THE RETURN OF DEPRESSION ECONOMICS.

THE RETURN OF DEPRESSION ECONOMICS by Paul Krugman Norton, $23.95

Most people are relieved by the fact that the Asian economic crisis did not turn into the worldwide, government-overturning, riot-and famine-inducing catastrophe some predicted, and no doubt Paul Krugman is relieved, too. But the entrepreneur in Krugman must also feel a small twinge of remorse. His new book, The Return of Depression Economics, was written in the darkest moments of the Asian flu, and it is packaged as a doomsaying prophecy. And now the crisis has disappeared from the headlines, giving Krugman's book the appearance of a dated piece of apocalyptic hysteria, like some decade-old Atlantic Monthly cover.

That is too bad, because despite its scary title and cover image (a businessman plunging to his imminent death), The Return of Depression Economics is not a prediction of disaster--indeed, it is not a prediction at all. It is, rather, an argument, and an important one at that. Using the backdrop of the Asian crisis, Krugman contends that the conventional wisdom of economists, executives, journalists, and policy-makers is utterly deluded. Readers of Krugman's work might find such a statement surprising. Krugman is not one to rail against the establishment; in fact, the most persistent themes of his popular work are an impatience with cranks and amateurs and the conviction that economics is best left to professionals. Why, then, would Krugman--who has made a career out of dismissing any sweeping criticism of conventional economics--make a sweeping criticism of conventional economics?

The answer, as Krugman explains, is that prevailing notions of international economics are actually not based on economics at all. This is a radical claim; the Brahmins of economic orthodoxy derive their authority from a supposedly superior understanding of market forces, and we are conditioned to think of any criticism of their doctrines in social or political--not economic--terms. In order to understand how such a counterintuitive thing could be true, we must backtrack a bit.

Before the 1930s, economics had a fatalistic view of recessions: They happened because the market temporarily got out of whack, or because people lived beyond their means, and so economic hardship was just the market's way of correcting itself. The only way out, the thinking went, was to allow prices and wages to settle to the corrective level. Government intervention would only make things worse.

John Maynard Keynes changed all that by arguing that painful measures, such as tax increases or spending cuts, would not help matters, but would actually make things worse. Government actions that put money into people's pockets right away, he argued, were actually virtuous for the economy as a whole. This view predominated for more than a generation, but the consensus began to fray during the '70s, when the economy slowed down, inflation skyrocketed, and Keynesian economics had no answer for the problems of the day. The solution to stagflation turned out to be painful austerity measures, enforced by an unrelenting Federal Reserve -- in other words, the opposite of what Keynes counseled. In recent years, as the economy has boomed under Alan Greenspan and Robert Rubin, tight-fisted budgeting and anti-inflationary vigilance have come to be seen as synonymous with prosperity.

While this new fiscal conservatism has done spectacularly well in this country over the past decade, it has run into the same problem that Keynesianism did: Its proponents have ceased to regard it as the proper corrective measure for a given set of conditions and started to regard it as an end-all, be-all remedy. This intellectual flabbiness was dramatically exposed during the Asian crisis. As economy after economy hurtled toward oblivion, the International Monetary Fund and the U.S. Treasury Department counseled interest rate hikes and budget cuts--that is, austerity measures likely to deepen recessions. It is as if the leading thinkers on economics had suddenly returned to the early '30s, when Herbert Hoover responded to the Great Depression with tax increases and budget cuts.

This happened not because the IMF was stupid, Krugman argues, but because it willfully ignored economics. International investors decide whether or not an emerging economy collapses, and since they believe fiscal conservatism creates a positive economic climate, their prejudices have a self-fulfilling quality. Even if there is nothing structurally wrong with a nation's economy, if enough investors believe it to be flawed and hence withdraw their capital, that nation will sink into a recession. Following this logic, the IMF insisted that the stricken nations pursue policies that did not make any independent sense simply because they conformed to the preferences of international business.

Krugman is at his most eloquent when arguing against this conventional wisdom:

"Twenty years ago, when even advanced countries were suffering from double-digit inflation, when intrusive foreign exchange control was a source of major economic distortions and wide-spread corruption, to preach the virtues of price stability and currency convertibility was clearly to move the world in the right direction. But we are no longer living in that world, and the useful rallying cries of one era have become the dangerous shibboleths of another."

The orthodoxy that Krugman identifies has become so entrenched that very few people are even aware of a reasonable alternative. Critics of the particular internationalist policies currently en vogue are frequently depicted as protectionists or isolationists--and in fact, many of them are. But one of the unexpected results of the Asian crisis is that a new coterie of economists has emerged--including not only Krugman but also Joseph Stiglitz of the World Bank, Jeffrey Sachs of Harvard, and Jagdish Bhagwhati of Columbia--who favor some restraints on unadulterated international capitalism precisely because of their internationalism. In the same way Keynes argued that capitalism must be modified in order to survive, these free-traders believe that only a more rationally constructed international marketplace can maintain the support of the world's population. If there is anything edifying to come out of the Asian crisis, it is this idea.

Jonathan Chait is a fellow at the New America Foundations.