October 15, 2008 | posted by Michael Baxter in banking rescue plans |

Earlier this week, the Nobel Prize in Economic Sciences was awarded to a Bush-bashing, Gordon Brown-loving American.

Paul Krugman, Professor of Economics and International Affairs at Princeton University, and a regular columnist for the New York Times, has made many fans and critics over the years. His fans love the way he has used his New York Times column to lambaste Bush and US economic policy. His critics say he seems to be running a one-man, anti-Bush show.

But his Nobel prize was awarded for something more important than all that.

First of all, he worked on something called New Trade Theory.

As you know, right now, US politicians are screaming blue murder at the injustice of developing countries still growing behind a wall of protection and subsidies, while US companies suffer.

You can see the argument. In some parts of the US, in areas that are reliant on the auto industry, economic depression has already descended. It is not fair, they say, we are losing jobs, not because manufacturers in other countries are more efficient, but because they are subsidised.

But, there is another side to the coin.

You may be familiar with the Law of Comparative Advantage. This is the law which is supposed to show, beyond all doubt, that free trade is best and that any tariffs are bad. The law is possibly the most important economic principle there is.  It shows that it pays for two countries to trade with each other, even when they produce exactly the same goods and one country has an absolute advantage in every single product produced.  What counts, instead, is relative, or comparative advantage. So, for example, it makes economic sense for a high-powered lawyer, who happens to have a knack for cleaning, to pay someone to clean his house, even though a cleaner may take longer than the lawyer to make the house look all pristine.

There is a snag with this argument, however. It does not take into account economies of scale.

Any new business will always struggle to compete against traditional business, because it is simply not big enough to enjoy the full benefits of mass production. It is at a disadvantage against the larger company.

And that is why, it is argued, it does make sense to protect infant industries.

Krugman then took the idea of New Trade Theory and asked why it is that some countries export and import similar products? Why does Japan export Toyotas and import BMWs? Why does Sweden import Volkswagens but export Volvos?

The answer lies, in part, with economies of scale.

The public want variety. But as companies specialize and grow, and then exploit further economies of scale, each company becomes a specialist in its own niche. And BMW becomes especially good at producing BMW-type cars, but not so good at Japanese-type vehicles.

Krugman also looked at why individuals might move from towns to cities. Again, it seems to have a lot to do with economies of scale, with the specialist pool of labour on tap in a city, accentuating its own advantages.

Krugman’s theories are not easy to understand. He himself said they are: “… pretty well incomprehensible to laymen.”

But this is the curiosity: Krugman has done something that has left many economists fuming. He has talked to the mass market, and tried to express his theories, including other less academically oriented ideas, via his newspaper column.

Some see the Nobel award as a kind of posthumous award, for a former economist who has become a populist..

The truth is, those criticisms are themselves arrogant. Some academics become too precious by far about their discipline.

Krugman has had very little good to say about George Dubya, and was one of the economists who warned most vociferously that there was trouble ahead. This has not endeared to him to many.

As for Gordon Brown, he has heaped eulogy on Brown’s banking rescue plan. Earlier this week, his Monday column for the New York Times began with the sentence: “Has Gordon Brown, the British prime minister, saved the world financial system?”

He said: “The Brown government has shown itself willing to think clearly about the financial crisis, and act quickly on its conclusions. And this combination of clarity and decisiveness hasn’t been matched by any other Western government, least of all our own.”

Mind you, Krugman is also a big critic of Gordon Brown’s friend, Alan Greenspan.

He also argued in his recent New York Times post that the George Dubya regime has effectively driven out “knowledge professionals”, meaning there was no one left at the US Treasury “with the stature and background to tell Mr. Paulson that he wasn’t making sense.”