Tag Archives: free trade

Paul Krugman On Economists Gone Wrong

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Now Britain finds itself in an alarming new landscape, where our very ways of feeding ourselves, like so much else, look uncertain.

– Bee Wilson, The New Yorker

Paul Krugman has a post The Macroeconomics of Brexit: Motivated Reasoning? on his blog The Conscience Of A Liberal about how “experts” exaggerated claims of the impact of a result to leave in the recent UK EU membership referendum (“Brexit”). Quite agree with Paul Krugman. When Michael Gove told Sky News that people in the UK have had enough of experts, he was laughed at. Video here.

Needless to say this is not an endorsement of Michael Gove’s other political position. Strange times, when you defend someone with different political ideology. The above is just meant to highlight a point that experts exaggerated and that people knew.

John Maynard Keynes also said this in the GT:

But although the doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purposes of scientific prediction has greatly impaired, in the course of time, the prestige of its practitioners. For professional economists, after Malthus, were apparently unmoved by the lack of correspondence between the results of their theory and the facts of observation;— a discrepancy which the ordinary man has not failed to observe, with the result of his growing unwillingness to accord to economists that measure of respect which he gives to other groups of scientists whose theoretical results are confirmed by observation when they are applied to the facts.

Paul Krugman’s main point is that economists’ arguments were motivated reasoning, involved circular reasoning and assumed what they wanted their model to output.

But maybe Paul Krugman himself is doing so? Krugman claims:

I believe that Brexit is a tragic development, which will do substantial long-run economic harm. But what we’re hearing overwhelmingly from economists is the claim that it will also have severe short-run adverse impacts. And that claim seems dubious.

Okay, financial markets have improved after some initial panic caused by the fear of fear. and FTSE 100 is at year-to-day highs. But Krugman still wishes to claim that Brexit is bad long term:

OK, let’s start at the beginning. Brexit will almost certainly have an adverse effect on British trade; even if the UK ends up with a Norway-type agreement with the EU, the loss of guaranteed access to the EU market will affect firms’ decisions about investments, and inhibit trade flows.

This reduction in trade relative to what would otherwise happen will, in turn, make the British economy less productive and poorer than it would otherwise have been. It takes fairly heroic assumptions to make this into a specific number, but 2-3 percent lower income in perpetuity seems plausible.

So far, so good, or rather so bad: this is standard economics, basically Ricardo with a dash of new trade theory.

Firstly it claims that is takes heroic assumptions. Second, but more importantly, Ricardo’s theory? Seriously? Ricardo’s theory and new trade theory claim there is convergence of successful and unsuccessful economies under free trade but emperically what is observed is that because of the process of circular and cumulative causation, there is polarization, not convergence.

It should be possible for the United Kingdom to negotiate protective arrangements (especially in manufactures) in such a way that the EU does not impose punitive tariffs and its exports do not suffer. Trade won’t suffer because although the propensity to import reduces, the government can expand domestic demand since such policies might ease the balance of payments constraint and the volume of UK imports won’t fall.

More generally, the solution of the problems of the world can come about if there is a concerted action, in which fiscal policy is coordinated and there are set of rules for balance-of-payments targets. In this system of regulated trade, world trade can rise because of higher world income as compared to a world with free trade.

Brexit should make economists realize that their models do not conform to empirical data. Ricardo and new trade theory can be cast aside.

The UK Should Leave The EU

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It’s the United Kingdom European Union membership referendum tomorrow. In my opinion, the UK should leave the EU.

When discussing the Euro Area, it is emphasized frequently that Euro Area governments do not have the power to make expenditures by making drafts at the central bank as argued by Wynne Godley in 1992:

It needs to be emphasised at the start that the establishment of a single currency in the EC would indeed bring to an end the sovereignty of its component nations and their power to take independent action on major issues. As Mr Tim Congdon has argued very cogently, the power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony. Local authorities and regions obviously cannot devalue. But they also lose the power to finance deficits through money creation while other methods of raising finance are subject to central regulation. Nor can they change interest rates.

The Euro Area was formed because Europeans wanted to come together and create a union which is big and powerful enough to be not affected by financial markets. The original intent was right but soon the whole idea came to be influenced by neoliberalism. The thing which was hugely missing (“the incredible lacuna” in Wynne Godley’s words in the above cited article) was the absence of central government of the Euro Area itself, which will have the power to collect taxes from Euro Area economic units and make expenditures. After some years of boom, the Euro Area found itself in crisis and could not deal with it well because there was no central government and fiscal policy to the rescue. The European Central Bank tried to save the monetary union but isn’t as powerful enough as a central government. More importantly, the Euro Area was brought into existence with the idea of free trade. Not only was power taken away from relatively economically weaker nations such as Greece but free trade was imposed by bringing their producers compete in the common market. In summary, there were two reasons why some Euro Area nations suffered.

  1. The monetary arrangement
  2. The common market.

Typically the former is emphasized more than the latter. Perhaps the reason is simple. It is easier to explain the former than the latter. In my experience, the latter is more difficult for people to understand and appreciate. Very few have emphasized it. Few exceptions are: Nicholas Kaldor, Wynne Godley.

Because economic growth is “balance of payments constrained”, free trade is devastating. The Euro Area could have had free trade if it had a central government which keeps imbalances in check because of fiscal transfers and regional policies.

Which brings us to the European Union itself and Britain’s membership. Although the UK government neither didn’t surrendered its sovereignty to make drafts at the central bank nor irrevocably fix the exchange rate in 1999, the nations’ producers still compete in the common market. It is better off leaving the European Union and have powers to impose tariffs on imports. Free trade is destructive to trade and one needs a lot of protection – at least the power of the optionality to impose such things any time a nation needs.

It was surpising to see less heterodox noise on this.

Nicholas Kaldor wrote a lot on this in the 1970s before the United Kingdom European Communities membership referendum in 1975. In his Collected Economics Essays, Volume 7, Nicky wrote (Introduction, page xxvi, October 1977) :

The final section of this volume, Part III, reproduces papers written in the course of the “Great Debate” on the question of British Membership of the Common Market in 1970 and 1971, and includes as a postscript a lecture on Free Trade written in 1977. As this debate came to an end when Britain entered the market, a decision which was later confirmed in popular referendum with a 2:1 majority, the reproduction of these papers may strike as otiose and serving little purpose other than somewhat ignoble one of self-vindication in the eyes of future historians. However, if the long-run effects of our membership turn out to be as disastrous as I feared they would be in 1971—and nothing that has happened has caused me to change my views—I think it is of the utmost importance that the true arguments against membership should be accessible to successive generations of students, the more so since the political debate continues to be dominated by issues (such as our effects of membership on the cost of food, on our agriculture, or the net budgetary cost of membership) which I regard as secondary and which could be brushed aside if the long-run effects on Britain’s manufacturing industry and on our capacity to provide employment were favourable.

…

[page xxviii] … the last essay of this volume, “The Nemesis of Free Trade”, which recounts the arguments in the great debate on Free Trade and Protection conducted at the beginning of this century between Herbert Asquith and Joseph Chamberlain. The points made on both sides seem to have lost none of their freshness or relevance in the intervening years. What has changed is our freedom to act. In 1905 we were free to decide whether to continue with the policy of free imports or to protect our industries. In 1977 the choice is no longer open to us, except at a political cost of withdrawing from the Common Market, an act which few people would contemplate seriously so soon after accession.

But after so many years, here is the chance to undo all this and withdraw from the EU. The UK should leave the EU.

Free Trade And Tight Fiscal Policy

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Harvard economist Dani Rodrik recently responded to a question/critique on why he doesn’t believe in the faith about free trade between nations while not showing that much dissent for trade within boundaries. Among the various points in his defence are fiscal transfers and regional policies. Rodrik says:

Another thing that happens is that there is an overarching state that will engage in transfer payments and other policies that aid the lagging region. The region will have political representatives in the national government who will push for the interests of those adversely affected.

That’s a nice point. See my blog post on how fiscal transfers help in reducing regional balance-of-payments problems.

Cafe Hayek responded to Rodrik here. An important point in that argument is: why does it matter if the consumer buys from a domestic producer as opposed to a foreign producer. The Cafe Hayek author Don Boudreaux says:

Now to point (1) – the more narrowly economic point.  Sellers in foreign countries sell things to buyers in the home country only because they – the foreign sellers – wish to increase their wealth.  The motives are identical to those of sellers in the domestic economy.  What do foreign sellers do with the revenues they earn from the sale of their exports?  They spend them.  They save them.  They invest them.  Perhaps on occasion they hoard them.  These options are no different from the options confronting domestic sellers.  If the funds spent on imports return to the domestic economy as demand for exports, jobs and economic activity shift from import-competing domestic industries into exporting industries.  No problem.  If these funds instead return as investments in the domestic economy, again there’s no problem: when, for example, Ikea opens a store in New Jersey it employs workers in that store no less than would an American who opened a similar store.

Now to argue straight with the above. FDI flow is just one flow in the capital and financial account of the balance of payments. And in the stock sense, FDI is just one type of liability among many others such as government debt held by foreigners. These just pay interest to foreigners.

Apart from that, foreigners are not likely to import as much as they export. A nation can have a high amount of imports and less exports. So there’s an asymmetry here – differing level of competitiveness.

But even if competitiveness were equal, nationality of buyers and sellers still matters. This is because creditor nations’ governments may not expand fiscal policy to the extent that is needed for the benefit of the world as a whole. If the government of a nation keeps fiscal policy relatively tight, it affects domestic demand, output and incomes of economic units and hence their imports.

So to summarize, difference in competitiveness and a relatively tighter fiscal stance of creditor nations affects trade and balance-of-payments of other nations. This in turn affects output because a nation which could potentially grow fast may find itself with balance-of-payments problems. Free trade doesn’t help poor nations.

This discussion can also be used in the case of the Euro Area where trade was made more free when the Euro Area was formed. Since there is no central government for the Euro Area, free trade works against nations which have been affected by the crisis.

“It’s remarks like that which explain why people hate economists!”

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A lot of heterodox economists are sympathetic to Paul Krugman because he seems to have argued for fiscal expansion.

Ha!

First, we are in this mess because of people like Paul Krugman who has promoted free trade – which has been destructive to the world economy as a whole and has prevented debtor nations from engaging in fiscal expansion to reflate their economies. The creditor nations won’t reflate their economies by fiscal expansion so easily – just barely the minimal needed to prevent social tensions from building up – because they don’t want to become debtors down the road. They overdo this but free trade has created this situation in the first place.

This crisis has made nations realize the importance of exports in growth and nations will want to improve their international investment position should there be growth in the rest of the world and they will want to wait sufficiently for exports to improve before expanding domestic demand. This creates a game theory like problem for growth of the world as a whole.

Now, Krugman is a smart man. He will make it look as if he was not all that dogmatic. And now ridicules everyone who opposes fiscal expansion. While it is good in a sense because the world needs a worldwide fiscal expansion (but this needs to be coordinated at least), it is nowhere close to the simplistic solutions Krugman presents with his comical IS/LM diagrams and liquidity trap theories and confusions with his notions of exogenous money – which is only a smart way of defending his earlier positions – even though we hear frequent Mea Culpas on his blog.

I came across this article by William Greider – Why Paul Krugman Is So Wrong in which he reminds the readers of how the mania of free trade has been promoted by Paul Krugman and how he has ridiculed everyone showing dissent.

It is generally nice in parts and is worth reading. I like the part in which Greider says that even though free trade has created problems for the United States, it wants to get out of the problems by promoting more free trade!

I am also reminded of a sacred tenet article of Paul Krugman making the case for free trade. The article titled Ricardo’s Difficult Idea not only ridicules anyone arguing against free trade but also gives out strategies on how to promote it.

Here is one paragraph which is worth quoting:

During the NAFTA debates I shared a podium with an experienced, highly regarded U.S. trade negotiator, a strong NAFTA suppporter [sic]. At one point a member of the audience asked me what I thought the effect of NAFTA would be on the number of jobs in the United States; when I replied “none”, based on the standard arguments, the trade official exploded in anger: “It’s remarks like that which explain why people hate economists!”

I like this quote by Francis Cripps from an article in The Guardian from 27 Feb 1979: Economists With A Mission:

Francis Cripps - If Economists Did Not Exist