Krugman wins Nobel for trade theory

14th October, 2008

The Financial Times, 14 October 2008

The Nobel economics prize was awarded yesterday to Paul Krugman, one of the great popularisers of economic ideas and a trenchant critic of the Bush administration. However, the prize was awarded for work done almost three decades ago in developing what is known as “new trade theory” and “new economic geography”.

Earlier trade theories suggested that a country would trade with partners that were different – rich would trade with poor, and capital-intensive would trade with labour-intensive. In practice, rich countries tend to trade with other rich countries.

Mr Krugman’s analysis showed why this was to be expected: many products were most efficiently produced by large companies, but consumers wanted variety and would buy products from foreign giants as well as the dominant domestic corporations.

Mr Krugman’s ideas on the importance of economies of scale could be traced back to Adam Smith, but the new ingredient was a usable mathematical description of what was going on.

Economic geography uses much the same mathematics to explain the location of jobs and businesses. Mr Krugman showed that the forces of globalisation, far from creating a “flat world”, could enhance the power of global cities such as New York and London, because they could do business with a global market.

Mr Krugman, a professor at Princeton University and a prominent columnist for the New York Times, has long been seen as a future Nobel laureate. He won the John Bates Clark medal for young economists in 1991. Yet if the choice is not surprising, the timing – just before the US presidential election – might be. Mr Krugman is an influential and partisan political commentator.

His columns, first in Slate magazine and then the New York Times, were at first clever refutations of popular misconceptions about trade protection or the “new economy”, but they have become far more notable for their stinging attacks on the Bush administration. He has recently criticised Hank Paulson, the US Treasury secretary, for mishandling the credit crisis, while praising the British government for being “willing to think clearly about the financial crisis, and act quickly on its conclusions”. He also warned of the US housing bubble in 2005.

This is not the first time that the Nobel prize committee has recognised an economist with a public profile and an appetite for political debate. Joseph Stiglitz shared the prize in 2001, after a combative stint as chief economist of the World Bank; Milton Friedman was an early laureate in 1976.

Among professional economists, Mr Krugman is admired for his work on currency crises as well as the work on trade that won the prize. Avinash Dixit, a Princeton colleague, once described Krugman’s methods: “He spots an important economic issue months or years before anyone else. Then he constructs a model of it, which offers new and unexpected insight. Soon the issue reaches general attention, and Krugman’s model is waiting for other economists to catch up.”

Mr Krugman’s trade model showed that there were circumstances in which trade protection could be in a nation’s economic interest. This idea was joyfully embraced by protectionists, and Mr Krugman spent much of the 1990s vigorously defending free trade and arguing that trade protection in practice was almost always harmful.

The experience may have fuelled his enthusiasm for economic popularisation, although even his early writing betrayed a wit and clarity not common amongst economists: he wrote, in 1978, “A theory of interstellar trade”, commenting that it was “a serious analysis of a ridiculous subject, which is of course the opposite of what is usual in economics.”

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