Frank’s Case Book

It is nearly always trivial to construct a theory that explains past observations. It is far more difficult to construct one that explains past observations and makes accurate predictions about the future. When a prediction is successful it lends great credibility to the original theory. Tony Blankley’s examination of the threat of the expanding culture of radical Islamofacism in Europe in The West’s Last Chance: Will We Win the Clash of Civilizations? published in September 2005) meets the prediction test. He foresaw much of the present violence before it happened.

There are two competing, though not entirely exclusive, explanations for the recent two-week (and counting) eruption of violence in France, and to a minor extent in other parts of Europe, perpetrated by Islamic youth: social or ideological explanations.

The social explanation is that Muslims predominately from North Africa have been the victims of racial discrimination in France. This second-class status coupled with economic stagnation and high unemployment rates has created alienation, frustration, and resentment. Joel Kotkin in Opinion Journal reports that the unemployment rate among those in their 20’s in France is 20% and among the immigrant population it could be twice that figure. Kotkin favors the social explanation for French violence.

When two youths were electrocuted while purportedly hiding from police in a power station, smoldering dissatisfaction ignited into full-flamed rioting in over 300 cities. The violence destroyed thousands of cars and many buildings including schools and day-care centers. As of this writing, violence is continuing, but ebbing in intensity.

As disheartening and challenging as such social problems facing these youths are, they are not existential in nature. Such problems do not challenge the stability and structure of French society. It is possible to conceive of straightforward French policies to mitigate the outward manifestations of discrimination and alter economic conditions to alleviate unemployment. If this violence is a metaphor for the Muslim minority banging on the door demanding to be allowed into the mainstream of French society, then presumably the rest of the French need merely to find ways to welcome them in.

The second explanation for the recent violence is ideology, rooted competing visions for the future of France and Europe. Blankley’s thesis paints a pernicious picture. According to Blankley, the problems in France and to a lesser extent Europe are not garden variety social troubles. The discrimination and economic challenges are real and difficult enough but they are being exploited by a radical Islamic ideology. Blankley draws a comparison with the rise of Nazism in post World War I Europe. Humiliated Germans, impoverished by excessive reparations and hyperinflation, easily embraced Nazism and the ironic combination of a notion of inherent superiority and a belief in unjust victimhood. As Blankley explains, “Just as the Nazis reached back to German mythology and the supposed Aryan origins of the German people, the radical Islamists reach back to the founding ideas and myths of their religious culture.”

Not all Muslims or even a plurality are radical Islamists, but such a view is endorsed by a large enough minority to intimidate others. These radicals are not knocking on the door asking to be allowed into the French culture. They despise the ethnic French and seek to establish areas under the control of Islamic culture. The parents of some of these ethnically North African Islamists may have come seeking assimilation, but the French-born French-speaking second generation is in danger of being co-oped by Islamofascism.

The conventional explanation of economic and social class conflict in Europe is not sufficient to explain events such as the murder of Dutch film maker Theo van Gough who made a movie exposing physical abuse of Muslim women. They are insufficient to explain the creation of “little Fallujahs” where ethnic French and even the police fear to enter. Blankley predicted the rise of Isalmofacist violence, whereas the previous conventional wisdom held that generous French welfare benefits would have precluded large scale violence.

Buttressing Blankley’s argument that the riots were not just about social economic problems, Newsweek reports that rather than shouts of “Jobs” the rioters in France were shouting “It’s Baghdad here… Now this is war… Jihad.” Of course, it is impossible to determine whether such rhetoric is just calculated to scare authorities or whether it represents the first steps toward a real insurgency.

The rise of this radical ideology is compounded by demographic momentum. Ethnic Europeans are not reproducing themselves and their mean age continues to grow. The birth rate in the Muslim and immigrant communities is very large. Over the last few decades the Muslim population in Europe has grown to 20 million. In coming decades, these new citizens will play a larger and larger role in French and European politics. Unless ways can be found to meaningfully assimilate first and second generation Muslims, economically, culturally, ideologically, and politically, we may just be seeing the beginning of many more decades of violence.

Back in 1993, when Vice-President Al Gore represented the Conservative end of the then more Conservative Democratic Party, he debated millionaire and former presidential aspirant, Ross Perot on Larry King Live about the virtues and disadvantages of the North American Free Trade Agreement (NAFTA). The pact eliminated most trade barriers between the United States, Canada, and Mexico. NAFTA passed with the strong support of President Bill Clinton and Republicans in the House of Representatives. If only Democratic votes had counted, NAFTA would have failed in Congress. The vote marked the beginning of the end of the post World War II bi-partisan consensus in support of free trade.

In 1993, Perot cleverly used the metaphor of a “great sucking sound” to represent what he predicted would be the effect of NAFTA on US employment. Instead, the great sucking sound was the precipitous deflation of Perot’s pumped-up argument. When the Perot-Gore debate was held in October 1993, the unemployment rate was 6.8%, having decreased from a high of over 7%. During the subsequent years, the unemployment rate plummeted to a nearly all-time low of 4% and now is an historically low 5%. During a most recent recession, the unemployment rate peaked at only 6.3%. If someone had predicted such numbers for the unemployment rate for the years following 1993, they would have been labeled as unrealistically optimistic.

Now, it is at least plausible that without NAFTA the employment numbers would have been even rosier, but that was certainly not the implication of Perot’s rhetoric. Perot’s clever metaphor would have not had the same saliency if he argued that employment will decrease rapidly, but less rapidly with NAFTA. Twelve years later, it is fair to conclude that Perot was radically wrong. Free trade with Mexico and Canada is consistent with a vibrant and growing United States.

In addition, the reduction of unemployment in the US did not come at the cost of a reduction in wages. From 1993 to the present there has been an increase in real per capita income and median household income. These increases came in the face of downward wage pressure caused by high levels of illegal immigration.

NAFTA has not proven to be as advantageous for Mexico as first anticipated. Much of the growth in US imports has not come from Mexico, but rather from China. Mexican low wages were not sufficient to guarantee its success. Mexico, like China, must be willing to free up entrepreneurial forces from excessively regulatory and corrupt bureaucracy.

This week, Congress by the narrowest of margins and aided by creative time stretching, passed the Central American Free Trade Agreement (CAFTA). Similar to NAFTA, the agreement eliminates or reduces trade barriers between the US, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and the Dominican Republic. Classically free trade in net benefits all trading partners, increasing economic efficiency and living standards.

However, even if the economic benefits for the US are marginal, it is hard to imagine opponents of CAFTA could believe that there could be much negative economic impact in trade with countries whose total gross national product (GDP) is less than 2% of the US GDP. The experience of NAFTA certainly does not support such apprehension. Moreover, the effect of trade will have the important foreign policy benefit of improving the economies of our neighbors and thus enhance their political stability. Whatever minor effects, positive or negative, there will be on the United States, free trade with the US will undoubtedly improve political and economic prospects for Central America.

Ironically, it is Democrats and the Left who claim concern for the poor of the world. Yet, there is no faster way for the developing countries to grow than by international trade. In latter half of the twentieth century, Japan, Europe, Taiwan, and South Korea recovered in a world of free trade. China and India are now growing rapidly fueled mostly through trade. Pouring aid into undeveloped countries made help in an acute disaster, but in the long run can have a debilitating influence. This is particularly true if aid enriches corrupt dictators rather than providing relief or assisting development. Trade, in general, and CAFTA in particular are the best ways to spread and share prosperity with Central America.

The disappointing aftermath of the CAFTA vote is the realization that most Democrats and many Republicans apparently see a fearful and apprehensive America, trembling at the economic might of Costa Rica. This is not the attitude that created an America that generates 25% of the world’s GDP. Rather, it is a vision that says more about the Congressmen and Senators who oppose CAFTA than it does about the United States. It is a vision that panders to fears, rather than appeals to hope.

There are at least two common misuses of economic statistics in public policy: the belief that the science of economics is capable of making long-term predictions with any degree of accuracy, and the use of absolute economic statistics without context or proportion. These mistakes are even made by those who ought to know better.

Economists should never commit their predictions to paper, where they can later be checked. In a September 1982 memo to Martin Feldstein, the Chairman of President Ronald Reagan’s Council of Economic Advisors, Princeton Economist Paul Krugman and presently a NY Times columnist, with colleague Larry Summers who became Secretary of Treasury in the last two years of the Clinton Administration, marshaled their MIT/Yale/Harvard educations to make a now embarrassing prediction. Inflation had just cooled from over 10% to just under 6% and these professional economists confidently concluded “…that it is reasonable to expect a significant reacceleration of inflation in the near future…Our very rough guess is that correction of … distorted relative prices will add at least 5 percentage points to future increases in consumer prices… This estimate is conservative…” This would have put inflation back to over 10%. The 1932 graduate in economics from Eureka College, Ronald Reagan, followed his own counsel. Contrary to learned predictions, inflation continued to drop and remained 5% and lower (mostly lower) for the rest of the decade.

One measure of the maturity of a science is its ability to make accurate predictions. Astronomers can tell us the position of the moon will be centuries in the future with great precision. Other sciences are less mature. Meteorologists are largely constrained in their predictions by limited measurements of the present state of the atmosphere for predictions. Meteorologists can perhaps make predictions up to a week or so before the use of climatology is just as accurate.

What made the Krugman-Summers prediction so disappointing is that one could have made a more accurate prediction using the simple assumption that, in the short term, current trends would continue. Even the simpler assumption that things would not change from their current state — persistence — would have been more accurate. Modern scientists are usually able to bound the accuracy of their predictions, specifying increasing uncertainty as the prediction horizons increase. This is discipline and humility is too often lacking from economic predictions.

Last year, the government predicted a $426 billon budget deficit for 2005. We are now in 2005, additional data have come in, and this week the budget deficit estimate for this year was just reduced by $94 billion. This means that while pundits argue about the budget deficits years in the future, there is a demonstrable 22% error in budge deficit estimates less than a year old. The predictions of $500 billion deficits as a result of the Bush tax cuts never materialized. If the deficit predictions had been underestimates, one can be sure that this information would be ammunition in Liberal punditry against the Bush Administration. The rapid decrease in the budget deficits, will, of course, be duly reported, but will certainly escape notice of all but the most attentive.

Even when predictions are accurate or even when economic statistics of the past are presented, context is often not provided. Since the economy grows over time, the absolute value of economic statistics will continually dwarf those of the past. During good times, the absolute amount of dollar growth in the economy will be larger than that of the past, just as the dollar amount of declines will be larger. Relative values are to providing context. Fortunately, for inflation and unemployment relative numbers are usually given. We concern ourselves less with the absolute price or employment level, but with inflation and unemployment rates. Such is not typically the case, when budget deficits are the cited.

The true measure of budget deficits is relative debt load and whether this load is increasing. By analogy, which is a preferable economic situation for an individual: a $100,000 mortgage with a $100,000 income or a $150,000 mortgage with a $200,000 income? Most would choose the latter, because the debt is smaller in comparison with the ability to pay. One normalization of federal debt is the debt-to-Gross-Domestic-Product (GDP) ratio. In 1946, in the aftermath of World War II, the total US debt was $223 billion, tiny compared to the nearly $8 trillion present debt. However, the GDP was far smaller. In 1946, the debt-to-GDP ratio was 121%, a tremendous burden on the economy. In 2005, the debt-to-GDP ratio is just under 65%. This value puts the US pretty much in the middle of debt-to-GDP ratio for the largest modern economies. The European Union, as whole, has the debt-to-GDP ratio of 79%, with the values for France and Germany of 74% and 72% respectively. The United Kingdom’s debt load is smaller than that of the US at 46%.

When there is a budget surplus and the economy is growing, it is clear that the debt load is decreasing. It is also possible for the debt to be growing, but if the economy is growing even faster, the debt load decreases. It is even, in principle, possible to have a budget surplus, but if the economy is contracting faster than the debt, then the debt load actually increases. For perspective, the attached figure shows the relative debt load with time. Recent budget numbers suggest that debt load increases are moderating. Indeed, last year’s projection predicted the 2006 budget deficit to be $390 billion. Given the recent $94 billion reduction in the current 2005 budget deficit, we will likely also see a downward adjustment for the 2006 budget deficit. Indeed, if the growth rates continue as projected, always an uncertain prospect, the budget deficit would have to be $441 billion in order for the debt load to increase in 2006. At the risk of making a reckless and irresponsible one-year projection, 2006 will see a decrease in the US government’s debt load. The only consolation in venturing such a prediction is that it would be harder to be more wrong than Krugman and Summers turned out to be.

“Grant me thirty years of equal division of inheritance and a free press, and I will provide you with a republic.” — Alexis de Tocqueville.

When Alexis de Tocqueville penned Democracy in America after his travels through the United States from 1831-1832, he noted the salutary consequence of the fact that the young republic had no law of primogeniture, passing estates intact solely to the first born. Since the first born cannot count upon inheriting his father’s estate, it is harder for landed estates to perpetuate through generations. Sons of the wealthy might realize some advantage from their affluent start in life, but one important consequence of the division of inheritance is that most heirs would have to make their own way in the world and could not rely on inherited wealth. This recognition encourages the individual industry and ambition that helped girder rapid American economic growth. The American economy is the beneficiary of this rigid meritocracy.

Some current Americans of a redistributionist bent are wont to cite de Tocqueville, usually an authority reserved for Conservatives, in defense of draconian inheritances taxes. Their argument is that inherited wealth robs heirs of their ambition and the country of the exertions of these heirs. The confiscation of estates is necessary for a robust economy.

Such an argument might be persuasive if wealth tended to propagate in families generation to generation. This is empirically not the case in the US. The current division of inheritance among children mitigates against accumulations of great wealth over many generations. In the US, there is large wealth mobility with the rapid and frequent migration of individuals from the lower to higher percentiles in wealth, while others descend this ladder. For example, according to Kerwin Kofi Charles and Erik Hurst [1], 20 percent of parents in the lowest quintile of the parent’s wealth distribution had children rise to the top two quintiles. They further found that, “Age-adjusted parental wealth, by itself, explains less than 10 percent of the variation in age-adjusted child wealth.” According to economist Bruce Bartlett [2], 80% of US millionaires acquired their wealth without benefit of a financial inheritance. Most wealth in the US is accumulated from privately-owned businesses and personal savings. The argument that we need more economic mobility is not a sufficient excuse for more severe inheritance taxes.

The economic impact of inheritance taxes is more limited than Conservatives believe or Liberals wish. The very wealthy can usually manage to create trusts and devise other mechanisms to avoid taxes on the generational transfer of wealth. Unfortunately, inheritance taxes hit most severely on the modestly affluent, especially the owners of small businesses who don’t realize that they have really accumulated substantial wealth. The inheritance tax is less a tax on wealth, and more a tax on the neglect to properly estate plan.

Inheritance taxes should be limited or repealed less because of any economic impact and more because of what they do to the cohesiveness of families. If we sever one generation from another by large inheritance taxes, we accelerate the process of atomizing individuals, unfettering people from civilizing familial bonds. If we can expect little help from our parents or children, we grow in dependence on collective provision. If we need help, we become more and more dependent upon government. This is the underlying principle of redistributionist policies.

There are many forces in modern culture that split apart generations and attenuate familial bonds. Although we can communicate over long distances easily, it is no longer the case that parents, children, and grandparents live close together. Modern media and the Internet exercise increasing, and many times negative, influences on children. The increasing probability that children grow up with multiple sets of parents weakens and even destroys family relationships. Inheritance taxes are just one more means of splitting generations, one way more of creating a society composed only of individuals and the state without the benefit of mediating institutions like families.

Part of growing older is the wish to perpetuate our influence down to our children and grandchildren. We certainly do this most effectively in intangible ways, in what we have taught by our words and actions. Yet the ability to grant an inheritance, to control the distribution of our wealth remains important. Indeed, it is a desire to extend our influence to the following generations that motivates some people to build and preserve wealth beyond what they personally can consume. This is the intuitive reason for the growing unpopularity of inheritances taxes.

References

1. Charles, Kerwin Kofi and Erik Hurst, “The Correlation of Wealth across Generations,” Journal of Political Economy, 111 1155–1182, 2003.
2. Bartlett, Bruce, “Death, Wealth, and Taxes,” The Public Interest , Fall 2000.

At over $55,000 per year, the state of Maryland enjoys one of the very highest household median incomes in the country. It is reasonably well insulated from business cycles by its geographical proximity to that well spring of spending: the federal government. Yet despite this, Maryland is running a budget deficit. Its government is so poorly run that Nathan Chapman Jr. a money manager was found guilty of defrauding the state retirement system last year. With this background of achievement, it is no wonder that the legislators of the state feel competent to tell Wal-Mart how to run its business.

This week the Maryland state legislature passed a bill directed against Wal-Mart. The bill specifically states that any private company in Maryland employing more than 10,000 people must spend at least 8% of its payroll on health care. Although there are a couple of companies as large, Wal-Mart is the only one for which the bill has any relevance.

Wal-Mart provides benefits for most its full-time employees. Wal-Mart’s strategy is to hire relatively few full-time employees with full-benefits supplemented by part-time employees including those elderly greeters at the front door who are, in many cases, covered by Medicare. This formula of efficiency and low prices has worked for Wal-Mart which has seen spectacular growth.

Many states will make foolish specific concessions to companies like Wal-Mart to entice them to enter. Maryland must be pretty well off if it not only eschews these advantages, but latches on to the anti-corporate Left-wing zeitgeist and directly penalizes Wal-Mart.

One might have been sympathetic if Wal-Mart were intruding into a small area and driving out Mom and Pop operations, while assuming monopoly control with their relentless efficiency. In the case of Maryland, however, the largest anti-Wal-Mart whiner is Giant Food Corporation that had grown fat in a grocery market oligarchy it dominated until Wal-Mart moved in. So the Maryland legislators get to have it both ways: They hobble the competitor of a politically-powerful Dutch-owned company, Ahod, the parent company of Giant, while at the same time congratulating themselves for championing the working class.

One indication of how little thought went into the legislation is the fact that it is rather poorly crafted. Should the measure of health care be the cost? Though health care has certainly improved over the last decade, costs grew faster. What if Wal-Mart was able to provide a medical plan superior in coverage to a more expensive plan at the cost of 6% rather than 8% of payroll? Maryland’s legislature again revealed the Liberal tendency to measure effectiveness as money spent rather than product or service out.

Wal-Mart’s present status with respect to provision of health care is complicated. The Maryland’s Citizen’s Health Initiative claims Wal-Mart spends 3.5% of its payroll on health care. While Wal-Mart claims that 56% of its workers are covered through its medical plan, while 86% are covered through medical plans of some sort: medical coverage through a spouse or some other alternative.

Wal-Mart with its 15,000 employees in Maryland now has several non-exclusive choices in complying with the Maryland law. They could just pass on additional costs to consumers, hurting customers that tend to be working class people for whom price is critical. Wal-Mart could partially balance increased health care costs by laying-off workers to meet the legislatively mandated 8% number. Or, they could meet the 8% legislative mandate by increasing the generosity of health care benefits for higher-paid full-time workers and still ignore part-time workers.

Most likely they will employ some combination of the above. The immediate loser may be the less-affluent Somerset County, Maryland. Wal-Mart had planned on building a distribution center in the county that would employ 1,000 people. Wal-Mart is now reconsidering these plans. Fortunately, for the Maryland legislature, those potential employees probably do not realize that they lost prospective employment. Maryland legislators can still sip wine at the cocktail parties while they congratulate themselves on their moral sensitivity in using someone else’s money to stand up for the working class. They should be so proud of themselves.