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STANFORD -- Paul Krugman, professor of international economics, who joined the economics faculty this month after serving as a visiting professor in the Graduate School of Business last year, is the author of a new book, Peddling Prosperity: Economic Sense and Nonsense in the Age of Diminished Expectations. In the book, Krugman criticizes journalists, academic economists and government "policy entrepreneurs" for confusing the public about national economic performance. This is an edited transcript of an interview with Krugman by Kathleen O'Toole for Campus Report.
Q: Could you summarize your criticisms of the economic competitiveness debate?
A: In the last 10 or 15 years there has grown up alongside a serious discussion [of international economics] an enormous set of organizations, literature and rhetoric surrounding the idea of competitiveness. It has as its central image, as President Clinton said, [that] each country is like a big corporation. the United States and Japan are like Coca-Cola and Pepsi, which is the way I put it in my Foreign Affairs article. What's odd about that is that I think most of my colleagues have just not taken it seriously. Their basic point of view is "Oh, c'mon. That's so transparently silly that there is no need to even discuss it." At the same time, out there in the world of affairs, people are taking it to be so obviously true that they feel no need to discuss it, and someone needed to do something.
Q: So you are trying to break through a communication gap?
A: I used in the article the metaphor of the emperor's new clothes. There are politicians, and for that matter, business leaders, who find this metaphor - that says countries are like corporations - a lot easier to cope with than the concepts we have worked out. There have really been a lot of people, including myself in the past, [who] say, "Yeah, I'm for competitiveness," and then try to actually turn the discussion to sensible things. So there's been a tremendous willingness on the part of people who know better to accommodate the desire to discuss things as if countries were locked in this great competitive struggle with each other.
Q: When did you decide to stop participating in that?
A: At the Little Rock summit, which was December 1992 after the election, when I realized that President Clinton, who is a very intelligent, widely read man, thought this rhetoric of competitiveness was sophisticated economic analysis. I realized we just weren't getting through. We had not managed to get across the fact that this is basically silly stuff.
Q: Is the communication gap partly economists' fault?
A: It's not that I think every [economist] should be out there constantly trying to translate things for the broader public. It's clear that not enough economists were trying to communicate, but you don't ask that every historian write best sellers. Somebody has to go out there and piece together the fragmentary evidence and find out what actually happened in some political struggle, and those books may not be readable. We do require that somebody be engaged in relatively remote scholarship. The problem is that we wound up with essentially nobody serious also being in the business of communicating.
Q: On the Democratic side or would you also say on the Republican side?
A: So far, the really damaging effects of pop economics have come from the right, not from the left. It was supply-side economists who certainly were the moral equivalent of this [Clinton administration's] competitiveness stuff, and [they] have done quite a lot of real harm, whereas with this competitiveness rhetoric, most of the harm is still potential.
Q: What is the harm? Is it to national trade policy or more broadly related to domestic policies such as health care?
A: I can't avoid being personal here. A huge [health care] task force operating in secret was put under the directorship of someone whose entire previous writings on policy had been on the issue of competitiveness and all of whose work was, in the opinion of people who knew anything about international trade, startlingly ignorant, someone who made a point of ignoring what anyone else had thought on the subject and was making up his own version of it. I think the shipwreck of the administration's health care plan was entirely predictable, given that, and I'm not surprised. When I heard not only that health care reform was going to be directed by Ira Magaziner but how it was going to be run, that there were going to be no checks on him, I remember telling people, "Look, they've just pointed the Titanic straight at the iceberg and ordered full speed ahead." I was saying this at a time when people were still very high on [health care reform]. So this was predictable.
Q: But they apparently did have some health economists involved. Stanford's Alain Enthoven was involved early on.
A: And he spoke his mind and was then shut out.
Q: You think that is Magaziner's style of operating?
A: I don't know how reliable Bob Woodward is, but there's a place in The Agenda when other Clinton aides plead with Magaziner to find some experts - any experts - to back his views on health care, and he replies, "They're all wrong." So this is an extreme case, and perhaps I shouldn't just attribute it to the competitiveness obsession, but certainly that played a role.
Q: How is health care related to the nation's economic performance?
A: A back-of-the-envelope estimate I have done suggests that health care reform is probably about 50 times as important as trade with Japan as an actual government policy issue. The potential gains from the most successful, aggressive negotiation with Japan would be not more than something like one-fortieth of 1 percent of national income. The difference between a good and a bad health care plan can easily absorb more than 1 percent of national income, so we're talking about truly the most important economic policy issue for the Clinton administration.
A: An estimate of how much more we would sell to Japan if they gave us everything we wanted - including things they don't know how to give us - would mean that we would export about $20 billion more of goods and services to Japan each year. Those don't come out of thin air. Those [goods] have to be produced, so the only net gain to us comes from the fact, basically, that these [goods] are in higher wage sectors than the sectors they would displace. If you then actually try to estimate the gain in wages, which I have done back of the envelope, it turns out we end up with a wage gain on the order of $1.5 billion if everything went perfectly. (High- technology industries seem to pay about 15 percent higher than other industries.) One and a half billion dollars is one-fortieth of 1 percent of the American economy.
I don't know what the numbers in health care are really. What we know is that we spend 14 percent of GNP on health care; that the spending is highly distorted because of perverse incentives provided both by government and the way our insurance system works; that it is entirely reasonable to suppose that we could save 1 or 2 percent of GNP improving those incentives. And it's entirely possible that we could, by doing the wrong plan, screw things up enough so that it ends up costing us an additional 1 or 2 percent of GNP. So you have no trouble at all believing that getting health care reform right is, as I say, at least 50 times more important than anything on the Japan trade front.
Q: At the June conference on economic growth at Stanford, Clive Crook, deputy editor of The Economist, said that, in his view, you had almost defined the American economy as a closed economy - that free trade seemed passe because 90 percent of the U.S. economy is domestic. Is that an accurate depiction of your view?
A: First off, international trade is a lot less important than people think. That's a funny thing. For years and years, economists used to go around trying to persuade people that international trade was important. Because Americans are very insular, people didn't think of it as being important. Now, what has happened is that we've discovered international trade does matter a bit, and we are so shocked that we go the other way around. We overstate it.
Q: When did we discover that "trade matters a bit"?
A: I think sometime during the '80s it became clear. I remember that as late as about 1979, people didn't realize that we imported oil. At that point, people still didn't really understand that there was an outside world. And then during the '80s, the U.S. began to build up trade deficits, and some factories closed in the face of imports.
We still are not a country that is used to having a lot of international trade for a long time, such as Britain. Britain has three times as much international trade, relative to their economy, as we do, and they actually talk about it less than we do. They are used to the idea that, sure, a lot of output gets exported, and a lot of consumption gets imported, and they very rarely obsess about their competitive position.
What is true now is that, despite the increase in international trade, we are more than 70 percent a service economy. Very few services can be sold internationally because they are not transportable. Even quite a few of the goods we produce are not easily transportable. For example, at this point, while the great bulk of the TVs that are sold in the United States are from foreign-owned firms, nearly all of the picture tubes are made in the United States.
Picture tubes turn out to be something that are hard to ship internationally because they break, so there is a manufactured good that is not very tradable. And so, overall, in the last year, imports were about 11 percent of U.S. gross domestic product. A hundred years ago, they were about 8 percent.
The reason that we have the impression that it has increased by leaps and bounds is partly that there was a great collapse in international trade because of the two world wars and the depression. If you go back to when John F. Kennedy was president, we still only had about 4 percent imports, so we have sprung back, but in fact, we are not all that globalized, even now.
Q: Other trade economists, such as Stanford Professor Anne Krueger, are worried about the fact that we could have another collapse. Are you?
A: History shows that politics can disrupt the global economy. We had a global economy in 1913 that was in many ways as integrated or more integrated than the economy we have now. Politics killed it, and that could happen again. I'm concerned about it. I think it would be devastating to smaller countries. The United States is a huge and largely self-sufficient economy, even now. The real victims of a world trade war would be those countries that are not so self-sufficient, which would be many of the world's smaller countries, and especially the world's poorest countries. I would be very concerned about a trade war: I don't think it would produce catastrophic results in the United States, at least not directly economically, but I think it would have catastrophic economic and eventually political impacts on many countries.
Q: Will the U.S. be more dependent on trade in the future?
A: Over the last century, there have been two offsetting forces operating on international trade. On the one hand, transportation and communication costs have continued to fall so that the ability to ship goods around the world is much greater than it was. On the other hand, we've increasingly become a service economy and services remain, by and large, non-tradable.
Q: Why have we become more of a service economy?
A: Manufacturing has become less important for the same reason that agriculture earlier became less important.
A: Yes. Productivity has grown in manufacturing, which means we need fewer and fewer workers and the prices get lower so we spend more and more of our income on the things we can't automate, which tend to be in the service sector.
The actual ratio of the output of manufacturing - the constant dollar output of manufacturing's share of the economy - has been almost exactly constant for the past four years. But the share of the value of the economy that originates from manufacturing is steadily declining, and that's all because of the higher productivity growth. That's true around the world.
If you look at any particular manufacturing industry, you discover that the international trade in that industry has grown, that the industry has been more finely divided into little slices of value added in different parts of the world, and you say, "Wow, globalization has increased by leaps and bounds." But then you look at the overall numbers and discover that the share of trade in the economy has not increased very much. The reason is that more and more, the economy is concerned with producing things that can't be traded.
In the long run, everything will be tradable. In the millennium, you will be able to get all of your services by slipping on your virtual reality helmet and have them delivered over whatever the future Internet is, right? But that's a long way off. It's not going to happen for quite a long time.
So I expect that the share of trade will rise gradually, although it's worth pointing out that it does move fairly gradually. The share of imports in the economy was only a little bit higher in Bill Clinton's first year in office than it was in Jimmy Carter's first year in office.
Q: Is it that politicians find globalization an easy way to explain to voters why some of them are losing their jobs in manufacturing?
A: Partly. There's [also] a strong element of intellectual fashion. If you add the adjective global, it adds cachet to whatever you are saying. It sounds sophisticated.
I have a favorite example here. During the 1980s, there were two major financial crises. One of them was very exciting and romantic and you could talk global. That was the Third World debt crisis. People were swarming over that issue; everyone wanted a piece of it; everyone wanted to be involved, wanted their names on plans to solve it. Economists, including me, were writing innumerable analyses.
There was also this dull, boring other financial issue involving savings and loans that was going on in unglamorous places like Texas and Oklahoma. Nobody was interested in that, and it turns out we lost about 10 times as much on savings and loans as we did on third world debt repudiations. That's a fairly common thing. We glamorize, we overstate the importance of international issues in this country, precisely because they are so new to us.
Q: So what are the more important issues than globalization and economic competitiveness?
A: I think our major problems are inadequate growth in productivity and the inequality of the income distribution. Those two basically dwarf everything else. I guess an out-of-control health care system would then be the third problem, and that ranks a fair bit below those two. Everything else, beyond that, is way down there in the rankings. And I don't have good answers for either of those [first two] problems.
A: I think nobody does. There are things we can do that would be a good idea. A higher national savings rate and a better quality of basic education would help on the productivity front and possibly on the income distribution front as well.
Q: You are not sure about education helping the income distribution?
A: I think it would help a little bit, but there's not a lot of evidence that would suggest it would do a great deal. I would go a little bit further. The connection between incomes and formal education looks less convincing the more you look at it. One of the things that's very striking about the widening income gaps is that they've not only widened between people with different levels of education, but they've also widened very heavily among people with the same level of education. I like to use the word fractal.
Q: Do you mean the difference in income earned by an English major and a computer science major?
A: I'm talking about looking among the computer science majors. Look among lawyers, and you'll find out that the best-paid lawyers are making much more relative to the average lawyer than they used to. Look among professors; this is clearly the case. That suggests that forces making for inequality are deeper than merely a matter of needing to upgrade the educational standards of the bottom half of the population. That doesn't mean we shouldn't do whatever we can to upgrade that, but I wouldn't expect to make more than a small dent in the problem.
Q: Does anybody in your field have any ideas about what is causing this widening disparity?
A: There is some wonderfully interesting theory that is only partially validated in this area - what economists have called the superstar theory, better known as winner-take-all models. Modern technology really tends to act as a kind of force multiplier on individuals who are exceptionally talented or lucky and tends to allow them to crowd out people who are less so. I think we can see that happening, to some extent, in a number of different kinds of employment. That's the best going explanation of what's happening, but it is fairly mysterious.
That doesn't mean we shouldn't be trying to do something about it, and I think we can try to do something about the scale of training. I have doubts about how much that will do. We can also try to tax the rich and help the poor, which is something - I am a liberal - I'm in favor of.
Q: You don't think taxing the rich undermines investment?
A: I'm not a romantic liberal. I believe that taxing the rich and helping the poor does have adverse effects, but I think we can afford a few more of those. I'm willing to make that tradeoff.
Q: Are you concerned about unemployment rates?
A: I am not much disturbed by the U.S. unemployment rate at its current level [of 6 percent]. I didn't list that as a major problem for the U.S.
A: In Europe they have suppressed many of the effects on income distribution. They haven't allowed the wages of less skilled or less lucky workers to fall. Unfortunately, it has cropped up as unemployment instead. So I think they have the same two basic problems, but one of the problems manifests itself as higher unemployment.
Q: The newly released World Competitiveness Report indicates the organizations who sponsor it believe white-collar jobs may move, the way manufacturing jobs have moved, to developing countries with cheaper wage rates. What do you think about that?
A: I question the premise that a lot of manufacturing jobs have moved. Some industries have moved there. Other industries have greatly increased their exports to those countries. If you ask what the net impact of trade with the Third World has been on the number of jobs [here], it turns out to be absolutely minimal. You can tell anecdotes, but the factory that closed because the production moved to Indonesia is more conspicuous than the factory that is working extra shifts because it's selling to Indonesia.
Q: Or more conspicuous than the factory that has added robots but not moved anywhere?
A: A concrete example - well, not a concrete example but a steel example - is that we used to have a lot more people working in the steel industry in the U.S. than we have now. Most people think that's because of imports. It turns out that it isn't. If you look at the steel industry - I just did this because I'm writing something up, so I know the numbers roughly - if you look at the steel industry in 1980 or thereabouts, it employed about 400,000 workers. If you look at it about 1991, it is something like 170,000 workers.
It turns out that the steel industry shipped about the same tonnage of steel in both years - about 85 million tons, and imports rose from about 15 million to 17 million tons over that period. Trade changes were not significant in that.
What happened was a tremendous increase in the productivity of steel making, a change in the way we make steel from the old integrated hearth to a lot of mini mills using new techniques, and the job loss was essentially because steelworkers became so much more productive, we didn't need as many of them. That's actually the dominant pattern in industry. Most of the decline of manufacturing's share of the economy is not because of imports but because of higher productivity.
Q: But don't economists say higher productivity is supposed to produce higher incomes?
A: The key story about the U.S. economy is that we've had quite a lot of productivity growth in manufacturing and virtually none in services.
Q: Could you define services? Are you talking largely about office workers?
A: Services is a tremendously complicated category. It includes office workers, fast food workers, everything out there. What it comes down to is that we've had rapid productivity growth in manufacturing, which doesn't translate into rapid growth in living standards because it is weighed down by the lack of productivity growth in the rest of the economy.
Q: At the recent Stanford conference on economic growth, Clive Crook of The Economist also said that he felt you were "very wrong to judge the significance of trade merely by the extent of trade." Trade and direct foreign investment, in his view, are important purveyors of knowledge, which leads to improvements in productivity. What is your response?
A: I'm not saying that if the U.S. economy did no trade, it would make no difference. I was arguing that successes or failures in international competition in particular industries matter very little for the real income of the U.S. economy. What is true is that international trade, whether you do well in it or not, is a conduit by which you get ideas and get to see things. But if you were to ask, how important was the caravan load of silk that Marco Polo brought back from China to his city state, the answer would be not very. And that is the kind of question I am asking.
Q: But is that the more important question to ask?
A: It depends on who you are arguing with and about what. If you think that the imports of Japanese automobiles causing some [U.S.] autoworkers to lose their jobs was a devastating issue for the U.S. economy, and what we really need to do is get back those manufacturing jobs, then I'm prepared to argue with you that it's just not that important. It's important to the particular workers, but from the point of view of the economy as a whole, it's just not a major factor.
If the question is, did the example of what the Japanese could do in car manufacturing have a positive impact on productivity in U.S. manufacturing of automobiles and perhaps more broadly, yes, of course [it did]. But that's a very different kind of issue. People who worry about competitiveness have this image of countries duking it out in world markets.
Clive Crook may be arguing about a point I made elsewhere, which is [that] if you try to estimate the direct costs of a trade war to the U.S. economy - run out hypothetical scenarios for a collapsed world trading system, the imposition of high tariffs and so on, you generally come up with losses that are on the order of a couple of percent. And he might argue the losses would be much larger than that because you chop off the flow of information.
A global trade war would produce costs over and above that couple of percent because it would choke off the flow of ideas, although in the example that we have, which is the inter-war period, I don't think there is any clear-cut evidence that the rate of progress of technology really did slow down.
Be that as it may, that doesn't really change the policy conclusions. I think a trade war is a bad thing anyway. I don't see how you can take the argument that international trade helps to spread ideas and fit it under the label of competitiveness.
Q: Perhaps some people who discuss competitiveness are really trying to argue with the average American worker or taxpayer or voter, who thinks it is the government's job to protect existing jobs.
A: People have tried to use the word competitiveness to advance one agenda or another. Some of them have good basic agendas. Some of them want to say, we need to be competitive, and what we need to be competitive is we need to save more and have better education and encourage the application of new technology, all of which would be good things even if the rest of the world didn't exist. But the argument is that the average guy doesn't understand that and so we have to motivate him. That's the Sputnik effect. It's like saying we needed the fear of the Soviet Union in order to get us to improve our science education.
Q: But didn't we improve science education as a result?
A: We also spent a lot of money on bomb shelters. It's a costly strategy and the problem is that it can easily backfire.
If you ask if what we did in response to the perceived Soviet threat was economically beneficial, I think that would be a very ambiguous calculus. We spent on science education and highways, but we also spent on bomb shelters and we spent a lot on bombs.
When it comes to competitiveness now, two things obviously happened. One was that we've launched on this confrontational course with Japan, where, so far, nothing terrible has happened but we're constantly on the edge and that's pretty nerve wracking. The other thing is that the world trade negotiations were loaded up with some baggage because of fears about competitiveness - things like labor standards that are sufficient to have created significant risk that the thing won't even pass now that it has been negotiated.
Q: But aren't you saying those confrontations are only scary at the margins for U.S. citizens?
A: So far. I've had a little mission here, which is to do what I can to head off what I think could be significantly scarier than that. What was happening was that the metaphor of countries in competition was spreading without anybody calling it to account. What I am hoping - and this may already be happening - is that when people stand up in front of some conclave and start talking about competitiveness, a certain number of people in the audience will say, "Wait a second, does this guy have the faintest idea what he is talking about?"
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