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Greg Mankiw

Global Perspectives: Greg Mankiw on economic advice, climate change and trade

Mark Wynne

The greatest American economist of the 20th century and the father of modern economics, Paul Samuelson, once wrote: “I don’t care who writes a nation’s laws, or crafts its advanced treaties, if I can write its economics textbooks.” Greg Mankiw took this advice to heart some years ago, and is now known to legions of economics students around the world as author of two of the best-selling textbooks in economics.

Last month, the Federal Reserve Bank of Dallas hosted Mankiw, the Robert M. Beren Professor of Economics at Harvard University, as part of the Bank’s Global Perspectives speaker series. This series was launched at the beginning of 2016 with the objective of bringing leaders from the worlds of business, academia and policymaking to the Dallas Fed to share their insights on global, national and regional developments.

Mankiw and Dallas Fed President Rob Kaplan discussed some of the things that economists don’t understand about politicians (and that politicians don’t understand about economists). They also spoke about how best to deal with climate change (Mankiw is a founding member of the Climate Leadership Council) and the case of free trade. The following are excerpts from their conversation, edited for clarity, and presented by topic.

What economists don’t understand about politicians, and what politicians don’t understand about economists

Mankiw: I don’t think economists fully understand the set of constraints that politicians operate under, probably because we have tenure, so we can say whatever we want. The politicians don’t. They constantly have to get approval by the voters, and the voters have different views of economic issues than economists do.

So the politicians are sort of stuck between the voters they have to appeal to and the economists who are giving them advice. I think understanding the difficult constraints that politicians operate under would be useful.

In terms of what politicians don’t understand about economists, I think they often turn to (economists) for the wrong set of questions. My mentor, [Princeton University economist] Alan Blinder, coined what he calls Murphy’s Law of economic policy, which says that economists have the most influence where they know the least, and they have the least influence where they know the most.

Politicians are constantly asking us, ‘What’s going to happen next year?’ But we are really bad at forecasting. I understand why people need forecasting, as part of the policy process, but we’re really bad at it, and we’re probably not going to be good any time soon.

On the other the hand, there are certain problems where we kind of understand the answer. We understand that rent control is not a particularly good way to run a housing market. We understand that if you want to deal with climate change, you probably want to put a price on carbon. If you have a city that suffers from congestion, we can solve that with congestion pricing.

The economics of climate change

Mankiw: There’re some problems in economics that are really hard. Climate change is really not. It may be hard politically, maybe it’s hard scientifically, but with economics, it’s pretty simple. It really goes back to sort of principles that we teach in introductory economics. Namely, that the market is usually a good way to organize economic activity. When it is in equilibrium, that’s usually a pretty good equilibrium. That’s just Adam Smith’s Invisible Hand.

But what if there are externalities, adverse side effects of economic activity? Then the market won’t reach the right outcome. The classic example of a side effect is pollution. There’s, of course, different kinds of pollution, but carbon emission is basically a particular kind of pollution leading to climate change.

So, what you do when you have these side effects? The market’s not going to solve the problem on its own because there are literally billions of bystanders who are affected by carbon emissions. What you need to do is internalize the externality. You need to get people in the market to understand the costs and benefits of their decisions. How do you do that? You put a price on those emissions.

Carbon taxes and pricing pollution

The basic idea of a carbon tax is to put a price on carbon emissions. It’s going to be a price that we build into the products—the prices of the products that involve carbon emissions: electricity, gasoline and so on. It’s going to incentivize people to conserve on carbon emissions. It will encourage them to move to electric cars, for example, or buy more fuel-efficient cars. It’ll encourage plants to switch away from coal toward more renewable forms of energy. It would encourage decisions on both the supply side and the demand side to reduce our carbon footprint.

And so that’s why there are groups of economists that basically say, ‘Yes, the way to solve climate change is to put a price on carbon through a carbon tax.’ The particular plan that we [the Climate Leadership Council] are pushing takes all the revenue from this carbon tax and rebates it in a lump sum in the form of what we call a carbon dividend to everyone. We take all the money, divide it by the population and then send a check either monthly or yearly or something like that.

International trade and trade deficits

Mankiw: One of the first things we teach in the basic economics course is the theory of comparative advantage and the gains from trade, ideas that goes back to David Ricardo.

This is not just a theory about trade between nations, which it is primarily, but also about trade among people. Why don’t I make my own clothes and grow my own food? Trade among people within a society is really based on the same principle as trade between nations. That’s why we start off with comparative advantage as the foundation of economics. Because economics is all about living in interdependent societies, not like Robinson Crusoe.

Trade deficits are basically difference between savings and investment. As with all the capital flows, a country can be running a trade deficit for a bad reason, but they can also be running one for good reasons. You have to look at the economic forces at work. Even if you think trade deficits are a problem, bilateral trade deficits—trade deficits between two countries—are particularly meaningless because trade happens among a lot of different countries. Looking at one particular set of transactions is very limited.

There is a famous quote from [Nobel laureate] Bob Solow that I like to quote: Bob says, ‘I run a chronic trade deficit with my barber, he never buys a damn thing from me.’  I think of that every time I get my hair cut. You would think I could get my barber to buy one of my books in exchange for the haircut, but that’s never worked.

When you open up to trade, the overall economic pie gets bigger. We have more prosperity. That doesn’t mean that everybody ends up with a bigger slice. So, there’re winners and losers. And some people can end up with small slice, and we need to be very cognizant on that. That is why we need a social safety net.

About the Author

Mark A. Wynne

Wynne is vice president and associate director of research in the Research Department at the Federal Reserve Bank of Dallas.

The views expressed are those of the author and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.