Krugman on Europe

Paul Krugman recently penned this article in The New York Times comparing the United States and Europe. The crux of his argument is that European-style social democracy does not sacrifice anything in terms of economic dynamism when compared to the relatively more liberal (in the classical sense) United States. As a result, he claims the United States can learn from Europe and shed its fear of the stagnancy that is commonly thought to accompany the welfare state. However, Krugman's argument is remiss and has several weaknesses.

Since 1980, per capita real G.D.P. — which is what matters for living standards — has risen at about the same rate in America and in the E.U. 15: 1.95 percent a year here; 1.83 percent there.

This is Krugman's attempt to forge a link between European-style social democracy and economic dynamism comparable to the United States. However, Krugman clumsily ignores his own words and avoids mentioning the per capita GDP values, instead opting for the more convenient growth rates. According to the IMF's 2008 PPP adjusted GDP per capita numbers, the 2008 average for the EU 15 was $38,174, and $47,440 for the US. This is not an insignificant difference. In addition, if both percentage growth rates are similar, while the actual per capita incomes are different, the larger income will gain more relative to the smaller income. This can hardly be considered equal, and seriously undermines Krugman's argument.

Taxes in major European nations range from 36 to 44 percent of G.D.P., compared with 28 in the United States. Universal health care is, well, universal. Social expenditure is vastly higher than it is here.

So if there were anything to the economic assumptions that dominate U.S. public discussion — above all, the belief that even modestly higher taxes on the rich and benefits for the less well off would drastically undermine incentives to work, invest and innovate — Europe would be the stagnant, decaying economy of legend. But it isn’t.

After Krugman's sleight of logic earlier, he takes his conclusions to the extreme by claiming taxes do not affect incentives to work, invest, and innovate. Coming from an economist, the idea that you can tax people and not impact incentives to work, invest, and innovate is cavalier. When you increase taxes, it does not affect everyone's decisions, it affects decisions at the margin. This does not mean an economy with 8-16% higher taxes morphs into a regressive, decaying economy, only that marginal investment, work, and saving decisions are impacted.

The general point he attempts to get across is that Europe is not that bad, and offers more welfare options for its citizens. Europe is not that bad, there are certainly worse places to live. But, that does not mean the US should increase taxes and welfare programs either. The US and Europe have different preferences, and one could argue that our governments reflect these preferences. Also, there is a surprising dearth of evidence that argues welfare is actually helpful for those who receive it. As an economist should know, just because a program intends to do help people, does not automatically mean it correctly aligns all relevant incentives (See "Poverty Traps" a couple posts down). At first Krugman's article appears lazy. Especially when he concludes with the vague notion that there is no trade-off between social justice and progress. These terms are far from clearly defined, and he does not even attempt to do so in his article. In the end, Krugman's article transcends its apparent laziness and reveals itself for what it is: blind promotion.