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Some Economics of Trade

As I pondered the issue of Americans trading with low-wage nations, Miles Stevenson e-mailed me to say that he’d just discovered Paul Krugman’s superb 1996 essay “Ricardo’s Difficult Idea.”  I couldn’t recall if I’d posted that essay here at the Cafe, so I searched.  Turns out that I did indeed post it, three years ago.  My vanity compels me to reprise that post:

Strange Case of Dr. K and Mr. K

by Don Boudreaux on January 5, 2008

in Myths and Fallacies,Trade

In yesterday’s edition of the New York Times, Paul Krugman again suggests that trade with low-wage countries poses real problems for high-wage America.  (Krugman’s column of December 28th is even more explicit on the point.)  I sent this letter yesterday to the Gray Lady in response:

Paul Krugman again insists that trade with low-wage countries – especially China – threatens to depress wages in America (“Dealing With the Dragon, January 4). So I again refer Mr. Krugman (the shrill pundit) to Dr. Krugman (the skilled scholar of trade).

In his excellent 1996 essay “Ricardo’s Difficult Idea,” Dr. Krugman pointed out that wages are determined by worker productivity.  Therefore, low wages reflect low productivity.  This fact, once grasped, reveals that low-wage countries have no general competitive advantage over high-wage countries.  Dr. Krugman continued: “Someone like [James] Goldsmith [a protectionist] looks at Vietnam and asks, ‘what would happen if people who work for such low wages manage to achieve Western productivity?’ The economist’s answer is, ‘if they achieve Western productivity, they will be paid Western wages’ – as has in fact happened in Japan.”

Substitute “Mr. Krugman” for “Goldsmith,” and “China” for “Vietnam,” and Dr. Krugman’s learning should calm Mr. Krugman’s fears.

Donald J. Boudreaux