Nobel laureate and New York Times columnist Paul Krugman has been known to say some wacky things. After the 9/11 attacks, he opined that they “could even do some economic good.” In 2002 he wrote that only a housing bubble could rescue the U.S. economy. After the tsunami, Krugman argued that the Japanese nuclear disaster “could end up being expansionary.” And just last month, Krugman went on CNN to claim that a fake alien invasion could pull the world out of recession in 18 months.

In this context, it’s not surprising that Krugman thought that the EPA should have gone forward with its plan to tighten ozone regulations—in order to create jobs. That’s right, Krugman wasn’t arguing (as an environmentalist economist might) that the benefits in human health outweighed the direct economic costs in terms of reduced output (and hence lower employment). No, Krugman actually claimed that it would stimulate the economy if businesses had been forced to spend money complying with the more stringent regulations.

Krugman on How to Fix the Economy

Let’s quote Krugman in his own words:

Let’s talk about the economics. Because the ozone decision is definitely a mistake on that front.

As some of us keep trying to point out, the United States is in a liquidity trap: private spending is inadequate to achieve full employment, and with short-term interest rates close to zero, conventional monetary policy is exhausted.

This puts us in a world of topsy-turvy, in which many of the usual rules of economics cease to hold. Thrift leads to lower investment; wage cuts reduce employment; even higher productivity can be a bad thing. And the broken windows fallacy ceases to be a fallacy: something that forces firms to replace capital, even if that something seemingly makes them poorer, can stimulate spending and raise employment. Indeed, in the absence of effective policy, that’s how recovery eventually happens: as Keynes put it, a slump goes on until “the shortage of capital through use, decay and obsolescence” gets firms spending again to replace their plant and equipment.

And now you can see why tighter ozone regulation would actually have created jobs: it would have forced firms to spend on upgrading or replacing equipment, helping to boost demand. Yes, it would have cost money — but that’s the point! And with corporations sitting on lots of idle cash, the money spent would not, to any significant extent, come at the expense of other investment.

There are (at least) two main problems with Krugman’s analysis. First and most important, he is neglecting the (obvious) fact that adding new constraints on economic activity is hardly the way to jumpstart a stalled economy. Second, he is wrong when he claims that business investment to comply with the new regulations would largely come out of “idle” cash. On the contrary, much of their spending would come at the expense of other investments—assuming the firms in question didn’t go out of business or relocate out of the country.

Kicking the Economy When It’s Already Down

Although he acknowledges the “Broken Window” fallacy (which I discuss at length in this article), Krugman nonetheless violates its commonsense lesson: It doesn’t “help the economy”—certainly not in any meaningful sense—to force businesses to spend money just in order to get back to their original starting position. Contrary to Krugman’s earlier analyses, the 9/11 attacks, the Japanese nuclear scare, and a hypothetical alien invasion hoax would not help us out of recession.

In the case of the proposed ozone regulations, Krugman doesn’t even discuss the disastrous impact on the “supply side.” Instead, he narrowly focuses on demand. Krugman thinks the problem with the economy right now is that people aren’t spending enough; he doesn’t realize that the EPA would have seriously hampered the economy’s ability to produce enough.

The EPA had proposed to reduce ozone standards down to 0.06 parts per million, or 60 parts per billion. That concentration works out to less than a cup of water in an Olympic-sized swimming pool. To understand just how draconian that threshold would have been, consider that the EPA itself conjectured that up to 96 percent of the monitored counties in the nation would have been in non-attainment. One study estimated that the tighter threshold would cost more than $1 trillion.

Environmental economists can argue about the pros and cons of such regulations. (Even the EPA’s own numbers, however, make a dubious case.) Yet Krugman hasn’t even attempted such a balancing act. What if the EPA banned the use of all fossil fuels? Imagine the huge burst of investment spending, as Americans loaded up on bicycles and skateboards!

This suggestion isn’t merely intended for humor. It is the same principle as that espoused by Krugman; the difference is merely one of degree. It would obviously be economic suicide if the EPA banned the use of fossil fuels. By the same token—though of course not nearly to the same extreme—it would be economically damaging if the EPA had gone through with its tighter ozone regulations.

“Idle” Cash Isn’t Really Idle

Krugman commits a subtler mistake in his analysis when he says that new spending on regulatory compliance wouldn’t come at the expense of other investment spending. He claims that because firms are currently sitting on huge balances of “cash” (which means short-term, liquid assets, such as Treasury bills, and not paper currency in a piggy jar), they would have no reason to curtail other expenditures if the EPA foisted new rules on them.

Krugman is simply wrong on this count. Just like households, firms hold liquid assets for a reason. They are currently holding large sums not because they “did all their spending” and had a bunch left over. Rather, when determining the optimal composition of their portfolios, firms have decided—because of the tremendous economic uncertainty—that it is prudent to carry a much larger share of their wealth in the form of “cash” than they normally do.

The EPA certainly wouldn’t make firms more relaxed about the future, if it tightened the screws on ozone regulations and thereby rendered the firms even more financially precarious. It’s true, firms might pay the compliance expenses partially by drawing down their cash balances, but they would also spread the pain around their other investments too. Ironically, Krugman has to agree with me, because I am merely repeating the same analytical framework that he deployed to (erroneously) criticize Eric Cantor’s position on hurricane disaster spending.


Contrary to the views of Nobel laureate Paul Krugman, shackling the economy is not the way to grow out of a recession. Rather than imposing new regulations that would drive up the prices of energy and other goods, the government should remove constraints on production.

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