Paul Krugman’s recent column on China has earned Krugman a few, admittedly only half-serious, remarks on the apparent “Austrianism” in his analysis. See, for example, Robert Murphy’s post today. But, consider the following passage,

But it also means that the Chinese economy is suddenly faced with the need for drastic “rebalancing” — the jargon phrase of the moment. Investment is now running into sharply diminishing returns and is going to drop drastically no matter what the government does; consumer spending must rise dramatically to take its place.

This passage is somewhat vague, and could probably fit the theories of just about any economist, but the emphasis on the need for a rise in consumption is telling. In fact, this signals that Krugman is making a plain vanilla Keynesian analysis. And, I don’t mean New Keynesianism, I mean Old Keynesianism — not even necessarily Neoclassical synthesis stuff.

In The General Theory, John M. Keynes advanced a theory of intertemporal discoordination based on the concept of the multiplier, which Richard F. Kahn had developed about five years earlier. According to the Cambridge economists, the return on investment is a direct function of the marginal propensity to consume (MPC). The less consumption there is, the less revenue entrepreneurs can come to expect. Thus, there is a paradox of thrift, because if the MPC falls low enough, revenue will be too low to induce entrepreneurs to invest these savings into the production of future consumers’ goods. The marginal productivity of capital will fall, requiring either a fall in the rate of interest or a fall in the price of inputs. Keynes argues that neither of these will do the trick: the rate of interest, being subject to changes in liquidity preference (including, and perhaps especially, speculative liquidity), will not equilibrate the loanable funds market on its own; and a downward movement in wages will not solve an underemployment equilibrium.

My reading of Keynes’ ‘1936 book is that he presents two models of the business cycle, both essentially based on the concepts discussed in the last paragraph. First, he posits a situation where the MPC falls too low and a monetary disequilibrium results, where unused savings are left idle and incomes fall (incomes fall and the marginal propensity to consume rises). The second model, which people may be more familiar with, is based on psychological theories of periods of excitement (“irrational exuberance” — although this term was coined by Alan Greenspan) and pessimism. A boom may lead to “over-investment” (or “under-consumption,” depending on what angle you’re looking at the issue from), and unless the government steps in to “socialize production” (fiscal stimulus) or the central bank reduces the rate of interest (modern monetary theorists also advocate nominally increasing revenues [e.g. inflation and NGDP targeting]) boom can give way to bust.

My reading of Krugman is that he is applying Keynes’ model to China. He’s arguing that China is at that point where there is too little consumption and the marginal productivity of capital is too low. If he were making an Austrian argument, Krugman would have advocated an increase in savings. Instead, he argues in favor of more consumption. And, if China were to face a contraction, I think we could bet on Krugman pushing for fiscal stimulus and unconventional monetary policy.

If we were to distinguish between the Austrian and Keynesian theories, one way to make an easy distinction is as follows,

The Austrian solution to unprofitable investment is to increase the real productivity of capital (by increasing savings and lowering the price of producers’ goods); The Keynesian/Monetarist solution is to increase nominal revenues, by conducting fiscal and/or monetary stimulus.

Krugman, in this op-ed and in probably every op-ed, most closely fits (2).