Letter in different form

Dear Dr. Krugman,

I write to encourage you to use the following argument in your arsenal. It is a simple argument that abides neo-classical principles but shows that sometimes the government is a better investor than individuals. If this argument is valid, then there is no justification for “tax cuts” as part of any stimulus package. The package should be purely spending (to keep us alive) and targeted government investment (to set the stage for future growth)

Tax cuts stimulate “better” investment only in certain circumstances. Tax cuts put decision-making power in the hands of those who hold more precise, but more local, information: individuals. When the basic parameters of decision making are already set — prices are stable, technologies and infrastructure are relatively fixed — individuals make better decisions than the government. This is because they have access to more precise information — they need to track fewer variables and receive more rapid feedback.

But in times of upheaval, when there are insufficient number of givens, calculations at the local level become too complex. Individuals have precise data but lack sufficient premises to interpret the data, rendering the precision useless. For example, since there are a dozen candidates for alternative energy technology, it is hard for a small business owner to know which kind of vehicle to buy. The individual can hold precise knowledge of the particular prices and features which are relevant to his/her business right now, but he/she assumes that the very basis of “relevant” could change dramatically at any point in time. When faced with this complexity, the rational thing for local investors to do is “wait and see” how things play out.  The deflationary trap is the manifestation of this collective “waiting and seeing” by rational individuals.

At these times, the most effective allocator of capital is any actor who can impose parameters rather than needing to wait for them to emerge from the decisions of others. This actor is the federal government. This pattern of toggling between local and central decision-making is well known in the studies of organizations (starting with March & Simon) and individual decision-making (see the work of Gigerenzer). More frighteningly, in biological communities that lack a central decision-maker, these situations generate calamitous collapses that solve the problem by forcibly removing interdependency. We don’t want that.

In 25 years, the current understanding of neo-classical economics will be changed. Either we will solve these problems by recognizing that government investment is a logical component of market systems with rational actors, or we will fail to solve them and have rejected the philosophy entirely. Please do what you can to encourage the former.

Thank you and sincerely,

Drew Margolin