Both saltwater and freshwater economists got it wrong on free trade -- and still do

“How Did Economists Get It So Wrong?” was the title of a New York Times magazine article on September 6. Good question -- answered at length by Paul Krugman, a Pulitzer prize-winner in economics. Now the question has become: did Krugman get it wrong in a crucial respect – international trade?

In his 7,000-word essay, Krugman targeted mainline economists not only for failing to foresee today’s economic crisis but, more important, for being blind “to the very possibility of catastrophic failures in a market economy.” They blinded themselves by their exuberant faith in an efficient free market, a faith that they successfully spread to others, policymakers included.

In the field of macroeconomics, a significant theoretical difference has long existed quietly between those whom Krugman called “freshwater” economists (mainly at inland schools) and “saltwater economists” (mainly in coastal U.S. universities) over the cause and cure of recessions. That difference did not erupt on the policy level until the unprecedented economic shock hit last year.

What both salt- and freshwater economists ignored

The September 20 Times magazine has now printed nine letters with thoughtful comments on Krugman’s article. One was from Philip K. Verleger Jr., a business professor at the University of Calgary in Alberta, Canada, a former staff economist at the U.S. Council of Economic Advisors and a visiting fellow at the Peterson Institute for International Economics in Washington, D.C.

Verleger praised Krugman’s essay “as far as it goes,” but faulted it for ending “at the edge of salt water.” His three-paragraph critique is worth quoting in full:

“Krugman does not raise the subject of international trade. Yet for years saltwater and freshwater economists have all written and preached of the benefits of free trade. Larry Summers [now director of the National Economic Council], for example, has endorsed the view that trillions of dollars of benefits would accrue by opening international markets. I was part of the chorus for more than 10 years as a fellow at the Peterson Institute for International Economics.

“Here, too, I believe economists got it wrong. The United States’ economic situation has been harmed, not helped, by the push for free trade. America’s skilled workers and middle class are undoubtedly much worse off thanks to the market-opening measures negotiated over the past three decades at the encouragement of almost all economists. The losses have occurred because the theoretical benefits projected by economists are blocked again and again by our trade partners.

“Unfortunately, few economists are willing to offer the same detailed criticism of trade policies that Krugman has offered of macroeconomics.”

The good news is that many policymakers now do understand that the financial markets, and their industry, are not self-regulating. As President Obama said in his weekly address on September 19, Congress must “put in place a series of tough, common-sense rules of the road that will protect consumers from abuse, let markets function fairly and freely, and help prevent a crisis like this from ever happening again.”

But it is not at all clear whether the Obama administration understands that international trade also is not self-regulating, and that it too needs a series of tough, common-sense rules of the road that will protect consumers and workers, let markets function fairly and freely, and help prevent a crisis like this one from ever happening again.

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