Friday, December 25, 2009


I Told You Guys That Krugman Was Misleading the Children

Jeff Tucker passed along a very critical comment from reddit on my recent article accusing Krugman of making a basic mistake on trade theory. Here's the opening salvo:
Has this author ever even taken macroeconomics in college? This crap was on my freakin midterm; Krugman is 100% right. Increasing or decreasing the amount of trade we do via protectionism or trade liberalization only changes the volume of trade, but not the balance of trade, ergo it doesn't affect short run GDP. That's what Krugman is saying, and it's extremely obvious to anyone who knows that NX = Savings - Investment. Maybe if the author actually went over NX = S - I, he'd realize why what he's saying is wrong.

OK, criticizing Krugman on general economics is one thing, but you'd have to be a damned fool to criticize him on trade theory. That's all Krugman does, academically speaking. The author of this piece is WAY out of his own league. To say that "Krugman is wrong even within the Keynesian framework" is completely laughable; take it from someone who just studied most of this junk.
If you are interested in using Keynesian macro variables to express sound economics, I think you will enjoy clicking the link and watching this guy (?) and me debate. For example here is part of his follow-up:
You're 100% right; trade barriers adversely affect C and I. But it's more of a long run effect than a short run effect.

Trade in itself does not contribute to output, it just turns your output into something else that you want. If I'm making 40 bushels of corn and trading them with China for 40 teddy bears (backwards, I know), and all of a sudden a barrier is put up so I can't trade for teddy bears anymore, if I'm still producing 40 bushels then my output hasn't changed; it is and always has been 40 bushels. So GDP remains the same.
This is--I believe--totally totally wrong, but it's a very interesting mistake that I've never encountered before. So if you want to see me pick it apart, follow the link.

Last point: I'm almost glad that this guy (?) made this confident comment about my article. Kevin Donoghue and some others had me doubting myself, and thinking that Krugman wasn't misleading his readers. Well, he certainly fooled this person.

I love love love the names you gave the person. "Bensmainsqueeze" Oh man that's great.

Can you try pulling one of these shenanigans in a serious journal article? Like, totally dismantle a Keynesian position, then just end it with "and that's why Paul Krugman should be called Paul Kruciallywrongabouttheeconomyman".
Anon, I don't think I could get away with that, at least not until I was a lot more famous.
Futhermore, can you clear up the following thought experiment inspired by your trade article that I've been struggling with:

Basically, if one country drops all trade barriers against another, the other will have to drop its trade barriers as well.

Two countries have 100% trade barriers with each other--effectively zero trading gets done between them. Now, country A one day decides that trade barriers are wrong, so it removes its barriers entirely; so that not only does it have 0 tariffs, but also has removed all subsidies and regulations with respect to trade. Country B, however, maintains its tariffs.

Now what would happen in the long run? I would guess that it would lead to country B eventually lowering its tariffs. Because since country A now has access to more goods than before, it will force the prices in its own economy down. And if it is exporting country A dollars (CAD), then country B will eventually have to use those CAD to purchase CA goods and services. Therefore, so long as CA remains productive, its new influx of goods will lead to higher savings, which will lead to lower interest rates, which will lead to more investment, which will increase productivity.

That came out longer than I wanted.

In short: country A removes all trade barriers with country B, while the latter does not buy any goods from country A. The new imports from CB will lead to more investment in CA, thus CA will become more productive. CB in the meantime collects CAD with which it can do nothing except by stuff from CA, thus it must eventually lower its barriers.

Even if CA exports gold instead of fiat CAD, that will lead in inflation in CB and deflation in CA. CA can then still saves (and invests) more while CB is forced to invest less, thus CA will become more productive while CB becomes less. CB will then drop trade barriers.

Do I have this right?

I'm not sure if you are assuming more than this, but...

No, in general there is nothing to force the one country to drop its trade barriers. The residents of the "protected" country could continue using their foreign exchange (earned from net exports) to acquire more and more financial assets in the liberalized country.

It's true, you start to wonder why the heck anyone wants to own financial assets that can never lead to anything tangible, but I guess it could continue for a long time in principle. There would certainly be nothing to force the government to drop its trade barriers, I think it would just mean that all trade would eventually stop if the "protected" people realized they would never ever see a single consumption good coming from their ownership of foreign assets.
I found it amusing that the guy on the reddit page responded to your comment by saying "I guess you dont understand economics." Isn't the internet wonderful for allowing people to say things they would never, and I mean never, say in a formal conversation...
So, Bob, are you saying that the protected country wouldn't eventually see a huge drop in productivity? And this drop in productivity wouldn't lead necessarily lead to less barriers?
Also, even if the other country always maintains its tariffs, can the liberalized country become worse off in any way?
Anonymous, if demand for B output drops, then A will stop supplying B with resources.

Easy enough? Now, you can complicate this by adding demand for B goods from travelers and immigrants sending money home. But the point remains, if demand for something drops, a supply drop will follow. The dynamics of lending/investment will only be different if people expect barriers to be drop in the future. Lending is only deferred buying.

Whether trade barriers will be standing or not depends on political economics, not on trade economics. That will in turn depend on the political institutions.

With regard to a gold standard, it will change our reasoning only in the sense that B citizens are able to export gold. Gold being the currency, it's supposedly not subject to the trade barrier. Country A will be willing to supply B with stuff in trade for gold. A producers may be active in this rent seeking exercise for awhile, but it will eventually come to an end. The time it takes depends on several factors (e.g. if country B has fallen into chaos then this can take awhile as there is no domestic demand for gold), but we know lending will be falling sooner than gold trade since lenders will be factoring in the fact that gold will buy less in the future.
Anonymous ask: «Also, even if the other country always maintains its tariffs, can the liberalized country become worse off in any way?»

Of course, trade is not a zero-sum game. If trade collapses, then both countries lose.
That was classic. Nothing better than someone basically calling you an idiot and then having to concede when you systematically break down their argument.
Blacksheep, I guess I wasn't clear enough in my post. My question was regarding productivity, and I was assuming constant, positive demand for B output in the long run. I familiar with the mechanics of supply and demand.

In this light, I'll try to rephrase my question:
Imagine a world where
1. Country A has completely liberal trade and has a productive domestic economy
2. Country B does not allow any imports from A, and is initially as productive as A
3. A's long-run demand for B output is positive and constant
4a. Trade is facilitated through fiat money
4b. Trade is facilitated through gold

Given these premises, here are my questions:

1a. Should any changes in long run productivity be expected?
1b. If so, will that necessarily imply changes to trade policy?
2. Will the outcome change at all if trade was facilitated through fiat money or gold?
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