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Paul Krugman is the Distinguished Professor of Economics at the Graduate Center of the City University of New York. He was a columnist for The New York Times from 2000 to 2024. In 2008, Krugman was the sole winner of the Nobel Memorial Prize in Economic Sciences for his contributions to new trade theory and new economic geography.
In this week’s conversation, Yascha Mounk and Paul Krugman discuss the value of economic models, the Euro crisis, and how to make a fruitful intellectual contribution in economics.
This transcript has been condensed and lightly edited for clarity.
Yascha Mounk: I have many questions I want to ask you, including what is going on right now with the Trump administration and the tariffs and so on. But I actually want to make sure that I understand a little bit better the breadth of your academic contributions as well. You started off writing a lot about trade. As I understand it, there were a couple of basic puzzles that economists hadn't really solved about international trade, like the question of why relatively similar countries ended up still trading a lot with each other, even when they didn't have that many comparative advantages relative to each other in more classical theory; or, why it is that some regions really specialize in particular industries beyond what, say, their resource endowments might suggest. Could you please explain those puzzles and how that was an important contribution to economics at the time when you were making it?
Paul Krugman: It's interesting because I think I now understand a lot better what I was doing 45 years ago than I did at the time. I like to think that trade between countries is at a fundamental level a lot like trade between individuals. Why do two people do different things? One answer is that they're different. Some people are better with their hands, some people become doctors, others can't stand the sight of blood, and that sort of thing. People do different things because they're different, but people also do different things because mastering a skill takes time. There are advantages to specializing, and even if people were otherwise identical, you'd expect them to sort themselves out into different areas.
International trade theory, from the early 19th century up until about 1980, almost entirely focused on why countries trade when those countries are different. That's the theory of comparative advantage. It's a very insightful, powerful theory. It tells you a lot. But there was very, very little attention given to the argument that countries trade because there are inherent advantages to specialization, because there are increasing returns in production. So, a small country doesn't want to produce its own automobiles because you have to produce something like 200,000 or 300,000 cars in an assembly plant to have an efficient scale. You also have industrial clusters where a bunch of people do related activities and so have creative advantages. You can see them out there in the world, but we actually didn't see them in the academic literature, which was kind of a blind spot, and it was a blind spot because people didn't know how to think about it clearly. Economics is built very much around stylized mathematical models, which I am in favor of. It doesn't have to be all equations, though often it is. But a very, very clear model is a tremendous way of clarifying your thinking. It's amazing what silly things you can say if you haven't got that as a basis.
Mounk: If I can take you on a brief tangent: explain that to us, because I think that's one of the things that a lot of people, who may take one class in economics as an undergrad, encounter and sometimes have a kind of revulsion towards. They see an economists’ model of, for example, what romantic partners people choose—or, in the context of political science, a model showing that legislators are just going to do whatever behavior maximizes their chances of getting reelected—and they think, well, this is just such an oversimplification of the world. Actually human beings are complex and these models miss out on all of those things. I would love to hear from you a good defense of why it is that, yes, these models miss some things, but they nevertheless reveal whether you've understood the basic logic of a situation and therefore they're really useful exercises.
Krugman: The true definition of economics is that it's about stuff that's not interesting. It's not about love, it's not about hate, it's not about the deeper motivations. Edwardian economist Alfred Marshall said it's about the ordinary business of life. It focuses on the prosaic stuff. We're talking about kitchen table issues. That stuff matters a lot. It's the backdrop to all the other more interesting things that human beings do. People's motivations when making and spending money tend to be relatively simple. They're not quite as simple as economists like to assume, but that's not because economists are naive—it's because you're looking for clarity, and strategic simplification is the way you get there. You often get really surprising insights that you would miss if you just think about your personal experience, or an intuitionist story about how things work, because there are often principles which are kind of invisible.
My favorite of those is the Ricardian theory of land rent. What determines what people who actually do the farming earn versus the people who own the land? The answer, which really pretty much works, is that what farmers get is equal to what a farmer can produce on the worst land. If a landlord tries to pay a farmer less than he could get on the worst land, then the farmer will go off and cultivate some bad land. You assume that people are rational: but sometimes people behave in ways for which a simplistic depiction of their motivations doesn't work. Sometimes markets don't actually reach an equilibrium. But much of the time it's a really good guide.
When we teach economics, we do a lot of, here's a bunch of little models that you need to learn. It's kind of like the required figures in Olympic skating—nobody cares—and yet it has to be done. I'm not sure that every undergraduate who takes economics should be taught that, but everyone who tends to go on for a career in it needs to know that stuff, because it's the basics.
Mounk: What do you think every informed citizen should know from economics? What do you think is helpfully illuminated in the broader world by having that kind of tool available to you? And perhaps on the other side, where do you think the dangers lie? Where do you think a little knowledge is a dangerous thing?
Krugman: Supply and demand. It's not a law, it's a model. It's a simplified depiction of how things work, but it's really important. It is important to understand that a market economy wants to go some place and that's pretty much how we coordinate stuff. And you defy it at your peril. If the President of the United States tries to order supermarkets to charge lower prices, that's probably going to lead to a lot of problems. But at the same time, I think people should know that it's a mechanism. It's how stuff works. It's not justice. So understanding the fact that something is the price that the market assigns to something doesn't mean that the people getting that price are getting their just desserts. It has nothing at all to do with morality.
The second thing to understand is that markets don't do everything. Supply and demand is not going to keep your neighborhood safe from criminals or control pollution, because there's no incentive for people to do that. So you need to understand how markets work, why they work, why you want to give them some respect—but also not deify them, and say, okay, let's look at the places where markets actually don't do it and intervene. The government is not a household. We have endless discussions about government deficits and debt, much of which is based upon thinking about the government as being just like you and me, which it is not. Among other things, the government doesn't have to turn a profit. If I had to summarize the principles of economics, the ones that really matter, it’s that $20 bills don't lie on the sidewalk for very long. People will take advantage of opportunities, and every sale is also a purchase. Stuff adds up. And it's amazing how much discourse of allegedly practical people just doesn't take account of the fact that things have to add up.
Mounk: It's interesting. There's this big question about whether economics is efficient, and you've contributed to that in a number of ways that I want to get to as well. But that metaphor of a $20 bill on the street actually expresses the common-sense answer to whether or not markets are efficient pretty well. If you're walking down the street and you see a $20 bill, you shouldn't assume that it must be a fake dollar bill (i.e. because if it was a real $20 bill, somebody else would already have picked it up). But at the same time, they're also somewhat efficient in the sense that, unless there are very strange extenuating circumstances, at some point somebody is going to pick up those $20 and those two things aren't mutually exclusive.
Krugman: A lot of what being a good economist or a good policy-maker who applies economics means is being able to hold contradictory views in your mind. Markets are impressive. There's a lot of obvious opportunities for self-improvement. But on the other hand, it is not the holy writ, the market is not God, and you need to be prepared to step in, and people really have a hard time striking that balance.
Mounk: Let's get back to the question of trade. You were explaining to us that it might be puzzling, for example, to think, why might Italy and Spain—which have somewhat similar natural resource endowments—still be trading olive oil to each other?
Krugman: That's a particularly hard one. But if you ask the question, why are cars shipped back and forth among European countries? Why is most European high finance in London?—those things really are clearly about the advantages of large-scale production, or the advantages of concentrating an industry in a particular place. I can explain what that's all about in plain English pretty easily, I think. It's not that hard to tell the story. Yet in some of my early papers on this in 1978/1979, I was running into a lot of incomprehension. People had no idea what I was driving at. It was hard to do simple models of this stuff. If you tried to do a mathematical model or even just an informal but clear verbal discussion about what's the role of London as a financial center and how does that play into international trade? Why do cars go back and forth between France and Germany? it quickly got awkward.
What happened circa 1980 is that Kelvin Lancaster, Victor Norman and I basically wrote the same paper independent of each other. You needed ways to think about imperfect competition, monopolistic competition. And we had new literature in industrial organization that gave us better ways to do that. But the really important thing was to back up and say, what is the question? If you want to ask the question why is London the financial center? there’s actually a lot of detail there. But if you ask the question, why is there a financial center?—sort of back up to the system level—or, why do different countries produce different things? that turns out to be a way easier, cleaner question to answer.
Mounk: It also might have a much more systematic answer. Presumably, for example, it might depend on contingencies about which government was in place at what time, what kind of incentives existed, or some great financier who happened to move to one city or another. But what you're saying is that the fact that a financial center would emerge is not fully predetermined, but made very likely by basic facts about how useful it is if you're in finance to be down the road from somebody who can give you a lot of money, from somebody who has already got a lot of experience in finance, and so forth.
Krugman: Trade between regions within a country has basically the same logic as trade between countries. Between countries, the smaller-scale industrial specializations often have adorable origin stories. I mean, most U.S. carpet production is still near Dalton, Georgia. And if you trace that, we happen to know that story, and it all goes back to a teenage girl who made a tufted bedspread as a wedding gift in 1896—that created a local craft industry, which then turned out to be the basis of a new method of carpet making. No textbook model is going to tell you that Catherine Evans was going to make a bedspread back in the 1890s. But it can tell you that there are reasons why carpet production is going to be someplace specific and not spread evenly across the country. One of the things these models do is they give you a language to discuss stuff and then also a statistical framework that you can use to analyze the data. But you need to analyze the data the right way in terms of these sort of systemic issues rather than local issues. It sounds obvious in retrospect—but it really, really wasn't back then.
Mounk: What do you think this teaches people who want to make a contribution to academic research? Let's imagine somebody listening who's a PhD student in economics, or somebody listening who's a PhD student in political science or sociology or history or English or the hard sciences. Is it the case that often the biggest contributions come from sort of recognizing the anomaly in your field, recognizing the thing that your academic field currently can't explain, but that obviously is out there, and really going back to basics and trying to figure out how to answer that question? Do you think it usually comes from having new tools available to you? What kind of question do you think is most generative? And if somebody is searching for where to fruitfully spend five or eight or 10 years of their intellectual effort, how should they go about it?
Krugman: I will repeat one piece of advice that I got from Rudi Dornbusch—a great international macroeconomist and also a really interesting person. When I was trying to figure out what to write a PhD thesis about, his advice was, for the next couple of months, do not read the journals. Do not read academic papers. Go out there and read the Economist, the Financial Times, Bloomberg. Look at the world and see what is out there that bothers you because it doesn't seem to fit the models. Doing a further twiddle on an existing literature is not a good use of your time. So observe the world. That was terrifically good advice.
The advice I give to people is listen to the Gentiles. Which is a reference to my own background, but what I mean by that is listen to people who do not speak your analytical language, who do not use the same techniques you do—basically people who are a little bit off kilter, but who are interesting. And so it turns out there was a kind of a counterculture in international trade. There were a lot of people who said, I don't believe these comparative advantage models.
I look at world trade and I see all kinds of countries exporting things for which they have strong domestic demand, and a lot of countries that look the same doing a lot of trade with each other. They tended to be dismissed by a lot of economists because they clearly had an imperfect understanding of comparative advantage. They didn't understand the standard economic models all that well. So why listen to them? The answer is, well, yeah, but maybe the fact that they're not in our intellectual sect, if you like, may mean that they're seeing things that we aren't.
That was even more true in economic geography. Economic geography is a field which is mostly not standard economists. They're people who focus a lot on urban planning, regional science—there's a lot more overlap between those fields now, but that's because me and my friends kind of integrated the two 30 years ago. At the time, there was this whole body of empirical work, even statistical work, that was kind of divorced from economics the way it's done in graduate departments. It was waiting there.
Mounk: Part of it is that the academic literature gets into moods or gets into fashions, or into a particular constrained way of seeing the world through the models that are particularly fashionable at a particular time. Normally they do that because those methodologies and those models do offer helpful insights. But even offering helpful insights in one way means they then obscure things in another way. One of the areas where I made a modest contribution in political science is that, as a graduate student, and in my comparative politics field seminar, I was taught by very distinguished scholars that democracies in certain countries are safe. That you can look at poor countries without much democratic history, like Nigeria, and you know their democracy might fail, or you can look at some rich dictatorships and their dictatorships will be stable—but when you look at Germany or France or the United States, we know those democracies are safe. There was a theory about the science that these stable democracies were supposed to have, and I looked out at the world and asked, well, is it true that that’s actually happening in the world at the moment? Is it true that traditional political parties seem to have a lot of legitimacy and people seem to be pretty enthusiastic about them? Is it true that there seems to be only a very small number of people who're deeply unhappy, not just with a particular prime minister or president, but with the political system as a whole? And I was no longer sure about that. And so that sort of pushed me and my colleague Roberto Foa towards using data that had been out there for a very long time, the World Values Survey, looking at questions that had been asked for 30 years, 50 years, and saying, hang on a second, perhaps the data tells us something that really goes against the theory.
One other way you did that was the currency crisis. There was an assumption that if a country is entering a currency crisis, presumably it is because there's fundamental things wrong with its economy, because it just is spending way more money, is profligate, is not raising the taxes it needs, and suddenly, you know, people in the financial markets realize, this is not sustainable. At some point, this country is not going to be able to repay its debt or it's not going to be able to keep up fixed currency rates that may be in place. Therefore there's a sudden swing that really has rational reasons. And you seemed to suggest that sometimes when a country enters a currency crisis, there aren't really any sort of fundamental economic reasons why that ends up happening.
Krugman: It's interesting because there was a debate over whether currency crises can basically come out of thin air. I was on the wrong side of that debate for a while. I invented currency crises—not the thing itself but the academic field. But the ones I invented were fundamentals driven. And other people said, yeah, but there's a lot of self-fulfilling prophecies going on there as well. And I was resistant to that for a few years and then eventually concluded, they’re right and I'm wrong. Being able to admit that you are wrong is kind of really important to doing research. But then as we went on to look at it, we saw, well, okay, there are characteristics, there are things that make you vulnerable to a crisis. They don't guarantee it. It may never happen. But there are some preconditions and you really want to look at them.
So if we’re asking right now, could the United States experience an emerging market-style crisis? There's one big reason that we're not exposed, which is that our external debt isn't our own currency. But there's a lot of other things. How much of the fact that we haven't had a crisis reflects either things that are just good luck or things that are no longer true? And so you do want to question these things.
I also want to say that there's a real problem in academia, which is that the easy route to getting a paper published is to do a minor technical extension on an existing field. And that's great if you're purely a careerist and you want to get yourself a tenured appointment somewhere. Fine. But no one will remember what you did 10, 15 years later. The fastest reaction I ever had with lots of people citing me was a paper I wrote on exchange rate target zones. It was clever. I had fun writing it. I think it was neat, but it was not really important. It did give people an opportunity to start using stochastic calculus in international finance. Publication lags in economics are terrible. Nobody reads the journals for information. They're just for the purpose of getting tenure. Everything happens in working papers. So by the time the thing actually got published, I had to include a section on subsequent research, because there were well over 100 derivative papers based on that first thing, almost none of which really added anything to it. If you want tenure someplace, maybe that's what you want to do—but if you want to actually do something important, question the assumptions, question the trends, stay away from whatever everybody else is writing about right now.
Mounk: To move back a little bit into substantive questions of economics: one of the things that's interesting in pointing out that currency crises sometimes don't come from the fundamentals is that it might give a different view about how to think about metrics like debt to GDP and so on. If you think this is a relatively mechanistic process by which, once the fundamentals just point in a danger zone, then the counter-crisis is going to happen, you're going to focus very fundamentally on how much debt is a country incurring, etc. If you think that it's really about more complicated dynamics, it complicates how you analyze those kinds of counter-crisis.
You obviously wrote very extensively about the Euro crisis for about 10 years while it was going on. I want to go back to the starting point which is, was the Euro a bad idea to begin with? There's a number of economists who are quite critical of the single currency, which was an admirable political project and part of trying to build European unity. Were those people right at the time? Or are they just right with the benefit of hindsight? Or do you think they were wrong all along and the Euro is in fact an important project, it's just that it wasn't done in the right way?
Krugman: We have a very conceptually clear, though quantitatively very elusive, story about when countries should share a currency. The advantage is obvious. It makes lots of businesses easier, transactions are easier, it's a very convenient thing. I would really hate it if I had to acquire a different currency when I go visit family in Queens right now. But on the other hand, we know that economic shocks hit countries and they don't hit them equally. There are asymmetric shocks. If something goes bad, if everybody loves Spanish real estate and then suddenly decides they hate it, then what? If the country has its own currency, there are ways to adjust. Actually, to be specific, there were lots of big flows of money in Europe before the Euro crisis hit. The countries that had been recipients of big inflows really needed after that to go back to manufacturing stuff, doing other things. They needed to get their costs and prices down. If you're looking at Spain, that took five years of extremely high unemployment and great suffering to make the adjustment. If you look at Iceland, which is tiny but still retained its own currency, it made that adjustment in a day.
Mounk: So the idea here, I believe, is that if you have your own currency and the exchange rate is flexible, the exchange rate just goes down. And so if you're earning 10,000 pesos today, you're still going to be earning 10,000 pesos tomorrow. There's no adjustment of your contract needed. But since the value of the pay source has gone down, suddenly it becomes much cheaper to employ people in this country, or to go visit this country as a tourist if it's a country that has a lot of tourism, or to buy real estate in that country. So effectively you’re stimulating economic activity because there's this natural devaluation. Now, in principle, you could do the same if you have an enforced stable currency rate because it's part of a broader currency. You could still say, well, we're going to cut wages, sellers are going to go down with the cost of housing, etc. But it's much harder to persuade your employees to take a pay cut when it's in the same currency. Is that the difference? Why can't this happen if you're part of the same currency zone?
Krugman: Yeah, when the markets decided, whoops, we've been pouring too much money into peripheral countries in Europe, these countries really needed to get their wages down by something like 20 or 25% relative to wages in Germany—how do you do that? Well, Spanish employers could have gone to their employees and said, look, things have changed. We need to cut your wages 25%. That just doesn't happen. It never has, never will. So they had to have just years and years of high unemployment, which meant low bargaining power for workers. It didn't even cut wages, they just stopped them from rising, while they continued to rise in Germany. Iceland was pretty much in the same situation, even though it's a very different country, but Icelandic wage contracts were in Icelandic Krona. And so all they did was they allowed the Kroner to fall 25% against the Euro, and they got that wage adjustment painlessly and instantly. And so there's a trade-off. There's a convenience to sharing a currency. There's a cost in that you lose an important mechanism for adjustment if you have a common currency. That cost can be offset if you have highly mobile laborers who can move to where the jobs are. It can be offset if you have fiscal integration so that regions that are being hit hard are at least partially compensated by paying less in taxes to the center and receiving more aid. So Florida had a big housing bust but got a lot of compensation from Washington.
If you looked at those things and you looked at Europe, it really did not look like an optimum currency area. There was limited labor mobility, and essentially zero fiscal integration, so the cost of adjustment was high. Yes, there are benefits. I've been traveling around Europe lately and having a single currency is really helpful, but it did not look like a good case and still doesn't. I think there’s a pretty good argument that the Euro still looks like a mistake. It has probably caused a lot of suffering and damage. But there's a very big difference between saying that you shouldn't have entered the Euro and saying that you should leave it. The cost of trying to leave the Euro, the disruption, just the problem of reprogramming all the computers, is just so huge that realistically we've got it. Now, if there's a country that is still considering whether to join, in most cases I would say, no, don't do this yet. But in terms of, should Portugal try to leave the Euro? No. Spain, probably even less of a good idea because Spain is a big country. So there it is. By the way, it was not that economists gave European politicians bad advice. I was part of some of those discussions. There was a big report on the case for single currency from the European Commission. Originally they had a chapter on costs and benefits of a single currency, but the economists were told to go back and rewrite it to be a chapter on the benefits of a single currency.
By and large, Anglo-Saxon economists were against it. Americans particularly, we said, okay, we have a single currency area in North America. We know what it looks like. Europe doesn't look anything like that. Really, this is not a good idea. I understand the political appeal of the project was so great that the politicians did not want to hear no for an answer.
Mounk: So Europe enters this currency zone even though some economists warn that it's a bad idea. One of the reasons why it's a bad idea is that it doesn't have a lot of labor mobility. And obviously, unlike the United States, the Eurozone does not have a common language. The other important reason is that it doesn't have the degree of fiscal integration that a country like the United States does.
So we get into the Euro crisis: explain to us what the structural problems were that made it so hard to get out of that, and then why you thought that, as I understand it, the right solution to this was to make it look more like an optimum currency zone. While we can't abolish the fact that people in Spain speak Spanish and people in Germany speak German, what we can do is to increase the extent of fiscal integration in the eurozone.
Paul Krugman: Fiscal integration is a big political project. It's going to take time. But one thing that I didn't think of is the importance of a sort of financial “out.” A country that has its own currency—one thing it never does is run out of its own money. It may have problems if it prints too much and so on, but it doesn't literally run out of cash. It turns out that a Euro area country can. The government can simply not have the Euros to pay its debt as it comes due.
One of the most influential papers in economic history I think was by the Belgian economist Paul de Grauwe, who said, these debtor countries, yeah, they have debt problems, they have adjustment problems, but the markets are treating them much worse than those fundamentals say they should. I think that we're looking at a self-fulfilling crisis of confidence. What you really just needed is somebody to say, no, they will not be allowed to run out of cash. About a year after De Grauwe wrote that paper, Mario Draghi said three words, whatever it takes—that the ECB, the European Central Bank, will in fact provide cash if necessary. He actually didn't have the authority at that point to do it, but he got it a little bit later. And the Euro crisis largely evaporated. This was a case really of self-fulfilling prophecies.
Now, I don't think this is a case of irrationality. This was simply a case where the logic of the situation created the possibility of a self-fulfilling crisis and it’s just amazing that just saying the right words suddenly made things much better. At this point, most of the Euro area countries are doing okay.
Mounk: To what extent is the crisis now solved?
Krugman: It would take something considerably worse than anything I see on the horizon to recreate a full-scale Euro crisis. What happened back in 2010 was both the fundamental inappropriateness of the single currency, but also the Europhoria. The first seven, eight years after the euro was introduced, everyone went wild and said, everything is fine. Spanish bonds are just as good as German bonds. That was a crisis created by the excessive confidence in the Euro itself. And I don't think that's going to happen again for a while. Someday something will happen and we may once again say, why? Why do these countries have a common currency? But probably we're not looking at anything remotely as bad as what went down 15 years ago.
Mounk: One of the things that I've been struck by is the extent of economic divergence between Europe and the United States. It seems to me that all of the relevant economic data really do show that. The United States has actually defended its share of global GDP to a remarkable degree, but Europe's share of global GDP has really quite rapidly declined over the last 25, 30 years. So what is needed in Europe in order to fix that? I know that part of your answer is more investment, and probably implementing something broadly along the lines of what Mario Draghi has now put forward in the Draghi report, et cetera. My question is whether that's enough. How can Europe actually get back to the technology frontier? How can Europe become a player again in some of the industries of the future, whether that's tech and AI, whether that's electric cars, whether that's other areas where the continent just doesn't feel like it's a player anymore? Is that just a question of investment or the deeper structural problems that Europe needs to address?
Krugman: A lot of the U.S. advantage in GDP per capita and productivity comes really from a handful of clusters. It's Silicon Valley and to a limited extent Seattle, and then Wall Street—these extremely high value industrial clusters. First of all, if you ask what is it about America that means that we have them, a lot of it is just that there has to be a Silicon Valley somewhere, and for historical reasons it's in America. There has to be a Wall Street somewhere, and it just happens for historical reasons to be in America. And if you take those out, the U.S. advantage over Europe is not nearly as large, and it's not clear how much the success of those regions redounds to the benefit of most people in the United States. It depends on what you look at—I think part of the quality of life consists in not being dead, and U.S. life expectancy is way below Europe's. So there's some of that. Then also it is true that technology has really been the cutting edge. The United States has been a much better place to do cutting-edge technology, partly because of our university system, which has been just more flexible and more forward-looking and less tied down. Germany is better than it was, but still, my God, the hierarchical nature of German academic life.
Also that the United States has been an open society. There's no place, as you yourself, I'm sure can attest, where some talented person from one country can come and feel welcomed and comfortable. America has had a big advantage over Europe in those things. Someone said that when, you know, during the 1930s and after when there were a lot of refugee scientists, to some extent Britain took in those scientists out of a sense of obligation and America took in those scientists out of a sense of opportunity. America was a welcoming place for technology, science, and that in turn provided the basis for a lot of what we've done.
Now, how do you cure that difference between Europe and the United States? Well, Europe should level up, but the United States seems to be in the process of leveling down. There is really a huge opportunity for Europe in the sense that America is becoming intolerant and anti-intellectual. The thing about Europe is there is this tendency, because the GDP numbers have lagged a bit and the most famous technology companies tend not to be European, to discount it. But there's a lot of potential in Europe and I think that it really wouldn't be that hard to turn it around. Of course I'm an outsider, but it does not look to me like there's a deep-seated malaise that can't be cured. There's a lot of potential but something has to be done.
Mounk: So we've been talking about an economic crisis that happened primarily in the 2010s in Europe for the last little while, but there is a potential economic crisis happening in the United States today. At this point, about two months ago, Donald Trump announced “Liberation Day.” It certainly liberated the markets of a good amount of stock valuation. He's since seemingly walked back some of those tariff announcements, and remarkably, the markets are back up to roughly where they were at the beginning of the year. You're somebody who has been more critical of free trade than a lot of other leading economists throughout your career, but also does believe in the importance of trade and globalization. Tell us the basic case for trade, and how that has held up over the course of the last decades.
Krugman: At a fundamental level, the reason why we should engage in international trade is the reason we shouldn't be raising our own chickens. Self-sufficiency is costly for two reasons. One, you probably do some stuff that you're not especially good at, and it pays to concentrate on things you do relatively well and let other people do things they do relatively well. And the other is there are just advantages in not trying to do everything. It's better to have everyone from your heart surgeon to your plumber be someone who has specialized in the field. The same is true for countries. It makes sense for countries to concentrate on doing things for which they are particularly well suited, either through climate or resources or just those mysterious things that make countries especially competent at something or other. It also makes sense to concentrate on a limited number of things so that you can get economies of scale. That's the basic case for trade, and it's as valid as it ever was.
We're clearly a lot richer as a planet. We're richer as individual countries because we don't try to do everything for ourselves and we trade. And in some ways, that's the important thing to understand. I would add that the special reason that I, at least, am especially fond of a relatively open world trading system is that it works for poor countries. When I was entering graduate school, clearly the most important thing in terms of the welfare of the world was development economics. What can we do to make poor countries less poor? But I didn't study it because it was too depressing a subject. This is the mid-1970s. Development economics was basically non-development economics. Nobody had really managed to make that transition. But we now have a lot of success stories—by no means all or even most of the developing world—but a number of success stories. China of course being an immense one, but before that we had South Korea, we had Taiwan, we had a number of countries that really went up the scale and all of them involved exports, all of them involved open economies.
I like to use the example of Bangladesh, which was a country that was right on the edge of a Malthusian crisis of just plain starvation through overpopulation. And now it's about four times as rich as it was then, which still leaves it very poor. And how do they do that? They're not a banana republic, they're a pajama republic. They export clothing. We don't have a garment district in New York, and that's a good thing, because those are very labor-intensive, low-productivity jobs. It makes a whole lot of sense to have those done in Bangladesh, where they desperately need that opportunity, and have the United States concentrate on different stuff. That's all the good stuff about trade.
Any form of economic change creates losers. And this is not something that runs counter to orthodox economic theory. The old trade theory begins with a 1941 paper by Paul Samuelson saying, hey, trade actually can cause large groups of people to suffer economic losses. We know that there are these downsides, but they're not unique to trade. They happen for technological change. The right way to deal with them is to try as much as possible to protect people from the losses. But trade is a good thing and we will miss it when it's gone.
Mounk: One of the things that strikes me is that I went to university in the early 2000s, and the argument that the left was making at the time was that world trade is bad because it's going to impoverish these countries. It’s a way for the United States and other rich countries to extract all of this value from countries like Bangladesh, India, and China and keep them in hunger and in penury. It's interesting that the arguments against trade have, even on the left, completely shifted because, as you're saying, Bangladesh and India have made significant economic progress. China and some other countries have made enormous economic progress over the course of those decades. It just turns out that those who thought that this world trade would somehow keep those countries impoverished have turned out to be very badly wrong.
Now, on the flip side of this, in part because of the success of these countries, we have a bunch of problems that weren't fully anticipated. As you're pointing out, economists knew that there would be losers, and perhaps there were some clever papers in the 1990s and early 2000s predicting that some of those losers might be in places like Michigan among auto workers or steel workers, et cetera. But neither the full economic scale of that nor the political impact were widely appreciated, nor the way in which that might undermine some of the basic trust in the political system and the impact it has across native working classes, not just in the United States, but in much of Western Europe and elsewhere as well.
It strikes me that often the problem when predictions go wrong is not necessarily that you don't know that something might happen, but is that you don’t appreciate the scale and the significance of it. That can come in part from people being disciplinary masters who don't look beyond their discipline. Overall, in economic terms, the United States has done very well for the last decades. And economists are probably right to say that, yes, there would be losers, we should compensate them, which in theory we can. But perhaps they neither quite appreciated the political difficulty of actually finding effective ways to compensate the losers for things like the loss of a job. You can't do that with transfer payments very easily. In the event it wasn't fully done. And they may not have appreciated what kind of political ramifications they would have, in part because they're economists rather than political scientists. Do you think that's a fair analysis? How would you grade the economic profession on its approach to free trade in those years?
Krugman: The first thing is that there were some actual economic blind spots. I blame myself in part. I wrote multiple papers and read hundreds of papers on distributional impacts of rising trade that took it seriously and said, there are some real issues here, but we pretty much completely missed the sort of localized impacts. We thought about the impact on non-college educated workers as a group. We didn't think about what this did to the furniture industry in the North Carolina Piedmont. A lot of rapid increases in trade undermined particular communities in ways that really were not in the models and should have been because I, of all people, having worked on economic geography, should have been thinking about that. And it really took a landmark paper by David H. Autor, David Dorn, and Gordon H. Hanson—Hanson being one of my students—that said the story there is really what it does to communities, not what it does to the aggregates. That was an economic failure.
On politics, economists have long argued that because trade is beneficial, trade increases a country's real income, that the winners can compensate the losers and everybody will end up better off. But it never actually happens. We never actually do that. This is where we really should have been talking to the political scientists and asking, why does this never happen? And what happens politically from the fact that it never happens? I think that was a blind spot. We have economic change that makes the country richer but hurts some people all the time. Look at what's happening with AI right now. I'm completely uncertain about how big AI will eventually turn out to be. But there's no question that if you took the advice to learn to code, boy, you made a big mistake because it turns out that one of the things AI is pretty good at is coding, and so coding jobs are disappearing. Translation jobs are disappearing. That doesn't mean that this is not a good thing for the economy but hey there are big losers. Now the question is why is the political backlash against job displacement from imports so much greater than the political backlash against job displacement from new technologies.
What happened to coal mining? Actually, that's not mostly a trade issue, but in this case people get furious with environmentalists, but environmentalism didn't kill coal mining. Technology killed coal mining because instead of digging for coal we can just blow the tops off mountains. But people don't seem to get riled up about that the same way they do about trade.
Mounk: In defense of the economists: if an economist had gone to a political scientist in 2000 and said, hey, we're anticipating these bad losses in places like Michigan. Do you think you're going to be able to compensate them? Probably political scientists would have said, no, that's going to be pretty hard. And perhaps, even if you compensate them for transfer payments, $2,000 in your bank account because of largesse doesn't give people the same dignity and self-worth as $2,000 that they've earned, so you're not going to fully compensate them. And if economists say, OK, and what do you think the political consequences of that are going to be? I doubt that a political scientist in 2000 would have predicted the extent of the populist surge. And that relates more broadly to my feeling that 2008 was a very bad year for economists because they really, by and large, had not foreseen the global economic crisis. That point has been made a number of times—you may agree or disagree with it, I don't know—but I would argue that 2016 was similar for political scientists. Because if you'd think that economists should be able to foresee a recession like 2008, then political scientists should be able to foresee a seismic year in which Britain votes to leave the European Union and the United States elects Donald Trump. And political scientists did not foresee that, any more than economists foresaw the crisis in 2008.
Krugman: Let me say a word about 2008 actually. I didn't feel that there was a huge failure of economics, even though there was a massive crisis nobody predicted. Within days after the fall of Lehman, everybody was going around saying, we've seen this kind of thing before. People were wandering around the halls of the National Bureau of Economic Research muttering, Diamond–Dybvig, Diamond–Dybvig, which is the classic model of bank runs. There were a lot of things we failed to understand. There was way too much stress on the efficiency of markets and so on. But the biggest thing that happened there was a failure to keep up with institutions. We knew that banks were pretty well protected as they were and had failed to appreciate that most banking in America by the year 2008 was undertaken by things that weren't called banks and weren't regulated like banks, and it was more of a failing to keep up with the changing institutional structure than a fundamental flaw in the theory. After that, everything that happened after 2008 in terms of impacts of fiscal and monetary policy was right, according to the textbook. By about 2011 I was saying, the world is a mess but, gee, it turns out that the models work. We all have blind spots and, how can I say it, the world is a very complicated place and the predictable bad things usually actually don't happen because if they're that predictable somebody does something about them and there's always something something going on in the world that you were not paying attention to and, yeah, it zaps you.
Mounk: That may be a problem more broadly of the kind of social science that we now prize and value. I get your point that some of the underlying models ended up being vindicated after 2008. But of course, the fundamental point of the model is to be able to predict something. And if you're not able to predict 2008 because you're not keeping up with those changes, that's still a problem. In the context of political science, I think about these as mid-range laws of the social world, and that's because they have a kind of scientific air to them.
But I wonder how helpful—in action-guiding terms—it is to know those kinds of mid-range laws of the social world. So, to give you one famous example, there is a very thorough paper that I think very convincingly shows that mountains and mountain ranges tend to favor civil war. Now, that sounds abstruse to people who don’t know much about military technology at first. But go back through history, and the partisans in World War II were often in the mountains. You look at countries like Afghanistan, and they tend to be very mountainous—and there’s a reason for that. In the plains, a central army with tanks can control territory pretty well. In the mountains, that is much harder. So it’s easier to sustain insurgencies and rebel activity in the mountains. Therefore, it’s much harder to pacify mountainous areas.
I think, as an observation about the social world, this is right. Now, the problem is: if you’re in Afghanistan, and you’re trying to figure out how to avoid falling into the next civil war, this doesn’t help you. Because a) you already know that your country is prone to civil war—if you’ve lived at all in the last 50 years, you already know that; and b) it’s not very action-guiding. What are you going to do—blow up all the mountains and flatten the country? That’s not going to happen.
So I wonder whether the problem here is not that we’re bad at creating those mid-range laws of the social world—we may actually be better at it in economics than in political science, all in all, I would guess—but that even the mid-range laws of the political world that political scientists have uncovered pretty convincingly may just not be as insightful about the world in terms of adding genuinely new understanding to a particular situation, and certainly not as action-guiding as we would like them to be.
Krugman: High theory was absolutely of no use whatsoever after the financial crisis. It’s basically of no use whatsoever right now. One of the problems we have is that the academic career goes to doing stuff that is very intricate and almost certainly of no practical use. But the mid-range stuff—the kind of stuff that’s done not so much by people getting tenure at Harvard as by staff people at the Federal Reserve—was extremely useful as a guide to what you should be doing, and was by and large ignored by policymakers.
There were some innovative, creative, unorthodox analyses of fiscal and monetary policy in 2010-2011 that had a large impact on policymakers—and also happened to have been completely wrong. The conventional standard models worked fine. It was the people coming up with novel reasons for why slashing government spending in a recession would actually increase employment—very clever, ingenious, and popular in Washington and Brussels, totally misleading—that actually had an impact.
Mounk: So part of the problem may simply be about the last step of translating academic insights into policy. Of course, that is a broader question right now. The idea that it makes sense to go and work in a think tank and answer some complicated technical question, and then trust mechanisms of knowledge transmission—to think that somehow the Donald J. Trump administration is then faithfully going to implement those technocratic insights—is definitely unrealistic. Which brings us back to the tariffs right now. I’ll ask you two questions about it.
The first is: what would the impact be if, after this 90-day pause that we’re in the middle of, Trump fails to reach agreements and deals with most of the countries that they are supposedly negotiating with, doesn’t want to lose face, and says, all right, I’m putting the tariffs back up—and we go back to something like what the United States announced on Liberation Day?
The second question is: how likely do you think that is? Are we actually going to go toward that world in which global trade is very significantly curtailed? Or do you think, in the end, the forces leaning on Trump—not wanting to risk another significant loss of value in the stock markets, not wanting to risk a recession, which would also be very politically damaging to him—do you think, in the end, globalization is not something we can get out of, and Liberation Day will enter the history books as a weird footnote? Or do you think there is a significant risk that we are seeing the beginning of the unraveling of a global trading order?
Krugman: Let me back that up and just say that if you take the tariffs that are currently in effect as we record this—the tariff on China has come down to 30%, which is still immense, and we have tariffs of 10% on pretty much everyone else. We no longer have the highest tariffs in 100 years—we merely have the highest tariffs in 90 years. And that’s a big deal.
One of the things about writing—even for Substack, definitely for The New York Times—is that there’s a tremendous amount of work that never sees the light of day, because it’s all going on behind the scenes—homework that I felt I had to do. I’ve been sifting through estimates of the impact of costs—whether tariffs or transportation costs—on trade. And we have, actually, a fair bit of literature on that. Plugging in the consensus estimates: They say that the tariffs we have right now will, in the long run, cut overall U.S. trade by half. We’re talking about the U.S. economy becoming half as open as it is now, so really going back to a 1950s level of trade, and cutting trade with China by two-thirds.
What we’re looking at right now is already a blow to globalization that would have been inconceivable in the past. This is one of these things where the practicalities matter a lot—the Liberation Day tariffs were different for every country. They put tariffs on the Heard Island and McDonald Islands, which are inhabited only by penguins. But sometimes the simple practicalities matter. Who is going to implement these tariffs? Where is the staff—assuming they’re not going to open the shipping containers and look at what’s inside, but they are at least going to look at the invoices? We don’t have the staff for that. It would take us years to stand up a force at Customs and Border Protection to do that.
There’s tremendous opportunity here for arbitrage. The Liberation Day tariffs were 20% on the European Union but only 10% on the UK.
There are even little things like the tariffs on Canada. We’re not quite clear where they stand now. But USMCA-compliant goods are exempt from the tariffs. The USMCA—NAFTA with some extra semicolons in it so Trump could name it after himself.
But what does that mean? So I’ve gone to the trade law experts on this, and they say nobody knows. They’re making it up as they go along. So we’re just heading for, aside from everything else, just a tremendous snafu. We’re probably talking about a lot of shipping containers piling up at the ports while they try to find somebody who can pass judgment on what the appropriate tariff rate is.
Mounk: So I guess the danger of this falls into at least two categories? One is just that this is a drag on economic growth and productivity? That’s going to happen if those tariffs are put in place. The second, I guess, is the risk of economic recession if we have a very significant drop in stock value again. How serious do you think that risk is if Trump came back at the end of these 90 days and said, all right, I have a deal with Ireland and I have a deal with Argentina, and that’s it. Everybody else is back to the tariffs they had previously? How big a risk do you think there is of creating an economic crisis that you then can’t get out of?
Krugman: Yes. The tariffs per se don’t necessarily cause recessions or high unemployment. The UK in the 1950s was still very protectionist. It still had about 25% average tariffs. There were a lot of exchange controls. It still had a lot of legacy wartime controls in place. It also had full employment. So you can have a protectionist nation that still has jobs for everybody. They’re not as productive as they should be, but that’s okay. What causes the risk of a crisis is the uncertainty—the fact that nobody knows. As we say, 90 days from now something is going to happen. Either Trump is going to say, well, back to Liberation Day, or he’s going to say, I declare victory and we’re going back to 10% tariffs—maybe even 3% tariffs, which is what we used to have. Which of those is going to happen? I don’t know. But more importantly, businesses don’t know. How is a business going to make plans? How is a business going to make investments when you have absolutely no idea what the international economic policy regime is going to be?
The other big Trump policy is deportation. We’re having a lot of deportation theater, with masked agents snatching people off the street. But the actual migrant labor force is still growing. Does that continue, or do they get serious about that? Are they just waiting to construct the camps to hold people? So between all of the policy uncertainties, I think the chance that a lot of economic activity just freezes while people wait for clarity that may never come, remains quite high.
Mounk: Answer the steelman case for tariffs. As I understand it, the best case for some level of tariffs is twofold. It’s, first of all, to say that—back then, when we were criticizing the WTO for impoverishing countries like China—we were wrong. In fact, China has become tremendously more affluent than it was. It now dominates industrial production in a lot of areas. Part of that is because of subsidies from the state. This is a significant national security concern in many industries. Also, it’s making it impossible for lots of Americans to find jobs. We should be doing something to cater to the population in the United States that perhaps is more gifted with their hands than sitting at a desk and writing emails or whatever else white-collar work tends to involve nowadays.
In terms of the well-being of our people—and perhaps our political stability—we should aim to have a good number of manufacturing jobs in the country. So perhaps the Liberation Day tariffs are the wrong way to go about it. But actually, some kind of change from the very open economy we had is called for. We need to make sure that we have real manufacturing bases in the United States, both for reasons of national security and for those reasons of, let’s say, political economy. What is your response to that line of argument?
Krugman: I support a sophisticated, limited, nationalistic, pro-manufacturing policy. We should be at least reasonably self-sufficient in strategically critical products. We should try to promote employment to some extent. The truth is, if you do the math, there’s no way we’re going to get back to anything like the number of manufacturing jobs we used to have. But we could have a few more—and more important, we could have more in the right places.
I’m for a place-based policy that tries to help. We have a serious problem of left-behind regions in America. You can tie that all to other goals, like fighting climate change—where, just given the politics of it, a policy that relies on carrots rather than sticks, that subsidizes green energy rather than tries to tell people to pay a price for emissions, is just a lot more politically feasible. And that can be linked in with the other stuff. You can try and promote green energy in left-behind regions that need the jobs.
But you know what I’m describing? First of all, it’s not tariff policy. It’s industrial policy. In fact, tariff policy can be counterproductive. You try to put tariffs to promote green energy, and you actually make some of the components of green energy more expensive and actually inhibit it. It also produces collateral damage—to consumers, to downstream industries, and so on. So it’s really subsidies rather than tariffs. You know who has kind of come up with an example of such a policy? That’s what the Biden administration was trying to do. It should have been much bigger than it was. The original Biden Build Back Better agenda looked a lot like what I would be advocating. And it was quite nationalistic. It had a lot of Buy American components. It was for political reasons mainly. It was, we’re doing this to some extent to help left-behind regions, but we’re going to try and do this stuff. And we got complaints. The Koreans, who have a free trade agreement with the United States, said, hey, this is in violation of the FTA. And they were right.
On the national security stuff, there’s actually a clause in the GATT, I think it’s Article 22, which says, if national security is at stake, forget everything else we said. You can do what you feel you need to do. Friends of mine who are much more unambiguously globalist than I am would complain about the other stuff, and I would say, well, look, do you want us to be sitting here 20 years from now saying, “Well, we cooked the planet, but at least we adhered to the rules of the World Trade Organization”? So to a certain extent, you have to make some compromises. But Trump is actually scrapping those policies and the stuff that was really relevant to national security. He’s definitely scrapping anything that was good for climate change. He’s pretty much scrapping anything that was helping left-behind regions—and instead responding with this broad tariff stuff that is very unlikely to do very much to help either the people or the places that need help.
In the rest of this week’s conversation, Yascha and Paul discuss the economic impact of AI, and how it feels to leave The New York Times for Substack. This part of the conversation is reserved for paying subscribers…
