My non-economist friends keep asking me about an essay by Paul Krugman published on September 2, 2009 in the NY Times Magazine. It seems to be a summary of his old book on the "return to Depression economics." As usual with Paul, it's cute and lucid and 85% correct. And as usual the 15% that's not correct turns out to be pretty important.
The basic mistake that Krugman and many economists and most journalists make is to suppose that the present bad situation (any present bad situation) is a Crisis of Capitalism. It's not. It's a routine severe recession. I don't say that it's fun (or a vacation, as my former colleagues at the University of Chicago have it). I don't say that government should do nothing to offset it. But I do say, as an economic historian, that we should realize that it's happened forty times since 1800, and every time the average person and the very poor have ended up with higher real incomes than at the previous peak. Every single time. Even during the horrible governmental foul-up 1929-1941 in the US.
Innovation is what drives any creative economy. The result since 1800 has been that the average person in the world has moved from $3 day (in current prices) to $30 a day, and a massive share of the world's poor have been relieved. The richest countries, like Norway, earn and spend fully $135 a day---and much, much more if you take into account the better goods we now have, such as anesthesia and jet travel and flat-screen TVs. Let's not foul it up.
So the Big Recession is not the Final Crisis that our friends on the left would like to see. It is not a matter of the sky falling. And so it does not require a New Economics. The current conventional wisdom is mistaken in saying that free-market capitalism has failed. For 37 percent of humanity in China and India it is succeeding spectacularly, and has long succeeded for many of the rest of us. We don't need to abandon markets, or to regulate much further the most regulated sector of the economy---banking and Wall Street.
Naturally, an innovation such as railways or mortgage-back securities can go too far. Usually they do, in economic science and in TV reality shows as much as in durable goods. People are people, and get innocently overexcited. They predict that the innovation will never stop paying off, and eventually they are wrong. As Yogi Berra put it, prediction is hard, especially about the future. Business bubbles and then crashes have happened when people have gotten overexcited about new railways and old farms, as in the 1850s, or overexcited about new financial assets and old houses, as in the 2000s. But when the bubble bursts, innovation soon repairs the damage. During the miserable down-times the opportunities pile up. The 1930s for instance was, surprisingly, the most innovative decade of the century.
Policy conclusion? By all means help people survive, with unemployment insurance and GI bills for education, to get ready for the next wave of innovations. But don't damage the economy's ability to innovate by freezing people in, say, jobs making autos---as Krugman's old Keynesian version of a New Economics would recommend.
The economy will right itself, and the poorest among use will be better off by 2011 than they were in 2007. We do not need fresh schemes inspired by a New Economics. In two years the economy will be booming again.
Historical perspective. For you, a money-back guarantee.