Wall Street Journal
Krugman Helped Us Understand Trade
Everyone should learn about comparative advantage.
The Royal Swedish Academy of Sciences announced yesterday that the 2008 winner of the Nobel Prize in Economic Sciences is Paul Krugman. A professor at Princeton University, Mr. Krugman is known to the American public mainly for his column in the New York Times, which reflects his highly partisan political views -- he hates George Bush and Republicans in general -- more than his solid economic understanding. Nevertheless, he is an original theorist in international trade and economic geography. His excellent book, "Pop Internationalism" (1997), and his popular articles of the 1990s (many of them published online, in Slate), make a strong case for free trade.
In the late 1970s, Mr. Krugman noticed that the accepted model economists used to explain patterns of international trade did not fit the data. The Hecksher-Ohlin model predicted that trade would be based on such factors as the ratio of capital to labor, with "capital-rich" countries exporting capital-intensive goods and importing labor-intensive goods from "labor-rich" countries. Mr. Krugman noticed that most international trade takes place between countries with roughly the same ratio of capital to labor. The auto industry in capital-intensive Sweden, for example, exports cars to capital-intensive America, while Swedish consumers also import cars from America.
Mr. Krugman's explanation is based on economies of scale. Both Volvo and General Motors reduce average costs by producing a large output in particular niches of the market. In presenting his trade model, Mr. Krugman planted the seeds for his later work in economic geography, in which he tried to explain the location of economic activity.
He summarized his basic finding (in "Geography and Trade," 1992) as follows: "Because of economies of scale, producers have an incentive to concentrate production of each good or service in a limited number of locations. Because of the cost of transacting across distance, the preferred locations for each individual producer are those where demand is large or supply of inputs is particularly convenient -- which in general are the locations chosen by other producers. Thus [geographical] concentrations of industry, once established, tend to be self-sustaining."
In his popular writing, Paul Krugman is at his best when defending free trade. My favorite is example is his "Ricardo's Difficult Idea," published in the mid-1990s, in which he shares a frustration many of us economists have felt -- that the vast majority of noneconomist intellectuals don't understand David Ricardo's famous insight about free trade almost 200 years ago.
Ricardo grasped that people will specialize in producing the goods and services in which they have a comparative advantage. The result is that we never need to worry about low-wage countries competing us out of jobs; the most they can do is change those goods and services in which we have a comparative advantage. For example, though you can rake leaves faster than the teenager next door, it still makes sense to hire him because you have a comparative advantage in writing software programs. Mr. Krugman points out that most noneconomist intellectuals are unwilling to take even 10 minutes to understand this. But that doesn't stop them from writing about trade as if they're informed.
Another strong point Mr. Krugman made in his Ricardo article (and elsewhere): If labor's share of national income is relatively constant (as it has been for about the last 80 years), then increases in productivity must cause real wages to increase. (Wages, as he noted, also include benefits.)
That kind of common-sense clarity seems noticeably absent in his New York Times columns, in which he often attacks the motives of people who disagree with him and even calls them "liars." This deserving Nobel recipient could set a better example when it comes to academic -- indeed basic human -- courtesy.
Mr. Henderson is a research fellow with the Hoover Institution, an economics professor at the Naval Postgraduate School and editor of "The Concise Encyclopedia of Economics" (Liberty Fund, 2008). He and Paul Krugman served together on President Reagan's Council of Economic Advisers.