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What Is Our Children Learning? Part 5.

And we’re back. We’re looking at the 10 principles in N. Gregory Mankiw’s Principles of Economics; We’ve covered 7 of his 10 principles already. Start at the beginning here.

Part 2 is here.

Part 3 is here.

Part 4 is . . . wait for it . . . here.

Today let’s check out:

Principle 8: A country’s standard of living depends on its ability to produce goods and services.

As Mankiw makes clear in the explanatory text, this means that our standard of living depends on our productivity. If we don’t make more pie, we can’t get more pie. And obviously, this has policy implications. Here’s Mankiw:

When thinking about how any public policy will affect living standards, the key question is how it will affect our ability to produce goods and services.

Sounds sensible, right?

But it’s not just important to make the stuff, it’s important to distribute it. If we only think about how a policy affects the size of the pie, we might sign off on policies that make one group’s slice bigger and don’t increase — or straight-up shrink — everyone else’s share. Which is, basically, the story of the last 40 years of American economic policy. Most of us don’t live any better than we used to, while a very small number of people live in insane luxury — so much that they would probably be better off if they had less.

Mankiw doesn’t mention this. Oh, and he doesn’t mention that some of our goods — clean air, clean water, etc. — aren’t so much produced as just there, and that many of our biggest problems are consequences of our high productivity — our ability to strip entire forests, to cover the landscape with tarmac, to burn coal until the trace mercury in it winds up poisoning the fish we eat, to pull all the fish out of the ocean, to pump CO2 into the air until the sea drowns our coastal cities, and so on.

Grade: C+.

Not wrong, exactly, but with big omissions that make it misleading when elevated to a principle. And once again, the omissions are political and on the side of the status quo: if the “key question” for any policy is its effect on the size of the pie (rather than on the size of the slices, or on the environment, or on the functioning of our democracy even), and if redistributing incomes shrinks the pie (which Mankiw already said), then policies that threaten Paris Hilton’s ability to spend a quarter-million dollars on an evening clubbing are a no-no. Q.E.D.

Suggested replacement principle: A country’s standard of living depends in large part on its ability to produce and distribute goods and services.

On to:

Principle 9: Prices rise when the government prints too much money.

Well, duh. “Too much money” is by definition the amount of money that causes prices to rise. (To rise more than we’d like, that is; a little inflation can be a good thing.) So this is just another tautology.

And yet, once again, Mankiw somehow manages to be misleading. How are we supposed to read that except as “when prices rise, the government has printed too much money”? And that just ain’t the case. Prices can rise when money stays constant but some people charge more for their products (like when there’s a bad harvest, or Saudi Arabia cuts oil production, or Bank of America decides to raise its fees because they want your money and fuck you).

Heck, it’s easy to misread this principle as “when governments print more money, the only result is that prices rise.”

Grade: D+.

I probably would have given this a better grade earlier on, but I’m getting tired of watching Mankiw give tautologies as principles, and then manage to somehow screw them up. It takes a weird kind of skill to flub a tautology.

Also, that last misreading? “When governments print more money, the only result is that prices rise”? It’s not really a misreading. Mankiw actually believes it. Check out:

Principle 10: Society faces a short-run trade-off between inflation and unemployment.

This is, on the face of it, true and important. If the government prints money (and gets it into people’s hands, a crucial step we forget today when we simply make it available to banks), we’ll spend more. This will normally have two effects: sellers will produce more to sell (hiring people in the process and reducing unemployment) and they’ll increase their prices (because they can and they’re not stupid). How much they do of each will depend to some degree on how much slack capacity there is in the economy.

So printing more money is a good idea in times of high unemployment but will spark unwanted inflation if you do it when the economy’s already going full blast. This isn’t just theory; the tradeoff — the Phillips curve — shows up in the real world again and again. It’s not an unbreakable rule (the stagflation of the 1970s didn’t follow it) but it is a definite pattern, which is about as good as it gets in economics.

So what’s the problem? It’s the term “short run.” What happens in the long run? According to Mankiw: “A higher level of prices is, in the long run, the primary effect of increasing the quantity of money.”

That makes sense until you think about it. Look at it this way: In the short run, if you print money, you increase economic activity and decrease unemployment. People can afford to educate themselves better, get better medical care, eat better, and remain non-homeless. They’re less stressed (which means their freaking brains don’t shrink), commit suicide less, and so on. Meanwhile, sellers faced with increased demand do their best to find more efficient ways to produce (creating new inventions that bring down prices in the future). How in God’s name does that all just automatically disappear in the long run, replaced by an economy that looks like what it would have looked like anyway but with higher prices?

Duh, it doesn’t. Increasing the money supply can increase prices to match in the long run, but it doesn’t have to, and even when it does, just because the general price level is higher doesn’t mean that that nothing else has changed.

Now: sometimes the experience of the 19th century is given as evidence for this “principle.” Back then currencies were backed by gold and the general price level, although it fluctuated wrenchingly year by year, didn’t vary in the long run. Gold is constant, prices were constant, Q.E.D., right?

But gold wasn’t constant. In the 19th century we stripped entire continents of their gold (think of the gold rushes in the Yukon, California, Australia, Colorado, and especially South Africa), multiplying the gold supply faster even than population rose, which had the same effect as printing money. So we increased the money supply and prices didn’t rise in the long run. This is evidence that a higher level of prices is not “in the long run, the primary effect of increasing the quantity of money.”

So where did this dumb idea come from? It’s another example of how hard it is for economics to get away from old bad ideas. The idea of “monetary neutrality” — that changing the money supply changes prices and nothing else – was just an axiom in the 18th century, asserted without direct evidence. But we can excuse that; good economic data were rare back then.

Then, over the next couple of historical epochs, evidence came in showing that changing the money supply does in fact affect the real economy, as common sense would suggest, to the point that (some) economists accepted it.

But the evidence was clearest in the short term — there are a million confounding factors in the long term — so economists continued to believe that the long-term effect is neutral, even though the idea that there’s a short-term effect and no long-term effect is freaking absurd. And they continue to believe it to this day, even as long-term evidence to the contrary has come in.

Oh, and once again, this is a political statement masquerading as science (“sure, expansionary policy can help the economy in the short term, if you only care about that, but you shouldn’t bother because in the long term all of those effects magically vanish.”)

Grade: C-.

The principle itself is broadly true and useful, but the more Mankiw tries to support it the more wrong he gets.

Suggested replacement principle: “Society often faces a trade-off between inflation and unemployment.” No “short-term”, and adding “often” leaves open the possibility of other situations (e.g., stagflation).

Phew! We’re done. Those are Mankiw’s principles.

Onward to our gripping conclusion!

 

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