Paul Krugman 's New Trade Theory

The international trade sector of the U.S. economy continues to draw attention in economic and political circles. It is true that, the international market has become increasingly important as a source of demand for U.S. production and a source of supply for U.S. consumption. Indeed, it is substantially more important than is implied by the usual measures that relate the size of the international sector to the overall economy. This paper explores the role international trade now plays in the U.S. economy and answers the important questions for economic policy: How does international trade affect economic well-being? Who gains and who loses from free

The book begins by saying that economics has more incorrect arguments than any other study. The two critical reasons for this are: People don’t care about the long term health of the public, as much as the care about the short term gain in their private lives. Special interest groups create or reuse correct-sounding fallacies to promote their viewpoint. Economics consists in looking at more than the immediate policy; It includes seeing the problems of the policy for not just one group but for all groups. The misconception that government spending boosts the Economy, is a result of a system of misconceptions. The fact that, we don’t address deficit spending and inflation and assume that public spending will be covered in taxes, is a delusional dream.

Krugman starts off his essay by painting the picture of his younger days in a rather fair and middle-class American society. The theme of his writing is centered around policies with the power to reverse the extreme economic imbalance the United States has been challenged with. The excessively divided American economy contradicts the basis of America’s birth: “Ever since America’s founding, our idea of ourselves has been that of a nation without sharp class distinctions- not a leveled society of perfect equality, but one in which the gap between the economic elite and the typical citizen isn’t an unbridgeable chasm” (Graff, Birkenstein,

“Why should we care about high and rising inequality?” (561). Krugman starts his article with a thought provoking question that most Americans want an answer to. He grabs the reader’s attention from the get go. Following this question, he then makes a claim about inequality. Inequality has caused an extreme amount of damage to our society and democracy. He supports this claim by relating it to a Thomas Jefferson quote. “The small landholders are the most precious part of a state” (562). This quote translated means that the middle class is the most precious part of state. Krugman points out how this Thomas Jefferson quote seems irrelevant in our society now because of the high rise of inequality. This high rise has weakened the middle class tremendously. Readers are more than likely going to relate to Jefferson’s quote. Most Americans relate to the idea of America being a society that values the middle class, fairness and

U.S. trade patterns are an important topic of study due to America’s power and central position in the international market. This topic of US trade partners and our trading patterns with those partners has been approached from a variety of perspectives by several economists. Namely, Sattinger (1978), Srivastava and Green (1986), Summary (1989), and Pollins (1989a and 1989b). The literature draws many conclusions from American competitiveness and the political and social factors that help explain bilateral trade patterns the choice of trade partners. And while there is an abundance of literature concerning this topic there has been little done from the perspective of how America’s trade partners have developed and shifted over the last 25 years, which is what this paper will focus on achieving. International trade flows are also an important topic and have been estimated by many economists including, Tinbergen (1962), Anderson (1979), Helpman and Krugman (1985), Helpman (1987), Feenstra (2002), and Anderson and van Wincoop (2003). Each of these researchers used a variant of the gravity model to estimate trade flows which not only demonstrates the continuing empirical validity of the model but gives firm background with which to base this analysis. The basic gravity model states that the volume of trade between two countries is proportional to the size of the two economies, and various measures of trade resistance such as geographical distance between the countries,

Krugman cites 2005 Congressional Budget Office report showing that between 1979 and 2005 the inflation adjusted income for Americans in the middle of the income distribution rose 21% while the richest 0.01% rose 400 percent (Muller). By using this statistic the author is showing his main point of the piece giving it factual support. Krugman also implies his own political views with his writing, especially in this excerpt. Krugman’s (2011) says that Democrats, by and large, want that super-elite to make at least some contribution to long-term deficit reduction, Republicans want to cut the super- elite’s taxes even as they slash Social Security, Medicare and Medicaid in the name of fiscal discipline. (P.

Some say you have to spend a dollar to make a dollar, when it’s our government its called deficit spending. Deficit spending is the result in the government spending more during a period of time then they make back in revenue causing a debt. This type of spending is normally during an economic recession and is justified in order to give the economy a jump-start in reviving. The validation of this is to stop the economy from losing more money as individuals become unemployed resulting in lose of taxable revenue. This drastic strategy has its advantages and disadvantages for both long term and short-term economic effects. “There are those that argue that government borrowing and spending would create jobs and induce economic growth which would lead us out of the recession. Conservative economists on the other hand argue that government spending causes high interest rates which in turn curbs investment and economic growth.” (Hassan and Nassar, 2015) While it may help create more jobs, wages and programs it can also cause taxes and interest rates to rise. If a consumer cant afford the inflated economy then the new job starts to seem obsolete.

Krugman (1999) had strong opinions about unsold commodities and unemployed workers. He was deeply concerned about both of them, and talked about how tragic it was to see those things take place. But, which one is worse - the unsold commodity or the unemployed worker? That is a matter of opinion, and there are several arguments that could be made when it comes to how one feels about those issues. Losing one's job would appear to be a tragedy, especially in an economic climate that is uncertain, because finding another job could be very difficult. However, some would say that staying in the mainstream is not always the way to go, and losing a job could be the catalyst for change that could change someone's financial and work life for the better (Taylor, 2004). Krugman (2008), though, was more concerned about the return of a high jobless rate. What would happen to all those people who lose their jobs? Where would they go, and what would they do in order to survive financially? How would they support their families?

Since the beginning of time people have been affected by their income and ability to accumulate wealth. People live their lives spending or saving money based on their own expectations of what the economy might do. For hundreds of years we have studied how the economic decisions of individuals and governments affect the welfare of society as a whole. John Maynard Keynes introduced a new economic theory that emphasized deficit spending to help struggling economies recover. Keynesian economics revolutionized the traditional thinking in the science of economics. His ideas and theories were deemed radical for his time but were later enacted by some of the largest governments in the world including the United States during the Great Depression. President Franklin Roosevelt enacted the New Deal in an attempt to stimulate the economy through government spending. In this paper I will be giving background to the history economics, the Great Depression, the New Deal, the development of Keynesian Economics. This paper will focus on analyzing the following question: In an attempt to address high unemployment and economic contraction, was Roosevelt’s The New Deal efficacious in stimulating the economy and ending the Great Depression?

“Free trade is not passé, but is an idea that has irretrievably lost its innocence” (Krugman, 1987, p.132). In his article, Is Free Trade Passé, Paul Krugman writes that the classical trade theory has been replaced with a new trade theory. The classical trade theory is based on constant returns to scale and perfect competition, is driven by comparative advantage, and endorses free trade. This classical theory emphasized the idea that trade was brought about by differences in tastes, technology, or factor endowments between countries (Krugman, 1987). However, the new theory of international trade is driven by increasing returns to scale, also known as economies of scale, and leads to imperfect competition (Carbaugh, 2011).

The country can maximize their wealth by putting the resources in the most competitive industries. Government created comparative advantage rather than free trade because now easier moves the production processes and the machines into countries that can produce more goods (Yeager & Tuereck, 1984). However, many countries now move to new trade theory suggests the ability firms to limit the number of competitors associated with economic scale (reduction of costs with a large scale of output) (Krugman, 1992). The comparative advantage occurs when two-way trade in identical products, it will useful where economic scale is important, but it will create problem with this model. As a result, government must intervene in international trade for protection to domestic firms (Krugman, 1990)

Adam Smith, author of The Wealth of Nations, shows support for free trade and emphasises it as a trade policy which ought to be adopted. Krugman and Obstfeld back Smith's support by stating that the efficiency of trade is increased by free trade and accumulates the national income of countries. Free trade is a theory which suggests that each nation benefits in specialising in an economic activity from which it gains absolute advantage, enjoying absolute superiority over other nations in a specif economical activity (Peng). With free trade follows opportunity, replacing regulation and growth of economic activity. (Rugmann and Collinson).

The international trade of goods across the world accounts for approximately 60% of the world Gross Domestic Product (The World Bank, 2014). A great proportion of goods transactions occur every second. The primary question is whether international trade benefits a country as an entirety, and, if so, why would a country implement protective trade policies to restrict particular exports? To address this question, this essay aims to explore the impact of trade on various economic stakeholders, including consumers, producers, labour and government and, furthermore, will compare models and theories with reality to ascertain the true winner/ loser in the international trade market.

The concept of absolute advantage is one of the most fundamental areas of concern in the study of economics. In its basic meaning, absolute advantage refers to the ability of one individual or party to produce more of a particular good or service than other competitors given the same amount of resources. In this regard, absolute advantage becomes a very important aspect in the concept of international trade as it clearly defines the different areas where countries should specialize in order to maximize their productivity and enhance international trade. The principle of absolute advantage was first elucidated by Adam Smith in his study of international trade using labor and capital as the only factor inputs(Free, 2010).

Comparative advantage is a principle developed by David Ricardo in the early 19th century to explain the benefits of mutual trade (Carbaugh, 2008). Many underlying assumptions of comparative advantage depend on states of economic equilibrium and an absence of economy of scale. In reality, economies are dynamic and subject to innovation and interference; which has led to revised assumptions of return and competition (Krugman, 1987). These factors have created questions of free trade and governmental participation in an economy by the development of strategic trade policies. These new concepts do not replace the theory of comparative advantage; however, they further explain how trade can benefit a country's economy (Krugman, 1987).