Running On Faith: Economics Claims Motives Determine Growth

Paul Krugman started the week with a list of three known knowns in, Interests, Ideology And Climate (emphasis throughout this post is mine):

There are three things we know about man-made global warming. First, the consequences will be terrible if we don’t take quick action to limit carbon emissions. Second, in pure economic terms the required action shouldn’t be hard to take: emission controls, done right, would probably slow economic growth, but not by much. Third, the politics of action are nonetheless very difficult.

The ideology that concerns Krugman is Ayn Rand inspired libertarianism:

Well, think about global warming from the point of view of someone who grew up taking Ayn Rand seriously, believing that the untrammeled pursuit of self-interest is always good and that government is always the problem, never the solution.

Two points:

  • I'd call it "dogma", not "ideology".
  • Is Krugman's claim about slowing economic growth similarly dogmatic, or is it something that--as Krugman states--we know?

Monday’s column refers back to a previous column here, which in turn refers to a study commissioned by the Chamber of Commerce to examine the economic impact of potential regulations limiting carbon emissions from power plants.

Problem One: GDP Does Not Equal “The Economy”

When all these folks, Krugman, the Chamber, the consultants, talk about slowing the growth of the economy, they mean the growth of Gross Domestic Product. But is that what we mean by the term "the economy"? No.

The meaning of a word is its use in the language. For the word “the economy” the current month of June abounds with examples like:

The class of 2014 is unlucky to be entering the workforce when the economy is in bad shape.

This example demonstrates that for speakers of English, "the economy" refers to the availability of jobs and the relative level of wages. When lots of jobs with wages close to the local average are available we say "the economy is good"; if the economy is adding jobs with decent wages faster than the population is increasing, we say “the economy is growing.”

So, we don't "know" that regulations will slow economic growth because Krugman isn't describing what you and I think of as the economy.

Problem Two: What Do Regulations Do To The Economy?

Let's go ahead and use the problematic idea of GDP as a measure of total economic activity in a country, the sum total of all our buying and selling.

To start, imagine just one act of buying and selling, a car purchase that might or might not happen. What does the choice mean for GDP?

To flesh it out, the trade-in value of my old car plus the $1000 in my checking account will cover the down payment on a fancy new Buick that offers better fuel economy, less maintenance, and room in the back for all the ladies. A bank loans me the rest of the purchase price which I will pay back with the same income stream that allowed me to save up the down payment.

If economics is even close to coherent, this choice has to represent an increase in GDP, especially when we remember that when they make loans, banks create money (Bank Of England: Money In The Modern Economy).

Would any of the following factors change the GDP impact of the car purchase?
* What if, for me personally, it made economic sense to continue driving my old car because the extra maintanance and fuel is not so costly as to make the price of a new car less expensive in the long run? Does the viability of the old car cause my money to somehow not ripple through the whole economy? Of course not.
* What if I would rather keep my old car but I am not allowed to by government regulations? Would my spending then count less toward GDP?

Turn now to Obama’s proposed Federal Power Plant Regulations. One way or another, every power company in the US will have to stop burning coal and instead produce electricy in a way that releases less CO2.

In GDP terms, the regulations will require power companies to engage in economic activity, buying supplies and labor to build new power plants. Left on their own these companies would not engage in this activity. The bottom line from a lay point of view is clear: GDP should go up.

Someone in China might say, "No duh! 'Increasing GDP by government command' is our motto and a good summary of the last 3 decades of our history."

So how do we get the opposite conclusion, that causing economic activity somehow reduces economic activity?

It turns out that for economists, the reason I buy a new car changes it’s impact on the economy. Market driven choices are “natural” and “economic” and drive GDP growth. Government driven decisions are “costs” and, by definition, can only slow GDP growth. This can only be described as economic theology.

In the report prepared for the Chamber of Commerce, IHS Energy determines that the new car—low/no emission power plants—will cost a total of $480 billion including the trade in of the old plants. Here’s the shopping list:

Power Plant Shopping List

Power Plant Shopping List

But this $480 billion of market activity magically disappears when it comes to GDP growth because of the:

significant unproductive deployment of capital by causing the noneconomic retirement of coal-fired power generators.

The required capital expenditures are essentially unproductive uses of capital because one source of electricity generation (i.e., coal-fired plants) will simply be replaced by an alternative source (i.e., natural gas–fired plants, renewables, nuclear).

So because (assuming we know future commodities prices!!!!) the coal plants are still cheaper to keep running than to replace, and because their replacements would still produce electricity, therefore the economic activity of replacing them is not productive (no matter that solar panels and power lines and all the rest of the shopping list above got “produced” by somebody)!

The consultants then speculate (with a bizarre air of certainty) on the false dichotomy between blowing the money on low emission power plants and investing it in good things that foster growth:

What contribution would the $480 billion potentially make if it were invested in initiatives that foster economic growth? Quantifying the answer to this question represents the opportunity costs of achieving the CO2 emissions reduction target. The opportunity costs transcend the first-order direct investment of capital on compliance rather than productive initiatives. For example, every dollar not spent with Tier-1 suppliers on productive growth initiatives removes money that typically would be re-spent multiple times throughout the supply chain. Less business in the supply chain leads to reduced employment levels. Fewer employees lead to less spending on consumer goods and services, which leads to less employment, and so on. The opportunity cost of $480 billion of unproductive investment will, on average, reduce U.S. GDP by $51 billion, employment by 224,000 jobs, and real disposable income per household by $200 over the 2014–2030 analysis period.

This is patently ridiculous.

Think back to the car example. If I don’t replace my car, the bank never makes a car loan and that money never enters the economy. Sure, the income that would have made the loan payments is now piling up in my savings account, but it wouldn’t be adding much to GDP. Even if you imagine it gets invested, there’s simply no way that, say $20,000 over 15 years split evenly between Bernie Maddoff, Steven Cohen, and Blackrock, generates as much economic activity as $20,000 spent all at once, right now, on a car assembled in Detroit.

These economists are saying that when a power company spends money the way it wants to, each dollar it spends gets re-spent multiple times, increasing GDP along the way. However, if that money is used to buy a new power plant, this re-spending effect won't happen. Why not? Is there a stain on the money? Does it smell like ass? Will the people who sell solar panels bury this stinky money it the back yard?

It’s even crazier when you remember that if power companies don’t borrow the money to build plants (through tax payer backed bonds, is the usual way), then the money never exists in the first place. What if they never have a reason to borrow it? Then it never gets spent, end of story.

So does Krugman criticize any of this crazy reasoning? No. He nods along because he “knows” government action in the market always costs money. His point, in two separate columns, is look, it won’t cost very much money.

Remember, we have a $17 trillion economy right now, and it’s going to grow over time. So what the Chamber of Commerce is actually saying is that we can take dramatic steps on climate — steps that would transform international negotiations, setting the stage for global action — while reducing our incomes by only one-fifth of 1 percent. That’s cheap!

The problem is that by agreeing with Krugman, liberals are agreeing with the underlying economics, an academic disipline built on faith in markets that is totally unjustified, and simply does not hold up under close scrutiny. This economic ideology is just as dangerous as the Ayn Rand nonsense that Krugman rightly deplores.