ECONOMICS IN PEOPLE Economist as Crusader Arvind CONOMICS made Paul Krugman 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 economists. Other giants of the 20th century, such as John Hicks, Ken Arrow, and Box 1 Paul Samuelson, sparkled in several fields. Sharp words Within international economics, though, Jagdish Bhagwati 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 Elhanan Helpman 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 Avinash Dixit has said that if Krugman were not so International macroeconomics 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 Robert Mundell, Indeed, Krugman is perhaps without peer among economists in the clarity Rudi Dornbusch, Michael Mussa, Maurice and sharpness of his prose. Commenting on the changing rationale for the Obstfeld, and Kenneth Rogoff. 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 James Meade, 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 John Bates Clark 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, 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 Robert Solow, 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 New York 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 Nobel Prize. 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 International Economics 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 free trade (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.