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Pop Internationglism. By Paul Krugman. Boston: MIT Press, 1996

~n aul Krugman owes much of his considerable reputation as an economic
¥ theorist to “new trade theory.” In contrast to traditional trade theory,
supporters of the new view deny that free trade is always advantageous:

¥::i the exceptions largely concern cases of “increasing returns.” “It’s
obvious that the new trade theory introduces the possibility that government
action can, in effect, create comparative advantage” (p. 110). Government action
does this, one gathers, by promoting large-scale production in industries where
increasing returns obtain. In pursuit of this end, tariffs may be a useful tool; such
is the new wisdom of “strategic trade policy.”

Krugman does not renounce the new theory—far from it. With forthright
immodesty, he declares the new “sophisticated” theory, of which he was a
principal developer, “part of the mainstream of economic analysis” (p. 109). But
he dislikes intensely the use that has been made of the new theory by writers he
damns as incompetent and economically illiterate.

The writers who arouse our author’s ire include Robert Reich, currently
Secretary of Labor, and the MIT economist Lester Thurow. They wrongly think
of international trade as if it were a “zero-sum” game, to use a phrase from the
title of a best-selling book by Thurow. In this view, one party’s gain in trade is
another’s loss. Trade becomes an instrument of economic warfare.

In fact, of course, the situation is quite otherwise. Trade does not take place
unless both parties expect to benefit from it; unlike war, the gain to one party
does not depend on the loss of another. Further, trade can still be advantageous
even if one country is, in all goods traded, inferior in productivity to its trading
partner. As David Ricardo long ago demonstrated, “a country will always find a
range of goods in which it has a ‘comparative advantage’ (p. 91).

Proponents of strategic trade make a great deal of fuss about the supposed
need for international “competitiveness.” This elusive concept appears to con-
sist, in large part, of a nation’s having a “favorable” balance of trade. Krugman
isn’t buying: “Both in theory and practice a trade surplus may be a sign of
national weakness, a deficit a sign of strength” (p. 6). Contrary to widespread
belief, deteriorating terms of trade have not been “a major drag on the U.S.

standard of living” (p. 8).

Review of Austrian Economics 10, no. 1 (1997): 141-43
ISSN:0889-3047

141


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142 Review of Austrian Economics 10, No.1 (1997)

Wherein lies the fundamental fallacy of the strategic traders? They think of
nations as if they were rival firms in competition for a market. But “countries do
not compete with each other the way corporations do . . . the major industrial
countries, while they sell products that compete with each other, are also each
other’s main export markets and each other’s main suppliers of useful imports”
(p- 9). International trade should not be viewed, in a parody of Clausewitz, as
“the continuation of war by other means,” our new traders to the contrary
notwithstanding.

Krugman's case may in one respect elicit surprise. As he himself is at pains
to stress, he is saying nothing new. He merely restates and reiterates common-
places of economic analysis. Here precisely arises the element of surprise. Why
do such elementary points require restatement in this day and age? Surely
authors of the stature of Reich have already taken account of them.

In fact they have not. Krugman mercilessly exposes many supposed emi-
nences as ignoramuses of the first order. He comments, for example, on a passage
on international trade by the Yale historian Paul Kennedy as follows: “did you
find the quotation from Professor Kennedy hysterically funny. . . . Kennedy feels
that he is in a position to discuss the idea of comparative advantage . . . without
understanding the idea” (p. 86). Readers will discover that this hapless historian is
but one of many offenders.

Students of Austrian theory will be reminded of a case that closely resembles
the situation Krugman has depicted. After Mises argued that economic calcula-
tion under socialism is impossible, sophisticated economists, notably Oskar
Lange and Abba Lerner, devised models of so-called market socialism which,
they claimed, could accomplish the task of calculation.

In my view, Mises and Hayek more than adequately dispatched these models.
But, regardless of how one judges the dispute, there is another point that
demands attention; and here is where the parallel with Krugman's case arises.
The Lange—Lerner models were abstractions that bore no relation to actually
existing socialist economics. Even if correct, they would have no bearing on the
question, can socialism in the actual world solve the calculation problem?

Nevertheless, socialists acted as if the mere existence of these models
sufficed to dispose of the calculation problem. In like manner, the strategic
traders take the very limited claims of the new trade theory to have demolished
altogether the basic Ricardian case for free trade. The plans of Reich and
company are not correctly derived from the new theory. Nevertheless the mere
existence of the new account somehow is supposed to redound to their benefit.

Readers who do not like loose ends may be inclined to raise a further point.
Just as the Lange-Lerner models do not succeed in answering Mises (or so


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Book Reviews 143

Austrians would claim), is there likewise a fallacy in the arguments of Krugman
and his fellow new traders that the case for free trade is in theory flawed?

To answer this far exceeds my competence; and Krugman's devastating
ripostes should be sufficient warning against any temptation to stray across
disciplinary boundaries. But I shall venture one remark about the normative
implications of the new theory, which our author acknowledges “are much more
controversial” (p. 110) than the descriptive part of the theory. Krugman informs
us that “clever government intervention cannot only shift the pattern of com-
parative advantage, but also do so in a way that raises the intervening country’s
real income at the expense of other countries” (p. 110). Those who have taken
their Mises and Rothbard to heart may wonder why “a country’s real income”
has any place at all in a sound welfare economics.

Throughout his book, Krugman has been concerned to assert the preroga-
tives of economic theory. Those not expert in these deep matters should not
presume to comment on them. Our author’s claim to authority rests on indis-
putable credentials; but at one point, I venture to suggest, he has gone beyond
his area of specialized knowledge.

In defense of the Nafta Agreement, Krugman admits that Nafta supporters
“considerably glamorize the reality” of the treaty’s supposed economic benefits.
In fact “NAFTA will . . . produce only a small gain in overall U.S. real income”
(p. 157).

Why, then, does Krugman wax enthusiastic over the arrangement? For him,
Nafta is primarily a foreign policy issue; it is needed to promote the stability of
the Mexican government. “For the United States, this agreement is not about
jobs. It is not even about economic efficiency and growth. It is about doing what
one can to help a friendly government succeed” (p. 165). If Krugman is right
about Nafta’s lack of economic impact, then he exits the scene as an expert on
the treaty’s merits. Prima facie, his opinions on foreign policy merit no more
consideration than those of any other layman. Those less inclined than our
author to view the Salinas government as a fit object of idolatry need here pay
him no heed.

David Gordon
Ludwig von Mises Institute