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Still on the mountaintop: Economically rational racism

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Forty years ago, as Martin Luther King Jr. spoke of the Promised Land and prophesied "I may not get there with you," a quiet revolution in economic theory was beginning, which would ensure that Dr. King's hearers, except perhaps the occasional Caleb or Joshua, wouldn't get there either. The architects of the revolution didn't plan it that way, but that's the way it turned out.

The revolution concerned the relationship between unemployment and inflation. A paper by Milton Friedman, published in the month before Dr. King spoke, and another by Edmund Phelps, published a few months later, gave reason to believe that in the long term, if unemployment falls below a certain rate, inflation speeds up, whereas if unemployment rises above that rate, inflation slows down. That magic unemployment number became known as the Non-Accelerating-Inflation Rate of Unemployment, usually abbreviated by the acronym NAIRU.

By about 1980, during the term of Federal Reserve Chairman Paul Volcker, it was accepted that the aim of interest-rate policy was to create enough unemployment to exert enough downward pressure on wages to give stable (and low) inflation. That didn't mean that central bankers always aimed at a particular unemployment rate — the NAIRU — because they didn't always know what the magic rate was. But it did mean that the Fed concentrated on inflation and accepted whatever the unemployment outcome might be. And it did mean that the Fed would sometimes cite falling unemployment as a sign of rising inflationary pressure, which supposedly had to be checked by raising interest rates.

While central banks determined interest rates, governments still had a role in setting other policies so as to minimize the NAIRU. But eventually that role was limited to making life for the unemployed as unpleasant as possible, in order to maximize wage restraint for any given unemployment rate, and defining an unemployed person as narrowly as possible, so that official statistics understated the extent of unemployment. (Attacking workers' wages and conditions is also widely advocated, but harder to do in a democracy. That's one reason why some people prefer dictatorship.)

The NAIRU was more commonly called the natural rate of unemployment. Well, of course it's "natural" to define a problem out of existence when you have no intention of solving it. More recently, politicians and central bankers have started referring to the natural rate as full employment. Yes, folks: in Newspeak, "full employment" means enough un employment to cause enough wage restraint to give stable inflation.

So we're living in a system of enforced failure. A percentage of people have to be unemployed, and therefore, at the boundaries of unemployment, another percentage of people have to be underemployed or intermittently employed or precariously employed. In other words, the economy is being run in such a way that a certain percentage of people have to be losers. And people know this is true, even if they don't know why. More than half the population are too young to remember a time of genuine full employment, and those who remember know that unemployment has been a continuous problem since the early '70s.

If a certain percentage of the population must be losers, two conclusions follow. First, any attempt to equalize opportunity is a zero-sum game, in which no one can be rescued from the pool of losers except by throwing someone else in. Second, and here's the rub: if a certain racial or religious minority is large enough to contain all or most of the losers, the majority stands to gain by discriminating against that minority, because if the pool of losers contains more members of the minority, it will contain fewer members of the majority, so that persons born into the majority face a lower risk of being among the losers. Such discrimination, although immoral, is economically rational. So members of the majority will discriminate, encourage their peers to discriminate, and vote for politicians who make it easy to discriminate.

Not every minority is a suitable target for economically rational discrimination. If a minority is very small, it can absorb only a small fraction of the losers, and in so doing will not greatly reduce the risk that a person born into the majority will be among the losers. That's why, from the majority's point of view, a minority needs to be at least a certain size before it's worth discriminating against. But there are other caveats. If a certain minority consists of recent immigrants and their descendants, they're the products of a favorable selection process. Immigrants come with big plans, on which they've already taken big actions. Immigrants are guaranteed to have some "get up and go", because they actually got up and went. Their children and grandchildren inherit some of these advantages, if not genetically then at least by example. In America, that's part of the Asian story and, to some extent, the Hispanic story. Employers know this. More obviously, if a certain minority has a very strong religious or cultural commitment to education, and especially if it can supply the teachers from among its own ranks, its members will be attractive to employers, and will be hired whether the majority of workers like it or not. In America that's the Jewish story and the Catholic story, and perhaps another part of the Asian story.

But none of these stories is the Black American story. The Black American minority is large enough to supply as many losers as the economy might need. The first Black Americans were immigrants, but only because they were brought in against their will, and any "get up and go" that they had was ruthlessly suppressed. To get ahead in their new country, they needed a Western education to which they were denied access, and which they couldn't supply for themselves. And what they didn't have, they could hardly bequeath to future generations. Therefore, as unemployment became a permanent feature of the economic landscape, Black Americans became the perfect targets for economically rational discrimination, which helped to keep them in the wilderness for another 40 years.

What then is to be done?

Clearly it's no use asking the majority not to engage in economically rational discrimination, because the majority rules, and because, in a zero-sum game, the majority can't help another group without harming itself.

But what if this accursed "natural rate" of unemployment were somehow drastically reduced, without attacking wages and working conditions? As the unemployment rate fell, all ethnic and religious groups could share the benefit. That part of the game would not be zero-sum. And when the unemployment rate stabilized at the new low level, there would be so few losers, and members of the majority would face such a low risk of being among the losers, that offloading the risk onto some minority group would no longer be worth the trouble. The effort that is now spent on discrimination would then pay a bigger dividend if spent on self-improvement. Discrimination would no longer be economically rational.

So the key to the Promised Land is to reduce the natural rate of unemployment without creating a new class of working losers. To see how to do that, we must revisit some basic economic principles.

For a century and a half, capitalists and socialists argued about ownership of the means of production as if the assets that make up the "means of production" were all of the same kind. But they're not; they fall into two distinct categories. In one category are the assets can be produced by private, competitive effort. For convenience I'll call these house-like assets, although they include not only houses but also other buildings, as well as movable plant and equipment. In the other category are those assets that cannot be produced by human effort, or at least cannot be produced by private, competitive effort. For convenience I'll call them land-like assets, although they include not only land but also other natural resources, building rights attached to land, and monopolies and privileges of all kinds.

The returns on house-like assets include interest, which is the price of time-preference, insurance, which is the reward for bearing (quantifiable) risk, and economic profit, which is the reward for bearing (unquantifiable) uncertainty. Those returns are an incentive to produce house-like assets. Any tax on those returns, or on the assets themselves, reduces the incentive. Conservatives repeat this argument ad nauseam but never acknowledge that it's valid only for house-like assets.

The net returns on land-like assets are usually called economic rent. Some people prefer to call them usury. But whatever you call them, they can't be an incentive to produce anything, because no private person or corporation can produce land-like assets, while the rental values of those assets are produced not by the owners, but by the demand from prospective users. It follows that any fraction of the rental value of a land-like asset can be diverted into the public treasury without discouraging any productive activity, and therefore without raising prices. In other words, taxes on the values of land-like assets are not inflationary.

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Gavin R. Putland is a former research officer for Prosper Australia. The opinions expressed in his contributions are his own.
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