N. Gregory Mankiw, the chair of the Council of Economic Advisors under Bush, talks about lessons learned from the economic disaster for Economics 101. He thinks the fundamentals are the same as they always were.

Despite the enormity of recent events, the principles of economics are largely unchanged. Students still need to learn about the gains from trade, supply and demand, the efficiency properties of market outcomes, and so on. These topics will remain the bread-and-butter of introductory courses.

Is it true that “gains from trade” and “efficiency properties of market outcomes” are the right guiding principles, or are there scenarios where they just aren’t worth it?

When the current crisis became so obvious that the financial elites couldn’t convincingly deny it, their first step was to bray about the dangers of protectionism, and the necessity of restoring the banking system. This was reinforced in the media, which never even offered an explanation of why either would be a good plan. The hired hands of the financial elites, Paulson and Bernanke at first, and now Geithner, set about trying to restore their failed business model, with its violent trading of financial “products”, securitization, stupefying pay levels and the whole thing. Their goal was to restore the status quo, in all its rococo glory. No one in power is asking why, or whether the benefits are worth the costs, and despite his claims to the contrary, the President isn’t listening to anyone who thinks there might be another option.

It’s a holiday, let’s play. So, there’s this book, A Theory of Justice, by John Rawls, dear to the hearts of many liberals. Rawls offers principles from which we can judge social structures:

First Principle: Each person has the same indefeasible claim to a fully adequate scheme of equal basic liberties, which scheme is compatible with the same scheme of liberties for all;

Second Principle: Social and economic inequalities are to satisfy two conditions:

1. They are to be attached to offices and positions open to all under conditions of fair equality of opportunity;
2. They are to be to the greatest benefit of the least-advantaged members of society (the difference principle).

That last idea, the difference principle, is the fundamental idea of liberal economics. We start with the knowledge that people have different levels of skills and capacities. Those differences can be used to improve our lives. If we have an opportunity to change our social structures or our economic arrangements, we judge whether to do it by checking to see if it benefits everyone, especially the least advantaged.

Let’s examine the last 30 years using the difference principle. In the period 1947-1980, as productivity improved, workers got a share of the increased economic output.


The chart above shows how that worked, and shows that the change began under Reagan. Productivity increased from 1980 forward, but the median wage stayed flat. The gains went only to the rich.

Wages of the top 1%

Wages of the top 1%

This pair of charts is a concrete demonstration of the failure of American society to meet the difference principle. The changes in social relations and economic arrangements under Reagan and the first Bush were not in any significant way adjusted under Clinton, a third way kind of guy. Then, under the second Bush, change really got going. The radical changes brought about under the Republicans and their enablers from the money wing of the Democratic party didn’t benefit the least advantaged, or anyone else except themselves. As Elizabeth Warren noted in the most recent report from the TARP Congressional Oversight Panel, in the current recession households have lost 20% of their net worth, after a recovery in which they were treading water.

Those changes were justified on the basis that they increased economic efficiency. That principle was enough for Alan Greenspan, Robert Rubin and the rest of the Wall Street class. Apparently that hasn’t changed under the current administration. The calamity they created by strict application of that rule certainly hasn’t changed Mankiw’s mind. How much failure and disaster will it take before we consider alternatives to market efficiency as the principle measuring tool for social change?