A game in which all the players win

This is one of the most stimulating books on international trade that I have read for a very long time. Paul Krugman is widely regarded as one of the world's most outstanding economists and perhaps best known for his work on the theory of trade in imperfectly competitive markets. He is generally considered to have been one of the originators of what is now commonly referred to as the "new trade theory". An important aspect of this is its demonstration that, in oligopolistic industries in which firms engage in strategic behaviour, government intervention to target and promote "winners" through the granting of direct subsidies can be welfare improving. An important exception to the conventional view that government intervention in trade is generally welfare reducing was thereby established, albeit one which was largely confined to high-technology industries.

In fact, as Krugman explains in this book, the new trade theory has often been misrepresented as an attack on traditional trade theory with its assumptions of perfectly competitive markets and advocacy of free trade. For a long while, economists knew that the case for free trade needed to be qualified in conditions where unit costs fall with output. What was lacking were theoretical models to explain trade flows in such markets. The new trade theory overcame this deficiency without in any way providing governments with a carte blanche for intervention.

However, Pop Internationalism is not essentially about strategic trade policy. Its main concern is to counter the growing body of popular literature which has emerged in recent years on the subject of international competitiveness. Krugman considers this to be a "dangerous obsession" because of the influence which it has had on an ill-informed public and, not least, on policy-makers often seeking an intellectual justification for politically motivated trade policies. Krugman sees in several recently published bestsellers, such as Lester Thurow's The Zero-Sum Solution and his more recent Head to Head, an approach to the study of international trade that has the appearance of sophistication but which is essentially an exercise in "sloppy thinking". Thurow and others are accused of failing to pay sufficient attention to the theory of comparative advantage that underlies all trade between countries and shows trade to be essentially a positive-sum game in which all participants gain.

Krugman blames international economists for yielding ground to the "pop internationalists" by their failure to "communicate" with the broader public. Too often trade theory is presented in a way which is inaccessible to anyone other than the diligent economics undergraduate. Basic theories such as comparative advantage are, as a result, often not understood. Pop Internationalism is an attempt to redress the balance.

Krugman certainly does an excellent job in explaining, in a remarkably clear and nontechnical manner, some of the complex arguments on which the case for free trade rests. He shows why the view, increasingly fashionable in all western industrialised countries, that countries are like giant companies competing for a position in the global market-place, is fundamentally flawed. When Pepsi and Coca-Cola compete for export markets they do so as rivals. However, the same is not true of countries. The success of the European economy is not achieved at the expense of the United States. On the contrary, it is more likely to help the American economy by providing larger markets and by supplying it with better goods at lower prices. The obsession with competitiveness is seen as leading governments into wrong economic policies that create conflicts with their trading partners. Trade deficits are not the result of declining competitiveness (a concept which, Krugman asserts, has virtually no meaning) but the consequence of inadequate domestic savings relative to the borrowing needs of the corporate and public sectors.

The issue becomes important in any discussion about Third World growth and its implications for First World prosperity. Are the western industrialised countries right to be fearful of the growth of the newly-industrialising economies of Southeast Asia? Krugman demonstrates that much First World hysteria is grounded in the same fundamental misunderstandings about competitiveness as generate trade conflicts between advanced industrialised countries.

Far from being a cause for anxiety, the rapid growth of these developing countries should be welcomed. The basis for western fears is that real wages will be reduced by low-wage competition from producers in Third World countries. Krugman shows that, at the level of the economy as a whole, this cannot be so. If Third World output is rising, the result will be higher Third World incomes. There is no reason why this should lead to lower real wages in First World countries, nor is there any evidence to show that this has been the case in the past.

The Stolper-Samuelson theorem, familiar to all students of international trade, shows that trade will not only reduce the relative income of the owners of a country's scarce factor of production but can conceivably lower their absolute income also. It is, therefore, possible that trade could worsen the position of unskilled workers in countries such as the US. It has, however, not happened yet. Although, in recent decades, the real wages of blue-collar workers in the US have fallen not only relative to those of white-collar workers but also in absolute terms, this is not due to trade. Rather it was the result of an increased demand for skilled workers within individual industrial sectors rather than a shift in industrial mix in response to trade.

The book contains Krugman's thoughts on a number of other important issues. Of particular interest is the chapter entitled "The myth of Asia's miracle", in which he defies the conventional wisdom by arguing that the growth of the Southeast Asian tiger economies was no miracle. Countries such as Singapore grew through increases in inputs (mainly, investment in physical capital and education) rather than through increased efficiency. Like the growth of the Soviet Union in the 1950s, it was "perspiration rather than inspiration". It follows that the rapid growth rates of the past will not be sustainable in the future.

As a whole, the reading of this book is an immensely rewarding experience and a vital antidote to some of the populist writings on trade that have emerged in recent years. Krugman pulls no punches in his treatment of the pop internationalists who he sees as engaging in "glib rhetoric". At times, he may be criticised for overplaying his argument. For example, does it follow that governments should pay no attention to competitiveness? This, however, does not detract from the book's overriding qualities.

Nigel Grimwade is head of the economics division, South Bank Business School, South Bank University, London.