Tuesday, December 09, 2008

Krugman Highlights Nobelists Limitations

Krugman's Big Idea is outlined pretty well in his Nobel speech. To the extent it truly captures something big, the essence of the idea is as simple as what he presented. The particulars of his academic papers, with their theorems and lemmas are ephemeral, the nature of current rhetoric, because defining a measure space, and outlining that this result only holds when U'(0)=inf and U''<0, is just not essential to his insight.

But consider his idea that increasing returns to scale are important. The obvious policy implication is, there might be situations where one wants to invoke the infant industry argument, to protect an industry that is about to 'take off'. Perhaps. But consider the political issues involved, in that such arguments are often used as pretexts for politicians to distribute monopoly power like patronage jobs. Ann Krueger wrote a very interesting piece in the AEA about this, and noted that while there were some good reasons for adopting tariffs and trade barriers, in practice, it was counterproductive because it merely encouraged wasteful rent-seeking, and the effect of sheltering an industry from competition leads not to a high-flying industrial sector, but a bloated one. Further, infant industries never appear to grow up, so that some industries like textiles and sugar are seemingly stuck in infancy for generations.

Anyway, Krugman took the bait, and put out some heretical books in the early 1990's on why infant industry arguments may work (increasing returns to scale), but then found he was often being used by simple Luddites to increase trade barriers, so wrote Pop Internationalism to point out that free trade is almost always a good thing. In any case, his one Big Idea, is merely one argument for trade protection. Further, it does not address why increasing returns to scale exist. In this sense, his result is a bit like Solow's famous result that productivity growth (the Solow residual), and not capital and labor growth, are the keys to productivity growth. Kind of interesting, but unless you can explain why certain countries have higher productivity growth, not so much. Thus, when a Nobel Prize Winning economists discusses his subject, in the realm of policy he is really a neophyte, because the debate involves many issues, not just one, and often his insight is very parochial even within his field of expertise.


Anonymous said...

Any geographical region that has a concentrated industry presence (New York finance, N. California, computer technology, Banglore, outsourcing) is an example of incraesing returns to scale. The question is are there public policies that will help increasing returns kick in. It may be as simple as having low taxes and no welfare state, or it may involve high taxes a robust safety net and public education system, or it could involve actually picking winners and losers in the marketplace by nurturing infant industries.

Observing that there are increasing returns should not be controversial. Figuring out if there is some way to help them along as a matter of public policy is complicated (particularly in view of the tradeoffs), and one of the reasons we have political institutions.

Anonymous said...

i hereby predict the next nobel will be for a theory that shows, yes, free markets and trade work in theory, but no, society should not implement them, because look at the track record. maybe as soon as next year, depends how fast/how cold we get.