Krugman's Baby-Sitting Analogy
This is another in an open-ended series on strengths and weaknesses in Paul Krugman’s writing.
One of Krugman’s strengths is his talent for analogies that help readers understand economic reasoning. He starts with an analogy, developed by Joan and Richard Sweeney in the February 1977 Journal of Money, Credit, and Banking, between a baby-sitting co-op in Washington, D.C., and a large, complex economy.
In the co-op, people earned one half-hour coupon by providing one half-hour of baby-sitting services. At one point there was too little scrip in circulation. Couples would try to earn more scrip by offering to baby-sit. But there weren’t enough other couples wanting to go out, because they didn’t want to run down their inventory of coupons, and so there was an excess supply of baby-sitting services. This baby-sitting economy with about 150 couples was in a recession.
As Krugman points out, this situation is analogous to an excess supply of goods in a real economy, and thus, he concludes, it shouldn’t be hard for people to accept that a much more complex economy in which millions of good and services are exchanged can suffer from lack of demand. The solution that the baby-sitting co-op finally accepted was to print more coupons, and it worked. This is like printing money to get an economy out of a recession, which also usually works.
But nowhere does Krugman mention that another way to solve a problem of excess supply is to let prices fall. This missing piece is interesting, given that it was explicitly discussed in the article from which Krugman draws the analogy. The Sweeneys pointed out that because the founders of the co-op economy imposed price controls, decreeing that one unit of scrip must always exchange for a half-hour of baby-sitting services, there would be shortages when demand was too high and surpluses when it was too low. It’s not surprising that Krugman left this out: He seems to be biased in favor of having government step in rather than letting markets work things out.
In other words, the problem came about because prices were not allowed to adjust. Interestingly, Krugman seems to alternate between saying that prices (wages) don’t adjust quickly and saying that prices (wages) shouldn’t adjust quickly. This is the same ambiguity that many scholars have noted in Keynes’s General Theory.
Interestingly also, after my review appeared, I noticed that the frequency with which Krugman used his day-care analogy declined substantially. I was disappointed, therefore, but not surprised, that he kept it in his latest edition of the book.
Also, one thing that rereading my review showed me, something I had forgotten in light of Krugman’s over 800 New York Times columns, is that the same weaknesses that are on display so regularly in his columns were presaged in the 1990s. See the second paragraph of my review.