An argument could be made that the Nobel Prize committee tried to influence the US election by giving the award to Krugman. Krugman deserves the prize but the timing looks suspicious. The Nobel Prize committee could have waited a year and given the prize to Krugman. There are plenty of great economists to choose from. Krugman is a prolific writer and is very well known to the readers of the New York Times where he writes a regular column. He generally hates Republicans and his unrelenting anti-Bush drumbeat delights my friends on the left and enrages my friends on the right. I am sure many of my European friends would love his columns.
The prize was given to Krugman for his contributions to International Trade theory, which is my own academic field.
The classic economists Adam Smith and David Ricardo were strong advocates of the freedom to trade freely and the advantages to be gained from trade. They went against the established order of their time which was trade regulated to the benefit of the merchants and to the detriment of consumers. David Ricardo’s theory of Comparative Advantage is not easy to understand as many economics students will testify. But it is the foundation of why we engage in trade. Most non-economists who write about trade do not know this theory. It goes against common sense.
In the early part of the 20th century two Swedish economists, Heckscher and Ohlin, developed a trade theory which for a long time dominated thinking about trade. They explained why a country would export certain goods and import others by differences in relative resource endowments which we observe between countries. The United States has more capital compared to labor than a country such as India. A producer of apparel products uses lots of labor and few machines. Since in India labor is cheap as compared to machines, India has an advantage in producing apparel products. In the US, labor relative to machines is much more expensive. This is why the United States has a disadvantage in producing apparel and an advantage in producing goods such as heavy machinery for building roads or in producing frozen chicken, produced in 5 weeks in automated houses for 150,000 birds run by one man. So if there is free trade between India and the US, we should see the US exporting heavy equipment and frozen chicken and importing apparel products.
In the Ricardian and the Heckscher Ohlin model, trade is the difference between countries. The former gives most weight to differences in productivity while the latter emphasizes differences in what we call factor endowments. The model has the additional advantage of leading to an elegant solution to the very important question of how income distribution is likely to change with trade. Two famous economists, Stolper and Samuelson, pioneered this field. Their conclusion from the economic model is that highly skilled workers and the owners of capital would gain from free trade while workers who perform routine tasks would lose. We should not be surprised to find opposition to free trade from assembly line workers.
The problem is most trade today is between similar countries. There are no big differences in productivity and no big differences in their relative endowments with resources. Here is where Krugman comes in. He developed an economic model explaining why countries would export and simultaneously import the same kinds of goods. Germans make great cars. They export cars to France but they also import cars from France, US and Italy. I see more and more US-made SUV’s on German roads. We economists call this intra-industry trade. Krugman’s model builds on the theory of competition between large firms which produce a large variety and large quantity of goods at low prices. Consumers want product variety and they can have this variety at low prices. This is at the core of Krugman’s model. It explains much of present day trade and has major trade policy implications.
Economic theory at its best is very simple but shows the complex relationships between economic variables. Krugman’s theory meets this test. A final thought on Krugman. He is a strong supporter of free trade but has not spoken out against the anti free trade sentiment of the Democrats. Bush and McCain are very much in favor of free trade and it is obvious that Krugman does not want to undermine the Democrats. In doing so Krugman loses much of his credibility as an economist. I hope that Krugman will tell his friends they are wrong about trade. That would be the old scholarly Krugman.
Hartmut Fischer is a professor of economics at the University of San Francisco.