This morning the Nobel Prize in Economics was given to Paul Krugman, an economist from Princeton and columnist for the N.Y. Times. It’s encouraging that the Nobel committee would select someone like Krugman, whose work in “new trade theory” finds that free trade is not always a good model. And it’s encouraging that they’ve returned to basics and recognized work in real economics instead of nonsense like “game theory” that they’ve rewarded in the recent past.
Krugman appeared on the “roundtable” segment of ABC’s “This Week” program on Sunday morning. I thought that his closing comment, in response to talk of Warren Buffet being the next Treasury Secretary, was profound: “Great business leaders generally make very poor economic leaders.” How true! What we see time and again is that, when business leaders are given government leadership roles, instead of government that’s run like a business, we get a government that’s run for business.
Almost every day I’m seeing more evidence of a turn away from the free trade model. At some point it might even penetrate America’s leaders’ thick skulls.
Here’s a sampling from the article explaining some basics about Krugman’s work:
Mr. Krugman won the prize for his research, beginning in 1979, that explained patterns of trade between countries, as well as what goods are produced where and why.
Traditional trade theory assumes that countries are different and will exchange only the kinds of goods that they are comparatively better at producing — wine from France, for example, and rice from China. This model, however, dating from the early 19th century, was not reflected in the flow of goods and services Mr. Krugman saw in the world around him. He set out to explain why worldwide trade was dominated by a few countries that were similar to each other, and why a country might import the same kinds of goods it exported.
In his model, many companies sell similar goods with slight variations. These companies get more efficient at producing their goods as they sell more, and so they grow. Consumers like variety, and pick and choose goods from among these producers in different countries, enabling countries to continue exchanging similar products. So some Americans buy Volkswagens and some Germans buy Fords.
He developed this work further to explain the effect of transportation costs on why people live where they live. His model explained under what conditions trade would lead people or companies to move to a particular region or to move away.
Mr. Krugman’s work has been praised for its simplicity and practicality — features economists are often criticized for ignoring.
Obviously, I think Krugman’s theories could be improved upon by incorporating the role of population density and its effects upon per capita consumption, but I’m pleased that the world of economics is beginning to consider that the principle of comparative advantage, proposed by Ricardo in the early 19th century – the theory upon which free trade is based – is overly simplistic and that there is much more at work.