In she taught AP Economics at Collegiate School in Paul Krugman, recipient of the Nobel Memorial Prize in Economics, is. Paul Krugman, recipient of the Nobel Memorial Prize in Eco- nomic Sciences CourseSmart eBooks offer the complete book in PDF for- mat. Students. KRUGMAN'S ECONOMICS for AP* *AP is a trademark registered and/or owned by the College Board, which was not involved in the production of, and does not.
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monograph Geography and Trade (Krugman a), which most people Economic Advisers, not a Council of Geographical Advisers, the. Keat/Young. Managerial Economics. Klein. Mathematical Methods for. Economics. Krugman/Obstfeld/Melitz. International Economics: Theory & Policy*. Laidler. specifically the linked set of ideas that I have elsewhere (Krugman ) development economics, in which Albert Hirschman appears as a major character.
My point is that the style of thinking necessary for economic analysis is very different from that which leads to success in business. By understanding that difference, we can begin to understand what it means to do good economic analysis and perhaps even help some businesspeople become the great economists they surely have the intellect to be. Let me begin with two examples of economic issues that I have found business executives generally do not understand: Both issues involve international trade, partly because it is the area I know best but also because it is an area in which businesspeople seem particularly inclined to make false analogies between countries and corporations.
Business executives consistently misunderstand two things about the relationship between international trade and domestic job creation. First, since most U.
Specifically, they believe that free trade agreements such as the recently concluded General Agreement on Tariffs and Trade are good largely because they mean more jobs around the world. Second, businesspeople tend to believe that countries compete for those jobs. The more the United States exports, the thinking goes, the more people we will employ, and the more we import, the fewer jobs will be available. According to that view, the United States must not only have free trade but also be sufficiently competitive to get a large proportion of the jobs that free trade creates.
Do those propositions sound reasonable? Of course they do. This sort of rhetoric dominated the last U. However, economists in general do not believe that free trade creates more jobs worldwide or that its benefits should be measured in terms of job creation or that countries that are highly successful exporters will have lower unemployment than those that run trade deficits.
The idea that free trade means more global jobs seems obvious: More trade means more exports and therefore more export-related jobs. But there is a problem with that argument. Unless there is some reason to think that free trade will increase total world spending—which is not a necessary outcome—overall world demand will not change.
Moreover, beyond this indisputable point of arithmetic lies the question of what limits the overall number of jobs available. Is it simply a matter of insufficient demand for goods? Surely not, except in the very short run.
It is, after all, easy to increase demand. The Federal Reserve can print as much money as it likes, and it has repeatedly demonstrated its ability to create an economic boom when it wants to.
Because it believes, with good reason, that if it were to do so—if it were to create too many jobs—the result would be unacceptable and accelerating inflation.
In other words, the constraint on the number of jobs in the United States is not the U. That is not an abstract point. During , the Fed raised interest rates seven times and made no secret of the fact that it was doing so to cool off an economic boom that it feared would create too many jobs, overheat the economy, and lead to inflation. Consider what that implies for the effect of trade on employment.
Suppose that the U. What would the Fed do? It would offset the expansionary effect of the exports by raising interest rates; thus any increase in export-related jobs would be more or less matched by a loss of jobs in interest-rate-sensitive sectors of the economy, such as construction. Conversely, the Fed would surely respond to an import surge by lowering interest rates, so the direct loss of jobs to import competition would be roughly matched by an increased number of jobs elsewhere.
Even if we ignore the point that free trade always increases world imports by exactly as much as it increases world exports, there is still no reason to expect free trade to increase U.
When the U. If he is, he is also instrumental in destroying a roughly equal number of jobs elsewhere in the economy. The ability of the U. Needless to say, this argument does not sit well with business audiences.
When I argued on one business panel that the North American Free Trade Agreement would have no effect, positive or negative, on the total number of jobs in the United States, one of my fellow panelists—a NAFTA supporter—reacted with rage: You can actually see the people making the goods that foreigners download, the workers whose factories were closed in the face of import competition.
The other effects that economists talk about seem abstract. And yet if you accept the idea that the Fed has both a jobs target and the means to achieve it, you must conclude that changes in exports and imports have little effect on overall employment. Our second example, the relationship between foreign investment and trade balances, is equally troubling to businesspeople. Suppose that hundreds of multinational companies decide that a country is an ideal manufacturing site and start pouring billions of dollars a year into the country to build new plants.
Business executives, almost without exception, believe that the country will start to run trade surpluses. They think of their own companies and ask what would happen if capacity in their industries suddenly expanded. Clearly their companies would import less and export more. If the same story is played out in many industries, surely this would mean a shift toward a trade surplus for the economy as a whole. The economist knows that just the opposite is true.
Because the balance of trade is part of the balance of payments, and the overall balance of payments of any country—the difference between its total sales to foreigners and its downloads from foreigners—must always be zero.
That is, it can download more goods from foreigners than it sells or vice versa.
But that imbalance must always be matched by a corresponding imbalance in the capital account. A country that runs a trade deficit must be selling foreigners more assets than it downloads; a country that runs a surplus must be a net investor abroad.
When the United States downloads Japanese automobiles, it must be selling something in return; it might be Boeing jets, but it could also be Rockefeller Center or, for that matter, Treasury bills. That is not just an opinion that economists hold; it is an unavoidable accounting truism. So what happens when a country attracts a lot of foreign investment? A country that attracts large capital inflows will necessarily run a trade deficit. But that is just accounting.
How does it happen in practice? When companies build plants, they will download some imported equipment. The investment inflow may spark a domestic boom, which leads to surging import demand. Whatever the channel, the outcome for the trade balance is not in doubt: Capital inflows must lead to trade deficits. During the s, nobody would invest in Mexico and the country ran a trade surplus.
The rest fueled a domestic boom, which sucked in imports and caused the peso to become increasingly overvalued. That, in turn, discouraged exports and prompted many Mexican consumers to download imported goods. The result: Massive capital inflows were matched by equally massive trade deficits. Then came the peso crisis of December Once again, investors were trying to get out of Mexico, not in, and the scenario ran in reverse.
A slumping economy reduced the demand for imports, as did a newly devalued peso. Meanwhile, Mexican exports surged, helped by a weak currency.
As any economist could have predicted, the collapse of foreign investment in Mexico has been matched by an equal and opposite move of Mexican trade into surplus. But like the proposition that expanded exports do not mean more employment, the necessary conclusion that countries attracting foreign investment typically run trade deficits sits poorly with business audiences.
The specific ways in which foreign investment might worsen the trade balance seem questionable to them. Will investors really spend that much on imported equipment? How do we know that the currency will appreciate or that, if it does, exports will decrease and imports will increase? In each of the above examples, there is no question that the economists are right and the business-people are wrong. But why do the arguments that economists find compelling seem deeply implausible and even counterintuitive to businesspeople?
There are two answers to that question. The deeper answer is that the kinds of feedback that typically arise in an individual business are both weaker than and different from the kinds of feedback that typically arise in the economy as a whole.
Let me analyze each of these answers in turn. Every once in a while, a highly successful businessperson writes a book about what he or she has learned. Some of these books are memoirs: They tell the story of a career through anecdotes. Almost without exception, the first kind of book is far more successful than the second, not only in terms of sales but also in terms of its reception among serious thinkers.
Because a corporate leader succeeds not by developing a general theory of the corporation but by finding the particular product strategies or organizational innovations that work. There have been some business greats who have attempted to codify what they know, but such attempts have almost always been disappointing.
After all, a financial wizard makes a fortune not by enunciating general principles of financial markets but by perceiving particular, highly specific opportunities a bit faster than anyone else.
A corporate leader succeeds by finding the right strategies, not by developing a theory of the corporation. Indeed, great business executives often seem to do themselves harm when they try to formalize what they do, to write it down as a set of principles.
They begin to behave as they think they are supposed to, whereas their previous success was based on intuition and a willingness to innovate. One is reminded of the old joke about the centipede who was asked how he managed to coordinate his legs: He started thinking about it and could never walk properly again. After all, what the president of the United States needs from his economic advisers is not learned tracts but sound advice about what to do next.
Because, in short, a country is not a large company. Many people have trouble grasping the difference in complexity between even the largest business and a national economy. The U. Yet even this to-1 ratio vastly understates the difference in complexity between the largest business organization and the national economy.
A mathematician will tell us that the number of potential interactions among a large group of people is proportional to the square of their number. Without getting too mystical, it is likely that the U.
Moreover, there is a sense in which even very large corporations are not all that diverse.
Most corporations are built around a core competence: As a result, even a huge corporation that seems to be in many different businesses tends to be unified by a central theme. The experience of a successful wheat farmer offers little insight into what works in the computer industry, which, in turn, is probably not a very good guide to successful strategies for a chain of restaurants. How, then, can such a complex entity be managed?
A national economy must be run on the basis of general principles, not particular strategies. Consider, for example, the question of tax policy. Responsible governments do not impose taxes targeted at particular individuals or corporations or offer them special tax breaks. In fact, it is rarely a good idea for governments even to design tax policy to encourage or discourage particular industries. Instead, a good tax system obeys the broad principles developed by fiscal experts over the years—for example, neutrality between alternative investments, low marginal rates, and minimal discrimination between current and future consumption.
Why is that a problem for businesspeople? After all, there are many general principles that also underlie the sound management of a corporation: But many businesspeople have trouble accepting the relatively hands-off role of a wise economic policy-maker. Business executives must be proactive. It is hard for someone used to that role to realize how much more difficult—and less necessary—this approach is for national economic policy.
Consider, for example, the question of promoting key business areas. But should a government decide on a list of key industries and then actively promote them?
At various times, governments have been convinced that steel, nuclear power, synthetic fuels, semiconductor memories, and fifth-generation computers were the wave of the future. Of course, businesses make mistakes, too, but they do not have the extraordinarily low batting average of government because great business leaders have a detailed knowledge of and feel for their industries that nobody—no matter how smart—can have for a system as complex as a national economy.
The same syndrome is apparent in some business leaders who have been promoted to economic advisers: They have trouble accepting that they must go back to school before they can make pronouncements in a new field. The general principles on which an economy must be run are different—not harder to understand, but different—from those that apply to a business.
An executive who is thoroughly comfortable with business accounting does not automatically know how to read national income accounts, which measure different things and use different concepts. Personnel management and labor law are not the same thing; neither are corporate financial control and monetary policy. A business leader who wants to become an economic manager or expert must learn a new vocabulary and set of concepts, some of them unavoidably mathematical. That is hard for a business leader, especially one who has been very successful, to accept.
Imagine a person who has mastered the complexities of a huge industry, who has run a multibillion-dollar enterprise. What are the effects of free trade and globalization? What are the driving forces behind worldwide urbanization? Paul Krugman has formulated a new theory to answer these questions. He has thereby integrated the previously disparate research fields of international trade and economic geography.
Meanwhile, consumers demand a varied supply of goods.
As a result, small-scale production for a local market is replaced by large-scale production for the world market, where firms with similar products compete with one another.
Traditional trade theory assumes that countries are different and explains why some countries export agricultural products whereas others export industrial goods. The new theory clarifies why worldwide trade is in fact dominated by countries which not only have similar conditions, but also trade in similar products — for instance, a country such as Sweden that both exports and imports cars. This kind of trade enables specialization and large-scale production, which result in lower prices and a greater diversity of commodities.
Economies of scale combined with reduced transport costs also help to explain why an increasingly larger share of the world population lives in cities and why similar economic activities are concentrated in the same locations. Lower transport costs can trigger a self-reinforcing process whereby a growing metropolitan population gives rise to increased large-scale production, higher real wages and a more diversified supply of goods.