Monthly Archives: February 2018

Paul Krugman, Twin Deficits And Centrism

Paul Krugman has a new articleTrump’s Twin Deficits (Wonkish), for The New York Times. The main point of the article is that Donald Trump doesn’t like trade deficits but ironically his policies (tax cuts with a rise in government expenditure) will cause more trade deficits.

Now, needless to say, Trump has to be resisted and we need an alternative. Apart from his xenophobia and racist attitude, he has also done a lot of economic damage by shifting an already unfair distribution of the national income in billionaires’ favour.

But the discussion shouldn’t end there because for one thing, economies always need a fiscal stimulus, despite the fact that economists such as Krugman make us believe that the US is at full employment and are telling us that expansionary fiscal policy is illegitimate. But Krugman and others are actually a bit late about the twin deficit part.

Before discussing twin deficits, it should be clarified what the casualties are. It’s not surprising that the two deficits are related. It is because of the national accounts identity:


where NL is the net lending of the private sector as a whole, DEF is the government deficit and CAB is the current account balance of payments.

The current account balance is in deficit if it is negative and the trade in goods and services is part of the current account. That the two deficits are related by an accounting identity doesn’t imply that the budget deficit causes trade deficits. The right causality between the balances is (for given trade elasticities) from demand, income and output at home and abroad. So it’s not necessary that the two deficits move together. Even the economic and financial crisis hit, some ten years ago, US output fell and this raised the budget deficit because of a fall in income and hence taxes and also reduced the trade deficit. Over the next many years, and going forward, we can say the two deficits move together, although remembering the causality above—which is not: budget deficits cause trade deficits.

Now coming back to Krugman and Trump, what’s needed is an alternative to Trump but just the “centrist” attitude of not doing anything isn’t the solution. Paul Krugman had been advocating expansion of fiscal policy till as late as before the US elections, i.e., November 2016 but when the administration changed, he is no longer a fan of fiscal policy. It’s surprising (or maybe not!) that Republicans are advocating an expansionary fiscal policy while opposing it when not in power. Ironically, the same is true of Democrats such as Paul Krugman!

Krugman could have instead suggested that Trump asks other governments to expand fiscal policy, so that their imports also rise and the US trade deficit isn’t affected because of the change in fiscal stance, which he is unlikely to do.

The important point is that there is always the case for fiscal stimulus. The really big constraint is the capacity to produce. But this requires not just coordination of fiscal policy between governments but also agreements via planned trade to reach balance of payments targets instead of orthodox beliefs like free trade, the existence of market mechanisms to resolve imbalances and the belief that the fortunes of nations will converge.


Good Video On Imperialism And Free Trade

A YouTube channel named “Bad Mouse Productions” has a great video titled, Debunking the Economic Freedom Map. Although, the title seems to advertise talking of talking how misleading the freedom map is, the video is much more than that.

The narrator argues that for some countries freedom is not even a choice. Poor nations need nurture but instead the international establishment through the IMF and the World Bank impose “structural reforms” on them which leads to more economic destruction.

[the title is the link]

Twin Deceits

If you believe economists and commentators, you’d get the impression that the US economy is at full employment.

Commentators till recently have been pointing out that the Phillips curve is flat. The curve can be thought in various ways and one way is a plot of wage rate in the y-axis and the employment rate in the x-axis, as in stock-flow coherent models.

One would think it has a positive slope as higher employment would mean better wage bargaining. Or like this as in Figure 11.1, page 387 from Monetary Economics, Ed. 1 written by Wynne Godley and Marc Lavoie.

Economists using the neoclassical paradigm however think of it without any flat segments.

But till recently, many economists had been claiming that the Phillips curve is flat, as in flat not only in a segment but just flat.

This might look welcome but it is a deceit. It’s ironic that economists using the neoclassical paradigm are claiming this as typically they would accuse heterodox of assuming a flat Phillips curve.

The reason it is a deceit is that it induces the reader into thinking that full employment has been achieved and that there’s no need to do anything such as a fiscal expansion.

But recently wages have risen a bit. Now economists and commentators such as Alan Blinder, Paul KrugmanJustin Wolfers and many more have been claiming that the US economy is at full employment.

Full employment?

The headline unemployment rate of the United States is 4.1%. That is infinitely far from than 0%. How is that full employment or near full employment?

But not only that, that’s what is called the U-3 unemployment rate. The U-6 unemployment rate is 8.2%.

The differences are explained in this Federal Reserve Economic Data (FRED) blog here.

This is the real picture:

click to expand

So the twin deceits are: shifting positions on the Phillips curve to make it look like the US economy has achieved full employment and now claiming that the US economy is already at full employment. This is to promote the idea that nothing needs to be done.

More Free Trade Orthodoxies

There is no branch of economics in which there is a wider gap between orthodox doctrine and actual problems than in the theory of international trade.

– Joan Robinson, written in 1970, in The Need For A Reconsideration Of The Theory Of International Trade in Contributions To Modern Economics, published in 1978.

Sometimes, when critiquing free trade, economists and leftists frequently point out to damaging clauses in free trade agreements, such as the ISDS (Investor State Dispute Resolution). While this is fine, and it’s accurate to say that these help powerful corporations and hurt poor nations badly, it’s not a full critique. The important thing to understand is that even without these things which are pushed, free trade (as oppose to free trade agreements) itself is damaging.

Instead of leading to convergence in the fortunes of nations and making everyone better off, free trade creates polarisation. As Kaldor argues in his 1980 article Foundations And Implications Of Free Trade Theory, written in Unemployment In Western Countries – Proceedings Of A Conference Held By The International Economics Association At Bischenberg, France:

Traditional theory, both classical and neoclassical, asserts that free trade in goods between different regions is always to the advantage of each trading country, and is therefore the best arrangement from the point of view of the welfare of the trading world as a whole, as well as of each part of the world taken separately.However, these propositions are only true under specific abstract assumptions which do not correspond to reality. Under more realistic assumptions unrestricted trade is likely to lead to a loss of welfare to particular regions or countries and even to the world as a whole – that is to say that the world will be worse off under free trade than it could be under some system of regulated trade.

The latter part of this proposition abstracts from the possibility that a particular country possesses some degree of monopoly power and thereby can turn the terms of trade in its favour by means of a tariff even after retaliation by other countries is taken into account.

[emphasis in original, boldening mine]

Somehow economists seem to not understand the case that free trade can be bad to the world as a whole. It’s not difficult to understand why. In the absence of any market mechanism to resolve imbalances in a system of free trade, nations facing balance of payments problems are forced to deflate demand and output. The successful nations don’t expand domestic demand enough because of orthodoxy about fiscal policy.

Some economists understand that free trade leads to winners and losers and argue for compensation for losers. While it’s true that losers need to be compensated, the argument is incorrect because it implicitly assumes that nations’ fortunes aren’t diverging. There are no winning and losing nations in this picture. Perhaps the economist who observes this empirically would blame it on domestic policies and not on rules of international trade or history as colonialism or imperialism. Free trade is the holy cow of economics. It’s a sin to critique it. That’s the economists’ attitude.

In a recent article, What Do Trade Agreements Really Do?, Dani Rodrik repeats various orthodoxies. Despite claiming frequently to be dissenter, it’s clear to see that he is a fan of free trade:

When economists teach the gains from trade, they emphasize that free trade is good for each nation on its own. (What it means to say “good for the nation” in the presence of losers as well as gainers is, if course, a thorny issue, but I will leave that aside, in keeping with the standard treatment.) Ricardo’s (1817) demonstration of the principle of comparative advantage — free trade expands a nation’s consumption possibilities frontier even if it has an absolute productivity advantage in producing every good – remains one of our profession’s most significant intellectual achievements.

[emphasis: mine]

Rodrik then goes on to argue that:

As trade agreements become less about tariffs and non-tariff barriers at the border and more about domestic rules and regulations, economists might do well to worry more about the latter possibility.

This line of thinking emphasises how it’s important to critique not just clauses in free trade agreements such as ISDS, but free trade itself. Else one risks of settling for free trade as a compromise in the best case (as opposed to “freer trade”), something which Dani Rodrik and other orthodox economists want to achieve.

More importantly, although people talk of ideologies such as neoliberalism, it is important to understand them as the ideology of the imperialist and not disconnected to them. The imperialist view of the world (modifying a quote by John Pilger) is that here are only two sides to an argument, and both those sides belong to the establishment.