Monday, October 13, 2008

Paul Krugman: Nobel Laureate

First Carter, the Gore, now this... the Nobel Committee won't give Bush a break! New York Times op-ed columnist and Princeton professor Paul Krugman has won a Nobel Prize for Economics.
Krugman has long been an implacable critic of the Bush administration, and attracted a following for his sharp incisive columns criticizing the administration. Personally, Krugman has bee one of my favorite commentators since I noticed one of his columns when I was in high school. I've bought his books and even went to hear him speak.
A blog post at the Times explains Krugman's theories further:
The Nobel Prize citation highlights two distinct but connected contributions: Mr. Krugman’s development of the “new trade theory” and his work on the “new economic geography.” International trade has a long history in economics, and for the bulk of the field’s history, patterns of trade have been explained by factor endowments and comparative advantage. Why does England export wool and Portugal export wine? The cold winters of Yorkshire produce really fluffy sheep and the banks of the Douro produce splendid grapes. Yet comparative advantage does little to explain much of modern international trade, especially not trade within industries.

Mr. Krugman published two seminal papers in 1979 and 1980 that made sense of the fact that Toyota sells cars in Germany and Mercedes-Benz sells cars in Japan. Mr. Krugman started with a variant of Edward Chamberlain’s model of monopolistic competition. In this model, every firm sells a slightly different good — an Infiniti is not exactly the same thing as a BMW. There are fixed costs of production, which means that producers get more efficient as they sell more. Finally, consumers like variety, so that even if they live in the Land of the Rising Sun, with its abundant well-made cars, they still occasionally want something a little more Teutonic.

These ingredients came together and provided a framework than can match the world’s trade patterns better than the 19th-century framework of David Ricardo, or the mid-20th-century models of Eli Heckscher, Bertil Ohlin and Paul Samuelson. The fact that two out of three of those 20th-century giants are themselves Swedes should remind us of how seriously the Swedes take their trade theory, and what a big deal it is for them to admit Mr. Krugman to the pantheon.

Mr. Krugman’s trade models became the standard in the economics profession both because they fit the world a bit better and because they were masterpieces of mathematical modeling. His models’ combination of realism, elegance and tractability meant that they could provide the underpinnings for thousands of subsequent papers on trade, economic growth, political economy and especially economic geography.

Mr. Krugman’s 1991 Journal of Political Economy paper, “Increasing Returns and Economic Geography,” is the first article that provides a clear, internally consistent mathematically rigorous framework for thinking simultaneously about trade and the location of people and firms across space. It is one of only two models that I insist that Harvard’s Ph.D. students in urban economics be able to regurgitate, equation by equation.

The model begins with the same basic elements as the new trade theory: monopolistic competition, scale economics, love of variety. To these elements Mr. Krugman adds free migration of workers across space and industries. Because workers are able to move, real wages equalize across space. People in New York City may be paid more, but they give some of that back in the form of higher housing prices. The paper provides economists with a clear framework that can make sense of where we all live. Firms and workers are pulled toward the same location to reduce transportation costs of shipping goods. For example, the garment industry located in New York City, in part because of the vast trade in textiles that was already moving through the city and because of the large number of customers already living in America’s largest city.

Of course, we don’t all live in the same city. A good model of geography needs both a centripetal and a centrifugal force. In Mr. Krugman’s model, populations are pulled apart by the desire to be close to natural inputs, like land or coal mines. Cyrus McCormick moved his reaper business from Virginia to Chicago to be closer to his rural customers in the Midwest. Later models incorporated traffic congestion and other forces that limit the growth of a single large urban area. Mr. Krugman’s model proved to quite adaptable; it has received thousands of citations.

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