How big of a government can a country afford?

Size matters! The larger the government the better, right? Of course, the larger the government the more expensive it is to maintain. Is it any surprise then that the largest government bureaucracies relative to their private sector tax base are in the most trouble? It might be since many politicians argue constantly for more money, more regulators, more military resources, more Park Rangers, more police, more wind turbines, etc. Certainly, politicians elected by their citizenry would not plead for "more' if it would endanger their country or would they? They might if their constituent base was primarily government workers. The more government employees are beholden to them for a job, the more secure their reelection would be. This is why dictatorships and totalitarian regimes throughout the world have the largest bureaucracies. These massive bureaucracies sustain corrupt regimes. Mubarak in Egypt had 30% of the populace beholden to him through government service in a poor country.

This chart shows the burden for the private sector. Paying for all these government employees must come from the private sector. China's figures can be thrown out since many of their industries are publicly owned and so their figure is not comparable to the others. You can see why Portugal, Greece, Italy and even France are in trouble. Especially when you consider some of these countries have nearly 20% acknowledged unemployment. The unemployment compensation they receive also comes from the government. To make this chart more informative the 20% unemployment should be added to the public sector employment or roughly half the people in many cases are supported by taxes. You can see it would take an extremely lucrative private sector to support half the population.

Imagine what the solution is to such a dilemma. It can only occur through massive private sector expansion, but these countries are notoriously anti-business. Many of them in their excessive desire to preserve their own salaries are sacrificing the future of their own country through surprisingly personal "greed."

The other choice is to massively reduce the size of government. N Theory makes the case that government should be reduced to maximize the growth possibilities of the private sector. Diverting funds now supporting government agencies to supporting growth of private business is unlikely. The bureaucracies of most western countries are too entrenched and powerful to embrace the sacrifices necessary to encourage private sector expansion. A large displacement of government funds would be necessary to encourage private business expansion. Maintaining the status quo is the simpler path.

Is there a solution? Yes. Government services and agencies must be privatized. This will preserve or actually convert many government jobs to private sector positions. This is a radical idea. Will it work? Let’s look at probably the most difficult case and see if it is even reasonable. What happens if the military is privatized? This simply converts a national military into a private mercenary force. The military becomes an entirely defensive provider. Now, the question is how much does the citizenry want to pay for security and not one of financing misdirected national pride. The military converts to a functional requirement of society like food and energy. This means the military budget is sized to need, not ego. These are the kinds of ideas that need to be explored if western governments are to survive.

Defense of Facebook

Washington Post article on Facebook

As of today the value of Facebook has lost $40 billion since its IPO according to the Washington Post article referenced above. Although I am a Facebook user, I am not a big fan. My issues with Facebook are the same as I have with Apple products. Neither company does a good job of explaining the bells and whistles of their products. If you are a iPhone user, like I am, you probably were surprised, like I was, when you opened your new phone box and discovered a one page instruction manual. Now granted I am sure everything you could ever want to know is in the "cloud," but couldn't they have at least explained how to get to the cloud on the back of their one page instruction manual?

If you are like me and don't eat your lunch in a cafeteria surrounded by chatty classmates, your friends are not likely to share discoveries of new iPhone features. I am in a group that learns by studying an instruction manual, and not listening to friends or reading texts.

Facebook provides the same hurdle for me. I just do not have enough social interaction about cool stuff to figure it out. From my perspective Facebook lacks a mature business perspective. The first responsibility of a company is to know their customer. Knowing a customer requires categorizing and analyzing the customer so their expectations can be met. There is at least one segment of the Facebook customer pool that is not being investigated!

The second responsibility of a company is to understand what they are selling. Facebook is nearly blind in this arena. Their Mr. Magoo vision into their product offering is disconcerting. It is disconcerting since they do not explain it to their customer. One of their largest products is space for displaying photos. Why not organize photos by categories? Why not have navigation systems for the "organized" albums. Each of these add on features could be charged a fee. Aah Ha, a monetary return is invented. Will people pay to have a "cool" page? Of course, they will. Today Facebook is essentially giving away "free stuff." This is not the best strategy to make money. I know they sell ads, but everybody sells ads. Why can't they step up and do something besides cluttering each page with ads?

Facebook has done some things right, but they seem unaware of what they have created. One example is the "Like" thumbs up graphic. This alone is a brilliant idea that properly used could generate millions of dollars in revenue. I am going to avoid explaining how this could be used, because that is what I sell (organizing raw business ideas into profitable endeavors). Certainly, any "great" business analyst could take the "Like" idea and turn the money making machine into high gear. A good business is one that not only has a lot of customers, but one that sells what their customers want.

Japanese Interest Rates

Economist article

One of the baffling economic mysteries of the past twenty years is how the government of Japan is able to sell debt to their citizens at near zero interest rates.  In an article published in the Economist on August 14, 2012 titled Defying gravity the mystifying Japanese investors' motives are explored. The author explains that if the Japanese investor used rational analysis they would not accept the low yields of the country's debt. He states numerous advanced countries offer higher rates. He questions whether solvency of Japan is ensured when the countries debt is over 230% of GDP.  Even considering all those factors a Japanese investor must still be giving an unrealistic value to debt that yields less than 2% the author argues.

The author makes some good arguments, but he should read Dan Ariely's book, Predictably Irrational, to understand what is going on. The Japanese investor is not making a rational decision. Investors have the right and often do choose investments not based solely on yield. Many angel investors make investments in projects that have little chance of success, but they feel some pull to try to challenge the inevitable even though the odds are ridiculously low. Clearly, Japanese investors feel it is important to support the home team even when the returns are extremely low. The author believes the day of reckoning is getting closer for Japanese bond dealers. Step back, the motives for purchasing will not change with worsening economic conditions in Japan. The Japanese investor is on board is unlikely to jump ship.

Next, the author proposes that the reason for this anomaly is government persuasion or regulatory manipulation. This is an explanation I can support. Please see the last half of my new book, Rule of Money: a solution to the global debt crisis. I discuss the long history of government managing the economic system within their borders to benefit themselves. On the other hand, most people believe government is working to secure the public's best interests, but this is contrary to the most basic tenet of economics: we act in own best interests. People in government are no different from you and I. They are going to do what secures their future first, and then if any money is left over, take care of the citizenry.

The author concludes foretelling disaster, maybe not tomorrow, but soon. I am not so sure. The author assumes that eventually, foreign lenders will be the only recourse and, of course, they will demand higher rates. Think about it. Is it possible foreign banks might buy the debt and sell options to gain on the likely lost in value compared to the purchaser's own currency. In fact, the opportunities through the option market regardless of the face value of the debt  is always a factor. I suspect issuing debt in the future will be more about dealing the cards for another round of poker and less about the cost of the cards. The game will continue and Japan is positioned to continue playing.

Employment Rate

In May 2012 the United States added 69,000 jobs. The headline figure everyone looks for is the Unemployment Rate, 8.2%. I think the number of jobs added is the most significant, because you can compare it to the need rather than looking at the number of people looking for work at the unemployment office. For instance the population is increasing at a rate of 260,000 people per month. Since the average family size is 2.6, there is a need for 100,000 family wage jobs monthly to just keep up with the population growth. On the other hand, 300,000 people are retiring every month. All these people have jobs. So really 369,000 new job openings occurred in May. This sounds good, but the reality is over 25,000,000 people are seeking jobs. Shouldn't the United States use the 25 million position job deficit and report how the deficit decreased? Unfortunately, in the month of May it was negative. The number of positions needed increased. The increase of a need for an additional 250,000 jobs states the problem more accurately than the fact the economy created 69,000 new positions.

Most countries calculate the rate of unemployment, but they really want to know the rate of employment. Do they calculate the complement, because it is easier? Well, in fact it is more difficult. The rate of employment can be determined from figures provided by employers, whereas the rate of unemployment depends on each individual person identifying themselves as unemployed. This is a task for the unemployed that is not clear, requires uncompensated effort and is unpleasant to one's ego. Consequently, the figures are derived indirectly through surveys or trend calculations. The result is a mixed figure without much relevance to solving the social problem. It lacks veracity or detail that can direct effective action.

Let's look at one aspect and see whether it would be more helpful if the figure originated from an employment calculation or an unemployment calculation. Let's evaluate why an employee was laid off. Both methods capture the fact the employee was laid off. Countries with unemployment agencies do try to capture why an employee was laid off, but usually to determine whether the employee qualifies for certain unemployment programs. For instance, in the United States certain employees are classified as unemployed due to the competitive forces of international trade. This may qualify them for a special  training program. The solution is directed at changing the skill set of the employee.

Whereas, if the country used an employment gathering system employers would report why they are laying off employees. This information could be used by the government to make employers more competitive and enable them to retain employees.  This is an employment collection system that allows more effective and focused employment management.

Another advantage of using an employment rate is business and industry can report deteriorating conditions to government officials before the fact. Presumably, this would allow government officials to take action before the situation became critical and irreversible. On the other hand, such a reporting system could also reveal economic bubbles where employment growth was unsustainable like the Housing Bubble in the early part of the this century. 

Using an employment rate system allows data to be collected by employer group. On the other hand, unemployment data is collected by individual and is not categorized by employer groups and consequently makes seeing the macro trends more difficult.

This prompts the question: "Why is this backwards system used throughout the world?" It is the way government is organized. Government is a reactive organization. Government is not proactive. Government responds when someone or a group brings a problem before them. Governments are not managers. Governments are judges. Governments do not create processes. They judge guilt or innocence. The result is government is reactive and therefore ineffective in maintaining employment levels or meaningful statistics.

Difference between Supply & Demand and N Theory

Definitions of Economic Theories

Common economic models begin with Supply and Demand Theory. Although there are many other so called theories, the fact is most return to Supply and Demand as the starting point. For instance "Marginalism" is just the last Supply and Demand event. "Budget Constraints" are factors affecting the Supply curve. "Aggregate" theories are simply summary Supply and Demand curves. Then there are the reason consumers select a certain level of Demand. These theories include "Rational Choice," "Utility" and "Opportunity Cost" theories of consumer behavior. Their choice is still made within the confines of the Supply and Demand model. Their choice lacks meaning unless interpreted within the S & D model.

Although N Theory, Negotiation Theory, is based on a repudiation of the Supply and Demand model as the primary economic model the reasons may not be apparent. Let's contrast the two and see if the differences can be made more apparent. First, initial product pricing is set by the Seller in the S & D model. In N Theory no price is set until a transaction is consummated by a Buyer and Seller. So N Theory states "price" is set by a negotiation between a Buyer and Seller. Both participants are given equal weight in the price setting process.

The S & D model states prices changes when the quantity offerred or demanded changes. The N Theory model disregards the "quantity" theory of the S & D model and states prices change when Buyers and Sellers alter their settlement point. N theory states the reson might be the quantity offerred, but it also might be an irrational reason, or an online astrology prediction or the result of an indepth analysis of the market. The reason is not judged as important as the fact the actors changed the direction of the market. In N Theory the movement of the market is the event to be evaluated since it likely foretells future movement.

The S & D model assumes top-down control. The Seller sets the market price and enters or leaves the market to influence the direction of prices. N Theory says future sales are subject to the influence of the millions of consumers and perceptions about the overall economy. N Theory is a bottom-up economic theory. The consumer can influence the Seller to adjust her prices. N Theory is the opposite of S & D Theory.

The way in which S & D  and N Theory operate determine the main market factors that influence each theory. For S & D Theory it is the "quantities" of products brought to market. For N Theory it is the perception of the overall economy and the economic position of the Buyers and Sellers in that economy. If a Buyer believes the market for her product will grow, she is unlikely to compromise on price to try to induce a sale, but if the Seller preceives the market is degrading she might make substantial concessions to induce a sale.

This is why S & D Theory based models performed so poorly in the Global Economic Crisis of 2008 and why a consumer based theory like N Theory could foretell an impending economic collapse. Buyers and Sellers are going to begin to change their attitudes before they change their actions. An economic theory that surveys the market actors is much more likely to foresee the direction of the market before the change is reflected in the products brought to market.

Who sets interest rates?

Paul Solman in an article (link is below) about interest rates and inflation identifies three factors that affect interest rates: waiting, repayment risk, and inflation.  Then a reader in the comment section to Paul's article adds the availability of money.

O.K., so there are four factors that contribute to the variance in interest rates, but aren't we overlooking the obvious. How about the willingness of the lender to loan us the money. I know from my experience in banking that lenders evaluate hundreds of factors before making a loan: the credit history of the borrower, the collateral the loan will be secured against, the market conditions affecting the likelihood of the borrower making a profit on his loan, competition from the bank across the street, the contents of the banks loan portfolio, the business case of the borrower, the general business environment, the geographic area where the funds will be employed, etc. Granted some of these issues the bank evaluates are "repayment risk factors," but many are simply business preferences. At the end of the day the personal relationship between the borrower and lender may affect the interest rate more than "repayment risk."

In N Theory I argue it is these factors that largely determine interest rates as manifest from the two major players in the loan transaction, the borrower and the lender. It is their characteristics and their negotiation that establishes the interest rate and the economic environment in which they live. The interest rate to borrow a million dollars for a snowmobile dealership in Miami will be quite different than borrowing for the same use in Edmonton, Ontario.

The simplistic explanation of Paul Solman misses the biggest point about interest rates. He fails to consider that interest rates are set by market conditions. Of course, duration, repayment risk and inflation enter into the equation, but there are many more factors. The two most important issues are who determines the repayment risk, and at what cost will the borrower walk away from the deal. Paul ignores that interest rates are a product cost and that there are two sides involved in setting the interest rate.

First and foremost interest rates are a market negotiation (N Theory). A lender will not get her interest rate unless a borrower can make the rate fit into his business plan. Paul may grant me a few points, but I suspect his argument would be that he was referring to the interest rate set by the Federal Reserve. If his three factors are all that weighs into a interest rate, why the huge historical difference between interest rates in the past 50 years between Japan and the United States? I suspect the interest rate difference is more determined by the Japanese borrower than financial factors alone.

Should Countries Borrow?

We all know too well that countries borrow, but should they? To answer this question requires knowing why different sectors borrow. It is not solely to have more money to spend. In the case of government it is to provide services that their citizenry want. In this regard, the government sector differs from the business sector in one significant way. The business sector borrows to make a profit. The government sector does not make a profit. The motivation in the government sector is to meet a request from their citizenry. Governments react like harried parent in a Toy 'r Us at Christmas time. Governments do not evaluate whether they can afford the gift, they just make the purchase and look for a lender to support their extravagance.

The profit factor is key in answering the question of whether governments should borrow. A profit provides the monetary resources to repay a loan. Since a government does make a profit they should not borrow. A government will not have the resources to repay the loan.

I can hear you stammering, but, but .... The fact of the matter is Governments are different from businesses. Borrowing is the vehicle that drives business. Business borrows, because it is just another way to increase their profits and acquire more wealth. Borrowing is central to business activity and one of the primary ways wealth is created in a society. It is not something that should be used by the government sector.

I can hear you arguing that government borrowing is older than business. Originally, government borrowing was for waging wars and capturing territory. This activity (tribute or tax revenue) is the equivalent of profit in the business sector. When a government undertook this risky activity borrowing made sense, because the hope was funds would be generated to repay the lenders. But in the modern world governments rarely seek additional territory to replenish their Treasuries.

Most borrowing by the government sector is for providing things for their citizenry: clean water, roads, good schools, social services, health care, etc. None of these activities when managed by unrestrained government bureaucracies provide a revenue stream sufficient to repay the cost of borrowing. Consequently, they should not be undertaken by the government sector.

You are starting to see the light. Yes, all these activities can be managed by the business sector. Business management is efficient and controlled by market factors that ensure a profit and an ability to repay the loans.

Why do governments undertake to provide all these services? It is simply to ensure their citizens provide tribute or taxes.