Big is better – Paul Krugman tells us why. American Paul Krugman won the Nobel economics prize "for his analysis of trade patterns and location of economic activity," according to the Royal Swedish Academy of Sciences announcement Monday.
Economies of scale are achieved by cost advantages a firm (or industry) obtains when it operates on a large scale. These cost advantages arise from things like bulk purchasing of materials, lower interest charges on large loans when borrowing from banks, and general selling and administrative expenses that are reduced because the same task is done for more business units. In widely cited research from the late 1970s, Dr. Krugman showed the advantages of large-scale production in all interregional trade.
In all, the ability to achieve economies of scale is what explains one country’s ability to specialize, and thereby trade in goods and services.
In a 1998 paper, Dr. Krugman discusses policy implications from his long track record of theoretical and empirical research. “In principle, the sort of economy envisaged by the models sketched out in this paper ought to be a prime target for government intervention. Clearly there is no presumption here that the market gets it right.” However, he goes on to caution nations that try too hard to compete in international trade through strategic government policies.
Evidence of Krugman’s theory was also reported on Monday. China's trade surplus in September jumped to another record high, as exports stayed surprisingly strong despite slowing global demand. Chinese manufacturing firms achieve economies of scale because of a large, low-priced, labor force and subsidized export industries. China also maintains a fixed exchange rate for its currency, keeping its value lower relative to the markets where it exports, such as the United States.
As China has done for years, Krugman advocates an active role for the government in economic policy.
As a regular columnist for The New York Times, he has blamed the current financial and economic woes on the Bush administration’s preference for deregulation. His latest comments in the Times advocate a government response to this financial crisis similar to that of the United Kingdom.
The stock markets Monday moved strongly upward on announcements of just such a strong government policy from around the world. Leaders in Europe agreed to a plan that will guarantee loans between banks, Australia regulators guaranteed funding for banks, and Britain said it would invest up to $63 billion into three banks. The currency and bond markets were closed to the Columbus Day holiday, so the overall effect of these active policies pronouncements remains to be seen. But following the stock market close, the Treasury announced it will invest directly into U.S. banks. It looks as if this is just what stock traders have been looking for.
Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.