Paul Krugman on Tariffs: “Oops!”
Paul Krugman is the best-known Keynesian economist in the United States. He won the Nobel Prize. He has a regular column in The New York Times.
Recently, he wrote an article for Bloomberg. Because Bloomberg has a paywall, the public normally could not get access to Krugman’s most recent article. So, his admission of a blunder 25 years ago would not be not available to the general public. The headline declares: What Economists (Including Me) Got Wrong About Globalization. The subhead explains: “The models that scholars used to measure the impact of exports from developing countries in the 1990’s underestimated the effect on jobs and inequality.”
The good news is this: MSN has reproduced the article here. I get to have some fun at his expense. I get to explain his thinking. But before I analyze his article, I want to review the basics of the economic and philosophical case in favor of free trade.
THE LOGIC OF FREE TRADE
The case for free trade across borders is conceptually identical to the case for free trade inside borders. I want to make this point clear from the beginning.
Let us say that two men, Brown and Smith, trade with each other. Each of them specializes in a particular form of production. Each of them finds that it is more profitable for him to specialize than to be a generalist. Through the agency of the free market, the two men can exchange money with each other, and each of them gets more money by specializing in production. There is nothing radical about this concept. It goes back to Adam Smith and The Wealth of Nations (1776).
There is a third man, Jones. He specializes in the production of goods that Brown specializes in. But he is out of the running. His prices are too high. The quality of his products is too low. Smith doesn’t consider buying anything from Jones.
Because Smith, Brown, and Jones live inside the same geographical borders, there is nothing that Jones can do about the fact that he doesn’t sell anything to Smith. Anyway, there is nothing with respect to barriers at a border. There is no border. He can find other ways for the government to intervene in order to restrict Brown’s ability to sell to Smith, but he cannot do anything about it with respect to a border.
Jones’ inability to sell to Smith does not get counted in any government-funded survey. He has been out of the running for so long that his lack of income due to his inability to sell anything to Smith is not counted by the government or anybody else. Jones is what we call an also-ran. He is a loser in the competitive marketplace. He needs to go into another line of work. Or maybe he has to find customers who have not heard about the tremendous advantages of buying from Brown.
A fourth man then comes along, bringing an offer to Smith. His name is Wong. He lives in China. There are invisible legal barriers between Wong and Smith: two national borders. These borders, in and of themselves, do not favor either Wong or Smith. Yet.
Smith finds that Wong’s products are even better than Brown’s. So, he stops buying from Brown. He decides that he prefers to trade with Wong.
Brown is now out of the running. He loses money. Because he used to make money by selling to Smith, this reduction in income is counted by the government in its statistics-gathering. But the statisticians still ignore Jones, who was never in the running.
Brown is outraged by Wong. He had a good deal going by selling to Smith. He doesn’t think he can sell to any of Wong’s peers in China. But he sees an opportunity. If he gets together with Jones, the two of them can pressure the government to erect tariff barriers (sales taxes) that increase the costs of Wong’s goods inside the United States. Brown thinks to himself: “That’ll teach that gook a lesson.” But, understanding the terrible dangers of hate speech these days, he keeps his thought to himself.
After the tariffs are imposed by the government, Wong is a loser. He doesn’t sell as many goods to Smith as he did before. This means he cannot get access to as many dollars — his profits from selling to Smith. That means he cannot buy as many goods from somebody in the United States who is exporting goods to China.
The statistics will now indicate that Brown is making money again. Things will look much better statistically for Brown. Jones, still a loser, won’t make any money selling to Smith. He hoped he might, but he won’t. But maybe he can sell to somebody else who has not heard of Brown, and who will not be able to afford anything sold by Wong.
The case for free trade is the case for freedom. The case for free trade is the right of anybody to offer his goods and services for sale to anybody else. Here is the logic of the free market, which is a gigantic auction: “high bid wins.” This is the logic of free-market economics. It has to do with individuals making decisions about whether to exchange goods and services with each other.
An invisible barrier known as a national border has nothing to do with the logic of free trade.
TARIFFS ARE LIKE DIRT ROADS
Whenever barriers exist between traders, such as poor transportation facilities, this keeps people poorer than they would otherwise have been if the transportation facilities were better. When the transportation problems are overcome by new technologies, some people will get richer because they can trade with each other. But some of those people who previously prospered as a result of the poor transportation facilities will now lose market share. Their goods and services no longer meet the standards of those local individuals who now decide to buy from somebody far down the newly paved road.
Would any economist in his right mind worry about the loss of revenue that is sustained by a few local sellers because the previously dirt road is now paved? I hope not.
Unfortunately, Keynesian economists and supporters of tariffs do not understand the logic of economics. They do not understand that lowering a tariff barrier has the same effects as paving a road between two towns that previously had not traded much. Similarly, they do not understand that raising tariffs has exactly the same effects as dropping bombs on paved highways.
Tariffs reduce trade. Tariffs reduce liberty. Tariffs reduce the net income of people who previously had traded with each other.
Whenever somebody tells you that it is a good idea to raise tariffs, think of somebody who tells you that it would be a good idea for the federal government to send out bombers to drop bombs on America’s highways.
KRUGMAN’S BELATED ADMISSION
It is now time to analyze Paul Krugman’s semi-mea culpa.
Concerns about adverse effects from globalization aren’t new. As U.S. income inequality began rising in the 1980’s, many commentators were quick to link this new phenomenon to another new phenomenon: the rise of manufactured exports from newly industrializing economies.
Economists took these concerns seriously. Standard models of international trade say that trade can have large effects on income distribution: A famous 1941 paper showed how trading with a labor-abundant economy can reduce wages, even if national income grows.
And so during the 1990’s, a number of economists, myself included, tried to figure out how much the changing trade landscape was contributing to rising inequality. They generally concluded that the effect was relatively modest and not the central factor in the widening income gap. So academic interest in the possible adverse effects of trade, while it never went away, waned.
Let me put this in language that I hope you will understand. I return to my metaphor of bombing paved highways. I need to revise Krugman’s statements slightly. I want to take them from the 1990’s back to the 1950’s. I will also shift from tariffs to roads.
Concerns about adverse effects from paving roads aren’t new. As U.S. income inequality began rising in the 1940’s, many commentators were quick to link this new phenomenon to another new phenomenon: the rise of manufactured exports from newly industrializing towns down the road.
Economists took these concerns seriously. Standard models of paved highways say that trade can have large effects on income distribution: A famous 1941 paper showed how trading with a labor-abundant town can reduce wages, even if regional income grows.
And so during the 1950’s, a number of economists, myself included, tried to figure out how much the paved roads were contributing to rising inequality. They generally concluded that the effect was relatively modest and not the central factor in the widening income gap. So academic interest in the possible adverse effects of paved roads, while it never went away, waned.
Are you beginning to get the picture? Yet if Krugman were to read this article, I seriously doubt that he would get the picture. That is because he thinks in terms of aggregates, not individuals. He does not start with individual freedom of exchange. He starts with statistical aggregates based on statistics collected by force by the United States government. So do his Keynesian peers.
From Gary North, here.