Paul Krugman’s Strawman Arguments Against Austrian Economics

Paul Krugman's attacks on the Austrian school of economics and its luminaries only serve to illustrate his own intellectual dishonesty.

Paul Krugman can’t stand the fact that students of the Austrian school of economics (e.g., Ron Paul) accurately predicted the housing bubble and financial crisis it precipitated and warned against the policies that caused it, while Krugman advocated that the Federal Reserve print money to push down interest rates to create a housing bubble to replace the dot-com bubble (as I document in my book). He despises the Austrians for showing him up and illustrating the intellectual bankruptcy of his Keynesian school of economics. Hence, he occasionally attacks the Austrian school and its luminaries, but this serves only to further illustrate his intellectual dishonesty.

In the most recent example, Krugman attacks the originator of the Austrian business cycle theory (ABCT), Ludwig von Mises. The title of his post is “Soup Kitchens Caused the Great Depression, AFF Edition”. His first sentence explains, “That’s AFF for ‘Austrian founding fathers.'”

So right off the bat, Krugman is asserting that, according to the “Austrian founding fathers”, the Great Depression was caused by the existence of soup kitchens — an automatic red flag that instead of addressing anything Mises actually wrote, Krugman is intent on manufacturing a strawman argument, falsely attributing it to Mises, and then vigorously attacking and defeating his own fabrication. Indeed, he sets out to do just that. It’s worth quoting him in full.

The blog Social Democracy for the 21st Century has a fascinating post about Austrian patron saint Ludwig von Mises in the Great Depression, and his attempts to make sense of what was happening. It’s a revealing story, because it bears so much resemblance to current right-wing flailing – and also highlights the lessons Keynes tried to teach but so few, economists included, have been willing to learn.

First of all, as the blog tells it, von Mises, faced with the reality of depression, basically dropped Austrian business cycle theory, and for the very reason people like me have always had trouble taking it seriously. (Yes, yes, we don’t grasp the depth and profundity of a theory that can never fail, it can only be failed.) ABCT is essentially a story about the excesses of the boom; it offers no clear or plausible story about how that boom leads to a sustained slump. And von Mises was in effect already conceding that point by 1931.

Pause right there. Krugman’s dishonesty here is absolutely astounding. He links to a pseudonymously-written blog post that contains several quotes from Mises’s actual writings. Instead of citing what Mises actually wrote, however, he attributes the assertion that Mises “basically dropped” ABCT to the pseudonymous blogger. And then he proceeds on the assumption that they way “the blog tells it” is an accurate characterization of Mises’ views.

Relying on the unknown blogger for this would be a shameful enough scholarly standard, but, as anyone can see by clicking his link, the blogger does not tell it that way. Nowhere in the post does its author, “Lord Keynes”, claim that Mises “basically dropped” ABCT. Instead, “Lord Keynes” writes that “Mises thought that his Austrian monetary theory of the cycle could not adequately explain the severity and length of the Great Depression” (emphasis added). Then he quotes Mises affirming that his theory of the business cycle had correctly identified the cause of the depression: the Federal Reserve’s inflationary monetary policy. Mises wrote:

The crisis from which we are now suffering is also the outcome of a credit expansion. The present crisis is the unavoidable sequel to a boom. Such a crisis necessarily follows every boom generated by the attempt to reduce the ‘natural rate of interest’ through increasing the fiduciary media.

As “Lord Keynes” notes, though, while Mises maintained that the ABCT explained the immediate cause of the depression, he also thought it “could not adequately explain the severity and length of the Great Depression”. To quote from Mises himself, “We are confronted here with a new problem, one that cannot be answered by the theory of cyclical changes alone” (emphasis added).

In sum, Mises stated that while the Austrian business cycle theory did explain the cause of the bust, it did not, by itself, explain the length and depth of the depression. Krugman’s claim that Mises abandoned the ABCT and conceded that it offered “no clear or plausible” explanation for the business cycle — whether attributed to “Lord Keynes” or not — is an outright lie.

Then, after lying that Mises abandoned the ABCT and conceded its invalidity, Krugman continues:

So what was the story? According to vM, it was excessive wages — trade unions were demanding too much, and unemployment benefits were leaving workers insufficiently desperate. Sound familiar? It should — it is, essentially, the current Republican story, in which unemployment is high because we’re being too nice to the unemployed — that, as I like to say, soup kitchens caused the Great Depression.

Did Mises argue that the problem was that the unemployed were treated too nicely? Of course not. Did he argue anything that could reasonably be interpreted that way? No. Was Mises, as Krugman attempts to characterize him, unconcerned about the plight of the unemployed? Certainly not. Turning once again to the quotes conveniently provided by “Lord Keynes”, in fact, it was out of concern for the unemployed that he argued against the price fixing of wages by the government. What Mises actually wrote was:

The unions now have the power to raise wage rates above what they would be on the unhampered market. However, interventions of this type evoke a reaction. At market wage rates, everyone looking for work can find work. Precisely this is the essence of market wages—they are established at the point at which demand and supply tend to coincide. If the wage rates are higher than this, the number of employed workers goes down. Unemployment then develops as a lasting phenomenon. At the wage rates established by the unions, a substantial portion of the workers cannot find any work at all. Wage increases for a portion of the workers are at the expense of an ever more sharply rising number of unemployed.

In sum, by attempting to fix wage prices higher, the government was causing unemployment by pricing many workers right out of the labor market. But where did unemployment benefits come in? Mises continued:

Those without work would probably tolerate this situation for a limited time only. Eventually they would say: ‘Better a lower wage, than no wage at all.’ Even the labor unions could not withstand an assault by hundreds of thousands, or millions of would-be workers. The labor union policy of holding off those willing to work would collapse. Market wage rates would prevail once again. It is here that unemployment relief is brought into play and its role [in keeping workers from competing on the labor market] needs no further explanation.

Thus, we see that unemployment, as a long-term mass phenomenon, is the consequence of the labor union policy of driving wage rates up. Without unemployment relief, this policy would have collapsed long ago. Thus, unemployment relief is not a means for alleviating the want caused by unemployment, as is link in the chain of causes which actually makes unemployment a long-term mass phenomenon.

To reiterate, Mises argued that absent government intervention in the market, unions would not be able to sustain wages at a rate above the market rate determined by the supply of workers and the demand for their labor, and thus would not be able to cause such rampant unemployment. The market would correct itself. Such a situation could only occur because of government intervention in the market. The benefits offered to the unemployed was a disincentive to demand a lower wage rather than no wage at all, and thus served to prop up wages above their market rate, which in turn caused unemployment.

Incidentally, Krugman himself writes in his own economic textbooks about the disincentive to find work created by unemployment benefits. So he cannot very well claim that Mises is way off base on that point. It is reasonable to presume that Mises thought that causing so many people to not be able to get a job was not a very “nice” thing to do. But if we apply Krugman’s own standard against him, we could just as well argue that since he has written that “People respond to incentives” and that, “If unemployment becomes more attractive because of the unemployment benefit, some unemployed people may no longer try to find a job or may not try to find one as quickly as they would without the benefit”, therefore he thinks the problem with such a government policy is that it is “too nice” to workers.

Then, after deliberately mischaracterizing Mises as having callous disregard for the plight of the unemployed, Krugman continues:

And this is where [John Maynard] Keynes [the British economist, not our dear pseudonymous “Lord Keynes”] comes in. Suppose, for the sake of argument, that unions and the dole really were holding up wages, and that breaking the unions and starving the unemployed would have led to a big wage decline. How would this have promoted employment?

Don’t say that it’s obvious, that labor would get cheaper and more would be employed.

And pause…. Why not say it’s obvious? After all, Krugman’s own economic textbooks also point out that the consequence of fixing wage rates above their market price is unemployment. Furthermore, Krugman has repeatedly argued for more inflation in part in order to reduce workers’ real wages (robbing them of their purchasing power by devaluing the currency) on the grounds that this would help reduce unemployment.

In an attempt to obfuscate what really is “obvious”, Krugman continues:

As Keynes pointed out, this makes sense for an individual worker or group of workers, but not if everyone takes a wage cut and — as one would expect — prices also fall. In that case, the relative price of labor hasn’t fallen, so there is no reason for employment to rise.

Krugman is thus arguing that if wages were allowed to fall, the price of labor would still not reach a clearing point in the market (at which there is an equilibrium between the supply of workers and the demand for their labor, i.e., full employment). But how can it possibly be the case that wages would not be subject to the law of supply and demand in this case? Turning again to Krugman’s own cited source, we find “Lord Keynes” has also conveniently provided Mises’ response to this argument of Keynes:

The demand that a reduction in prices be tied in with the reduction in wage rates ignores the fact that wage rates appear too high precisely because wage reductions have not accompanied the practically universal reduction in prices.

Krugman’s response to this? Well, he doesn’t have one, of course. He simply repeats Keynes’ fallacy as though Mises hadn’t already shown why it is a fallacy. Then, by means of this willful ignorance, he pretends like he’s somehow proven how Mises was the one whose argument was fallacious. Krugman goes on:

Or think about it a different way. Again as Keynes pointed out, workers don’t negotiate real wages, they negotiate nominal wages. Why should the overall level of these wages matter? Rudi Dornbusch used to say that “it takes two nominals to make a real.” The usual argument for how wage-price flexibility leads to full employment is that wages “push” against a fixed nominal money supply, so that a fall in the overall wage level leads to a rise in the real money supply, a fall in interest rates, and so on. But under liquidity trap conditions this channel doesn’t work, and other channels — notably Fisherian debt deflation — almost surely mean that lower wages reduce, not increase, employment.

So it’s a nonsense story. But it turns out that it’s always the story the right turns to when market economies go bad — because the alternative would be to admit that market economies can in fact go bad, and that sometimes government is the solution, not the problem.

So now Krugman is arguing not only that falling wages would not have helped the unemployment problem during the Great Depression, but would have made it worse.

Welcome to Wonderland, where it is “nonsense” to say that the law of supply and demand applies to the price of labor (wages) during a depression just the same as during normal economic times.

Nonsense indeed. Start with the desired conclusion “that sometimes government is the solution”, and then do whatever it takes to get there . (The link he provides here, incidentally, is to another blog post of his, in which he resorts to similar dishonesty to likewise attack another Austrian school luminary, Henry Hazlitt. For the full response I wrote at the time, please see here.)

To dispel with Krugman’s nonsense here, it is enough to point out once again the fact that he argues that during the present ongoing downturn, there has been a problem of “downward nominal wage rigidity”, meaning that “people are very reluctant to demand or accept actual wage cuts”, which is necessary in order to reduce unemployment, and that price inflation resulting from central bank money printing is therefore a good thing, since it reduces workers’ real wages by decreasing their purchasing power.

Krugman likes to try to have it both ways. With him, it’s always, “Heads, I win; tails, you lose.” He is perfectly content to constantly contradict himself, so long as whichever his argument of the day is gets him to his desired conclusion.

So there you have it. This is the best Krugman can to do try to discredit the Austrian school and its theory of the business cycle: strawman argumentation (i.e., simply lying about Mises’ views), ad hominem argumentation (i.e., attacking Mises’ character from the premise of his deliberate mischaracterization of his views), willful ignorance (i.e., ignoring Mises’ explanation for why Krugman’s argument is fallacious and simply repeating the fallacy as though Mises had not addressed it), irreconcilable self-contradictions (i.e., claiming on one hand that Mises was wrong to argue that falling wages would help reduce unemployment while at the same time himself arguing for higher inflation in order to reduce worker’s real wages to help fight unemployment), and sheer hypocrisy.

Why anyone takes this guy seriously is one of life’s great mysteries.

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