Author or Economist - Greg Mankiw and the Principal-Agent Problem

October 7, 2014
Posted by Jay Livingston


Greg Mankiw regularly comes to the moral and economic defense of the very, very, very rich (here for but one example). He himself is also rich (though without the verys) thanks in part to his best-selling economics textbook.

(If you haven’t been a student for a while, you might think that the $286.36 is not a misprint. It isn’t.)

Planet Money recently asked why college textbooks were so expensive (the $286 for Mankiw’s 7th edition at Amazon is actually $17 less than the price on the 6th edition). Their answer: the principal-agent problem. The student (i.e., the principal)  shells out the $286, but the decision as to which book the student must buy is made by the professor (the agent). The agent need not care so much about price; it’s not his own money that’s paying for the book.

The result is that textbooks cost much more than they would in a market where students were free to make their own consumer decisions or where the agent paid attention to price.*  So Planet Money asks bluntly if a textbook author is “making more money than he should.”

It’s an economics question, and since Mankiw’s is the best selling economics textbook, Planet Money called Greg Mankiw.  But it seems that the person they reached was not Greg Mankiw the Economist. It was Greg Mankiw the Author.

Mankiw the Economist might have answered that yes, in a market that operated according to ideal principles, textbook prices would be lower. Under the current system, authors, publishers, and bookstores are getting “rents.” They are making more money than they should.

Instead, the answer came from Mankiw the Author, who justified his royalties in two ways:

1.  Hey, lots of people get away with this. It’s “not unusual” said Mankiw. When our doctor recommends a procedure, when our auto mechanic picks out the replacement parts, when our contractor buys materials – in all these areas and others, we “rely on someone else to look out for our best interest and . . . help us make an informed decision.”  The Planet Money reporter pointed out that health care, car repair, and home contracting are precisely the areas where people complain about getting screwed by their agents. So yes, it’s not unusual (as economist Tom Jones might have said, “It’s not unusual to be screwed by anyone”). But it’s still an economic and moral problem.

Mankiw does admit that “there’s a risk” that the agent will not “do due diligence.”  “But a good professor would do that.”

Economist Mankiw would, I hope, point out that the principal-agent problem is a distortion of the market.  It puts the agent in a position of inherent conflict of economic interest, and conflicts of interest make it harder for people to be virtuous. Mankiw the Economist might even recommend a free market that does not rely on the virtue of the agent (“a good professor”). But Mankiw the Author has no problem with the current system.

2.  Hey, no big deal – it’s just a few bucks.  For students, Mankiw says, “the biggest expenditure is not money, it’s time. Giving them the best book. . .  is far more important than saving them a few dollars.” 

Mankiw the Economist might have said that those “few dollars” are excess profits. Whose pocket those dollars should wind up in is, of course, a moral question, not an economic one. But in his writing in defense of huge salaries and low taxes for CEOs and hedge-funders, Mankiw blends the moral into the economic, so it’s interesting that he omits it from his discussion of textbook prices.

The Planet Money reporters, to their credit, turned to other economists (who are not also textbook authors), and they looked at a different textbook market – high school. In college, the student is not the one who decides which book to buy, the professor is, and profs don’t have to worry about price. In any case the student is buying only one book. Not a lot of leverage there. 

But with high school texts, the school district is both decider and buyer.  Unlike the professor-as-decider (agent), the school district as decider-and-buyer (agent and principal) does care about the price. A lot. The school district is also buying those books by the carload, so it can exert some pressure on price.  Consequently, publishers’ profit margins on high school books are only 5-10%. On college textbooks, profits are closer to 20-25%.

I’m sure that Mankiw’s book is a very good book, and Mankiw himself sounds like a nice man. But if you want to know about who wins and who loses in the principal-agent problem, maybe your primary source of information shouldn’t be the agent.

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* If the professor is the author of the book, his economic interest runs directly opposite to the interests of the student. The more money he can make the students pay for the book, the more money he makes, so we have the principal-vs.-agent problem. Some schools, including Montclair State, have policies aimed at preventing professors from making money in this way. I think it’s a New Jersey state law. I do not know if Harvard requires Mankiw to give up the royalties that come from sales to students in his courses.