The economics community was set ablaze last week with talk about whether Paul Krugman the out-spoken economist famous for his progressive economic views had won the debate with the other side of economists led by Reinhardt & Rogoff, preaching that government stimulus driven by increased debt was the path to economic growth, not austerity for governments as Reinhardt & Rogoff claimed. This debate reached fever pitch over the past four years with western governments passing wildly through a 90% debt to GDP ratio causing Reinhardt & Rogoff to claim those countries would suffer from a permanent economic malaise, whereas Krugman argued for more debt laden government stimulus. Is Paul Krugman vindicated and should the austerity crowd back down on their constant harping about government spending and the associated debt? Or is there a third dimension that truly wins the argument.
The problem here evolved from a research study presented by economists Reinhardt & Rogoff that proved theoretically that countries' economies suffer permanent malaise when government debt surpasses 90% of that nation's gross domestic product (the United States is presently about 105%). This argument of course was diametrically opposed to the theories of Krugman who argued that governments need not worry so much about debt, but instead need to stimulate their economies by borrowing and spending even more. While the Reihardt & Rogoff study seemed to be leading the debate, it was recently discovered that they had come to their conclusions using data that was inaccurate. In simple terms, the correct data was not supportive of their idea but rather showed a different conclusion; that countries having more than 90% debt/GDP did not suffer from undue malaise.
So with this error noted, the media and many in the economics community ran quickly away from the notion that nations' debt ratio's negatively affect economic growth and ran instead to the Krugman corner accepting his claim that government stimulus was the solution to getting countries out of their economic woes. The Society would suggest however that these two disparate views miss the third and most critical option available to solve economic malaise; that is building the private sector.
The question that should be asked by these academic economists is not whether stimulating an economy is needed to get things going again after a shock like 2008 happens - in the real world, it does, but the question is instead how should it be done. There are really only a couple of ways in which a government can stimulate an economy; government can increase spending or government can offer tax cuts so citizens can spend more. In the case of the United States post 2008, the government spent $1 trillion dollars to stimulate the economy. To be sure, some of the ways in which government spends money is clearly beneficial (although only stimulating in the short term); new roads, new bridges, new shared resources that benefit all. Some of the ways however are decidedly unproductive and non-stimulating; such as government playing "venture capitalist" or government creating transfer payments from rich to poor through cell phone giveaways and the like. These "stimulating" activities on the part of government do NOT stimulate the economy but rather create a non-additive situation in which a dollar transferred to the project creates no new value but actually becomes worth less than the original dollar. In short, the opposite of true stimulus occurs. After the very short direct operation of the government program, the money is gone and no sustainable economic growth has occurred.
Counter this to a "stimulate the citizen" approach. Let's assume that rather than government spending $1 trillion on its stimulus ideas, it instead provided a $1 trillion dollar tax holiday? To the government debt, the immediate impact would be no different; both scenarios raised government debt by $1 trillion dollars. However, unlike that money moving through the government systems it instead runs through private system which has a positive economic multiplier effect. In other words, the $1 trillion increases in value as it moves through the economy which is true stimulus. The simple explanation is this; when government gives away a dollar, the recipient is not given incentive to do anything productive with that dollar. This could be the individual who received an "Obama phone" or a company like Solyndra that received government funding. The incentives are just wrong. However in the private economy, money is spent on things people desire and are willing to work for therefore the recipients are incentivized to use that money to its most productive purpose. That is true of the individual who might spend the money on a needed good or service, or the business working to support consumer demand in a competitive marketplace.
So the argument between the academics on whether government spending as a stimulus is needed or government austerity is needed falls as it so often does on ignorance of the real world of economics. Economies grow for two primary reasons; population growth and productivity growth. The key real world driver of productivity growth is the individual desire on the part of people to improve their lot in life; this simple idea is at the core of why productivity grows. Person A wants a better life for themselves and therefore they work hard so that they can accrue the benefit they wish. It is this simple "rational self-interest" that causes capitalism (free markets) to work so well over socialism (state controlled markets).
Mr. Krugman may be a credentialed economist and for this the Society offers some measure of appreciation. However, to conclude that he has won a debate over government spending as an economic stimulus vs. governmental austerity fails to recognize that the only real stimulus comes from building the private sector and with that in mind, he has not won the debate but only served to perpetuate another myth bought into by low-information voters who accept his big government views simply because he has an academic degree. Mr. Krugman like so many academics needs to work in the real world in a productive business before he truly can claim to understand the "way the world works" and therefore have credibility in his opinions which have so much impact on everyday people's lives.