Krugman gets the Nobel

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Almost a decade ago, I was working on an article for Fortune about the then-current state of economics. The narrative I settled on was one in which in the late 1970s and early 1980s, Cambridge, Mass., had been the birthplace of a new economic mainstream:

This was the context in which the young scholars of Harvard and MIT learned economics in the late 1970s and early 1980s. Keynesian macroeconomics was dead, but nothing had sprung up in its place. Microeconomics, meanwhile, had moved away from the dead certainties of the past into a much more interesting thicket of research possibilities. The mathematical models that had come to form the basis of academic economics were shifting from general equilibrium, in which everything worked out for the best, to multiple equilibriums, in which it might not. “That was kind of a golden age for economic theorizing,” says Krugman.

Krugman is of course Paul Krugman, winner of this year’s Sveriges Riksbank Prize in Economics in Honor of Alfred Nobel for some of his golden-age theorizing. He’s the first of the 1970s/1980s MIT/Harvard crowd–a group that includes such familiar-to-noneconomists names as Larry Summers, Ben Bernanke, Frederic Mishkin, Greg Mankiw and Glenn Hubbard–to win a Nobel. And that’s pretty much what one could have predicted back in 1999. In fact, I distinctly remember Mankiw predicting it, although, sadly, I didn’t put that into my article. Here’s what I did write:

Krugman, whose academic work probably best represents the direction economics has taken, built lots of mathematical models of real-world economic phenomena. The models, Krugman says, are constructed upon a couple of basic principles: “self-interested behavior and interaction–$100 bills don’t lie in the street for very long, and you don’t have sales that aren’t purchases.” Beyond that there are no clear rules. “What you end up looking for is a specific set of strategic simplifications,” he says.

The two models that made Krugman’s name in the late 1970s both involved international economics. One concluded that currency crises were rational, inevitable reactions to untenable government policies. The other overturned the conventional economic wisdom that countries could gain an advantage in trade only because of better technology or greater resources–by showing that the increasing returns inherent in making huge quantities of a product can lock in an advantage.

These two models shared no grand theme or ideology, and matters got even murkier when Krugman tried to draw policy conclusions from them. He gradually came over to the view that currency collapses can also result from self-fulfilling investor panics that overrun even countries with sensible economic policies. This has led him to conclude that controls on capital flows sometimes make sense. But he does not believe in restricting trade, even though his increasing-returns model seems to suggest advantages for the sort of protectionist, volume-building tactics used by Japanese industries in the 1980s.

The Nobel committee gave Krugman the prize for work growing out of that second model, on increasing returns to trade, which he introduced in a paper in the Journal of International Economics in 1979:

Krugman’s approach is based on the premise that many goods and services can be produced more cheaply in long series, a concept generally known as economies of scale. Meanwhile, consumers demand a varied supply of goods. As a result, small-scale production for a local market is replaced by large-scale production for the world market, where firms with similar products compete with one another.

None of this, of course, has anything to do with why most people who are familiar with Krugman’s name are familiar with it. As the Nobel gang concludes in its “Information for the Public”:

In addition to his scientific research, Paul Krugman is highly appreciated by his students as a pedagogical lecturer and author of textbooks. In wider circles, he is better known as a lively blogger and spirited columnist in the The New York Times.

I imagine there will be lots of speculation that the Nobel committee is trying to reward Krugman for his critiques of the Bush administration, his reasonably prescient writing on the current financial crisis, or just the fact that he’s such a great blogger. His post this morning:

A funny thing happened to me this morning …

I make no claim to know what mischievousness lurks in the minds of Swedes, so maybe all those really were factors. But it’s also true that Krugman has been considered a likely eventual winner of this prize for a long time.

Update: Tyler Cowen, another product of that Cambridge-Mass.-in-the-70s-and-80s crowd (albeit on the late side; he got his PhD from Harvard in 1987), has some of the best stuff on the meaning of Krugman’s Nobel. A tiny sample:

I have to say I did not expect him to win until Bush left office, as I thought the Swedes wanted the resulting discussion to focus on Paul’s academic work rather than on issues of politics. So I am surprised by the timing but not by the choice.

What? Bush is still in office? I thought this was the Paulson administration. In other interesting posts: Dani Rodrik points out, somewhat obliquely, that Krugman getting the prize means Jagdish Bhagwati’s Nobel prospects sure aren’t looking good (at least, that’s how I read it). Ezra Klein finds a nice clear explanation of Krugman’s trade work. And a certain TigerHawk fears that “the depreciating but nonetheless potent prestige of the Nobel Prize will only make [Krugman] more insufferable.”

Update 2: Harvard’s Edward Glaeser, who doesn’t have much in common with Krugman when it comes to politics, has written a nice appreciation of Krugman’s economics for the NYT’s Economix blog.