Wednesday, January 25, 2012

Greece is Nearing Default and Portugal is Imploding

Europe is imploding right now and the US Federal Reserve can only watch and wait. Investors are already pricing in a Greek default, with 10-year bonds hitting a yield of 33%! And while it’s easy to dismiss Greece as the black sheep of the European Union family, there’s also new trouble brewing in Portugal.

The country simply can not any longer compete in a single-currency monetary union. According to the Bank of International Settlements, Portuguese debt is now 479% of their entire country’s GDP!

The Federal Reserve can’t paper over these problems. America’s day of financial reckoning getting closer. Instead of providing a solution, the Fed’s easy money approach — one that continually gets extended out further and further into the future — is a sign of how bad things really are in the Western world.

Sunday, January 22, 2012

The unsustainable expansion of the public sector

The current death spiral of the Western Wold economies has been caused by promises that no government will be able to deliver on a long term period. The Swedish professor in economy Erik Moberg predicted years ago that the expanding public sector could cause a serious threat to our democracy. The politicians competition for votes are inevitably driving our society to the abyss. The conclusion by Moberg is that favors to particular target groups may be quite profitable, and are more likely to be more profitable in the parliamentary, proportional setting than in other constitutional contexts such as the US presidential constitution with plurality.

Today the work of Moberg and the International Joseph A Schumpeter Society is more important than ever, since several countries apparently are running out of other peoples money that has paid for good welfare gifts to the voter base. Countries like Greece has already run out of funds and states like California are close to experience the same destiny.

Already in 1992 Moberg proved that Sweden, in spite of rapidly expanding total public expenses, the share of those expenses used for collective goods has, over a long period, and except for the time of the second world war, been fairly constant in-between 3–6%. The balance of public expenses has consequently increased continuously and has been used for individual goods or redistribution of wealth. Moberg suggests that public means are extensively used for buying votes. Sweden has a parliamentary constitution with proportional elections. In such a system parliamentary incentives for discipline are absent. Thats most likely the reason for that Sweden has progressed faster than US. But, although the public sector probably expands more slowly during normal times in the US presidential democracy than in a parliamentary democracy such as Sweden with proportionalism, it may nevertheless be more difficult to reverse the expansion in US.

Even if the expansion of the public sector is relatively slow due to the US presidential constitution with plurality, it is still important to design the constitution with provisions that automatically contain public sector growth. US Congressman Paul Ryan has suggested a cap on total government spending, that establishes a binding cap on total spending as a percentage of GDP at the levels projected to result from this legislation. In addition he has suggested to introduce a discretionary caps, enforced by sequestration, to freeze non-defense discretionary spending.

To ensure that the US economy over a long period of time could be strengthen the introduction of direct-democratic procedures like in Switzerland would reduce tax avoidance and lower the level of public debt. It has been well proven that Swiss municipalities requiring that budgets must be approved by a referendum have public expenditures 10% lower per capita than in municipalities where the political class is executing such rights. The the US ideology promoting excessive government levels of spending, deficits, and increasing debt stands in stark contrast to the the ideology with the Swiss municipalities allowing a finance referendum. The peoples referendum municipalities have 25% lower public debt than municipalities governed by the political class. This fact can not be dismissed and is extremely convincing for every individual believing in a limited government.

If no significant amendments will be made to the US constitution the nation will face an almost unavoidable expansion of the governments public sector and inevitably the republic will break down at a point when the big government (public sector) gets impossibly huge. Due to the political competition the US government public sector is always, and almost unavoidably, likely to expand. The basic cause is the majority rule, which makes it possible for the political class to exploit the minority. An introduction of a representative direct democracy with final checks and balances performed by the citizens combined with a cap on total government spending would prevent the present kind of exploitation to occur.

Societies has collapsed before and the most significant was the collapse of the Roman Empire. The breakdown was slow and painful. Some people moved to other regions and others stayed to excise their options. People who stayed turned from white to black markets, and from paying taxes to not doing so at all. When the empire lost its tax-collecting power the defense was week it was no match 476 AD for the barbarian German chieftain Odoacer to push aside the last Roman emperor, Romulus Augustulus, and to install himself as the new authority and liberator of a corrupt and decayed ideology.

Does Americans and Europeans have to repeat the same historical mistakes once again?

Why do the Swiss produce more wealth than Americans and Europeans?

Switzerland has demonstrated an incomparable economic strength to United States and the European Union. This little Alpine-country have shattered several myths created by misguided progressive (socialist inspired) economists and politicians. The dominating myths are that the Swiss political system does not matter in relation to the country’s extraordinary success and the assumption that manufacturing could be replaced with services, financial products and information-technology ideas. In interesting fact is that the Swiss federal republic’s constitution is in principle based on the United States Constitution, with double majorities required in its Federal Assembly (looking like the US two chamber Congress). The significant difference is laying in that Switzerland is a representative direct democracy with the final checks and balances by the citizens. By calling a federal referendum a group of citizens may challenge any law that has been passed by the Swiss Federal Assembly.
This system has prevented Switzerland from going on the same path as United States and the European Union. The Initiative & Referendum Institute Europe has proven how the widespread use of direct-democratic procedures in Switzerland actually strengthens the economy, reduces tax avoidance and lowers the level of public debt. A study by Zurich University economists Bruno Frey and Alois Stutzer showed that the influence of direct democracy on economic growth were striking. In cantons with stronger rights of participation on financial issues, economic performance is 15% higher and where citizens can vote on the budget, there is 30% less tax-avoidance. In municipalities where the budget must be approved by a referendum, public expenditures is 10% lower per capita than in places where residents have no such rights. It appears that citizens are more careful with the money taken from them as taxation than the politicians are. Municipalities which have the finance referendum have 25% lower public debt (5,800 Swiss francs per taxpayer) – the direct result of lower expenditure and greater tax income. Public services cost less in towns and cities with direct democracy. Professor Kirchgässner and his colleagues concludes: “In economic terms, everything is in favor of direct democracy – nothing against.”
While troubled industrial powers of the past like United States and United Kingdom have allowed their once strong manufacturing bases to become marginalized, Switzerland has supported a manufacturing renaissance that has led to a remarkable $63,000 (USD) GDP per capita. That is 50% higher than United States. Switzerland is achieving the top spot in the World Economic Forum global competitiveness index. The Swiss are applauded for their business sophistication and ability to innovate.
Although the Swiss franc has been strong against the euro and the dollar – raising the prices on Swiss export – manufacturing in Switzerland accounts today for more than 20% of Swiss GDP, well above most developed countries. Furthermore, the Swiss unemployment was only 3.3 percent in December 2011, the best number in Europe.
When China, Mexico and Eastern European countries, among others, offered an inexpensive manufacturing option for multinational enterprises the opinion that North America and Europe could succeed without a healthy production engine gained popularity. United States pursued economic policies that unwittingly ceded whole industries to these emerging countries. The progressive thinkers assumed that developed economies could replace manufacturing with services, financial products and information-technology ideas. The fact is that such services does not create more value than factories do. In decline of manufactured goods produced in United States and the European Union along with huge obligations for promised entitlement programs the political leaders are desperately trying to generate global economic activities to make up for cash-strapped consumers at home and looming deficits from stimulus programs promised to turn-around the recession.
Despite the fact that Switzerland is a high-cost country at the upper end of the product price pyramid it has not shared this destiny with the other western world countries. The Swiss have pursued a dual-pronged strategy: creating healthy conditions for a modern manufacturing base to flourish and stressing the importance of continuous innovation. The business friendly climate is nurturing industrial growth within the skilled sectors, such as, specialty chemicals, complex machinery, precision medical equipment and biotechnology. In those sectors knowledge and skills trump low labour costs stressing the importance of continuous innovation.
Five factors distinguish the industrial environment in Switzerland from other developed countries with declining fortunes in manufacturing: Openness – For a small country, Switzerland houses the headquarters of an outsized number of global multinationals. Liberal immigration rules have played a significant role. Targeted Training – The Swiss educational system tracks a minority of its young into academic paths in universities to study advanced disciplines but the majority of its students are directed into technical apprenticeships, often at manufacturing companies, to learn sophisticated operational skills and factory floor technologies in their teens. Workplace Flexibility – The ability of companies to increase or reduce employment and work days or hours relatively quickly creates an environment in Switzerland that lets companies be nimble in the face of changes in global manufacturing. As importantly, this flexibility has placed Switzerland below many of its European neighbours in total labour costs. Strong Clusters – Close proximity of manufacturers, suppliers and other stakeholders in industry clusters that cover virtually every critical manufacturing sector in Switzerland has made communications and interactions among product designers, developers and producers relatively easy, spurring product and process innovation in manufacturing. “Natural” Industry Restructuring – The Swiss have an aversion to let the government prop-up companies that are losing competitiveness, viewing this as costly in the short term and unsustainable over longer periods. This means that there is a more organic and gradual evolution and migration of value chain activities out of Switzerland, to companies and regions that can perform them better. The result is that the strongest companies survive and there are fewer large disruptions to the Swiss economy over time.
The main reasons for the Swiss success are based on a high level of competition in goods and labour markets combined with its unique political system that ensures contestability (a stabilized efficient system with checks and balances) providing the fundament for stability and prosperity of the country. The openness towards foreign markets and early internationalization of companies has led to a high degree of competition with positive effects on innovation, productivity and flexibility. The characteristics of the Swiss political system with direct democracy combined with a high degree of federalism or subsidiarity has lead to a political contestability that is preserving stability and decentralization.
The founding fathers of United States knew that local government and limited government were important in order to create laws that the people supports and believes in, and yet over the years the US government has become increasingly illegitimate. More and more political power in US is accumulated in the national government and representatives increasingly represent larger and larger population groups. Once the progressives changed the US system and the direction of the nation the nation has become increasingly unhappier. The laws Congress passes, both by Republicans and Democrats does not represent the majority as much as special interest groups. It is well known that the public sector has increased continuously and considerably in United States and other welfare countries. In several Western European countries the public sector is now well above 50% of GDP. The trend is clear, the USA is in a not to distant future reaching the same level. Due to political competition the public sector is always, and almost unavoidably, likely to expand in a republic like United States. An almost unavoidable expansion of the public sector seems to imply that the US democracy breaks down when the public sector gets impossibly large. Obviously the life of the US presidential democracy is limited to the time it takes for the public sector to grow to impossibly high levels. If United States and the European Union shall stand a possibility to survive it would be necessary to reduce the public sector according to research made by the International Joseph A Schumpeter Society.
Presently the US Constitution does simply not work like the founding fathers intended it to function. The system is inevitably leading to an impending break-down, and only a noteworthy repair can put the nation on the track it was intended to travel. Most certainly Switzerland's representative direct democracy system, adopted to the United States of America, could serve as that solution.