Features Editor Russell Roberts recently spoke with N. Greg Mankiw of Harvard University who just finished a two year stint as head of President's Council of Economic Advisers. Here is the text of the interview.
Mankiw: I feel like I've come home. I am in my heart of hearts an academic. I feel like it's much more natural for me to be at a university and so the transition from Washington back to Harvard has been very easy.
Roberts: How long have you been back?
Mankiw: Two months.
Roberts: What do you like the most about the change?
Mankiw: Well the nice thing about being an academic is you have complete freedom over your time and over what issues you want to spend your days thinking about—that's one of the nicest things about being a professor or a student. In Washington you have to think about the issues that are important at that moment and so unfolding economic events—those are always commanding your immediate attention. You don't have the luxury to say, "well, I don't want to think about that today, I want to think about something else."
Roberts: What do you find yourself thinking about in your free time now?
Mankiw: Oh, a whole variety of things. One of the things I'm doing is a new edition of my Principles of Economics textbook, so I'm going back to that and revising it to make it up to date. I've been thinking about business cycle theory for a long time and thinking about the business cycle again is something I've gone back to and will surely continue to go back to. I've also kept my fingers in the policy debates and I wrote a piece in the New Republic on the President's Social Security proposals. And I'm writing a piece for Foreign Affairs on the anti-dumping laws. I've got a lot of interests.
Roberts: Although your time there wasn't your own, there must have been some fun moments working for the White House. What was that like?
Mankiw: It was truly exhilarating getting to see how the policy process works and how economics can contribute to that process. That was very edifying for me and it was a great opportunity to spend two years doing public service. If you've watched the TV show the "West Wing" you get the sense that all important decisions are made as you're walking from one meeting to another. The truth of it is that the White House has a very structured policy apparatus where staff meets and discusses issues and they report to their principals and then the principals meet and discuss issues. I was the principal for the Council of Economic Advisers. I would meet with John Snow, Secretary of Treasury and Steve Friedman, head of National Economic Council and the other economic principal, Josh Bolton of the Office of Management and Budget. We would discuss the issues and try to reach a consensus or at least sketch out the list of options. Then we'd have meetings with the President. We'd say "Mr. President, we have this consensus recommendation." Or, "we don't have a consensus recommendation, here are the options and the pros and cons as we see them and here are our personal opinions." Ultimately, the President would make the call. So getting to participate in those discussions and see how the process worked and see how the economic and non-economic issues came into play was truly fascinating.
Roberts: What is your perception of the President as a consumer of economic analysis?
Mankiw: I think he's got a great intuition for economics—he doesn't think like an economist in the sense of thinking in terms of equations and graphs. He was an undergraduate history major and that's a pretty good description of how he thinks about things. He thinks about things more intuitively, more verbally. But he also has an MBA and so he thinks about things very much from the standpoint of what institutional framework is going to allow businesses to flourish and allow markets to work. I had the opportunity once to spend the weekend with him, and John Snow and Steve Friedman at Camp David. When I came back from that weekend I sent him a thank you note and I included a copy of Milton Friedman's Capitalism and Freedom because I thought that was a book that he would very much relate to. It's very good economics, it's free market economics, but it explains economics verbally. It talks about economics as individuals speak, rather than as we teach in the classroom with graphs and equations.
Roberts: Can you tell us something that you accomplished in that time that you were proud of, perhaps a way a policy debate came out that embodied the economic way of thinking?
Mankiw: I think that there were a lot of issues that I had a finger in, right when I arrived. The second round of tax cuts was gearing up and reducing the taxes on dividends and capital gains was an important accomplishment. I'm a big believer in moving the tax code in the direction of the consumption tax and what we did in changing the tax code is to take a step in that direction by reducing the double taxation of corporate capital income. I think this administration is very much of a free trade administration and I think while I was there I saw lots of political forces pushing in the direction of protectionism. One of things I did both publicly and privately is fight for free trade. The President is very much a believer of free trade.
Trade is one of the most politically contentious issues and Congress is split right down the middle on it. For an economist it's frustrating because it's one of the few things in economics that economists are generally unanimous on. As an intellectual matter, trade's a very easy issue, but as a political matter it's a very hard one.
Roberts: I agree. Any regrets from your time in Washington you'd like to mention?
Mankiw: I don't have regrets. I had a great time there. The only time I found myself in hot water in the press was when I was defending free trade in a way certain members of Congress didn't like.
Roberts: I remember that.
Mankiw: They jumped on top of me, but I actually don't regret defending free trade because I feel as passionately about that as I do about any policy issue.
Roberts: Did you get any internal political heat in that fight?
Mankiw: None. Obviously, it's not the job of an economic advisor to make headlines and I deeply regret that. But no one inside in the administration said, "Why are you defending free trade, we don't believe in that here." This is very much an administration of free traders.
Roberts: What are your thoughts on the President's individual retirement account idea and on the longer term health of Social Security?
Mankiw: Well I think there's no question that something at some point will have to be done to change the Social Security system. Anybody that looks at the numbers comes away thinking that the current system is just not sustainable in its current form. Social Security is part of a larger fiscal sustainability problem that involves the aging of the population and also the other entitlement programs of Medicare and Medicaid. So something has to be done. I think the President has put forward a very credible plan and I hope it passes. [Editor's Note: This discussion of the President's proposal took place just before President Bush proposed means-testing of social security benefits. Mankiw's remarks refer to the part of the President's proposal to allow private accounts within social security.] The President wants to move from the current defined benefit structure to a more defined contribution structure which is a good thing because it gives people more of an ownership right over their own retirement income and it increases—
Roberts: What do you mean by that?
Mankiw: Right now, the way the Social Security system works is you pay taxes when you're working and you get some benefits when you're retired. In between the government takes care of your money for you. What it actually does is spend your money and hopes to tax somebody else in the future. What a defined contribution system would mean is that the government would take your money from your paycheck and put it in your account and you would have control over that account. You would decide whether you would want to invest that account conservatively, let's say lots in bonds or more aggressively—more in equities, and that would be your account. A lot of private firms have moved in the direction of defined contribution plans, which gives individuals more choice and control over their own assets. The plan I have here at Harvard is a defined contribution plan. What the President has proposed is to gradually transition Social Security from a defined benefit plan to a defined contribution plan, which I think would be a good thing. Then you have to look at the promised benefits. Even if we were to stay with the current defined benefit structure, the current promises cannot be met given the current tax revenues. So even if we aren't going to take the bolder vision of moving toward a defined contribution plan, we're still going to have to sit down and see how we can bring promised benefits in line with the tax revenues.
Roberts: There have been a spate of articles in the press that Social Security reform is dead and no one likes the President's idea of private retirement accounts. I noticed that the President has continued to talk about it. What are your thoughts on the political likelihood of passage?
Mankiw: I think very few people actually know the answer to that question, and I think a lot of the speculation in the media about political chances is based on very little true knowledge. To pass a reform proposal, you need at least 60 votes in the Senate so you need a few moderate Senate Democrats to join the Republicans. To know the likelihood of reform, then, you need to know what those few moderate Democrats in the Senate are thinking. My guess is that they are holding their cards pretty close to their chest and talking to very few people. I certainly don't know what those moderate Senate Democrats are thinking. My guess is that they are talking behind closed doors to their advisors and to some members of the Republican leadership. But the people in the press are just guessing what they're thinking. So I think it is very, very hard at this point to handicap the probabilities of something coming out.
Roberts: Do you think that the President's going to fight hard for fundamental reform?
Mankiw: The President is very resolute. If he decides that something's the right thing to do, he fights for it. He does it if he thinks it's the right thing to do. For example, you saw this in the Iraq war. He didn't go into Iraq because it was the politically popular thing to do—he did it because he thought it was the right thing to do. It's the same with Social Security—he thinks that we need Social Security reform and he's put out a credible plan and he wants to get it done.
Roberts: Let's turn to international trade, which you mentioned earlier. Any thoughts as a one-time insider as to why the political factors you mentioned have become so important and why Congress is so divided? If you go back 15-20 years, trade was a quieter issue. Why has it gotten noisier even on issues life the Central American Free Trade Agreement where the stakes are fairly small?
Econlog's co-blogger Bryan Caplan explored the relationship between public opinion and public policy outcomes in his two-part essay, "Mises and Bastiat on How Democracy Goes Wrong" (part I) and part II.
Mankiw: I think the fundamental reason trade is so politicized is that the American people are very divided on trade. If you look at polls of the American public it's pretty close to 50/50 as to whether people think trade is good for the economy or bad for the economy. I've never actually seen the right polls done to answer this question—I have a suspicion that it's closely correlated with how much education on economic issues that someone has had. I would guess that someone that has taken a basic principles course comes away understanding at least at some level the basic theory of comparative advantage that Smith and Ricardo talked about and are much more sympathetic to trade than people who have not.
Roberts: I sure hope so.
Mankiw: So the way to move the trade agenda forward is to teach more people good economics. I'm not sure that I agree with your premise that it's worse now than it was. Twenty years ago people were talking about Japan and how Japan was the big threat and that we had to sort of stop cars coming from Japan that were destroying our auto industry.
Roberts: Yeah, you're right. I should have said thirty years ago. (Laughter)
Mankiw: Whenever the economy goes through difficult times there's a tendency for some people in the political sphere to look for scapegoats and the scapegoats are better if they're abroad.
Roberts: Well, that's true.
Mankiw: In some ways, the recent recession was a mild recession overall, but it was a very deep recession in manufacturing. So it's not a surprise that those congressmen from manufacturing states were particularly irate over these trade issues.
Roberts: The outsourcing debate that you got tangled up in as you mentioned earlier was bizarre given what a small number of jobs were affected and even might be affected in the future, and yet I think the places where that was happening must have felt a much bigger impact.
Mankiw: Absolutely, the level of fundamental misunderstanding about trade, even the facts in that debate was really stunning. Of course, the basic theory of comparative advantage from David Ricardo was completely lost, but even some of the facts—outsourcing is basically about trade in the service sector. We have a trade surplus in services, we are a net exporter of services. So while it's true that we implicitly import some services like call centers from India, we also export a lot of services like banking and higher education and so on. I think most of the people who were on the anti-outsourcing side of that debate were confused both about the concepts and the facts at the same time.
Roberts: What are your thoughts on the permanent repeal of the estate tax?
Mankiw: I have been a believer in the repeal of the estate tax for a long time. I wrote a Fortune column on that probably seven or eight years ago. I favor repeal for two reasons. One is just simple economic efficiency. I'm a believer that we should try to move towards a consumption tax and the estate tax which is a tax on capital is fundamentally inconsistent with that. So from the standpoint of efficiency it's a bad thing. But I also think from the standpoint of equity it's a bad tax. If you have two people that have made the same amount of money over their lifetime, why should the person who wants to leave his money to his children pay more tax than the person who wants to spend it on himself? So either from the standpoint of equity or from the standpoint of efficiency, I don't see the case for an estate tax.
Roberts: What do you say to people who argue that it only affects a small number of people—so it's ok?
Mankiw: I don't see why that makes it a good policy. There are lots of bad policies that I could imagine that only affect a small number of people but that doesn't suddenly turn them into good policies.
Roberts: Yeah, it's a bizarre argument, I don't really understand it myself, but you hear it all the time. Oh, the estate tax is ok—it only affects a few thousand people. I understand you've argued that the revenue from the estate tax might be zero or even negative. Can you explain?
The Bernheim paper appeared in the NBER volume Tax Policy and the Economy edited by Larry Summers and was published in 1987. Online: NBER working paper version of the paper.
Mankiw: I was citing research by Doug Bernheim. He wrote a paper in the NBER volume, Tax Policy and the Economy, 15 or 20 years ago, where he argued that the tax avoidance behavior that the estate tax generates, reduces income tax revenue. For example, you may give money to your children while you're alive instead of leaving to them when you die. As a result of that, the income from those assets gets taxed at a lower rate because the children face a lower tax rate. As a result income tax revenues declined. Doug did some calculations where he concluded that on net, the estate tax probably raised approximately zero revenue. He estimated that the reduction in income tax revenue was roughly the same magnitude as the direct revenue effect of the estate tax.
Roberts: What about fundamental tax reform? You mentioned that you want to push the tax code towards a consumption tax as opposed to an income tax. I know there's a presidential commission looking at fundamental tax reform. Do you think that instead of incremental steps of the kind that we talked about earlier such as cuts in capital gains and dividend taxation, do you think there's any chance of a more fundamental reform that would simplify taxes or push more towards a consumption tax?
Fred McChesney expressed skepticism about the possibility of permanent, radical tax reform in last month's Econlib essay, "What's Mine is Theirs: The Ever-Shimmering Mirage of Tax Reform."
Mankiw: I'd be surprised if they literally threw out the tax code and started from scratch, but I wouldn't be surprised if we get something that could be viewed as a large incremental step that substantially broadens the base by eliminating various deductions that would allow lower rates and at the same time to take another step in the direction of moving the income tax towards the consumption tax by, for example, expanding the availability of vehicles like IRA's and 401(k) plans and so on.
Roberts: Do you worry about the political economy of having so little income tax coming from the lowest half of the income distribution? For the income tax, not the payroll tax, but for the income tax, the bottom half of the income distribution pays about 5% of total tax revenue. I like low tax rates, but if a dollar of spending costs you a nickel, you tend to favor a lot of it. I worry about incremental reforms that take so many people off the tax rolls in order to make them politically palatable. Do you worry about the political economy effects at all?
Mankiw: I think everyone should contribute to the financing of government and, so that expansion of government is supported by everyone—it's a joint decision. I think one of the problems we have now is that for many people, taxes are very well hidden. There's a lot of discussion of a VAT or value added tax. Strictly from an economics standpoint, a VAT looks like a very attractive tax, because it's basically a flat consumption tax. But from a political economy standpoint it looks a lot less attractive because it's such a well hidden tax. It's very easy to raise it because people don't feel like they're paying it.
In this interview with Reason magazine, Milton Friedman discusses his role in creating the withholding system.
Roberts: Yeah, my preference would be to have a big window where you have go every week and pay your taxes, none of this withholding thing. I think Milton Friedman blames himself for that.
Mankiw: Yes, I read that.
Roberts: I heard a very perceptive observation from Dan Pink that as more people are self employed and have to pay their taxes explicitly with a check, people are going to demand less government.
Mankiw: That's an interesting hypothesis—that should be able to be studied.
Roberts: Yeah, I agree. It's a great point. It's hard to get the numbers on self-employment but it shouldn't be hard to get the number of people who file schedule C and other signs of self-employment.
Mankiw: It would be interesting to know whether all other things equal, self-employed people are more likely to be more conservative, too.
Roberts: That's an interesting question. I don't know. Although I do remember when George McGovern was running a restaurant he became less tolerant of regulations. I'd rather not rely on that. Let's shift gears, a big shift; let's talk a little bit about the state of, not the economy, which I won't ask you about by the way. I think it's a total waste of time, nothing personal, I don't ask anybody.
Mankiw: But you know though one thing I'm very happy about is not having to be wedded to everyday data. One thing we do at the Council of Economic Advisers, the CEA is sit down with the President and talk about what data is coming out the next day. It's fascinating for a while to follow every day-to-day release but after a while it gets tiresome.
Roberts: Like those poor people that have to write about the stock market for the newspaper or the evening news. They have to come up with a reason everyday for why it went up or down. Which is not an intellectually honest activity. But I was going to ask you about the state of economics. What are your thoughts on what questions economist will and ought to be spending time on in the coming years?
Mankiw: You mentioned that it's a bad idea to talk about the stock market. I think a case could be made that predicting directions for research is not that different from predicting the direction of the stock market. In a sense that I think there's a certain efficient markets hypothesis that goes on in academia. If I had a really great idea, about what the next research idea was going to be, I wouldn't sit here and tell you about it, I would go and do it. Similarly, if I had a great stock pick I am not going to tell you on the pages of the Wall Street Journal, I'm going to go buy it.
Roberts: But you could tell me without risk whether it's in macro or micro.
Mankiw: (Laughter) Well I'm sure there are great questions in both. I follow economic research very, very closely and I have participated in it in my own little way, but I think when people ask me where the research from here is going to go, or where it's going to be ten years from now, I really view that it's basically an unanswerable question. Here at Harvard there is a tremendous enthusiasm for behavioral economics and the intersection between psychology and economics, I think it's a fascinating area, but I think it's impossible to say how big a deal that will be ten years from now. Or at what point that particular line of research will run into diminishing returns.
Roberts: One of the differences between the stock market—I think—between the stock market and the market for ideas is that really great ideas in the stock market do tend to make a lot of money. I'm not convinced or at least I am more ambivalent about whether really great ideas in the academy lead to social good.
Mankiw: We certainly have our share of false starts, but then again the dot-com boom had its share of false starts, too. But I think what academics do is place their bets. Just as money managers place their bets. Academic reputations rise and fall just as the reputations of sellers and money managers rise and fall. So I think it's a closer parallel than you do.
Roberts: I probably don't disagree with you in general, but who do you think are the consumers of our ideas?
Mankiw: Each other.
Roberts: Yeah, that's the only—
Mankiw: That is a little different, but the money managers are buying and selling with each other, too.
Roberts: That's true.
Mankiw: It's a little more complicated phenomenon. They're trying to maximize a very tangible number of dollars and academic reputation is less tangible, perhaps best measured by something like number of citations.
Roberts: Presumably if research is merely clever and doesn't affect people's lives, it's less likely to be honored and lauded than research that's merely clever and beloved by a handful of practitioners, so I do think that there's a market.
Mankiw: Yeah, that certainly should be true; I think sometimes clever goes a little farther in our profession than it should.
Roberts: It seems to, I don't know if that's a fair criticism.
Mankiw: It's hard to know. It could. I get a lot of consumption value reading a really clever paper. It does get me to think about the world in new ways, so I don't want to discount clever. But I do worry a little bit that clever and mathematical sophistication and certain characteristics are weighted too highly relative to looking at data and having concrete policy ideas.
Roberts: You're the author of an incredibly successful textbook. In some departments, writing a textbook is considered a foolish waste of time, and in a few places it's honored. What's been your experience of being the author of that textbook and how do you feel about the time you've put in to it?
Mankiw: I've enjoyed writing my two textbooks, quite a lot. You know the Principles book you're referring to took several years to write, and I am sure some of my colleagues were scratching their heads as to why I was spending my time that way. But I personally enjoyed it. I enjoy writing. I enjoy teaching. I really do believe very fundamentally that the way we're going to get better economic policy is by getting better economics education. Teaching people the basic lessons of Adam Smith and David Ricardo and the economics profession more broadly, is fundamentally very, very important for a society to flourish. I actually do think that economics education is getting better in the sense that when I was in high school it was quite rare for someone to take economics. Now, many people take economics. I think roughly half the states have an economics requirement in high schools. Many high schools are offering advance placement economics. So I think the state of economics education is improving.
Roberts: Although I would alarm you by pointing out that in a lot of those high school classes they spend a lot of time playing a stock market game which encourages people to invest their money in short-term, high-risk ways.
See also N. Gregory Mankiw's article on New Keynesian Economics in the Concise Encyclopedia of Economics.
Mankiw: There is a question of what they are teaching and it's not always what an economist wants them to be teaching. And I think what we definitely need to do as a profession is to provide more guidance for those high school teachers. I've talked to high school teachers and principals. There's a shortage of people in high schools who teach economics. One of the reasons is that since they haven't traditionally taught economics, if you were expecting to be a high school teacher, you wouldn't have thought to major in economics. That should change, but it will take years.
Roberts: I think a lot of people are thrown into that job are social studies or history teachers, learning on the fly and doing the best they can. A lot of them are wonderful teachers. So I'd encourage you to write a high school principles text. That would be a good deed.
Mankiw: I'm afraid that two textbooks is enough for one life time. I understand that Alan Krueger is in the process of writing a high school economics text. I think it's great when very serious economists want to write for high school students, I think it's terrific.