Monday, December 6, 2010

Krugman Error-of-the-Day

Apparently Krugman is one of those people who reserves macro for one part of his brain, and micro for the other, and the two parts do not converse. Here, he seems to forget all the trade theory he knows. A trade deal with South Korea turns out to be a bad thing. The potential increases in exports and imports turn out to be a wash, according to Krugman, and do not increase "demand," so there is no effect on GDP. Further, employment will actually go down, i.e. "demand" does not change, effectively productivity has gone up, so employment must decrease.

Sometimes a little knowledge of national income accounting can be a dangerous thing, apparently. The trade deal with South Korea may indeed have a small effect, but US GDP has to increase. This is just basic gains from trade, which Krugman of course is quite familiar with. As for employment, the effect will work in a manner similar to a productivity increase. There are income and substitution effects, and it could go either way. In any case, we are better off as a nation.

It was a great thing when macroeconomic thought was integrated with what everyone else in economics was doing - in international trade, public finance, industrial organization, and general equilibrium theory, for example. It's too bad that some people want to take us back to the Dark Ages.


  1. Krugman shows in his newest paper, which you appear to have read judging from the blog (scrolling just down a little), than an increase in productivity at zero interest rates reduces employment.

  2. he doesn't make a judgment on whether it is a positive thing or a negative thing, he simply explains that the trade deal is not a job creation deal and does not generate demand. you're "rebuttal" doesn't seem to disagree with his position. if this is true. how is it an error on his part?

  3. "US GDP has to increase"
    I thought gains from trade were measured in utility, not GDP.

  4. "but US GDP has to increase."

    This is not necessarily true. Standard theory says opening to trade increases welfare, but does not increase gdp.

    See Tim Kehoe's talk from last year's SED:

  5. First anonymous:

    This isn't new to Krugman's paper. It's a standard sticky price result.


    He says it's not going to help the recovery. I say it will, though not much.

    Last two: Yes, agreed, but that's quibbling. You get the point, right?

  6. I agree that it's quibbling, but I think it's important to distinguish between GDP and welfare.

    I also agree that the US most likely stands to gain from trade with Korea

  7. Krugman hasn't forgotten any of this. He's just making a bunch of partial equilibrium statements to keep the writing from getting very complicated and intricate. The post is for the general public in a newspaper, with pressure either explicit or implicit from that paper not to make the writing too intricate, dry, and clunky.

    He does note, "There is a case for freer trade — it may make the world economy more efficient."

  8. "I think it's important to distinguish between GDP and welfare."

    Yes, I agree. I like Kehoe's presentation. In the simple static cases it's essentially a measurement issue. Freer trade implies that the composition of quantities consumed changes, as does the composition of the quantities produced. As well, relative prices changes, and so when we compute the change in real GDP, it can go down, in spite of the fact that welfare increases. Then we get into more complications when we think about dynamics.

    Kehoe's key point, which relates to my discussion, is that you need a model to address the problem. Krugman's model is lame - it's national income accounting with some sticky prices thrown in. Among the things that Krugman neglects is the fact that freer trade should also have effects on consumption and investment expenditures - it's not all in exports and imports.

  9. If market didn't exist you would produce your own food, so unemployment would be zero. Briliant!!

  10. We have to say even that, if the export will increase, the commercial balance will become better, and that's good if we look at the USA debt...

  11. You seem to be in love with Krugman...

  12. This isn't about disliking the man. Frequently I don't like what he writes.

  13. Krugman is correct in that, most of the time imports rises faster then exports when national real income rises.

    However, this has more to do with savings and investment levels then anything else (the age-old current account = savings - investment identity).

    So long as our savings rate continues to rise, this will offset the rise in imports. It'll also lead to more domestic investment spending.

    Of course, the Administration has to make sure the savigns rate does, indeed, rise. . .which I'm not sure they are serious about doing.

  14. Basically, we need to:

    1. Shrink the deficit to reduce current-account pressure (and crowding out of private investment, which has happened).

    2. Raise domestic savings rate at least to 10%

    3. Be grateful China is appreciating its currency (both by changing nominal rates and tolerating higher levels of inflation).