Neither Keynesian stimulus nor fiscal austerity will solve our economic problems.

Mohamed El-Erian, chief executive and co-chief investment officer of Pimco, wrote about getting beyond the false growth vs austerity debate in the Financial Times. Paul Krugman says he disagrees, but I don't think he really understood El-Erian's point—that we are not in just another business cycle that will respond to the traditional stimulative tools that Krugman keeps pressing us to use urgently. Here's my comment on Krugman's post:

I think El-Erian is saying that there are actions that should be taken now but that the usual responses to an ordinary business cycle won't work because this is not an ordinary business cycle. He says, "[C]ountries must quickly implement what were once known in the emerging market lexicon as 'second generation structural reforms'. Basically these involve enhancing the longer-term responsiveness of western economies that have had their comparative advantages eroded, and now see their populations stranded on the wrong side of significant global changes."

Loose monetary and fiscal policies will not solve the structural problem that the US has had declining laborforce participation for a full decade. If Keynesian stimulus can only get us back to that trend line, we may as well get started with the adjustment now, instead of first pouring more water into the hot sands of it's-all-going-to-hell-anyway.

One of the fundamental problems for America to address is whether we're going to continue to permit and encourage the shift of job growth to developing nations at our expense and the convergence of our wage levels with theirs. El-Erian calls for more education and increased productivity, but those old remedies will not be effective in our new predicament--American jobs are not going offshore because Asian workers are better educated but because they are paid less. In the US, 12 percent of mail carriers, a quarter of travel agents and retail-sales supervisors, a third of flight attendants, and nearly half of aerobics instructors have B.A. degrees. Only 2 of the 10 job categories projected by BLS to grow the fastest require college degrees. States and nations that have a high percentage of college educated people do not necessarily have faster economic growth, and at least one study found a negative correlation. http://www.realitybase.org/journal/2008/5/22/education-is-doing-a-lot-less-for-the-economy-than-we-all-th.html

So, Paul, you and El-Erian agree stimulative actions should be taken now, but he says (and I agree) that your specific proposals are insufficient to the task. He also says, and here I heartily disagree, that we are "stranded on the wrong side of global changes" and must remain there. Americans are looking for policies and leadership that gets us out of our big, long-term, stagnating, job-shedding, deflationary mire. Who better than Paul Krugman to take on that larger problem?

Update on Friday, June 25, 2010 at 09:38AM by Skeptic

This earlier post raised the question whether the US economy can recover or if this is the "new normal."  I'm getting more pessimistic, not less.

Update on Sunday, June 27, 2010 at 04:09PM by Skeptic

Several other comments on the Krugman post made the same basic point--that El-Erian does not accept the conventional dichotomy between fiscal stimulus now and fiscal austerity now.  Instead, he says neither of those approaches solves our big structural problem(s) and that we need to adopt now a third set of policies.

Update on Friday, July 9, 2010 at 10:56AM by Skeptic

Michael Spence agrees in this FT opinion piece.  But this Nobel laureate in economics is also stumped for an answer. 

Solutions to these problems are not easy to find. The unequal distribution of income can be dealt with through the tax system, although this does not attack the underlying problem. Protectionism could alter the pattern of out-migration of manufacturing, but only by imposing costs on domestic consumers and risking the breakdown of the open global economy model.

To avoid an outbreak of protectionism, there has to be an alternative. President Barack Obama’s new export council, announced on Wednesday, is a step in the right direction. But a bolder move is needed: a broad public-private partnership to invest in the development of technology in parts of the tradable sector where there are opportunities to make advanced countries competitive. The goal must be to create capital-intensive jobs that have labour productivity levels consistent with advanced country incomes.