Krugman’s conundrum

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“This paper is the manifestation of a guilty conscience.” With those words, Paul Krugman began the recent presentation of his new study of trade and wages at the Brookings Institution. Mr Krugman, a leading trade economist (as well as a New York Times columnist), had concluded in a 1995 Brookings paper* that trade with poor countries played only a small role in America’s rising wage inequality, explaining perhaps one-tenth of the widening income gap between skilled and unskilled workers during the 1980s. Together with several studies in the mid-1990s that had similar findings, Mr Krugman’s paper convinced economists that trade was a bit-part player in causing inequality. Other factors, particularly technological innovation that favoured those with skills, were much more important.

At some level that was a surprise. In theory, although trade brings gains to the economy as a whole, it can have substantial effects on the distribution of income. When a country with relatively more high-skilled workers (such as America) trades with poorer countries that have relatively more low-skilled workers, America’s low skilled will lose out. But when the effect appeared modest, economists heaved a sigh of relief and moved on.

In recent years, however, the issue has returned. Opinion polls suggest that Americans have become increasingly convinced that globalisation harms ordinary workers. As a commentator,

Mr Krugman has become more sceptical. “It’s no longer safe to assert that trade’s impact on the income distribution in wealthy countries is fairly minor,” he wrote on the VoxEU blog last year. “There’s a good case that it is big and getting bigger.” He offered two reasons why. First, more of America’s trade is with poor countries, such as China. Second, the growing fragmentation of production means more tasks have become tradable, increasing the universe of labour-intensive jobs in which Chinese workers compete with Americans. His new paper set out to substantiate these assertions.

That proved hard. Certainly, America’s trade patterns have changed. Poor countries’ share of commerce in manufactured goods has doubled. In contrast to the 1980s, the average wage of America’s top-ten trading partners has fallen since 1990. All of which, you might think, would increase the impact of trade on wage inequality.