Paul Krugman and the Washington Consensus

Among Krugman’s achievements in the field of international trade is “strategic trade policy.” He argued that governments should play a role in connecting beneficiaries of strategic trade policy with the overall economy. Developing countries often needed a “big push” of coordinated government investments to help strategic industries get off the ground and to link to the economy as a whole. Problem is, today’s trading system is out of whack with these frontier issues in economic thought. The world’s trading system makes it much more difficult for nations to craft strategic trade and industrial policies for growth and development.

On Saturday the New York Times quoted the World Bank as saying “There is no question that the Washington Consensus is dead,” indeed it “died at the time of the $700 billion dollar bail-out.” If the bail-out is death, then awarding Paul Krugman the Nobel Committee Prize for Economics is a nail in the coffin.

Paul Krugman did not win the Nobel for his popular critiques of Bush-era economic policy in his New York Times column, though the column no doubt helped raise his profile outside the economics profession. The committee cited Krugman’s theoretical contributions to the economics of international trade, the policy implications of which fly in the face of the Washington Consensus (where the mantra is to free trade every chance you get).

Among Krugman’s achievements in the field of international trade is “strategic trade policy.” In this work Krugman (and others) showed that tariffs and subsidies to domestic industries can divert profits away from highly concentrated foreign firms and increase a nation’s income. Though Krugman himself shies away from prescribing such policy, the textbook example of strategic trade theory is the choice by the Brazilian government to subsidize and develop the aircraft company Embraer.

The free trade theories espoused by the Washington Consensus would warn Brazil of the high cost of subsidization. To free traders, Brazil should focus on its advantage in agricultural products and forget about climbing the manufacturing ladder. Strategic trade theory helps explain why Brazil was willing to gamble in the short term to become one of the finest aircraft manufactures over the long term. They squeezed foreign firms out of the market and carved out a global niche for themselves.

In a classic book, Development, Geography, and Economic Theory, Krugman argued that the government should also play a role in connecting beneficiaries of strategic trade policy with the overall economy. Evoking the work of economists such as Albert O. Hirschman and Paul Rosenstein Rodan, Krugman argued that developing countries often needed a “big push” of coordinated government investments to help strategic industries get off the ground and to link to the economy as a whole.

Problem is, today’s trading system is out of whack with these frontier issues in economic thought. In a new study published by Boston University’s Pardee Center for the Study of the Longer-Range Future, trade lawyer Rachel Denae Thrasher and I examined the extent to which the World Trade Organization (WTO) agreements, European Union trade agreements, and United States trade agreements bit into a nation’s ability to deploy strategic trade and other industrial policies to benefit from the globalization process.

We find that the world’s trading system makes it much more difficult for nations to craft strategic trade and industrial policies for growth and development. Indeed, enshrined in virtually all trade agreements is the “national treatment” idea that says a nation may not treat its domestic industries any differently than foreign ones. That may make sense when rich nations compete against each other, but in a world where 57.6 percent of the population lives on less than $2.50 per day, one size can’t fit all. This restriction is accentuated in provisions for foreign investment, intellectual property, and subsidies.

Interestingly however, we find that there is more “policy space” for innovative growth strategies under the WTO than under most regional trade agreements—especially those pushed by the United States. In fact, we find that US-style trade agreements are the most severe in constraining the ability of developing countries to deploy such policy. EU agreements interestingly, tend to have the same policy space as the WTO.

It doesn’t make sense that the World Bank and (implicitly) the Nobel Committee are declaring the death of the Washington Consensus when the United States is choking the ability of nations to use policies that are gaining increasing legitimacy in theory and practice. Change is in the air. As we know in the aftermath of the financial crisis the United States has justified—like never before–a strong role for government in economic affairs. And, of the two candidates the Obama campaign has expressed concern over the direction of US trade policy and has pledged to rethink it. Perhaps these events will make strategic trade and industrial policy rise again.

——————————————————————————————

Links:

[Krugman on strategic trade theory->http://www.amazon.com/Strategic-Trade-Policy-International-Economics/dp/0262610450] [Where I say krugman didn’t push for Brazil type intervention->http://www.amazon.co.uk/Pop-Internationalism-P-Krugman/dp/0262611333] [Krugman on “big push”->http://www.amazon.com/Development-Geography-Economic-Theory-Lectures/dp/026261135X] [Gallagher and thrasher on trade agreements-> http://www.bu.edu/pardee/publications/Pardee-Paper-002-Trade/index.shtml]

Leave a comment

Your email address will not be published. Required fields are marked *