(click to embiggen)

Harvard economics professors Gregory Mankiw and Robert Barro got prime real estate in the New York Times to push stale Republican economic theory with a faint dusting of John Maynard Keynes. Princeton Professor Paul Krugman jumps on Barro directly:

I mean, here’s the structure of what he says:

1. Keynes said that investment is what drives the business cycle
2. Investment depends on long-term incentives
3. ???
4. Austerity!

Krugman says that point 1 is the way things usually work in a recession. But Keynes argues for expansionary fiscal policy in big slumps, because business investment is driven by other factors, like customer demand. When that isn’t present, businesses won’t invest. Point 2 is “just wrong” as Krugman’s chart, reproduced above, shows. Business investment follows the business cycle. It is strong when demand is high, and falls quickly in recessions, when demand is weak. So, stimulating demand is the logical solution according to Krugman. He concludes with this:

… all [Barro] offers is word games and nonsequiturs.

Why did he even bother?

Ouch. Barro doesn’t have any charts, but he has plenty of ideas for austerity: 1) cut Social Security and Medicare, 2) remove tax breaks like the mortgage interest deduction; 3) cut marginal tax rates on individuals; 4) impose a Value Added Tax on consumption; 5) end corporate taxation; and 6) end the Estate Tax.

In other words, he wants to decrease taxes on capital and increase taxes on consumption. The idea that income from capital is more important than income from labor is a standard piece of right wing gibberish intended to entrench the rich in their wealth. The Washington Post reports today that capital gains are concentrated at the top of the income heap:

Over the past 20 years, more than 80 percent of the capital gains income realized in the United States has gone to 5 percent of the people; about half of all the capital gains have gone to the wealthiest 0.1 percent.

The idea that we should put a VAT in place, raising prices on everything, is just another blow at average Americans, and will crush demand for years until people figure out how it actually affects their finances.

Gregory Mankiw agrees with Barro that we need to stimulate business investment. Following Krugman, we can summarize Mankiw’s argument as follows:

1. Recovery is weak.
2. Business investment is very weak.
3. Keynes says business investment is driven by animal spirits.
4. Confidence Fairy!

As usual, we induce the Confidence Fairy to make an appearance by cutting taxes on capital. Also free trade treaties.

Krugman’s chart makes me wonder what data Mankiw was talking about when he said business investment is weak. Look at the slope of the upturns in the last three recessions. If anything, it looks to me like business investment is growing faster this time than it did in prior recessions. Taking the 1980 recession, Mankiw’s example, business investment went up for a couple of years, but not nearly as much as it did in the subsequent upswings. After that little bump, which lasted about two years, business investment dropped for seven years.

Business investment can take two forms. There might be new plants and new businesses, which will probably increase jobs. Or, businesses might invest in more efficient equipment, making each worker more productive. That won’t increase jobs in the short term, and might even reduce total employment, because fewer workers can produce the same output. When demand is stagnant and interest rates are very low, which is more likely? Even animal spirits aren’t intoxicating enough to drive business investment into areas of no demand. Maybe I should have added Krugman ??? after summoning the Confidence Fairy.

I call it Princeton 2, Harvard 0.