Disagreeing with Paul Krugman ? 2

Still looking for a case in which I disagree with Paul Krugman, I jump in the deep end and discuss his thoughts on international trade in “The Return of Elasticity Pessimism (Wonkish)”. That is “the belief that trade flows barely respond to price signals, and hence that devaluations don’t help alleviate imbalances.”

It is amazing that such a basic question is still being debated. To me the very interesting thing is Krugman’s critique of the evidence presented in support of elasticity pessimism

the argument rests in large part on specific cases where large changes in relative prices don’t seem to have produced large changes in trade (Greece’s lagging exports), or conversely, where large changes in trade seem to have happened without large changes in relative prices (Spain’s export recovery, maybe).

This is exactly the sort of evidence that Krugman often presents himself — a time series of relevant raw data from one to three countries. The interesting thing is that he, very often, responds to an example presented in support of a conclusion with an example which suggests the opposite or with an alternative example of the pattern in the original example (based on considering one other variable).

I can’t help suspecting that there are no such counter-examples to hand (I can’t think of one). Krugman also discusses the limits of looking at simple correlations

Devaluation that takes place along with an economic recovery may not be associated with a falling trade deficit, because rising demand is offsetting improved competitiveness — I think this is relevant for Iceland.

At the end of the post, Krugman proposes econometric analysis of lots of data — this is not the sort of evidence he usually finds convincing

I’m also skeptical about the persuasive power of complicated econometrics; my sense is that mind-changing empirical work almost always involves not much more than simple correlations, usually from natural experiments — that is, even multiple regression turns out, in practice, to be too complicated to persuade

Here he proposes looking at analyzing lots of data and considering conflating factors such as GDP growth — so multiple regressions. A sign of intellectual distress.

I admit that I actually agree with Krugman (sigh) so the answer to the question in the title is “not yet but I’m trying”.

His convincing argument is

First, it’s worth thinking about where those big external imbalances came from. Big capital flows to the European periphery led to inflation and rising real exchange rates, and this was associated with huge trade imbalances. How did that happen, if real exchange rates don’t matter?

But I can argue against this using the exact same argument Krugman makes about Iceland. I’d say that real estate bubbles and general irrational exuberance could have caused trade imbalances — Spaniards, Greeks and Icelanders felt rich and spent a lot.

However, it is also true that Spanish (and Italian) price levels and unit labor costs drifted up compared to Germany and that the expected current account imbalances followed. Those simple correlations have the sign Krugman expects (of course since he knows about them and thinks about them a lot).

But in inconclusion, if one considers income and wealth (and irrationally perceived wealth) in addition to relative prices when looking at post 2008 data, one really should worry about them when looking at pre 2008 data.

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