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  • Writer's pictureThe San Juan Daily Star

The perils of tough-guy economics


By Paul Krugman


Some economics textbooks used to define their subject as the “science of scarcity.” Maybe some still do. That’s actually quite wrong: Some of the most useful economics involves telling people that they need not settle for less — for example, that we don’t simply have to accept recessions as a fact of life, that we can and should fight them with expansionary monetary and fiscal policy. Still, a fair bit of economics does involve explaining limits and constraints — for example, that you can’t sustain a Denmark-style system of social benefits without something like Denmark-style tax rates.


But accepting the need for hard choices can turn into a kind of trap itself. You might think that everyone is always looking for easy answers, but that’s not actually how it works: In some professional contexts you get reputational points for sounding realistic and tough-minded. (I can’t help thinking about the foreign policy “realists” who assured us that Ukraine had no chance of fighting off a Russian invasion.) As a result, some economists and economic commentators seem to positively exult in prescribing harsh economic medicine (for other people, of course); after the 2008 crisis, the U.S. economy suffered badly at the hands of Very Serious People who moralized about debt in the face of persistently high unemployment.


As an aside, I’ve long been puzzled by the way Paul Volcker, who engineered the extremely painful U.S. disinflation of the 1980s, continues to be held up as the preeminent central banker of all time. Eminent, yes — Volcker was courageous, and an admirable human being as well. But shouldn’t we be giving something like equal billing to Ben Bernanke and Mario Draghi, who respectively can claim to have saved the world financial system and the euro? Are their achievements devalued because they prevented pain rather than inflicting it?


Anyway, trying to be tough-minded can cause political and public relations problems, too. Many economists, even among progressives, use wage growth as an important indicator of “underlying” inflation (although that’s a slippery concept). You need, however, to be careful not to suggest — as Andrew Bailey, the governor of the Bank of England, did — that greedy workers are the villains behind inflation.


Which brings me to the furor created by some tone-deaf remarks by Huw Pill, the Bank of England’s chief economist (what is it with the BOE, anyway?), to the effect that British inflation — which has been running higher than inflation here — reflects a general unwillingness on the part of workers and others to “accept the fact that they’re worse off.”


Foot, enter mouth.


But clumsiness aside, was Pill’s diagnosis correct? The answer, I’d argue, is that there was some truth to his analysis, but for the United States, at least, a lot of it was wrong — and I suspect that this is true for Britain as well.


What Pill got right was describing inflation as a game of “pass the parcel”: Everyone is trying to get ahead by raising prices, but because everyone else is doing the same thing, on average, any gains people get from higher prices for the things they sell are offset by higher prices for the things they buy. So the overall effect of efforts by individual players to make gains at others’ expense is inflation, which hurts everyone. A few months ago I wrote about the football game theory of inflation, in which everyone stands up to get a better view, with the result that nobody’s view is improved but everyone is less comfortable. That still seems right.


What’s more dubious about Pill’s story is that he attributes this zero-sum jockeying for position to an attempt to avoid an inevitable decline in real income, brought on largely by higher energy prices. Although he was careful to include price hikes by firms as well as wage demands in his discussion, this is still basically the classic wage-price-spiral story. In that story, workers see a rise in their cost of living, say, because of surging energy prices, and demand wage increases to offset these losses — but firms then raise prices to reflect higher labor costs, and off we go.


Well, for what it’s worth, the International Monetary Fund has looked at data across several countries and found no evidence that wage-price spirals are developing. And in the United States I haven’t seen any evidence of one, either. Wage growth did accelerate, but this seems to have been mainly because workers were in demand in a very tight labor market. Indeed, wage growth has come down from its peak (although it’s still running unsustainably high) as indicators of labor-market tightness such as the quits rate come down.


If anything, in the United States we have seen something like what Lael Brainard, the former second-in-command at the Fed and now the Biden administration’s chief economist, calls a “price-price spiral,” in which some firms raise prices more than their costs go up. At least some of this may have involved firms believing that they could get away with exceptional price hikes because customers wouldn’t notice in a time of widespread price hikes.


Now, Britain, which relies a lot on imported natural gas, has taken a much bigger real income hit from Russia’s invasion of Ukraine than the United States, which is a gas exporter. So the British story may be different. But my guess is that for the most part the overall picture is similar: Inflation mainly reflecting the combination of various disruptions and an overheated economy, rather than the obstinate unwillingness of ordinary workers to face reality.


This doesn’t mean that curing inflation will be painless. The latest data on U.S. wages, which seems to show them moving sideways rather than down, suggest that our economy still needs to cool further, which might involve a rise in the unemployment rate. But economists especially, although not only those with public positions, need to avoid even the appearance of blaming workers for the problem.

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02 may 2023

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02 may 2023

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