The Accidental Theorist

by Krugman, Paul

  While the idea that capitalism suffers from being too productive mainly rests on a naive failure to think the matter through, some commentators who hold this view have managed to convince themselves that they are bold and forward-looking thinkers, drawing their inspiration from that great economist John Maynard Keynes—who must, as I argue in “Vulgar Keynesians,” be turning over in his grave.

  Of course, some countries are having trouble creating jobs. I conclude this section with an essay about the sad case of France: a country in which fashionably muddled thinking has helped to create mass unemployment—and in which the political elite seems determined to draw the wrong lessons from that experience.

  The Accidental Theorist

  Imagine an economy that produces only two things: hot dogs and buns. Consumers in this economy insist that every hot dog come with a bun, and vice versa. And labor is the only input to production.

  OK, time out. Before we go any further, I need to ask what you think of an essay that begins this way. Does it sound silly to you? Were you about to turn the page, figuring that this couldn’t be about anything important?

  One of the points of this essay is to illustrate a paradox: You can’t do serious economics unless you are willing to be playful. Economic theory is not a collection of dictums laid down by pompous authority figures. Mainly, it is a menagerie of thought experiments—parables, if you like—that are intended to capture the logic of economic processes in a simplified way. In the end, of course, ideas must be tested against the facts. But even to know what facts are relevant, you must play with those ideas in hypothetical settings. And I use the word “play” advisedly: Innovative thinkers, in economics and other disciplines, often have a pronounced whimsical streak. It so happens that I am about to use my hot-dog-and-bun example to talk about technology, jobs, and the future of capitalism. And I plan to make some serious points about those subjects—the kind of points that can only be made if you are willing to play around with a thought experiment or two.

  So let’s continue. Suppose that our economy initially employs 120 million workers, which corresponds more or less to full employment. It takes two person-days to produce either a hot dog or a bun. (Hey, realism is not the point here.) Assuming that the economy produces what consumers want, it must be producing 30 million hot dogs and 30 million buns each day; 60 million workers will be employed in each sector.

  Now, suppose that improved technology allows a worker to produce a hot dog in one day rather than two. And suppose that the economy makes use of this increased productivity to increase consumption to 40 million hot dogs with buns a day. This requires some reallocation of labor, with only 40 million workers now producing hot dogs, 80 million producing buns.

  Then a famous journalist arrives on the scene. He takes a look at recent history and declares that something terrible has happened: Twenty million hot-dog jobs have been destroyed. When he looks deeper into the matter, he discovers that the output of hot dogs has actually risen 33 percent, yet employment has declined 33 percent. He begins a two-year research project, touring the globe as he talks with executives, government officials, and labor leaders. The picture becomes increasingly clear to him: Supply is growing at a breakneck pace, and there just isn’t enough consumer demand to go around. True, jobs are still being created in the bun sector; but soon enough the technological revolution will destroy those jobs, too. Global capitalism, in short, is hurtling toward crisis. He writes up his alarming conclusions in a five-hundred-page book. It is full of startling facts about the changes underway in technology and the global market; larded with phrases in Japanese, German, Chinese, and even Malay; and punctuated with occasional barbed remarks about the blinkered vision of conventional economists. The book is widely acclaimed for its erudition and sophistication, and its author becomes a lion of the talk-show circuit.

  Meanwhile, economists are a bit bemused, because they can’t quite understand his point. Yes, technological change has led to a shift in the industrial structure of employment. But there has been no net job loss; and there is no reason to expect such a loss in the future. After all, suppose that productivity were to double in buns as well as hot dogs. Why couldn’t the economy simply take advantage of that higher productivity to raise consumption to 60 million hot dogs with buns, employing 60 million workers in each sector?

  Or, to put it a different way: Productivity growth in one sector can very easily reduce employment in that sector. But to suppose that productivity growth reduces employment in the economy as a whole is a very different matter. In our hypothetical economy it is—or should be—obvious that reducing the number of workers it takes to make a hot dog reduces the number of jobs in the hot-dog sector but creates an equal number in the bun sector, and vice versa. Of course, you would never learn that from talking to hot-dog producers, no matter how many countries you visit; you might not even learn it from talking to bun manufacturers. It is an insight that you can gain only by playing with hypothetical economies—by engaging in thought experiments.

  Is this thought experiment too simple to tell us anything about the real world? No, not at all. For one thing, if for “hot dogs” you substitute “manufactures” and for “buns” you substitute “services,” my story actually looks quite a lot like the history of the U.S. economy over the past generation. Between 1970 and the present, the economy’s output of manufactures roughly doubled; but, because of increases in productivity, employment actually declined slightly. The production of services also roughly doubled—but there was little productivity improvement, and employment grew by 90 percent. Overall, the U.S. economy added more than 45 million jobs. So in the real economy, as in the parable, productivity growth in one sector seems to have led to job gains in the other.

  There is also a deeper point: A simple story is not the same as a simplistic one. Even our little parable reveals possibilities that no amount of investigative reporting could uncover. It suggests, in particular, that what might seem to a naive commentator like a natural conclusion—if productivity growth in the steel industry reduces the number of jobs for steelworkers, then productivity growth in the economy as a whole reduces employment in the economy as a whole—may well involve a crucial fallacy of composition.

  But wait—what entitles me to assume that consumer demand will rise enough to absorb all the additional production? One good answer is: Why not? If production were to double, and all that production were to be sold, then total income would double, too; so why wouldn’t consumption double? That is, why should there be a shortfall in consumption merely because the economy produces more?

  Here again, however, there is a deeper answer. It is possible for economies to suffer from an overall inadequacy of demand—recessions do happen. However, such slumps are essentially monetary—they come about because people try in the aggregate to hold more cash than there actually is in circulation. (That insight is the essence of Keynesian economics.) And they can usually be cured by issuing more money—full stop, end of story. An overall excess of production capacity (compared to what?) has nothing at all to do with it.

  Perhaps the biggest objection to my hot-dog parable is that final bit about the famous journalist. Surely, no respected figure would write a whole book on the world economy based on such a transparent fallacy. And even if he did, nobody would take him seriously. But while the hot-dog-and-bun economy is hypothetical, the journalist is not. The inspiration for this essay was Rolling Stone reporter William Greider’s widely heralded 1997 book, One World, Ready or Not: The Manic Logic of Global Capitalism. That book is exactly as I have described it: a massive, panoramic description of the world economy, which piles fact upon fact (some of the crucial facts turn out to be wrong, but that is another issue) in apparent demonstration of the thesis that global supply is outrunning global demand. Alas, all the facts are irrelevant to that thesis; for they amount to no more than the demonstration that there are many industries in which growing productivity and the entry of new producers has led to a loss of tr
aditional jobs—that is, that hot-dog production is up, but hot-dog employment is down. Nobody, it seems, warned Greider that he needed to worry about fallacies of composition, that the logic of the economy as a whole is not the same as the logic of a single market.

  I think I know what people like Greider would answer: that while I am talking mere theory, their arguments are based on the evidence. The fact, however, is that the U.S. economy has added forty-five million jobs over the past twenty-five years—far more jobs have been added in the service sector than have been lost in manufacturing. Greider’s view, if I understand it, is that this is just a reprieve—that any day now, the whole economy will start looking like the steel industry. But this is a purely theoretical prediction. And such theorizing is all the more speculative and simplistic because he is an accidental theorist, a theorist despite himself—because he and his unwary readers imagine that his conclusions simply emerge from the facts, unaware that they are driven by implicit assumptions that could not survive the light of day.

  Of course, neither the general public, nor even most intellectuals, realized what a thoroughly silly book Greider had written. After all, it looked anything but silly—it seemed knowledgeable and encyclopedic, and was written in a tone of high seriousness. It strains credibility to assert the truth, which is that the main lesson one really learns from all those pages is how easy it is for an intelligent, earnest man to trip over his own intellectual shoelaces.

  Why did it happen? Part of the answer is that Greider systematically cut himself off from the kind of advice and criticism that could have saved him from himself. His acknowledgments conspicuously did not include any competent economists—not a surprising thing, one supposes, for a man who describes economics as “not really a science so much as a value-laden form of prophecy.” But I also suspect that Greider was the victim of his own earnestness. He clearly took his subject (and himself) too seriously to play intellectual games. To test-drive an idea with seemingly trivial thought experiments, with hypothetical stories about simplified economies producing hot dogs and buns, would have been beneath his dignity. And it is precisely because he was so serious that his ideas were so foolish.

  Downsizing Downsizing

  The Clinton administration isn’t particularly mendacious on economic matters—in fact, economic analysis and reporting under Clinton have been unusually scrupulous. But the president has changed his mind about economic policy so often that now his officials sound insincere even when they speak the plain truth. And so I felt a bit sorry for Joseph Stiglitz, the eminent economist who for a time chaired Clinton’s Council of Economic Advisers. In the spring of 1996, Stiglitz released a report on the state of the American worker, more or less confirming what most independent economists had already concluded: Workers were not doing as badly as the headlines might have suggested. In particular, the impact of corporate downsizing had been greatly exaggerated.

  Stiglitz’s report was, to all appearances, a sincere attempt to produce a realistic picture of the American labor market. Yet it was treated by nearly all commentators as a purely political document—an election-year effort to accentuate the positive.

  But the commentators had reason for their skepticism. After all, other members of the administration—especially Labor Secretary Robert Reich—had been insistently pushing a very different view. In the world according to Reich, even well-paid American workers have now joined the “anxious classes.” They are liable any day to find themselves downsized out of the middle class. And even if they keep their jobs, the fear of being fired has forced them to accept stagnant or declining wages while productivity and profits soar.

  Like much of what Reich says, this story was clear, compelling, brilliantly packaged, and mostly wrong. Stiglitz, by contrast, was telling the complicated truth rather than an emotionally satisfying fiction.

  To understand why Reich was wrong (about this and most other things), think about the strange case of the missing children. During the early 1980s, sensationalist journalism, combining true-crime stories with garbled statistics, convinced much of the public that America is a nation where vast numbers of children are snatched from their happy families by mysterious strangers every year. TV shows about “stranger abductions” are a media staple to this day. In reality, however, such crimes are rare: about 300 per year in a nation of 260 million. It’s not that abductions never happen. They do, and they are terrible things. Nor is the point that the kids are all right: For hundreds of thousands of American children, life is sheer hell. Almost always, however, the people who victimize children are not strangers. For every child kidnapped by a stranger, at least a thousand are sexually abused by family members. But stranger abductions made good copy, and therefore became a public concern out of all proportion to their real importance.

  Corporate downsizing is neither as terrible nor as rare as stranger abduction, but the two phenomena share some characteristics. Like stranger abductions, downsizing is a camera-ready tragedy, perfect for media exploitation, that is only a minor part of the real problem.

  Stiglitz’s report is full of dense statistical analysis making this point, but here’s a quick do-it-yourself version. A February 1996 Newsweek cover story entitled “Corporate Killers” listed just about every large layoff by a major corporation over the last five years. The number of jobs eliminated by each company appeared in large type next to a photo of the CEO responsible. The article implied that it was describing a national catastrophe. But if you add up all the numbers, the total comes to 370,000. That is less than one worker in 300—a tiny blip in the number of workers who lose or change jobs every year, even in the healthiest economy. And the great majority of downsized workers do find new jobs. Although most end up making less in their new jobs than they did before, only a fraction experience the much-publicized plunge from comfortable middle class to working poor. No wonder Stiglitz found that the destruction of good jobs by greedy corporations is just not an important part of what is happening to the American worker.

  The point is that Reich’s style of economics—which relies on anecdotes rather than statistics, slogans rather than serious analysis—cannot do justice to the diversity and sheer size of this vast nation. In America anything that can happen, does: Strangers kidnap children; mathematicians become terrorists; executives find themselves flipping hamburgers. The important question is not whether these stories are true; it is whether they are typical. How do they fit into the big picture?

  Well, the big picture looks like this: Both the number of “good jobs” and the pay that goes with those jobs are steadily rising. The workers who have the skill, talent, and luck to get these jobs generally do very well. Only a relative handful of “good job” holders (which is to say only a few hundred thousand a year) experience serious reverses. America’s middle class may be anxious, but objectively, it is doing fine.

  The people who are really doing badly are those who do not have good jobs and never did. Those with lousy jobs have seen their already-low wages slowly but steadily sink. In other words, the main victims of (to use another of Reich’s phrases) the “new economy” are not the few thousand managers who have become hamburger flippers but the tens of millions of hamburger flippers, janitors, and so on whose real wages have been declining 1 or 2 percent per year for the last two decades.

  Does this distinction matter? It does if you are trying to set any sort of policy priorities. Should we, as some in the administration wanted, focus our attention on preserving the jobs of well-paid employees at big corporations? Should we pressure those companies to stop announcing layoffs? Should we use the tax system to penalize companies that fire workers and reward those that do not? Or, instead, should we fight tooth and nail to preserve and extend programs like the Earned Income Tax Credit that help the working poor? It is disingenuous to say we should do both: Money is scarce and so is political capital. If we focus on small problems that make headlines, we will ignore bigger problems that don’t.

  So let’s give Joe
Stiglitz some credit. No doubt his political masters allowed him to downsize the issue of downsizing at least partly because they believed that good news reelects presidents. Sometimes, however, an economic analysis that is politically convenient also happens to be the honest truth.

  Vulgar Keynesians

  Economics, like all intellectual enterprises, is subject to the law of diminishing disciples. A great innovator is entitled to some poetic license. If his ideas are at first somewhat rough, if he exaggerates the discontinuity between his vision and what came before, no matter: Polish and perspective can come in due course. But inevitably there are those who follow the letter of the innovator’s ideas but misunderstand their spirit, who are more dogmatic in their radicalism than the orthodox were in their orthodoxy. And as ideas spread, they become increasingly simplistic—until what eventually becomes part of the public consciousness, part of what “everyone knows,” is no more than a crude caricature of the original.

  Such has been the fate of Keynesian economics. John Maynard Keynes himself was a magnificently subtle and innovative thinker. Yet one of his unfortunate if unintentional legacies was a style of thought—call it vulgar Keynesianism—that confuses and befogs economic debate to this day.

  Before the 1936 publication of Keynes’s The General Theory of Employment, Interest, and Money, economists had developed a rich and insightful theory of microeconomics, of the behavior of individual markets and the allocation of resources among them. But macroeconomics—the study of economy-wide events like inflation and deflation, booms and slumps—was in a state of arrested development that left it utterly incapable of making sense of the Great Depression.