Monday, December 6, 2010

The Darkest Age of Macroeconomics

. Monday, December 6, 2010

Modern Keynesians like Brad DeLong and Paul Krugman routinely excoriate those who forget the the wisdom of old economists, and rightly so. But Krugman seems to have forgotten the original lesson: the Smith-Ricardo insight that mercantilism does not increase the wealth of nations. It doesn't get more fundamental than that, as Krugman used to teach. I covered this once already here, and now Ryan Avent drives home the point:

What does economist Paul Krugman think of the [US/Korea FTA]? ... If you want to create jobs, go as mercantilist as possible. Maximise your exports; minimise your imports. ...

Hence, as Mr Krugman says, tariffs are good and free trade is bad.

But of course, tariffs aren't good and free trade isn't bad. Why? Well, if every country goes about using tariffs to maximise X and minimise M then no one gains (indeed, everyone loses).

Meanwhile, Mr Krugman does allow that:

There is a case for freer trade — it may make the world economy more efficient. But it does nothing to increase demand.

But a more efficient economy is one that can do more with less. Which is to say, it's one that produces more Y at full employment. Now, America isn't at full employment, and Mr Krugman argues that in a world of limited demand higher efficiency is a bad thing; it means that fewer people do the available work leaving more people jobless. But the actual economy is more dynamic than that. If expectations for long run growth improve, then businesses may increase I, which feeds into Y. And if tariffs shrink potential output, expectations may decline, curtailing investment and shrinking Y.

This is a fundamental theoretical mistake. That is not to say that the US/Korea FTA will have a huge impact on employment or output. As I noted in comments to my previous post, and as Avent claims in his, this is unlikely. If Krugman had said about the FTA that it was a good thing that was likely to have a minor effect on the US economy, I'd have no complaint. But to say that the effect on output and employment will be nil or negative (as Krugman alleges) or that mercantilism is preferable (as he also alleges) is just wrong. I really can't understand why he'd be arguing the point.

I suspect that he is mostly concerned about the distributional effects of increased trade, and is willing to make specious anti-trade arguments for that purpose. If that's the case I would only refer him to these excellent articles here and here, written by... Paul Krugman, in a more enlightened age. Now he favors placing countervailing duties on China. Now he says that a FTA with Korea will have a negative effect if it has any effect at all. He concluded the first article by noting this about "fuzzy-minded" individuals making similar anti-trade arguments:

I doubt that they are purely cynical. It is more likely that some kind of double-think, some convenient ability to stop thinking clearly when the situation demands it, is at work. But the truth is that I don't know--and I don't think it matters.

And the coup de grace in the latter:

In short, my correspondents are not entitled to their self-righteousness. They have not thought the matter through. And when the hopes of hundreds of millions are at stake, thinking things through is not just good intellectual practice. It is a moral duty.

I couldn't've said it better myself.

ADDENDUM: There's also a practical mistake. The U.S. is not at full employment, but global growth is still expected to be nearly 5% this year. There is demand in the world, even if there isn't in the U.S. So opening up to trade right now might have a stronger effect on employment than it otherwise would.


The Darkest Age of Macroeconomics




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