Professor Paul Krugman is undeniably witty, and his blog posts are always very well written. However, often times his desire to insert that bearded face of his onto the well-limelit political stage has him so carried away that he arrives in a rush, bearing only half-baked economic arguments with which to justify his presence. In Krugman's defence, these arguments are often only secondary to more moralistic or political messages that he wishes to impart.
A couple of days ago, Krugman gatecrashed another political debate: the row over Obamacare and its effects upon employment. (Some argue that the Affordable Health Care Act will reduce the incentive to work, increasing the unemployment rate.) Krugman's real contribution to the debate was to bring attention to the paternalism in the right wing, a sort of "I-know-what's-best-for-you" attitude that demands long and sweaty hours of endless toil from all. He is right to condemn what amounts to the prescription of masochists, and thus I offer no opposition to Krugman here. So let's move quickly on and look instead at the accompanying economic argument with which he justifies his intrusion:
You might say that by withdrawing their labor, subsidized workers reduce the overall size of the economic pie, which is true. However, they also take a smaller share of the economic pie, because they earn less in wages and salaries. And if you believe to a first approximation in the marginal productivity theory of income distribution (as free-market advocates should), this means that the reduction in GDP from reduced labor input should be approximately equal to the reduced wages of those working less. In other words, the amount left over for everyone else should be unchanged. Why do you care how much other people work?
So, to summarise: regardless of how many others work, the same amount of wealth is left for an individual, as long as he personally remains employed. Does this logic hold up? Let's conduct a little thought experiment. Imagine that, tomorrow, every last worker laid down his tools, from broomsticks to stethoscopes. By Friday, Krugman is the only man left with a job. For how long, I wonder, would he remain nonchalant? Would he start to care about how much others worked before, or after, he resorted to clothing himself in cut outs from his New York Times column?
We can see now that his argument is fallacious. This 'economic pie' of which he speaks, is not homogeneous, like a real pastry. No man can survive from the consumption of his contribution alone; he requires others to produce and to trade with him. Therefore, one should take a personal interest in how much others work, contrary to Krugman's assertion.
But this is not the only problem with Krugman's argument. Within his claim that labourers are the only ones to bear the brunt of reduced production lies a common, niggling little fallacy. The assumption, which seems reasonable at first glace, is that the value placed upon the item by the consumer can be measured by the price that she pays. I will set about demonstrating the falsity of this assumption in good time. Bear with me. For now, put on your labcoats and goggles: it's time for another thought experiment!
Let's imagine a worker who makes wind chimes. His 'nominal productivity' is determined by what people will pay for his product. If his labour contributes to 100% of the product's value (for the sake of simplicity), and it sells for $10, his marginal productivity, in nominal terms, can be said to be $10 per wind chime; if it sells for $20, then that's $20 per wind chime. We will assume his wage to be equal to his marginal productivity.
Along comes a consumer, looking for something suitably noisy to hang in her porch way. She is happy to pay $20 for the product. Ker-ching! Our worker has pocketed 100% of this ($20).
Now let us re-play the scenario. This time, the worker, no longer stuck in what Krugman calls a 'job lock' thanks to Obamacare, has thrown in the towel. He will no longer be making wind chimes, and he has therefore sacrificed his $20 per wind chime wage; this is fine with him, hence the decision to quit!
But what about the consumer? Well, in Krugman land, she valued the wind chime at $20, nothing more. She is just as happy to keep her $20 as she is to have the $20 wind chime, i.e., whether she buys the wind chime or not, she does not care.
So, using Krugman's assumptions, it is easy to see why he believes there to be no losses. The lady is fine to keep her 20 dollars. The worker is happy to quit production. But, again, this assumes that the value a consumer places upon a good can be measured by the price paid; that money is just like any other measuring utensil in this sense, e.g., a ruler or stopwatch. Except it isn't.
Why does anyone trade? Because they value good x more than they value the price that they are being asked to pay for it. If our consumer was just as happy with the $20 as she was the wind chime, why even trade at all? Or, having made the trade, why not undo it and re-do it ad infinitum (assuming no transaction costs)? A price will not tell us the value that a person places upon a good. Nothing can accurately measure such a thing.
So, we may conclude that the woman gained more than she lost by purchasing the wind chime. And having ceased wind chime production, the worker is now depriving the consumer of the opportunity to trade and to benefit. Can we quantify the loss to the consumer? No. But we do know that a loss has been made, and we can confirm that, contrary to Professor Krugman's argument, the worker is not the only one affected by his unemployment.
That concludes my first blog post. More Krugman bashing to come in the future, so, if you enjoy that sort of thing, follow me on twitter @MrThriftyBlog, or alternatively enter your email into the 'follow by email' box at the top right corner of this page.
Link to Krugman's article: http://krugman.blogs.nytimes.com/ (scroll to Feb. 10th).