How Was Krugman So Wrong On Trade?

Dave Johnson

Have our trade policies helped or hurt the country? You can look down at equations and models, or you can look up and see what is happening around you. Equations and models will tell you that “free trade” is a good thing. But if you look up and see what is happening around you … “not so much” is such an understatement. So a comparison of what economists predicted “free trade” would bring with what has actually happened might help us find a way out of the economic mess we are in.

William Greider in The Nation, Why Was Paul Krugman So Wrong?, knocks Paul Krugman’s past (1990s) support for “free” trade policies while working people and labor were warning of the catastrophe that has come to pass, and looks at why Krugman got it so wrong. Because of Krugman’s position near the top of the opinion-leader ladder, Greider writes, “his argument prevailed where it counts – among the political elites who influence government policy-making.”

A good many Americans did not believe [Krugman], mainly working people who saw their jobs and middle-class wages decimated by the processes of globalizing production. Krugman said they didn’t see the big picture. Educated professionals whose own livelihoods were not threatened by globalization were more likely to embrace Krugman’s perspective. While he never won the debate with the broad public, his argument prevailed where it counts – among the political elites who influence government policy-making. Both political parties, every president from Reagan to Obama, embraced the same free-trade strategy: support US multinational corporations in global competition, as their success is bound to lift the rest of the country.

Then Greider hits home, writing about how it has turned out, with “the nation is … mired in large and permanent trade deficits” and “continuing downward pressure on US employment and wages,”

Roughly speaking, the opposite occurred, not only for the working class but for the broad US economy. The multinationals did fine, but the nation is now mired in large and permanent trade deficits that translate into huge indebtedness … and that exerts continuing downward pressure on US employment and wages. Yet the Obama government is seeking still more free-trade agreements as the answer. The current fiscal debates in Congress do not even recognize that free trade globalization is a core source of America’s diminished prosperity.

The Dirty Hippies were mocked and banished from the discussion,

Like Krugman, governing elites dismissed critics and simply stated that free trade will be good for America because US energies and endless creativity are sure to prevail, as they always have in the past. Opponents like organized labor were typically ridiculed as backward Luddites, promoting what Krugman called “disguised protectionism.” That label scared off major media. Reporters take their cues from the “supposed authority” of business leaders and scholarly experts. At the most prestigious newspapers, reporters and editors simply ignored the substantive critiques … After thirty years, the case against free trade is still a taboo subject in respectable circles.

So why, Greider asks, was Krugman so wrong? One way was asserting that increases in productivity always lead to increases in wages. Greider explains, “His most egregious error was perhaps the assertion that wages always rise with an economy’s rising productivity.”

Certainly that had been the American experience for many years, but Krugman did not seem to grasp that globalization liberated American businesses from sustaining that relationship. If US labor costs became a burden, the multinational corporations and even smaller firms can now move the production to low-wage countries or merely threaten to do so. In my experience as a reporter, workers on the factory floor recognized this shift in power long before conventional economists figured it out.

Krugman, nevertheless, stuck with standard theory. “One last assertion that may bother some readers is that wages automatically rise with productivity,” he wrote. “Is this realistic? Yes. Economic history offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages.”

Actually, as Krugman was writing this, US industrial wages were already diverging from the old pattern…

Again, “workers on the factory floor recognized this shift in power long before conventional economists figured it out.” Because they were looking at the real world, and economists look at equations and models. (Bill Gates walks into a room full of really, poor people. The economist sees that the average wealth in the room is enormous.)

Another way Krugman and other free-traders were wrong was not seeing what was actually happening in China. Greider writes that Krugman was dismissing China’s ability to compete against out technological advantages. But Greider was on the ground in China, looking at what was actually happening,

As it happened, about the time Krugman was belittling China, I was there reporting for my book on the global economy. I toured massive factories and dismal sweatshops, interviewed workers, managers and well-placed economists. ….

When I was in Beijing, the city was abuzz with US corporate types from the best names in US manufacturing—General Motors, Boeing, IBM and many others. They were negotiating deals to make things in China and sell them to Chinese consumers. Multinationals from around the world were scrambling to gain access to what would someday become the largest consumer market in the world. The price of entry, demanded by the government, was that foreign companies would have to share their precious technology with domestic partners, the infant Chinese companies learning to make things that could compete with the best and brightest from America and Europe.

Greider concluded, “People are capable, everywhere in the world,” I decided. Americans who still believed in their inherent superiority were about to learn a little humility.”

If you want to understand what has happened to our economy, please read Greider’s entire article!!! But do not miss these paragraphs:

The American problem is not trade theory but self-delusion—an overweening confidence that the US as world leader would prevail because it always had. …

The problem was, the rest of the world declined to cooperate. If they could, developing nations pursued their own nationalistic strategies not so different from how the US did industrial development in the 19th century. And these newcomers succeeded spectacularly … Authorities like Krugman whose expectations were so wrong now tell Americans have no other alternative except the ugly protectionism which would be ruinous for all.

That assertion is mistaken too. The most compelling evidence of American self-delusion is not in Asia but in Europe. The best evidence that a nation can both manage its industrial system strategically while participating fully and fairly in global trade is Germany. …

Trade realities and economists… From my post a year ago,Manufacturing on Planet Economus,

The countries that are successful in today’s economy have national industrial/economic policies. We do not. They work to capture parts or all of key strategic industries, and line up the infrastructure, finance, education, supply chains, power grid, tax policies and everything else needed to compete in the world economy. We do not.

We send our companies out against these national systems, and even our largest companies cannot compete with national systems. So we lose.

Are China, Germany and so many other countries just wrong, putting so much into these efforts to capture parts or all of strategic industries? Or are they being smart? Look at who has a trade surplus and who has a trade deficit, and see if you can guess the answer.

And especially,

4) Planet Economus is a place far from Earth. On planet Economus they apparently have free markets, and free trade. But on Earth free markets and free trade never existed anywhere at any time, and never worked when they were tried. So on Earth we have to have policies that reflect what happens on Earth, not on planet Economus.

Planet Economus is a place far from Earth.

On Earth free markets and free trade never existed anywhere at any time, and never worked when they were tried.

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