Krugman's Deficient Analysis

by Don Boudreaux on April 24, 2006

in Myths and Fallacies, Trade

In his column in today’s New York Times, Paul Krugman worries about the trade deficit.  As regular Cafe visitors know, I do not worry about the trade deficit — and I seldom lose an opportunity to explain why I believe that concern over the trade deficit is misplaced.  (Coyote blog is also wisely unconcerned about the trade deficit.)

There’s nothing new or compelling in Krugman’s worry.  He wrongly claims, for example, that a trade deficit means that Americans must “sell stocks, bonds and businesses to foreigners.”  But this claim is untrue.  The U.S. trade deficit rises even when foreigners make new investments in the U.S. — when foreigners create in the U.S. productive assets that never before existed.

And Krugman’s answer to a question that he correctly anticipates his critics asking is facile.  The question is, in Krugman’s words, “if things are really that bad, why are so many foreign investors still buying U.S. bonds?”  Krugman’s answer is: “I have two words for those who place their faith in the judgment of investors, and believe that a few good years are enough to prove the skeptics wrong: Nasdaq 5,000.”

First, the collapse of the Nasdaq is hardly a sufficient basis on which to generalize about investors’ judgments.  Yes, bubbles exist — but this fact hardly means that all steady investment is the result of a bubble.

Second, the U.S. has run a current-account deficit every year for nearly thirty years.  Indeed, more generally, America ran a current-account deficit for pretty much the entire period ranging from the English settlement at Jamestown in 1607 until World War I.  (See William A. Niskanen, “The Determinants of US. Capital Imports,” Annals of the American Academy of Political and Social Science, July 1991, pp. 36-49.)

Those 300+ years — and the past thirty years — are much more that a mere “few good years” that can be dismissed as flukey.


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