Bold strokes
Oct 16th 2008
>From The Economist print edition
A strong economic stylist wins the Nobel prize
WHEN Paul Krugman won the Nobel prize in economics on October 13th, the news
was greeted with
nostalgia as well as congratulation by some of his fellow economists. Since
1999 Mr Krugman has written
a twice-weekly column for the New York Times, in which he has devoted
himself to attacking the Bush
administration and all of its works. The nostalgists feel these jeremiads
have distracted him from the
cutting-edge research that secured his reputation. The polemicist, they
feel, has buried the theorist.
And yet the old Krugman is still recognisable in the new. Indeed, the arts
of the columnist are not so far
removed from Mr Krugman's style as an economist. In his most celebrated
academic papers, Mr Krugman
paints with bold strokes, striving to render his insights as starkly as
possible. Like a good columnist, he
cuts to the quick of a problem, stripping it of clutter and encumbering
nuance. The result is a revealing
caricature: what economists call "models".
Mr Krugman won the prize for his models of international trade and economic
geography. Both belong to
the same grand project he confidently launched just a year after earning his
doctorate: "Before my 25th
birthday," he has written, "I basically knew what I was going to do with my
professional life." In 1978 he
realised that a model of "monopolistic competition", published a year
earlier by Avinash Dixit and Joseph
Stiglitz, could help him introduce economies of scale into trade theory and
beyond.
Economies of scale had long posed awkward problems for theorists. If bigger
firms face lower costs, then
in principle one firm should supply the entire market, thereby enjoying the
lowest costs of all. But in the
Dixit-Stiglitz model, this monopolising logic is offset by a countervailing
force: consumers' taste for
variety. People prefer to spread their custom over different versions of the
same good. The market is
therefore carved up among competing firms, each offering a product bearing
its own distinctive stamp.
The model is highly stylised. Nonetheless it gave Mr Krugman, as he put it,
"a tool to open cleanly what
had previously been regarded as a can of worms".
Mr Krugman used this tool to save economics from an abiding empirical
embarrassment. According to one
of the discipline's founding doctrines, countries gain from specialisation
and exchange, concentrating on
what they do best and importing the rest. The theory explains why the
Portuguese might sell wine in
exchange for English cloth. But it cannot explain why similar countries,
blessed with similar ratios of
capital, labour and land, should so vigorously trade similar goods back and
forth. This is not a small blind
spot. According to the World Trade Organisation, 52% of Germany's exports to
France are things France
also produces and exports to Germany. But the Dixit-Stiglitz model, with its
subtly differentiated firms
competing for variety-loving consumers, lent itself to explaining why
Germans might import Renaults,
even as the French imported Volkswagens.
Mr Krugman's model showed that when trade barriers fall, firms gain access
to bigger markets, allowing
them to expand production and reap economies of scale. But openness also
exposes them to competition
from rival foreign firms, paring their margins. Some firms may go out of
business. But between the
domestic survivors and the foreign entrants, consumers still have more goods
to choose from. Thus the
gains from trade arise not from specialisation, but from scale economies,
fiercer competition and the
cornucopia of choice that globalisation provides.
Scale economies also allowed Mr Krugman to give economics for the first time
a sense of space. In a 1991
article, he notes that night-time satellite photos of Europe reveal the
distinctive contours of economic
activity: bright lights cluster around metropolitan centres, shining
particularly brightly around the triangle
of Brussels, Amsterdam and Dortmund.
Before Mr Krugman, economists found these images difficult to square with
the rest of their body of
theory. They were accustomed to assuming that firms face constant returns to
scale. But if that were true,
then every peasant could build a small smelter or assembly line in his
backyard. There would be no need
for an economy to divide into a farm belt and an industrial belt.
Geography lessons
In Mr Krugman's model, by contrast, big factories benefit from lower costs
of production. Manufacturing
firms might therefore cluster near to a large market, leaving behind a
sparsely populated hinterland, in
order to make the most of scale economies and minimise the cost of
transporting goods to their
customers.
Earlier theorists had instead assumed that firms herd together to benefit
from some kind of "spillover".
Perhaps firms pick up tricks of the trade and other know-how from their
neighbours. However plausible,
these explanations were nonetheless unsatisfying. Because economists could
not measure spillovers or
delimit their scope ("How far does a technological spillover spill?" Mr
Krugman wondered), they could
invoke them to explain just about anything.
Mr Krugman's models instead identified a less elusive benefit of proximity.
He pointed out that a firm's
decision to locate in a district is a gift to other firms in the area,
because in attracting new workers it also
brings new customers. Unlike a technological spillover, this gift would in
principle leave a paper trail,
showing up in local firms' sales figures.
In neither contribution did Mr Krugman claim great originality for his ideas
or great realism. His
achievement was to formalise insights that many people had previously had
informally. Ideas that had
fluttered in and out of people's grasp for decades, he pinned down like a
butterfly on display. Sometimes a
good economist, like a good columnist, succeeds not by making a point before
everyone else, but by
making it better than anyone else.
Copyright C 2008 The Economist Newspaper and The Economist Group. All rights
reserved.
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Best Regards,
Benedictus Dwiagus S.
bdwiagus.blogspot.com
"The most difficult thing in the world is to know how to do a thing and to
watch somebody else doing it wrong, without comment." - T. H. White
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