The first intro-to-economics class often starts with the question: why are diamonds expensive and water cheap? After all, we need the latter to survive.

The answer, of course, is scarcity, a concept at the core of economics. Diamonds are rare and water literally falls from the sky. Were there no scarcity, we wouldn’t need economics. But given that scarcity exists, we have a price system to signal the economic value of stuff — how much of it there is and how badly we want it.  

And yet, there’s a key area where prices fail us every day. They fail us every time you fill up your gas tank: Fossil fuels are severely underpriced.

What do I mean by that? I mean that fossil fuels are imposing costs on our environment, our economy, and our future that are not being captured by their price.

That underpricing has consequences. Energy costs are so low and so unresponsive to the environmental challenge we face that they send us a signal to literally keep cruising along, ignoring the pressing reality of climate change.

How is it that a discipline fundamentally based on scarcity has failed to accurately price in the damage we’re doing to our most important, scarce resource: the environment? Naomi Klein writes that the climate crisis is “born of the central fiction on which our economic model is based: that nature is limitless.”

But I don’t think the economic model fails because it denies scarcity and embraces limitless nature. It fails because of its interaction with two things in particular: 1) our tendency to focus on the present at the expense of the future; and 2) the toxic cycle of profit and influence that distorts policy making and blocks the accurate pricing of carbon.

This diagnosis matters because we need to either unjam the model and attach a sustainable price on carbon or recognize that politics as currently practiced won’t allow us to do that, in which case we’ll need to figure out other, bolder ways to fight climate change. The Green New Deal may well play a role in that alternative vision.

When price sends the wrong signal

One can’t overestimate the centrality of price signaling in market economics. The work of two of the most towering figures in the field — Friedrich Hayek and Milton Friedman — was largely premised on respecting the information in market-formed price signals and critiquing government actions that allegedly distorted such signals. In this framework, minimum wages, for example, are a huge problem as they distort/inflate the price of low-wage labor. Taxes on wages or capital similarly distort behaviors to work and invest.

But the real world shows the theory has often been found wanting. There are literally hundreds of places, both here and abroad, where minimum wages appear to have little distortionary effects on labor markets. Most recently, Trump’s big tax cut for the rich hasn’t led to anything close to the investment boom its proponents promised. To be sure, most card-carrying economists, myself included, still believe prices convey useful information. It’s just that a ton of empirical research reveals that life is a lot more complicated than the simple theory suggests.

When it comes to the environment in general and fossil fuels in particular, the price system isn’t merely failing to work. It’s sending wrong signals, and fatefully so. This is not because fossil fuels themselves are scarce. It’s because their price fails to reflect their contribution to global warming. One recent study put the gap between what fossil fuels (not just gas, of course) do cost and what they should cost, given the environmental damage they inflict, at over $5 trillion, or more than 6 percent of global GDP, per year.

Over the last decade, energy costs grew on an annual basis at a mere 1.4 percent, a touch slower than overall prices, which were up 1.5 percent per year. Last month, the average price of a gallon of gas was $2.59; 10 years prior, in September 2009, that price — in nominal terms — was an almost identical $2.55.

How can that be? Given the increasing awareness of the urgency of climate change over the past 10 years, fossil fuel costs should be higher and they should be growing faster than overall prices, signaling their contribution to global warming.

Why is the price system failing so miserably in such an important facet of our lives and our children’s lives?

Discounting the future

One hint to the answer is embedded in that phrase: “our children.” Whenever you hear a plea made on behalf of a future concern — or, in the case of climate, a present concern that is expected to worsen as time proceeds — recognize that you’re bumping up hard against our unfortunate bias toward the present.

In some ways, discounting the future makes sense. A dollar a year from now will have less buying power than a dollar today because of inflation.

That’s how too many of us appear to think about the future of the environment. And by so doing, we’re unmotivated to spend more now to stave off destruction later, a preference expressed in the resistance of policy makers and elected officials to enact policies to fight climate change.

Sixteen-year-old Greta Thunberg put not too fine a point on this shortcoming in her speech to the United Nations last month: “We are in the beginning of a mass extinction, and all you can talk about is money and fairy tales of eternal economic growth. How dare you!”

Those “fairy tales” to which Thunberg refers are often told by long-term economic projections that typically leave out the costs of climate change. Sen. Bernie Sanders (I-VT) recently upbraided the Congressional Budget Office for suggesting the economic impact of climate change would be “small” or “modest” in coming decades. The CBO responded by pointing out that relative to GDP growth, damage estimates over the next few decades look pretty small, though it admitted that “even if the economic costs are modest 50 or 60 years from now, they may no longer be modest 80 or 90 years from now.”   

There are, of course, cost estimates that could get us to dial back our tendency to discount the future. A 2006 report from the United Kingdom predicted that “if we don’t act, the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year, now and forever,” with the largest burden falling on poor countries. A recent and, given its source, somewhat miraculous example is a report from the Trump administration’s Environmental Protection Agency warning of significant losses to hours of work, heat-related deaths, property loss, destruction of roads, rail, bridges, and so on, valued at over $200 billion per year, by the end of this century.

But while these studies garner headlines for a few days, they’ve changed neither our proclivity to discount future threats nor the prices of fossil fuels.

When polluters buy politicians

So, market-driven price signals aren’t working, and our bias for the present is part of the problem. Still, under the rubric of “market failures,” contemporary economics should be equipped to deal with this type of a short circuit.

That is, when markets and people interact in ways that are harmful for human welfare, there’s a well-established economic rationale for the government to step in and fix the problem by “internalizing the externality,” meaning making the persons or institutions that are, in this case, polluting the environment pay for the damage they’re doing to the rest of us. If the price system isn’t picking up the true cost of the damage and short-sighted people — which is most of us — are okay with that, then there’s a role for government to realign the higher social cost of fossil fuels with its lower actual cost.

And yet, this realignment has yet to occur. Why not?

Part of the explanation is the toxic intersection of capitalism and money in politics. As the great fortunes of those in energy extraction industries show, capitalism creates a lucrative platform from which to profit from the failure of price signals today and our unwillingness to worry enough about tomorrow.

By itself, that wouldn’t be enough to protect the capitalists from government action to make them internalize the damage they’re imposing on the world. But when you add in the final ingredient — the fact that we have more private money in politics than any other advanced economy — you can see why we’re in this increasingly hot mess.

Is this fixable?

There is no analytical solution to this set of problems. More accurate estimates of the costs and their timing are surely useful but they will not fix the price signals or get people to react with requisite urgency.

The solution must be political — and it is here where there’s some hope.

Good, socially minded economists, even Nobel laureates, have argued for pricing carbon more accurately, but thus far they’ve been ignored. Clearly, a different approach is necessary. Which is why we really should take the Green New Deal seriously.

The GND potentially works precisely because it does not try to hit the problem head-on. It doesn’t adjust price signals by taxing carbon or try to convince people that there’s a big problem out there beyond their discounting horizon.

Instead, the GND puts action against climate change in an immediate and broad social justice context that recognizes the urgency of present needs — better jobs (many in green sectors, a way in which action on climate can be pro-growth, for the record) and health care — while plotting an ambitious course to 100 percent renewable and emission-free electricity in the relatively near future.

This is not the place to debate the viability of the GND’s goals. It is, of course, possible that the well-resourced politics that has blocked everything else so far will be able to block the GND’s initiatives, too.

But what I take from the above analysis — from the broken price signals, future discounting, and corrupt politics that have heretofore blocked the path forward — is that something big, different, and oriented toward both future crises and present injustices is required. This is what it will take to override the powerful forces jamming the economic model and, in so doing, reveal the true scarcity of our natural resources and the sustainable path to preserve them.

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities and was the chief economic adviser to Vice President Joe Biden from 2009 to 2011.

The American economy has some serious, structural problems — and the economists are partly to blame.

At least that’s the verdict of Binyamin Appelbaum, member of the New York Times editorial board and author of the new book The Economist’s Hour. In the book, Appelbaum critically examines economists’ contributions to public policy in the last few decades. Though he does recognize some of my profession’s positive contributions to American life, he is unsparing in blaming some of its most prominent practitioners for policies that have contributed to “the mess we’re in.” 

It’s a fair accusation. For decades, the dominant strain of the profession has interacted with conservative politics on a project both sides shared: cutting taxes (mostly for the wealthy), deregulating business, and aggressively steering government interventions away from helping the economically vulnerable under the argument that to do so invited “inefficient” outcomes.

The underpinnings of this “old economics” is simple. Once markets were set up and individual ownership was protected by the rule of law, individuals were assumed to interact in ways that would produce the optimal amount of goods and services that people needed and desired to consume and invest. Left to its own devices — without the interference of unions or minimum wages or food stamps or distortionary taxes — the system would generally hit this optimal equilibrium at prices and wages that matched supply with demand.

To call this the “old economics” is not to imply that it’s no longer with us. To the contrary, from the Trump tax cuts favoring the wealthy to their work requirements hassling the poor, the old principles still dominate the conservative policy agenda. (Of course, Trump himself is unorthodox, and when he ventures outside old-economics territory, as with his trade policies, he’s called out by the profession.)

That’s the bad news. The good news is that there’s a new economics that’s increasingly ascendant, one that rejects the market-centric framework and its conservative policy tools on behalf of Appelbaum’s simple but profound conclusion: “Communities can decide what they want from markets.”

That probably sounds obvious. In democracies, why shouldn’t majorities decide what sorts of economic outcomes they desire and, conversely, those they’d like to avoid? If we want less child poverty, less environmental degradation, less financial risk, less concentrated wealth, and so on, surely we could distribute, tax, and regulate in the interest of achieving those goals.

Not according to the old economics, at least not unless we’re willing to unleash inefficiencies that will unravel the benefits of the “optimal” system, distort price signals, and give rise to incentives that will steer people and capital away from their most productive uses.

To which the new economics basically says … meh. The new economics doesn’t reject efficiency, but neither does it fetishize it. It is one laudable goal among many. It is guided by Appelbaum’s recognition that “efficiency has no special claims as the primary purpose of a marketplace.”

A higher tax rate, minimum wage, or regulation might or might not ding growth — there’s evidence on both sides. But we as a community or a society might decide that because we want workers to earn living wages, the wealthy to pay a fairer share, and businesses not to degrade the environment and regularly blow up financial markets, the benefits of these policies outweigh their costs.

If that strikes you as obvious, all I can tell you is that a lot of at least marginally cool economists are finally catching up with you.

The new economics, explained

It is not a coincidence that the new economics is in ascendency at this moment. Though by some measures, inequality has not grown much in recent years, it remains at levels as high as the late 1920s, which, for the record, didn’t end well. In one of the most disturbing developments emerging from recent research, the inequality of income and wealth is increasingly associated with the inequality of life expectancy.

The assumption that self-interested firms would self-regulate gave rise to repeated rounds of deregulation that gave us what I call the “shampoo economy”: bubble, bust, repeat. The old economics wrongly claimed we couldn’t have persistently low unemployment without spiraling inflation, yet that’s precisely what we’ve enjoyed in recent years.

In other words, the new economics isn’t arising just because we want “better” outcomes from our markets. It’s also arising because a lot of the old stuff has turned out to be just plain wrong. The best way to learn more about this new strain of work is to briefly highlight some examples.

To start with the most obvious, in recent years, inequality has become a subject of legitimate study and attention in the profession. Spearheading this shift have been Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, who brushed away the dire warning by 2004 Nobel laureate Robert Lucas: “Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution.”

And they’re not alone. Raj Chetty and company’s highly influential work on mobility sits firmly in this camp. Think tanks like the Economic Policy Institute (which, for the record, predated the researchers named above), the Roosevelt Institute, the Institute for New Economic Thinking, and especially the Washington Center for Equitable Growth put inequality and broadly shared growth at the core of their work, implicitly rejecting the old-economics’ precept that growth can be either efficient or equitable, but not both. Moreover, these economists’ work is now feeding directly into policy proposals, such as Sen. Elizabeth Warren’s wealth tax.

Many who elevate and practice new economics are card-carrying members of the profession’s mainstream. The chair of the Federal Reserve, Jerome Powell, may be a lawyer by training, but he’s also the nation’s chief economist. He and the large staff of economists he oversees have taken a data-driven, critical look at the old monetary policy rulebook. For years, those rules militated against letting unemployment fall to levels where working people might gain a bit of the bargaining power they sorely lacked in slack labor markets. But the rulebook said that to allow this to occur would lead to runaway inflation.

Perhaps the simplest way to show how Powell and company are practicing a new type of economics is to note that the actual unemployment rate has been below the Fed’s own estimate of the so-called “natural rate” (the lowest rate consistent with stable prices) for over two years, and the central bank has been cutting, not raising, their benchmark interest rate. As they’ve done so, Powell has commented on the benefits of this policy stance in providing “second chances” to those “left behind,” rhetoric that suggests a renewed focus on those further down the economic ladder among our chief economic policymakers (Powell’s predecessor, Janet Yellen, made similar claims).

To be clear, they’re not rejecting the old idea that low unemployment can trigger faster inflation. But they’re both being honest about our ignorance of the precise parameters in play in that relationship, and even should inflation rise some, willing to trade at least some of that off for second chances.

Another casualty of the new economics is austerity. Appelbaum provides painful memories from the very recent past of budget austerity: the far-too-early pivots to deficit reduction in the wake of the Great Recession, both here and especially in Europe. In response to such misguided policy, Stephanie Kelton and others in the Modern Monetary Theory (MMT) movement have disseminated a highly influential and far more expansionist way of thinking about fiscal policy and budget constraints.

More mainstream economists who have little sympathy for MMT, including Paul Krugman, Olivier Blanchard, Larry Summers, and Jason Furman, have nonetheless sounded similar notes, arguing for rejecting “deficit reduction” as sound fiscal policy in and of itself, especially when its opportunity costs are inadequate stimulus for weak economies or scrimping on investments in productive public goods. (I’ve long made similar arguments.)

The new economics has also rejected the old principle that assistance to poor people invokes a tradeoff between efficiency and equity — that anti-poverty programs distort the economic behavior and choices of the poor.

There is now a robust research agenda exploring and identifying long-term gains to society from investing in a variety of supports to the poor (especially children), including nutrition, housing, income and education. My own colleagues at the Center on Budget and Policy Priorities deserve credit for this turn, as do many others like Diane Schanzenbach, Hilary Hoynes, and Nathan Hendren.

Finally, the practitioners of new economics have challenged the old notion that interventions in international trade kill the golden goose of “comparative advantage” (the theory behind the benefits of trade).

We’ve argued for much stronger safety nets to help those hurt by trade, currency interventions, trade deals that represent a very different set of stakeholders (workers, consumers, environmentalists), and industrial policies to shape the outcomes of global trade is ways that violate the norms of a status quo long embraced by international economists and politicians from the center-left to the center-right. Some of the folks you want to listen to on this front include Thea Lee, Dani Rodrik, Michael Pettis, Dean Baker, Joe Gagnon, Lori Wallach, Brad Setser, and Rob Scott.

Can new economics drive policy?

This summary just scratches the surface of a new economics that rejects the supremacy of unfettered markets (and I could’ve named many more names — apologies to those I’ve left out). Exciting work in this spirit is well underway on antitrust, patent rules, minimum wages, union power, the environment, and even the fundamental measurement of growth itself. In every case, the research is grounded in Appelbaum’s admonition about communities deciding what they want from markets.

Is this new strain of thinking as ascendant as I claim? Or could it be overwhelmed by the potent and toxic combination of economic orthodoxy and deep-pocketed, anti-government, conservative politics?

I’m confident that it will last. First, much of the work and people noted above are firmly ensconced in academia, implying that the profession has become increasingly ideologically diverse. In fact, some of the names cited above are Bates medal winners, awarded to younger economists judged to have made the “most significant contribution to economic thought and knowledge.” In other words, many of these practitioners are embedded in the mainstream.

Far more important, from my perspective, is seeing these ideas show up in the thinking of policy makers, including many of the Democrats running for office (as with Saez and Zucman’s help with Warren’s wealth tax). Many of the people and think tanks named above are offering informal guidance to various campaigns on inequality, labor markets, and trade. (Disclosure: I was chief economist for Vice President Biden, though I don’t advice his campaign in an official capacity.)

While we won’t know it until we see it, there’s a good chance that the next president will staff her economics team with non-usual suspects who are more than willing to shape market outcomes on behalf of the majority on the wrong side of the inequality divide.

Any form of social analysis that aims to be useful to society must evolve in ways that enhance social welfare, equity, racial and gender justice, and environmental sustainability. For too long, much of economics failed that test — yet its interaction with the ruling class elevated it to a powerful perch. As Appelbaum documents, the pervasive damage of this interaction has cleared a path for a growing number of economists who are busy knocking the old school off its privileged perch.

To which I say: It’s about time.

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities and was the chief economic adviser to Vice President Joe Biden from 2009 to 2011.

When it comes to President Trump and trade, it’s been all pain, no gain.

Last week began with China retaliating against a planned 10 percent tariff on $300 billion of its exports by letting its currency fall significantly against the dollar. Markets tanked. When Trump announced that he would delay implementing those tariffs, markets regained most of their losses, only to decline steeply again on more trade war fallout, including spillovers to other countries. The “fear” index, which tracks market volatility, has spiked 75 percent over the past month.

I wish I could report some upside to this war of Trump’s own choosing, but there is none. When the Federal Reverse recently cut the interest rate it controls, it cited the trade war as generating business uncertainty and dampening investment. Articles warning of the next recession cite the trade war as a contributor.

But if Trump’s trade policy has been a disaster, with the potential to do lasting damage to supply chains, trade flows, and global stability, it does raise an important question: What does good trade policy look like?

Democrats might know that they stand against Trump’s policies, but coming up with their own plan is harder than you think. For a long time, the party’s top echelon has been captive to free trade orthodoxy. Since Bill Clinton, the theory of the case among the Democratic Party’s elite has been the more globalization, the better — with mostly a deaf ear turned to the people and places most badly affected. Worse, their response to globalization’s excesses has been: “Here’s a new trade deal, much better than the last one.”

Working people were right to disbelieve them. Trade deals, which are necessary to set out the rules by which countries with different systems engage in international commerce, haven’t improved much from the perspective of working-class people on either side of the border. Who benefits from the deals is, unsurprisingly, a function of who gets to write them. For the Trans-Pacific Partnership, Obama’s signature trade pact that never did get ratified, 85 percent of those who gave direct input to US trade negotiators were from “corporate interests and their related trade associations,” according to the Washington Post.

There’s a better approach, one that avoids Trump’s reckless trade war and Democrats’ longstanding alignment with the corporate class on trade. We’ve already heard glimmers of this in the campaign, with Sens. Elizabeth Warren and Bernie Sanders having the most detailed plans thus far. Tellingly, even moderates like former Vice President Joe Biden explicitly recognize the need for a new direction for Democrats on trade. (Disclosure: I was Vice President Biden’s economic adviser from 2009 to 2011.)

The following is a rough guide for a progressive trade policy, one that aims to preserve the benefits of global trade flows while ensuring that those gains flow more equitably to working people both here and abroad. Targeted, not sweeping tariffs; an understanding of what trade deficits mean and what they don’t; export-oriented industrial policies; trade deals representing a very different group of stakeholders; a laser focus on those left behind — these are some of the foundational ideas that any Democratic trade policy should champion.

No more sweeping tariffs

Tariffs can be a useful tool, but the problem with Trump’s is that they’re far too sweeping.

An effective approach to tariffs would be more surgical. Tariffs should be targeted at specific goods that are being dumped in our country — that is, sold far below cost to capture market share.

To be effective, administrations must be willing to move quickly to go after such practices, and, in fact, presidents of both parties have done so. The way countries underprice all their exports is through currency misalignment, but tariffs are far too indirect a tool against that problem.

For example, about a decade ago, the Obama administration placed a tariff on a specific grade of Chinese tire exports, which our Commerce Department believed were being sold here as much as 200 percent below their normal market value. Importers of US poultry have long cried, um, “fowl” (sorry) against alleged dumping by American exporters. The current list of US anti-dumping investigations includes steel from India, tomatoes from Mexico, and something called strontium chromate (don’t ask me) from France.

Not as sexy, perhaps, as Trump’s tariffs on essentially everything from China but a far more legit path to fairer trade. 

The trade deficit is not a scorecard

Another problem with Trump’s current approach is that its goal is balanced trade. On the other side, globalization’s cheerleaders — the dominant center left/right coalition noted above — view trade deficits as always benign, which is also problematic.

To be sure, there are times when a growing trade deficit is not undesirable. When our economy is doing notably better than others, we pull in more imports than exports, as both our relative demand and our currency are stronger than those of our trading partners. In this way, trade deficits enable American consumers and investors to spend and invest more than we produce. And because such periods are typically associated with high employment, those in sectors that have to compete with imports can find jobs (though the quality of those jobs may be worse than the ones they lost).

But when demand is weak, trade deficits compound the problem. They’re a further drag on growth, and they’re not offset by more activity coming from the non-tradable sectors. In fact, scholars have argued, correctly in my view, that this has been a long-term factor underlying “secular stagnation”: the long-term lackluster performance of the US economy.

The policy prescription calls for a trade balance serenity prayer. First, we must admit the problem: Trade deficits are not always benign. Second, we must recognize periods when the trade deficit is hurting our markets and sapping demand that’s not being replaced from other growth components. Third, at such times, we must reduce trade imbalances by investing in our own exporters and pushing back on currency misalignment.

Speaking of which …

We need export-oriented industrial policies

Shaping globalization doesn’t mean trying to shut it down with fantasies of widespread import substitution, producing here what we’re now buying abroad. Nor does it mean hoping that more of trade’s benefits will finally trickle down to workers if only the next trade deal were even more protective of Big Pharma and international investors.

It means looking around corners to find new, remunerative, productive opportunities for American exporters to meet global demands, and positioning American producers to meet those demands. Green technology, including solar, wind, and energy storage capacity, are obvious targets, as are robotics, AI, genomics, transportation, and sustainable agriculture.

Two ways to move this process along: a) help smaller manufacturers link up to global supply chains, and b) strengthen connections between R&D and expanding production and exports into new areas.

As it happens, we already have government functions that perform both of these roles, but they need to be scaled and strengthened. The Manufacturing Extension Partnership is designed to help smaller manufacturers make both these supply and R&D connections; the 14 Manufacturing USA Institutes are public-private partnerships focused on the diffusion of advanced manufacturing technology.

Our trade competitors are already deep into implementing such industrial policies. It’s time we executed our own.

Trade deals must be written by a broader set of stakeholders

From NAFTA to the Trans-Pacific Partnership, our trade deals have not been about lowering tariffs and, you know, freeing up trade. They’ve been technical rulebooks on how to manage trading among countries with different legal, financial, labor, and environmental systems and standards.

As you’d expect, whom these rules help is a function of writes them. Thus far, that’s been investors, not workers or consumers. That’s why you find the TPP and even Trump’s new NAFTA replacement deal extending US drug patents (this, by the way, is why Doctors Without Borders opposed the TPP). This is clear protectionism, not free trade, and yet there it is in one trade deal after another.

The new rules of the road must be written by labor, environmental, and consumer advocates. Yes, there must be room for the usual suspects — investor protections are necessary if we want to see capital flow to countries with weaker rule of law than our own. But there’s no reason for such protections to crowd out the others.

Trade deal expert Lori Wallach and I wrote an essay on what the new rules of the road should include, but the way forward is through a much more inclusive, transparent processes, with enforceable rules that replace the corporate capture of the current system with ones that raise sovereign rights and labor, consumer, and environmental standards.

We must get currency right

Here’s something that’s long been missing from US trade policy: mechanisms to push back on currency manipulation. In the wake of the recent China dustup, this problem of countries holding down the value of their currency relative to the dollar to make their imports cheaper (and our exports more expensive) has been elevated. The media warns of a “currency war,” or, in economists’ lingo, “competitive devaluations” (using your currency to purchase the foreign currency you want to strengthen).

In fact, while China did for years suppress the value of its currency in a powerful and successful effort to gain a trade advantage, it has not done that for a few years now, though some other countries still do so. This includes what happened in China last week: This latest fall in the value of the yuan is market-driven, as the People’s Bank of China had been propping up the currency (when the bank stopped for a moment, it tanked).

Still, the fact that China or other large exporters are not now manipulating says nothing about future efforts, and it is increasingly mainstream thinking that we need some enforceable rules in place (besides being too late, the Trump administration’s formal labeling of China as a manipulator is toothless).

The most effective ways to push back on currency manipulation is to offset it by either taxing it, thus making it more expensive, or doing unto others what they’re doing unto us: If they buy dollars in international exchange markets to push up the dollar exchange rate, we buy the same amount of their currency to offset their misalignment play.

Truly helping those left behind

Finally, Trump has usefully blown away the false notion that everybody wins from expanded trade — though he never had any intention of truly helping those left behind. To the contrary, similar to the tilted trade deals described above, his tax plan further redistributes income upward, exacerbating the ongoing forces of inequality. A fulsome, alternative trade policy must correct this.

The two most promising policy ideas to do so are refundable tax credits to those whose earnings are too low for them to make ends meet, and subsidized employment in places where trade imbalances have long sapped labor demand. Both ideas are in play, as Democrats have a spate of tax plans that work in the opposite direction of Trump’s and job-creating programs targeting people and places where, even at low national unemployment, gainful opportunities are limited and the jobs they lost have higher value added and compensation than the ones they can get.

Of course, there are many details to flesh out. How do we recognize misaligned currencies? What’s the most effective jobs program for workers displaced by trade? What are the best sectors in which to seek new, global market share?

These are tough questions. But they’re the ones we want to be asking if our goal is to finally build a policy architecture that neither ignores nor exacerbates the challenges posed by international trade. 

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities and was the chief economic adviser to Vice President Joe Biden from 2009 to 2011.

In a House hearing on monetary policy last week, Federal Reserve Chair Jerome Powell made a telling confession in response to a question from Rep. Alexandria Ocasio-Cortez (D-NY). The topic was the so-called natural rate of unemployment: the idea, believed by many economists and policymakers, that there is a rate at which unemployment could get so low that it could trigger ever-rising inflation.

It’s an idea that has governed decades of monetary policymaking, often prompting the Fed to keep interest rates higher than it should — slowing down the economy in the process — out of fear of accelerating inflation.

Ocasio-Cortez didn’t waste time poking holes at it. She pointed out that the unemployment rate, now 3.7 percent, has fallen well below the Fed’s estimates of the natural rate, which it forecast at 5.4 percent in 2014 and 4.2 percent today. And yet, she noted, “inflation is no higher today than it was five years ago. Given these facts, do you think it’s possible that the Fed’s estimates of the lowest sustainable unemployment rate may have been too high?”

Powell’s response, to his credit, was as simple and direct as you’ll ever hear from a central banker: “Absolutely.” He elaborated: “I think we’ve learned that … this is something you can’t identify directly. I think we’ve learned that it’s lower than we thought, substantially lower than we thought in the past.”

Powell’s response was commendable, perhaps even groundbreaking; here was the Fed chair challenging decades of conventional economic wisdom. It was a welcome sign of a policymaker’s willingness to question age-old assumptions that have dictated policy and affected millions.

And it’s not the only economic “iron law” that we need to revisit. In the spirit of Powell’s act, I’d like to dig deeper into some assumptions that have defined economic policymaking these past few decades, assumptions that have needlessly caused a lot of economic pain.

The natural rate of unemployment that AOC questioned is one such idea (more on that below). There are three others worth singling out:

• that globalization is a win-win proposition for all, an idea that has deservedly taken a battering in recent years;
• that federal budget deficits “crowd out” private investments; and
• that the minimum wage will only have negative effects on jobs and workers.

Economists and policymakers have gotten these ideas wrong for decades, at great cost to the public. Especially hard hit have been the most economically vulnerable, and these mistakes can certainly be blamed for the rise of inequality. It’s time we moved on from them.

1) Going below the natural rate of unemployment could spark an inflationary spiral

The mandate of the Federal Reserve is to achieve maximum employment at stable prices. It has interpreted the latter to mean an inflation rate of 2 percent. For decades, the Fed has used the benchmark interest rate it controls to target that inflation rate, and it’s done so by trying to keep actual unemployment close to its estimate of what’s called the natural rate of unemployment — a rate below which it was believed inflation would spiral up.

The problem is that the core relationship behind this model — the negative correlation between unemployment and inflation — has been weakening for years, and with it any ability to reliably estimate the natural unemployment rate. Moreover, as Powell acknowledged, there’s been an asymmetry: Because the estimates of the natural rate have been too high, the Fed has often intervened in the direction of raising or failing to cut interest rates.

The cost of this asymmetry has been steep. Since 2009, the average of the Fed’s natural rate estimate has been about 5 percent. As Powell stressed, we can’t accurately identify the natural rate of unemployment, but suppose it’s actually 3.5 percent. Targeting 5 percent unemployment when we could achieve 3.5 percent with little risk of spiraling inflation would mean 2.4 million people unnecessarily out of work. Even targeting the Fed’s current natural rate (4.2 percent) would sacrifice a million potential workers to the altar of an empirically elusive concept.

And the unemployed are just one subgroup that gets hurt in such a scenario. Much research has shown that in slack labor markets, middle- and low-wage earners lack the bargaining clout they have in tight labor markets. As such, they face lower pay, fewer hours of work, higher poverty, and wider racial economic gaps.

By contrast, high-income households are little affected — which means that labor market slack can deepen inequality. The figure below, from a recent paper by Keith Bentele and me, shows the acceleration — the difference between wage growth in strong versus weak labor markets — for real annual earnings.

For low-income workers, we found earnings rose at about a 2 percent annual pace in hot labor markets and fell at about a 4 percent pace in cool ones (the difference, 6 percent, is the first bar). Clearly, the benefits of moving from slack to taut conditions are much more important for low- than for high-earning households.

Such are the costs of over-estimating the natural rate.

2) Everybody wins with globalization

Back in the 1990s, when the Clinton administration was trying to sell NAFTA, the view that expanded trade was virtually all upside began to pervade the rhetoric and politics of both parties. They were supported by economic arguments that exporting industries would expand into markets and add new jobs, and consumers would have cheaper goods. By dint of their superior productivity, US manufacturers and their communities wouldn’t be hurt. Any disruption to workers’ livelihoods was either dismissed as an impossibility or placed under the antiseptic rubric of “transition costs.”

This excerpt from the 1994 economic report of the president nicely captures the zeitgeist:

As economists have long predicted, freer trade has been a win-win strategy for both the United States and its trading partners, allowing all to reap the benefits of enhanced specialization, lower costs, greater choice, and an improved international climate for investment and innovation. American industries—both their workers and their owners—have benefited from increased export markets and from cheaper imported inputs. American consumers have been able to purchase a wider variety of products at lower prices than they could have without the expansion of trade.

When pressed as to how expanded trade could truly be “win-win,” advocates like Clinton’s economics team above cited the economic theory of comparative advantage: When trading partners produce what they’re best at producing, both countries will come out ahead.

But the theory never said expanded trade would be win-win for all. Instead, it (and its more contemporary extensions) explicitly said that expanded trade generates winners and losers, and that the latter would be our blue-collar production workers exposed to international competition. True, the theory maintained (correctly in my view) that the benefits to the winners were large enough to offset the costs to the losers and still come out ahead. But as trade between nations expanded, policymakers quickly forgot about the need to compensate for the losses.

The era of free trade eventually led to large trade deficits with countries with comparatively productive factories to ours but with much lower wages, most notably Mexico and China. As in every other advanced economy, the share of US manufacturing employment had long been drifting down. But the number of US factor jobs held pretty constant around 17 million — until around 2000, when, over the next decade, almost 6 million such jobs were lost. Economists who’ve studied the period now refer to it as “the China Shock.” 

Once again, these impacts didn’t just translate into just job losses; wages were hit, too. Between the late 1940s and the late 1970s, when production workers were relatively insulated from foreign competition, blue-collar manufacturing compensation more than doubled. By contrast, it’s grown only 5 percent since then.

Did the winners from trade — the multinational corporations that relocated production, the finance sector that made the deals, the retailers that profited from “the China price” — compensate the losers? Of course not. They argued that “everyday low prices” were reward enough.

But not only did the winners fail to help the losers — say, through serious employment-replacement programs, robust safety net assistance, direct job creation, and investments to make our manufacturers more competitive — they instead used their winnings to invest in politicians to cut their taxes and write ever more trade deals favoring investors over workers.

Let me be very clear. Both the US and developing countries have significantly benefitted from global trade. But because of the demonstrably false view that free trade is all upside — win-win — considerable economic pain has been meted out, pain that has not been met with anything approaching an adequate policy response.

3) Deep budget deficits will crowd out private investment

For decades, economists argued that when the federal government runs a budget deficit, it pushes up interest rates and slows economic growth. It’s a theory known as “crowd-out,” suggesting government borrowing from a relatively fixed stock of loanable capital crowds out private borrowing, which in turn raises the cost of capital — i.e., the interest rate.

But this is yet another relationship that has failed to hold up, though not before its adherents created considerable hardship, both here and even more so in Europe, through austere budget policy in the wake of the Great Recession. The belief in this idea prompted policymakers to reduce government spending to avoid alleged crowd-out effects well before the private sector had recovered and could generate enough growth on its own.

There were certainly periods in the past when crowd-out did indeed appear in the data. The 1970s and early 1980s saw larger budget deficits (i.e., more negative) and higher interest rates. But since then, deficits have swung significantly up and down while interest rates have consistently drifted down.

Most recently, we’ve been posting very large budget deficits given the state of the economy (due to both deficit-financed tax cuts and spending) and interest rates are nonetheless hitting historic lows — precisely the opposite of crowd-out predictions.

This all sounds pretty abstract, but it has stark implications on the ground. Based on the deeply embedded notion (at the time) that the deficits built up in the Great Recession needed to come down quickly, the federal government pivoted to deficit reduction well before our private sector had recovered.

As a member of the Obama economic team at the time, I can confirm that crowd-out fears were a motivation for the pivot. According to this analysis by the Brooking’s Institute, between 2011 and 2014, fiscal policy cut about 1 percentage point per year from real GDP growth. Based on the historical correlation between growth and jobs, this austerity added 2 points to the unemployment rate in those years, or about 3 million jobs.

I tend not to give Trump a lot of credit for economic policy, and I believe his tax cut will exacerbate inequality and rob the Treasury of needed revenue. But the fiscal economics of Trump’s tax cuts are revealing in ways that relate both to crowd-out and the natural rate of unemployment. As noted, deficits are up and interest rates are down. Meanwhile, the positive fiscal boost has helped drive the unemployment rate down to 50-year lows while inflation remains low and stable. These developments clearly undermine long-held economic doctrines, and they’ve been a boon to working families.

That said, a final point must be underscored: The absence of crowd-out doesn’t mean deficits no longer matter. Even with low rates, we’ll still be devoting more tax revenue to financing our debt, and even more worrisome is the fact that we’re almost certain to enter the next recession with a debt-to-GDP ratio that’s twice that of the historical norm. This will likely lead Congress to be more timid in fighting the next recession. But this is a political constraint, not an economic one.

4) A higher minimum wage will only hurt workers

Another big mistake with lasting consequences has been the assumption that minimum wage increases will hurt their intended beneficiaries: low-wage workers.

The theory is that free markets set an “equilibrium” wage that perfectly matches supply and demand given employers needs and workers’ capabilities. Force that equilibrium wage up and rampant unemployment will result. 

When I was coming up in the profession, our textbooks argued that believing minimum wages could help low-wage workers was akin to believing that water flowed uphill. Their message was particularly comforting to conservative politicians who wanted to protect the profits of employers of low-wage workers.

Today, decades of high-quality research (much of it initiated by the late, great economist Alan Krueger) have introduced a much more nuanced view about the true impacts of minimum-wage hikes. But years of economists’ opposition to the policy have left us with a national minimum wage of $7.25 per hour, a level far too low to support the many families that depend on the minimum wage. (Another myth was that only teenagers earned the minimum; David Cooper’s work shows the main beneficiaries of higher minimum wages are working adults.)

How the consensus began to change is instructive. To their credit, some state policymakers decided to ignore the economists and raise minimum wages in their states. This provided researchers like Krueger with quasi-natural experiments of a type too rare in economics. The positive results of these studies led many more states and cities to raise their wage floors (29 states plus DC now have minimums above the federal level), and this fed back into the experimental research, creating a powerful loop.

Summarizing a large and still contentious body of research, a fair conclusion is that, conditional on their magnitude, minimum wage increases accomplish their goal of raising pay for low-wage workers without large job-loss effects. But the broader point is that an economic relationship believed to be steadfast was tested and was found wanting.

The changing consensus can be seen in a new report from the Congressional Budget Office — a bastion of mainstream economics — that found an increase in the minimum wage to $15, phased in by 2025, would benefit 27.3 million workers, with an average gain of $1,500 per year, reduce the number of the poor by 1.3 million, but also cut employment of affected workers by 1.3 million. Yes, some would lose jobs, but so many more would benefit — hardly the “everybody loses” prediction that prevailed among economists for decades.

What all these economic mistakes have in common

Pegging the “natural rate” too high, ignoring the harm from exposure to international competition, austere budget policy, low and stagnant minimum wages — all of these misunderstood economic relationships have one thing in common.

In every case, the costs fall on the vulnerable: people who depend on full employment to get ahead; blue-collar production workers and communities built around factories; families who suffer from austerity-induced weak recoveries and under-funded safety nets, and who depend on a living wage to make ends meet. These groups are the casualties of faulty economics.

In contrast, the benefits in every case accrue to the wealthy: highly educated workers largely insulated from slack labor markets, executives of outsourcing corporations, the beneficiaries of revenue-losing tax cuts that allegedly require austere budgets, and employers of low-wage workers. 

In this regard, there is a clear connection between each one of these mistakes and the rise of economic inequality.

I cannot overemphasize the importance of recognizing who benefits and who loses from these economic mistakes, because that difference is why these mistakes persist. Every one of the wrong assumptions described here benefits conservative causes, from reducing the bargaining clout of wage earners, to strengthening the hand of outsourcers and offshorers, to lowering the labor costs of low-wage employers. These economic assumptions are thus complementary to the conservative agenda and that, in and of themselves, makes them far more enduring than they should be based on the facts.

It is no coincidence that the assumptions are being so rigorously questioned by a new group of highly progressive politicians, like Rep. Ocasio-Cortez. They are making the critical connections in our political economy to challenge old assumptions that have hurt working people for too long. The vast majority of us will be better off for their work.

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities and was the chief economic adviser to Vice President Joe Biden from 2009 to 2011.