Paul Krugman’s Weird Prediction that Romney Would Turn America into Ireland
New York Times economics pundit Paul Krugman peers into … the future!
“Ireland is Romney economics in practice. They’ve laid off a large fraction of their public workforce, they’ve slashed spending, they’ve had extreme austerity programs,” Krugman said on “The Colbert Report” on Monday night, promoting his book, “End This Depression Now.” “They have 14 percent unemployment, 30 percent youth unemployment, zero economic growth. Ireland is a demonstration – Ireland is America’s future if Romney becomes president.
But I think the good professor’s fearless forecast founders on a few facts:
1. Mitt Romney isn’t proposing to raise taxes. Actually, he wants to cut them. But at least 40% of the EU’s fiscal adjustment has been from the tax side in high-tax Europe, a region already at the top of the Laffer Curve. Successful fiscal consolidations in general are more like 80-20, not 60-40. Austerity in Europe, given the eurozone’s giant tax burden, probably should have been all spending cuts.
2. Romney isn’t proposing to balance the budget in a year. He’s pledged to reduce federal spending to 20% of GDP by the end of his first term and balance the budget in 8 to 10 years. Would gradually cutting government spending kill growth?
Maybe not, according to Stanford University economist John Taylor. His widely respected economic model analyzed the impact of Paul Ryan’s budget plan (which would have average deficits of 1.7% of GDP under slow-growth assumption and balance the budget by as early as 2019 assuming faster growth).
The plan calls for sizeable reductions in expenditures in both discretionary and mandatory program expenditures relative to the budget baseline between 2013 and 2022. Under the plan, noninterest federal spending is projected to decline to 17.3 of GDP in 2022; a full 2.6 percentage points of GDP below the CBO baseline in that year. …
According to the initial model simulations, the strategy increases GDP in both the short run and the long run relative to the baseline.
There appear to be three sources of this positive effect.
First, lower levels of government spending in the future, compared to the baseline, imply lower tax rates which provide incentives and stimulate employment.
Second, the expectation of reduced government spending in the future lowers interest rates, which stimulates demand today offsetting the decline in government spending in the short run. And third, the lower interest rate reduces the exchange rate thereby increasing net exports which also offset the decline in government spending.
More generally, the gradual and credible decline in government spending allows the private sector to adjust smoothly to the decline in spending without negative disruptions.
3. Krugman again ignores evidence that suggests deep spending cuts don’t necessarily cause high unemployment:
From 1944 to 1948, Uncle Sam cut spending by a whopping 75% as World War II came to end. Spending as a share of GDP plunged to 9% in 1948 from 44% in 1944. … Despite cuts which dwarfed those seen in the EU today—not to mention those Republicans are calling for here at home—the U.S. economy thrived. There was no mass unemployment despite rapid demobilization of the armed forces. … And after the Cold War ended, overall federal spending fell to 18% of GDP in 2000 from 22% in 1991. But again the economy boomed. Real U.S. GDP grew by 40% with an average annual growth rate of 3.8%
If Krugman is looking for a proof-of-concept that cutting spending and cutting taxes is the smart way to reduce debt, he need not look any further than his own backyard.