Hi everyone. In this video I want to persuade you that when an economist says
their analysis is more credible because they have a model on their side, they are
usually wrong and should be ignored.
It's not that I'm better than this, it's just that I'm much cleverer than you need to be to work here.
I want to use the example of globalization and how economists have approached it to
illustrate my point. It's no secret that the negative consequences of
globalization have made themselves felt over the past few years, and that
economists have a best committed a sin of omission by failing to notice them
unfold. Globalization has been linked to economic decline in former manufacturing hubs...
Our town is dying. One out of every four homes is an abandoned dilapidated
structure and you get told "keep picking up trash and let leaders do what leaders do".
...creating unemployment, deaths of despair,
and political backlash. This is despite economists being consistent supporters
of and even architects of trade deals. Surely there is no better person to use
as a foil than Nobel Prize winning economist Paul Krugman, who probably has
the biggest public reach of any economist today. Krugman won his Nobel
for his work on trade, but before that he made his name as a public intellectual
in the 1990s, responding to critics of globalization who were unhappy with
economists' cheerleading for free trade. He was dismissive of critics of
globalization as unsophisticated, ideological, and ignorant. In fact, he was
so insufferable that the New York Times eventually gave him a column. Centrist
Twitter still salivates over his 1990s articles to this day.
Why are you the way that you are?
These debates are useful for us as they often dovetailed into
discussions about economic theory. The critics were convinced that the
unrealistic assumptions used in trade theory made it irrelevant, while Krugman
defended them as a source of insights. Krugman frequently denied the
globalization would have a major impact on wages and employments at home. His
view is best summed up by the following quote from the man himself:
Yet Krugman has himself admitted he was
wrong. In an article on Bloomberg a few months ago - and don't worry I will link
all of these sources in the bio - he said:
The article is actually a limited admission
of wrongness, and Krugman doesn't hesitate to
take pre-emptive snipes at would-be critics like me. But we have to ask why
he was even wronger than he thinks. And to do this we need to learn - and then
unlearn - some trade theory.
International trade theory begins - and for some, ends - with the 19th century economist David
Ricardo's idea of comparative advantage. Krugman called it 'Ricardo's difficult
idea' and chided journalists and pundits for not understanding it. An example like
this one is usually used to illustrate the principle. Here we have two countries -
England and Portugal - who can produce two different goods - cloth and wine. With an
hour of work the UK can produce either five pieces of cloth, or ten bottles of
wine. Portugal can produce 20 of either.
Ricardo argued that although it appears Portugal is dominant in this situation -
which might lead an unsophisticated observer to call for protectionism in
the UK - both countries will benefit from specializing in their so-called
comparative advantage, which just means using your own time most effectively to
produce. Here the UK is better at producing wine than it is at producing
cloth, so it should specialize in wine. Countries never have the same
comparative advantage in these examples so Portugal should produce cloth. By
doing this, then trading, each country ends up with more in total than they
could have produced alone. If the UK produces ten bottles of wine while
Portugal produces 20 pieces of cloth, the two countries can then trade six bottles
of wine for four pieces of cloth. Now after an hour of work the UK has four of
each, which would have taken them over an hour to produce. Portugal has six bottles
of wine and sixteen pieces of cloth, which would also have taken them over an
hour to produce. Trade effectively acts as a 'cheat': even if you are not the best
of producing something, you can sneakily access another country's ability to
produce it via the magic of trade.
It doesn't take much to see that this
example is hugely oversimplified. One key assumption of comparative advantage, as
well as the more advanced Heckscher-Ohlin model, is that countries
have a kind of innate propensity to produce particular goods, which doesn't
change with trade policy. When applied to the real world this amounts to saying
that Germans just have some innate ability or resource that makes them good
at producing cars, or that Japanese people have an innate knack for producing video games.
The Japanese!? Those sandal-wearing goldfish tenders?
In fact, it turns out comparative advantage isn't so good at explaining trade.
I'll let some guy explain why.
Economists talked about international
trade for a couple of centuries and for about 180 of those 200 years there
was a basic view which was that countries trade because they're
different: this country is tropical so it exports bananas; this country's got lots
of land so it exports wheat. And...there's been this...there was this kind of
building discontent because a lot of world trade is between countries that
don't look very different.
Krugman's work on theories of trade addressed at least
some of these concerns and is the reason he won the Nobel Prize in Economic
Sciences. Countries specialize because they face increasing returns: the more
they produce in a given industry, the lower the costs, and as certain countries
become established in certain industries others are unable to enter the market
and compete. As a result, different countries specialize in different
industries so they will benefit from trading with each other. Many of these
theories anticipate the problems we've seen in the real world, with trade
creating 'winners' and 'losers' in terms of income - even if overall income increases.
But Krugman recently admitted that even these improved models:
If you read his papers you will see
that they routinely assume full employment and it's kind of hard to talk
about unemployment when you assume that it doesn't exist. I don't want to get too
bogged down in the details of the theories because they are mathematically
complicated but in case you do I have linked Krugman's papers along with an
excellent short explainer by Jonathan Catalan in the bio.
What I want to ask is the following:
With Krugman's admission that despite
all these supposedly sophisticated developments in economic theory,
economists like him still underplayed the downsides of trade, what was the
point in using theory to analyze trade? Why was he so sure of his models in the
1990s - including comparative advantage - when refuting critics of globalization?
Paul Krugman is not stupid. In fact, he
has anticipated my objection by several decades, using a very clever argument.
One of Krugman's most relevant articles from the 90s is entitled 'the fall and rise
of development economics' which is what I will focus on in this part of the video.
Krugman discusses the evolution of economic theory as a process of first
building overly simplified models, only to bring realism back in as techniques
develop. Although there'll be a short-term loss of knowledge, the end point will be
a fuller understanding - or so his argument goes. He compares this process
to 15th century maps of Africa, which in many ways were inferior to the
non-scientific understanding the local populations had before. Over time though,
cartography gave us modern maps, which are superior to pre-scientific understanding
in many respects. Once again, a key part of this debate was increasing returns to
production, which was not originally feasible because the maths just didn't
work out. Instead, theorists had to assume costs
rose without put, an unrealistic assumption which a tutor of mine once said:
This assumption put the models at odds with theories
of development that held the stage at kickstart industry because these relied
on industry benefiting from economies of scale, growing in competitiveness until
the government could step aside. Krugman argues that the mathematical
models with increasing returns which were eventually developed by economists
were worth the wait.
Let's back up to summarize the debate so far:
All in all this is starting to feel a bit like...
I need to send this
parcel with the profit projections to Pete Porter in Pasadena. And it
absolutely positively has to be there overnight.
Pete Porter pass it on.
Pasadena promptly. Package for parcel processing pronto.
For Pete Porter in Pasadena.
Priority? Precisely.
Here's your package, Mr. Burns!
My name is the return address you senseless dunderpate!
Unlike 15th century maps, or Krugman's other example of meteorology, the more
advanced versions of economic theory do not seem to say much more than the
informal theories they replaced, and perhaps even say less. Krugman argues
that we had "no way to know" that the hyperglobalisation that began in the
1990s would happen, but this is false. A book Krugman called "thoroughly silly" in
the 1990s predicted globalization would leave:
Towards the end of The Fall and Rise of Development Economics
Krugman gives a list of reasons that models lead to greater
clarity than the informal theories they replaced. Instead of painstakingly going
through them one by one and responding, I'll just state my view on the matter
and leave you to come to your own conclusions,
including how my view relates to his should you care to read his essay - which
I do of course, recommend.
The problem is that economists tend to believe there is
some intrinsic benefits to putting ideas into mathematical models: they are their
own justification. In a 1979 paper Krugman outright stated that he was
simply creating a model for ideas which have been 'in the air' for some time. But
how much work is the model doing when it's telling us something we already
knew? Whatever mechanisms and variables are most important for 'proving' these
ideas mathematically are only relevant if you assume the model itself is. Even
worse, it's not clear economists are really willing to follow models to their
logical conclusions when they don't like these conclusions. In a 1997 article
Krugman proclaimed:
He goes on to defend free trade in spite of his own models.
At one point he states:
Now I have some sympathy for
this statement - it's sensible. The problem is that it has nothing to do
with trade models at the time, and once you open up the possibility of using ad
hoc, subjective reasons like this to reject models, it's not clear where you
draw the line. I could equally invoke reasons of
unemployment and community to defend protectionism, and they're not in the models
either. Or I could invoke political economy against free trade deals.
Dean Baker has a lot of excellent work on how, through patent laws, trade deals are
rigged to favor the wealthy. Dani Rodrik has discussed how stronger protections
against the downsides of trade can actually increase political support for
globalization over the long term. I would prefer a discourse which wrestled with
these different ideas in their own right, instead of waylaying and misdirecting
understanding for decades and even centuries. As a final point I want to say
that this is not a screed against models altogether. My rule is that if you want
to illustrate a principle, keep a model simple if you want to make it more
complex thing you need to show it's worth it. This is why despite everything
I actually prefer comparative advantage to Krugman's more complex trade theories
and that's why I spent some time explaining it to you. It's a neat way to
illustrate the gains from specialization and trade, and it's so obviously unrealistic
that, as long as it's taught properly, it would never be taken too literally. And
there is almost never a case for disregarding historical or qualitative
analysis over models of any kind.
Thanks for watching this video. Please like and
subscribe for more videos about economics. If you have any thoughts on
how to manage globalization or the uses and abuses of economic theory I'd love
to hear them