498 Words on Krugman’s Nobel Prize*

Readers of this blog are undoubtedly aware that Paul Krugman was awarded this week the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel. Readers of this blog also know that I have a long-standing interest in this particular prize. Krugman won the award “for his analysis of trade patterns and location of economic activity.” Krugman was not a favorite to win the prize, although his early work has long been seen as groundbreaking, and many blogging economists were not surprised with the choice.

So what problem did Krugman solve and how**? As far as I can tell, the basic problem Krugman addressed is why rich countries traded with each other and, in particular, traded each other very similar things. Trade theory goes back a long way, to Ricardo at least, but before Krugman had focused primarily on trade between countries with different ‘factors’ – climate, skilled labor, etc. And yet, in the actual data on trade, many rich countries with similar factors (e.g. Germany and France, Canada and the U.S.) trade each other different kinds of the same things, e.g. German cars are imported in the U.S. and vice versa. This intraindustry, international trade is important and massive, and previous economic theory had little to say about it. So, how did Krugman solve the problem? The details are technical, but the basic ideas are pretty simple. Assume people have some preferences for variety, and that firms have increasing returns to size. Then, it makes more sense to have big firms competing in the world market rather than smaller firms competing in local markets. So, instead of say, four car companies Germany and four in the US, we get 1 based in Germany and 3 based in the US (or whatever), all of whom sell in both countries. Consumers get access to the same variety of goods, but the firms have access to bigger markets and thus get bigger economies of scales. Thus, Krugman created a framework which made it much easier to understand international trade as we actually observe it.

Speculation abounds about whether Krugman ‘deserved’ the prize, or if instead the decision to give him the award reflected his contributions to the discipline as a popularizer (via the incredibly readable Peddling Prosperity, say, as well as his NYTimes column) or as a liberal pundit. The politics of the prize have been murky ever since the prize turned its eyes towards politicized figures like Myrdal, Hayek and Friedman. But Hayek and Myrdal, for example, thought the prize was a bad idea as it would give undue political influence to particular viewpoints.

So, what do we make of Krugman’s prize? I do not know if Myrdal and Hayek are right in their belief that the prize endows an economist with political sway, but if any economist could use a bit more influence right now, it would be Krugman. His columns have been a shining beacon through the dark years of the Bush Administration’s war on authority, fact and dissent.

* Yes, the title is an oblique West Wing reference, as well as a challenge to myself. And no, footnotes don’t count here.
** Krugman also gives a nice summary in his interview with Jim Lehrer, available here.

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