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How Was Krugman So Wrong On Trade?

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Reposted from the Campaign for America’s Future blogdave-johnson

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How Was Krugman So Wrong On Trade?

David Johnson  |  April 2, 2013  |  Campaign for America’s Future

Have our trade policies helped or hurt the country? You can look down at equations and models, or you can look up and see what is happening around you. Equations and models will tell you that “free trade” is a good thing. But if you look up and see what is happening around you … “not so much” is such an understatement. So a comparison of what economists predicted “free trade” would bring with what has actually happened might help us find a way out of the economic mess we are in.

William Greider in The Nation, Why Was Paul Krugman So Wrong?, knocks Paul Krugman’s past (1990s) support for “free” trade policies while working people and labor were warning of the catastrophe that has come to pass, and looks at why Krugman got it so wrong. Because of Krugman’s position near the top of the opinion-leader ladder, Greider writes, “his argument prevailed where it counts – among the political elites who influence government policy-making.”

A good many Americans did not believe [Krugman], mainly working people who saw their jobs and middle-class wages decimated by the processes of globalizing production. Krugman said they didn’t see the big picture. Educated professionals whose own livelihoods were not threatened by globalization were more likely to embrace Krugman’s perspective. While he never won the debate with the broad public, his argument prevailed where it counts – among the political elites who influence government policy-making. Both political parties, every president from Reagan to Obama, embraced the same free-trade strategy: support US multinational corporations in global competition, as their success is bound to lift the rest of the country.

Then Greider hits home, writing about how it has turned out, with “the nation is … mired in large and permanent trade deficits” and “continuing downward pressure on US employment and wages,”

Roughly speaking, the opposite occurred, not only for the working class but for the broad US economy. The multinationals did fine, but the nation is now mired in large and permanent trade deficits that translate into huge indebtedness … and that exerts continuing downward pressure on US employment and wages. Yet the Obama government is seeking still more free-trade agreements as the answer. The current fiscal debates in Congress do not even recognize that free trade globalization is a core source of America’s diminished prosperity.

The Dirty Hippies were mocked and banished from the discussion,

Like Krugman, governing elites dismissed critics and simply stated that free trade will be good for America because US energies and endless creativity are sure to prevail, as they always have in the past. Opponents like organized labor were typically ridiculed as backward Luddites, promoting what Krugman called “disguised protectionism.” That label scared off major media. Reporters take their cues from the “supposed authority” of business leaders and scholarly experts. At the most prestigious newspapers, reporters and editors simply ignored the substantive critiques … After thirty years, the case against free trade is still a taboo subject in respectable circles.

So why, Greider asks, was Krugman so wrong? One way was asserting that increases in productivity always lead to increases in wages. Greider explains, “His most egregious error was perhaps the assertion that wages always rise with an economy’s rising productivity.”

Certainly that had been the American experience for many years, but Krugman did not seem to grasp that globalization liberated American businesses from sustaining that relationship. If US labor costs became a burden, the multinational corporations and even smaller firms can now move the production to low-wage countries or merely threaten to do so. In my experience as a reporter, workers on the factory floor recognized this shift in power long before conventional economists figured it out.

Krugman, nevertheless, stuck with standard theory. “One last assertion that may bother some readers is that wages automatically rise with productivity,” he wrote. “Is this realistic? Yes. Economic history offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages.”

Actually, as Krugman was writing this, US industrial wages were already diverging from the old pattern…

Again, “workers on the factory floor recognized this shift in power long before conventional economists figured it out.” Because they were looking at the real world, and economists look at equations and models. (Bill Gates walks into a room full of really, poor people. The economist sees that the average wealth in the room is enormous.)

Another way Krugman and other free-traders were wrong was not seeing what was actually happening in China. Greider writes that Krugman was dismissing China’s ability to compete against out technological advantages. But Greider was on the ground in China, looking at what was actually happening,

As it happened, about the time Krugman was belittling China, I was there reporting for my book on the global economy. I toured massive factories and dismal sweatshops, interviewed workers, managers and well-placed economists. ….

When I was in Beijing, the city was abuzz with US corporate types from the best names in US manufacturing—General Motors, Boeing, IBM and many others. They were negotiating deals to make things in China and sell them to Chinese consumers. Multinationals from around the world were scrambling to gain access to what would someday become the largest consumer market in the world. The price of entry, demanded by the government, was that foreign companies would have to share their precious technology with domestic partners, the infant Chinese companies learning to make things that could compete with the best and brightest from America and Europe.

Greider concluded, “People are capable, everywhere in the world,” I decided. Americans who still believed in their inherent superiority were about to learn a little humility.”

If you want to understand what has happened to our economy, please read Greider’s entire article!!! But do not miss these paragraphs:

The American problem is not trade theory but self-delusion—an overweening confidence that the US as world leader would prevail because it always had. …

The problem was, the rest of the world declined to cooperate. If they could, developing nations pursued their own nationalistic strategies not so different from how the US did industrial development in the 19th century. And these newcomers succeeded spectacularly … Authorities like Krugman whose expectations were so wrong now tell Americans have no other alternative except the ugly protectionism which would be ruinous for all.

That assertion is mistaken too. The most compelling evidence of American self-delusion is not in Asia but in Europe. The best evidence that a nation can both manage its industrial system strategically while participating fully and fairly in global trade is Germany. …

Trade realities and economists… From my post a year ago,Manufacturing on Planet Economus,

The countries that are successful in today’s economy have national industrial/economic policies. We do not. They work to capture parts or all of key strategic industries, and line up the infrastructure, finance, education, supply chains, power grid, tax policies and everything else needed to compete in the world economy. We do not.

We send our companies out against these national systems, and even our largest companies cannot compete with national systems. So we lose.

Are China, Germany and so many other countries just wrong, putting so much into these efforts to capture parts or all of strategic industries? Or are they being smart? Look at who has a trade surplus and who has a trade deficit, and see if you can guess the answer.

And especially,

4) Planet Economus is a place far from Earth. On planet Economus they apparently have free markets, and free trade. But on Earth free markets and free trade never existed anywhere at any time, and never worked when they were tried. So on Earth we have to have policies that reflect what happens on Earth, not on planet Economus.

Planet Economus is a place far from Earth.

On Earth free markets and free trade never existed anywhere at any time, and never worked when they were tried.

3 Responses to “How Was Krugman So Wrong On Trade?”

  1. Lincoln's Economics says:

    If these quotes are any reflection of Greider’s logic, I contend he is wrong. It IS precisely flawed economic theory that got us in this mess. Free trade theory suggests that a nation even as an inferior competitor can still gain from free trade. See rescuingeconomics.wordpress.com for a new model to make sense of Lincoln’s protectionism. There has never been a sound theory of economics. This is the problem, not American arrogance. This lesson was learned very early on under the Articles of Confederation. Daniel Webster said the main reason we have our Constitution is to stop free trade. The Chinese understand our founding father’s economics better than we do.

  2. Will Wilkin says:

    Greider is mostly correct here, wages and employment have dropped for the vast majority of Americans as globalized corporations bought the political system and the so-called “free trade” policies they’ve used to offshore America’s productive economy. The 1% have grown fabulously rich by dismantling our country’s future, offshoring production and research and development.

    Krugman and the rest of the economists were so wrong in not understanding that Ricardo’s “comparative advantage”, which is the theoretical basis for “free trade” being beneficial to both countries in a trade, is based on the assumption that capital will stay in its home country, seeking its best return (and therefore most efficient use) in the home country. Once capital and technology became internationally mobile, comparative advantage disappeared and the corporations now seek absolute advantage. Their profits and executive compensation baloon as they put America out of work and dismantle our country’s industrial ecosystem, dooming us to deeper decline over the long run, unless we reverse the offshoring and reindustrialize America.

    How to do it? A BALANCED TRADE POLICY. Import Certificates issued in the same dollar denominations as export values would balance our trade, redirecting $600Billion every year from import purchases to stimulus of American industry. This would directly create millions of mfg jobs and indirectly create many millions more multiplier-effect jobs. It would solve the fiscal crises of the feds and states and municipalities by growing our GDP and tax base and decreasing the need for social safety net spending. It would make public investment possible, and our country badly needs a new infrastructure if we are to become truly globally competitive again.

  3. Will Wilkin says:

    More on “How Krugman was so Wrong,” from Paul Craig Roberts’ new book, “The Failure of Laissez Faire Capitalism and Economic Dissolution of the West”.

    EXCERPTS:

    For developed economies, offshoring is a reversal of the development process. As offshoring progresses, the domestic economy becomes less developed, and there is less demand for university education. Economists cannot speak the obvious truth, because they confuse jobs offshoring with free trade, when in fact offshoring is a process of deindustrialization…

    …the latest work in trade theory, Global Trade and Conflicting National Interests (MIT Press, 2000), by Ralph E. Gomory and William J. Baumol, shows that the case for free trade was incorrect from the beginning….show that free-trade theory has many problems because “the modern free-trade world is so different from the original historical setting of the free-trade models.”

    Gomory and Baumol dismiss the alleged gains from offshoring production for home markets: “in almost all cases, most of the economic benefit stays where the value is added. Profits are usually only a small portion of the value added through economic activity, and most of the value added, such as wages, remains local. It matters to a country to be the site of an economic activity, whoever may own the company.”

    Gomory and Baumol show that unlike Ricardo’s win-win outcome based on a simple arithmetical example, sophisticated mathematics proves that in most cases “the outcome [from trade] that is best for one country tends not to be good for another.” Gomory and Baumol re-establish the gains from trade (win-win situation) as a special case of limited applicability. They conclude that “free trade between nations is not always and automatically beneficial. It can yield many stable equilibria in which a country is worse off than it would be if it isolated itself from trade altogether.”

    ….The reformulation of trade theory achieved by Ralph Gomory and William Baumol was published by MIT Press six years prior to Porter’s report [from the Council on Competitiveness titled “Competitiveness Index: Where America Stands,” asserting that Americans were benefitting from globalism], but there is no mention of this seminal work in Porter’s report. Just as Porter’s report ignored the empirical evidence, it ignored the reformulation of trade theory.

    Why are economists content with free trade policy that rests in fantastic error?   Perhaps the answer is that the corruption of the outside world has found its way into universities. Today, universities look upon “name” professors as rainmakers who bring in funds from well-heeled interest groups. Increasingly, research and reports serve the interests that finance them and not the truth. Money rules, and professors who bring money to universities find it increasingly difficult to avoid serving the agendas of donors. The same is true of think-tanks…..

    ….Economists have made themselves irrelevant.   If you have any doubts, have a look at the 2010 summer issue of the magazine, International Economy, a publication endorsed by former Federal Reserve chairmen Paul Volcker and Alan Greenspan, by Jean-Claude Trichet, former president of the European Central Bank, by former Secretary of State George Shultz, and by the New York Times and Washington Post. The main feature is “The Great Stimulus Debate,” which addresses the question: Is the Obama fiscal stimulus helping the economy or hindering it?   Princeton economics professor and New York Times columnist Paul Krugman and Moody’s Analytics chief economist Mark Zandi represent the Keynesian view that government deficit spending is needed to lift the economy out of recession. Zandi declares that thanks to the fiscal stimulus, “The economy has made enormous progress since early 2009,” a mistaken opinion shared by the President Obama’s Council of Economic Advisors and the Congressional Budget Office.

    The opposite view, associated with Harvard economics professor Robert Barro and with European economists, such as Francesco Giavazzi and Marco Pagano and the European Central Bank, is that government budget surpluses achieved by cutting government spending spur the economy by reducing the ratio of debt to Gross Domestic Product. This is the “let them eat cake school of economics.”

    If one overlooks the real world and the need of life for sustenance, one can become engrossed in this debate. However, the minute one looks out the window upon the world, one realizes that cutting Social Security, Medicare, Medicaid, food stamps, and housing subsidies is a certain path to death by starvation, curable diseases, and exposure when 15 million or more Americans have lost jobs, medical coverage, and homes….

    …The Krugman Keynesian school is just as deluded.   Neither side in “The Great Stimulus Debate” has a clue that the problem for the U.S. is that a large chunk of U.S. GDP and the jobs, incomes, and careers associated with it, have been moved offshore and given to Chinese, Indians, and others with low wage rates. Corporate profits have soared, while job prospects for the middle class have been eliminated.

    The offshoring of American jobs resulted from (1) Wall Street pressures on corporations for “higher shareholder earnings,” that is, for more profits, and from (2) no-think economists, such as the ones engaged in the debate over fiscal stimulus, who mistakenly associate globalism with free trade instead of with its antithesis–the pursuit of lowest factor cost abroad or absolute advantage.   As economists assume, incorrectly, that free trade is always mutually beneficial, economists have failed to examine the devastatingly harmful effects of offshoring. The more intelligent among them who point it out are dismissed as “protectionists.”

    The reason fiscal stimulus cannot rescue the U.S. economy has nothing to do with the difference between Barro and Krugman. It has to do with the fact that a large percentage of high-productivity, high-value-added jobs and the middle class incomes and careers associated with them have been given to foreigners. What used to be U.S. GDP is now Chinese, Indian, and other country GDP. When the jobs have been shipped overseas, fiscal stimulus cannot put unemployed workers back to work.

    END EXCERPTS

    Citation: Roberts, Paul Craig (2013-02-02). “The Failure of Laissez Faire Capitalism and Economic Dissolution of the West”. Atwell Publishing. Kindle Edition.

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