It is less about Wall Street and more about healthcare.

Question: Can anyone from either side of the aisle reasonably address the credit crisis? 

David Frum: I think when you think about the economic problems the country [USA] faces, you need to distinguish between the emergencies and then the chronic problems. And one of the things where we get in trouble in political life is when we spend so much time on the emergency, that we lose track of the longer term difficulty.

I have no doubt that the United States will successfully work its way through this credit crisis, that interest rates will be lowered, the Federal Reserve will apply money where it can. 

Ben Bernanke has done a series of brilliant improvisations; for example, he's now allowing investment banks to borrow from the Federal Reserve, which only commercial banks used to be able to do, as a way of getting capital into the markets and calming things.

I don't worry too much about the credit crisis. What I worry about instead are two deeper problems that require something more than just good emergency management. I worry about the crisis in middle class incomes, but it's wrong to call it a crisis because it's been going on for so long; but the deep reasons why a successful modern economy, and not just in the United States, but everywhere, seems to be concentrating its rewards on a few people and why so many people feel that they are left out of this.

And then I worry about the finances of the United States in that we have a really chronic fiscal problem where the country's obligations are much greater than its projected revenues. Where we're soon going to have this massive wave of retirements, where the country has written checks that it can only honor by imposing taxes on productive enterprise that are going to slow the growth of the economy and make it even more impossible to honor the checks than it already is.

When I think what am I worried about, I'm not worried that there's going to be some debacle on Wall Street that's going to defeat the Federal Reserve, I'm worried that you're going to have an audience for destructive, radical ideas because middle class people feel under pressure. And I'm worried that the United States has made commitments that it can only honor by corroding its own productiveness.

Topic: It sounds like you are talking about a Social Security Crisis.

David Frum: It's not just Social Security. 

I used the word crisis and I'm sorry, because what I mean is a chronic corrosion, a gradual weakening, and it's not just Social Security.  The medical commitments are even bigger. The United States has promised over the next 40 years to write tens of trillions of dollars of checks that are greater than the projected revenues of the United States, and that is a big problem. And if the United States tries to solve that problem by saying, "Well, we'll raise the taxes to try to honor the checks," what that will mean is it will crush the productive economy and one of the things that is one of the great arts-- I think Louis the Fourteenth's finance minister said, "The art of taxation is to extract the maximum feathers from the goose with the minimum of hissing."

Well, we're in danger of having a situation where the government is not getting very many feathers and there's a lot of hissing. And one thing to bear in mind as you look at the future of the country [USA] in the 2030s, that it's generally true that the more homogeneous a country is, the easier it is for it to be taxed to support programs.

So it's not a surprise when you look at which countries have the highest level of government involvement in the economy, they tend to be places like Denmark, Norway, Sweden, highly homogenous societies.

Canada, Australia, the United States, have the lowest because they're the most diverse.

In the 2030s we're going to have a population of young workers that is very heavily Latin American, and we're going to have a population of retirees that is very heavily white European. And it is going to be an interesting question whether that population of young workers, who by the way are not going to be very well off because their levels of education are rather lower than the levels of education of the retirees, if they're going to consent to be taxed at much higher rates than are in place now for the benefit not of their own grandparents but of somebody else's grandparents.

I think that's a formula for a lot of social tension.

Question: How do we start to address this? 

David Frum: Well, start right away. The Social Security side is the easier side. With the Social Security, we have to lower the rate at which our commitments increase.

For example, right now, Social Security benefits rise in proportion as wages rise. If Social Security benefits rose in proportion as inflation rises, that doesn't sound like a big difference, it's like three-quarters of a point a year. But it makes a huge difference to the affordability of the system.

If you can reduce it from rising in tandem with wages, to rising in tandem with inflation, you can make Social Security much more affordable.

The great nightmare is Medicare and Medicaid; and that requires some larger changes in the health care system to prevent those programs from growing at the fantastic rate they're growing. But their growth is driven by the general inflation of health care costs; you can't solve the Medicare and Medicaid problem independent of the larger health care problem.

I would say there you need to have much higher degrees of effective competition in the market place to suppress health care inflation. And we are also going to have to break it early to people of my generation that the level of public provision for us is not going to be as high as it is for the current generation of retirees. Society just can't manage it.

Recorded on: May 5 2008