The Accidental Theorist: And Other Dispatches from the Dismal Science

by Paul Krugman

  It isn’t as easy to summarize federal regulation as it is to summarize federal spending, but the basic point is similar: Most of what the government does is actually serving, not opposing, the public’s will. Lots of people snicker at snail-darter jokes, but only a small minority wants to see a repeal of the clean-air or clean-water laws. And the voters are prepared to punish those politicians whom they suspect of belonging to that minority.

  Of course, the federal government wastes a lot of money; so does the private sector (have you read “Dilbert” lately?). But the kind of oppressive government, run by meddling elitists, that Bob Dole tried to tell us about in San Diego exists only in the conservative imagination. And that is why Gingrich and Dole did not snatch defeat from the jaws of victory. Their reversal of fortune was preordained, because their doctrine could not withstand the responsibility that came with success.

  Gold Bug Variations: Understanding the Right-Wing Gilt Trip

  The legend of King Midas has been generally misunderstood. Most people think the curse that turned everything the old miser touched into gold, leaving him unable to eat or drink, was a lesson in the perils of avarice. But Midas’s true sin was his failure to understand monetary economics. What the gods were really telling him is that gold is just a metal. If it sometimes seems to be more, that is only because society has found it convenient to use gold as a medium of exchange—a bridge between other, truly desirable, objects. There are other possible mediums of exchange, and it is silly to imagine that this pretty, but only moderately useful, substance has some irreplaceable significance.

  But there are many people—nearly all of them ardent conservatives—who reject that lesson. While Jack Kemp, Steve Forbes, and Wall Street Journal editor Robert Bartley are best known for their promotion of supply-side economics, they are equally dedicated to the belief that the key to prosperity is a return to the gold standard, which John Maynard Keynes pronounced a “barbarous relic” more than sixty years ago. With any luck, these latter-day Midases will never lay a finger on actual monetary policy. Nonetheless, these are influential people—they are one of the factions now struggling for the Republican party’s soul—and the passionate arguments they make for a gold standard are a useful window on how they think.

  There is a case to be made for a return to the gold standard. It is not a very good case, and most sensible economists reject it, but the idea is not completely crazy. On the other hand, the ideas of our modern gold bugs are completely crazy. Their belief in gold is, it turns out, not pragmatic but mystical.

  The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate. There are powerful advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened recessions by pumping in money. To take only one example, that flexibility is the reason the stock market crash of 1987—which started out every bit as frightening as that of 1929—did not cause a slump in the real economy.

  While a freely floating national money has advantages, however, it also has risks. For one thing, it can create uncertainties for international traders and investors. Over the past five years, the dollar has been worth as much as 120 yen and as little as 80. The costs of this volatility are hard to measure (partly because sophisticated financial markets allow businesses to hedge much of that risk), but they must be significant. Furthermore, a system that leaves monetary managers free to do good also leaves them free to be irresponsible—and, in some countries, they have been quick to take the opportunity. That is why countries with a history of runaway inflation, like Argentina, often come to the conclusion that monetary independence is a poisoned chalice. (Argentine law now requires that one peso be worth exactly one U.S. dollar, and that every peso in circulation be backed by a dollar in reserves.)

  So, there is no obvious answer to the question of whether or not to tie a nation’s currency to some external standard. By establishing a fixed rate of exchange between currencies—or even adopting a common currency—nations can eliminate the uncertainties of fluctuating exchange rates; and a country with a history of irresponsible policies may be able to gain credibility by association. (The Italian government wants to join a European Monetary Union largely because it hopes to refinance its massive debts at German interest rates.) On the other hand, what happens if two nations have joined their currencies, and one finds itself experiencing an inflationary boom while the other is in a deflationary recession? (This is exactly what happened to Europe in the early 1990s, when western Germany boomed while the rest of Europe slid into double-digit unemployment.) Then the monetary policy that is appropriate for one is exactly wrong for the other. These ambiguities explain why economists are divided over the wisdom of Europe’s attempt to create a common currency. I personally think that it will lead, on average, to somewhat higher European unemployment rates; but many sensible economists disagree.

  So where does gold enter the picture? While some modern nations have chosen, with reasonable justification, to renounce their monetary autonomy in favor of some external standard, the standard they choose these days is always the currency of another, presumably more responsible, nation. Argentina seeks salvation from the dollar; Italy from the deutsche mark. But the men and women who run the Fed, and even those who run the German Bundesbank, are mere mortals, who may yet succumb to the temptations of the printing press. Why not ensure monetary virtue by trusting not in the wisdom of men but in an objective standard? Why not emulate our great-grandfathers and tie our currencies to gold?

  Very few economists think this would be a good idea. The argument against it is one of pragmatism, not principle. First, a gold standard would have all the disadvantages of any system of rigidly fixed exchange rates—and even economists who are enthusiastic about a common European currency generally think that fixing the European currency to the dollar or yen would be going too far. Second, and crucially, gold is not a stable standard when measured in terms of other goods and services. On the contrary, it is a commodity whose price is constantly buffeted by shifts in supply and demand that have nothing to do with the needs of the world economy—by changes, for example, in dentistry.

  The United States abandoned its policy of stabilizing gold prices back in 1971. Since then the price of gold has increased roughly tenfold, while consumer prices have increased about 250 percent. If we had tried to keep the price of gold from rising, this would have required a massive decline in the prices of practically everything else—deflation on a scale not seen since the Depression. This doesn’t sound like a particularly good idea.

  So why are Jack Kemp, the Wall Street Journal, and so on so fixated on gold? I did not fully understand their position until I read a letter to, of all places, the left-leaning magazine Mother Jones from Jude Wanniski—one of the founders of supply-side economics and its reigning guru. Wanniski’s main concern was to deny that the rich have gotten richer in recent decades; but the letter also contained the following noteworthy passage:

  First let us get our accounting unit squared away. To measure anything in the floating paper dollar will get us nowhere. We must convert all wealth into the measure employed by mankind for 6,000 years, i.e., ounces of gold. On this measure, the Dow Jones industrial average of 6,000 today is only 60 percent of the DJIA of 30 years ago, when it hit 1,000. Back then, gold was $35 per ounce. Today it is $380-plus. This is another way of saying that in the last 30 years, the people who owned America have lost 40 percent of their wealth held in the form of equity…. If you owned no part of corporate America 30 years ago, because you were poor, you lost nothing. If you owned lots of it, you lost your shirt in the general inflation.

  Never mind the question of whether the Dow Jones industrial average is the proper measure of how well the rich are doing. What is fascinating about this passage is that Wanniski regards gold as the appropriate measure of wealth, regardless of the quantity of other go
ods and services that it can buy. Since the dollar was de-linked from gold in 1971, the Dow has risen about 700 percent, while the prices of the goods we ordinarily associate with the pursuit of happiness—food, houses, clothes, cars, servants—have gone up only about 250 percent. In terms of the ability to buy almost anything except gold, the purchasing power of the rich has soared; but Wanniski insists that this is irrelevant, because gold, and only gold, is the true standard of value. Wanniski, in other words, has committed the sin of King Midas: He has forgotten that gold is only a metal, and that its value comes only from the truly useful goods for which it can be exchanged.

  I wonder whether the gods check out my columns. If so, they know what to do.

  Part 3

  Globalization and Globaloney

  The useful term “globaloney” was coined by none other than Claire Booth Luce. What she had in mind was gaseous talk about geopolitics, but the term applies equally well to the way many modern pundits ascribe everything that happens in the world to the vaguely defined impacts of the global economy. Globalization is, of course, a real phenomenon: International trade and investment have consistently grown faster than the world economy as a whole, so that national economies have steadily become more interdependent. But both the extent of that interdependence and its impacts are usually exaggerated. And among intellectuals, at least, there is a strong tendency to demonize the whole phenomenon—to blame it for all the evils in the world, and to deny that growing trade and investment could possibly be doing anybody except fat-cat capitalists any good.

  The first essay here, “We Are Not the World,” is an attempt at a corrective—an effort to explain that America, at least, is nowhere near to being a mere pawn of global economic forces. When the original version of the piece was published, I was surprised at the vehemence of some of the responses—and also surprised that so much of the vitriol was focused not on the main argument, but on a side remark I had made, to the effect that many poor people in the Third World had benefited from globalization. I guess I had thought that was obvious—but it turned out to demand a fuller discussion, which I tried to provide in the next essay, “In Praise of Cheap Labor.”

  Finally, “The East Is in the Red” deals with a view that has rapidly achieved prominence among some pundits and politicians: the view that the rise of newly industrializing economies will lead to a global glut, that these economies—China in particular—will produce but not consume, export but not import. In this essay I tried to use the reunification of Hong Kong with China as an occasion to take this view on, trying to show that it represents a misunderstanding of both the facts and the theory of the case—and along the way to give readers a quick, painless lesson in the economics of trade balances.

  We Are Not the World

  It is a truth universally acknowledged that the growing international mobility of goods, capital, and technology has completely changed the economic game. Nations, conventional wisdom tells us, no longer have the power to control their own destinies; governments are at the mercy of international markets.

  Some celebrate this development, saying that both rich and poor nations benefit. At the same time, a growing number of journalists, union leaders, politicians of both parties, and even businessmen deplore it, blaming globalization for instability, unemployment, and declining wages.

  But both sides have it wrong. They take the omnipotence of global markets for granted—not realizing that reports of the death of national autonomy are greatly exaggerated.

  A certain fascination with the march of globalization is understandable. For half a century, world trade has grown faster than world output, and international capital now moves more quickly than ever before. The rapidly expanding exports of newly industrializing economies have put pressure on less-skilled workers in advanced countries even as they offer unprecedented opportunities to tens of millions in the Third World. (As discussed in the next essay, the wages of those workers are shockingly low but nonetheless represent a vast improvement on their previous, less visible rural poverty.)

  But while global economic integration is increasing, its growth has been far outpaced by that of “global economy” rhetoric. William Greider’s recent book One World, Ready or Not is a jeremiad about the evils of unfettered economic globalism. Politicians like Pat Buchanan and Ross Perot have made careers out of assailing open markets. Even the financier George Soros warns, in the Atlantic Monthly, that global capitalism is now a greater threat than totalitarianism to “open society.”

  Such oratory has become so pervasive that many observers seem determined to blame global markets for a host of economic and social ills in their countries, even when the facts point unmistakably to mainly domestic—and usually political—causes.

  For example, critics of globalization often cite France, whose government has taken no serious action to reduce its double-digit unemployment rate, as the perfect example of how states have become powerless in the face of impersonal world markets. France cannot act, according to a recent New York Times article, because of the demands of “European economic integration—itself partly a response to the competitive demands of the global marketplace.”

  French policy is indeed paralyzed—not, however, by impersonal market forces but by the determination of its prestige-conscious politicians not to let the franc decline against the German mark. Britain, which has been willing to let the pound sink relative to the mark, has steadily reduced its unemployment rate with no visible adverse consequences. The cause of France’s paralysis, in other words, is political rather than economic. True, the country must meet the conditions laid down by the Maastricht Treaty of 1991, which is supposed to lead to a unified European currency. But creating this currency is more a political than an economic project. Its main purpose is to serve as a symbol of European unity, and many economists think that the costs of the common currency will exceed its benefits. It would actually be more accurate to say that French politics has battered markets rather than the other way around.

  And what about the United States, where the continuing power of the government—or at any rate that of the Federal Reserve—to push the economy around can hardly be questioned? Critics of the global economy invariably reply that America may be creating lots of jobs but that they are tenuous because of the prevalence of downsizing, which is a reaction to international competition (a line of reasoning that also provides a good excuse for companies undertaking layoffs).

  Come again? Early in 1996, Newsweek ran a story titled “The Hit Men,” about executives responsible for massive layoffs. The chief executives of AT&T, Nynex, Sears, Philip Morris, and Delta Air Lines were high on the list. Of course, international competition plays a role in some downsizings, but as Newsweek’s list makes clear, it is hardly the most important cause of the phenomenon. To my knowledge there are no Japanese keiretsu competing to carry my long-distance calls or South Korean conglomerates offering me local phone service. Nor have many Americans started buying their home appliances at Mexican stores or smoking French cigarettes. I cannot fly Cathay Pacific from Boston to New York.

  What explains this propensity to overstate the importance of global markets? In part, it sounds sophisticated. Pontificating about globalization is an easy way to get attention at events like the World Economic Forum in Davos, Switzerland, and Renaissance Weekends in Hilton Head, S.C.

  But there is also a deeper cause—an odd sort of tacit agreement between the Left and the Right to pretend that exotic global forces are at work even when the real action is prosaically domestic.

  Many on the Left dislike the global marketplace because it epitomizes what they dislike about markets in general: the fact that nobody is in charge. The truth is that the invisible hand rules most domestic markets, too, a reality that most Americans seem to accept as a fact of life. But those who would like to see us revert to a more managed society in all ways hope that popular unease over the economic influence of people who live in far-off places and have funny-sounding names can be u
sed as the thin end of an ideological wedge. Meanwhile, many on the Right use the rhetoric of globalization to argue that business can no longer be expected to meet any social obligations. For example, it has become standard for opponents of environmental regulations to raise the banner of “competitiveness” and to warn that anything that raises costs for American businesses will price our goods out of world markets.

  But even if the global economy matters less than the sweeping assertions would have us believe, does this “globaloney,” as the cognoscenti call it, do any real harm? Yes, in part because the public, misguided into believing that international trade is the source of all our problems, might turn protectionist—undermining the real good that globalization has done for most people here and abroad. But the overheated oratory poses a more subtle risk. It encourages fatalism, a sense that we cannot come to grips with our problems because they are bigger than we are. Such fatalism is already well advanced in Western Europe, where the public speaks vaguely of the “economic horror” inflicted by world markets instead of turning a critical eye on the domestic leaders whose policies have failed.

  None of the important constraints on American economic and social policy come from abroad. We have the resources to take far better care of our poor and unlucky than we do; if our policies have become increasingly mean-spirited, that is a political choice, not something imposed on us by anonymous forces. We cannot evade responsibility for our actions by claiming that global markets made us do it.