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Former Bush economic adviser Greg Mankiw interpreted the indicators for the President. Now he explains the President's policies to CFO.
CFO Staff, CFO Magazine
June 1, 2005
Ever since N. Gregory Mankiw resigned from the Council of Economic Advisers (CEA) in February, there have been some indications that the U.S. economy is headed for a rocky stretch. First-quarter gross domestic product grew only 3.1 percent — the slowest rate in two years. Congress approved additional funding of $82 billion for the Iraq war. Interest rates have continued to rise.
Mankiw, now back at the Harvard University economics department, argues that no one indicator should be viewed in isolation. "At CEA, we took every piece of data with a grain of salt," says Mankiw, who was charged with analyzing economic indicators and explaining their import to President Bush. "You always need to sit back and take each one in a broader perspective."
In April, for example, the economy added 274,000 new jobs, the dollar demonstrated new strength against the euro, and the trade deficit reported for the prior month surprisingly narrowed to $55 billion. When all indicators are taken together, says Mankiw, "the economy is doing fine."
That optimism is tempered by caveats, most of them political. As chairman of the three-member CEA, the 47-year-old Mankiw advised the President on some of the country's most heated problems — Social Security, tax, and the burgeoning budget deficit. He warns that continuing inertia on these issues — especially entitlement programs — will have dire consequences.
Those concerns are one step removed from his current post, where Mankiw is engaged in revising his two textbooks, Macroeconomics (Worth Publishers) and Principles of Economics (South-Western/Thomson), and preparing to teach introductory economics in the fall. Truth be told, that's fine with him. "Temperamentally, I'm a professor," he says. "And one of the differences between policy jobs and academic jobs is that professors think about whatever they want to think about. In a policy job, you have to think about what needs to be thought about at that moment."
Recently, Mankiw sat down with CFO deputy editor Lori Calabro to discuss the issues that marked his time in Washington, and to offer his own thoughts of the moment.
Does the influence of the CEA vary from Administration to Administration?
I'm sure it does, but it's hard to judge. Most White House decision-making in any Administration is not in public view. When I was there, it worked very efficiently.... Essentially, CEA works as an internal economic think tank for the President.
Did you believe you had more or less influence as your term progressed?
I always felt very good about the process. I thought the right people were in the room to discuss whatever issue was pressing, and that all the options were presented to the President. Ultimately, it's his decision.
Business is being really quiet on the issue of Social Security. Does that concern you?
The business community thinks about issues that have a very direct impact. The job of the CEO, after all, is to maximize shareholder value, not to be a philosopher or king. What Social Security reform does affect, however, is the state of fiscal policy, which in turn will affect future budget deficits, as well as the level of taxation. And the fiscal health of the nation depends on dealing with the aging population.
As an advocate of private accounts, do you see a viable alternative if they're rejected?
There are two issues. First, do we want to make a transition from the current defined-benefit structure to more of a defined-contribution structure? The second issue is how to deal with the fact that the present value of promises greatly exceeds the present value of tax revenues coming in to the Social Security system. Even if we stay with the current defined-benefit structure...the numbers don't add up. So at some point, folks have to come together around such things as raising the retirement age, or more means-testing, or changing the indexation rules, or raising the cap on taxable payroll....
[As for alternatives,] I would like to see an increase in the age of eligibility for benefits. The progressive indexing proposal suggested by [former Fidelity Investments executive] Robert Pozen also has much merit.
If the funding gap is such a problem, why not eliminate enough of the proposed tax cuts to cover it?
This is the standard refrain from the Left: let the rich pay for it. The same answer seems to apply to saving Social Security, saving Medicare, reducing the budget deficit, giving health insurance to the uninsured, and so on. But let's face it: if we are going to have a government do all these things with higher taxes, then we all will end up paying more taxes to finance the larger government.
What do you expect from the President's panel on tax simplification reports?
Tax reform is an issue that can't be avoided, because of the number of people hit by the alternative minimum tax (AMT). Once they start paying it, they're going to say to themselves, "Why am I being taxed two different ways?" [My suggestion] is something along the lines of a consumed-income tax. I'm reticent to use the term consumption tax because people immediately think retail sales tax. What I really mean is an income-tax-like structure that shelters savings more. Imagine a world in which most or all savings gets 401(k)-like treatment. It still looks in some ways like an income tax, but it would really boil down to a tax on what you consumed. That's because anything you don't consume, you can put in a vehicle that wouldn't incur extra taxes by virtue of the fact that you're saving it rather than spending it.
What we have now really is a hybrid; a mutated consumption tax and income tax. We started out with a relatively pure income tax, and over time we've added things like IRAs and 401(k)s and other ways people can shelter savings. So I wouldn't be surprised if the panel suggested that further movement in that direction is a good thing.
Former IRS commissioner Charles Rossotti has suggested that overhauling family provisions, savings accounts, and the AMT would simplify the code. Do you agree?
There are really two alternatives: move in the direction of encouraging economic growth in savings or move toward simplification, which means getting rid of a variety of deductions and loopholes—broadening the base and lowering the rate. But how much base-broadening are people willing to consider? Are people willing to consider looking at the deduction for state and local taxes? For mortgage interest? You can make an economic case for looking at those deductions. Whether it's feasible politically, I don't know.
Turning to the deficit, the Administration's goal was to cut it in half in five years. Are you still comfortable with that?
You can think about the deficit over three different horizons: short, medium, and longer. In the short run, the President inherited an economy that was heading into recession, and then he had to fight the war on terror. War and recession are two times when running a budget deficit is appropriate. In the medium horizon — sort of a 5-year horizon — I think we can, through spending restraint, reduce the budget deficit. But the big issue is, really, what does the budget look like 10, 20, 30 years from now? That's where the big problems lie, with the aging of the population and growing costs of entitlements.
The easy thing, as we increase spending, would be to increase taxes. But I believe that very high tax rates are bad for the economy. One difference between the U.S. and Europe is that Europe has much higher tax rates and lower growth, which is in part a reflection of the higher tax rate. It would be very disappointing if the United States, over time, due to the aging population, went in a European direction regarding tax policy.
On the stock-options issue, were you surprised that expensing was delayed again?
I'm of the view that eventually stock options should be expensed. But to me the issue is not should they be expensed, but how should they be evaluated.... I think the high-tech community has done itself a disservice by fighting the wrong battle — over whether they should expense, rather than over the valuation formula.
So you don't buy the argument that expensing will hurt the Silicon Valley economy?
What they're basically arguing against is accurate accounting. When a company says accurate accounting will hurt the company, I say, "Well, if it is, it should."
The other issue CFOs are dealing with is Sarbox compliance. Many argue that the costs exceed the benefits. Do you agree?
A lot of this debate comes down to the role of corporate capital. Corporate capital is in some ways an astonishing institution, built on this idea that shareholders will voluntarily give their money to people they've never met and expect those people to protect it and maximize its value and give returns with a profit. What Sarbanes-Oxley tries to do is provide some balance between protecting shareholders and instituting regulations that aren't so overwhelming that [they deny managers the time to] maximize shareholder value.
I've talked to enough CEOs in the past few years to strongly suspect that Sarbanes-Oxley went a bit too far. At some point, [Congress] may want to look back and ask, How do you strike this balance?
A lot of companies are hoping that will happen sooner rather than later.
They should be careful what they wish for. It's true that Sarbanes-Oxley is far from perfect, but they shouldn't compare it to what's ideal; they should compare it to what Congress would do next.
In the middle of your tenure, you issued an economic report stating that the outsourcing of manufacturing jobs "makes sense." It caused quite an uproar. Do you still believe that?
What I said was basic Economics 101, which is that trade benefits both trading partners. The only thing new about outsourcing is the kind of economic activity that is being traded. We are used to goods going from country to country on ships or planes; we are not used to services being transported over a fiber-optic cable or over the Internet. And outsourcing is basically a form of international trade in the form of services, not goods. The economics are not fundamentally different. So what I intended with my outsourcing comments was what Adam Smith would have said, if he had seen the Internet.
Were you surprised that you became such a lightning rod?
I was surprised at the reaction. But the gains from trade are really a very interesting issue, in the sense that economists are nearly unanimous about their views — and they're nearly unanimous about almost nothing. But the general public is very divided; about half is pro-free-trade and the other half is very skeptical. Politicians want to do what's right, but even more they want to get reelected. So while members of Congress know that free trade is the right solution, they often pander to their constituents, who are a lot less convinced.
Paul Samuelson once said that the theory of comparative advantage — basically the theory of trade that we have been teaching for hundreds of years — is one of the few things in economics that is true without being obvious. The fact that trade is win-win and not a contest, and that both sides can be better off, is a surprising conclusion. But it is a conclusion that economists are pretty sure is right.
What do you want to be remembered for?
As a professor who took two years' leave and did his best to offer solid economic advice to the President. My grandparents all came from Ukraine to the United States, none of them having more than a fourth-grade education. And here they found an economic system that provided opportunities to work hard and make life better for their children. Now, here I am, a Harvard professor. I feel a tremendous gratitude to the system that allows such a thing to occur.