Paul Krugman On Trade, Tariffs, & America’s Role In The Global Economy

Introduction

With U.S. President Trump’s recent imposition of tariffs throwing global markets into chaos, it’s an apt time to look back on the history of international trade theory and to discuss trade policy with one of the most prominent international macroeconomists of the last fifty years. 

Protectionist approaches to trade policy such as Trump’s are, of course, nothing new. 

In a bygone world of metallic currencies, the theory of mercantilism once argued that the path to national prosperity laid in a country actively seeking to promote a trade surplus, thereby allowing gold to flow into the country and making it, the theory ran, wealthier. The theory thus posited trade as a zero-sum game: a country could only become richer via trade at the expense of other countries.

In contrast, the 18th-century Scottish political economist Adam Smith - widely considered to be the father of modern economics - is credited with advancing a theory of mutually beneficial international trade based on ‘absolute advantage’. The theory prescribes that countries specialize in the production of goods which they can make most efficiently and then engage in exchange with each other.

A few decades later, David Ricardo, a wealthy English financier and later a Member of UK Parliament, is credited with developing a refinement to the theory. According to Ricardo, countries need not have an ‘absolute advantage’ in the production of any good in order to engage in mutually beneficial trade. Countries could, Ricardo argued, specialize in making goods which they can produce with the least relative disadvantage (i.e. their ‘comparative advantage’) and then engage in mutually beneficial trade.

This theory of mutually beneficial trade based on comparative advantage has since seen numerous refinements - and critiques - over the centuries.

And waves of globalization and more open trade have been interspersed with periods of rising economic nationalism and protectionist sentiment, perhaps most notably during the Great Depression. 

But at the conclusion of World War II, the United States designed a highly rules-based international trading system, establishing the General Agreement on Tariffs and Trade (GATT) in 1948 and then the World Trade Organization (WTO) in 1995. This post-World War II framework for international trade has seen tariffs and other barriers to international trade continually reduced. And the United States has held a central multi-part role at the heart of this system as its chief architect, the issuer of the global reserve currency that helps facilitate international trade, and as a supplier of assets that the world heavily invests in.

It is in this international macroeconomic context that Professor Krugman helped develop new trade theory (NTT) in the 1970s and 80s, for which he was awarded the 2008 Nobel Prize in Economics. 

NTT argued that mutually beneficial international trade could be based, not merely on comparative advantage across industries, but also on concepts such as economies of scale and product differentiation within industries. 

It sought to answer questions such as why countries engage in trade of similar goods - for example, why do the U.S. and Japan trade in cars? In other words, whereas comparative advantage had focused on inter-industry trade, Krugman explored questions such as why countries might choose to engage intra-industry trade. 

His research also explored the role of geography in trade and considered questions such as why the production of certain products tend to be concentrated in tight geographical areas (e.g. why financial services institutions are heavily concentrated in two global cities - New York & London).

Professor Krugman remains a leading public intellectual on international macroeconomics and trade policy. And with the re-emergence of protectionist policy in Washington, we sat down to discuss the Trump tariffs, whether bilateral trade deficits are an appropriate focus for trade policy, and what Trump’s approach to trade means for the post-World War II international trading system - and America’s role in it. 

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New Trade Theory & The Conditions For Mutually Beneficial Trade

Aiden Singh: Can you explain the ‘new trade theory’ you helped develop in the 1970s and 1980s? What outstanding questions about trade was it trying to address?

Paul Krugman: The insight of new trade theory - which seemed really obvious in retrospect and which some people had, but not that clearly - was that there were really two reasons for international trade. 

The standard reason was comparative advantage which is an intellectual tradition that says countries trade to take advantage of their differences. 

The new trade theory says that countries also trade because there are inherent advantages in specialization and doing things on a large scale. 

I like to think of it in terms of people. Why do people why do people take different jobs? Why is one person a lawyer and another person a brain surgeon? 

One answer is that there may be inherent differences. Maybe the brain surgeon doesn't like to argue and the lawyer can't stand the sight of blood. So people are different. 

But the other reason is that it takes a lot of time and effort to learn to be either a good lawyer or a good surgeon. And so, even if people were the same, they would still sort themselves out with some of them becoming surgeons and some of them becoming lawyers. 

So these are two different reasons for trade which in practice are both always operating but to varying degrees. 

And the outstanding problem which new trade theory sought to address was why is a lot of world trade between very similar countries. For example why was there so much trade in automotive products between the United States and Canada, which are both highly-educated relatively high-wage countries? Trying to have replica auto industries on both sides of the border would mean that you have duplication and inefficiently small-scale production. 

The explanation was that different pieces of the automotive industry were located on different sides of the border so that you could have the advantages of large-scale production - Canada focused on the production of certain components.

And the new trade theory connected right into an older area of research about the growth of trade between industrial countries. 

Aiden Singh: And so new trade theory is not antagonistic to comparative advantage; comparative advantage explains a certain type of trade and new trade theory explains a different type of trade.

Paul Krugman: Right. And comparative advantage and NTT can even work in parallel.

So initially the thinking ran something like this.

We can think of intra-industry trade - trade in similar products between similar countries - as being driven by increasing returns. So if we ask why do Canada and the United States send automobile components and finished automobiles back and forth across the border, the NTT explains that it’s driven by increasing returns.

We can think of a lot of other trade as being about comparative advantage. So if we ask why does Bangladesh export apparel to the United States, the answer is comparative advantage. 

We later came to realize that you could also have complimentary relationships between comparative advantage and NTT.

So for example, China is still a very different economy from Western economies and the kinds of things it ships are largely driven by its comparative advantage. But then if you look inside China and ask how is production carried out, we find that there are a bunch of industrial clusters that are clearly driven by increasing returns.

So why does China produce most of the world’s buttons? Well, that's comparative advantage. And why are most of the button factories in one city in China? Well, that's increasing returns. 

And the gains from increasing returns magnify the effects of comparative advantage.

Aiden Singh: Under what conditions does NTT posit trade can be mutually beneficial?

Paul Krugman: In general, new trade theory says that the gains from trade are bigger than we would otherwise have thought: it suggests that even if countries are very similar, they can still benefit from trade which allows them to specialize and gain the advantages of larger-scale production. So it’s beneficial.

Now, there has always been a little bit of a of a dark side to trade, even in the models. Our standard models of comparative advantage which emphasize international differences in resources (e.g. differences in capital or labor skill levels) do suggest that there can be people who are hurt by trade - there can be income distribution effects that are quite strong.

But if the trade is based on increasing returns, there don't have to be large distributional effects. 

In a way, this all started with the happy story that the formation of the common market in Europe and the liberalization of trade between the US and Canada resulted in a growth of trade without distributional effects.

Now, this doesn't mean that all trade is like that. And it doesn't mean that you should only engage in trade that doesn't have strong effects on income distribution. 

But it does suggest that there's more to the story. 

And it does say that the gains from trade, even when that trade is comparative advantage driven, can be bigger than you would otherwise thought.

So by and large, NTT gives us a more optimistic - though not totally optimistic - view about the effects of trade.

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Economic Geography

Aiden Singh: Your research looked into, not only the factors that drive trade between countries, but also the things that influence where production is located within a country. 

And you briefly alluded to this research when you mentioned industrial clusters in China.

Can you explain the concept of economic agglomeration and its implications for international trade?

This was not news to economists: it's all in Alfred Marshall’s work. But it was informal. And because it was hard to produce clear models, it was largely downplayed. 

When you think about it, you find that the existence of cities must mean that there are increasing returns and there must be agglomeration economies. But what were those agglomeration economies?And how do you measure them? They tended to be sort of invisible. 

So I and several other people, after the new trade theory had become respectable within international economics, started to think about what goes on inside countries - things like how distance and transportation costs interacted with increasing returns. 

And you get one story that is extremely clear, which is that if you have a bunch of people and firms close together, they generate a large market. It also generates the advantages of being close to the production of products, which lowers the cost of those products. And you get a sort of natural tendency for the economy to concentrate production and population in a few locations. 

Now, that tendency is always opposed: there’s always a tension between the forces that say “let's clump together” and the forces that say, “well the land is cheaper over there so why don't I move away from the big cluster?”. So it’s not pre-determined.

And you can get tipping points where things like changes in transportation technology or production technology can cause economic activity to clump together or, alternatively, can cause the concentrations to break up and spread out. 

Now, in practice, the invisible forms of agglomeration economies also come into play. For example, if you wanted explain the existence of Silicon Valley, you wouldn’t just want to look at things in terms of market size and access to intermediate goods. You'd also want to consider things like information spillovers, which are very hard to measure but are obviously part of the story. 

So you put all of that together to explain industrial clustering within countries.

And then that all ties back into explaining international trade. So, for example, agglomeration economies means that there are really strong reasons why there should be a Silicon Valley somewhere. And it just happens to be located in the United States, which makes the U.S. a technology exporter. 

Similarly with financial services: the logic of agglomeration for financial services probably means there should be only a couple of global centers of financial services. And by historical accident, those financial centers happen to be New York and London. And so the U.S. and U.K. export financial services.

So economic geography and the idea of agglomeration economies says that a lot of international trade is not just about comparative advantage and the increase in returns at the level of individual factories or individual firms, but also about the fact that you have these industrial clusters. 

And then on top of that, the agglomeration economies add to the comparative advantage forces. For example, we can think about Bangalore as a services cluster which helps India build a comparative advantage in the export of those services. 

So the idea of agglomeration economies just adds another layer of understanding to what's driving international trade.

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America’s Role As Architect of the Post-World War II International Trading System

Aiden Singh: From the perspective of the United States, what are the benefits of the international trading system it designed post-World War II and which had been in place prior to this second Trump administration?

Paul Krugman: There's a kind of a subtlety about the international trade system that was set up. 

The United States invented it. The Reciprocal Trade Agreements Act of 1934 was the template and then the GATT was built on that template. 

Part of the reason for this was that U.S. officials thought that there are economic benefits from free exchange of goods between countries. 

The other part is that US officials also thought - until very recently - that international trade was good for peace and security: trade relations between countries - while not a silver bullet for everything that ails the world - would bind countries more closely together, would help to create alliance among the world's democracies, and would help to prevent war.

And sometimes that was really explicit.

Very much approved by the United States, when the European Union started with the coal and steel community it was very explicitly about intertwining the French and the German economies so closely that there will never be another war between them. And that has worked so far. 

So these were all thought by U.S. officials to be the advantages of greater trade. 

Now why have international agreements? Why not just preach the virtues of free trade? 

The answer is that has never worked. We've never had major trade liberalization because politicians started reading David Ricardo.

What has worked is a strategy of countervailing interests. The reason why President Franklin D. Roosevelt and his people came up with the Reciprocal Trade Agreements Act was that they realized that they could offset the special interest politics of import protection by bringing exporters to the table. And the exporters would say, “no, there’s an agreement with, say, Brazil, and they'll take our stuff and we take their stuff." And that would at least mitigate special interest politics, not by creating saintly politicians who didn't care about special interests, but by bringing countervailing forces to the table. And that required agreements. 

Originally, it was bilateral agreements involving the United States.

But it became clear that the more people you could bring into the process, the more political balancing you could do.

And so then came the GATT which brought about multilateral negotiations and also established rules to prevent backsliding.

And the peculiar thing about it is that, yeah on paper it protects the United States from unfair actions by other countries and vice-versa, but the purpose is actually largely to protect us from ourselves: these international agreements are a way of disciplining special interest politics. 

Yes, the way that negotiations are conducted is very mercantilist: when we agree to accept foreign stuff - even if it's cheaper and better than we could make for ourselves - that's a concession.

But the way these agreements have worked out historically is that they end up leading to much cleaner tariff and trade policies than we would otherwise have. 

Until about three months ago, international trade policy was remarkably clean: tariff rates were actually very low and distortions of international trade were very low. Compare that with how we handled, say, water rights in California. By comparison, we were actually doing a very clean job on trade. It was one of the most straightforward, transparent, low distortion areas of policy. That was the system we built.

And while there have been some serious shadows on that system, we will miss it when it's gone. 

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Costs To The U.S. Of The Post-WWII Arrangement

Aiden Singh: Were there costs to the United States under the post-WWII trading system it built?

Paul Krugman: I find it very hard to see that the United States as a whole was hurt.

Obviously the current leadership of The United States believes that other countries were taking advantage of us. But it really doesn't hold up to scrutiny.

Now, there are two negatives that I think we need to keep in mind when considering this question. 

One is that internal distribution issues have been a big deal.

Trade liberalization, in general, produces losers as well as winners. 

Intra-industry trade based on increasing returns is a big exception.

But a lot of the growth in world trade since 1980 or so has actually been based on comparative advantage. And this hyper-globalization and the surge in international trade between circa 1985 and circa 2005, which was based on value chains, intermediate goods, containerization, and so forth, meant that you had a lot more exports from labor abundant countries with relatively low wages. And that almost certainly adversely affected at least some workers in wealthy countries. 

A lot of economists, me included, have tried to estimate how big these negative effects were. And they seem to be fairly modest. 

But I think we didn't think enough about the effects of rapid change and particularly how that interacted with economic geography. 

So the China shock - the rapid growth in Chinese exports - displaced, maximum estimate, 2 million U.S. workers.

And that sounds like a lot, except that the U.S. is a dynamic economy: a million and a half workers are fired every month. 

But the thing about the displacement of the max 2 million workers due to the China shock is that they weren't evenly distributed.

So, for example, furniture imports probably displaced a couple of hundred thousand U.S. workers. And in the grand scheme of the dynamic U.S. economy that may seem like a small proportion except that basically all of those workers were located in the Piedmont area of North Carolina. 

The agglomeration economies meant that you had localized industries. And therefore the impact of these imports on communities, and the impact on people's lives, was bigger than anything that economists had really contemplated. 

And so, although the downsides of globalization overall are not that big, they’re bigger than we had realized - and more contentious. 

So that's really the major downside: the distribution of the dislocations more than the overall income distribution effects.

And then the other thing is that issues of national security really took a back seat in discussions of trade for a long time because we didn't think of that as being a really serious concern.

If you had said twenty years ago “we're going to be back to large scale conventional wars taking place in Eastern Europe”, people would say, “oh, come on”. But here we are. 

So the national security issues are quite real. 

And we were careless in not thinking about the implications of so much of the world's semiconductor production being in Taiwan or rare earth production being dominated by China.

So those were the areas trade economists failed to take into account. 

But overall it’s not true that US economic growth has been hurt by trade. In fact, it’s almost certainly the other way around: the openness of world markets has been good for almost everybody.

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International Financial Flows

Aiden Singh: Of course, any discussion of flows in international trade is incomplete without a discussion of international flows in capital and investment. 

What were the costs and benefits of international investment flows under the system of international trade in place prior to this second Trump administration?

Paul Krugman: Now that's a very different story than the story of the benefits of trade.

If you try to produce evidence of the benefits of international capital mobility, it's actually pretty thin.

And volatile international capital flows have been a big problem for the world. 

I've spent much of my academic career studying international trade flows. But the other part of it has been spent on studying crises: I invented the early academic literature on balance of payments crises in 1979.

And international capital flows have repeatedly produced crises owing to the phenomenon of sudden stops in which lots of money flows into a country and then suddenly stops. 

We had a Latin American debt crisis in the 1980s. We had the Tequila Crisis in Mexico in 1995. We had the Asian crisis in the late nineties. We had the Argentine crisis. And then we had the Euro crisis, which was pretty much the same kind of thing. All of these crises were driven by international capital loving a country and then suddenly leaving it. 

And so there's a real question about whether international capital flows are a good thing. 

And the main counterargument is actually not that the capital flows themselves are beneficial, but that trying to restrict the capital flows has a lot of costs: a dollar crossing international borders doesn't tell you whether it's for the purchase of goods and services or whether it's for the purpose of a possibly volatile investment. 

And there’s actually a long-standing division on this subject. 

My original trade teacher was Jagadish Bhagwati, the grand old man of classical trade theory who, by the way, should have won a Nobel.

And Jagadish always said he wanted free trade in goods but he wanted restricted movements of capital. 

And the best argument against that was it's too hard to do: you impose a large administrative burden if you try to make that distinction. 

But it's an open question. 

But it does mean, among other things, that because we have large international movements of capital, we also have the flip side of that which is that we have large persistent imbalances in trade.

It’s not clear that those persistent trade imbalances are a problem - but it feels like a problem to a lot of people. 

The abrupt reversals of capital movements that have afflicted a lot of developing countries over the decades are clearly a problem. 

But on the issue of of trade imbalances, it's hard to actually show clear adverse effects except that people don't like it. 

And so you have to wonder at this point to what extent it might have been worth accepting the administrative burden of capital controls in order to avoid some of the other problems we're getting into.

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Have International Financial Flows Benefited The U.S.?

Aiden Singh: You mentioned the numerous developing countries which suffered balance of payments crises.

From the perspective of the United States, have international capital flows and investment have been net beneficial?

Paul Krugman: It’s unclear.

The United States certainly has attracted a lot of capital from the rest of the world and has paid pretty low interest rates on it. 

Has it been productively invested in the United States?

Obviously, again, you don't get a label that says this dollar of foreign investment is going for this kind of real investment. 

So the question of what extra investment in the United States is made possible by inflows of capital is not clear. 

Do we think that foreign capital was a crucial factor in that? Probably not.

But it's something. 

And I think, in general, international financial flows tend to loom much larger in the minds of people who haven't looked at them closely than the minds of people who have: the more you look at all of that stuff, the less important it tends to seem. 

But the appeal of focusing on international financial flows, which sounds important and mysterious, tends to lead to it being bigger in peoples' minds than probably the reality.

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The U.S. Dollar As Global Reserve Currency

Aiden Singh: How does the U.S. dollar’s role as global reserve currency fit into this system?

Paul Krugman: So the dollar is the premier international currency, which actually involves it having multiple roles. There are a bunch of ways in which the dollar is special.

Most financial transactions around the world between countries go through dollars. 

And there's a lot of holding of not just U.S. dollar reserves, but also private players who have assets that are in dollars.

Is this a huge benefit to the United States? Do we get 'exorbitant privilege’, to use the old Gaullist phrase? 

Most of the evidence suggests that it’s not such a big deal. The ‘exorbitant privilege’ is probably a fairly modest sum - it's a small fraction of U.S. GDP. 

We maybe get slightly lower interest rates, though that’s not obvious from the data. 

We certainly have something like a trillion dollars of US currency held outside the country, mostly in hundred dollar bills. And that's a zero interest loan to America. 

But, again, we're a very big economy so that's not a big deal. 

So it's probably a marginal benefit to the United States, but we don't get a whole lot of economic advantage. 

In terms of possible costs to the U.S., does the dollar’s role as global reserve currency explain US trade deficits? 

It’s an idea that is constantly being floated: the rest of the world is accumulating dollars and so the US is essentially forced to run a trade deficit to supply those dollars. 

But that ignores the fact that the United States also invests abroad. People could be buying dollar assets and the U.S. could be using the proceeds to invest abroad. 

In fact, until about 1980 the U.S. consistently ran trade surpluses even as world dollar reserves were constantly increasing. 

And since then, yeah we've run deficits, but if you try to figure out how big a role the reserve status of the dollar is playing, it may be a partial explanation, but it's certainly not the main story.

The main story is that the US has been an engine of growth with faster technological progress and better demography than other advanced countries. 

I wrote my first paper on will the dollar lose its role as the key global currency in 1981. So the idea has been floating around forever. It could happen, but so far hasn’t.

A number of us economists, myself included, are concerned that the real risk is not that the dollar will be replaced with something else, like the euro or the renminbi. There are all kinds of reasons why those are not suitable currencies to play that role. 

The real risk is that nothing replaces it: that people lose faith in the dollar and become unwilling to use dollars for transactions, that Treasury bills cease to be regarded as the ultimate safe asset collateral for deals all across the world, and that nothing else takes their place. And that would throw sand into the gears of the global economy. 

So one way to think about it is that the US actually provided a service, inadvertently, by having debt that everybody considered safe and by having a currency that everybody used. 

A wonderful old paper by Charlie Kindleberger, who was one of my teachers, compared the role of the dollar in the world economy to the role of English as an international language. 

Essentially, everybody speaks English because everybody else speaks English. 

Is that an advantage to The United States? Maybe a little bit. Certainly it means that, for example, U.S. scientists don't need to learn German the way they once had to. 

But mainly, it's an advantage to the world. You want to have a lingua franca. And that's kind of the role of the dollar in world commerce.

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Critics of Free Trade

Aiden Singh: Despite America’s central role as architect of the international trading system, I think it’s fair to say that, both on the political left and the political right, there have consistently been anti-trade elements. And Trump has tapped into and exemplifies the protectionist wing of the Republican Party.

Do you think any of the anti-trade arguments advanced by either the left or right have any merit? If so, which? And if not, what are those critics misunderstanding?

Paul Krugman: So anti-free trade arguments are not unadulterated nonsense - they're adulterated nonsense. 

There are some pieces in the critiques which point to something: the distributional effects.

The furniture workers of North Carolina really did experience a pretty serious blow from foreign imports.

And the wages of US workers without college degrees are probably a couple of percent lower than they would be if we shut off globalization. 

So those things are real. 

The really big complaints, though, are not justified.

So the kind of left-wing critique that said this was exploiting poor countries is very much wrong-headed. 

And then the Trumpian mercantilist view that the rest of the world is taking advantage of us because they're running trade surpluses also doesn't stand up.

The idea that we used to be a country with lots of manufacturing and good wages, and that was taken away, there's a little bit of truth to that, but not much. 

You can try to estimate how much bigger US manufacturing would be if we didn't have trade deficits. And my estimate is that it might be 12.5% of the workforce instead of 10%. But it wouldn't be 25% of the workforce the way it was in the sixties. 

And you can also look at countries that run big trade surpluses of manufacturing, like Germany, and even they have deindustrialized.

So it's not that there's nothing to the critiques, but the big critiques which claim that international trade is a terrible thing don't hold water.

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Bilateral Trade Deficits

Aiden Singh: Trump’s tariff policy appears very concerned with bilateral trade deficits. Is there ever any justification for concern with specific bilateral trade deficits?

Paul Krugman: It’s completely bonkers; completely ignorant. 

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Multilateral Trade Deficits

Aiden Singh: Are there scenarios in which a multilateral trade deficit is a legitimate cause for concern? If so, in such scenarios, are tariffs effective in addressing the deficit?

Paul Krugman: It's probably not normally a source of concern. 

The cases where trade deficits have really been a problem, historically, have been where they are the counterpart of unsustainable capital inflows.

But the the sort of mercantilist argument that says that trade deficits take away jobs doesn't hold. It doesn't hold empirically and it doesn't hold analytically. 

And would tariffs, even if they were being imposed out of a misplaced concern about trade deficits, actually reduce trade imbalances? 

At some level, sufficiently high tariffs would do that: you can't have trade deficits if you don't have trade. And so if we really had prohibitive tariffs that shut down international trade, that would lead to trade deficits going away. 

But if you stop short of that point, it's not at all clear: there are both macroeconomic and macroeconomic reasons why tariffs don't actually do much to trade deficits. 

The microeconomic reason is that in today's world tariffs raise costs of production because you have so many imported inputs. 

And the macroeconomic reason is that you would normally expect tariffs to raise the value of the currency and that would wipe out most of the effect on the trade deficit (although it’s interesting to note that, so far, the chaos caused by the tariffs has weakened the dollar, but more normally and maybe when things settle down, a stronger dollar will wipe out most of the effect of the tariffs on the trade deficit).

The IMF actually did a big cross-national comparison of tariff effects. And they pretty much found what simple models would have suggested: tariffs lead to stronger currencies and do not actually lead to smaller trade deficits.

Also the effects of retaliation by other countries can offset the effect of tariffs on trade deficits.

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China

Aiden Singh: The United States and China have a highly-intertwined trading and financial relationship: China is both the second largest holder of U.S. Treasuries and a major supplier of cheap goods to the U.S.

This enmeshed relationship has long been a source of consternation for China hawks.

And China is the country upon which Trump has imposed the steepest tariff rate. 

Its critics argue that China manipulates its currency, steals intellectual property, and implements non-tariff barriers to trade.

Leaving aside his tariffs on ally countries such as Canada, is there any case to be made for Trump’s aggressive tariff policy towards China?

Paul Krugman: So China does manipulate its currency - that’s pretty much documented. They’re able to do that partly because they have capital controls. It means that they're able to intervene and, most of the time, keep the renminbi weaker than markets would want it to be. And that does help to keep their trade surplus large. 

But, at this point, the fundamental problem with China is that it is an economy that has very high savings and slowing growth. Technological catch-up is still happening, but at a slower rate. And their demography looks more like Japan than anything else. So they have slowing growth. And they don't really have enough domestic investment opportunities for all of those savings.

And rather than try to increase consumption and reduce their savings rate to something more reasonable, they have instead tried to use trade surpluses as an escape valve.

It's not clear that that really hurts the rest of the world, but it's politically unacceptable. 

So China is a problem case.

And you really would want to do something about it. 

Then on top of that there’s strategic competition. Sadly, this is not a world where you can just brush aside the concern that the United States might find itself in a war with China, that China might invade Taiwan, or what have you. 

So you do need a policy towards China. 

But if you wanted to devise one, you would want to make sure that the United States and Western allies are not too vulnerable to China. 

And you would want to do things in a targeted way. Imposing a tariff that makes Chinese-made toys more expensive shouldn't be part of your strategy.

But that's what we're doing.

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The Future Of The International Trading System

Aiden Singh: You began to allude to it a bit earlier, but I’d like to close on the following question: what does the world look like if the U.S. chooses to relinquish its role as architect of the international trading and financial system?

Paul Krugman: Charlie Kindleberger argued about the Great Depression, and many other episodes, that it's really important to have a global hegemon. You want somebody to take responsibility for the world system, to take responsibility for free trade, to take responsibility for international monetary stability. 

And, on trade, we had actually already moved to a system where there were really two co-hegemons: the European Union is actually almost as big a player as we are on that front. But we needed both of them. 

And on international financial front, we really needed the United States.

And the United States is by no means a saintly actor on the world stage.

But by the standards of previous hegemons, we've been pretty good. We always maintain the pretense of equality, and we actually in reality kind of adhere to the rules we set for other countries as well. 

There were test cases. For example, when the WTO ruled against the United States, as it did in several prominent cases like the Bush steel tariffs, would the United States obey the ruling?

The answer was yes, we did because we thought it was important. We believed that the system needed to be maintained. 

And then at the national security level, the United States has been a dominant military power and we didn't go around invading Greenland or anything. 

So we had a good thing going. We were not saintly, but we were probably the best hegemon in world history.

And now we're not.

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