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Home , Avinash Dixit, Jagdish Bhagwati, James Meade, Kelvin Lancaster, Kenneth Rogoff

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PEOPLE as Crusader

Arvind conomics made suasion, and through the shaping of historic famous. Punditry has made him a changes. This last is denied to all but those Subramanian celebrity, famous for being famous. who find themselves at the right place at an But Krugman aspires to be long re- epochal time. But on the first two scores, at interviews Emembered, and, in this respect, John May- least, Krugman may well become the first per- economist nard Keynes is the gold standard. Keynes left son outside the field of literature to win both his mark in three distinct ways: through the the Nobel and Pulitzer Prizes, the acme of Paul Krugman power of ideas, through the art of public per- achievement in academics and journalism. The dismal science has produced many versatile . Other giants of the 20th century, such as , Ken Arrow, and Box 1 , sparkled in several fields. Sharp words Within international , though, tells the story of Krugman’s first summer job as his research specialization has tended to be the rule. Bertil assistant at MIT. “I was in the middle of a paper on international migration. Ohlin, Eli Hecksher, Jagdish Bhagwati, and I gave Paul an outline of my thoughts—when he came back, he already had a made seminal contri- finished paper, and I could not change even a comma! So I gave him the lead butions in the field of international trade. authorship.” Princeton’s has said that if Krugman were not so International has seen valuable to academics, “we should appoint him to a permanent position as the many that fall somewhere between the great translator of economic journals into English.” and the very good, including , Indeed, Krugman is perhaps without peer among economists in the clarity , , Maurice and sharpness of his prose. Commenting on the changing rationale for the Obstfeld, and . tax cuts of the Bush administration, he called them “an obsession in search of a justification.” His recipe for the Japanese deflation of the early 2000s was But Krugman, like , is a rare aggressive monetary expansion, and he called upon the ultraorthodox Bank economist whose accomplishments at the of Japan to “credibly commit itself to being irresponsible.” highest level span both of these subfields. He Keynes’s famous remark “In the long run we are all dead” is more widely opened up the study of trade under increas- quoted than understood. Here is how Krugman explains it: “What he meant ing returns and imperfect competition and was recessions may eventually cure themselves. But that’s no more a reason later resuscitated the study of economic geog- to ignore policies that can end them quickly than the fact of eventual mor- raphy. And his work on currency crises and tality is a reason to give up on living.” exchange rates has been highly influential. In He raised questions about the plausibility of real business cycle theory by 1991, he was awarded the asking, “If recessions are a rational response to temporary shocks in produc- medal in recognition of his “significant con- tivity, was the Great Depression really just an extended, voluntary holiday?” tribution to economic thought and knowl- edge.” The cognoscenti know that this honor,

4 Finance & Development June 2006 ©International Monetary Fund. Not for Redistribution One of his former teachers, Jagdish Bhagwati, tells F&D, “We were all pleasantly surprised that Krugman has been able to play the Mike Moore of the economics profession.” Another teacher, Nobel Laureate , calls his former student “an all-purpose pest to the Bush administration.” To many on the right, Krugman has seemed a shrill partisan who makes repetitious whining his stock-in-trade. But to others, he is now a cult figure: a brilliant and prescient analyst and, more important, a Economist man of courage who stepped up to the plate in the aftermath of 9/11, when his fellow journal- ists became derelict in their duty to question, probe, and dissent. as Crusader Powerful ideas Born in 1953, Krugman grew up in the suburbs, earning an undergradu- ate degree from Yale and a Ph.D. from the Massachusetts Institute of Technology (MIT). Although initially drawn to history, he soon embraced economics because, as he has put it, while history could answer the how and when, economics could answer the why. A 1978 conversation with his teacher Rudi Dornbusch sparked a decision to work on increasing returns—the notion that a firm’s unit costs decrease as its scale of production increases—marking a defining moment in his career. At Boston’s Logan Airport a few months later, the eureka moment came when he cracked the mathematical problem of incorporating increasing returns and imperfect competition which is awarded once every two years to an economist under into trade models. In the summer of 1979, he presented his 40, is a little more difficult to win than the annually awarded results at the Summer Institute of the U.S. National Bureau . of Economic Research. “It was the happiest 90 minutes of Then there is Krugman the communicator. From writing my life,” he tells F&D. He knew he had wowed his demand- “Greek letter” academic papers, he moved on to conveying ing peers. economic ideas to the wider world (see Box 1). His Age of Krugman believes that this breakthrough is his biggest Diminished Expectations and Peddling Prosperity filled the achievement. The idea of increasing returns has been around gap between the boringly descriptive genre of “up-and- in economics at least since Adam Smith, as has the infer- down economics” books and sensationalist and shallow ence that competition and international trade are affected “airport economics” books. Age of Diminished Expectations, by it: in particular, increasing returns are incompatible with commissioned by the Washington Post, ended up being not the assumption of perfect competition that forms a basis just an analysis of the U.S. economy in the postwar period of traditional trade theory. Krugman was one of the first but also a cracklingly lucid primer on international eco- economists to incorporate increasing returns and imperfect nomics. Peddling Prosperity was an incisive and opinionated competition explicitly in trade models (he notes that these account of the history of economic ideas. Both books also ideas were developed simultaneously but independently by worked as parables, illustrating Keynes’s nostrum that the two other researchers, Victor Norman and Kelvin Lancaster). use and abuse of ideas are the most “dangerous for good This move represented a radical departure. Indeed, it was so and evil.” radical that one of his early papers was rejected by the top Krugman as public persuader was so successful that the journals, but Bhagwati, playing editor as deus ex machina, New York Times offered him an op-ed column, the most published it in the Journal of despite prestigious piece of real estate in mainstream U.S. jour- the verdict of two very negative referees. nalism. Almost by accident, he moved from demystifier of Krugman’s increasing returns papers were powerful partly arcane economics to hard-hitting political commentator. because they explained a simple but uncomfortable fact

Finance & Development June 2006  ©International Monetary Fund. Not for Redistribution about international trade: in the postwar period, a large and apparently, did others because it found a home only in a increasing share of trade occurred not between rich and poor lesser journal. Krugman faults the paper’s craftsmanship and countries but among the rich, and involved countries import- wishes he had written it differently. Still, it has come to be ing and exporting similar goods like cars, machines, and hailed as a groundbreaking study. Krugman also deserves cereals, the so-called phenomenon of two-way trade. Such credit for outlining the basics of the “third generation model” trade between countries with similar endowments is diffi- of currency crises, in which unhedged foreign currency lia- cult to reconcile with traditional trade theory. But increasing bilities play a large role in causing and transmitting crises. returns showed that countries could specialize in different varieties of goods, leading countries to simultaneously export and import different varieties of similar goods. From the confines of positive economics (“what is”), the “His biggest contribution may theory of increasing returns was developed and extended into well be that he provided normative (“what ought to be”) terrain by Krugman (along with Helpman, Barbara Spencer, James Brander, and others) the technique or language as the strategic trade theory. This extension led to controver- sial policy conclusions that appeared to support government for discussing economic ideas intervention, contributing to perceptions of a certain schizo- phrenia in Krugman’s position on (see Box 2). and problems rigorously and On the macroeconomic front, Krugman developed the “first generation model” that locates the causes of currency sensibly.” crises in unsustainable government policies. Borrowing both the idea and the mathematical technique from the commod- Krugman’s exploration of currency target zones in the late ity price stabilization literature, he showed how and when a 1980s was considered clever and published in the prestigious pegged exchange regime would be subject to a fatal specu- Quarterly Journal of Economics. History’s verdict has, however, lative attack by investors. When the paper was first writ- been less generous, in part because the study’s key prediction— ten, MIT’s Dornbusch did not fully understand it—nor, that currencies stabilize as they approach the extremes of the target zones—has not found empirical support. Similarly, Krugman’s pioneering work on trade and geog- Box 2 raphy, which showed a lot of early promise and continues A free trader or a protectionist? to spawn an industry of academic papers (it is his most fre- It is hard to argue with the perception that Krugman is quently cited work), has not quite caught fire in the broader conflicted on trade policy. His work on strategic trade the- public debate. Again, the key idea about external econo- ory suggested novel and controversial policy conclusions mies—the benefits to one firm of activities by another firm— against free trade, which, he now concedes, he was tempted had been described by the economist and teacher early on to exploit in an effort to showcase the theory. In his of Keynes, Alfred Marshall. But Krugman found a way of for- 1987 article “Is Free Trade Passé?” he pronounced that free malizing this idea and derived some interesting implications, trade had “irretrievably lost its innocence” and that “it can namely, that spatial patterns of development can be arbitrary never be asserted as the policy that economic theory tells us and that historical accidents can have long-lasting effects. is always right.” Silicon Valley (near San Francisco) and Route 128 (near But the very individuals of whom he was so dismissive— Boston), both U.S. technological centers, are classic cases of Robert Reich, Lester Thurow, and Robert Kuttner— agglomerations having idiosyncratic origins. aggressively peddled the interventionist policies legitimized It is one of the ironies of Krugman the economist that for by his work, especially vis-à-vis Japan in the late 1980s, in someone who said, “The point . . . is to wear one’s technique ways that he thought misguided. Any satisfaction in see- lightly,” his biggest contribution may well be that he provided ing his work informing the policy debate was replaced by the technique or language for discussing economic ideas outrage at the appropriation of his ideas by these “policy and problems rigorously and sensibly. The contribution was entrepreneurs” (whom he has described as “intellectu- immense because it allowed powerful ideas such as increasing ally dishonest self-proclaimed experts who tell politicians returns and external economies, which had been around for what they want to hear”). Krugman promptly changed some time, to be mainstreamed. It allowed models to replace tack and summoned all the (very good) arguments against his earlier views. The result was Pop Internationalism, metaphors as the basis for analysis. Without models, “guess- Krugman’s tribute to free trade, arising as much from his work is all that we have to go on, and those who discipline desire to bury the policy entrepreneurs as to praise David their guesses with models are more reliable than those who Ricardo’s great idea. But these days, even while disavowing fly by the seat of their pants, no matter how well tailored.” overtly protectionist positions, Krugman’s columns can Krugman’s style of building mathematical models is famously sometimes have a protectionist tenor that disconcerts his spartan and simple and occasionally even simplistic in its purist colleagues. assumptions. But his sharp wielding of Occam’s Razor (the principle that explanations should be as simple as possible)

6 Finance & Development June 2006 ©International Monetary Fund. Not for Redistribution was so successful that the term “Krugmanesque” may yet enter the economics lexicon as the standard to which mathematical Box 3 models aspire. Just short of the White House A fateful moment in Krugman’s career occurred after Bill Economist as pundit Clinton’s victory in the 1992 U.S. presidential election. Krugman’s academic output, unlike that of some others, did Krugman was widely tipped to be Chairman of Clinton’s not head dramatically south after the John Bates Clark award. Council of Economic Advisers (CEA). Instead, Clinton But the frenetic pace did slow down because, as he explains chose Laura Tyson, then a professor at the University of honestly, “You begin to wonder about the value of yet another California at Berkeley. Krugman was intensely disappointed paper even if it finds its way into a good journal. You also begin and saw this as the revenge of Robert Reich, the head of Clinton’s transition team, whom Krugman had criticized in to doubt your ability to be creative and come up with really big, 1983 for being a “policy entrepreneur.” lasting ideas.” And with his reputation as a communicator start- Looking back, though, Krugman expresses relief that ing to soar, academia perhaps took a natural backseat. things turned out the way they did. “Had I been selected, Over the past five years, Krugman the columnist has overshad- I might well have been ineffective,” he says. “Economic owed Krugman the economist. Has it been worth it? Krugman policymaking in the early Clinton years was dominated less accepted offer late in 1999, very much expect- by economists than by the policy entrepreneurs. Besides, a ing to continue the vocation he had stumbled into over the years treasury led (a few years later) by Larry Summers (a personal of writing on economics for the general public. Indeed, his initial juggernaut) would have been the power center, diminishing columns were focused largely on such standard economics fare the role of the CEA.” He also believes he would have been as the new economy, , and fiscal deficits. associated with Clinton’s early economic policy failures (such But after 9/11, and especially after the war began in Iraq, as the aborted efforts at reforming health care) and may not Krugman judged that his comparative advantage had shifted have lasted until the later successes, especially the rescue of from being an economist to being a political commentator. Mexico after the 1994 peso crisis, which he considers the He was willing to see things differently because he was not an high point for Clinton’s economic policy team. insider infected by groupthink or the “contagion of mutual imitation” (as the Indian poet Rabindranath Tagore put it). his current polemics. Solow calls Krugman’s decision to The typical insider (“the commentariat”) needs “sources” to become a full-time columnist a “big sacrifice” because he get information, becomes compromised, and hence is less believes his former student has “so much good economics prone to ruffling feathers. Krugman, by contrast, had the still left in him.” comparative advantage of distance from Washington, D.C., Does Krugman the economist have any regrets? He and a full-time job that gave him the independence to be wishes he had done a greater amount of serious empirical “unrestrained by deference,” he explains. He could also do work. He also wishes he had produced some really great stu- the “budget arithmetic” on his own. So, to him, the normal dents, a tribute to his own mentors—including Bhagwati, journalistic ethic of balance and moderation, which he dis- Dornbusch, Solow, Bill Nordhaus, and . At paragingly dubs “he-said-she-said journalism,” was less a vir- , which is his home after years at MIT, tue than an intellectual shortcoming—an unwillingness or he says he is being a good citizen, taking on a full load of inability to process information independently and come to teaching. But he does not regret missing out on a White considered conclusions. House post in 1992 (see Box 3) and doubts he will ever want Krugman counts a number of successes in his stint as a to be a full-time Washington policymaker. “I just don’t have journalist: revealing market manipulation by insiders as the the right temperament, I don’t want to wear a suit every day, real cause of the California energy crisis some years before and anyway, I think I do more good on the outside.” anyone else; challenging Alan Greenspan’s iconic status when Krugman’s abiding belief, like that of Keynes, is that ideas he appeared to bless the Bush administration’s tax cuts (“Et matter and matter a lot. The role of public intellectuals is tu, Alan?” was the title of one of his columns); and exposing less to come up with good ideas, which is fiendishly hard, weaknesses in the economic policies and arguments of what but more to serve as a watchdog to get rid of bad ideas and he calls the Bush administration’s “fuzzy math.” The broader prevent their coming back. There are more bad ideas and success, in his estimation, is a sense of vindication because his more purveyors of bad ideas than their benign counter- opinions, considered beyond the pale in the years following parts. And the asymmetry is further compounded because, 2001, have now become mainstream. But Krugman thinks he in Yeats’s words, “The best lack all conviction, while the might have paid too high a personal cost in enduring the per- worst are full of passionate intensity.” In Paul Krugman, we sonal and professional attacks on his credibility for his politi- have the very best, with conviction and passion, rendering cal writings. Gone are the days when his biggest worry was the struggle between good and bad ideas, and between dis- the state of his basement. putation and acceptance, a little less unequal. n The reaction of some fellow economists to Krugman the columnist is often, “Ah, when Krugman used to be Krugman,” Arvind Subramanian is a Division Chief in the IMF’s Research combining a wistfulness for his brilliance with doubts about Department.

Finance & Development June 2006  ©International Monetary Fund. Not for Redistribution