Economics

Not as Bad as You Thought

Why Paul Krugman deserved the Nobel Prize.

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Paul Krugman received a Nobel Prize for his contributions to international trade theory. Even for those of us who disagree with his political views and see little value in his recent work as a columnist, this award brings neither surprise nor disappointment.

In 1991, Krugman received the John Bates Clark medal, awarded every other year to the most productive American economist under the age of forty. In the view of many in the economics profession, the Clark medal has been more consistently awarded to deserving winners than the Nobel. Any way you look at it, Krugman is a giant in the field. As Tyler Cowen points out, the really significant honor for Krugman's Nobel is that he did not have to share it. Unshared Nobel Prizes in economics are on a somewhat loftier plane than shared honors.

International trade theory, when Krugman and I first studied it, was dominated by the theory of factor endowments. If your nation could mobilize a lot of savings relative to its labor supply, the theory went, then you would export capital-intensive goods and import labor-intensive goods. The prevailing assumption in trade and location theory at that time was diminishing returns, which said that increments to productivity are the greatest when you start from low levels of output in a product.

But no one bothered to look at one of the theory's biggest implications, which was that very little trade should take place within an industry. We should not be exporting some steel products while importing others, in other words. Nor should we be exporting some high-tech manufactures while importing others.

Similarly, no one bothered to look at one of the major implications of diminishing returns, which is that when an industry starts to get big in one city, the next increment of capacity should be built in a different city, where diminishing returns would be less of a drag on production.

Paul Krugman, however, bothered to look. And what he found was that the facts contradicted the theory. Intra-industry trade, it turned out, is more widespread than trade that can be explained by factor endowments. Moreover, industries tend to agglomerate rather than to disperse. Examples of agglomeration include Detroit automobiles, Hollywood movies, Silicon Valley computer startups, and New York fashion.

Krugman attacked these problems by dropping the assumption of diminishing returns. As he points out, he faced a major mathematical hurdle, since the mathematics of diminishing returns had been elegantly worked out, particularly by Paul Samuelson, the first American to win the Nobel in economics. Calculating the mathematics of increasing returns was new and challenging.

With increasing returns, agglomeration emerges as a natural phenomenon, with historical accidents and path dependence playing a key role. Intra-industry trade also makes sense. One country may happen to build an industry of personal computers, while another country may become the leader in television sets. Again, historical accidents and path dependence play a role.

Apart from the math, the theory of increasing returns seems logical and obvious in hindsight. The economic advantages of agglomeration make intuitive sense. But it is important to recognize that Krugman's highly original contribution was needed to open the minds of the rest of the economics profession to the real-world significance of increasing returns.

David Warsh, in Knowledge and the Wealth of Nations, provided a highly accessible account of the development and significance of the theory of increasing returns. Warsh focused on how Krugman used the theory to explain trade as well as on how Paul Romer used it to explain economic growth.

Krugman's own writing is also highly accessible. Development, Geography, and Economic Theory
is probably the book to look for if you want to read Krugman's own explanation of his most important work.

Krugman's subsequent scholarly work is less clearly of durable value. He has described Japan's crisis of the 1990's as a liquidity trap, meaning that interest rates were so low that monetary expansion was no longer effective. Others have argued that Japan's stagnation was due to poor capital allocation, resulting from a reluctance to close failed banks, which in turn were unwilling to shut off credit to inefficient firms. I find the latter argument more persuasive.

More recently, Krugman has focused on inequality of income and wealth as a phenomenon of political economy. I believe that other factors are more important.

Paul Krugman is motivated by real-world problems and he's an effective communicator with lay audiences, something that cannot always be said of most economists. His Nobel Prize reflects a breakthrough in the way we think about how trade and the location of economic activity are determined in the real world.

Arnold Kling is the author of Crisis of Abundance. He blogs at Econlog.

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  1. but can he explain Beverly Hills Chihuahua?

  2. Giving “economist Krugman” his due, he was one of the few to correctly predict the end of the Japanese expansion at a time when the conventional wisdom was, shall we say, irrationally exuberant, even if his reasoning probably missed a larger factor.

    “Increasing returns” has a lot of implications for the mid-term future. It tends to support a Kurzweilian view for the West, and a less effective expansion in Asia than we see now. I think too much emphasis is being put on percentage growth in quickly-developing markets, considering the real-dollar growth still trails developed countries.

  3. http://krugman.blogs.nytimes.com/2008/01/29/an-iraq-recession/

    Paul Krugman was right about the Iraq War — more so than the balance of opinion at the [i]Hit N Run[/i] blog. This is another reason that you should take him more seriously than you do. He sees fundamental truths before many of you are able to.

  4. NO WAY? They gave the Nobel Prize to George Clooney? I guess it was inevitable after Gore.

  5. Warren, now you know what George will be doing as a sequal to Michael Clayton.

  6. Paul Krugman was right about the Iraq War — more so than the balance of opinion at the [i]Hit N Run[/i] blog.

    So what? Many people were right about the Iraq war. What does the Iraq war have to do with acumen in regard to economics? The two have nothing to do with eachother. Well, as much as looking to someone who plays guitar kind of well as a luminary on Africa’s problems…

  7. But, was he right about tower number seven, Dave? Huh, was he?

    Does he believe a jet fuel fire can melt steel?

    That’s what really perceptive people want to know.

  8. [i]Many people were right about the Iraq war.[/i]

    Yes, and those people are generally a lot smarter than the people who were wrong about it. If a first someone who supported the Iraq War is inclined to criticize a second someone who was against it (back when it started, I mean), then said first someone needs to drink the shut-em-up juice. If a first someone who mildly opposed the Iraq War is inclined to criticize a second someone who was strongly against it (back when it started, I mean), then, again, said first someone needs to drink the shut-em-up juice.

    This is the kind of thread where I would hope that a lot of shut-em-up juice would be consumed. It tastes horrible, but it is good for you. Congrats Dr. (is he a doctor?) Krugman!

  9. Can we maybe focus on the fact that an outright socialist who advocates depression era public policy all the time just won the Nobel Prize? I don’t care what he thinks about the Iraq war, I do care that he advocates compulsory programs in a broad scale to “sustain a decent society”. Can’t we all agree that we are looking right now at the result of government attempts to control the ‘decency’ of our society through economic policy and then wonder how this guy win’s regardless of his international trade theory?

  10. I find it amusing that prominent academic economists*, no matter their political leanings, all say that Krugman deserved it. The only people who disagree are idiot blog commenters and conservative bloggers that know little to nothing about econ except that they hate Krugman.

    * You know, the guys that know a thing or two about the field.

  11. Yes, and those people are generally a lot smarter than the people who were wrong about it.

    No, it just means they were right about the Iraq war. I wouldn’t be looking to someone’s position on the Iraq war as a litmus test for their overall intelligence or ability within another unrelated field. But I have a feeling that’s not what this discussion is about. Only a feeling.

  12. In the article http://krugman.blogs.nytimes.com/2008/01/29/an-iraq-recession/

    He was saying how the Iraq war was GOOD!!!!!
    The fact is that war is, in general, expansionary for the economy, at least in the short run. World War II, remember, ended the Great Depression.

    God bless those keynesians. We can build pyramids and kill people into prosperity.

  13. shut-em-up juice

    with or without HFCS?

  14. First, how many Canadians, would Canadians in the room please raise your hands.

  15. Well, as much as looking to someone who plays guitar kind of well as a luminary on Africa’s problems.

    So what you’re saying is that we need Joe Satriani to save Africa?

  16. So what you’re saying is that we need Joe Satriani to save Africa?

    I was thinking more like Pete Seeger. Oh wait, I said “played guitar well”, didn’t I? Never mind.

  17. Paul Krugman was right about the Iraq War

    His 2003 statements probably looked prescient in 2006, but I doubt his pronouncements in 2006 look very intelligent today.

  18. What I want to know, is what is Krugman’s view on front-wheel-drive vs. rear-wheel-drive?

    If he’s right on Iraq, he’s bound to have a hefty opinion on drivetrain technology.

  19. I may not know much about economics, but I know what I like.

  20. Wow. I guess all of you Reason guys really do only care about impressing popular liberals.

    Nobel prizes are given to statists by a statist central bank in Sweden. Hayek had to share his with a communist. So, that considered, you guys are right to say Krugman deserves the prize.

    But how the socialist fool Krugman can get more flattering coverage in Reason than Ron Paul is beyond me.

  21. Chip, I give props to reason for covering a fairly wide range of opinion- even though the core opinion is ‘free markets/free minds’. I don’t mind they occasionally print a contrarian article. What fun would the discussions be if everyone just nodded their heads and said “ditto”.

  22. Arnold Kling is everywhere!

  23. Paul, it is good for any publication to have a wide range of opinion present. I actually liked it when Reason posted a blog about a libertarian argument for central banks. I do think giving Krugman a congratulation is far and away from appropriate use of space in a free-market publication. I can’t tell you why I should have read this article or the New York Times this afternoon. For a libertarian reading a libertarian publication, this is troubling.

    Is the ultimate result of representing “both sides of the story Reason becoming, what, Newsweek or Time Magazine junior?

    Krugman gets enough positive press from all of the socialists in the media. Can we libertarians perhaps, oh I dunno, focus primarily on recognizing accomplished capitalists? Or at least focus on the arguments of the socialist award-winner rather than just sucking up to him with a congratulaions?

    Reason sponsors “intelligent” and “award-winning” socialism now, I guess.

  24. Favorite Krugman Moment:

    Krugman: –and I wanted to ask, actually two questions, to the audience. First, how many Canadians, would Canadians in the room please raise your hands. [One person applauds, laughter]

    Donvan: We have about seven hands going up-

    Krugman: OK, not as many as I thought. OK, of those of you who are not on the panel who are Canadians, how many of you think you have a terrible health care system. [pause] One, two–

    Donvan: We see-almost all of the same hands going up. [laughter]

    Krugman: Bad move on my part.

  25. When Prof K writes about economics he can be great. I wish he woudn’t write the other stuff. But his 2002 pieces on accounting fraud are good reading today as are his pieces on SSN privitization. It’s hard to see how the person who wrote those would also advocate history’s greatest pump and dump, but nobody is 100%.

  26. For a libertarian reading a libertarian publication, this is troubling.

    Dammit, it’s too early to be drinking on the West Coast.

  27. Reason sponsors “intelligent” and “award-winning” socialism now

    Linus Pauling was batshit insane and Chomsky’s politics blow. Chip The Wonder Boy wants to conflate accomplishments in a field with the man’s other activities.

  28. What if Osama bin Laden had done some groundbreaking physics research back in the 70s? Should he be eligible for the Nobel Prize?

  29. Libertarians praising Paul Krugman is like Jerry falwell (RIP) praising Richard Dawkins. Market fundies quiver with righteous rage!

  30. I guess I have a hard time taking this guy seriously because he looks like my 8 year old cousin with a beard glued on.

  31. Well, socialist Scandinavia plus a panel of chosen socialists deliver prices to…socialists. I guess the few non-socialists who get the Nobel really deserve it. The others…?

  32. Marcel,

    Sinners…er…I mean, socialists don’t know the Lord…er…I mean The Market.

    You’re too fucking stupid to understand what socialism is, asshole.

  33. I still need to know what Krugman thinks about tower number seven.

    Because if he believes that a jetfuel fire can melt steel then what kind of economist is he, anyway?

  34. Why are so many economists bearded?

  35. What if Osama bin Laden had done some groundbreaking physics research back in the 70s? Should he be eligible for the Nobel Prize?

    Yes. I’d say the same if Timothy McVeigh cured cancer.

  36. I find it significant that what Krugman won the Nobel for is not touched upon in most of his columns.

    And most libertarians actually agree with his views on international trade (indeed, he was extensively quoted in an article on voter biases reprinted on this site).

    And, Dave W., I strongly opposed the Iraq War from the start and support free trade. That doesn’t make me a socialist in everything else, like Krugman.

  37. laughed out loud at john c. jackson @ 7:07

  38. Mo. True, a lot of conservative and libertarian economists are praising Krugman, but how do you know that this isn’t some massive display of signaling?

    No one likes to be seen as a partisan hack when it comes to “serious academic matters.” Anybody who opposes Krugman’s selection is immediately deemed as an ignorant, intolerant, droll by the arbiters of class and taste. It makes much more sense to demonstrate what an “open-minded” conservative you are by lavishing praise on the economist you secretly can’t stand.

  39. No, “The Angry Optimist”, I am not conflating his accomplishments with his other views by criticizing his being awarded a Nobel prize in economics for his shitty New York Times op-eds about (gasp) economics.

    Do you call everyone who has a problem with Keynesian democratic party operative douche bags a “Boy wonder”?

    Paul Krugman is as anti-liberty as it gets. An award from a Swedish central bank doesn’t make him any better.

  40. His column is not what the award was for. How many times does this need to be said?

    No, I call people who obviously have no clue what they’re talking about “boy wonder”, among other condescending nicknames, like “hero” or “ace” or “doodles”.

    All you’ve done is yell “socialism” “statism” and “central bank”. No evidence. No argument. You thought you could show up and invoke the Magic Words for the Dogmatic Libertarians and we’d all laud you.

    Wrong champ. you’re just dumb, is all.

  41. Krugman got a prize from a committee of bankers. Maybe it’s just me, but I’m not looking to bankers as examples of good judgement lately.

    -jcr

  42. And, Dave W., I strongly opposed the Iraq War from the start and support free trade. That doesn’t make me a socialist in everything else, like Krugman.

    True. The difference between you and Krugman is that he did those thing PLUS won a Nobel Prize.

    Even if you ultimately disagree with him, he is the kind of man who should get your knees to stop jerking long enuf to seriously consider that he might be right about some stuf that you have been wrong about.

    Be like the reflective “Sanch.” Don’t be like the smug KMW.

  43. Dave and other nobrainers were about as wrong on Iraq as Bush was, just in the opposite direction.

    Bush: a cakewalk invasion, uncovering tons of WMDS, a joyous liberation, and no occupation necessary.

    Dave: bogged-down invasion, (endless urban warfare), war with Syria, escalation into genocide, a mullah take-over of Saudi Arabia, Pakistan, Jordan, etc. , nuclear weapons being used on and by Israel, oil being completely shutoff, Haliburton & Blackwate becoming nation states.

    Neither Dave nor Bush deserve being acknowledged.

  44. I didn’t make any of those predictions. I just thought: (i) there were no WMDs; (ii) there were no hidden genocides; (iii) the war was an unjust war absent (i) and/or (ii); and (iv) unjust wars are evil.

    I still think all four of these things continuously about The Iraq War since before it started.

  45. A detail : there is no Nobel Prize in Economic Sciences. There is “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel” (from the central bank of sweden)
    Big difference. Not the same people or independance as in the “normal” Nobel Prizes…

  46. No, the prize isn’t awarded by “the state” or the central bank, but by…

    The Royal Swedish Academy of Sciences or Kungliga Vetenskapsakademien is one of the Royal Academies of Sweden. The Academy is an independent, non-governmental scientific organization which acts to promote the sciences, primarily the natural sciences and mathematics.

    http://en.wikipedia.org/wiki/Royal_Swedish_Academy_of_Sciences

  47. I am always amused for awards in what amounts to sociology (thats meant to be derogatory and sarcastic). We are going through a great financial upheaval because guys much, much smarter than me wrote equations justifying giving loans to people who could not pay they back…because the data did not account for defaults decreasing because you were making so many loans.
    Krugman wins a Nobel because he looked at real data and says it didn’t fit the theory. Only problem is – his won’t either in a few years. Hollywood the center of filmmaking 10 years from now? Why, with digital cameras, much, much cheaper distribution, and so on. Equations can not capture the complexity of human behavior or economic activity.

  48. Thanks Bjornnak !

    So from wikipedia here is the “critical” part of this Prize, the part that bother quite a lot of people :

    Some critics argue that the prestige of the Prize in Economics derives in part from its association with the Nobel Prizes, an association that has often been a source of controversy. Among the most vocal critics of the Prize in Economics is the Swedish human rights lawyer Peter Nobel, a great-grandnephew of Alfred Nobel.[25] Swedish economist Gunnar Myrdal and former Swedish minister of finance Kjell-Olof Feldt have also advocated that the Prize in Economics should be abolished.[26] Myrdal’s objections were based on his view that the 1976 Prize in Economics to Milton Friedman and the 1974 Prize in Economics shared by Friedrich Hayek (both classical liberal economists) were undeserved, on the argument that Economics did not qualify as a science. If he had been asked about the establishment of the Prize before receiving it, Hayek stated that he would “have decidedly advised against it.”[26][27]

    Some critics claim the selection of recipients for the Prize in Economics is biased toward mainstream economics.[28][29] The Department of Economics at the University of Chicago has garnered nine of these Prizes-more than any other university-leading some critics to opine that such an outcome demonstrates either a bias, or the appearance of one, against candidates with alternative views.[29]

    Milton Friedman was awarded the 1976 prize for his work on monetarism. The prize to Friedman caused international protests,[30] primarily in relation to a six-day trip he took to Chile in March 1975 where he gave lectures on inflation and met with many Chilean government officials, including the dictator Augusto Pinochet.[31] Four Nobel Prize laureates – George Wald, Linus Pauling, David Baltimore and Salvador Luria – wrote letters to the New York Times protesting the award in October 1976.[32][33]

    The 1994 prize to John Forbes Nash caused controversy within the prize’s selection committee because of his history of mental illness and alleged anti-semitism.[34] The controversy resulted in a change to the rules governing the committee in 1994. Previously, members of the Economics Prize Committee members had no limit to their term of service; they now serve for three years.[22]

    Nassim Taleb has also criticised the Prize for promoting economic theories based on a misunderstanding of risk. He points to the 1990 Prize in Economics, awarded to William Sharpe and Harry Markowitz for theories that, Taleb says, had already been undermined by the stock market crash of 1987; the 1997 Prize, awarded to Robert C. Merton and Myron Scholes for their option pricing formula; and the 2003 Prize, awarded to Robert F. Engle for his “ARCH” method of prediction of volatility, which Taleb says underperforms relative to volatility forecasts made by ordinary traders.[35]

  49. I can’t dispute the importance of Krugman’s economic work. However, I can’t escape the thought that the prize was in fact awarded for anti-Bushism: another chance for the committee to stick a finger in Bush’s eye.

  50. A select few of the many commenters here have hit the nail on the head in my opinion: You may be able to justify some of krugman’s opinions with libertarian logic, but why? When every other mag in the world is busy praising him for being a good socialist and solving the world’s problems, why join in?

    Krugman isn’t even worth paying attention to enough for me to find an idea I agree with him on. He’s just another economist who has such a gigantic ego that he thinks people are statistics for him to play with by adjusting numbers around. Economics is only useful as a means of understanding events that happen in the free-market, it is not a means for some bureacrat to tweak the variables of the world as if we’re all a part of someone’s big math equation.

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