11 April 2015

Paul Krugman wrong, again


This is the weekly newsletter from Iain Martin, editor of CapX. To receive it by email every Friday, along with a short daily email of our top five stories, please subscribe here.

I’ve never bought the Paul Krugman schtick, not since the Nobel Prize winner gave one of the poorest presentations I’ve ever seen.

In 2003, the economist was invited to give Scotland the benefit of his wisdom. That wisdom amounted to very little beyond a threadbare analysis of the country’s then condition and some very basic “on the one hand, and on the other hand” speechifying. The audience that evening had been invited to hear a supposed great sage deliver fresh-thinking. Alas, it was not to be. The guests began to shift uneasily in their seats when it became apparent that Krugman had come equipped with not very much to say.

Since then I have followed his writing in the New York Times with interest, particularly the pieces in which he says other people do not know what they are talking about. His assessment of the Scottish National Party’s currency plans in the Scottish referendum was good punchy material.

But Krugman’s fame outside the US rests most of all on his persistent criticism of “austerity” in general and the policies pursued by the UK government in particular.

He returned to the theme earlier this week, with another blog – titled Osbornia Revisited.

You have to hand it to Krugman. He has made this wrongheaded stuff the dominant narrative, meaning that the European Left cites him continually. In Britain, his view has been adopted and popularised, in Scotland and beyond, by the SNP leadership with its calls for “an end to Tory austerity.” One hears this said all the time now, to the extent that it is even shaping the ongoing general election campaign here. Although the UK is in the process of adding £1 trillion to its its national debt in under ten years, the Keynesians say that just a few billion more (£180bn in the case of the SNP) spent by the government will somehow make everything ok.

There have been plenty of good takedowns of the Krugman critique of austerity, not least that written by Andrew Lilico for CapX last month.

However, what I find most curious is the simplistic, myopic nature of the Krugman view, in which absolutely everything is seen through the prism of government spending. What else was happening in the economy barely seems to get a look in.

The last five years or so in Britain, and the adoption of public spending restraint by the incoming coalition in 2010, will be argued over for decades by economists and economic historians. But it should be obvious that there was much more to it than cuts, and I don’t just mean that the Eurozone crisis had an impact on business confidence.

If you really want to understand what happened to the UK post-2010, it seems perverse not to consider what was happening in the bloated banking sector, which had blown up when the property and lending boom ended so spectacularly.

Simon Nixon of the Wall Street Journal wrote a seminal piece on this in May 2013. In How Mervyn King lost the battle of Britain’s banks, he explained how the Governor of the Bank of England’s war on the banks backfired, with negative consequences for credit creation, business lending and a wider economy that was struggling to recover.

Soon after the financial crisis, despite opposition from King, the Special Liquidity Scheme was established.

Simon wrote that: “The SLS was arguably the single most successful crisis response deployed in the U.K. With £185 billion of cheap funding for four years, the banks had breathing space to adapt their businesses. A tentative recovery began in early 2009; by mid-2010, the economy was growing at an annual rate of nearly 2% and bank share prices had risen to the point where it was possible to imagine a quick U.K. government sale of its stakes in RBS and Lloyds.”

In August 2010, a furious King signalled that he wanted banks to pay back the SLS a year early. It is not hard to see why the impact of this might hit a fragile recovery.

By mid-2012, a worried Chancellor Osborne had to launch his own Funding for Lending scheme, to try and get lending and business moving. Full recovery in the UK began not long after that.

The point is that austerity – as well as being necessary to restore order to out of control public finances – is only part of a much more interesting story. Next time you hear someone piously demand “an end to austerity”, or mouth Krugman’s high spending mantra, email them that piece by Simon Nixon.

Elsewhere on CapX this week, we published Victoria Bateman’s thought-provoking piece on the State and markets. Chris Deerin caused a stir with his assessment of how the land of Adam Smith (Scotland, again) is now in the grip of an anti-market fantasy. I looked at great political insults, from both sides of the Atlantic. And Rachel Cunliffe analysed Iceland.

Iain Martin is Editor of CapX.