be translated as "when hell freezes over."

So because politicians cannot be trusted to restrain deficits at all, you push them to start cutting at the wrong time? This is truly inflicting pain for its own sake, nothing more. There have been, contrary to popular option, times when American politicians have behaved responsibly in fiscal terms -- such as during the Clinton administration. But -- and here's the important part -- the political dynamic is most favorable when the economy is expanding, not stagnating. This was the case in Germany under Chancellor Gerhard SchrÃ¶der during the years running up to the financial crisis as well. So, if you are prone to fretting about political will to reduce deficits, then get growth going first.

4. Finally, Franz complains about the burden we are placing on "later generations" by deficit spending, and points to research showing that German government spending does not raise revenues enough to justify Keynesian policies.

This is a cheap attempt to corral some emotion, not a dispassionate argument befitting a prominent economist. If you take this attitude, then you must be in the habit of reading fractions by looking only at the numerator and not the denominator. A rising debt burden will only get noticed by our children and grandchildren if their incomes are stagnating or falling, which is why we talk about debt to GDP ratios. Debt becomes manageable if growth is brisk. Also, it ignores -- back to point one here - the global context.

Krugman, and, it appears, the Obama administration, don't want Germany to spend-spend-spend for the sake of narrow German interests. They want a collective global effort involving major surplus countries -- principally China and Germany -- to kickstart anemic global growth and rebalance the out-of-kilter global economy, something that would benefit Germany to a greater magnitude than if any one country acts alone.

If Franz were a little more global in his thinking, perhaps he'd serve German interests better.

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