Do I Agree with Paul Krugman on Trade?

Not that it would be so terrible, given that Paul Krugman is clearly a fairly brilliant economist.  But over the past few years, as he has become more and more of a shrill political voice, and less and less of a measured economic voice, I’ve found myself disagreeing with him more often than not.

First, hat’s off to Google for sharing their visiting scholar program online.  I found this video, from December 14th, on Youtube this week.  It’s a great talk, from Paul Krugman, about the causal elements behind the current housing liquidity crunch.  (It’s over 1 hour, including Q&A.  And yes, I listened to the whole thing.)

But that’s about housing, not trade.  However, hearing Krugman speak live (vs. his normal Op-Ed tirades), reminded me of how intelligent and thoughtful he can be.

Interestingly, in the same week, I caught this piece from his NY Time blog (Dec 28, 2007).   It’s about the current references to his original work on global trade, which is where I remember first seeing references to Krugman’s work.  He references this blog post, which discusses some of Krugman’s original positions on trade in some detail.

Of course, Krugman wrote a full Op-Ed on trade in the December 28 edition of the New York Times.  It’s available online here.  Strangely, it’s an extremely rational piece, and it makes me wonder if his politics are moderating a bit as we get closer to the 2008 election.

Some paragraphs worth sharing:

…recently we crossed an important watershed: we now import more manufactured goods from the third world than from other advanced economies. That is, a majority of our industrial trade is now with countries that are much poorer than we are and that pay their workers much lower wages.

For the world economy as a whole — and especially for poorer nations — growing trade between high-wage and low-wage countries is a very good thing. Above all, it offers backward economies their best hope of moving up the income ladder.

But for American workers the story is much less positive. In fact, it’s hard to avoid the conclusion that growing U.S. trade with third world countries reduces the real wages of many and perhaps most workers in this country. And that reality makes the politics of trade very difficult.

This is perhaps one of the most fairly balanced assessments I’ve seen on free-trade recently.  The macro-economics behind the benefits of free-trade between nations is overwhelmingly positive, in terms of the aggregate economic gains.   But I’ve learned to be very suspicious of arguments that persist over long periods of time, between well-educated people, on topics that theoretically should be very simple.  If they really were that simple, you’d expect that over time, most well-educated people would resolve the discussion and move on.

The oscillation between free trade and protectionism doesn’t surprise me historically at a political level – it’s pretty easy to understand why the steel worker, seeing his wages drop and/or his local plant disappear, wouldn’t push politically towards protectionism.  But there has to be something more to this argument.  The macro-economics of this situation are clear: cheaper foreign steel means less money for domestic steel makers, but cheaper steel for everyone else in the country.  That may not be much consolation for the steel worker, but it is the answer on why free trade in the aggregate, tends to benefit the country more than it hurts it.

(No, I’m not going to touch the recent China poisoned toys issue.  Yes, it’s obvious that we need some amount of regulation to prevent poisoned toothpaste and lead-painted toys, etc.)

More from Krugman’s article:

All this is textbook international economics: contrary to what people sometimes assert, economic theory says that free trade normally makes a country richer, but it doesn’t say that it’s normally good for everyone. Still, when the effects of third-world exports on U.S. wages first became an issue in the 1990s, a number of economists — myself included — looked at the data and concluded that any negative effects on U.S. wages were modest.

The trouble now is that these effects may no longer be as modest as they were, because imports of manufactured goods from the third world have grown dramatically — from just 2.5 percent of G.D.P. in 1990 to 6 percent in 2006.

And the biggest growth in imports has come from countries with very low wages. The original “newly industrializing economies” exporting manufactured goods — South Korea, Taiwan, Hong Kong and Singapore — paid wages that were about 25 percent of U.S. levels in 1990. Since then, however, the sources of our imports have shifted to Mexico, where wages are only 11 percent of the U.S. level, and China, where they’re only about 3 percent or 4 percent.

This is interesting.  Theoretically, it has always been roughly assumed that the high wage countries compensate for their wages, somewhat, with high productivity.  More value created per worker, usually due to heavy investment in education, capital, infrastructure, and low-risk environments.  But it’s possible that while mostly true, that logic reaches it’s limit at some point.  If labor in some countries is priced at 3-11% of US costs, and our trade shifts meaningfully in that direction, then that becomes a competitive depression on wages.

Once again, the economics are fairly clear that in the aggregate, those lower wages should mean cheaper goods for everyone.  But if a large percentage of our population faces this pressure all at once, it could lead to some extremely negative adjustment periods for not just those people, but for the entire economy.  This, in fact, is a potential explanation for some of the income disparity we’ve been seeing this decade as trade has shifted to China & Mexico.

One flaw I can see here already, potentially, is that a ever-declining percentage of our workforce is in manufacturing.  The last number I recall seeing was as low as 19%.  (please comment if I’m mistaken here). It’s tough to get to “most workers in this country” from there.

Now here is the part that scares me a bit – Paul Krugman’s conclusion:

So am I arguing for protectionism? No. Those who think that globalization is always and everywhere a bad thing are wrong. On the contrary, keeping world markets relatively open is crucial to the hopes of billions of people.

But I am arguing for an end to the finger-wagging, the accusation either of not understanding economics or of kowtowing to special interests that tends to be the editorial response to politicians who express skepticism about the benefits of free-trade agreements.

It’s often claimed that limits on trade benefit only a small number of Americans, while hurting the vast majority. That’s still true of things like the import quota on sugar. But when it comes to manufactured goods, it’s at least arguable that the reverse is true. The highly educated workers who clearly benefit from growing trade with third-world economies are a minority, greatly outnumbered by those who probably lose.

As I said, I’m not a protectionist. For the sake of the world as a whole, I hope that we respond to the trouble with trade not by shutting trade down, but by doing things like strengthening the social safety net. But those who are worried about trade have a point, and deserve some respect.

He’s right, the critics have a point.

Too often, opponents to free trade are kowtowing to special interests or misunderstanding economics.  Despite that fact, however, it’s clear that there are some significant macro-economic impacts from free trade that can not be brushed away, particularly around wage pressure and the percentage of the population affected.

I haven’t had time to formulate my own theories on how to weave through this complexity, but chances are that there is some analysis that could better quantify the impact of wage pressure of a given trade relationship.  That would give some guidance about when to slow down the pace of opening markets to phase in the pressures rather than having them catastrophically adjust over relatively small time periods.