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Thursday, July 07, 2022

An absolute advantage

Economists are obsessed with elegance. Their bodies might be proportioned more like refrigerators or lampposts than ballerinas, but that is of no consequence.

Written by Karnabasu |
October 16, 2008 1:20:16 am

Economists are obsessed with elegance. Their bodies might be proportioned more like refrigerators or lampposts than ballerinas, but that is of no consequence. To an economist, elegance lies in a description of human behaviour that is at once explanatory, predictive, and parsimonious. This is a little like building a recognisable model of the world with as few Lego blocks as possible. The best economists are able to refine our view of this world by adding or removing just a few blocks. Paul Krugman, the 2008 Nobel laureate in economics and a giant in the theory of international trade, is such an economist.

Krugman has received this award early, at the age of 55. But precocity has been a consistent feature of his professional life. He completed his PhD in just three years. When he received his degree from the Massachusetts Institute of Technology in 1977, he had already done much of the work that was to make him famous. He has taught at several top economics departments, including long stretches at MIT and Princeton. In 1991, he was recognized as the best American economist under 40 when he received the John Bates Clark Medal.

Krugman has also made notable forays outside academia. He served on the Council of Economic Advisors during the Reagan administration, has written several popular books on economics, and is now an unabashedly liberal columnist for The New York Times. Yet, it is unlikely that he could have achieved any of this was it not, as the Nobel Committee described it, “for his analysis of trade patterns and location of economic activity.”

To get a better sense of Krugman’s contributions to economics, we need to make a brief stop in early 19th century England. In response to rising domestic prices of food grain, independent traders had begun importing wheat and corn. While this was welcomed by many, landowners were understandably displeased. Their agricultural profits went down, and they were forced to reduce expenditure on essential items such as wigs. However, landowners eventually took advantage of their majority in parliament to enact the “Corn Laws”, which effectively banned imports of food grain.

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One of the loudest voices in opposition to the Corn Laws was that of David Ricardo, now recognized as the father of theoretical economics. Despite his own considerable land-holdings (the result of a successful career in stockbroking), Ricardo was committed to reopening trade. Two of his insights from that period have been immensely influential in modern economics. The first is the idea that abstraction is a useful tool. Ricardo’s arguments were based on a vision of a world stripped down to the bare essentials: a few “types” of individuals who differed in preferences and endowments, and well-defined markets in which they interacted. The logical clarity that comes from mathematical abstraction is now the trademark of economic theory, for better or for worse.

Ricardo’s second insight was more specific: when countries specialise production according to “comparative advantage”, they are (generally) made better off. Suppose that, in India, it takes one worker to produce a bushel of corn and two workers to produce a wig. Also suppose that in England, it takes ten workers to produce a bushel of corn and five workers to produce a wig. In this case, India has a comparative advantage in corn and England has a comparative advantage in wigs (even though India has an absolute advantage in both). Ricardo’s argument, reinforced and formalised by many economists since then, is that both India and England will gain if India exports corn to England and England exports wigs to India.

This is a powerful idea with far-reaching implications for global welfare. While critics of globalisation have valid concerns (such as the difficulty of distributing the gains from trade and the short-run costs of reallocating labour), their reluctance to acknowledge the fundamental wisdom of comparative advantage has put them at a comparative disadvantage in the academic discourse.

When Krugman was in graduate school, there was concern that some patterns of trade could not be explained by this theory. Why do nearly identical countries trade in nearly identical goods? For example, Germany exports BMWs to Sweden while Sweden exports Saabs to Germany. Shouldn’t the country with a comparative advantage in cars produce both BMWs and Saabs? And if neither has a comparative advantage, why doesn’t each produce its own BMWs and Saabs?

Krugman showed, in a ten-paged paper, that two very simple modifications to the theory could explain this and more. First, consumers like having choices over similar goods (Saabs and BMWs, for example). Second, there are economies of scale. In other words, the more Saabs a country produces, the lower the average cost of making each Saab. In this setting, even if Germany and Sweden were identical (in that neither had a comparative advantage in car production), it would make sense for each to specialize across brands. Allowing Sweden to produce all Saabs and Germany to produce all BMWs keeps the average cost of each car lower than if trade was blocked.

Krugman built on these insights to expand and improve theories not only of international trade but also economic geography. This is the study of where and how labour and capital are distributed. Thanks to his research, we now have a clearer understanding of the mechanisms through which cities might or might not emerge as centers of production. Krugman’s arguments are brilliant because they are so stark and simple that they seem obvious. This is the trademark of many great inventions, from the wheel to the Sudoku puzzle.

While the decision to award the Nobel Memorial Prize in Economic Sciences to Paul Krugman is certainly appropriate, it will come as a disappointment to Indians that the prize was not shared with Jagdish Bhagwati and Avinash Dixit. Both Bhagwati and Dixit have written seminal papers that have deeply influenced Krugman’s research, and several economists had predicted a three-way award.

That this did not happen is perhaps in part due to Krugman’s notoriety as a columnist. Krugman is unique among economists for the vehemence of his political positions. He has the distinction of being one the most provocative commentators in the mainstream American media. While his reasoned arguments for greater redistribution and undisguised support for the Democratic party have won him many enemies, economists should also be grateful to him for showing that the necessary amorality of the discipline does not necessitate silence on the ethical issues of the day.

The writer teaches economics at the University of Chicago

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