Economics Articles by Paul Krugman

Scrounged from the Internet and Compiled by Erik V.
with ratings indicated by *
Economics Articles
by Paul Krugman
• There is something about macro ***

• The world’s smallest macroeconomic model **
• The rise and fall of development economics **
• Is capitalism too productive? **
• Capitalism’s mysterious triumph *
• Soft microeconomics: The squishy case against
you-know-who **
• In praise of cheap labor **
• The spiral of inequality ***
• Economic culture wars **
• Ricardo’s difficult idea ***
• What economists can learn from evolutionary
theorists **
• What should trade negotiators negotiate about: A
review essay *
• Requiem for the New Economy: Millennial
optimism confronts reality *
Paul Krugman’s Articles 2
There is something about Macro
Paul Krugman
It's holiday season, and my thoughts have turned to ... course preparation. Classes don't begin until February, but
books must be ordered, reading packets must receive copyright clearance and go to Graphic Arts, and background
notes must be prepared.
This spring I have a new assignment: to teach Macroeconomics I for graduate students. Ordinarily this course is
taught by someone who specializes in macroeconomics; and whatever topics my popular writings may cover, my
professional specialties are international trade and finance, not general macroeconomic theory. However, MIT has a
temporary staffing problem, which is itself revealing of the current state of macro, and I have been called in to fill
the gap.
Here's the problem: Macro I (that's 14.451 in MIT lingo) is a quarter course, which is supposed to cover the
"workhorse" models of the field - the standard approaches that everyone is supposed to know, the models that
underlie discussion at, say, the Fed, Treasury, and the IMF. In particular, it is supposed to provide an overview of
such items as the IS-LM model of monetary and fiscal policy, the AS-AD approach to short-run versus long-run
analysis, and so on. By the standards of modern macro theory, this is crude and simplistic stuff, so you might think
that any trained macroeconomist could teach it. But it turns out that that isn't true.
You see, younger macroeconomists - say, those under 40 or so - by and large don't know this stuff. Their teachers
regarded such constructs as the IS-LM model as too ad hoc, too simplistic, even to be worth teaching - after all, they
could not serve as the basis for a dissertation. Now our younger macro people are certainly very smart, and could
learn the material in order to teach it - but they would find it strange, even repugnant. So in order to teach this course
MIT has relied, for as long as I can remember, on economists who learned old-fashioned macro before it came to be
regarded with contempt. For a variety of reasons, however, we can't turn to the usual suspects this year: Stan Fischer
has left to run the world, Rudi Dornbusch is otherwise occupied, Olivier Blanchard is department head, Ricardo
Caballero - who is a bit young for the role, but can swallow his distaste if necessary - is on leave. All of which
leaves me.
Now you might say, if this stuff is so out of fashion, shouldn't it be dropped from the curriculum? But the funny
thing is that while old-fashioned macro has increasingly been pushed out of graduate programs - it takes up only a
few pages in either the Blanchard-Fischer or Romer textbooks that I am assigning, and none at all in many other
tracts - out there in the real world it continues to be the main basis for serious discussion. After 25 years of rational
expectations, equilibrium business cycles, growth and new growth, and so on, when the talk turns to Greenspan's
next move, or the prospects for EMU, or the risks to the Brazilian rescue plan, it is always informed - explicitly or
implicitly - by something not too different from the old-fashioned macro that I am supposed to teach in February.
Why does the old-fashioned stuff persist in this way? I don't think the answer is intellectual conservatism.
Economists, in fact, are in general neophiles, always looking for something radical and different. Anyway, I have
seen over and over again how young economists, trained to regard IS-LM and all that with contempt if they even
know what it is, find themselves turning to it after a few years in Washington or New York. There's something about
primeval macro that pulls us back to it; if Hicks hadn't invented IS-LM in 1937, we would end up inventing it all
over again.
But what is it that makes old-fashioned macro so compelling? To answer that question, I find it helpful to think
about where it came from in the first place.
Afficionados know that much of what we now think of as Keynesian economics actually comes from John Hicks,
whose 1937 article "Mr. Keynes and the classics" introduced the IS-LM model, a concise statement of an argument
that may or may not have been what Keynes meant to say, but has certainly ended up defining what the world thinks
he said. But how did Hicks come up with that concise statement? To answer that question we need only look at the
book he himself was writing at the time, Value and Capital, which has in a low-key way been as influential as
Keynes' General Theory.
Value and Capital may be thought of as an extended answer to the question, "How do we think coherently about the
interrelationships among markets - about the impact of the price of hogs on that of corn and vice versa? How does
the whole system fit together?" Economists had long understood how to think about a single market in isolation -
that's what supply-and-demand is all about. And in some areas - notably international trade - they had thought
through how things fitted together in an economy producing two goods. But what about economies with three or
more goods, where some pairs of goods might be substitutes, others complements, and so on?
This is not the place to go at length into the way that Hicks (and others working at the same time) put the story of
"general equilibrium" together. But to understand where IS-LM came from - and why it continues to reappear - it
helps to think about the simplest case in which something more than supply and demand curves becomes necessary:
a three good economy. Let us simply call the goods X, Y, and Z - and let Z be the "numeraire", the good in terms of
which prices are measured.
Now equilibrium in a three-good model can be represented by drawing curves that indicate combinations of prices
for which each of the three markets is in equilibrium. Thus in Figure 1 the prices of X and Y, both in terms of Z, are
shown on the axes. The line labeled X shows price combinations for which demand and supply of X are equal;
similarly with Y and Z. Although there are three curves, Walras' Law (if all markets but one are in equilibrium, that
market is in equilibrium too) tells us that they have a common intersection, which defines equilibrium prices for the
economy as a whole. The slopes of the curves are drawn on the assumption that "own-price" effects are negative,
cross-price effects positive - thus an increase in the price of X increases demand for Y, driving the price of Y up,
and vice versa; it is also, of course, possible to introduce complementarity into such a framework, which was one of
its main points.
This diagram is simply standard, uncontroversial microeconomics. What does it have to do with macro?
Well, suppose you wanted a first-pass framework for thinking coherently about macro-type issues, such as the
interest rate and the price level. At minimum such a framework would require consideration of the supply and
demand for goods, so that it could be used to discuss the price level; the supply and demand for bonds, so that it
could be used to discuss the interest rate; and, of course, the supply and demand for money.
What, then, could be more natural than to think of goods in general, bonds, and money as if they were the three
goods of Figure 1? Put the price of goods - aka the general price level - on one axis, and the price of bonds (1
divided by 1+i, if they are one-period bonds) on the other; and you have something like Figure 2 - or, more
conventionally putting the interest rate instead of the price of bonds on the vertical axis, something like Figure 3.
And already we have a picture that is essentially Patinkin's flexible-price version of IS-LM.
If you try to read pre-Keynesian monetary theory, or for that matter talk about such matters either with modern
laymen or with modern graduate students who haven't seen this sort of thing, you quickly realize that this seemingly
trivial formulation is actually a powerful tool for clarifying thought, precisely because it is a general-equilibrium
framework that takes the interactions of markets into account. Here are some of the things it suddenly makes clear:
1. What determines interest rates? Before Keynes-Hicks - and even to some extent after - there has seemed to be a
conflict between the idea that the interest rate adjusts to make savings and investment equal, and that it is
determined by the choice between bonds and money. Which is it? The answer, of course - but it is only "of course"
once you've approached the issue the right way - is both: we're talking general equilibrium here, and the interest rate
and price level are jointly determined in both markets.
2. How can an investment boom cause inflation (and an investment slump cause deflation)? Before Keynes this was
a subject of vast confusion, with all sorts of murky stuff about "lengthening periods of production", "forced saving",
and so on. But once you are thinking three-good general equilibrium, it becomes a simple matter. When investment
(or consumer) demand is high - when people are eager to borrow to buy real goods - they are in effect trying to shift
from bonds to goods. So as shown in Figure 4, both the bond-market and goods-market equilibrium schedules, but
not the money-market schedule, shift; and the result is both inflation and a rise in the interest rate.
3. How can we distinguish between monetary and fiscal policy? Well, in a fiscal expansion the government sells
bonds and buys goods - producing the same shifts in schedules shown in Figure 4. In a monetary expansion it buys
bonds and "sells" newly printed money, shifting the bonds and money (but not goods) schedules as shown in Figure
5.
Of course, this is all still a theory of "money, interest, and prices" (Patinkin's title), not "employment, interest, and
money" (Keynes'). To make the transition we must introduce some kind of price-stickiness, so that incipient
deflation is at least partly translated into output decline; and then we must consider the multiplier impacts of that
output decline, and so on. But the basic form of the analysis still comes from the idea of a three-good general-
equilibrium model in which the three goods are "goods in general", bonds, and money.
Sixty years on, the intellectual problems with doing macro this way are well known. First of all, the idea of treating
money as an ordinary good begs many questions: surely money plays a special sort of role in the economy. Second,
almost all the decisions that presumably underlie the schedules here involve choices over time: this is true of
investment, consumption, even money demand. So there is something not quite right about pretending that prices
and interest rates are determined by a static equilibrium problem. (Of course, Hicks knew about that, and was quite
self-conscious about the limitations of his "temporary equilibrium" method). Finally, sticky prices play a crucial role
in converting this into a theory of real economic fluctuations; while I regard the evidence for such stickiness as
overwhelming, the assumption of at least temporarily rigid nominal prices is one of those things that works
beautifully in practice but very badly in theory.
But step back from the controversies, and put yourself in the position of someone who must reach a judgement about
the likely impact of a change in monetary policy, or an investment slump, or a fiscal expansion. It would be
cumbersome to try, every time, to write out an intertemporal-maximization framework, with microfoundations for
money and price behavior, and try to map that into the limited data available. Surely you will find yourself trying to
keep track of as few things as possible, to devise a working model - a scratchpad for your thoughts - that respects the
essential adding-up constraints, that represents the motives and behavior of individuals in a sensible way, yet has no
superfluous moving parts. And that is what the quasi-static, goods-bonds-money model is - and that is why old-
fashioned macro, which is basically about that model, remains so useful a tool for practical policy analysis.
The World’s Smallest Macroeconomic Model
Paul Krugman
I learned this model from Robert Hall back in 1975. It can seem silly and trivial; but it seemed to me then, and still
seems to me now, to capture the essence of what is going on in "demand-side" macroeconomics, and to clarify
points that both the general public and, I'm sorry to say, quite a few Ph.D. economists often seem to find confusing.
It also maps pretty well into my favorite economic parable, the story of the baby-sitting coop ("Baby-sitting the
economy") that I have put to good use a number of times.
There is only one good, produced at constant returns by the single factor of production, labor. Choose units so that
one unit of labor produces one unit of the good; then the price level and wage rate must be the same, and can be
referred to with a single symbol, P.
There is also only one asset, money. Agents start the current period with M dollars, and end with M' after spending
on consumption and earning from the sale of their labor. They derive utility both from consumption and from the
expected purchasing power of the money they hold at the end of the period. (The utility of money presumably
reflects its usefulness in providing future consumption; but we sweep this implicit dynamic problem under the rug).
The utility function is assumed to take a specific form:
U = (1-s) ln(C) + s ln (M'/Pe)
where Pe is the expected price level. However, consumers are also assumed to have static expectations, so that Pe =
P.
Finally, people are assumed to be endowed with L units of labor.
First, let us consider the full-employment version of the model. If labor is fully employed, then the budget constraint
is
C + M'/P = L + M/P
But if the money supply is constant, M' = M; also, C = L. Given the utility function, consumers will spend a share 1-
s of their initial wealth on goods, s on money. So we can represent equilibrium either by the condition that demand
for goods equal supply,
L = (1-s)(L + M/P)
or by the condition that demand for money equal supply,
M/P = s(L + M/P).
Both ways of looking at it imply the price-level equation
P = [(1-s)/s)](M/L)
so the price level is proportional to the money supply.
But now let us introduce some rigidity of prices. Suppose that for some reason - never mind why - the price (wage)
level is fixed above the level consistent with full employment, so that real balances M/P are too low. There are two
ways of describing the problem this poses. You could say that at full employment the demand for real balances
would exceed the supply:
M/P < s(L + M/P)
Or you could say that at full employment aggregate demand would fall short of output:
(1-s)(L + M/P) < L
These are just different ways of looking at the same thing.
What must happen, then, is that output is demand-constrained. But that in turn means that employment, and hence
income, is also demand-constrained: the equation for consumption, which must equal output, is
C = (1-s)(C + M/P)
which has an immediately identifiable "multiplier" flavor.
The clear policy implication is that one should increase output by increasing the money supply; after all,
C = ((1-s)/s)(M/P)
Or, to put it differently, the problem is that at full employment the public would want to hold more real balances
than there are available; and because P will not fall, M must be increased.
This is presumably the meaning of John Maynard Keynes' famous remark in The General Theory:
"Unemployment develops, that is to say, because people want the moon: men cannot be employed when the object
of desire (i.e. money) is something which cannot be produced and the demand for which cannot readily be choked
off. There is no remedy but to persuade the public that green cheese is practically the same thing and to have a green
cheese factory (i.e. central bank) under public control."
What is wrong with this model? Don't get me started ... but actually there are three main objections that
macroeconomists are likely to raise:
1. What happened to the interest rate? For most purposes we will want at the minimum a theory of employment,
interest, and money; that means a model with bonds as well as money and goods, which means IS-LM. (See my note
"There's something about macro").
2. More fundamentally, the quasi-static approach here is at best a crude approximation to a dynamic model in which
behavior results from plans that are based on expectations about the future.
3. Finally, the output effects of money come from the assumption of price rigidity. Where does that come from?
(Overwhelming empirical evidence, that's where - but why?).
All these objections help to set the agenda for the last six decades of research.
But if you are one of those people to whom macroeconomics always sounds like witchcraft, who is hung up on Say's
Law, who cannot even comprehend how a shortfall of aggregate demand is possible - then the world's smallest
macro model is a good place to start on the road to enlightenment.
The Rise and Fall of Development Economics
Paul Krugman
This is not exactly a paper about Albert Hirschman.
In the first place, I am unqualified to write such a paper. My acquaintance with Hirschman's works is very limited.
In essence, the Hirschman I know is the author of The Strategy of Economic Development and little else. So I am in
no position to write about his larger vision.
Furthermore, while I am a great admirer of The Strategy of Economic Development, I do not think that it was
helpful to development economics. That may sound paradoxical, but I'll try to explain what I mean as I go along. To
put it briefly, however, I regard the intellectual strategy that Hirschman adopted in writing that book as an
understandable but wrong response to what had become a crisis in the field of economic development. Perversely,
the very brilliance and persuasiveness of the book made it all the more destructive.
If this paper is not about Hirschman, what is it about? It is some reflections on two intertwined themes. One is the
strange history of development economics, or more specifically the linked set of ideas that I have elsewhere
(Krugman 1993) called "high development theory.” This set of ideas was and is highly persuasive as at least a partial
explanation of what development is about, and for a stretch of about 15 years in the 1940s and 1950s it was deeply
influential among both economists and policymakers. Yet in the late 1950s high development theory rapidly
unravelled, to the point where by the time I studied economics in the 1970s it seemed not so much wrong as
incomprehensible. Only in the 1980s and 1990s were economists able to look at high development theory with a
fresh eye and see that it really does make a lot of sense, after all.
The second theme is the problem of method in the social sciences. As I will argue, the crisis of high development
theory in the late 1950s was neither empirical nor ideological: it was methodological. High development theorists
were having a hard time expressing their ideas in the kind of tightly specified models that were increasingly
becoming the unique language of discourse of economic analysis. They were faced with the choice of either
adopting that increasingly dominant intellectual style, or finding themselves pushed into the intellectual periphery.
They didn't make the transition, and as a result high development theory was largely purged from economics, even
development economics.
Hirschman's Strategy appeared at a critical point in this methodological crisis. It is a rich book, full of stimulating
ideas. Its most important message at that time, however, was a rejection of the drive toward rigor. In effect,
Hirschman said that both the theorist and the practical policy-maker could and should ignore the pressures to
produce buttoned-down, mathematically consistent analyses, and adopt instead a sort of muscular pragmatism in
grappling with the problem of development. Along with some others, notably Myrdal, Hirschman didn't wait for
intellectual exile: he proudly gathered up his followers and led them into the wilderness himself. Unfortunately, they
perished there.
The irony is that we can now see that high development theory made perfectly good sense after all. But in order to
see that, we need to adopt exactly the intellectual attitude Hirschman rejected: a willingness to do violence to the
richness and complexity of the real world in order to produce controlled, silly models that illustrate key concepts.
This paper, then, is a meditation on economic methodology, inspired by the history of development economics, in
which Albert Hirschman appears as a major character. I hope that it is clear how much I admire his work; he is not a
villain in this story so much as a tragic hero.
THE FALL AND RISE OF DEVELOPMENT ECONOMICS
The glory days of "high development theory" spanned about 15 years, from the seminal paper of Rosenstein Rodan
(1943) to the publication of Hirschman's Strategy (1958).
Loosely, high development theory can be described as the view that development is a virtuous circle driven by
external economies -- that is, that modernization breeds modernization. Some countries, according to this view,
remain underdeveloped because they have failed to get this virtuous circle going, and thus remain stuck in a low
level trap. Such a view implies a powerful case for government activism as a way of breaking out of this trap.
It's not that easy, of course -- just asserting that there are virtuous and vicious circles does not qualify as a theory.
(Although Myrdal (1957) is essentially a tract that emphasizes the importance of "circular and cumulative causation"
without -- unlike Hirschman (1958), which is often treated as a counterpart work -- providing much in the way of
concrete examples of how it might arise). The distinctive features of high development theory came out of its
explanation of the nature of the positive feedback that can lead to self-reinforcing growth or stagnation.
In most versions of high development theory, the self-reinforcement came from an interaction between economies of
scale at the level of the individual producer and the size of the market. Crucial to this interaction was some form of
economic dualism, in which "traditional" production paid lower wages and/or participated in the market less than the
modern sector. The story then went something like this: modern methods of production are potentially more
productive than traditional ones, but their productivity edge is large enough to compensate for the necessity of
paying higher wages only if the market is large enough. But the size of the market depends on the extent to which
modern techniques are adopted, because workers in the modern sector earn higher wages and/or participate in the
market economy more than traditional workers. So if modernization can be gotten started on a sufficiently large
scale, it will be self-sustaining, but it is possible for an economy to get caught in a trap in which the process never
gets going.
The clearest and simplest version of this story is in the original paper by Rosenstein Rodan (1943) himself. In that
seminal paper, he illustrated his argument for coordinated investment by imagining a country in which 20,000 (!)
"unemployed workers ... are taken from the land and put into a large new shoe factory. They receive wages
substantially higher than their previous income in natura." Rosenstein-Rodan then went on to argue that this
investment is likely to be unprofitable in isolation, but profitable if accompanied by similar investments in many
other industries. Both key assumptions are clearly present: the assumption of economies of scale, embodied in the
assertion that the factory must be established at such a large scale, and the assumption of dualism, embedded in the
idea that these workers can be drawn from unemployment or low paying agricultural employment.
I regard Rosenstein Rodan's Big Push story as the essential high development model. Admittedly, some of the
classics of high development theory differed in their emphasis from this central vision. On one side, Arthur Lewis's
famous "Economic development with unlimited supplies of labor" emphasized dualism while ignoring the role of
economies of scale and circular causation. On the other side, some authors, notably Fleming (1954), argued that
owing to the role of intermediate goods in production -- what Hirschman would later memorably dub forward and
backward linkages -- self-reinforcing development could conceivably occur even without dualism.
There were also disputes over the nature of the policies that might be required to break a country out of a low-level
trap. Rosenstein Rodan and others appeared to imply that a coordinated, broadly based investment program -- the
Big Push -- would be required. Hirschman disagreed, arguing that a policy of promoting a few key sectors with
strong linkages, then moving on to other sectors to correct the disequilibrium generated by these investments, and so
on, was actually the right approach. Indeed, Hirschman structured his book as an argument with what he called the
"balanced growth" school. He did not acknowledge that he had far more in common with Rosenstein Rodan and
other "balanced growth" advocates like Nurkse (1953) than any of them had with the way that mainstream
economics was going.
For mainstream economics was, by the late 1950s, becoming increasingly hostile to the kinds of ideas involved in
high development theory. Above all, economics was going through an extended period in which increasing returns
to scale, so central to that theory, tended to disappear from discourse.
It may not be obvious just how crucial economies of scale were to high development theory. One of the
characteristics of the writing of many of its expositors was a certain vagueness that makes it hard to know exactly
what the essence of their arguments were -- a vagueness that, as we will soon see, was no accident. Still, if reads
carefully, one finds that increasing returns are invariably crucial to the argument.
Consider, for example, what may have been Hirschman's most cited concept, that of "linkages." Some crude
followers of Hirschman have identified these directly with having a lot of entries in the input-output table.1 But
Hirschman's own discussion makes it clear that the idea involved the interaction between market size and economies
of scale.
In Hirschman's definition of backward linkages the role of market-size externalities linked to economies of scale is
quite explicit: an industry creates a backward linkage when its demand enables an upstream industry to be
established at at least minimum economic scale. The strength of an industry's backward linkages is to be measured
by the probability that it will in fact push other industries over the threshhold.
Forward linkages are also defined by Hirschman as involving an interaction between scale and market size; in this
case the definition is vaguer, but seems to involve the ability of an industry to reduce the costs of potential
downstream users of its products and thus, again, push them over the threshhold of profitability.
So economies of scale were crucial to high development theory. Why did that present a problem? Because
economies of scale were very difficult to introduce into the increasingly formal models of mainstream economic
theory.
THE EVOLUTION OF IGNORANCE
A friend of mine who combines a professional interest in Africa with a hobby of collecting antique maps has written
a fascinating paper called "The evolution of European ignorance about Africa." The paper describes how European
maps of the African continent evolved from the 15th to the 19th centuries.
You might have supposed that the process would have been more or less linear: as European knowledge of the
continent advanced, the maps would have shown both increasing accuracy and increasing levels of detail. But that's
not what happened. In the 15th century, maps of Africa were, of course, quite inaccurate about distances, coastlines,
and so on. They did, however, contain quite a lot of information about the interior, based essentially on second- or
third-hand travellers' reports. Thus the maps showed Timbuktu, the River Niger, and so forth. Admittedly, they also
contained quite a lot of untrue information, like regions inhabited by men with their mouths in their stomachs. Still,
in the early 15th century Africa on maps was a filled space.
Over time, the art of mapmaking and the quality of information used to make maps got steadily better. The coastline
of Africa was first explored, then plotted with growing accuracy, and by the 18th century that coastline was shown
in a manner essentially indistinguishable from that of modern maps. Cities and peoples along the coast were also
shown with great fidelity.
On the other hand, the interior emptied out. The weird mythical creatures were gone, but so were the real cities and
rivers. In a way, Europeans had become more ignorant about Africa than they had been before.
It should be obvious what happened: the improvement in the art of mapmaking raised the standard for what was
considered valid data. Second-hand reports of the form "six days south of the end of the desert you encounter a vast
river flowing from east to west" were no longer something you would use to draw your map. Only features of the
landscape that had been visited by reliable informants equipped with sextants and compasses now qualified. And so
the crowded if confused continental interior of the old maps became "darkest Africa,” an empty space.
1
One US industrial policy advocate suggested that we target industries that either "provide inputs to or use inputs
from a large number of other industries." I have often wondered what industry does not meet this criterion -- hand
thrown pottery?
Of course, by the end of the 19th century darkest Africa had been explored, and mapped accurately. In the end, the
rigor of modern cartography led to infinitely better maps. But there was an extended period in which improved
technique actually led to some loss in knowledge.
Between the 1940s and the 1970s something similar happened to economics. A rise in the standards of rigor and
logic led to a much improved level of understanding of some things, but also led for a time to an unwillingness to
confront those areas the new technical rigor could not yet reach. Areas of inquiry that had been filled in, however
imperfectly, became blanks. Only gradually, over an extended period, did these dark regions get re-explored.
Economics has always been unique among the social sciences for its reliance on numerical examples and
mathematical models. David Ricardo's theories of comparative advantage and land rent are as tightly specified as
any modern economist could want. Nonetheless, in the early 20th century economic analysis was, by modern
standards, marked by a good deal of fuzziness. In the case of Alfred Marshall, whose influence dominated
economics until the 1930s, this fuzziness was deliberate: an able mathematician, Marshall actually worked out many
of his ideas through formal models in private, then tucked them away in appendices or even suppressed them when
it came to publishing his books. Tjalling Koopmans, one of the founders of econometrics, was later to refer
caustically to Marshall's style as "diplomatic": analytical difficulties and fine points were smoothed over with
parables and metaphors, rather than tackled in full view of the reader. (By the way, I personally regard Marshall as
one of the greatest of all economists. His works remain remarkable in their range of insight; one only wishes that
they were more widely read).
High development theorists followed Marshall's example. From the point of view of a modern economist, the most
striking feature of the works of high development theory is their adherence to a discursive, non-mathematical style.
Economics has, of course, become vastly more mathematical over time. Nonetheless, development economics was
archaic in style even for its own time. Of the four most famous high development works, Rosenstein Rodan's was
approximately contemporary with Samuelson's formulation of the Heckscher-Ohlin model, while Lewis, Myrdal,
and Hirschman were all roughly contemporary with Robert Solow's initial statement of growth theory.
As in Marshall's case, this was not because development economists were peculiarly mathematically incapable.
Hirschman made a significant contribution to the formal theory of devaluation in the 1940s, while Fleming helped
create the still influential Mundell-Fleming model of floating exchange rates. Moreover, the development field itself
was at the same time generating mathematical planning models -- first Harrod-Domar type growth models, then
linear programming approaches -- that were actually quite technically advanced for their time.
So why didn't high development theory get expressed in formal models? Almost certainly for one basic reason: high
development theory rested critically on the assumption of economies of scale, but nobody knew how to put these
scale economies into formal models.
The essential problem is that of market structure. From Ricardo until about 1975, what economists knew how to
model formally was a perfectly competitive economy, one in which firms take prices as given rather than actively
trying to affect them. There is a standard theory of the behavior of an individual monopolist who faces no
comparably-sized competitors, but there is no general theory of how oligopolists, firms who have substantial market
power but also face large rivals, will set prices and output. Still less is there any general approach to modeling the
aggregate behavior of a whole economy largely peopled by oligopolistic rather than perfectly competitive industries.
Since the mid 1970s economists have broken through this barrier in a number of fields: international trade,
economic growth, and, finally, development. The way they have done this is essentially by making some peculiar
assumptions that allow them to exploit the bag of tricks that industrial organization theorists developed for thinking
about such issues in the 1970s. (We'll see an example of the power and limitations of this kind of intellectual
trickery below, when I present a quick formal version of the Big Push story). In the 1950s, although the technical
level of the leading development economists was actually quite high enough to have allowed them to do the same
thing, the bag of tricks wasn't there. So development theorists were placed in an awkward bind, with basically
sensible ideas that they could not quite express in fully worked-out models. And the drift of the economics
profession made the situation worse. In the 1940s and even in the 1950s it was still possible for an economist to
publish a paper that made persuasive points verbally, without tying up all the loose ends. After 1960, however, an
attempt to publish a paper like Rosenstein Rodan's would have immediately gotten a grilling: "Why not build a
smaller factory (for which the market is adequate)? Oh, you're assuming economies of scale? But that means
imperfect competition, and nobody knows how to model that, so this paper doesn't make any sense." It seems safe to
say that such a paper would have been unpublishable any time after 1970, if not earlier.
Some development theorists responded by getting as close to a formal model as they could. This is to some extent
true of Rosenstein Rodan, and certainly the case for Fleming (1954), which gets painfully close to being a full
model. But others at least professed to see a less formal, less disciplined approach as a virtue rather than an awkward
necessity. It is in this light that one needs to see Hirschman and Myrdal. These authors are often cited today (by me
among others) as forerunners of the recent emphasis in several fields on strategic complementarity. In fact, however,
their books marked the end, not the beginning of high development theory. Myrdal's central thesis was the idea of
"circular causation." But the idea of circular causation is essentially already there in Allyn Young (1928), not to
mention Rosenstein Rodan, and Nurkse in 1952 referred repeatedly to the circular nature of the problem of getting
growth going in poor countries. So Myrdal was in effect providing a capsulization of an already extensive and
familiar set of ideas rather than a new departure. Similarly, Hirschman's distinctive idea of linkages was more
distinctive for the effectiveness of the term and the policy advice that he derived loosely from it than for its
intellectual novelty; in effect Rosenstein Rodan was already talking about linkages, and Fleming very explicitly had
both forward and backward linkages in his discussion.
What marked Myrdal and Hirschman was not so much the novelty of their ideas but their stylistic and
methodological stance. Until their books, economists doing high development theory were trying to be good
mainstream economists. They could not develop full formal models, but they got as close as they could, trying to
keep close to the increasingly model-oriented mainstream. Myrdal and Hirschman abandoned this effort, and
eventually in effect took stands on principle against any effort to formalize their ideas.
One imagines that this was initially very liberating for them and their followers. Yet in the end it was a vain stance.
Economic theory is essentially a collection of models. Broad insights that are not expressed in model form may
temporarily attract attention and even win converts, but they do not endure unless codified in a reproducible -- and
teachable -- form. You may not like this tendency; certainly economists tend to be too quick to dismiss what has not
been formalized (although I believe that the focus on models is basically right). Like it or not, however, the
influence of ideas that have not been embalmed in models soon decays. And this was the fate of high development
theory. Myrdal's effective presentation of the idea of circular and cumulative causation, or Hirschman's evocation of
linkages, were stimulating and immensely influential in the 1950s and early 1960s. By the 1970s (when I was
myself a student of economics), they had come to seem not so much wrong as meaningless. What were these guys
talking about? Where were the models? And so high development theory was not so much rejected as simply
bypassed.
The exception proves the rule. Lewis's surplus labor concept was the model that launched a thousand papers, even
though surplus labor assumptions were already standard among development theorists, the empirical basis for
assuming surplus labor was weak, and the idea of external economies/strategic complementarity is surely more
interesting. The point was, of course, that precisely because he did not mix economies of scale into his framework,
Lewis offered theorists something they could model using available tools.
METAPHORS AND MODELS
I have just acknowledged that the tendency of economists to emphasize what they know how to model formally can
create blind spots; yet I have also claimed that the insistence on modeling is basically right. What I want to do now
is call a time out and discuss more broadly the role of models in social science.
It is said that those who can, do, while those who cannot, discuss methodology. So the very fact that I raise the issue
of methodology in this paper tells you something about the state of economics. Yet in some ways the problems of
economics and of social science in general are part of a broader methodological problem that afflicts many fields:
how to deal with complex systems.
It is in a way unfortunate that for many of us the image of a successful field of scientific endeavor is basic physics.
The objective of the most basic physics is a complete description of what happens. In principle and apparently in
practice, quantum mechanics gives a complete account of what goes on inside, say, a hydrogen atom. But most
things we want to analyze, even in physical science, cannot be dealt with at that level of completeness. The only
exact model of the global weather system is that system itself. Any model of that system is therefore to some degree
a falsification: it leaves out some (many) aspects of reality.
How, then, does the meteorological researcher decide what to put into his model? And how does he decide whether
his model is a good one? The answer to the first question is that the choice of model represents a mixture of
judgement and compromise. The model must be something you know how to make -- that is, you are constrained by
your modeling techniques. And the model must be something you can construct given your resources -- time,
money, and patience are not unlimited. There may be a wide variety of models possible given those constraints;
which one or ones you choose actually to build depends on educated guessing.
And how do you know that the model is good? It will never be right in the way that quantum electrodynamics is
right. At a certain point you may be good enough at predicting that your results can be put to repeated practical use,
like the giant weather-forecasting models that run on today's supercomputers; in that case predictive success can be
measured in terms of dollars and cents, and the improvement of models becomes a quantifiable matter. In the early
stages of a complex science, however, the criterion for a good model is more subjective: it is a good model if it
succeeds in explaining or rationalizing some of what you see in the world in a way that you might not have
expected.
Notice that I have not specified exactly what I mean by a model. You may think that I must mean a mathematical
model, perhaps a computer simulation. And indeed that's mostly what we have to work with in economics. But a
model can equally well be a physical one, and I'd like to describe briefly an example from the pre-computer era of
meteorological research: Fultz's dish-pan.
Dave Fultz was a meteorological theorist at the University of Chicago, who asked the following question: what
factors are essential to generating the complexity of actual weather? Is it a process that depends on the full
complexity of the world -- the interaction of ocean currents and the atmosphere, the locations of mountain ranges,
the alternation of the seasons, and so on -- or does the basic pattern of weather, for all its complexity, have simple
roots?
He was able to show the essential simplicity of the weather's causes with a "model" that consisted of a dish-pan
filled with water, placed on a slowly rotating turntable, with an electric heating element bent around the outside of
the pan. Aluminum flakes were suspended in the water, so that a camera perched overhead and rotating with the pan
could take pictures of the pattern of flow.
The setup was designed to reproduce two features of the global weather pattern: the temperature differential between
the poles and the equator, and the Coriolis force that results from the Earth's spin. Everything else -- all the rich
detail of the actual planet -- was suppressed. And yet the dish-pan exhibited an unmistakable resemblance to actual
weather patterns: a steady flow near the rim evidently corresponding to the trade winds, constantly shifting eddies
reminiscent of temperate-zone storm systems, even a rapidly moving ribbon of water that looked like the recently
discovered jet stream.
What did one learn from the dish-pan? It was not telling an entirely true story: the Earth is not flat, air is not water,
the real world has oceans and mountain ranges and for that matter two hemispheres. The unrealism of Fultz's model
world was dictated by what he was able to or could be bothered to build -- in effect, by the limitations of his
modeling technique. Nonetheless, the model did convey a powerful insight into why the weather system behaves the
way it does.
The important point is that any kind of model of a complex system -- a physical model, a computer simulation, or a
pencil-and-paper mathematical representation -- amounts to pretty much the same kind of procedure. You make a set
of clearly untrue simplifications to get the system down to something you can handle; those simplifications are
dictated partly by guesses about what is important, partly by the modeling techniques available. And the end result,
if the model is a good one, is an improved insight into why the vastly more complex real system behaves the way it
does.
When it comes to physical science, few people have problems with this idea. When we turn to social science,
however, the whole issue of modeling begins to raise people's hackles. Suddenly the idea of representing the
relevant system through a set of simplifications that are dictated at least in part by the available techniques becomes
highly objectionable. Everyone accepts that it was reasonable for Fultz to represent the Earth, at least for a first pass,
with a flat dish, because that was what was practical. But what do you think about the decision of most economists
between 1820 and 1970 to represent the economy as a set of perfectly competitive markets, because a model of
perfect competition was what they knew how to build? It's essentially the same thing, but it raises howls of
indignation.
Why is our attitude so different when we come to social science? There are some discreditable reasons: like
Victorians offended by the suggestion that they were descended from apes, some humanists imagine that their
dignity is threatened when human society is represented as the moral equivalent of a dish on a turntable. Also, the
most vociferous critics of economic models are often politically motivated. They have very strong ideas about what
they want to believe; their convictions are essentially driven by values rather than analysis, but when an analysis
threatens those beliefs they prefer to attack its assumptions rather than examine the basis for their own beliefs.
Still, there are highly intelligent and objective thinkers who are repelled by simplistic models for a much better
reason: they are very aware that the act of building a model involves loss as well as gain. Africa isn't empty, but the
act of making accurate maps can get you into the habit of imagining that it is. Model-building, especially in its early
stages, involves the evolution of ignorance as well as knowledge; and someone with powerful intuition, with a deep
sense of the complexities of reality, may well feel that from his point of view more is lost than is gained. It is in this
honorable camp that I would put Albert Hirschman and his rejection of mainstream economics.
The cycle of knowledge lost before it can be regained seems to be an inevitable part of formal model-building.
Here's another story from meteorology. Folk wisdom has always said that you can predict future weather from the
aspect of the sky, and had claimed that certain kinds of clouds presaged storms. As meteorology developed in the
19th and early 20th centuries, however -- as it made such fundamental discoveries, completely unknown to folk
wisdom, as the fact that the winds in a storm blow in a circular path -- it basically stopped paying attention to how
the sky looked. Serious students of the weather studied wind direction and barometric pressure, not the pretty
patterns made by condensing water vapor.
It was not until 1919 that a group of Norwegian scientists realized that the folk wisdom had been right all along --
that one could identify the onset and development of a cyclonic storm quite accurately by looking at the shapes and
altitude of the cloud cover.
The point is not that a century of research into the weather had only reaffirmed what everyone knew from the
beginning. The meteorology of 1919 had learned many things of which folklore was unaware, and dispelled many
myths. Nor is the point that meteorologists somehow sinned by not looking at clouds for so long. What happened
was simply inevitable: during the process of model-building, there is a narrowing of vision imposed by the
limitations of one's framework and tools, a narrowing that can only be ended definitively by making those tools
good enough to transcend those limitations.
But that initial narrowing is very hard for broad minds to accept. And so they look for an alternative.
The problem is that there is no alternative to models. We all think in simplified models, all the time. The
sophisticated thing to do is not to pretend to stop, but to be self-conscious -- to be aware that your models are maps
rather than reality.
There are many intelligent writers on economics who are able to convince themselves -- and sometimes large
numbers of other people as well -- that they have found a way to transcend the narrowing effect of model-building.
Invariably they are fooling themselves. If you look at the writing of anyone who claims to be able to write about
social issues without stooping to restrictive modeling, you will find that his insights are based essentially on the use
of metaphor. And metaphor is, of course, a kind of heuristic modeling technique.
In fact, we are all builders and purveyors of unrealistic simplifications. Some of us are self-aware: we use our
models as metaphors. Others, including people who are indisputably brilliant and seemingly sophisticated, are
sleepwalkers: they unconsciously use metaphors as models.
THE BIG PUSH
We can now return to the story of development economics. By the late 1950s, as I have argued, high development
theory was in a difficult position. Mainstream economics was moving in the direction of increasingly formal and
careful modeling. While this trend was clearly overdone in many instances, it was an unstoppable and ultimately an
appropriate direction of change. But it was difficult to model high development theory more formally, because of the
problem of dealing with market structure.
The response of some of the most brilliant high development theorists, above all Albert Hirschman, was simply to
opt out of the mainstream. They would build a new development school on suggestive metaphors, institutional
realism, interdisciplinary reasoning, and a relaxed attitude toward internal consistency. The result was some
wonderful writing, some inspiring insights, and (in my view) an intellectual dead end. High development theory
simply faded out. A constant-returns, perfect-competition view of reality took over the development literature, and
eventually via the World Bank and other institutions much of real-world development policy as well.
Figure 1
And yet in the end it turned out that mainstream economics eventually did find a place for high development theory.
Like the Norwegians who discovered that the shapes of clouds do mean something, mainstream economics
discovered that as its modeling techniques became more sophisticated some neglected insights could be brought
back in.
Since this sounds rather abstract, it will be best if I explicitly present an example of how one can now do a formal
treatment of the classic model of high development theory: Rosenstein-Rodan's Big Push. The treatment is a
streamlined version of the exposition in Murphy, Shleifer, and Vishny (1989), and reproduces my presentation in
Krugman (1993).
Our paper-and-pencil dish-pan -- our model economy -- consists of a set of assumptions about the supply of
resources; technology; demand; and market structure.
Resources. The only resource in the economy is labor -- that is, we neglect the role of capital, physical or human.
Labor is in fixed total supply L. It can, however, be employed in either of two sectors: a "traditional" sector,
characterized by constant returns, or a "modern" sector, characterized by increasing returns. Although the same
quality of labor is used in the traditional and modern sectors, it is not paid the same wage. Workers must be paid a
premium to move from traditional to modern employment. We let w1 be the ratio of the wage rate that must be paid
in the modern sector to that in the traditional sector.
Technology. It is assumed that the economy produces N goods, where N is a large number. We choose units so that
the productivity of labor in the traditional sector is unity in each of the goods. In the modern sector, average labor
cost is decreasing in the scale of production. For simplicity, decreasing costs take a linear form. Let Qi be the
production of good i in the modern sector. Then if the modern sector produces the good at all, the labor requirement
will be assumed to take the form
Li = F + cQi
where c<1 is the marginal labor requirement. Note that for this example it is assumed that the relationship between
input and output is the same for all N goods.
Demand. Each good receives a constant share N of expenditure. The model will be static, with no asset
accumulation or decumulation; so expenditure equals income.
Market structure. The traditional sector is assumed to be characterized by perfect competition. Thus for each good
there is a perfectly elastic supply from the traditional sector at the marginal cost of production; given our choice of
units, this supply price is unity in terms of traditional sector labor. By contrast, a single entrepreneur is assumed to
have the unique ability to produce each good in the modern sector.
How will such a producer price? She cannot raise her price as much as she would like. The reason is that potential
competition from the traditional sector puts a limit on the price: she cannot go above a price of 1 (in terms of
traditional labor) without being undercut by traditional producers. So each producer in the modern sector will set the
same price, unity, as would have been charged in the traditional sector.
We can now ask the question, will production actually take place in the traditional or the modern sector?
To answer this, it is useful to draw a simple diagram (Figure 1). On the horizontal axis is the labor input, Li, used to
produce a typical good. On the vertical axis is that sector's output Qi. The two solid lines represent the technologies
of production in the two sectors: a 45-degree line for the traditional sector, a line with a slope of 1/c for the modern
sector.
From this figure it is immediately possible to read off what the economy would produce if all labor were allocated
either to the modern or the traditional sector. In either case L/N workers would be employed in the production of
each good. If all goods are produced traditionally, each good would have an output Q1. If they are all produced using
modern techniques, the output is Q2. As drawn, Q2Q1; this will be the case provided that
[(L/N) - F]/c L/N
i.e., as long as the marginal cost advantage of modern production is sufficiently large and/or fixed costs are not too
large. Since this is the interesting case, we focus on it.
But even if the economy could produce more using modern methods, this does not mean that it will. It must be
profitable for each individual entrepreneur in the modern sector to produce, taking into account the necessity of
paying the premium wage w -- and also the decisions of all the other entrepreneurs.
Suppose that an individual firm starts modern production while all other goods are produced using traditional
techniques. The firm will charge the same price as that on other goods, and hence sell the same amount; since there
are many goods, we may neglect any income effects and suppose that each good continues to sell Q1. Thus this firm
would have the production and employment illustrated by point A.
Is this a profitable move? The firm uses less labor than would be required for traditional production, but must pay
that labor more. Draw in a ray from the origin whose slope is the modern relative wage w; OW in the figure is an
example. Then modern production is profitable given traditional production elsewhere if and only if OW passes
below A. As drawn, this test is of course failed: it is not profitable for an individual firm to start modern production.
On the other hand, suppose that all modern firms start simultaneously. Then each firm will produce Q2, leading to
production and employment at point B. Again, this will be profitable if the wage line OW passes below B. As
drawn, this test is satisfied.
Obviously, there are three possible outcomes.2 If the wage premium w-1 is low, the economy always
"industrializes"; if it is high, it never industrializes; and if it takes on an intermediate value, there are both low- and
high-level equilibria.
One would hardly conclude from this model that the high development idea that countries can be caught in low-
income traps, but that self-reinforcing growth is also possible, is necessarily right. Even within this model, that story
is true only for some parameter values. And the specific assumptions are obviously unrealistic. Yet the model
illustrates several key points about the relationship between mainstream economics and high development theory.
First, it shows that it is possible to tell high development-style stories in the form of a rigorous model. The methods
of mainstream economics may have created a predisposition to constant returns, perfect competition models, but
they need not be restricted to such models.
Second, this example, like Fultz's dish-pan, shows that the essential logic of high development stories emerges even
in a highly simplified setting. It is common for those who haven't tried the exercise of making a model to assert that
underdevelopment traps must necessarily result from some complicated set of factors -- irrationality or short-
sightedness on the part of investors, cultural barriers to change, inadequate capital markets, problems of information
and learning, and so on. Perhaps these factors play a role, perhaps they don't: what we have just seen that a low-level
trap can arise with rational entrepreneurs, without so much as a whiff of cultural influences, in a model without
capital, and with everyone fully informed.
Third, the model, unlike a purely verbal exposition, reveals the sensitivity of the conclusions to the assumptions. In
particular, verbal expositions of the Big Push story make it seem like something that must be true. In this model we
see that it is something that might be true. A model like this makes one want to go out and start measuring, to see
whether it looks at all likely in practice, whereas a merely rhetorical presentation gives one a false feeling of security
in one's understanding.
Finally, the model tells us something about what attitude is required to deal with complex issues in economics. This
model may seem childishly simple, but I can report from observation that until Murphy et al. published their
formalization of Rosenstein-Rodan its conclusions were not obvious to many people, even those who have
specialized in development. Economists tended to regard the Big Push story as essentially nonsensical -- if modern
technology is better, then rational firms would simply adopt it! (They missed the interaction between economies of
scale and market size). Non-economists tended to think that Big Push stories necessarily involved some rich
interdisciplinary stew of effects, missing the simple core. In other words, economists were locked in their traditional
models, non-economists were lost in the fog that results when you have no explicit models at all.
How did Murphy et al break through this wall of confusion? Not by trying to capture the richness of reality, either
with a highly complex model or with the kind of lovely metaphors that seem to evade the need for a model. They did
it instead by daring to be silly: by representing the world in a dish-pan, to get at an essential point.
CONCLUDING THOUGHTS
When I look at the Murphy et al representation of the Big Push idea, I find myself wondering whether the long
slump in development theory was really necessary. The model is so simple: three pages, two equations, and one
2
Actually four, if one counts the case where (2) is not satisfied, so that the economy actually produces
less using modern techniques. In this case it clearly stays with the traditional methods.
diagram. It could, it seems, have been written as easily in 1955 as in 1989. What would have happened to
development economics, even to economics in general, if someone had legitimized the role of increasing returns and
circular causation with a neat model 35 years ago?
But it didn't happen, and perhaps couldn't. Those economists who were attracted to the idea of powerful
simplifications were still absorbed in the possibilities of perfect competition and constant returns; those who were
drawn to a richer view, like Hirschman, became impatient with the narrowness and seeming silliness of the
economics enterprise.
That the story may have been preordained does not keep it from being a sad one. Good ideas were left to gather dust
in the economics attic for more than a generation; great minds retreated to the intellectual periphery. It is hard to
know whether economic policy in the real world would have been much better if high development theory had not
decayed so badly, since the relationship between good economic analysis and successful policy is far weaker than
we like to imagine. Still, one wishes things had played out differently.
One would like to draw some morals from this story. It is easy to give facile advice. For those who are impatient
with modeling and prefer to strike out on their own into the richness that an uninhibited use of metaphor seems to
open up, the advice is to stop and think. Are you sure that you really have such deep insights that you are better off
turning your back on the cumulative discourse among generally intelligent people that is modern economics? But of
course you are.
And for those, like me, who basically try to understand the world through the metaphors provided by models, the
advice is not to let important ideas slip by just because they haven't been formulated your way. Look for the folk
wisdom on clouds -- ideas that come from people who do not write formal models but may have rich insights. There
may be some very interesting things out there. Strangely, though, I can't think of any.
The truth is, I fear, that there's not much that can be done about the kind of apparent intellectual waste that took
place during the fall and rise of development economics. A temporary evolution of ignorance may be the price of
progress, an inevitable part of what happens when we try to make sense of the world's complexity.
REFERENCES
Fleming, J.M. 1955. "External Economies and the Doctrine of Balanced Growth." Economic Journal. June.
Hirschman, A. 1958. The Strategy of Economic Development. New Haven, Conn.: Yale University Press.
Leibenstein, H. 1957. Economic Backwardness and Economic Growth. New York: Wiley.
Lewis, W.A. 1954. "Economic Development with Unlimited Supplies of Labor." The Manchester School. May.
----------. 1955. The Theory of Economic Growth. London: Allen and Unwin.
Little, I.M.D. 1982. Economic Development. New York: 20th Century Fund.
Little, I., T. Scitovsky, and M. Scott. 1970. Industry and Trade in Some Developing Countries. Oxford: Oxford
University Press.
Murphy, R., A. Shleifer, and R. Vishny. 1989. "Industrialization and the Big Push." Journal of Political Economy.
Myrdal, G. 1957. Economic Theory and Under-developed Regions. London: Duckworth.
Nelson, R. 1956. "A Theory of the Low Level Equilibrium Trap in Underdeveloped Economies." American
Economic Review. May.
Rosenstein-Rodan, P. 1943. "Problems of Industrialization of Eastern and South-Eastern Europe." Economic

Journal. June-September.
Scitovsky, T. 1954. "Two Concepts of External Economies." Journal of Political Economy. April.
Young, A. 1928. "Increasing Returns and Economic Progress." Economic Journal. December.
Is Capitalism Too Productive?
Paul Krugman
The great majority of those who voted for Lionel Jospin's Socialists in the recent French election were surely voting
against, not for: they were protesting high unemployment and the aloof austerity of Alain Jupp’s government, not
endorsing the specifics of the opposition's program. Nonetheless, Jospin's elevation to Prime Minister is a
remarkable event. Sooner than anyone might have expected, a radical economic doctrine has emerged from
obscurity to become, in principle at least, the official ideology of a major advanced nation's government.
Let me give that economic doctrine a name, and call it the doctrine of global glut. It may be summarized as the view
that capitalism is too productive for its own good - that thanks to rapid technological progress and the spread of
industrialization to newly emerging economies the ability to do work has expanded faster than the amount of work
to be done. In its milder forms, the global glut doctrine involves the belief that policies should be aimed at
increasing demand rather than supply; thus its American advocates have opposed efforts to eliminate the budget
deficit or increase national savings, claiming that such efforts will actually reduce the economy's growth. In its more
extreme forms, the doctrine calls for actual reductions in the economy's capacity, in particular through "work-
sharing" schemes that reduce the length of the work week. And it was this extreme form that was a central plank of
Jospin's program: he called for a mandated reduction in France's work week from 39 to 35 hours.
Heterodox doctrines, in economics and elsewhere, often fail to get adequately discussed in their formative stages:
both the intellectual and the political establishment tend to regard them as unworthy of notice. Meanwhile, those
doctrines can seem compelling to large numbers of people (some of whom may have considerable political clout,
large financial resources, or both). By the time it becomes apparent that such influential ideas demand serious
attention after all, reasoned argument has become very difficult. People have become invested emotionally,
politically, and financially in the doctrine; careers and even institutions have been built on it; and the proponents can
no longer allow themselves to contemplate the possibility that they have taken a wrong turning.
The doctrine of global glut - unlike, say, supply-side economics - has probably not yet reached that point. Even
Jospin's Socialists could still quietly drop work-sharing from their program without much backlash (provided they
deliver in other ways). And with only a few exceptions those American intellectuals and politicians who have been
flirting with some version of the doctrine can still modify their views without too much embarrassment. But now is
the time to discuss the doctrine seriously, before it becomes a dogma impervious to logic and evidence.
Let me not be too coy about the verdict. The idea of a global glut does not stand up to examination; it is
conceptually confused, and its advocates seem oddly unaware of even very basic facts. But it is evidently a doctrine
that many intelligent people find compelling; it is therefore important both to lay out the case against a global glut
and to try to understand why the doctrine is so appealing despite its intellectual vulnerability.
TOO MUCH OF A GOOD THING?
Concerns that capitalism might be too productive for the good of its workers, perhaps even too productive for the
good of the capitalists themselves, have been with us almost since the beginning of the Industrial Revolution. The
slump that followed the end of the Napoleonic Wars, and the brutal displacement of handweavers by the power
loom, forced even the classical economists to consider the possibility that the introduction of improved technology
might have some adverse effects. Thus David Ricardo's 1817 Principles of Political Economy, which among other
things first demonstrated rigorously the virtues of free trade, also included a chapter entitled "On Machinery", about
the possibility of technological unemployment.
More or less modern concerns about excessive productivity emerged in the 1930s and 1940s. It was natural that
some observers would tie the lack of jobs during the Depression to the widespread introduction of mass-production
techniques in the 20s. And Keynesian economics, which legitimized concerns about overall inadequacy of demand,
helped to provide an intellectual framework. Indeed, during the late 30s and early 40s many economists temporarily
subscribed to a doctrine - often referred to as "secular stagnation" - that is quite similar to the current doctrine of
global glut. (As Keynes himself famously put it: "Practical men, who believe themselves exempt from any
intellectual influence, are usually the slaves of some defunct economist.”) Secular stagnationists pointed out that
well-off families tend to save a higher fraction of their income than poorer ones; thus, they argued, per capita
consumer spending would not keep pace with growth in per capita income. The economy could therefore only
maintain full employment if investment spending grew much more rapidly than income - and this seemed unlikely.
So the secular stagnationists (backed, incidentally, by forecasts made using early econometric models) predicted a
return to Depression conditions once World War II was over, and a tendency toward ever-growing unemployment
rates over time.
Postwar developments in economic theory, together with the actual experience of the postwar boom, pretty much
eliminated secular stagnationism as a view among professional economists. The doctrine did live on in more popular
writings, often tied to concerns about the impact of "automation,” the supposedly imminent widespread replacement
of workers by machines. But by and large concerns that capitalism might simply be too productive went dormant
from the early 1950s to the 1980s.
The rise of the current doctrine of global glut can be tied to three main developments. First, mass unemployment has
reemerged in Western Europe, though not in the United States. Most economists and business leaders blame the
long-term rise in European unemployment on "Eurosclerosis,” a condition brought on by excessive taxation and
regulation. But many of Europe's trade union leaders and some of its political leaders have concluded instead that
there simply is not enough work to go around, and that this problem is becoming ever more acute as labor
productivity rises. Thus Jospin-like proposals for work-sharing have been common on the European scene for a
decade or more. Demands for work-sharing became particularly intense when Europe went into an economic slump
in the early 90s; the concept even received a somewhat blurry endorsement in the European Commission's 1993
White Paper Growth, Competitiveness, Employment.
Second, there is a widespread perception that productivity growth in the advanced countries, especially in the United
States, has dramatically accelerated. In particular, what turned out in the end to be a temporary period of "jobless
recovery" in 1991-2 - that is, of growing GDP but rising unemployment - apparently had a permanent impact on
some economic writers, convincing them that the traditional link between growth and jobs had been severed.
Finally, the spread of industry to newly emerging economies, and the rapid growth in exports from those economies,
has fed the sense that global productive capacity is growing at a headlong pace, far too fast for demand to keep up.
Indeed, some of the global glut doctrine's adherents - notably William Greider - not only believe that growth will lag
behind capacity, but warn that the growing gap between potential supply and demand will provoke a 1930s-style
economic crisis, with output actually plunging. The doctrine of global glut, then, is a response to some real changes
in the world economy. But is it a reasonable response? Does it make sense conceptually? Does it fit the facts?
IS THERE REALLY A GLOBAL GLUT?
To get some perspective on the global glut, it may be useful to focus on three propositions that are crucial to the
doctrine - one proposition about supply and two about demand. (Why two propositions about demand? Because, as
we will see, we need to ask somewhat different questions about demand in advanced and in developing countries).
The propositions are:
1. Global productive capacity is growing at an exceptional, perhaps unprecedented rate.

2. Demand in advanced countries cannot keep up with the growth in potential supply.
3. The growth of newly emerging economies will contribute much more to global supply than to global demand.
Are these propositions true about the present, or likely to be true about the future?
Productive capacity
Popular economic discussion tends to be driven by impressions and anecdotes rather than statistics. There is
something to be said for this attitude, especially in times of rapid change: statistics designed to track last generation's
economy can easily miss crucial aspects of what is happening right now. On the other hand, anecdotes tend to
emphasize the exciting and different, and to miss the continuities. The fundamental things remain as time goes by,
but you may not remember this if you focus too much on the interesting anecdotes.
The belief of commentators like Greider that there is a huge growth in productive capacity seems to be driven
largely by tales of individual industries that clearly do have a problem of overcapacity, notably automobiles. The
problem with such stories is that in an unpredictable world the emergence of excess capacity in particular industries
that overestimated their market prospects is just a normal hazard of business as usual - as is the emergence of
capacity shortages in industries that underestimated demand. At times the balance is clear: at the bottom of a severe
recession, or even after a more modest slump like 1990-91, there is a clear predominance of excess supply. But at
the moment there are clearly shortages of some things - such as office space in many cities, coffee beans, and skilled
machinists - at the same time that there are excess supplies of others, like auto assembly plants. Which stories should
we regard as defining, and which as incidental?
Another source of belief in surging productive capacity is the impression of breakneck progress created by the
triumphs of digital technology, where Moore's Law - the rule that says that the price of a given computation halves
every 18 months - implies a state of permanent revolution. But there is more to production than computation. Even
in manufacturing reports of the workerless factory have repeatedly proved premature; the much-hyped arrival of
industrial robotics in the 1980s turned out to be no more than a modest addition to the arsenal of production
techniques. And evidence for a productivity revolution is even harder to find outside the manufacturing sector. The
paperless, secretary-less office, for example, is something that is always about to happen but somehow never does.
For what they are worth, official estimates of the overall rate of capacity growth in advanced countries are distinctly
unimpressive. The OECD and the IMF both estimate the rate of growth of potential GDP in the advanced economies
as a group at no more than 2-3 percent - about the same as in the previous 20 years, and well below the growth rates
of the 50s and 60s. But can such estimates be trusted? Technological enthusiasts are quick to point to qualitative
improvements that are missed by normal estimates of real GDP - like the convenience offered by automatic teller
machines. On the other hand, such poorly measured quality improvements were arguably equally important in
earlier decades; it is anybody's guess whether the undermeasurement is greater now than before.
There is one point nobody would dispute: the stunningly rapid industrialization of some developing countries,
mainly in Asia, has contributed to an acceleration in the growth of world capacity.
When you put the evidence together, what do you find? Averaging the dreary official estimates of potential growth
with the impressive actual growth rates in Asia suggests that overall world productive capacity is growing at
something close to 4 percent per year. This is better than the 3 or so percent growth of market economies in the
1970s and 1980s, but somewhat less than the rate of growth achieved by market economies in the 1950s and 60s.
Perhaps the estimates are wrong now, to a greater extent than they were wrong then; but the case for unusually high
growth in productive capacity is weak at best, and there is no case at all for the more breathless claims about
unprecedented expansion.
Demand in the advanced countries
Even if the growth in capacity is more modest than the hype would have it, the capacity will go unused unless
consumers provide sufficient demand. Will they? Conventional economists don't see any problem here. After all, if
the growing capacity of advanced countries is in fact used, income will rise in line with that capacity; and if income
rises, why won't consumer demand rise too? Somewhat oddly, none of the main proponents of the global glut
doctrine seem to offer any direct counter to this standard view. Greider, Rifkin, and even Heilbroner (who should at
least be aware of the conventional argument) seem to take it for granted that if growth in supply is too rapid it will
outstrip growth in demand. Judis has pointed out that the 1930s did happen, proving that demand need not always
equal supply; but this says nothing about whether growing capacity itself (as opposed to, say, monetary
mismanagement) need provoke a slump.
Reading between the lines a bit, however, it seems likely that the global glutters, like the secular stagnationists of
yore, have in mind the idea that as income rises, consumers become saturated - that having bought all their
necessities, they become reluctant to increase spending even if their income rises. This idea seems confirmed by
ordinary experience: well-off families typically do save much more of their income than the poor. Some of the
global glutters follow this logic a bit further, suggesting that consumer demand is further limited by the
maldistribution of income within advanced countries (or at least within the United States). Struggling families would
spend more if they could; but income gains go instead to the rich, who hoard their incomes instead of spending
them.
It's evidently a persuasive story. But it runs up against an awkward fact: consumer spending in the United States has
kept up with rising income for a very long time. Real per capita income today is roughly triple what it was in the late
1940s, the heyday of secular stagnationism. And that income is substantially more unequally distributed. Yet the
fraction of personal income that consumers save is actually lower now than it was then. Somehow or other most
Americans, including many of those in the upper echelons of the income distribution, have found ways to spend
their income without becoming saturated.
If you think about it, this does not seem all that amazing. Most readers of Foreign Affairs surely know people who
have annual incomes of $300,000 or more. Indeed, a fair number of readers probably meet that description
themselves. In reality, how hard is it to find ways to spend that money? A really nice home, a second home or nice
vacations, private colleges for the children, two good cars ... Yet even if median family income in the United States
grows at 2 percent per year, it will take a century before that median family has an income equivalent to $300,000 in
today's prices.
It is true that people with above-average incomes tend to save more than people with lower incomes. But economists
have long realized that this is mainly a sort of statistical optical illusion. In any one year, the class of people with
high incomes includes a number of people who are doing better than usual and saving for a rainy day, while the
class of people with low incomes includes a number of people who are doing worse than usual and drawing down
their savings from the past. But when peoples' normal or typical (or, in the jargon of economists, "permanent")
income rises, as it does as the economy grows, their spending grows right along with it. In short, it is hard to see any
justification at all for the belief that consumer demand in advanced countries cannot keep up with growing capacity.
The Third World
It is when we come to the role of newly industrializing economies that emotions and confusion run highest. Perhaps
the best way to sort things through is to present the story as a Panglossian conventional economist might tell it; see
how the global glut advocates differ from that story; and look at the relevant facts.
The agreed starting point is that there has been a rapid increase in the productivity of labor in some developing
countries. This means that hundreds of millions of workers who were previously of little account in the global
economy are now an important productive resource, adding to the world's productive capacity.
The conventional economist sees no problem in this development. To be sure, the world's productive capacity is
increased; but higher productivity will also mean higher incomes. And since one can hardly claim that consumers
are already saturated in such poor nations, demand will increase along with supply. The newly industrializing
economies will in general, says conventional theory, spend about as much as they earn - or, what is the same thing,
import as much as they export.
Actually, a conventional economist might well predict that emerging economies will in general run trade deficits.
After all, one might expect these economies to attract inflows of investment from abroad. And a country which
attracts a net inflow of capital must, by definition, be a country where domestic investment exceeds domestic
savings, and therefore where spending exceeds income - that is, a country that runs a trade deficit (or more precisely
a deficit on the current account, which includes services and the income from past investments).
But how can this be? Won't countries that have very low wage rates be extremely cost-competitive, and therefore
run trade surpluses? Well, the conventional economist has a pat answer for that too: wages will rise in line with
productivity, so that these countries won't be all that cost-competitive after all.
To believers in an emerging global glut, this all seems naively optimistic. A representative statement of their
position came in Alan Tonelson's recent review [NYT Book Review, June 15] of Jeffrey Garten's The Big Ten: The
Big Emerging Markets and How They Will Change Our Lives. Tonelson asserts that "consumer markets in these
emerging markets are likely to stay small for decades ... Two reasons stand out. First, largely because most of these
countries have huge foreign debts to pay off, and therefore need to discourage consumption by their populations,
they are pursuing export-led growth strategies. Second, if they don't keep wages and purchasing power low, they
will have difficulty attracting the foreign investment they require, both to service debt and to finance growth.” In
short, emerging economies will not add nearly as much to global demand as they do to global supply.
This seems clear enough. Yet if one rereads Tonelson's remarks, or similar passages in Greider, and also does some
research - say, by buying a copy of The Economist on the newsstand, and opening to the "emerging market
indicators" on the last page - one receives a bit of a shock. Tonelson seems to believe that newly industrializing
economies are currently engaged in "export-led" growth - that is, that they are selling much more to advanced
countries than they buy in return - and that it is naive to expect this to change. Presumably, then, he believes that
these economies are currently running large trade surpluses. Table 1, however, shows the actual trade and current
account balances of Garten's "big ten": six are currently running trade deficits - as is the group as a whole - and all
but one are running current account deficits. More broadly, of the 25 emerging markets covered in The Economist,
17 are running trade deficits, 20 current account deficits. This is export-led growth?
Table 1: Trade and current balances in the "Big Ten" ($billion)

Trade balance Current account
Argentina -0.9 -4.0
Brazil -10.3 -27.8
China 23.6 1.6
India -5.0 -5.1
Indonesia 7.1 -7.8
Mexico -2.1 -4.3
Poland -9.8 -3.1
South Africa 1.9 -2.0
South Korea -22.3 -25.9
Turkey -18.4 -4.4
Let me put it this way: if you read what the global glut advocates have to say, you might have the impression that
right now the newly industrializing countries are running huge trade surpluses, and that it is merely a dubious
theoretical prediction that at some future date they will begin to import as much as they export. But the truth is just
the opposite: right now the emerging economies as a group run trade deficits, and it is merely a speculative
prediction on the part of the global glutters that at some future date they will start to run large trade surpluses. (And
it is a speculative prediction that seems to have some conceptual problems too. Notice that Tonelson appears to say
that these countries will run large surpluses because they must keep wages low to attract foreign investment. He
seems unaware that a country that attracts a net inflow of foreign investment must, as a matter of sheer accounting,
run a current account deficit).
There is a similar inversion of the real relationship between fact and hypothesis when we turn to the behavior of
wages in newly industrializing economies. If you read the global glut writers, you might have the impression that
thus far wages in emerging economies have failed to rise along with productivity, and that assertions that they will
rise in future are purely optimistic speculation. In fact, however, those developing economies that have had rapid
productivity growth in past decades have also, without exception, had rapid increases in wages. Japan, one should
not forget, was once a low-wage country, and as late as the early 1970s many Western critics accused it of
deliberately keeping wages low in order to foster a trade surplus. Today its hourly compensation in manufacturing is
higher than that in the United States. And as Table 2 shows, the original four "tiger" economies have experienced
huge wage increases over the past two decades. In other words, the experience to date is that wages do in fact rise
along with productivity, and it is the assertion by global glutters that they will not do so in the future that is purely
speculation.
Table 2: Wages in the Asian "tigers" (hourly compensation as % of US)

1975 1995
Hong Kong 12 28
Singapore 13 43
South Korea 5 43
Taiwan 6 34
All this is fairly puzzling. The advocates of the global glut doctrine see themselves as being realistic in a way that
conventional economists are not; they see themselves as rejecting an abstract theoretical framework that gives
excessively optimistic assurances in favor of a clear-eyed view of the world as it really is. Yet the actual facts bear
out the supposedly naive views of conventional economists quite well, while the global glutters turn out to be
speculative theorists who assert, based on no evidence, that the future will be entirely different from the past and
present. There must, then, be something peculiarly compelling about the idea of a global glut - so compelling that it
persuades intelligent men not just to reject conventional economics but to overlook inconvenient facts. What is the
source of the doctrine's persuasiveness?
A FAILURE OF IMAGINATION
There are probably many readers who, despite the previous discussion, still find it hard to shake the notion that there
is now or soon will be a massive global oversupply of goods. After all, world productive capacity is increasing
steadily - even if not quite as rapidly as some accounts would have it - and it is hard to imagine how all that capacity
can be used. That, I believe, is at the heart of the global glut doctrine's gut appeal: it is hard to imagine what a much
more productive world economy will look like. The important thing to recognize is that the deficiency is in our
imaginations, not in the real economy, which will have no trouble at all using that capacity.
The misconceptions that make the idea of a global glut seem plausible probably begin with a fallacy of composition.
If you look at individual industries in isolation, both productivity growth and globalization can easily seem to be
job-destroying forces. The U.S. steel industry has experienced a dramatic rise in output per worker since 1980; the
result has been a sharp drop in the number of steelworkers. Many developing countries have become exporters of
clothing; the result has been a decline in advanced-country garment industries. So won't the further rise in
productivity throughout the economy, the further industrialization of the Third World, mean job losses throughout
the economy?
What this kind of reasoning misses is the indirect effects of these changes. Productivity gains in steel may reduce the
number of jobs in steel, but they create jobs elsewhere (if only by lowering the price of steel, and therefore releasing
money to be spent on other things); advanced countries may lose garment industry jobs to developing-country
exports, but they gain other jobs producing the goods that those countries buy with their new export income. To
observe that productivity growth in a particular industry reduces employment in that same industry tells us nothing
about whether productivity growth in the economy as a whole reduces employment in the economy as a whole. As
long as consumers find a way to spend the increased income that is generated by economic growth, there is no
reason for such growth to lead to any inadequacy of demand. And all the evidence suggests that people will find
something to buy with whatever income they have.
But what, exactly, will they buy? That is a natural question, but an unfair one. Suppose that you had approached an
economist in, say, 1840 - a time when most Americans were farmers, and textiles dominated the still-small
manufacturing sector - and informed him that 150 years later some 2 percent of the labor force could grow all of the
food, and less than 1 percent produce all the cloth. And suppose you had demanded that he explain what everyone
else would do for a living. He could not have given a very good answer; but he could with justice have argued that
on general principles the economy would find something useful for them to do. (Global glut advocates tend to focus
in particular on the loss of jobs in manufacturing, and find it hard to imagine that the service sector could make up
for that loss. Yet we have already seen how it can be done, since the U.S. economy is already overwhelmingly a
service, rather than goods, economy. As a Russian émigré neighbor of mine once put it, "I don't understand this
country: it seems very prosperous, but I don't ever see anybody making anything".)
A somewhat different failure of the imagination applies to the populations of the newly industrializing economies.
Here it is obvious what consumers will demand: they will want the same sorts of things that people in advanced
countries already have. What seems hard for people to visualize is a world in which Chinese and Indonesians
actually earn decent wages. After all, they have always been poor - and as one distinguished diplomat, journalist,
and author said to me, "I can't see how their wages can rise, no matter how productive they become - there are just
so many of them". But one cannot argue that an increase in the productivity of Chinese workers is a massive shock
to the world economy, because they are so numerous, and at the same time argue that it is too small a force to raise
the wages of so many people. Again, the deficiency is in our imaginations, not in the real world.
Finally, lurking behind the global glut argument may be a very old fallacy about the relationship between
consumption and investment. One thing capitalistic economies do is to accumulate capital. That is, not all of their
productive capacity is used to produce consumption goods; some of it is used to produce capital goods that will
expand future productive capacity. But then not all of that future productive capacity will be used to satisfy
consumers - some of it will be used to expand capacity even more, and so on. Now it is very easy, if one puts it that
way, to start to think of the whole thing as a sort of chain letter or Ponzi game: surely, you may imagine, at some
point this business of building machines to build machines must come to an end, with disastrous results. (Something
like this seems to be what Greider has in mind when he talks of the "manic logic" of capitalism). But in fact - as
even Karl Marx could have told you - there is nothing wrong or unsustainable about an ever-growing capital stock in
an ever-growing economy. It has worked for the last 50 years, and there is no obvious end in sight.
TILTING AT WINDMILLS
None of the preceding should be taken as a declaration that all is right with the world economy. There are severe
real problems: inequality in the United States (exacerbated though not caused by imports of labor-intensive
products), unemployment in Europe (also slightly exacerbated by labor-intensive imports, but mainly due to rigid
labor markets and bad macroeconomic policy), a Japanese economy struggling to overcome the consequences of a
burst financial bubble, a number of newly industrializing countries facing potential crises due to financial excesses
and lax banking regulation, and so on. On the whole, the condition of humanity - as measured by such raw, crude,
but crucial indicators as life expectancy and child malnutrition - is far better now than it was 20 years ago, largely
because of economic growth in the Third World; but there are many shadows in the picture. One problem capitalism
does not suffer from, however, is being too productive for its own good.
Imagining problems that do not really exist has real costs. To speak to European advocates of the global glut theory
is to be struck by their fatalism: they really seem to have given up on the idea of actually making the European
economy grow. And this fatalism already seems, at the time of writing, to have left the new Jospin administration in
France almost completely ineffectual. Meanwhile, American global glutters seem to spend half their time
complaining that nothing good can be done unless the country gives up the idea of a balanced budget, the other half
converting their doctrine into a new justification for good old-fashioned protectionism.
It is a bit funny, but also quite sad: Those who preach the doctrine of global glut are tilting at windmills, when there
are some real monsters out there that need slaying.
Capitalism’s Mysterious Triumph
Paul Krugman
Recently my local public television station has been showing a fascinating series entitled "Russia's War" - a history,
produced in Russia, of the Soviet Union's struggle in World War II. It is not a pretty story: the producers do not
hesitate to tell the full story of Stalin's brutality, and they do not try to mask the ugliness of war with patriotic
romanticism. Yet this stark honesty in a way makes the account of the Soviet Union's wartime achievement all the
more impressive. The Soviet Union did not win through military genius: most of its trained officers had been purged
in political witch-hunts, and while the war eventually threw up a new set of leaders, they were competent rather than
brilliant - and their advice was often overruled by a dictator whose military judgement was usually disastrous.
Russian soldiers fought with dogged heroism - but then so did the Germans. Why did the Russians prevail?
The answer is surprising, given the way the 20th century has actually turned out. The Soviet triumph in World War
II was, above all, a victory of production. Despite huge losses in the first months of the war, despite mass
dislocations of population and the German occupation of many of the country's key manufacturing centers, Soviet
industry managed to build tanks, artillery, and aircraft that were technologically a match for Germany's weapons,
and to do so at a rate that consistently exceeded anything their opponents thought was possible. Indeed, the decisive
German defeats at Stalingrad and Kursk came about precisely because the Germans launched offensives against
what they imagined to be a weaker opponent, and were taken by surprise when counterattacked by thousands of
tanks whose existence they had never suspected.
What does this have to do with the world of 1997? Well, nowadays we take the triumph of capitalism as something
preordained by the superiority of our economic system. After all, it now seems obvious to everyone except North
Korea and Cuba that a market economy is vastly more productive than one controlled from the center - and the
Cuban economy is imploding, while the North Koreans are quite literally starving to death. Moreover, every time a
Communist regime collapses, it turns out that the actual state of the economy it governed was far worse than anyone
had imagined. For example, typical estimates of the GDP of East Germany before the old regime collapsed put its
real GDP per capita at 70 or 80 percent of the West German level - meaning that East Germany was actually richer
than some regions in the West. Yet after the fall of the Berlin Wall, visiting Westerners found something that looked
like a Third World economy, with antiquated factories (and disastrous environmental problems) producing
consumer goods of ludicrously low quality (like the notorious East German Trabant, an automobile that makes a
Honda or Ford seem like a Mercedes). We used to think that the Soviet Union had an economy about half as large as
America's, that is, bigger than Japan's; nowadays Russia seems to have less economic power than, say, Italy. We
used to think that there was a real technological race between socialism and capitalism; nowadays the symbol of
Russian technology is the hapless Mir space station. It seems obvious to many people in retrospect that the
productive and technological triumphs that Communists used to claim - all those heroic photographs of dams and
posters of muscular steelworkers - were mere propaganda; in reality, we think we have learned, socialism is a
system that just can't deliver the goods, while capitalism is a system that can.
But one lesson of "Russia's War" is that matters are not that simple. Were the supposed productive triumphs of the
Soviet Union under Stalin merely a hoax? Tell that to the soldiers of Germany's Army Group Center - the few who
survived. The fact is that Stalin did transform Russia into a massive industrial power - a power tested in the most
unambiguous way imaginable. And his successors did achieve real technological triumphs - not just showy triumphs
like sending cosmonauts into orbit, but the creation of a highly sophisticated scientific and engineering
establishment. True, Russia was never any good at producing high-quality consumer goods. But it was not always
the bumbling, incompetent system we now imagine. What this means is that the collapse of Communism and the
triumph of capitalism need more of an explanation than the stories we usually hear. It is not enough to explain all the
reasons why a market economy is more efficient than a centrally planned one. Those explanations are basically right
- but the question is why a system that functioned well enough to compete with capitalism in the 1940s and 50s fell
apart in the 1980s. What went wrong?
One possible answer is that changing technology changed the rules. When the communist leader Joseph
Dzhugashvili changed his name to Stalin - "man of steel" - he reflected the times in which he lived, an era in which
heavy industry ruled, in which giant steel plants were the symbol of progress. These days, of course, steel-producing
regions throughout the world - not just in the old Soviet Union - are depressed; try visiting southeastern Belgium.
And it's not just steel: the age when countries or companies grew rich by making heavy products in big factories
seems to have passed. One can make a case that whereas old-fashioned heavy industry was susceptible to central
planning, new technologies, especially in microelectronics, favor free-wheeling competition over centralized
control. Russia could at least appear to hold its own in a technological race defined by the ability to build giant
rockets; it was left completely flatfooted when the West started putting powerful computers on a chip. In fact, in the
last few years even Japan's great corporations have started to look a bit like dinosaurs, lumbering helplessly in
pursuit of the little startups of Silicon Valley.
Another possible answer is that capitalism triumphed because of "globalization" - a process everyone talks about but
which we really don't fully understand. For some reason - perhaps some synergistic interaction among declining
tariffs, cheaper transportation, and better communications - it has become possible in the last generation for many
countries to industrialize rapidly, not through massive programs of government-led investment, but simply by
throwing themselves open to the world market and letting events take their course. Socialist economies could not
avail themselves of this new opportunity, and so they began to fall behind instead of catching up.
But neither technological change nor globalization can explain the fact that socialist economies did not merely lag
the West: they actually went into decline, and then collapse. Why couldn't they at least hold on to what they had?
I don't think anyone really knows the answer, but let me make a conjecture: the basic problem was not technical, but
moral. Communism failed as an economic system because people stopped believing in it, not the other way around.
A market system, of course, works whether people believe in it or not. You may dislike capitalism, even feel that as
a system it will eventually fail, yet do your job well because your family needs the money you earn. Capitalism can
run, even flourish, in a society of selfish cynics. But a non-market economy cannot. The personal incentives for
workers to do their jobs well, for managers to make good decisions, are simply too weak. In the later years of the
Soviet Union, workers knew that they would be paid regardless of how hard they tried; managers knew that
promotions would depend more on political connections than on performance; and nobody was offered rewards
large enough to justify taking unpopular positions or any sort of serious risk. (There can't have been more than a few
dozen people in the Soviet Union - all of them politicians - who had the kind of lavish life style enjoyed by tens of
thousands of successful entrepreneurs and executives in the United States). So why did the system ever work?
Because people believed in it. I don't mean that people went singing to their jobs, praising the motherland. I do mean
that they did not take as much advantage of the system as they might have (and did, in the system's later years). And
I also mean that because people in authority believed in the system, they were willing to impose brutal punishments
on those who did try to take advantage. (Stalin used to shoot unsuccessful generals).
We see this kind of thing all the time, in microcosm. The market does not require people to believe in it; but the
centrally planned economies that live inside a market economy, known as corporations, do. Everybody knows that
financial incentives alone are not enough to make a company succeed; it must also build morale, a sense of mission,
which makes people work at least somewhat for the good of the company rather than think only of what is good for
them. Luckily, under capitalism an individual company can fail without taking the whole society down with it - or it
can be reformed without a bloody revolution.
Why did people stop believing in socialism? Part of the answer is simply the passage of time: you can't expect
revolutionary fervor to last for 70 years. But perhaps also the unexpected resurgence of capitalism played a role. By
the 1980s Russia's elite was all too aware that the country, instead of overtaking the capitalist nations, was slipping
behind - that Russia was failing to take advantage of new technology, that if anyone was challenging the West it was
the rising nations of Asia. Communism lost any claim to the mandate of history well before it actually fell apart, and
perhaps that is why it fell apart.
In the end, then, capitalism triumphed because it is a system that is robust to cynicism, that assumes that each man is
out for himself. For much of the past century and a half men have dreamed of something better, of an economy that
drew on man's better nature. But dreams, it turns out, can't keep a system going over the long term; selfishness can.
Soft Microeconomics:
The squishy case against you-know-who.
Paul Krugman
(posted on Slate – The Dismal Science Thursday, April 23)
I wrote this piece in WordPerfect, not Word, mainly because Word’s equation editor is awful (are you listening, Mr.
Myhrvold?), and I may as well use the same software for plain English articles and professional gobbledygook. I
surf with Netscape Navigator and check e-mail in Eudora. So, I am not a fan of Microsoft’s products. Moreover, for
reasons explained below, it is in the public interest to have Bill Gates always running a bit scared of the Justice
Department. Nonetheless, the more anti-MS propaganda I read, the more pro-MS I get. There is a case against
Microsoft, but it is not the one you hear, and I would hate to see crude misunderstandings posing as sophisticated
analysis prevail.
Probably the first thing one ought to say is that the public has no interest in helping Bill Gates’ rivals for their own
sake. It’s easy to think of the people who run software companies other than Microsoft as underdogs fighting Big
Bad Bill. But those “little” guys are no more in need of extra money than Gates is, and if allowing him to get an
extra billion at Larry Ellison’s—or even Marc Andreesen’s—expense is good for the rest of us, so be it. Those of us
who do not get paid in software stock options should not allow ourselves to become pawns, either way, in struggles
among those who do.
So what is the public interest?
The case for leaving Microsoft alone does not rest on some naive faith in the perfection of free markets. Software is
an industry characterized by powerful increasing returns in both production and consumption: The more units
Netscape ships, the lower its per unit cost; the more copies of Navigator in use, the more attractive it is to the typical
user. These increasing returns make the kind of atomistic, “perfect” competition that prevails in the market for, say,
wheat impossible in the market for browsers or word processors. Necessarily, each type of product will in the end be
produced by only a few companies, perhaps only one.
But how does this concentration of production take place? One of the depressing things about public discussion of
the Microsoft case, even among supposedly well-informed people, is that much of it has come to be dominated by a
basically primitive view about what increasing returns do to markets—namely, that they convey monopoly power
purely randomly, on whoever happens to be in the right place at the right time—and that this “path dependence”
allows clearly inferior technologies to become “locked in.” Now path dependence has its place—but when applied to
the Microsoft case it misses the point. After all, high-technology companies are themselves quite aware of
increasing returns, and their strategies—above all the prices they charge when they are trying to establish themselves
in a market—are very much affected by that awareness.
Consider, for example, one particular form of increasing returns: The so-called “learning curve,” which says the
more units of something you have already produced, the lower the cost of producing the next one. You might think
this means that whoever gets into a market first will simply have a snowballing advantage. But as Stanford’s
Michael Spence pointed out in a classic, 20-year-old paper on this subject, profit-maximizing companies that know
they face a learning curve will compete fiercely to move down it more rapidly, selling cheaply in the early stages of
a product cycle (and therefore losing money) in the hope of making the money back later.
The same logic applies to increasing returns on the demand side: As a manufacturer, if I know that a typical
customer’s choice of browser depends both on the price and on the number of other people using that browser, I will
initially make my own browser cheap—maybe even free—so as to build market share. In either case I must incur
initial losses that are, in effect, part of the price of entry into the market—an add-on to the cost of developing a
product in the first place. And because nobody will want to pay this entry fee without a reasonable hope of earning it
back, only a few companies will enter a market subject to strong increasing returns. The point is that the eventual
domination of an industry by a few companies—and a high rate of profit on sales for these companies in the later
stages of the cycle—doesn’t happen because these companies just happened to get a head start. On the contrary, it is
precisely because it isn’t purely a matter of luck—because everyone competes so fiercely on prices in an effort to
get some of those nice increasing returns—that only a few dare enter.
Of course, there is also an element of luck. It’s not true that whoever gets a head start always dominates the
market—if a company has a small head start but offers a clearly inferior product or has clearly higher costs, rivals
can and will overtake it. But nobody can be sure just what an as-yet undeveloped product will cost to produce, or
how it will go over with consumers. Thus, competition in a market characterized by increasing returns is—as it must
be—a sort of demolition derby in which only some of those who enter cross the finish line. Those who do make it
across the finish line will typically make big profits. But this profitability is necessary to the enterprise. Who will
enter a demolition derby without the incentive of a prize?
So this is the case for leaving Microsoft alone: High-tech competition is, necessarily, a competition that ends up
being won by a handful of players. Those who make vast fortunes may not always be the most deserving—but so
what? For the rest of us, what matters is not who wins or loses, but how they play the game. And if they know or
suspect that too much success will be punished—that anyone who does too well will become a target of envy-driven
litigation—they will have that much less incentive to play hard.
Now there is, of course, also a case against Microsoft. Never mind the crude complaint that it is too big, or too
profitable, or that nerdy types tend to dislike its products. The real concern is that because Microsoft’s victory in an
earlier derby happens to have given it control over a particularly strategic part of the industry—because it supplies
operating systems—it is in a position to squeeze out rival suppliers of other software. And that is a real concern: If
Microsoft had, for example, written Windows 95 in a way that made it hard or even impossible for me to use
WordPerfect, the Justice Department would have been absolutely justified in calling out the arsonists.
But the fact is that MS has been very careful not to use its undoubted power to practice any crude, obvious version
of what is known in the trade as “vertical foreclosure.” WordPerfect and Netscape work just fine on my Windows-
based machine. This restraint may partly reflect Microsoft’s market strategy—after all, Microsoft beat Apple partly
because Apple did practice vertical foreclosure, and as a result inhibited the development of complementary
software (although the main problem was Apple’s persistent belief, despite all the evidence to the contrary, that
everyone would be willing to pay a premium price for a niftier machine). For sure, however, Microsoft has mainly
been restrained by the knowledge that any crude use of its power would indeed land it in court.
And yet, despite all that restraint, Microsoft is in court anyway. Any nontechnologist ventures into the browser wars
at his peril, but here is how I understand it: After initially missing the significance of the Internet, Microsoft has
gone to the other extreme, designing Windows 95 so that it uses an Internetlike metaphor for everything. It makes
sense, then, for a browser that can find both internal and external documents to be an integral part of the system—
unless, that is, you regard browsers and operating systems as still basically different things, and view Microsoft as
practicing vertical foreclosure under the guise of product enhancement. Well, maybe—but it’s a pretty subtle point.
Microsoft isn’t preventing anyone from using Netscape or charging Netscape for the right of access; it’s providing
Internet Explorer free, but then that would be normal practice in this kind of industry even if IE wasn’t allegedly an
integral part of Windows 95. You can argue that Microsoft has stepped across the line on this one—but surely by
only a few inches.
Here’s what worries me: Given the subtlety of the real issues here, what is the chance that this stuff will be decided
on its merits? When you hear that despite the fact that he has economists who know better, the Justice Department’s
Joel Klein apparently either believes or chooses to claim that this case is about path dependence, you start to
wonder. And when you hear that the anti-Microsoft side has retained the services of that economic and technology
expert Bob Dole, you start to despair.
Links
An article in the Feb. 25 Wall Street Journal (“QWERTY Spells a Saga of Market Economics”) is a good example
of the mistaken view that path dependence is the core of the case against Microsoft. Nicholas Economides, who
really understands these things, took the Wall Street Journal to task in a letter that it, of course, did not print. His
useful site also contains a good, slightly anti-MS discussion of the vertical foreclosure issue on browsers as well as a
set of links to just about everything relevant to the case.
Paul Krugman is a professor of economics at MIT. His new book, The Accidental Theorist and Other Dispatches
From the Dismal Science, will be published this month. His home page contains links to many of his other articles
and essays.
In Praise of Cheap Labor

Bad jobs at bad wages are better than no jobs at all.
Paul Krugman
Slate – The Dismal Science
(1,669 words; posted Thursday, March 20; to be composted Thursday, March 27)
For many years a huge Manila garbage dump known as Smokey Mountain
was a favorite media symbol of Third World poverty. Several thousand
men, women, and children lived on that dump--enduring the stench, the
flies, and the toxic waste in order to make a living combing the garbage for
scrap metal and other recyclables. And they lived there voluntarily, because
the $10 or so a squatter family could clear in a day was better than the
alternatives.
The squatters are gone now, forcibly removed by Philippine police last year as a cosmetic
move in advance of a Pacific Rim summit. But I found myself thinking about Smokey
Mountain recently, after reading my latest batch of hate mail.
The occasion was an op-ed piece I had written for the New York Times, in which I had
pointed out that while wages and working conditions in the new export industries of the
Third World are appalling, they are a big improvement over the "previous, less visible
rural poverty." I guess I should have expected that this comment would generate letters
along the lines of, "Well, if you lose your comfortable position as an American professor
you can always find another job--as long as you are 12 years old and willing to work for
40 cents an hour."
Such moral outrage is common among the opponents of globalization--of the transfer of
technology and capital from high-wage to low-wage countries and the resulting growth of
labor-intensive Third World exports. These critics take it as a given that anyone with a
good word for this process is naive or corrupt and, in either case, a de facto agent of global
capital in its oppression of workers here and abroad.
But matters are not that simple, and the moral lines are not that clear. In fact, let me make
a counter-accusation: The lofty moral tone of the opponents of globalization is possible only because they have
chosen not to think their position through. While fat-cat capitalists might benefit from globalization, the biggest
beneficiaries are, yes, Third World workers.
After all, global poverty is not something recently invented for the benefit of multinational corporations. Let's turn
the clock back to the Third World as it was only two decades ago (and still is, in many countries). In those days,
although the rapid economic growth of a handful of small Asian nations had started to attract attention, developing
countries like Indonesia or Bangladesh were still mainly what they had always been: exporters of raw materials,
importers of manufactures. Inefficient manufacturing sectors served their domestic markets, sheltered behind import
quotas, but generated few jobs. Meanwhile, population pressure pushed desperate peasants into cultivating ever
more marginal land or seeking a livelihood in any way possible--such as homesteading on a mountain of garbage.
Given this lack of other opportunities, you could hire workers in

Jakarta or Manila for a pittance. But in the mid-'70s, cheap labor
was not enough to allow a developing country to compete in world
markets for manufactured goods. The entrenched advantages of
advanced nations--their infrastructure and technical know-how, the
vastly larger size of their markets and their proximity to suppliers
of key components, their political stability and the subtle-but-
crucial social adaptations that are necessary to operate an efficient
economy--seemed to outweigh even a tenfold or twentyfold
disparity in wage rates.
And then something changed. Some combination of factors that we

still don't fully understand--lower tariff barriers, improved
telecommunications, cheaper air transport--reduced the
disadvantages of producing in developing countries. (Other things
being the same, it is still better to produce in the First World--
stories of companies that moved production to Mexico or East
Asia, then moved back after experiencing the disadvantages of the
Third World environment, are common.) In a substantial number of
industries, low wages allowed developing countries to break into world markets. And so countries that had
previously made a living selling jute or coffee started producing shirts and sneakers instead.
Workers in those shirt and sneaker factories are, inevitably, paid very little and expected to endure terrible working
conditions. I say "inevitably" because their employers are not in business for their (or their workers') health; they
pay as little as possible, and that minimum is determined by the other opportunities available to workers. And these
are still extremely poor countries, where living on a garbage heap is attractive compared with the alternatives.
And yet, wherever the new export industries have grown, there has been measurable improvement in the lives of
ordinary people. Partly this is because a growing industry must offer a somewhat higher wage than workers could
get elsewhere in order to get them to move. More importantly, however, the growth of manufacturing--and of the
penumbra of other jobs that the new export sector creates--has a ripple effect throughout the economy. The pressure
on the land becomes less intense, so rural wages rise; the pool of unemployed urban dwellers always anxious for
work shrinks, so factories start to compete with each other for workers, and urban wages also begin to rise. Where
the process has gone on long enough--say, in South Korea or Taiwan--average wages start to approach what an
American teen-ager can earn at McDonald's. And eventually people are no longer eager to live on garbage dumps.
(Smokey Mountain persisted because the Philippines, until recently, did not share in the export-led growth of its
neighbors. Jobs that pay better than scavenging are still few and far between.)
The benefits of export-led economic growth to the mass of people in the newly industrializing economies are not a
matter of conjecture. A country like Indonesia is still so poor that progress can be measured in terms of how much
the average person gets to eat; since 1970, per capita intake has risen from less than 2,100 to more than 2,800
calories a day. A shocking one-third of young children are still malnourished--but in 1975, the fraction was more
than half. Similar improvements can be seen throughout the Pacific Rim, and even in places like Bangladesh. These
improvements have not taken place because well-meaning people in the West have done anything to help--foreign
aid, never large, has lately shrunk to virtually nothing. Nor is it the result of the benign policies of national
governments, which are as callous and corrupt as ever. It is the indirect and unintended result of the actions of
soulless multinationals and rapacious local entrepreneurs, whose only concern was to take advantage of the profit
opportunities offered by cheap labor. It is not an edifying spectacle; but no matter how base the motives of those
involved, the result has been to move hundreds of millions of people from abject poverty to something still awful
but nonetheless significantly better.
Why, then, the outrage of my correspondents? Why does the image of an Indonesian sewing sneakers for 60 cents an
hour evoke so much more feeling than the image of another Indonesian earning the equivalent of 30 cents an hour
trying to feed his family on a tiny plot of land--or of a Filipino scavenging on a garbage heap?
The main answer, I think, is a sort of fastidiousness. Unlike the starving subsistence farmer, the women and children
in the sneaker factory are working at slave wages for our benefit--and this makes us feel unclean. And so there are
self-righteous demands for international labor standards: We should not, the opponents of globalization insist, be
willing to buy those sneakers and shirts unless the people who make them receive decent wages and work under
decent conditions.
This sounds only fair--but is it? Let's think through the consequences.
First of all, even if we could assure the workers in Third World export industries of higher wages and better working
conditions, this would do nothing for the peasants, day laborers, scavengers, and so on who make up the bulk of
these countries' populations. At best, forcing developing countries to adhere to our labor standards would create a
privileged labor aristocracy, leaving the poor majority no better off.
And it might not even do that. The advantages of established First World industries are still formidable. The only
reason developing countries have been able to compete with those industries is their ability to offer employers cheap
labor. Deny them that ability, and you might well deny them the prospect of continuing industrial growth, even
reverse the growth that has been achieved. And since export-oriented growth, for all its injustice, has been a huge
boon for the workers in those nations, anything that curtails that growth is very much against their interests. A policy
of good jobs in principle, but no jobs in practice, might assuage our consciences, but it is no favor to its alleged
beneficiaries.
You may say that the wretched of the earth should not be forced to serve as hewers of wood, drawers of water, and
sewers of sneakers for the affluent. But what is the alternative? Should they be helped with foreign aid? Maybe--
although the historical record of regions like southern Italy suggests that such aid has a tendency to promote
perpetual dependence. Anyway, there isn't the slightest prospect of significant aid materializing. Should their own
governments provide more social justice? Of course--but they won't, or at least not because we tell them to. And as
long as you have no realistic alternative to industrialization based on low wages, to oppose it means that you are
willing to deny desperately poor people the best chance they have of progress for the sake of what amounts to an
aesthetic standard--that is, the fact that you don't like the idea of workers being paid a pittance to supply rich
Westerners with fashion items.
In short, my correspondents are not entitled to their self-righteousness. They have not thought the matter through.
And when the hopes of hundreds of millions are at stake, thinking things through is not just good intellectual
practice. It is a moral duty.
Links
To get a taste of moral outrage against globalization, turn to Corporate Watch, a site dedicated to exposing the
"greed" of transnational giants. Or, for a bizarre twist, check out Sweat Gear, a satirical online catalog that attacks
sweatshops in Central America. Another argument against globalization--that it threatens democracy--is made by
Benjamin Barber in the Atlantic. The Clinton administration's word on the subject can be found in a speech by Labor
Secretary Robert Reich to the International Labor Organization urging better compliance with core labor standards.
For more on Paul Krugman, see a Newsweek profile that dubs him "The Great Debunker." And information on
employment at McDonald's can be found on the Web site of Hamburger U, their worldwide management-training
center.
Paul Krugman is a professor of economics at MIT whose books include The Age of Diminished Expectations and
Peddling Prosperity.
Illustrations by Robert Neubecker.

The spiral of inequality
If calling America a middle-class nation means anything, it means that we are a society in which most people live
more or less the same kind of life. In 1970 we were that kind of society. Today we are not, and we become less like
one with each passing year.
Paul Krugman
Ever since the election of Ronald Reagan, right-wing radicals have insisted that they started a revolution in America.
They are half right. If by a revolution we mean a change in politics, economics, and society that is so large as to
transform the character of the nation, then there is indeed a revolution in progress. The radical right did not make
this revolution, although it has done its best to help it along. If anything, we might say that the revolution created the
new right. But whatever the cause, it has become urgent that we appreciate the depth and significance of this new
American revolution—and try to stop it before it becomes irreversible.
The consequences of the revolution are obvious in cities across the nation. Since I know the area well, let me take
you on a walk down University Avenue in Palo Alto, California.
Palo Alto is the de facto village green of Silicon Valley, a tree-lined refuge from the valley’s freeways and shopping
malls. People want to live here despite the cost—rumor has it that a modest three-bedroom house sold recently for
$1.6 million—and walking along University you can see why. Attractive, casually dressed people stroll past trendy
boutiques and restaurants; you can see a cooking class in progress at the fancy new kitchenware store. It’s a cheerful
scene, even if you have to detour around the people sleeping in doorways and have to avoid eye contact with the
beggars. (The town council plans to crack down on street people, so they probably won’t be here next year,
anyway.)
If you tire of the shopping district and want to wander further afield, you might continue down University Avenue,
past the houses with their well-tended lawns and flower beds—usually there are a couple of pickup trucks full of
Hispanic gardeners in sight. But don’t wander too far. When University crosses Highway 101, it enters the grim
environs of East Palo Alto. Though it has progressed in the past few years, as recently as 1992 East Palo Alto was
the murder capital of the nation and had an unemployment rate hovering around 40 percent. Luckily, near the
boundary, where there is a cluster of liquor stores and check-cashing outlets, you can find two or three police
cruisers keeping an eye on the scene—and, not incidentally, serving as a thin blue line protecting the nice
neighborhood behind them.
Nor do you want to head down 101 to the south, to “Dilbert Country” with its ranks of low-rise apartments, the
tenements of the modern proletariat—the places from which hordes of lower-level white-collar workers drive to sit
in their cubicles by day and to which they return to watch their VCRs by night.
No. Better to head up into the hills. The “estates” brochure at Coldwell Banker real estate describes the mid-
Peninsula as “an area of intense equestrian character,” and when you ascend to Woodside-Atherton, which the New
York Times has recently called one of “America’s born-again Newports,” there are indeed plenty of horses, as well
as some pretty imposing houses. If you look hard enough, you might catch a glimpse of one of the new $10 million-
plus mansions that are going up in growing numbers.
What few people realize is that this vast gap between the affluent few and the bulk of ordinary Americans is a
relatively new fixture on our social landscape. People believe these scenes are nothing new, even that it is utopian to
imagine it could be otherwise.
But it has not always been thus—at least not to the same extent. I didn’t see Palo Alto in 1970, but longtime
residents report that it was a mixed town in which not only executives and speculators but schoolteachers, mailmen,
and sheet-metal workers could afford to live. At the time, I lived on Long Island, not far from the old Great Gatsby
area on the North Shore. Few of the great mansions were still private homes then (who could afford the servants?);
they had been converted into junior colleges and nursing homes, or deeded to the state as historic monuments. Like
Palo Alto, the towns contained a mix of occupations and education levels—no surprise, given that skilled blue-collar
workers often made as much as, or more than, white-collar middle managers.
Now, of course, Gatsby is back. New mansions, grander than the old, are rising by the score; keeping servants, it
seems, is no longer a problem. A couple of years ago I had dinner with a group of New York investment bankers.
After the business was concluded, the talk turned to their weekend homes in the Hamptons. Naively, I asked whether
that wasn’t a long drive; after a moment of confused silence, the answer came back: “But the helicopter only takes
half an hour.”
You can confirm what your eyes see, in Palo Alto or in any American community, with dozens of statistics. The
most straightforward are those on income shares supplied by the Bureau of the Census, whose statistics are among
the most rigorously apolitical. In 1970, according to the bureau, the bottom 20 percent of U.S. families received only
5.4 percent of the income, while the top 5 percent received 15.6 percent. By 1994, the bottom fifth had only 4.2
percent, while the top 5 percent had increased its share to 20.1 percent. That means that in 1994, the average income
among the top 5 percent of families was more than 19 times that of the bottom 20 percent of families. In 1970, it had
been only about 11.5 times as much. (Incidentally, while the change in distribution is most visible at the top and
bottom, families in the middle have also lost: The income share of the middle 20 percent of families has fallen from
17.6 to 15.7 percent.) These are not abstract numbers. They are the statistical signature of a seismic shift in the
character of our society.
The American notion of what constitutes the middle class has always been a bit strange, because both people who
are quite poor and those who are objectively way up the scale tend to think of themselves as being in the middle. But
if calling America a middle-class nation means anything, it means that we are a society in which most people live
more or less the same kind of life.
In 1970 we were that kind of society. Today we are not, and we become less like one with each passing year. As
politicians compete over who really stands for middle-class values, what the public should be asking them is, What
middle class? How can we have common “middle-class” values if whole segments of society live in vastly different
economic universes?
If this election was really about what the candidates claim, it would be devoted to two questions: Why has America
ceased to be a middle-class nation? And, more important, what can be done to make it a middle-class nation again?
The Sources of Inequality
Most economists who study wages and income in the United States agree about the radical increase in inequality—
only the hired guns of the right still try to claim it is a statistical illusion. But not all agree about why it has
happened.
Imports from low-wage countries—a popular villain—are part of the story, but only a fraction of it. The numbers
just aren’t big enough. We invest billions in low-wage countries—but we invest trillions at home. What we spend on
manufactured goods from the Third World represents just 2 percent of our income. Even if we shut out imports from
low-wage countries (cutting off the only source of hope for the people who work in those factories), most estimates
suggest it would raise the wages of low-skill workers here by only 1 or 2 percent.
Information technology is a more plausible villain. Technological advance doesn’t always favor elite workers, but
since 1970 there has been clear evidence of a general “skill bias” toward technological change. Companies began to
replace low-skill workers with smaller numbers of high-skill ones, and they continue to do so even though low-skill
workers have gotten cheaper and high-skill workers more expensive.
These forces, while easily measurable, don’t fully explain the disparity between the haves and the have-nots.
Globalization and technology may explain why a college degree makes more difference now than it did 20 years
ago. But schoolteachers and corporate CEOs typically have about the same amount of formal education. Why, then,
have teachers’ salaries remained flat while those of CEOs have increased fivefold? The impact of technology and of
foreign trade do not answer why it is harder today for most people to make a living but easier for a few to make a
killing. Something else is going on.
Values, Power, and Wages
In 1970 the CEO of a typical Fortune 500 corporation earned about 35 times as much as the average manufacturing
employee. It would have been unthinkable to pay him 150 times the average, as is now common, and downright
outrageous to do so while announcing mass layoffs and cutting the real earnings of many of the company’s workers,
especially those who were paid the least to start with. So how did the unthinkable become first thinkable, then
doable, and finally—if we believe the CEOs— unavoidable?
The answer is that values changed—not the middle-class values politicians keep talking about, but the kind of values
that helped to sustain the middle-class society we have lost.
Twenty-five years ago, prosperous companies could have paid their janitors minimum wage and still could have
found people to do the work. They didn’t, because it would have been bad for company morale. Then, as now, CEOs
were in a position to arrange for very high salaries for themselves, whatever their performance, but corporate boards
restrained such excesses, knowing that too great a disparity between the top man and the ordinary worker would
cause problems. In short, though America was a society with large disparities between economic classes, it had an
egalitarian ethic that limited those disparities. That ethic is gone.
One reason for the change is a sort of herd behavior: When most companies hesitated to pay huge salaries at the top
and minimum wage at the bottom, any company that did so would have stood out as an example of greed; when
everyone does it, the stigma disappears.
There is also the matter of power. In 1970 a company that appeared too greedy risked real trouble with other
powerful forces in society. It would have had problems with its union if it had one, or faced the threat of union
organizers if it didn’t. And its actions would have created difficulties with the government in a way that is now
unthinkable. (Can anyone imagine a current president confronting a major industry over price increases, the way
John F. Kennedy did the steel industry?)
Those restraining forces have largely disappeared. The union movement is a shadow of its former self, lucky to hold
its ground in a defensive battle now and then. The idea that a company would be punished by the government for
paying its CEO too much and its workers too little is laughable today: since the election of Ronald Reagan the CEO
would more likely be invited to a White House dinner.
In brief, much of the polarization of American society can be explained in terms of power and politics. But why has
the tide run so strongly in favor of the rich that it continues regardless of who is in the White House and who
controls the Congress?
The Decline of Labor
The decline of the labor movement in the United States is both a major cause of growing inequality and an
illustration of the larger process under way in our society. Unions now represent less than 12 percent of the private
workforce, and their power has declined dramatically. In 1970 some 2.5 million workers participated in some form
of labor stoppage; in 1993, fewer than 200,000 did. Because unions are rarely able or willing to strike, being a union
member no longer carries much of a payoff in higher wages.
There are a number of reasons for the decline of organized labor: the shift from manufacturing to services and from
blue-collar to white-collar work, growing international competition, and deregulation. But these factors can’t explain
the extent or the suddenness of labor’s decline.
The best explanation seems to be that the union movement fell below critical mass. Unions are good for unions: In a
nation with a powerful labor movement, workers have a sense of solidarity, one union can support another during a
strike, and politicians take union interests seriously. America’s union movement just got too small, and it imploded.
We should not idealize the unions. When they played a powerful role in America, they often did so to bad effect.
Occasionally they were corrupt, often they extracted higher wages at the consumer’s expense, sometimes they
opposed new technologies and enforced inefficient practices. But unions helped keep us a middle-class society—not
only because they forced greater equality within companies, but because they provided a counterweight to the power
of wealthy individuals and corporations. The loss of that counterweight is clearly bad for society.
The point is that a major force that kept America a more or less unified society went into a tailspin. Our whole
society is now well into a similar downward spiral, in which growing inequality creates the political and economic
conditions that lead to even more inequality.
The Polarizing Spiral
Textbook political science predicts that in a two-party democracy like the United States, the parties will compete to
serve the interests of the median voter—the voter in the middle, richer than half the voters but poorer than the other
half. And since ordinary workers are more likely to lose their jobs than strike it rich, the interests of the median voter
should include protecting the poor. You might expect, then, the public to demand that government work against the
growing divide by taxing the rich more heavily and by increasing benefits for lower-paid workers and the
unemployed.
In fact, we have done just the opposite. Tax rates on the wealthy—even with Clinton’s modest increase of 1993 --
are far lower now than in the 1960s. We have allowed public schools and other services that are crucial for middle-
income families to deteriorate. Despite the recent increase, the minimum wage has fallen steadily compared with
both average wages and the cost of living. And programs for the poor have been savaged: Even before the recent
bipartisan gutting of welfare, AFDC payments for a typical family had fallen by a third in real terms since the 1960s.
The reason why government policy has reinforced rather than opposed this growing inequality is obvious: Well-off
people have disproportionate political weight. They are more likely to vote—the median voter has a much higher
income than the median family—and far more likely to provide the campaign contributions that are so essential in a
TV age.
The political center of gravity in this country is therefore not at the median family, with its annual income of
$40,000, but way up the scale. With decreasing voter participation and with the decline both of unions and of
traditional political machines, the focus of political attention is further up the income ladder than it has been for
generations. So never mind what politicians say; political parties are competing to serve the interests of families near
the 90th percentile or higher, families that mostly earn $100,000 or more per year.
Because the poles of our society have become so much more unequal, the interests of this political elite diverge
increasingly from those of the typical family. A family at the 95th percentile pays a lot more in taxes than a family at
the 50th, but it does not receive a correspondingly higher benefit from public services, such as education. The greater
the income gap, the greater the disparity in interests. This translates, because of the clout of the elite, into a constant
pressure for lower taxes and reduced public services.
Consider the issue of school vouchers. Many conservatives and even a few liberals are in favor of issuing
educational vouchers and allowing parents to choose among competing schools. Let’s leave aside the question of
what this might do to education and ask what its political implications might be.
Initially, we might imagine, the government would prohibit parents from “topping up” vouchers to buy higher-
priced education. But once the program was established, conservatives would insist such a restriction is unfair,
maybe even unconstitutional, arguing that parents should have the freedom to spend their money as they wish. Thus,
a voucher would become a ticket you could supplement freely. Upper-income families would realize that a reduction
in the voucher is to their benefit: They will save more in lowered taxes than they will lose in a decreased education
subsidy. So they will press to reduce public spending on education, leading to ever-deteriorating quality for those
who cannot afford to spend extra. In the end, the quintessential American tradition of public education for all could
collapse.
School vouchers hold another potential that, doubtless, makes them attractive to the conservative elite: They offer a
way to break the power of the American union movement in its last remaining stronghold, the public sector. Not by
accident did Bob Dole, in his acceptance speech at the Republican National Convention, pause in his evocation of
Norman Rockwell values to take a swipe at teachers’ unions. The leaders of the radical right want privatization of
schools, of public sanitation—of anything else they can think of—because they know such privatization undermines
what remaining opposition exists to their program.
If public schools and other services are left to deteriorate, so will the skills and prospects of those who depend on
them, reinforcing the growing inequality of incomes and creating an even greater disparity between the interests of
the elite and those of the majority.
Does this sound like America in the ‘90s? Of course it does. And it doesn’t take much imagination to envision what
our society will be like if this process continues for another 15 or 20 years. We know all about it from TV, movies,
and bestselling novels. While politicians speak of recapturing the virtues of small-town America (which never really
existed), the public— extrapolating from the trends it already sees—imagines a Blade Runner-style dystopia, in
which a few people live in luxury while the majority grovel in Third World living standards.
Strategies for the Future
There is no purely economic reason why we cannot reduce inequality in America. If we were willing to spend even a
few percent of national income on an enlarged version of the Earned Income Tax Credit, which supplements the
earnings of low-wage workers, we could make a dramatic impact on both incomes and job opportunities for the poor
and near-poor—bringing a greater number of Americans into the middle class. Nor is the money for such policies
lacking: America is by far the least heavily taxed of Western nations and could easily find the resources to pay for a
major expansion of programs aimed at limiting inequality.
But of course neither party advanced such proposals during the electoral campaign. The Democrats sounded like
Republicans, knowing that in a society with few counterweights to the power of money, any program that even hints
at redistribution is political poison. It’s no surprise that Bill Clinton’s repudiation of his own tax increase took place
in front of an audience of wealthy campaign contributors. In this political environment, what politician would talk of
taxing the well-off to help the low-wage worker?
And so, while the agenda of the GOP would surely accelerate the polarizing trend, even Democratic programs now
amount only to a delaying action. To get back to the kind of society we had, we need to rebuild the institutions and
values that made a middle-class nation possible.
The relatively decent society we had a generation ago was largely the creation of a brief, crucial period in American
history: the presidency of Franklin Roosevelt, during the New Deal and especially during the war. That created what
economic historian Claudia Goldin called the Great Compression—an era in which a powerful government,
reinforced by and in turn reinforcing a newly powerful labor movement, drastically narrowed the gap in income
levels through taxes, benefits, minimum wages, and collective bargaining. In effect, Roosevelt created a new,
middle-class America, which lasted for more than a generation. We have lost that America, and it will take another
Roosevelt, and perhaps the moral equivalent of another war, to get it back.
Until then, however, we can try to reverse some of the damage. To do so requires more than just supporting certain
causes. It means thinking strategically—asking whether a policy is not only good in itself but how it will affect the
political balance in the future. If a policy change promises to raise average income by a tenth of a percentage point,
but will widen the wedge between the interests of the elite and those of the rest, it should be opposed. If a law
reduces average income a bit but enhances the power of ordinary workers, it should be supported.
In particular, we also need to apply strategic thinking to the union movement. Union leaders and liberal intellectuals
often don’t like each other very much, and union victories are often of dubious value to the economy. Nonetheless,
if you are worried about the cycle of polarization in this country, you should support policies that make unions
stronger, and vociferously oppose those that weaken them. There are some stirrings of life in the union movement—
a new, younger leadership with its roots in the service sector has replaced the manufacturing-based old guard, and
has won a few political victories. They must be supported, almost regardless of the merits of their particular case.
Unions are one of the few political counterweights to the power of wealth.
Of course, even to talk about such things causes the right to accuse us of fomenting “class warfare.” They want us to
believe we are all members of a broad, more or less homogeneous, middle class. But the notion of a middle-class
nation was always a stretch. Unless we are prepared to fight the trend toward inequality, it will become a grim joke.
Economic Culture Wars
For reasons explained below, the editor dares not add a subtitle to this article.
Paul Krugman
Slate – The Dismal Science
(1,295 words; posted Thursday, Oct. 24; to be composted Thursday, Oct. 31)
Economics writer Bob Kuttner devotes an essay in the American Prospect,

a journal he edits, to an attack on my writings in SLATE and elsewhere.
Don't worry, I won't respond here to that attack. If you're interested, you
can read my response in the November-December issue of Kuttner's
journal. What I would like to discuss is what I think is the true reason
people like myself and Kuttner--who also writes columns for Business
Week and the Boston Globe--have so much trouble getting along. We are
both, after all, liberals. I have even written for the American Prospect. It is
not, I claim, really a political issue in the normal sense. What we are really
fighting about is a matter of epistemology, of how one perceives and
understands the world.
If you try to follow arguments about economics among intellectuals whose

politics are more or less left-of-center, you gradually become aware that the
participants in these arguments are divided not only by particular issues--
deficit reduction, NAFTA, and so on--but by the whole way that they think
about the economy. On one side there are those whose views are informed
by academic economics, the kind of stuff that is taught in textbooks. On the
other there are people like Kuttner, Jeff Faux of the Economic Policy
Institute, and Labor Secretary Robert Reich. Some members of this faction
have held university appointments. But most of them lack academic
credentials and, more important, they are basically hostile to the kind of
economics in which such credentials are based
If the anti-academic faction does not draw its ideas from textbook
economics, however, where does its worldview come from? Well, here's a
story that may sound trivial but which I regard as revealing. Back in 1992, I
supplied the American Prospect with an article on the problem of growing
income inequality. In the published piece, the editor, Kuttner, improved on
my drab title, but also added a dreadful subtitle: "The Rich, the Right, and the Facts: Deconstructing the Income
Distribution Controversy."
Deconstructing? Why on earth would anyone not a member of the Modern Language Association want to use an
academic buzzword that has been the butt of so many jokes? (What do you get when you cross a Mafioso and a
deconstructionist? Someone who makes you an offer you can't understand.) How could the cause of liberal revival
be served by making me sound like a character out of a David Lodge satire?
A strong desire to make economics less like a science and more like literary
criticism is a surprisingly common attribute of anti-academic writers on the
subject. For example, in a recent collection of essays (Foundations of
Research in Economics: How do Economists do Economics?, edited by
Steven G. Medema and Warren Samuels),
James K. Galbraith, a constant critic of the profession (and a frequent

contributor to the American Prospect), urges economists to emulate "vibrant
humanities faculties" in which "departments develop viciously opinionated,
inbred, sometimes bitter and tyrannical but definitely exciting intellectual
climates." Economics, in short, would be a better field if the MIT economics
department were more like the Yale English department during its
deconstructionist heyday.
Academic economics, the stuff that is in the textbooks, is largely based on

mathematical reasoning. I hope you think that I am an acceptable writer, but
when it comes to economics I speak English as a second language: I think in
equations and diagrams, then translate. The opponents of mainstream
economics dislike people like me not so much for our conclusions as for our
style: They want economics to be what it once was, a field that was
comfortable for the basically literary intellectual.
This should sound familiar. More than 40 years ago, the scientist-turned-
novelist C.P. Snow wrote his famous essay about the war between the "two
cultures," between the essentially literary sensibility that we expect of a card-
carrying intellectual and the scientific/mathematical outlook that is arguably
the true glory of our civilization. That war goes on; and economics is on the
front line. Or to be more precise, it is territory that the literati definitively lost
to the nerds only about 30 years ago--and they want it back.
That is what explains the lit-crit style so oddly favored by the leftist critics of
mainstream economics. Kuttner and Galbraith know that the quantitative,
algebraic reasoning that lies behind modern economics is very difficult to challenge on its own ground. To oppose it
they must invoke alternative standards of intellectual authority and legitimacy. In effect, they are saying, "You have
Paul Samuelson on your team? Well, we've got Jacques Derrida on ours."
A similar situation exists in other fields. Consider, for example, evolutionary biology. Like most American
intellectuals, I first learned about this subject from the writings of Stephen Jay Gould. But I eventually came to
realize that working biologists regard Gould much the same way that economists regard Robert Reich: talented
writer, too bad he never gets anything right. Serious evolutionary theorists such as John Maynard Smith or William
Hamilton, like serious economists, think largely in terms of mathematical models. Indeed, the introduction to
Maynard Smith's classic tract Evolutionary Genetics flatly declares, "If you can't stand algebra, stay away from
evolutionary biology." There is a core set of crucial ideas in his subject that, because they involve the interaction of
several different factors, can only be clearly understood by someone willing to sit still for a bit of math. (Try to give
a purely verbal description of the reactions among three mutually catalytic chemicals.)
But many intellectuals who can't stand algebra are not willing to stay away from the subject. They are thus deeply
attracted to a graceful writer like Gould, who frequently misrepresents the field (perhaps because he does not fully
understand its essentially mathematical logic), but who wraps his misrepresentations in so many layers of
impressive, if irrelevant, historical and literary erudition that they seem profound.
Unfortunately, Maynard Smith is right, both about evolution and about economics. There are important ideas in both
fields that can be expressed in plain English, and there are plenty of fools doing fancy mathematical models. But
there are also important ideas that are crystal clear if you can stand algebra, and very difficult to grasp if you can't.
International trade in particular happens to be a subject in which a page or two of algebra and diagrams is worth 10
volumes of mere words. That is why it is the particular subfield of economics in which the views of those who
understand the subject and those who do not diverge most sharply.
Alas, there is probably no way to resolve this conflict peacefully. It is possible for a very skillful writer to convey in
plain English a sense of what serious economics is about, to hide the algebraic skeleton behind a more appealing
facade. But that won't appease the critics; they don't want economics with a literary facade, they want economics
with a literary core. And so people like me and people like Kuttner will never be able to make peace, because we are
engaged in a zero-sum conflict--not over policy, but over intellectual boundaries.
The literati truly cannot be satisfied unless they get economics back from the nerds. But they can't have it, because
we nerds have the better claim.
Links
Nerds can write, too. Mathematically minded biologist William Hamilton's new book of collected papers, Narrow
Roads of Geneland, was recently praised by fellow evolutionary biologist Richard Dawkins in a London Times
review. (Dawkins' new book, Climbing Mount Improbable, was itself the focus of a recent review by John Horgan in
SLATE.) For another argument about how algebra-avoidance leads to shallow thinking, see David Berreby's piece
about the complexities of human biology that appeared in SLATE last month. For the latest in the Krugman/Kuttner
Kontroversy, see their debate in the new American Prospect. And to see Krugman face off with James K. Galbraith,
see their "Dialogue" in SLATE.
Paul Krugman is a professor of economics at MIT whose books include The Age of Diminished Expectations and
Peddling Prosperity.
Illustrations by Robert Neubecker

Ricardo’s Difficult Idea
Paul Krugman
The title of this paper is a play on that of an admirable recent book by the philosopher Daniel Dennett, Darwin's
Dangerous Idea: Evolution and the Meanings of Life (1995). Dennett's book is an examination of the reasons why
so many intellectuals remain hostile to the idea of evolution through natural selection -- an idea that seems simple
and compelling to those who understand it, but about which intelligent people somehow manage to get confused
time and time again.
The idea of comparative advantage -- with its implication that trade between two nations normally raises the real
incomes of both -- is, like evolution via natural selection, a concept that seems simple and compelling to those who
understand it. Yet anyone who becomes involved in discussions of international trade beyond the narrow circle of
academic economists quickly realizes that it must be, in some sense, a very difficult concept indeed. I am not talking
here about the problem of communicating the case for free trade to crudely anti-intellectual opponents, people who
simply dislike the idea of ideas. The persistence of that sort of opposition, like the persistence of creationism, is a
different sort of question, and requires a different sort of discussion. What I am concerned with here are the views of
intellectuals, people who do value ideas, but somehow find this particular idea impossible to grasp.
My objective in this essay is to try to explain why intellectuals who are interested in economic issues so consistently
balk at the concept of comparative advantage. Why do journalists who have a reputation as deep thinkers about
world affairs begin squirming in their seats if you try to explain how trade can lead to mutually beneficial
specialization? Why is it virtually impossible to get a discussion of comparative advantage, not only onto newspaper
op-ed pages, but even into magazines that cheerfully publish long discussions of the work of Jacques Derrida? Why
do policy wonks who will happily watch hundreds of hours of talking heads droning on about the global economy
refuse to sit still for the ten minutes or so it takes to explain Ricardo?
In this essay, I will try to offer answers to these questions. The first thing I need to do is to make clear how few
people really do understand Ricardo's difficult idea -- since the response of many intellectuals, challenged on this
point, is to insist that of course they understand the concept, but they regard it as oversimplified or invalid in the
modern world. Once this point has been established, I will try to defend the following hypothesis:
(i) At the shallowest level, some intellectuals reject comparative advantage simply out of a desire to be intellectually
fashionable. Free trade, they are aware, has some sort of iconic status among economists; so, in a culture that always
prizes the avant-garde, attacking that icon is seen as a way to seem daring and unconventional.
(ii) At a deeper level, comparative advantage is a harder concept than it seems, because like any scientific concept it
is actually part of a dense web of linked ideas. A trained economist looks at the simple Ricardian model and sees a
story that can be told in a few minutes; but in fact to tell that story so quickly one must presume that one's audience
understands a number of other stories involving how competitive markets work, what determines wages, how the
balance of payments adds up, and so on.
(iii) At the deepest level, opposition to comparative advantage -- like opposition to the theory of evolution -- reflects
the aversion of many intellectuals to an essentially mathematical way of understanding the world. Both comparative
advantage and natural selection are ideas grounded, at base, in mathematical models -- simple models that can be
stated without actually writing down any equations, but mathematical models all the same. The hostility that both
evolutionary theorists and economists encounter from humanists arises from the fact that both fields lie on the front
line of the war between C.P. Snow's two cultures: territory that humanists feel is rightfully theirs, but which has
been invaded by aliens armed with equations and computers.
1. You just don't understand

In scholarly discourse, it is a normal courtesy to give one's debating opponents the benefit of the doubt. If they say
something that seems confused, one tries to find a charitable interpretation -- although it may seem that they are
saying X, which is patently wrong, perhaps they are merely badly expressing their belief in Y, which could be right
in principle (although it is inconsistent with the data).
Many economists -- myself included -- have tried to extend this same courtesy to people who seem, on a casual
reading, not to understand comparative advantage. Surely, we have argued, the problem is one of different dialects
or jargon, not sheer lack of comprehension. What these critics must be trying to do is draw attention to the ways in
which comparative advantage may fail to work out in practice. After all, economists are familiar with a number of
reasons why the gains from free trade may not work out quite as easily as in the simplest Ricardian model. External
economies may mean underinvestment in import-competing sectors; imperfect competition may lead to a strategic
competition over industry rents; because of distortions in domestic labor markets, imports may reduce wages or
cause unemployment; and so on. And even if national income rises as a result of trade, the distribution of income
within a country may shift in a way that hurts large groups. In short, there are a number of sophisticated extensions
to and qualifications of the model introduced in the first few chapters of the undergraduate textbook (typically
covered later in the book -- for example, in Chapters 10-12 of Krugman and Obstfeld (1994)).
And so one is prepared to be sympathetic after reading a passage like the following, on the first page of Sir James
Goldsmith's The Trap: "The principal theoretician of free trade was David Ricardo, a British economist of the early
nineteenth century. He believed in two interrelated concepts: specialization and comparative advantage. According
to Ricardo, each nation should specialize in those activities in which it excels, so that it can have the greatest
advantage relative to other countries. Thus, a nation should narrow its focus of activity, abandoning certain
industries and developing those in which it has the largest comparative advantage. As a result, international trade
would grow as nations export their surpluses and import the products that they no longer manufacture, efficiency
and productivity would increase in line with economies of scale and prosperity would be enhanced. But these ideas
are not valid in today's world." (Goldsmith 1994:1). On close reading, the passage seems a bit garbled; but maybe he
is just a careless writer (or the translation from the original French is imperfect). One expects him to follow with a
discussion of some of the valid reasons why one might want to qualify Ricardo's idea -- for example, by referring to
the importance of external economies in a high-technology world.
But this expectation is utterly disappointed. What is different, according to Goldsmith, is that there are all these
countries out there that pay wages that are much lower than those in the West -- and that, he claims, makes Ricardo's
idea invalid. That's all there is to his argument; there is no hint of any more subtle content. In short, he offers us no
more than the classic "pauper labor" fallacy, the fallacy that Ricardo dealt with when he first stated the idea, and
which is a staple of even first-year courses in economics. In fact, one never teaches the Ricardian model without
emphasizing precisely the way that model refutes the claim that competition from low-wage countries is necessarily
a bad thing, that it shows how trade can be mutually beneficial regardless of differences in wage rates. The point is
not that low-wage competition never poses a problem. Rather, what is significant is that despite ostentatiously citing
Ricardo, Goldsmith completely misses one of the essential lessons of his argument.
One might argue that Goldsmith is a straw man, that he is an intellectual lightweight whom nobody would take
seriously as a commentator on these issues. But The Trap is structured as a discussion with Yves Messarovitch, the
economics editor of Le Figaro; Mr. Messarovitch certainly took Sir James seriously (never raising any objections to
his version of international trade theory), and the book became a best-seller in France. In the United States,
Goldsmith did not sell as many books, but his views were featured in intellectual magazines like New Perspectives
Quarterly; he was invited to speak to the US Congress; and the Clinton Administration took his views seriously
enough to send its chief economist, Laura Tyson, to debate him on television. In short, while Goldsmith's failure to
understand the basic idea of comparative advantage may seem stunningly obvious to any trained economist, other
intellectuals -- including editors and journalists who specialize on economic matters -- regarded his views as, at the
very least, a valuable addition to the debate.
Or consider the recent anti-free-trade writings of James Fallows, the Washington editor of The Atlantic Monthly and
one of America's most prominent intellectuals. In his book Looking at the Sun (1994), Fallows argues that Asian
success proves the effectiveness of protectionist policies in promoting economic growth. One might have expected
him to offer some intellectually cutting-edge explanation of why this might be so, of why comparative advantage is
invalid in the modern world economy. But instead he claims that economists have gone astray by ignoring the
nineteenth-century ideas of Friedrich List! One must assume that Fallows actually read List; in which case his praise
for List shows clearly that he does not understand Ricardo. For List's old book, like Goldsmith's new one, is the
work of a man who, right from the beginning, just didn't get it; who could not get straight in his mind how trade
between two countries could raise incomes in both. (A sample List argument: he points out that agricultural land
near cities is more valuable than that far away, and concludes that tariffs on manufactured goods will help farmers as
well as industrialists).
While the ideas of both Fallows and Goldsmith have been well received in intellectual circles, they have not by any
means persuaded everyone. What is striking, however, is that virtually none of the reviews of their books have
pointed out that they appear not to understand comparative advantage. (Indeed, reviews of Fallows's book tended to
praise his economic sophistication and question his political and cultural analysis). The explanation, of course, is
that the reviewers don't understand it either -- or, in some cases, that editors who didn't understand the concept
refused to allow it to be mentioned in the reviews. (I speak from personal experience). I believe that much of the
ineffectiveness of economists in public debate comes from their false supposition that intelligent people who read
and even write about world trade must grasp the idea of comparative advantage. With very few exceptions, they
don't -- and they don't even want to hear about it. Why?
2. The cult of the new
One of America's new intellectual stars is a young writer named Michael Lind, whose contrarian essays on politics
have given him a reputation as a brilliant enfant terrible. In 1994 Lind published an article in Harper's about
international trade, which contained the following remarkable passage:
"Many advocates of free trade claim that higher productivity growth in the United States will offset pressure on
wages caused by the global sweatshop economy, but the appealing theory falls victim to an unpleasant fact.
Productivity has been going up, without resulting wage gains for American workers. Between 1977 and 1992, the
average productivity of American workers increased by more than 30 percent, while the average real wage fell by 13
percent. The logic is inescapable. No matter how much productivity increases, wages will fall if there is an
abundance of workers competing for a scarcity of jobs -- an abundance of the sort created by the globalization of the
labor pool for US-based corporations." (Lind 1994: )
What is so remarkable about this passage? It is certainly a very abrupt, confident rejection of the case for free trade;
it is also noticeable that the passage could almost have come out of a campaign speech by Patrick Buchanan. But the
really striking thing, if you are an economist with any familiarity with this area, is that when Lind writes about how
the beautiful theory of free trade is refuted by an unpleasant fact, the fact he cites is completely untrue.
More specifically: the 30 percent productivity increase he cites was achieved only in the manufacturing sector; in the
business sector as a whole the increase was only 13 percent. The 13 percent decline in real wages was true only for
production workers, and ignores the increase in their benefits: total compensation of the average worker actually
rose 2 percent. And even that remaining gap turns out to be a statistical quirk: it is entirely due to a difference in the
price indexes used to deflate business output and consumption (probably reflecting overstatement of both
productivity growth and consumer price inflation). When the same price index is used, the increases in productivity
and compensation have been almost exactly equal. But then how could it be otherwise? Any difference in the rates
of growth of productivity and compensation would necessarily show up as a fall in labor's share of national income -
- and as everyone who is even slightly familiar with the numbers knows, the share of compensation in U.S. national
income has been quite stable in recent decades, and actually rose slightly over the period Lind describes.
The question here is not why Lind got these numbers wrong. It takes considerable experience to know where to look
and what to worry about in economic statistics, and one should not expect someone who does not work in the field
to be able to get it right without some guidance. The question is, instead, why Mr. Lind felt that it was a good idea to
make sweeping pronouncements about this subject, when he clearly was unwilling to invest time and energy in
actually understanding it. The short answer in this case is surely that Mr. Lind, who is always looking for ways to
enhance his enfant terrible status, saw this as a perfect opportunity. Free trade is a sacred cow of economists, who
are well-known to be boring, stuffy types; what could be a better way to reinforce one's credentials as a radical,
innovative thinker than to skewer their most beloved doctrine? (It seems not to have occurred to him that there might
be a reason other than ideological rigidity that the striking fact he thought he knew has not been noticed by
economists).
This is a fairly extreme case, but by no means unique. Modern intellectuals are supposed to be daring innovators, not
respecters of tradition. As any publisher will tell you, books about startling new scientific discoveries always sell
better than books about known areas of science, even though the things science already knows are in many ways
stranger than any of the speculations in the latest cosmological best-seller. Old ideas are viewed as boring, even if
few people have heard of them; new ideas, even if they are probably wrong and not terribly important, are far more
attractive. And books that say (or seem to say) that the experts have all been wrong are far more likely to attract a
wide audience than books that explain why the experts are probably right. Stephen Jay Gould's Wonderful Life
(Gould 1989) which to many readers seemed to say that recent discoveries refute Darwinian orthodoxy, attracted far
more attention than Richard Dawkins' equally well-written The Blind Watchmaker (Dawkins 1986), which explained
the astonishing implications of that orthodoxy. (See Dennett for an eye-opening discussion of Gould). Roger
Penrose's The Emperor's New Mind, which rejects the possibility of explaining intelligence in terms of
computational processes, attracted far more attention than any of the exciting discoveries of cognitive scientists who
are actually trying to understand the nature of intelligence.
The same principle applies to international economics. Comparative advantage is an old idea; intellectuals who want
to read about international trade want to hear radical new ideas, not boring old doctrines, even if they are quite
blurry about what those doctrines actually say. Robert Reich, now Secretary of Labor, understood this point
perfectly when he wrote an essay for Foreign Affairs entitled "Beyond free trade". (Reich 1983). The article
received wide attention, even though it was fairly unclear exactly how Reich proposed to go beyond free trade (there
is a certain similarity between Reich and Gould in this respect: they make a great show of offering new ideas, but it
is quite hard to pin down just what those new ideas really are). The great selling point was, clearly, the article's title:
free trade is old hat, it is something we must go beyond. In this sort of intellectual environment, it is quite hard to get
anyone other than an economics student to sit still for an explanation of the concept of comparative advantage. Just
imagine trying to tell an ambitious, energetic, forward-looking intellectual who is interested in economics -- William
Jefferson Clinton comes to mind -- that before he can start talking knowledgeably about globalization and the
information economy he must wrap his mind around a difficult concept that was devised by a frock-coated banker
180 years ago!
3. A harder concept than it seems
To a trained economist, the basic Ricardian model seems almost trivial. Two goods, two countries, one productive
factor, perfect competition: what could be simpler? Indeed, one of the fierce joys of being an international trade
economist is that so many seemingly sophisticated tracts can be revealed as nonsense, so many self-important men
unmasked as poseurs, using such a minimalist framework.
And yet if one tries to explain the basic model to a non-economist, it soon becomes clear that it really isn't that
simple after all. Teaching the model, to docile students, is one thing: they get the model in the course of a broader
study of economics, and in any case they are obliged to pay attention and learn it the way you teach it if they want to
pass the exam. But try to explain the model to an adult, especially one who already has opinions about the subject,
and you continually find yourself obliged to backtrack, realizing that yet another proposition you thought was
obvious actually isn't. Just before this paper was written, I was trying to explain to an editorial writer for a major
U.S. newspaper why international trade is probably not the main cause of the country's ills. After a confused
interlude, it became clear what one of the blocks was: he just didn't understand, even after being told the numbers,
why a situation in which productivity increases were not being shared with workers would necessarily be reflected
in a decline in the labor share of income -- and therefore why the stability of that share in practice is a crucial piece
of evidence. Eventually I was reduced nearly to baby-talk ("suppose the factory produces 10 tons of cheese, and
pays out wages equal in value to 6 tons; now suppose that the workers become more productive and turn out 12 tons
of cheese, but that wages haven't changed ..."). This was not a successful conversation: he wanted to talk about
global trends, and instead I was teaching him first-grade arithmetic.
That particular confusion is more common than one might expect. But even at a somewhat higher level, there are, I
believe, at least three implicit assumptions that underlie the most basic Ricardian model, assumptions that are
justified by the whole fabric of economic understanding but are not at all obvious to non-economists. Here they are:
- Wages are determined in a national labor market: The basic Ricardian model envisages a single factor, labor,
which can move freely between industries. When one tries to talk about trade with laymen, however, one at least
sometimes realizes that they do not think about things that way at all. They think about steelworkers, textile workers,
and so on; there is no such thing as a national labor market. It does not occur to them that the wages earned in one
industry are largely determined by the wages similar workers are earning in other industries. This has several
consequences. First, unless it is carefully explained, the standard demonstration of the gains from trade in a
Ricardian model -- workers can earn more by moving into the industries in which you have a comparative advantage
-- simply fails to register with lay intellectuals. Their picture is of aircraft workers gaining and textile workers
losing, and the idea that it is useful even for the sake of argument to imagine that workers can move from one
industry to the other is foreign to them. Second, the link between productivity and wages is thoroughly
misunderstood. Non-economists typically think that wages should reflect productivity at the level of the individual
company. So if Xerox manages to increase its productivity 20 percent, it should raise the wages it pays by the same
amount; if overall manufacturing productivity has risen 30 percent, the real wages of manufacturing workers should
have risen 30 percent, even if service productivity has been stagnant; if this doesn't happen, it is a sign that
something has gone wrong. In other words, my criticism of Michael Lind would baffle many non-economists.
Associated with this problem is the misunderstanding of what international trade should do to wage rates. It is a fact
that some Bangladeshi apparel factories manage to achieve labor productivity close to half those of comparable
installations in the United States, although overall Bangladeshi manufacturing productivity is probably only about 5
percent of the US level. Non-economists find it extremely disturbing and puzzling that wages in those productive
factories are only 10 percent of US standards.
Finally, and most importantly, it is not obvious to non-economists that wages are endogenous. Someone like
Goldsmith looks at Vietnam and asks, "what would happen if people who work for such low wages manage to
achieve Western productivity?" The economist's answer is, "if they achieve Western productivity, they will be paid
Western wages" -- as has in fact happened in Japan. But to the non-economist this conclusion is neither natural nor
plausible. (And he is likely to offer those Bangladeshi factories as a counterexample, missing the distinction
between factory-level and national-level productivity).
- Constant employment is a reasonable approximation: The standard textbook version of the Ricardian model
assumes full employment in both countries. But in reality unemployment is constantly a concern of economic policy
-- so why is this the usual assumption? There are two answers. One -- the answer that Ricardo would have given -- is
that international trade is a long-run issue, and that in the long run the economy has a natural self-correcting
tendency to return to full employment. The other, more modern answer is that countries have central banks, which
try to stabilize employment around the NAIRU; so that it makes sense to think of the Federal Reserve and its
counterparts acting in the background to hold employment constant. This is not at all the way that non-economists
think about the issue. Both supporters and opponents of free trade normally claim that their preferred policies will
create jobs; free-traders are forever warning that the Smoot-Hawley tariff caused the Great Depression. And the
alternative view does not come at all naturally. During the NAFTA debates I shared a podium with an experienced,
highly regarded U.S. trade negotiator, a strong NAFTA supporter. At one point a member of the audience asked me
what I thought the effect of NAFTA would be on the number of jobs in the United States; when I replied "none",
based on the standard arguments, the trade official exploded in anger: "It's remarks like that which explain why
people hate economists!"
- The balance of payments is not a problem: The standard textbook presentation of the Ricardian model assumes
balanced trade -- indeed, it is usually a one-period model in which trade must be balanced. Yet the news is full of
stories about the balance of payments, of complaints about trade surpluses and deficits. Why are these absent from
the story?
Again, economists have good reasons for thinking that it is a good approximation to separate balance of payments
from real international trade issues. In Ricardo's case, the essential ingredient was the argument by David Hume that
trade imbalances are self-correcting: a surplus country will acquire specie, leading to rising prices that price its
goods out of world markets, while a deficit country will correspondingly find its goods increasingly competitively
priced. In the modern world, again, the channels involve less Invisible Hand and more government intervention:
when monetary policies target the unemployment rate, exchange rates do the adjusting. Economists are also aware
that even persistent trade imbalances are not necessarily a problem, and certainly that surpluses are not a sure sign of
health or deficits one of weakness. Trade may be balanced in Chapter 2; but Chapter 13 explains that the trade
balance is equal to the difference between savings and investment, and that a country may justifiably run persistent
deficits if it is an attractive site for foreign investment.
Again, none of this is obvious to non-economists. The essential accounting identity, savings minus investment
equals exports minus imports, is if anything a better-kept secret than the concept of comparative advantage. The
debate over NAFTA was entirely phrased in terms of the apparent prospect that the United States would run a trade
surplus with Mexico -- that was why the treaty was in our interests -- and the deficit that has actually materialized is
universally regarded as a bad thing.
In sum, while the concept of comparative advantage may seem utterly simple to economists, in order to achieve that
simplicity one must invoke a number of principles and useful simplifying assumptions that seem natural and
reasonable only to someone familiar with economic analysis in general. ("What do you mean, objects fall at the
same rate regardless of how heavy they are -- if I drop a cannonball and a feather ... you're assuming away air
resistance? Why would you do that?") Those principles and simplifying assumptions are indeed reasonable, but they
are not obvious.
4. The Two Cultures
I once had a very unpleasant, but ultimately useful, conversation with the editor of one of America's leading
intellectual magazines. He was in the process of refusing to print a piece I had written at his request, and his
dissatisfaction with what I had written was the main subject at hand. But along the way I somehow mentioned the
need to represent economic ideas with carefully thought-out models, and he responded with a mixture of bafflement
and asperity. Clearly the idea that economic ideas could benefit from being modeled was new to him, even though
his journal frequently publishes articles on economic affairs; and he suggested to me that in future I would do well
to explain why models are sometimes useful and why they usually are not.
At the time I was fairly flabbergasted: to question the usefulness of economic models at this late date seemed rather
strange. But the economist's idea that economic theory for the most part consists of models has by no means been
accepted by intellectuals outside our field. In fact, if one looks at the favorite economic writers of the non-economist
intellectual -- Robert Reich, Lester Thurow, John Kenneth Galbraith -- one realizes that they have in common an
aversion to or ignorance of modeling. There are model-oriented economists, like Alan Blinder, who also write for a
broader audience, and they don't put their equations in their books and articles; but the skeleton of the models that
structure their thought is visible under the surface to those who know how to look. By contrast, in the writings of
Reich or Galbraith what you read is what you get -- there is no hidden mathematical structure to the argument, no
diagram one might draw on a blackboard or simulation one might run on a computer to clarify the point.
In this the situation in economics is virtually identical to that in evolutionary theory. Ask a working biologist who is
the greatest living evolutionary thinker, and he or she will probably answer John Maynard Smith (with nods to
George Williams and William Hamilton). Maynard Smith not only has a name that should have made him an
economist; he writes and thinks like an economist, representing evolutionary issues with stylized mathematical
models that are sometimes confronted with data, sometimes simulated on the computer, but always serve as the true
structure informing the verbal argument. A textbook like his Evolutionary Genetics (1989) feels remarkably
comfortable for an academic economist: the style is familiar, and even a good bit of the content looks like things
economists do too. But ask intellectuals in general for a great evolutionary thinker and they will surely name
Stephen Jay Gould -- who receives one brief, dismissive reference in Maynard Smith (1989). (One of my ill-advised
moves in the conversation with the editor was to point out that the index to Tyson (1993) contains no references
either to Reich or to Thurow).
What does Gould have that Maynard Smith does not? He is a more accessible writer -- but evolutionary theory is, to
a far greater extent than economics, blessed with excellent popularizers: writers like Dawkins (1989) or Ridley
(1993), who provide beautifully written expositions of what researchers have learned. (Writers like Gould or Reich
are not, in the proper sense, popularizers: a popularizer reports on the work of a community of scholars, whereas
these writers argue for their own, heterodox points of view). No, what makes Gould so popular with intellectuals is
not merely the quality of his writing but the fact that, unlike Dawkins or Ridley, he is not trying to explain the
essentially mathematical logic of modern evolutionary theory. It's not just that there are no equations or simulations
in his books; he doesn't even think in terms of the mathematical models that inform the work of writers like
Dawkins. That is what makes his work so appealing. The problem, of course, is that evolutionary theory -- the real
thing -- is based on mathematical models; indeed, increasingly it is based on computer simulation. And so the very
aversion to mathematics that makes Gould so appealing to his audience means that his books, while they may seem
to his readers to contain deep ideas, seem to people who actually know the field to be mere literary confections with
little serious intellectual content, and much of that simply wrong. In particular, readers whose ideas of evolution are
formed by reading Gould's work get no sense of the power and reach of the theory of natural selection -- if anything,
they come away with a sense that modern thought has shown that theory to be inadequate.
Economics is not as well served by its writers as evolution. Still, the distinctive feature of the writers whose ideas
about world trade play well with an intellectual audience is the same: the successful books are those that not only do
not explicitly discuss mathematical models, they are not even implicitly based on mathematical reasoning. A book
like Robert Reich's The Work of Nations (Reich 1991) not only eschews equations and diagrams, it never even tries
to present the idea of comparative advantage informally. In fact, it never uses the phrase "comparative advantage" at
all, even to criticize it. As a result, books by authors such as Reich or Thurow do not make humanists
uncomfortable. Unavoidably, however, they also give them no sense of the power and importance of economic
models in general, or of Ricardo's difficult idea in particular. If anything, the message one gets from these books is
that in the new economy nineteenth-century concepts no longer apply.
It might be worth pointing out one exception to the general intellectual aversion to mathematical models.
Intellectuals do reserve, both in evolution and economics, a small pedestal for mathematical modelers -- as long as
their models are confusing and seem to refute orthodoxy. Call it the "Santa Fe syndrome". At one point in Dennett's
book he reports a list of the top ten objections raised to Steven Pinker's theories about the evolution of language; one
of them is "Natural selection is irrelevant, because now we have chaos theory". At about the same time I read this
passage I had received a barrage of protests over an article that tried, without explicit mathematics, to walk through
some simple models of international trade (Krugman 1994); several of the letters insisted that because of nonlinear
dynamics it was impossible to reach any meaningful conclusions from simple models. ("Have you ever thought
about the implications of increasing returns? You should read the work of Brian Arthur and Paul Romer.")
There are two odd things about the popularity of certain kinds of mathematical modeling among intellectuals who
are generally hostile to such models. One is that the preferred models are typically far more difficult and obscure
than the standard models in the field. The other is that the supposedly heterodox conclusions of these models are
often not heterodox at all. To take a theme common to both evolution and economics: the idea that small random
events can under certain conditions set in motion a cumulative process of change is the theme both of "peacock's
tail" accounts of sexual selection and of external economy accounts of international specialization, both familiar
stories that lie well inside the boundaries of academic orthodoxy, stories that can be and are illustrated with simple
models in advanced undergraduate textbooks like Maynard Smith (1989) and Krugman and Obstfeld (1994). Yet
many intellectuals believe that this idea was discovered at Santa Fe and challenges the foundations of both fields.
The secret to the popularity of certain mathematical modelers, I suspect, is that they are valued precisely because
they seem to absolve intellectuals from the need to understand the models that underpin orthodox views. Hardly
anyone tries to understand what the Santa Fe theorists are actually saying; it is the pose of opposition to received
wisdom, together with the implication that in a complicated world you can't learn anything from simple models
anyway, that is valued, because it seems to say that not knowing what's in the textbooks is OK.
A final note here: there is a new trend among people who don't like conventional economics, toward what is
sometimes called "bionomics". The manifestos of groups like the Bionomics Institute claim that they are developing
a new science of economics that abandons the mechanistic approach of the existing field in favor of a model based
on ecology and evolution. (Speaker of the House Newt Gingrich is reported to be among those who find bionomics
appealing). The irony is that neoclassical economics, with its emphasis on modeling the interactions of self-
interested individuals, is no more mechanistic than neo-Darwinian evolutionary theory -- in fact, the theories are
very similar to one another, down to the details of the models and the curves on the diagrams.
5. What can be done?

I cannot offer any grand strategy for dealing with the aversion of intellectuals to Ricardo's difficult idea. No matter
what economists do, we can be sure that ten years from now the talk shows and the op-ed pages will still be full of
men and women who regard themselves as experts on the global economy, but do not know or want to know about
comparative advantage. Still, the diagnosis I have offered here provides some tactical hints:
(i) Take ignorance seriously: I am convinced that many economists, when they try to argue in favor of free trade,
make the mistake of overestimating both their opponents and their audience. They cannot believe that famous
intellectuals who write and speak often about world trade could be entirely ignorant of the most basic ideas. But they
are -- and so are their readers. This makes the task of explaining the benefits of trade harder -- but it also means that
it is remarkably easy to make fools of your opponents, catching them in elementary errors of logic and fact. This is
playing dirty, and I advocate it strongly.
(ii) Adopt the stance of rebel: There is nothing that plays worse in our culture than seeming to be the stodgy
defender of old ideas, no matter how true those ideas may be. Luckily, at this point the orthodoxy of the academic
economists is very much a minority position among intellectuals in general; one can seem to be a courageous
maverick, boldly challenging the powers that be, by reciting the contents of a standard textbook. It has worked for
me!
(iii) Don't take simple things for granted: It is crucial, when trying to communicate Ricardo's idea to a broader
audience, to stop and try to put yourself in the position of someone who does not know economics. Arguments must
be built from the ground up -- don't assume that people understand why it is reasonable to assume constant
employment, or a self-correcting trade balance, or even that similar workers tend to be paid similar wages in
different industries.
(iv) Justify modeling: Do not presume, as I did, that people accept and understand the idea that models facilitate
understanding. Most intellectuals don't accept that idea, and must be persuaded or at least put on notice that it is an
issue. It is particularly useful to have some clear examples of how "common sense" can be misleading, and a simple
model can clarify matters immensely. (My recent favorite involves the "dollarization" of Russia. It is not easy to
convince a non-economist that when gangsters hoard $100 bills in Vladivostock, this is a capital outflow from
Russia's point of view -- and that it has the same effects on the US economy as if that money was put in a New York
bank. But if you can get the point across, you have also taught an object lesson in why economists who think in
terms of models have an advantage over people who do economics by catch-phrase). None of this is going to be
easy. Ricardo's idea is truly, madly, deeply difficult. But it is also utterly true, immensely sophisticated -- and
extremely relevant to the modern world.
REFERENCES
Dawkins, R. (1986), The Blind Watchmaker, New York: Longman.

Dennett, D. (1995), Darwin's Dangerous Idea: Evolution and the Meanings of Life, New York: Simon and Schuster.
Fallows, J. (1994), Looking at the Sun, New York: Pantheon.
Goldsmith, J. (1994), The Trap, New York: Carroll and Graf.
Gould, S.J. (1989), Wonderful Life, New York: Norton.
Krugman, P. (1994), "Does Third World growth hurt First World prosperity?", Harvard Business Review , July.
Krugman, P. and M. Obstfeld (1994), International Economics: Theory and Policy (3rd edition), New York:
HarperCollins.
Lind, M.
List, F. (1856), The National System of Political Economy
Maynard Smith, J. (1989), Evolutionary Genetics, Oxford: Oxford University Press.
Penrose, R. (1989), The Emperor's New Mind, New York: Oxford.
Reich, R. (1983)
Reich, R. (1991), The Work of Nations, New York: Basic Books
Ridley, M. (1993), The Red Queen: Sex and the Evolution of Human Nature, New York: Penguin.
Tyson, L. (1993), Who's Bashing Whom?, Washington: Institute for International Economics.
What Economists Can Learn From Evolutionary Theorists

(A talk given to the European Association for Evolutionary Political Economy)
Paul Krugman
Nov. 1996
Good morning. I am both honored and a bit nervous to be speaking to a group devoted to the idea of evolutionary
political economy. As you probably know, I am not exactly an evolutionary economist. I like to think that I am more
open-minded about alternative approaches to economics than most, but I am basically a maximization-and-
equilibrium kind of guy. Indeed, I am quite fanatical about defending the relevance of standard economic models in
many situations.
Why, then, am I here? Well, partly because my research work has taken me to some of the edges of the
neoclassical paradigm. When you are concerned, as I have been, with situations in which increasing returns are
crucial, you must drop the assumption of perfect competition; you are also forced to abandon the belief that market
outcomes are necessarily optimal, or indeed that the market can be said to maximize anything. You can still believe
in maximizing individuals and some kind of equilibrium, but the complexity of the situations in which your
imaginary agents find themselves often obliges you - and presumably them - to represent their behavior by some
kind of ad hoc rule rather than as the outcome of a carefully specified maximum problem. And you are often driven
by sheer force of modeling necessity to think of the economy as having at least vaguely "evolutionary" dynamics, in
which initial conditions and accidents along the way may determine where you end up. Some of you may have read
my work on economic geography; I only found out after I had worked on the models for some time that I was using
"replicator dynamics" to discuss the problem of economic change.
But there is another reason I am here. I am an economist, but I am also what we might call an evolution
groupie. That is, I spend a great deal of time reading what evolutionary biologists write - not only the more popular
volumes but the textbooks and, most recently, some of the professional articles. I have even tried to talk to some of
the biologists, which in this age of narrow specialization is a major effort. My interest in evolution is partly a
recreation; but it is also true that I find in evolutionary biology a useful vantage point from which to view my own
specialty in a new perspective. In a way, the point is that both the parallels and the differences between economics
and evolutionary biology help me at least to understand what I am doing when I do economics - to get, to be
pompous about it, a new perspective on the epistemology of the two fields.
I am sure that I am not unique either in my interest in biology or in my feeling that we economists have
something to learn from it. Indeed, I am sure that many people in this room know far more about evolutionary
theory than I do. But I may have one special distinction. Most economists who try to apply evolutionary concepts
start from some deep dissatisfaction with economics as it is. I won't say that I am entirely happy with the state of
economics. But let us be honest: I have done very well within the world of conventional economics. I have pushed
the envelope, but not broken it, and have received very widespread acceptance for my ideas. What this means is that
I may have more sympathy for standard economics than most of you. My criticisms are those of someone who loves
the field and has seen that affection repaid. I don't know if that makes me morally better or worse than someone who
criticizes from outside, but anyway it makes me different.
Anyway, enough preliminaries.
Sister fields
If you are familiar with economics and start reading evolutionary biology in earnest - and presumably vice
versa - you quickly realize that these are sister fields. They actually have a remarkable amount in common, not only
in terms of the kind of questions they ask and the methods they use, but in terms of the way they relate to and are
perceived by the rest of the world.
To begin with, there is the similarity in the basic approach. Let me give you my own personal definition of the
basic method of economic theory. To me, it seems that what we know as economics is the study of those phenomena
that can be understood as emerging from the interactions among intelligent, self-interested individuals. Notice that
there are really four parts to this definition. Let's read from right to left.
1. Economics is about what individuals do: not classes, not "correlations of forces", but individual actors. This is not
to deny the relevance of higher levels of analysis, but they must be grounded in individual behavior. Methodological
individualism is of the essence.
2. The individuals are self-interested. There is nothing in economics that inherently prevents us from allowing
people to derive satisfaction from others' consumption, but the predictive power of economic theory comes from the
presumption that normally people care about themselves.
3. The individuals are intelligent: obvious opportunities for gain are not neglected. Hundred-dollar bills do not lie
unattended in the street for very long.
4. We are concerned with the interaction of such individuals: Most interesting economic theory, from supply and
demand on, is about "invisible hand" processes in which the collective outcome is not what individuals intended.
OK, that's what economics is about. What is evolutionary theory about?
The answer, basically, is that evolutionists share three of the four concerns. Their field is about the interaction
of self-interested individuals - who are often thought of as organisms "trying" to leave as many offspring as possible,
but which are in some circumstances best thought of as genes "trying" to propagate as many copies of themselves as
possible. The main difference between evolutionary theory and economics is that while economists routinely
suppose that the agents in their models are very smart about finding the best strategy - and an economist is always
defensive about any model in which agents are assumed to act with less than perfect rationality - evolutionists have
no qualms about assuming myopic behavior. Indeed, myopia is of the essence of their view.
I'll talk later about what difference this makes. My point right now is that because the basic methods are similar
if not identical, economics and evolutionary theory are surprisingly similar. It is often asserted that economic theory
draws its inspiration from physics, and that it should become more like biology. If that's what you think, you should
do two things. First, read a text on evolutionary theory, like John Maynard Smith's Evolutionary Genetics. You will
be startled at how much it looks like a textbook on microeconomics. Second, try to explain a simple economic
concept, like supply and demand, to a physicist. You will discover that our whole style of thinking, of building up
aggregative stories from individual decisions, is not at all the way they think.
So there is a close affinity in method and indeed of intellectual style between economics and evolution. But
there is another interesting parallel: both economics and evolution are model-oriented, algebra-heavy subjects that
are the subject of intense interest from people who cannot stand algebra. And as a result in each case it is very
important to distinguish between the field as it is perceived by outsiders (and portrayed in popular books) and what
it is really like. We all know that economics is a field in which the most famous authors are often people who are
regarded, with good reason, as not even worth arguing with by almost everyone in the profession. Do you remember
that global best-seller The Coming Great Depression of 1990 by Ravi Batra? And I guess it is no secret that even
John Kenneth Galbraith, still the public's idea of a great economist, looks to most serious economists like an
intellectual dilettante who lacks the patience for hard thinking. Well, the same is true in evolution.
I am not sure how well this is known. I have tried, in preparation for this talk, to read some evolutionary
economics, and was particularly curious about what biologists people reference. What I encountered were quite a
few references to Stephen Jay Gould, hardly any to other evolutionary theorists. Now it is not very hard to find out,
if you spend a little while reading in evolution, that Gould is the John Kenneth Galbraith of his subject. That is, he is
a wonderful writer who is bevolved by literary intellectuals and lionized by the media because he does not use
algebra or difficult jargon. Unfortunately, it appears that he avoids these sins not because he has transcended his
colleagues but because he does does not seem to understand what they have to say; and his own descriptions of what
the field is about - not just the answers, but even the questions - are consistently misleading. His impressive literary
and historical erudition makes his work seem profound to most readers, but informed readers eventually conclude
that there's no there there. (And yes, there is some resentment of his fame: in the field the unjustly famous theory of
"punctuated equilibrium", in which Gould and Niles Eldredge asserted that evolution proceeds not steadily but in
short bursts of rapid change, is known as "evolution by jerks").
What is rare in the evolutionary economics literature, at least as far as I can tell, is references to the theorists
the practitioners themselves regard as great men - to people like George Williams, William Hamilton, or John
Maynard Smith. This is serious, because if you think that Gould's ideas represent the cutting edge of evolutionary
theory (as I myself did until about a year and a half ago), you have an almost completely misguided view of where
the field is and even of what the issues are.
This is important, because it is at least my impression that what economists who like to use "evolutionary"
concepts expect from evolution is often based on what they imagine evolutionary theory to be like, not on what it is
actually like. And conversely, you learn a lot about why conventional economics looks the way it does by seeing
how evolutionary theorists have been driven to some of the same positions.
To explain these rather cryptic remarks, let me talk briefly about what - it seems to me, but I am happy to be
corrected - economists think an evolutionary approach can give us, then about what evolutionists seem to be saying
in practice.
What evolutionary economists want

I don't think that there are many economists, even among the unconventionally minded, who would quarrel
seriously with my basic definition of economics as concerning the interactions among intelligent, self-interested
individuals. I guess a Marxist would have problems with the whole idea of methodological individualism, and a
Galbraithian would have problems with the idea that self-interest can be defined without taking into account the
ability of advertisers and so forth to shape preferences. But such quarrels apart I would guess that we do not have
much difference with the basic statement.
Where the dissatisfaction sets in is with how we implement the first two terms in my four-part program. Yes,
of course economics is about interaction, and the agents are intelligent; but exactly how intelligent are they, and
what is the nature of the their interaction?
For there is no question that conventional economics has gone beyond the general ideas of intelligence and
interaction to a much harder-edged, extreme formulation. At least since Paul Samuelson published Foundations of
Economic Analysis in 1947, the overwhelming thrust of conventional theory has been to say that agents are not only
intelligent, they maximize - that is, they chose the best of all feasible alternatives. And when they interact, we
assume that what they do is achieve an equilibrium, in which each individual is doing the best he can given what all
the others are doing.
Now anyone who looks at the world knows that these are extreme and unrealistic assumptions. I just had some
work done on my house; it is painfully obvious, looking at the final bill, that I did not maximize - I did not engage in
optimal search for a contractor. In trying to find someone to do the remaining work, I have discovered that local
wages and prices have not caught up with the economic boom in Massachusetts, so that it is extremely hard to find
anyone to do carpentry or plumbing - the market is definitely not in equilibrium. So can't we get away from the
maximization-and-equilibrium approach to something more realistic?
Well, as I understand it that is what evolutionary economics is all about. In particular, evolution-minded
economists seem to want the following:
1. They want to get away from the idea that individuals maximize. Instead, they want to represent decisions as the
result of some process of groping through alternatives, a process in which it may take a long time to get to a
maximum - and in which the maximum you find may well be local rather than global.
2. They want to get away from the notion of equilibrium. In particular, they want to have an approach in which
things are always in disequilibrium, in which the economy is always evolving. Latterly there have also been some
economists who want to merge evolutionary ideas with the Schumpeterian notion that the economy proceeds via
waves of "creative destruction".
Now as I understand it evolutionary economists basically believe that an evolutionary approach will satisfy
these desires. After all, real organisms often look to the discerning eye like works in progress - they are full of
features that fall short of what would adapt them perfectly to their environment, that is, they have not really
maximized their fitness. And they also often seem to be stuck on local maxima: dolphins may look like fish, but they
still need to surface for air. Meanwhile, what is evolution but a process of continual change, which has taken us from
microbes to man? And if you are a reader of Gould and his acolytes, you have the sense that evolution proceeds
through spasms of sudden change that seem positively Schumpeterian in their drama.
So the attractiveness of an evolutionary metaphor - especially if you believe that economics has gotten off on
the wrong track by basing itself on physics - is understandable. But before we get too carried away with the
prospects for an evolutionary revolution, we had better look at what the evolutionists themselves really do.
What evolutionary theory is really like

To read the real thing in evolution - to read, say, John Maynard Smith's Evolution and the Theory of Games, or
William Hamilton's new book of collected papers, Narrow Roads in Gene Land, is a startling experience to someone
whose previous idea of evolution comes from magazine articles and popular books. The field does not look at all
like the stories. What it does look like, to a remarkable degree, is - dare I say it? - neoclassical economics. And it
offers very little comfort to those who want a refuge from the harsh discipline of maximization and equilibrium.
Consider first the question of maximization. Clearly it is a crucial point about evolution that it must proceed by
small steps, which means that maxima must be approached only gradually and that you could easily be trapped on a
merely local maximum. But do these observations actually play a large role in evolutionary theory? No, not really.
Look, for example, at William Hamilton's deeply influential paper "The genetical basis of social behavior". In
the first part of that paper he introduces a model of population dynamics and shows that a gene will tend to spread if
it enhances not an organism's individual fitness, but its "inclusive fitness": a weighted sum of the fitness of all the
individual's relatives, with the weights proportional to their closeness of relationship. (An alternative way to think of
this is to think of the gene spreading if it is good for its own fitness, never mind the organisms it lives in; this is the
theme of Richard Dawkins's book The Selfish Gene). Now Hamilton's derivation concerns process - it is a dynamic
story about which direction the next small step will proceed in. But when it comes to the second part, in which he
uses the idea to discuss the real world - why birds expose themselves to predators by warning their neighbors, why
insects have such massively organized societies - he simply assumes that what we actually see can be viewed as the
culmination of that process, that the creatures we see have already maximized. In short, even though evolution is
necessarily a process of small changes, evolutionary theorists normally take the shortcut of assuming that the
process gets you to the maximum, and pay surprisingly little attention to the dynamics along the way.
What about the possibility of being trapped on local maxima? Well, this is a big concern for some theorists,
like the Santa Fe Institute's Stuart Kauffman - but Kauffman is not a central player in the field. The general attitude
of evolutionary theorists seems to be that Nature can often find surprising pathways to places you would have
thought unreachable by small steps; that over a few hundred thousand generations a slightly light-sensitive patch of
skin can become an eye that appears to be perfectly designed, or a jaw-bone can migrate around and become a piece
of exquisitively sensitive sound-detection equipment. This is the theme of Richard Dawkins's new book Climbing
Mount Improbable. It is also, if I understand it, the point of what philosopher Daniel Dennnet calls Leslie Orgel's
Second Law: "Evolution is smarter than you are". (Alternative version, according to Dennett: Evolution is smarter
than Leslie Orgel).
In practice, then, evolutionary theorists generally end up assuming that organisms (or genes, when that is the
more useful perspective) do maximize; the process, the necessary caveat that they must get wherever they are going
by small steps, gets put to one side.
What about equilibrium? To outsiders, it appears that evolutionary theory must be a theory of continuing,
progressive change. Indeed, Stephen Jay Gould's latest book is an argument against the supposed orthodoxy that
evolution must be a matter of continuing progress toward ever-higher levels of complexity. But who defends that
orthodoxy? The really amazing thing I have found when reading evolutionary theory is how little they talk about
evolution as an ongoing process. Instead, they tend to try to explain what we see as the result of a finished process,
in which each species has adapted fully to its environment - an environment that includes both other members of its
own species and members of other species. It is revealing that the title of the classic book by George Williams that is
often credited with a seminal role in modern evolutionary theory - a book that essentially established the principle
that social behavior should be explained in terms of the self-interest of genes - is Adaptation and Natural Selection.
"Evolution" isn't in the title, and certainly isn't in the text if it is taken to mean some kind of inexorable drive toward
greater perfection. The working assumption of Williams and most other evolutionary theorists, at least as far as I can
tell, is that we should model the natural world not as being on the way but as being already there.
The most telling example of this preference is the widespread use of John Maynard Smith's concept of
"evolutionarily stable strategies". An ESS is the best strategy for an organism to follow given the strategies that all
others are following - the strategy that maximizes fitness given that everyone else is maximizing fitness, with each
taking the others' strategies into account. Does this sound familiar? It should: the concept of an ESS is virtually
indistinguishable from an economist's concept of equilibrium.
And by the way: Maynard Smith's textbook is explicitly skeptical of claims that evolution is necessarily an
ongoing process, let alone that it need have any particular direction. Not only do the models normally settle down to
an equilibrium; so do experiments, for example with RNA evolution. And any evolutionist has got to be aware that
life appears to have stayed happily single-celled for several billion years before something led to the next big step.
Now you can understand why I say that a textbook in evolution reads so much like a textbook in
microeconomics. At a deep level, they share the same method: explain behavior in terms of an equilibrium among
maximizing individuals.
But why does evolutionary theory in practice fail to take advantage, if we can call it that, either of the myopia
or of the dynamics inherent in any evolutionary story?
Why evolutionists don't do evolution

What I have argued to this point is that even though evolution is a theory of gradual change, of myopic
dynamics, in practice most evolutionary theory focuses on the presumed end result of such dynamics: an equilibrium
in which individuals maximize their fitness given what other individuals do. Why should the theory have taken this
turn?
The answer is surely the ever-present need to simplify, to make models that are comprehensible. The fact is
that maximization and equilibrium are astonishingly powerful ways to cut through what might otherwise be
forbidding complexity - and evolutionary theorists have, entirely correctly, been willing to adopt the useful fiction
that individuals are at their maxima and that the system is in equilibrium.
Let me give you an example. William Hamilton's wonderfully named paper "Geometry for the Selfish Herd"
imagines a group of frogs sitting at the edge of a circular pond, from which a snake may emerge - and he supposes
that the snake will grab and eat the nearest frog. Where will the frogs sit? To compress his argument, Hamilton
points out that if there are two groups of frogs around the pool, each group has an equal chance of being targeted,
and so does each frog within each group - which means that the chance of being eaten is less if you are a frog in the
larger group. Thus if you are a frog trying to maximize your choice of survival, you will want to be part of the larger
group; and the equilibrium must involve clumping of all the frogs as close together as possible.
Notice what is missing from this analysis. Hamilton does not talk about the evolutionary dynamics by which
frogs might acquire a sit-with-the-other-frogs instinct; he does not take us through the intermediate steps along the
evolutionary path in which frogs had not yet completely "realized" that they should stay with the herd. Why not?
Because to do so would involve him in enormous complications that are basically irrelevant to his point, whereas -
ahem - leapfrogging straight over these difficulties to look at the equilibrium in which all frogs maximize their
chances given what the other frogs do is a very parsimonious, sharp-edged way of gaining insight.
Now some people would say that this kind of creation of useful fictions is a thing of the past, because now we
can study complex dynamics using computer simulations. But anyone who has tried that sort of thing - and I have, at
great length - eventually comes to realize just what a wonderful tool paper-and-pencil analysis based on
maximization and equilibrium really is. By all means let us use simulation to push out the boundaries of our
understanding; but just running a lot of simulations and seeing what happens is a frustrating and finally unproductive
exercise unless you can somehow create a "model of the model" that lets you understand what is going on.
I could multiply examples here, but I think the point is clear. Evolutionary theorists, even though they have a
framework that fundamentally tells them that you cannot safely assume maximization-and-equilibrium, make use of
maximization and equilibrium as modelling devices - as useful fictions about the world that allow them to cut
through the complexities. And evolutionists have found these fictions so useful that they dominate analysis in
evolution almost as completely as the same fictions dominate economic theory.
What is neoclassical economics?

I just said that these fictions dominate economics. But the question in economics is whether we understand that
they are fictions, rather than deep-seated truths. For there, perhaps, is where economists have something to learn
from evolutionists.
In economics we often use the term "neoclassical" either as a way to praise or to damn our opponents.
Personally, I consider myself a proud neoclassicist. By this I clearly don't mean that I believe in perfect competition
all the way. What I mean is that I prefer, when I can, to make sense of the world using models in which individuals
maximize and the interaction of these individuals can be summarized by some concept of equilibrium. The reason I
like that kind of model is not that I believe it to be literally true, but that I am intensely aware of the power of
maximization-and-equilibrium to organize one's thinking - and I have seen the propensity of those who try to do
economics without those organizing devices to produce sheer nonsense when they imagine they are freeing
themselves from some confining orthodoxy.
That said, there are indeed economists who regard maximization and equilibrium as more than useful fictions.
They regard them either as literal truths - which I find a bit hard to understand given the reality of daily experience -
or as principles so central to economics that one dare not bend them even a little, no matter how useful it might seem
to do so.
To be fair, there is some justification in the insistence of some economists on pushing very hard on the
principles of equilibrium and in particular of maximization. After all, people are smarter than genes. If I offer a
model in which people seem to be passing up some opportunity for gain, you may justifiably ask me why they don't
just take it. And unlike the case of genes, the argument that the alternative is quite different from what my imagined
agent is currently doing is not necessarily a very good one: in the real world people do sometimes respond to
opportunities by changing their behavior drastically. In biology purely local change is a sacred principle; in
economics it has no comparable justification.
And yet I think that despite the differences, it would be better if economists were more self-aware - if they
understood that their use of maximization-and-equilibrium, like that of evolutionary biologists, is a useful fiction
rather than a principle to be defended at all costs. If we were more modest about what we think our modeling
strategy is doing, we might free ourselves to accommodate more of the world in our analysis.
And so let me conclude this talk by giving two examples of how a more relaxed, "evolution"-style approach to
economics might help us out.
Two economic examples

As you know, one of my areas of research has been the study of economic geography. Perhaps the most basic
insight in these models has been the possibility of a cumulative process of agglomeration. Suppose that there are two
regions, and one region starts with a slightly larger concentration of industry. This concentration of industry will
provide larger markets and better sources of supply for producers than in the other region, perhaps inducing more
producers to locate in that region, further reinforcing its advantage, and so on. It's a good story, and I am quite sure
that in some sense it is correct. Yet when I and my students try to present this work, we often run into a surprising
difficulty: theorists get very upset about the dynamics. Why, they ask, don't individuals correctly anticipate the
future location of industry? How can you have such a model without forward-looking agents and rational
expectations?
Now the fact is that when you try to do rational expectations in such models they become vastly more difficult,
and the basic point becomes obscured. In short, here is a situation in which going all the way to full maximizing
behavior - and trying to avoid the disequilibrium, evolutionary dynamics I assume - makes life harder, not easier. It
seems to me, at least, that this is a situation where economists would do a better job if they understood that
maximization is a metaphor to be used only to the extent that it helps understanding.
And when I run into this sort of critique I am envious of evolutionary theorists who do models like, say, the
Fisher theory of runaway sexual selection, and can use myopic, disequilibrium dynamics without apology. (If you
don't know that model, it works like this: suppose that there is one gene that makes peahens - that's the female of
peacock - like males with big tails, and another that causes males to have big tails. If there is a preponderance of
females that carries this gene, then males with big tails will have more offspring even if they have less chance of
surviving because of their visibility to predators. But because a male with a big tail is likely to be the son of a female
who likes big tails, this success will also tend to spread the gene for big-tail preference .... The resemblance to
agglomeration is obvious- isn't it?)
Another issue: consider the question of whether and how monetary policy has real effects. In the end this
comes down to whether prices are sticky in nominal terms. In my view there is overwhelming evidence that they are.
But many economists reject such evidence on principle: a rational price-setter ought not to have money illusion,
therefore it is bad economics to assume that they do. If neo-Keynesians like me suggest that a bit of bounded
rationality would do the trick, the answer is that bounded rationality is too open-ended a concept, and can be used to
rationalize too many different behaviors.
And yet in evolution the idea that there are limits to the precision of maximization is adopted cheerfully. When
a bird sees a predator, it issues a warning cry that puts itself at risk but may save its neighbors; the reason this
behavior "works", we believe, is that many of those neighbors are likely to be relatives, and thus the bird may
enhance its "inclusive fitness". But why doesn't the bird issue a warning only its relatives can hear? Well, we just
suppose that isn't possible.
In short, I believe that economics would be a more productive field if we learned something important from
evolutionists: that models are metaphors, and that we should use them, not the other way around.
What should trade negotiators negotiate about: A

review essay
Paul Krugman
If economists ruled the world, there would be no need for a World Trade Organization. The economist's
case for free trade is essentially a unilateral case - that is, it says that a country serves its own interests by
pursuing free trade regardless of what other countries may do. Or as Frederic Bastiat put it, it makes no
more sense to be protectionist because other countries have tariffs than it would to block up our harbors
because other countries have rocky coasts. So if our theories really held sway, there would be no need for
trade treaties: global free trade would emerge spontaneously from the unrestricted pursuit of national
interest. (Students of international trade theory know that there is actually a theoretical caveat to this
statement: large countries have an incentive to limit imports - and exports - to improve their terms of
trade, even if it is in their collective interest to refrain from doing so. This "optimal tariff" argument,
however, plays almost no role in real-world disputes over trade policy.)
Fortunately or unfortunately, however, the world is not ruled by economists. The compelling
economic case for unilateral free trade carries hardly any weight among people who really matter. If we
nonetheless have a fairly liberal world trading system, it is only because countries have been persuaded to
open their markets in return for comparable market-opening on the part of their trading partners. Never
mind that the "concessions" trade negotiators are so proud of wresting from other nations are almost
always actions these nations should have taken in their own interest anyway; in practice countries seem
willing to do themselves good only if others promise to do the same.
But in that case why should the tits we demand in return for our tats consist only of trade
liberalization? Why not demand that other countries match us, not only in what they do at the border, but
in internal policies? This question has been asked with increasing force in the last few years. In particular,
environmental advocates and supporters of the labor movement have sought with growing intensity to
expand the obligations of WTO members beyond the conventional rules on trade policy, making
adherence to international environmental and labor standards part of the required package; meanwhile,
business groups have sought to require a "level playing field" in terms of competition policy and domestic
taxation. Depending on your point of view, the idea that there must be global harmonization of standards
on employment, environment, and taxation is either the logical next step in global trade negotiations or a
dangerous overstepping of boundaries that threatens to undermine all the progress we have made so far.
In 1992 Columbia's Jagdish Bhagwati (one of the world's leading international trade economists) and
Robert E. Hudec (an experienced trade lawyer and former official now teaching at Minnesota) brought
together an impressive group of legal and economic experts in a three-year research project intended to
address the new demands for an enlarged scope of trade negotiations. Fair Trade and Harmonization:
Prerequisites for Free Trade? (Cambridge MA: MIT Press, 1996) is the result of that project. This massive
two-volume collection of papers is unavoidably a bit repetitious. One also wonders why only economists
and lawyers were involved - what happened to the political scientists? (More on that later). But the
volumes contain a number of first-rate papers and offer a valuable overview of the debate.
In this essay I will not try to offer a comprehensive review of the papers; in particular I will give
short shrift to those on competition and tax policy. Nor will I try to deal with the quite different question
of how much coordination of technical standards - e.g. health regulations on food (remember the
Eurosausage!), or safety regulations on consumer durables - is essential if countries are to achieve "deep
integration". Instead, I will try to sort through what seem to be the main issues raised by new demands for
international labor and environmental standards.
The economics and politics of free trade

In a way, the most interesting paper in the Bhagwati-Hudec volumes is interesting precisely because
the author seems not to understand the logic of the economic case for free trade - and in his
incomprehension reveals the dilemmas that practical free traders face. Brian Alexander Langille, a
Canadian lawyer, points out correctly that domestic policies such as subsidies and regulations may
influence a country's international trade just as surely as explicit trade policies such as tariffs and import
quotas. Why then, he asks, should trade negotiations stop with policies explicitly applied at the border?
He seems to view this as a deep problem with economic theory, referring repeatedly to the "rabbit hole"
into which free traders have fallen.
But the problem free traders face is not that their theory has dropped them into Wonderland, but that
political pragmatism requires them to imagine themselves on the wrong side of the looking glass. There is
no inconsistency or ambiguity in the economic case for free trade; but policy-oriented economists must
deal with a world that does not understand or accept that case. Anyone who has tried to make sense of
international trade negotiations eventually realizes that they can only be understood by realizing that they
are a game scored according to mercantilist rules, in which an increase in exports - no matter how
expensive to produce in terms of other opportunities foregone - is a victory, and an increase in imports -
no matter how many resources it releases for other uses - is a defeat. The implicit mercantilist theory that
underlies trade negotiations does not make sense on any level, indeed is inconsistent with simple adding-
up constraints; but it nonetheless governs actual policy. The economist who wants to influence that
policy, as opposed to merely jeering at its foolishness, must not forget that the economic theory
underlying trade negotiations is nonsense - but he must also be willing to think as the negotiators think,
accepting for the sake of argument their view of the world.
What Langille fails to understand, then, is that serious free-traders have never accepted as valid
economics the demand that our trade liberalization be matched by comparable market-opening abroad;
and so they are not being inconsistent in rejecting demands for an extension of such reciprocity to
domestic standards. If economists are sometimes indulgent toward the mercantilist language of trade
negotiations, it is not because they have accepted its intellectual legitimacy but either because they have
grown weary of saying the obvious or because they have found that in practice this particular set of bad
ideas has led to pretty good results.
One way to answer the demand for harmonization of standards, then, is to go back to basics. The
fundamental logic of free trade can be stated a number of different ways, but one particularly useful
version - the one that James Mill stated even before Ricardo - is to say that international trade is really
just a production technique, a way to produce importables indirectly by first producing exportables, then
exchanging them. There will be gains to be had from this technique as long as world relative prices differ
from domestic opportunity costs - regardless of the source of that difference. That is, it does not matter
from the point of view of the national gains from trade whether other countries have different relative
prices because they have different resources, different technologies, different tastes, different labor laws,
or different environmental standards. All that matters is that they be different - then we can gain from
trading with them.
This way of looking at things, among its other virtues, offers an en passant refutation of the
instinctive feeling of most non-economists that a country that imposes strong environmental or labor
standards will necessarily experience difficulties when it trades with other countries that are not equally
high-minded. The point is that all that matters for the gains from trade are the prices at which you trade -
it makes absolutely no difference what forces lie behind those prices. Suppose your country has been
cheerfully exporting airplanes and importing clothing in return, believing that the comparative advantage
of your trading partners in clothing is "fairly" earned through exceptional productive efficiency. Then one
day an investigative journalist, hot in pursuit of Kathie Lee Gifford, reveals that the clothing is actually
produced in 60-cent-an-hour sweatshops that foul the local air and water. (If they hurt the global
environment, say by damaging the ozone layer, that is another matter - but that is not the issue).You may
be outraged; but the beneficial trade you thought you had yesterday has not become any less economically
beneficial to your country now that you know that it is based on these objectionable practices. Perhaps
you want to impose your standards on these matters, but this has nothing to do with trade per se - and
there are worse things in the world than low wages and local pollution to excite our moral indignation.
This back-to-basics case for rejecting calls for harmonization of standards is elaborated in two of the
papers in Volume 1 of Bhagwati-Hudec: a discussion of environmental standards by Bhagwati and T.N.
Srinivasan, and a discussion of labor standards by Drusilla Brown, Alan Deardorff, and Robert Stern. In
each case the central theme is that neither the ability of a country to impose such standards nor its benefits
from so doing depend in any important way on whether other countries do the same; so why not leave
countries free to choose?
Bhagwati and Srinivasan also raise two other arguments on behalf of a laissez-faire approach to
standards, arguments echoed by several other authors in the volume. The first is that nations may
legitimately have different ideas about what is a reasonable standard. (The authors quote one
environmentalist who asserts that "geopolitical boundaries should not override the word of God who
directed Noah" to preserve all species, then drily note that "as two Hindus .. we find this moral argument
culture-specific"). Moreover, even nations that share the same values will typically choose different
standards if they have different incomes: advanced-country standards for environmental quality and labor
relations may look like expensive luxuries to a very poor nation. Second, to the extent that nations for
whatever reason choose different environmental standards, this difference, like any difference in
preferences, actually offers not a reason to shun international trade but an extra opportunity to gain from
such trade. It is very difficult to be more explicit about this without being misrepresented as an enemy of
the environment - an excerpt from the entirely sensible memo along these lines that Lawrence Summers
signed but did not write at the World Bank a few years ago is reprinted in my copy of The 776 Stupidest
Things Ever Said - so it is left as an exercise for readers.
The back-to-basics argument against harmonization of standards, then, is completely consistent and
persuasive. And yet it is also somehow unsatisfying. Perhaps the problem is that we know all too well
how little success economists have had in convincing policymakers of the case for unilateral free trade.
Why, then, should we imagine that restating that case yet again will be an effective argument against the
advocates of international harmonization of standards? Confronted with the failure of the public to buy
the classical case for free trade, and unwilling simply to preach the truth to each other, trade economists
have traditionally followed one of two paths. Some try to give the skeptics the benefit of the doubt,
attempting to find coherent models that make sense of their concerns. Others try to make sense not of the
skeptics' ideas but their motives, attempting to seek guidance from models of political economy. The
same two paths are followed in these volumes, with several papers following each approach.
Second-best considerations and the "race to the bottom"

The general theory of the second best tells us that if incentives are distorted in some markets, and for
some reason these distortions cannot be directly addressed, policies in other markets should in principle
take the distortions into account. For example, environmental economists have become sensitized to the
likely interactions between pollution fees - designed to correct one distortion of incentives - with other
taxes, which have nothing to do with environmental issues but which, because they distort incentives to
work, save, and invest may crucially affect the welfare evaluation of any given environmental policy.
There is a long history of protectionist arguments along second-best lines. (Among Jagdish
Bhagwati's seminal contributions to international trade theory was, in fact, his work showing that many
critiques of free trade are really second-best arguments - and that the first-best response rarely involves
protection). Here's an easy one: suppose that an industry generates negative environmental externalities
that are not properly priced, and that international trade leads to an expansion of that industry in your
country. Then that trade may indeed reduce national welfare (although of course trade may equally well
have the opposite effect: it may cause your country to move out of "dirty" into "clean" industries, and
thereby lead to large welfare gains). However, the advocates of international environmental and labor
standards seem to be offering a more subtle argument. They seem to be claiming that an environmental
(or labor) policy that would raise welfare in a closed economy - or that would raise world welfare if
implemented by all countries simultaneously - will reduce national welfare if implemented unilaterally.
Thus the independent actions of national governments in the absence of international standards on these
issues can lead to a "race to the bottom", with global standards far too lax.
What sort of model might justify this fear? In an extremely clear paper in Volume 1, John D. Wilson
gives the issue his (second) best shot, showing that international competition for capital - in a world in
which the social return to capital exceeds its private return, for example due to capital taxation - could do
the trick. Other things being the same, tighter environmental or labor regulation will presumably decrease
the rate of return on investments, and thus any country which has a pre-existing tendency to attract too
little capital will have an incentive to avoid such regulations; whereas a collective, international decision
to impose higher standards would not lead to capital flight, since the capital would have nowhere to go.
Is this a clinching argument? Not necessarily. For one thing, like all second-best arguments it is very
sensitive to tweaking of its assumptions. As Wilson points out, capital importation may have adverse as
well as positive effects, especially from the point of view of an environment-conscious country. In that
case a positive rate of taxation is appropriate - and if the actual rate of taxation is too low, countries may
adopt excessively strong environmental standards in a "race to the top". If this seems implausible, Wilson
reminds us of the NIMBY (not in my backyard) phenomenon in which no local jurisdiction is willing to
be the site for facilities the public collectively needs to locate somewhere.
Even if you regard a race to the bottom as more likely than one to the top, there is still the question
of whether such second-best arguments are really very important. This is doubtful, especially where
environmental standards are concerned. The alleged impact of such standards on firms' location decisions
looms large in the demands of activists who want these standards harmonized. But the chapter by Arik
Levinson, surveying the evidence, finds little reason to think that international differences in these
standards actually have much effect on the global allocation of capital.
So while it is possible to devise second-best models that offer some justification for demands for
harmonization of standards, these models - on the evidence of this collection, at any rate - do not seem
particularly convincing. The classical case for laissez-faire on national economic policies is surely not
precisely right, but it does not seem wrong enough to warrant the heat now being generated over the issue
of harmonization. Simply pointing this out, however, while important, does not make the phenomenon go
away. So it is at least equally important to try to understand the political impulse behind demands for
harmonization, and in particular to ask whether the political economy of standard-setting offers some
indirect rationale for insisting on harmonization of such standards.
The political economy of standards

Consider - as Brown, Deardorff, and Stern do - a single industry, small enough to be analyzed using
partial equilibrium, in which a country is considering imposing a new environmental or labor regulation
that will raise production costs. As they point out, if the costs of the regulation are less than the social
costs imposed by the industry in its absence, then it is worth doing regardless of whether other countries
follow suit. But the distribution of gains between producers and consumers does depend on whether the
action is unilateral or coordinated. If one country imposes a costly regulation while others do not, the
world price will remain unchanged and all of the burden will fall on producers; if many countries impose
the regulation, world prices will rise and some of the burden will be shifted to consumers.
So what? Well, it is a fact of life, presumably rooted in the public-goods character of political action,
that trade policy tends to place a much higher weight on producers than on consumers. So even though
the national welfare case for the regulation is not weakened at all by the fact that the good is traded, the
practical political calculus of getting the regulation implemented could quite possibly depend on whether
other countries agree to do the same. This suggests an alternative version of the "race to the bottom"
story. The problem, one might argue, is not that countries have an incentive to set standards too low in a
trading world. Rather, it is that politicians, who respond to the demands of special-interest groups, have
such an incentive. And one might argue that this failure of the political market, rather than distortions in
goods or factor markets, is what justifies demands for international harmonization of standards.
An environmentalist or defender of workers' rights might also make a related argument. He or she
might say "You know that countries aren't in a zero-sum competition, and I know that they aren't, but the
public and the politicians think they are - and industry lobbies consistently use that misconception as an
argument against standards that we ought to have. So we need to set those standards internationally in
order to neutralize that bogus but effective political ploy". It is very difficult for trade economists to reject
this line of argument on principle. After all, it is very close to the reason why free-traders who know that
the economic case for liberal trade is essentially unilateral are nonetheless usually staunch defenders of
the GATT: trade negotiations may be based on a false theory, but by setting exporters as counterweights
to producers facing import competition they nonetheless are politically crucial to maintaining more or less
free trade. That is, the true purpose of international negotiations is arguably not to protect us from unfair
foreign competition, but to protect us from ourselves. (When the United States recently imposed utterly
indefensible restrictions on Mexican tomato exports, an Administration official remarked off the record
that Florida has a lot of electoral votes while Mexico has none. The economically correct rebuttal to this
sort of thing is to point out that the other 49 states contain a lot of pizza lovers; the politically effective
answer is to subject US-Mexican trade to a set of rules and arbitration procedures in which the Mexicans
do too have a vote).
While one cannot dismiss such political-economy arguments as foolish, however, the problem is to
know where to stop. Here is where it would have been useful to hear from some political scientists, who
might be able to tell us more about when international negotiations over standards are likely to improve
domestic policies, and when they are likely simply to serve as a cover for protectionist motives. But while
I would have liked to see an analysis from that point of view, much of the legal analysis that occupies
Volume 2 of the Bhagwati-Hudec books does shed light on the problem.
Standards and the rule of law

Economists pronounce on legal matters at their peril: law, even international trade law, is a discipline
all its own, with a jargon just as impenetrable to us as ours is to them. Let me therefore tread cautiously in
interpreting the arguments here. As I understand it, the problem involved in defining the limits of fair
trade is not too different from that of defining the limits of free speech. Take it as a given that countries
can do things that are perceived to be economically harmful to other countries - it does not necessarily
matter whether this perception is correct. Which of these things can realistically be prohibited, and which
should be tolerated? The answer is a matter of degree. The fellow at the next table who insists on talking
loudly to his partner about marketing is annoying, but one cannot reasonably ask the law to do anything
about him; the person who shouts "Fire" in a crowded theater is something else again.
Where does one draw the line in international economic relations? The prevailing principle of
international law derives from the 17th-century Peace of Westphalia, which ended the Thirty Years' War
by establishing the rule that states may do whatever they like (such as imposing the sovereign's religion)
within their borders - only external relations are the proper concern of the international community. By
this principle labor law, or environmental policies that do not spill across borders, should be off limits.
Now in practice we do not always honor the principle of the hard-shell Westphalian state. We are
sometimes willing to impose sanctions or even invade to protect human rights. Even in trade negotiations
it is an understood principle that if a country de facto undoes its trade concessions with domestic policies
- for example, offsetting a tariff cut with an equal production subsidy - it is considered to have failed to
honor its agreement. But while borders are fuzzier in legal practice than they are on a map, the basic
structure of trade negotiations is still basically Westphalian. The demand for harmonization of standards
is, in effect, a demand that this should change.
We have seen that the strictly economic case for that demand is fairly weak, but there may be a
stronger case on grounds of political economy. But what do the legal experts say? The general answer, as
I understand it, is that they don't think it is a good idea. A lucid chapter by Frieder Rousseler grants that
the political argument for harmonization has some force, but concludes that to give in to it would open up
too wide a range of potential complaints, much the same as would happen if I were allowed to sue people
whose words annoy rather than actually slander me. Other authors, such as Virginia Leary and Robert
Hudec himself, seem to have a similar point of view, suggesting only that nations might want to enter into
specific environmental and labor agreements that would then be enforced by the same institutions that
enforce trade agreements. (One essay, however, a piece by Daniel Gifford and Mitsuo Matsushita on
competition policy, seems more economistic than the economists: it argues that the international
acceptability of competition policies should be judged on whether they seem likely, or at least motivated
by the desire, to enhance efficiency).
To an economist, at least, the legal case here seems fairly similar to the economic case for trade
negotiations. We have a purist principle : unilateral free trade, the Westphalian state. We recognize based
on experience that it is useful to compromise that principle a bit, so that we work with mercantilists rather
than simply castigating them and allow a bit of international meddling in internal affairs. But while a bit
of pragmatism is allowed, the principle remains there; and it is not a good idea to stray too far. On the
evidence of these volumes, then, the demand for harmonization is by and large ill-founded both in
economics and in law; realistic political economy requires that we give it some credence, but not too
much. Unfortunately, that will surely not make the issue go away. Expect many more, equally massive
volumes to come.
Requiem for the New Economy

Millennial optimism confronts reality
Paul Krugman
MIT economist Paul Krugman travels ahead in time to report on the presidential election of 2000:
Fortune Magazine November 10, 1997
Like every presidential election in the past 20 years, last week's contest was driven largely by
economics--specifically, by public dismay over the economy's recent performance. What is strange about
the near-hysterical public mood is that objectively, things aren't really that bad. Unemployment is
nowhere near as high as in the early 1980s, and most forecasters think the economy either has already
bottomed out or will do so in the near future. Yet the public is furious and bitter; it feels betrayed. Why?
The answer, surely, is that people feel that they had been led to expect better. Just a couple of years
ago it was virtual dogma among business economists and the media that we had entered a new era, that of
the so-called New Economy--an economy that would grow at unprecedented rates thanks to the magic of
digital technology, that would no longer be subject to the vagaries of the business cycle, that would never
again find its ability to expand hobbled by inflationary pressure. Even Alan Greenspan cautiously
endorsed the New Economy doctrine. As belief in that doctrine spread, the stock market soared to
dizzying heights, and the strength of the market only reinforced the sense of millennial optimism.
Yet even three or four years ago it was obvious to anyone who thought about it that there were, to
say the least, some major problems with the whole New Economy idea. Conventional economic measures
showed no sign at all of an increase in the economy's potential growth rate. From the middle of 1994 to
the middle of 1997, real GDP grew at an annual rate of 2.8%; over the same period the unemployment
rate fell from more than 6% to less than 5%. Since unemployment can't fall indefinitely, this suggested
that the economy's long-run sustainable growth was considerably less than 2.8%--perhaps no more than
2%. And with a growth rate of not much more than 2%, inflation of less than 3%, and long-term interest
rates of more than 6%, it was hard to see how profits could possibly grow fast enough to justify the level
of stock prices.
The response of the New Economy enthusiasts to such dismal calculations was to insist that a
dramatic acceleration of productivity growth had changed the rules. There was not a shred of statistical
evidence for such an acceleration--but the statistics, the enthusiasts insisted, were missing the real story.
And wasn't the combination of unexpectedly low inflation and high profits proof that something had
changed for the better? Critics pointed out in vain that low inflation and high profits could be entirely
accounted for by slow growth in wages--and that while workers had been cautious about demanding wage
increases, this restraint could not be expected to last as labor markets became ever tighter.
The New Economy crowd also seemed to have failed to grasp the seemingly technical but actually
crucial point that official measures of productivity, GDP growth, and inflation are not independent of one
another. If productivity is understated by the official data, so is growth--by exactly the same amount.
Even if there was unmeasured productivity growth, there was no reason to think that the economy could
grow faster than it was already growing.
In short, the New Economy doctrine made no sense at all, and without that intellectual justification
there was no way to regard the great stock market boom as anything other than a bubble. Yet as long as
inflation stayed low and the market continued to rise, skeptical voices were ignored.
So strong was the desire to believe, in fact, that even when inflation did begin to accelerate over the
course of 1998, the general response was denial. The pundits and the business press insisted it was only a
statistical blip. Even Greenspan seems to have been unwilling to face the facts--or perhaps to face the
howls of outrage he knew would greet any rise in interest rates. And so the Fed waited until the evidence
that inflation was back was unmistakable to everyone (except a few hundred die-hard Wall Street gurus).
By that time, it was impossible to manage a soft landing. When the markets woke up to reality, they
panicked. And as millions of people watched their fortunes dwindle, they began cutting back with a
vengeance: consumer spending spiraled downward. By late last year the Fed--alas, minus Greenspan, who
averted the possibility of impeachment by resigning of his own accord--was backpedaling, frantically
cutting interest rates in an effort to reverse the slump.
All signs point to an incipient recovery, and unemployment is unlikely to rise above 8%. But while
the economic havoc could have been worse, the political fallout was devastating. Prosperity had been an
essential lubricant of the Washington political process during the good years. A hot economy had allowed
Congress and the President to offer a little bit to everyone. Once the good times stopped rolling, ideology
ran rampant: Republican radicals demanded sweeping tax cuts and a return to the gold standard, while
Democratic radicals demanded massive public works programs and import quotas. Moderates were
caught in the crossfire. The result was a strange and ugly campaign.
The good news is that the U.S. economy remains fundamentally sound. Our ever resilient private
sector is ready to bounce back; all it really needs are calm, sensible policies at the top. The big question is
this: Can we really count on sensible policies from President-elect Perot?

Economics Articles by Paul Krugman

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Economics Articles by Paul Krugman

Uploaded by

Copyright:

Available Formats

Scrounged from the Internet and Compiled by Erik V.

with ratings indicated by *

• There is something about macro ***

There is something about Macro

The World’s Smallest Macroeconomic Model

U = (1-s) ln(C) + s ln (M'/Pe)

Finally, people are assumed to be endowed with L units of labor.

or by the condition that demand for money equal supply,

M/P = s(L + M/P).

Both ways of looking at it imply the price-level equation

so the price level is proportional to the money supply.

M/P < s(L + M/P)

(1-s)(L + M/P) < L

These are just different ways of looking at the same thing.

which has an immediately identifiable "multiplier" flavor.

The Rise and Fall of Development Economics

This is not exactly a paper about Albert Hirschman.

THE FALL AND RISE OF DEVELOPMENT ECONOMICS

THE EVOLUTION OF IGNORANCE

METAPHORS AND MODELS

THE BIG PUSH

[(L/N) - F]/c L/N

Myrdal, G. 1957. Economic Theory and Under-developed Regions. London: Duckworth.

Rosenstein-Rodan, P. 1943. "Problems of Industrialization of Eastern and South-Eastern Europe." Economic

Is Capitalism Too Productive?

TOO MUCH OF A GOOD THING?

IS THERE REALLY A GLOBAL GLUT?

1. Global productive capacity is growing at an exceptional, perhaps unprecedented rate.

Demand in the advanced countries

The Third World

Table 1: Trade and current balances in the "Big Ten" ($billion)

Table 2: Wages in the Asian "tigers" (hourly compensation as % of US)

Capitalism’s Mysterious Triumph

So what is the public interest?

In Praise of Cheap Labor

Given this lack of other opportunities, you could hire workers in

And then something changed. Some combination of factors that we

Illustrations by Robert Neubecker.

The spiral of inequality

The Sources of Inequality

Values, Power, and Wages

The Decline of Labor

The Polarizing Spiral

Strategies for the Future

Economic Culture Wars

Economics writer Bob Kuttner devotes an essay in the American Prospect,

If you try to follow arguments about economics among intellectuals whose

economics in which such credentials are based

James K. Galbraith, a constant critic of the profession (and a frequent

Academic economics, the stuff that is in the textbooks, is largely based on

Illustrations by Robert Neubecker

Ricardo’s Difficult Idea

1. You just don't understand

2. The cult of the new

3. A harder concept than it seems

4. The Two Cultures

5. What can be done?

Dawkins, R. (1986), The Blind Watchmaker, New York: Longman.

What Economists Can Learn From Evolutionary Theorists

What evolutionary economists want

What evolutionary theory is really like

Why evolutionists don't do evolution

What is neoclassical economics?

Two economic examples