Saturday, February 14, 2009

Krugman's Defense Of Short-Term Protectionism

Many critics of Paul Krugman, including me, have argued that while Krugman may be good on trade, he is horrible on macroeconomics. Now it seems that he is letting his horrible macroeconomics infect even his analysis of trade. In this post, Krugman argues that under "normal circumstances" the standard comparative advantage argument for free trade is the end of the story. But these are not normal circumstances, Krugman argues, and under these circumstances a case exists for short-term protectionism. His argument essentially goes like this:

1) Because other countries will benefit from one country's stimulus package, while not sharing any of the costs in the form of a higher debt, positive externalities for fiscal policy exists, which means that fiscal stimulus will be smaller than it should be.

2) By adopting protectionism, these externalities will be reduced, and so will encourage more stimulus which will boost output everywhere.

This argument has 3 key flaws. First of all, it presumes that the effects of the stimulus really are positive, which is possible in some well designed versions, but is hardly universally true. Secondly, the argument really isn't about the protection per se, but about its indirect effect on the behavior on politicians. The direct effect of protectionism remains negative. And thirdly, it assumes that other countries will "turn the other cheek" and not retaliate. That is a very unrealistic assumption, and a global trade war would have very disrupting effects on global economies. Not just because of loss of comparative advantage effects, but in the short-term (and it is the short-term that the fiscal action is supposed to be beneficial for) also because of adjustment costs as factors of production in many cases can't instantly move from industries focused on exports to industries that sell to buyers that can no longer buy imported goods.


Blogger happyjuggler0 said...

It is even worse than you state. Imagine that the US government chooses to listen to Krugman.

Aside from predictable revenge protectionism as you state, there is the very understandable reaction from governments all around the world who say something like this: Well, Krugman did win the Nobel Prize in economics, so we should do as he says and engage in protectionism.

In other words, if economically ignorant politicians (close to being 100% redundant) wouldn't have retaliated because of advice from free trade minded economists who would loudly chide them for being self destructive, they now have the perfect excuse (Nobel winner) for obtuse protectionism.

In other words, Krugman takes a likely bad response and turns it into a virtually guaranteed bad response. Everything else is as you state in my opinion.

Recessions happen because investment was misplaced, and hence there is less supply to trade than there otherwise would have been. Which is another way of saying producers have less demand for trading than they used to, which means there is less demand for other suppliers than there used to be, and they have to reduce supply to compensate. Hence a recession.

Krugman is simply calling for all kinds of specialist investments to become redundant, with accompanying massive unemployment and investor losses, with no credible way for buildings, equipment, and labor used to making product A to easily switch to making product B, all through the entire "alphabet" of industries.

It is precisely because of the above mentioned specialization that trade is good to begin with, because with specialization comes productivity, and with productivity comes higher incomes. It is simply mind boggling that Krugman wants to derail that. Perhaps readers should be protected from Krugman's labor, with no one but Krugman being allowed to read his writings! That would be protectionism I can believe in.

5:05 AM  
Blogger Michael said...

I am sure you have thoroughly grasped all the things that the Nobel Prize winner carelessly overlooked.

5:59 PM  
Blogger stefankarlsson said...

Michael, I sense a certain degree of sarcasm in that comment. Are you suggesting that because he was awarded for some of his theories, we should mindlessly accept everything he says just because he said it?

6:08 PM  
Blogger said...

Although I don't share your general contempt for Krugman, I do feel that the case for short term protectionism would be damaging to the US. It's forcing companies in distress to choose suboptimal trade partners, which in turn will lead to suboptimal products. And the effect on the US economy will be disastrous because of the retaliation. Unless of course you can enact on protectionism and sell it as free trade to the rest of the world. But I'm preaching to the converted here...

9:14 PM  
Anonymous Anonymous said...

"Perhaps readers should be protected from Krugman's labor, with no one but Krugman being allowed to read his writings! That would be protectionism I can believe in."


1:18 AM  
Anonymous hajjen said...

Michael would probably eat dog shit if some authoritative person told him to. Thinking for himself obviously isn't his cup of tea.

11:46 AM  
Blogger Tomas said...

Michael: Of course, other people who have been awarded with the same prize would argue basically what Stefan argues.

So where does that leave us?

2:55 PM  

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