The other day, Paul Krugman argued that successful businessmen and entrepreneurs are not drivers of economic growth. Here’s the relevant part of his July 9th post:
So, imagine a Romney supporter named John Q. Wheelerdealer, who works 3000 hours a year and makes $30 million. And let’s suppose that he really does contribute that much to the economy, that his marginal product per hour — the amount he adds to national income by working an extra hour — really is $10,000. This is, by the way, standard textbook microeconomics: in a perfectly competitive economy, factors of production are supposedly paid precisely their marginal product.
Now suppose that President Obama has reduced Mr. Wheelerdealer to despair; not only does the president waste money by doing things like feeding children, he says mean things about some rich people, which is just like the Nazis invading Poland, or something. So Wheelerdealer decides to go Galt. Well, actually just one-third Galt, reducing his working time to just 2000 hours a year so he can spend more time with his wife and mistress.
According to marginal productivity theory, this does in fact shrink the economy: Wheelerdealer adds $10,000 worth of production for every hour he works, so his semi-withdrawal reduces GDP by $10 million. Bad!
But what is the impact on the incomes of Americans other than Wheelerdealer? GDP is down by $10 million — but payments to Wheelerdealer are also down by $10 million. So the impact on the incomes of non-Wheelerdealer America is … zero. Enjoy your leisure, John!
Treating aggregates like GDP as the fundamental basis of economic analysis leads to terrible and misleading arguments like this. As William Anderson notes, Krugman’s former professor Paul Samuelson used GDP models to praise the planned economy of the Soviet Union, which he estimated would overtake the American economy in size sometime between 1984 and 1997. The problem with Samuelson’s argument was that it lumped together low quality and misallocated goods into a meaningless aggregate. Krugman makes a similar mistake by lumping together different types of labor, of equating the work of a productive entrepreneur with that of any other member of the economy.
Let’s make Krugman’s argument more concrete so we can trace out where he goes wrong: say John Wheelerdealer is the inventor and marketer of the ipod. And say, just as in the original example, he decreases his output from $30 million to $20 million. It’s true, as Krugman argues, that this action has no impact on the monetary incomes of non-Wheelerdealer America. But this does not mean that the economic well-being of non-Wheelerdealer America is unaffected. Ipods are by far the most popular type of portable mp3 player, and with our entrepreneur on vacation for 1/3 of the year, fewer of them will be produced. All else staying equal, their price must increase, and consumers on the margin will be forced to buy less desirable knock-offs. In other words, while the incomes of non-Wheelerdealer America do not change, the buying power of those incomes does.
The effect is obviously much larger when high taxes and onerous regulations decrease the output of entrepreneurs across the economy. The negative effects, however, are unseen. We can only talk about what could have been. And that’s why bad economists like Krugman can get away with using accounting tricks to argue the absurd.