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Could the new world order lead back to the old financial crisis?

THE RETURN OF DEPRESSION ECONOMICS By Paul Krugman W.W. Norton 176 pp., $23.95

If Paul Krugman had signed off on the manuscript for this small book today rather than in January, he might have sounded a bit less anxious about the world economy.

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The economic outlook for Asia, including Japan, and for Brazil and Latin America has improved in the past six months. Yet the basic thesis of this MIT economist stands intact: The world economy shows more vulnerability to slumps than imagined prior to the financial crisis in Asia.

Capitalism, says Krugman in a recent interview, "can go off the rails."

In 1997 and 1998, seven economies producing about a quarter of the world's output and home to two-thirds of a billion people experienced an economic decline that "bears an eerie resemblance to the Great Depression," Krugman writes.

Japan's economy has stalled for eight years, something economists regarded as highly unlikely for an industrial nation.

The downturn in Asia actually hasn't been as bad as it was in the 1930s, except perhaps in Indonesia. So Krugman coins the phrase, the "Great Recession." The Asian crisis "struck out of a clear blue sky," Krugman notes. Most pundits were predicting continuing boom in such nations as Thailand, South Korea, Malaysia, and Indonesia. Many experts even saw excellent prospects for progress in Russia.

Further, Krugman finds, the damage done to the crisis countries "seems vastly disproportionate to the cause - capital [capital market] punishment imposed on economies guilty of nothing more than financial misdemeanors."

Conventional economic medicine has proved "ineffective" for bringing back these economies, charges Krugman.

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That assertion might be challenged by officials at the International Monetary Fund and the US Treasury, now that some recovery is visible. But the IMF did modify its financial packages to rectify early mistakes in conventional rescue policies.

Krugman's book is a valuable addition to a growing stack of volumes dealing with the latest economic crisis. It is a lively, clear, modest package for those trying to understand the ins and outs of a bewildering mess.

He writes in normal language, not economists' jargon. He provides background on developments in the post-cold-war era, touching on globalization, the Mexican crisis, an explanation of the currency board in Argentina, the Asian boom, productivity, technology, and so on.

Krugman describes himself as a "free-market Keynesian." Like conservative economists, he is a fan of free enterprise, free markets, as the best way for organizing the supply and demand for goods and services. But as a Keynesian, a term referring to John Maynard Keynes, a famed British economist, Krugman sees government as having an important role in managing economic developments.

So his proposals for making the world economy a less "dangerous place" will be controversial. They will be especially so to those supply-side economists who won much attention in the Reagan years with their insistence that the government should keep its fingers out of the economic pie.

"Once again," Krugman writes, "the question of how to keep demand adequate to make use of the economy's capacity has become crucial. Depression economics is back."

He suggests, for instance, that nations may need to avoid capital flight when investors' fears of economic collapse are turning into a self-fulfilling prophecy. One way would be to tax local companies when they borrow in foreign currencies, he says.

Krugman also makes a plea for governments going into the red in their budgets when faced with recession. He worries that Europe, like Japan, may be caught in what Keynes called a "liquidity trap" - an unwillingness of fearful consumers to spend that thereby holds up recovery.

He argues that a 2 percent inflation rate is not a bad thing for industrial economies.

"A good economic system should not require perfect policies of its denizens," he writes. It is advice that has become more acceptable today after the Asian crisis challenged much economic doctrine.

*David R. Francis is the Monitor's senior economics writer.

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