Entries from August 1997

Misunderstanding What Inflation Is And Where It Comes From

David Frum August 23rd, 1997 at 12:00 am Comments Off

Last week, Big Labor won its first strike against a U.S. company in almost 20 years. The Teamsters shut down United Parcel Service for six days. To end the strike, which had grounded 90% of the U.S.’s package shipments, UPS conceded a
substantial raise to both full-time and part-time workers, promised to reduce the ranks of its part-time employees while hiring more full-timers, and gave up its plan to remove its employees’ pension fund from the control of the notorious Teamsters.

Many economic commentators are speculating that the union’s win means the long spell of near-zero inflation is coming to an end. The Teamsters’ victory, they predict, will embolden other workers to demand raises. With unemployment in the U.S. under 5% (in Midwestern states like Nebraska and Ohio it’s closer to 3%), managers will find it tough to say no. And rising wages, these commentators claim, will push prices up.

These warnings are entirely wrong, because they misunderstand what inflation is, and where it comes from.

UPS can cough up the extra money for its workers in one of three ways. It can pay the money out of its profits, at the expense of its shareholders. It can cut other costs. Or it can try to pass a price increase onto its customers.

The operative word here is ”try.” Not all customers will meekly accept price increases. They may switch to other companies. Or they can do without delivery services altogether. UPS, remember, isn’t competing only with the Post Office, Federal Express and a dozen other shippers. It’s also competing with the private car — instead of buying from a catalogue and having UPS deliver to you, the customer can always drive to the mall and buy the product himself.

If this agreement pushes UPS’s workers’ wages up enough to cause price increases, UPS’s sales will drop. If enough workers in enough different industries force their wages up too fast all at the same time, sales will drop across the whole
economy. The result will not be inflation, but recession.

Unless government interferes.
If a government is run by leaders terrified of recessions and willing to pay any price to prevent them, it will be tempted to do something sneaky. Knowing that excessive wages can tip an economy into recession, a government will sometimes try to pull wages back down again — not by cutting them, but by printing enough money to inflate the wage increases out of existence.

That’s exactly what happened in Canada in the late 1960s. Strong unions and booming exports to the Vietnam-war inflated economy in the U.S. forced wages up and up. By 1968-69, Canada was clearly heading toward the nastiest recession since the Great Depression of the 1930s. The clever and unscrupulous Trudeau government decided that what the country needed was a pay reduction.

But of course no democratic government can say: ”All right people: everybody’s pay will be slashed 10%.” It can, however, print 10% more money. Instead of prices staying the same and wages dropping 10%, wages stay the same and prices rise 10%. The economic effect is exactly the same; but rather than blaming the government for reducing their pay, voters blame Loblaw’s and Sunoco for hiking their prices.

Throughout the 1970s, the Canadian government repeated this stunt again and again and again. That’s why the dollar in your pocket today buys less than what a single quarter bought in 1967.

Now it looks as if private-sector wages, after a decade of stagnation, may be resuming their rise. That’s fine — better than fine. We want people’s wages to rise. That’s the whole point of our economic system. And if workers and employers miscalculate, if wages rise beyond the ability of companies to pay for them by cutting other costs or redirecting income from shareholders to employees, then the economy will go into a recession until things get rebalanced. But rising wages alone never have and never will trigger inflation. As the Nobel Prize winner Milton Friedman famously said, ”Inflation is always and everywhere a monetary phenomenon.” Translated into plain English: inflation is never the fault of workers, never the fault of employers. Always and everywhere it is the fault of governments.

Originally published in The Financial Post

Islam And Democracy Don’t Mix Well

David Frum August 19th, 1997 at 12:00 am Comments Off

In the past 20 years, democracy has spread farther and faster than ever before in human history. Now, in all the world, there remains only one large area of human culture to which democracy remains a stranger: the Muslim world, stretching from Morocco on the Atlantic to Indonesia on the Pacific Ocean. In all that vast expanse, there are today only two freely elected governments: Turkey and Pakistan. And in the heartland of Islam, in the Arab countries, there cannot be found a single freely elected government. Not every Arab government is despotic — Jordan, Kuwait, Tunisia
and Morocco are all quite mild regimes — but all are, when push comes to shove, ruled by a single man, family or party.

One of the hopes that was entertained by many when Yitzhak Rabin shook hands with Yasser Arafat on the White House lawn was that an independent Palestinian state might become the first exception to this dismal rule. Having fought so hard for freedom from Israel, the Palestinians’ friends promised, there was no way they would submit to arbitrary rule by Arabs. Alas, that promise has been falsified — if Arafat’s rule has not been as totalitarian as that of Libya’s
Moammar Gadhafi, Syria’s Hafez Assad and Iraq’s Saddam Hussein, it has been oppressive enough.

What is the problem? A fascinating new book by Bernard Lewis, the greatest living scholar of the Middle East, offers some clues. Lewis is a remarkable mind, a man fluent in Turkish and Persian as well as in Arabic, as familiar with the Middle East of Alexander the Great as he is with the Middle East of Norman Schwarzkopf. Nearing the end of his long career, he has pulled together his vast knowledge in a grand summation: The Middle East: A Brief History of the Last 2,000 Years. Without arguing the point, Lewis has this suggestion to make: the Muslim world’s problem with democracy is that Islam and democracy do not fit well together.

Lewis notes that Islam, in contrast to Christianity, forms a coherent system of rules for regulating human behavior in this world. Lewis cites a book by one of the first Muslim visitors to England, the 18th century traveller Mirza Abu Talib, and its horror at the sight of the House of Commons in action: ”Unlike the Muslims, (Talib) explains to his readers, the English have not accepted a divine law revealed from heaven, and were therefore reduced to the expedient of making their own laws… ” Of course, as Lewis acknowledges, the Islamic world made its own laws too. But ”the making of new law, though common and widespread, was always disguised, almost furtive, and there was therefore no room for legislative councils or assemblies such as formed the starting-point of European democracy.”

Islam not only inhibited the rise of democratic institutions; it prevented the emergence of the civic spirit that makes democracy work. A constitutional democracy is built on two beliefs: that the people must participate in government and that government must be limited in its powers. Muslim culture, according to Lewis, evolved in the opposite direction: participation is sinful and government’s power ought to be limitless. The Muslim clergy have taught from the earliest times that ”the state was a necessary evil, but one with which good men would not become involved.” Which meant that one had to accept that the state would be run by bad men. At the same time, because Islam never developed
a doctrine of separation of politics and faith — because it was the job of government to enforce and defend the faith — Muslim culture utterly rejected Western conceptions of personal freedom.

Is Lewis right? It is striking that even the exceptions to Lewis’ rule — Pakistan and Turkey – have been at best episodic democracies. Pakistan has an elected government now, but has been a dictatorship for most of the years since independence in 1947. Since the death of the founder of modern Turkey, Kemal Ataturk, Turkey has had three military coups, each of them aimed at beating back Islamic extremists and restoring Turkey to liberal secularism. A fourth coup seems to be brewing now.

Secular-minded people minimize the importance of religion. But the evidence is strong: European democracy owes
more to Europe’s Christian heritage than we now like to admit, and the Islamic world’s autocracy is likewise in many ways attributable to its spiritual traditions. The devout Muslim may say that this is unimportant: if Islam leads one to salvation in the next world, who cares whether it is conducive to freedom here below? But for non-Muslims, Lewis’
observations are reasons for gloom about the political prospects of almost one billion of our fellow creatures.

Originally published in The Financial Post

Perpetual Abundance And Its Discontents

David Frum August 18th, 1997 at 12:00 am Comments Off

It’s a good thing Americans have a holiday formally set aside for Thanksgiving. It means there is at least one day a year on which complaining is prohibited. Not that complaining is an altogether bad thing — America’s endless dissatisfaction is an important spur to progress — but it is often a very misleading thing. Especially in politics, where Americans are prone to complain about the problems of poverty, when the country’s most troubling problems may be based on its inability to cope well with abundance.

If one were to read through the past 15 years of popular analysis of the American economy, one would be horrified by the endless prophecies of disaster. Remember ”deindustrialization”? “Hollowing out”? “Sunrise industries” and “Atari Democrats”? Remember the savage attacks on paper entrepreneurialism and the so-called coastal economy? And all
the while, serenely ignoring the best advice of experts like Felix Rohatyn and Lester Thurow, Robert Reich and Chalmers Johnson, the American economy went chugging magnificently along.

This month is the fifteenth anniversary of the onset of one of the great booms of American history. August 1982, the month that Mexico defaulted on the debts run up by President Lopez Portillo, was the nadir of the 1980-83 slump. For a second it looked as if Mexico (and Brazil, which had sunk into nearly equally desperate trouble) would drag the
international banking system down with it. But Federal Reserve Board chairman Paul Volcker arranged an elegant bailout, Ronald Reagan signed it, and since then –with a brief pause in 1991 to digest the savings and loan debacle — the
American economy has never looked back.

In 1982, Americans produced $3.2 trillion worth of goods and services. This year, they will produce nearly $8 trillion worth. Those figures aren’t adjusted for inflation, but then, there has hardly been any inflation to adjust for. The rate of growth of the American economy has hardly been electrifying — it’s averaged a little better than 2.5 percent a year since 1982 — but it hasn’t needed to be electrifying. When you start with a big enough pile of cash and keep on adding a little bit to it every year for a long enough period of time, you end up with an absolute mountain of cash.

Many people, even now, find it hard to believe in the prosperity of the United States. The left-wing press sank so deeply
into the habit of denigration during the Reagan years that it ended by getting stuck. There’s a fascinating passage in Dick Morris’s book in which he recalls urging President Clinton’s White House staff to stop poor-mouthing the economy. He showed them a poll that divided the public between those who thought the economy was in good shape and those who thought it was in bad shape. Whom do you think the optimists are backing in 1967 he asked. Dole, they all replied.
Wrong, said Morris; they’re backing the incumbent. It’s a good story, because it suggests that, no matter what they say in public, the Clinton people deep down suspect that this is still Ronald Reagan’s economy: They want to believe the worst of it. It’s a good story too because it sheds light on an interesting curiosity of American journalism: Morris’s speech to the White House staff coincides almost exactly with the sudden collapse of interest at the New York Times in gloom-and-doom stories about “downsizing.”

As for conservatives, so many of us have become so transfixed by the — quite genuine and horrifying – problems of American society that we have become almost inured to the good news about the American economy. Besides, for those on record as having predicted that Clinton’s 1993 tax increase would plunge the country into endless economic night, the whole topic of prosperity is an awkward embarrassment, best avoided.

But this is evasive. It’s time to look America’s good fortune squarely in the face, rather than engaging in partisan squabbles over exactly who deserves credit for it. And since it’s August, the traditional season for journalistic thumb-sucking, maybe the best way to think about this prosperity is by indulging in a great bout of wholly speculative theorizing about the future.

Here’s the question: What if it doesn’t stop? What if the American economy continues to grow at its stately 1982-97 pace for another 15 years? That would imply that by August 2012, the United States will be producing $ 21 trillion worth of goods and services annually. What difference will it make?

It’s an interesting thought experiment. Many people might be tempted to answer: very little. Most Americans would surely hesitate to describe themselves as twice as rich as they were 15 years ago. Nor do the economic statistics present a very encouraging picture: In 1995 dollars, the median household brought in barely over $34,000 in 1995.
That’s a small improvement over the $32,000 median of 1982, but it’s only $65 more than the median in 1978.

In reply, it might be pointed out that the statistics are missing something. One reason that the average household isn’t doing better is that the increased national income must be divided among a rapidly rising number of households: 16 million more in 1995 than in 1982. In 1982, remember, a child born in the baby-boom year of 1959 was still only 23 and quite likely still living with his parents; by 1995, even the most shiftless boomer had long ago moved out. And those households have changed their character: Many more of them are made up of single-parent families, of individuals living alone, and of recent immigrants than used to be the case. If one looks only at those households made up of married husbands and wives, one can see income rising smartly — by 15 percent over the past 15 years.

It could also be said, as the libertarian economist Murray Rothbard once pointed out, that in non-inflationary times, living standards tend to improve more through falling prices than through rising wages. And certainly Americans in the mid-1990s seem able to afford many more things than the Americans of the early 1980s. Robert Bartley, in his book The Seven Fat Years, notes that in 1982, only 20 percent of American supermarkets stocked fresh fruits and vegetables year-round; by 1990, 80 percent did. An American’s home is a more comfortable place. Of the 94 million homes in the United States, more than three-quarters now enjoy air conditioning and more than half can boast a dishwasher. In 1982, only half the homes were air conditioned and one-third had a dishwasher. And these homes have readier access to information: not only the Internet, but CNN (celebrating its sixteenth anniversary this year), C-SPAN, Fox News, and ever-tumbling telephone long-distance charges.

Obviously, the debate over the living standard of the average American is a contentious and often murky one. But here’s something we can say for sure: One unquestionable result of the past 15 years’ prosperity has been a stunning surge in the number of Americans earning above the average. And it is this that poses the most fascinating questions about the future of the U.S. economy.

In 1982, not quite 3 million of America’s households took in more than $ 100,000 a year. This year, some 7 million
households will. If the current trends were to prevail, some 16 million households, containing almost 50 million people, would exceed the $ 100,000 mark by 2012. America, which in the 19th century created the first society in
which everyone could count on getting enough to eat, which in the mid-20th century transformed its industrial proletariat into a middle class, is at the turn of the 21st century creating the world’s first mass upper class.

Drive through the exurbs of Washington, D.C., and you see the physical evidence of this mass upper class. In Potomac, McLean, Great Falls, where once were farms and orchards, there are now thousands upon thousands of houses, each of them larger than the gentlemen’s houses that fed the pride of Jane Austen’s heroines, each of them outfitted with luxuries that would have made a Jazz Age banker goggle: garage doors that open and shut at the press of a button,
televisions in every room, climate controls that can chill a 5, 000-square-foot house to 60 degrees in a south-of-the-Mason-Dixon-line summer, refrigerators that can hold a dismembered cow, underground sprinklers to keep the grass green at the turn of a dial. Fifteen years from now, how many more miles will these lavish developments extend? Clear to
West Virginia? All the way to Baltimore?

Who are those people? What kind of country are they creating about them? There are so many of them that it seems unlikely that they hold any strong sense of themselves as an upper class. Our mental images of what it means to be rich are still formed by old movies and novels — movies and novels created in eras when to be rich meant to have leisure and employ domestic help, neither of which is true of the mass of newly affluent.

The new affluent work hard, and as for domestic help, it’s on the Census Bureau’s list of most rapidly shrinking occupations. (The bureau’s intermediate forecast suggests that America will have more PR men than domestic employees by the year 2005.) And anyway, as well-to-do as one is on $ 100,000 a year, the fact remains that successful people like that are strivers — they tend to look up much more than they look down. Compared with what they see above them, they don’t feel privileged at all. A friend of mine earns what even he considers a very handsome living at a Wall Street investment bank. Every year, the principal of the firm invites all his employees out to his Long Island estate for a picnic. My friend recalled how inexpressibly depressing it was to tour the palatial house, pass the pool, tennis courts, and orchards, and stumble upon the pen in which the great man kept his collection of ornamental goats — and to quickly calculate that those goats annually cost his boss more than his own salary and
benefits did.

How will the people living in those houses vote? It might seem obvious that they would vote Republican. But an impressive number of them declined to vote Republican in 1996, and the party has no permanent claim upon their allegiance. More and more upper-income people earn their livelihoods in ways that the Republican agenda of reduced government regulation, if taken seriously, would threaten. Why should the president of a state university vote Republican? Or the administrator of a county arts program? Or a doctor with a large Medicare practice? Or the environmental-compliance officer of a Fortune 500 corporation? Republicans often complain bitterly about the Democratic sympathies of liability lawyers. But the corporate defense bar has an equally strong incentive to wish the party of litigation well.

Well-to-do people are economically sophisticated people. They, or people like them, started voting Republican in the 1970s because they had got the Republican message that the power of government to help you economically is strictly limited. Many of them have resumed voting Democratic in the 1990s because they have absorbed the subliminal message of the Clinton campaign: Government’s power to hurt you economically also turns out to be limited. Inflation seems to have vanished forever. So have 70 percent tax rates. And so, many upper-income voters have come to believe that they can vote their environmentalist or pro-abortion opinions without risk.

Not that the Democrats are taking any chances with that disinterestedness. The Republicans are quite wrong to accuse the Democrats of waging “class war” against upper-income voters. The strange truth is that the Clinton Democrats are pandering to the newly prosperous with a zeal that would impress even the Clintons’ Indonesian friends. They may be unwilling to give them a tax cut. But they are eager to spend money in ways that redound to the benefit of the growing
constituency of the affluent — notably the president’s proposed tax credits and deductions for college tuition, the heart and soul of his second-term agenda. A $ 3,000 remission of income tax for heads of households with a freshman and sophomore in college won’t do the average migrant farm laborer much good, but it certainly would put an agreeable bump into the wallets of the newly affluent.

Will these sorts of tricks do the job? Who knows? The growth of an enormous mass of financially comfortable people is an utterly unprecedented thing. It dumbfounds all predictions. It is changing the character, tone, and style of American society in ways that we have only begun to register. It may account, for example, for late-20th-century
America’s susceptibility to hypochondriacal panic. A poorer America had more immediate worries than the dangers of secondhand cigarette smoke, firecrackers, fatty food, and unhelmeted bicycling.

But the main impact of mass affluence seems likely to be this: The explosion of affluence will accelerate the transformation of America into an ever more individualistic society — a society where ever fewer people feel the need to conform to other people’s expectations, where ever fewer people feel bound by traditional norms.

It’s possible, of course, to imagine a society where the affluent would feel themselves bound by those norms more strictly than anyone — the much maligned Victorian epoch seems to have been a society like that. But that isn’t our society. Perhaps what we are seeing is the emergence of an elite that persistently refuses to acknowledge that it is an elite — that resolutely thinks of itself as middle class and that therefore cannot easily be talked into bearing the political, military, and cultural responsibilities that elites have traditionally shouldered.

It’s always possible, of course, that the trend may bend. Economic changes as yet unknown or unimagined may redirect the benefits of economic growth from the top of the income distribution to the bottom and middle. Or it may be that, as it expands, the new mass upper class will alter its behavior and show more respect toward the traditions of its society. Perhaps the real source of change will turn out to be age: The baby boom may at last acquire some old-fashioned
gravitas and self-control as its leading edge enters its seventh decade on earth.

But it’s at least equally possible that things will continue on their present course. Which means that it will be in America
that we get our first glimpse of an answer to a question that has excited and terrified students of society since the Greeks: What will human beings do when the tremendous creative power of the human mind at last permits them to do
anything they please?

Originally published in The Weekly Standard