Modern Capitalism, or How to Guarantee a Military-Industrial Complex

My uncle once told me, "In the future, there will be five companies, and they'll own everything."  We needn't go into the future to see such a reality--in most important ways, the aforementioned scenario is already here if you add two zeros to the end of the number above.

Where does innovation come from after a company achieves multinational status, starts paying a dividend, but still has to grow by x% annually to please Wall Street? Some people may know that such growth comes from buy-outs and mergers. Indeed, after a certain size, large companies succeed based on how adept they are at incorporating a newly bought company's products and remaining employees into their own pre-configured business and legal systems. In short, scalability, supply chain management, and risk controls drive value in a major corporation if it survives long enough. What about innovation?

Under the current merger-and-acquisition system, major companies will "buy" innovation and pay premiums--sometimes obscene ones--to avoid having large and unpredictable R&D budgets. In such a dynamic, large companies can pay a small percentage of their revenue to attract a smaller company, but without taking the risk of having larger or recurring R&D costs on the books that don't produce consistent ROI. Smart, right?

Yet, it is precisely the large companies, with their established products and revenue streams, that are best able to take the risks necessary to produce great ideas. If only smaller companies are taking bank loans or SBA loans to try new ideas, then the banks become the primary risk-takers and consequently demand greater influence and political power to take on such risk. If the big banks' investment banking, consulting, and M&A groups are the major players backing smaller companies or venture capital firms, then most innovation not linked to academia is supported by the banking sector.

Guess who supports the banking sector? The FDIC and your deposits.  In other words, under America's current capitalist system, taxpayers are back-stopping the risks of innovation under "too big to fail" because many larger corporations aren't investing enough in R&D, which is seen as an unpredictable cost by Wall Street. Today, only Tesla (TSLA) appears to be choosing innovation over steadily increasing share price. Other companies like General Electric have large R&D budgets, but as a percentage of gross revenue, they're actually minuscule--usually no more than 7%.

Seen this way, of course America's banking and insurance sectors will have the most influence in Congress--they're the ones driving innovation by funding R&D that larger companies should be funding but won't. Not only will large banks and insurance companies demand favorable tax policy for their risk-taking (witness Warren Buffett asking for and receiving a "terrorism" exemption post-9/11), they get their funding directly from the Federal Reserve or indirectly by convincing the Federal Reserve to lower interest rates. What are you, the taxpayer, getting in exchange for stricter personal deductions than businesses; receiving low interest rates on your deposits; and being the insurer of last resort?

You probably won't guess the correct answer: a military with a budget not subject to audits that does the R&D for you, but with the higher risk of pursuing war as a testing ground for new weapons and strategies, and with debt that could sink or split the entire country if mismanaged. If the larger companies have external checks and balances that mitigate R&D risk-taking, and the banks are being back-stopped by the government (and therefore taxpayers) when they make loans that support R&D, big banks and the military become the two groups not subject to checks and balances but necessary for innovation. Under such incentives, it's only a matter of time before the military and banking sectors dominate the entire country and become powerful enough to ignore President Eisenhower rolling in his grave.

And so it goes.

Matthew Rafat (copyright 2017) 

Bonus: "In the past 30 years, America has had 13 wars at a cost of $14.2 trillion...what if they [had] spent part of the money on building up infrastructure?" -- Alibaba CEO Jack Ma

Bonus: below are the numbers supporting the arguments above:

People don't understand the difference between budgetary outlays and discretionary spending, or appropriations/expenditures, which is responsible for the inability to see eye-to-eye on fiscal responsibility debates.

Mandatory spending is federal spending based on existing laws. This budgetary spending is mainly entitlement programs, such as Social Security and Medicare, whose spending criteria are determined by who is eligible to apply for benefits and not by Congress, and includes items supposed to be relatively predictable. Discretionary spending, on the other hand, is the portion of the budget that the president requests and Congress appropriates every year through legislation. In the past, such spending was supposed to be for one-off, unusual and unpredictable items but has now become a slush fund for military adventurism, as we'll see.

Furthermore, when discussing military spending, it's debatable whether to include VA spending as part of the national defense budget, which creates further confusion. Let's try to clear up these issues.

Spending on national defense is estimated to be about 15% of all outlays in 2017. This is less than average when compared to budgets from other years. (Average proportion = 22%). That 15% is about $516 billion, not including VA funding.

The President’s 2017 budget includes $182.3 billion for the VA in 2017. This includes $78.7 billion in discretionary resources and $103.6 billion in mandatory funding (for veteran's disability benefits). Including national defense and VA budgetary amounts together, we have a total of $698 billion spent on military-related budget items. Technically, that's less than what we spend on Health and Human Services (e.g., Medicare) and Social Security (almost a trillion projected in 2017). However, the above figures do not include discretionary spending, which causes annual deficits funded partly by issuing debt to foreign countries. Let's look at those numbers.

For 2017, 49% of total discretionary spending is projected to go towards national defense, or about $500 billion. That means we spend about $1.2 trillion every year on the military and military-related items. Thus, the largest spending items in America in 2017 are the military and the VA; Social Security; and Medicare. Why is that a problem?

In 2017, the government is estimated to have a total debt of $17.7 trillion. At 104.4% of GDP, this percentage is extremely high when compared to other years (avg. 59.0%). Spending on SS is fine--that debt is owed to Americans. Spending money borrowed from future generations on unnecessary or inflated medical expenses like pharmaceuticals and on unnecessary wars or wars of choice is unconscionable. It guarantees fewer opportunities for younger generations. It means our intelligence agencies work overtime trying to justify illegal military invasions or are tempted to engage in false flag or psychological operations to justify security spending. It means millennials are called lazy or immature when they're anything but. In short, when you're going in debt for unnecessary items, and you need the jobs related to that unnecessary spending to get votes and stay in political office, you have to resort to fear and outliers to maintain the status quo. Such an approach is inadvisable in any era, but especially so in an era of increasing competition worldwide and against countries to which you owe money.

Bonus: The local level creates no reason for optimism, either.  In most major American cities, 50% to 70% of all local tax revenue is spent on "public safety" aka cops and firefighters. Many of these taxes go to pension obligations, i.e., paying gov employees who no longer work and who haven't paid into the retirement fund in sufficient amounts to sustain it without higher taxes or cutting other local programs.  Consequently, America's military budget is not subject to any real audits due to the federal gov's ability to borrow almost unlimited debt, while even local entities are forced to divert their taxes into strengthening a police state because by law, pension interests are vested and therefore untouchable. What could possibly go wrong?

Well, this is the kind of activity required in such a regime: http://www.post-gazette.com/news/nation/2015/11/06/Department-of-Defense-paid-53-million-to-pro-sports-for-military-tributes-report-says/stories/201511060140

Basically, the gov spends taxpayer monies to normalize the abnormal, then demands the entities continue its show at their own cost or be called unpatriotic.

Both parties are complicit, and both parties are locked into unsustainable programs that require more debt because neither party wants to impose any fiscal discipline. Why should they, when they can rely on more debt to maintain the status quo and their jobs? In the case of California Democrats, their allegiance is to an unsustainable K-12 system, teachers' unions, and the teachers' pension plan, which guarantees a return of 7.5%--even though the economy is growing about 2% to 3% a year.

Rather than take a common sense approach and reduce benefits for existing retirees--who negotiated an 8% ROI under much different economic conditions--it appears govs will reduce benefits for incoming, younger employees and wait a generation to try to balance their books without relying so much on debt.  It remains to be seen whether any system that depends on achieving consistent 7.5% ROI can be sustained in the "new normal." 

Random Thoughts: Welcome to 2017 Edition & UBI

Welcome to 2017! May your year be filled with wonder, health, and joy.

1. Reporting earnings once a year makes a lot of sense, especially for cyclical industries. For instance, many consumer companies make most of their revenue in the holiday season. What's the point of reporting four times a year? It's as if businesses want to encourage short-term outlooks. If it didn't work in American foreign policy, why would it work in American multi-national policy?

Response: "For that reason, it makes sense to report data adjusted for seasonality:)"

My response: Your approach is better than the current one, but doesn't address short-term outlooks or the practice of excessive end-of-quarter discounting based on nothing more than needing a sales boost at the end of an artificially-created time period.

2.  Emma Stone's face in La La Land (2016) when she said, "Are you serious?" is forever preserved in cinematic history, dedicated to everyone who's ever been given a zinger out of anger and hurt so badly, the idea of a response never even enters the equation.

3.  Think of UBI (universal basic income) as a small VC investment in everyone. Right now, VCs invest millions and hope for a 2 to 5% home run rate.The idea of UBI is to invest thousands of dollars and hope for a 10%+ home run rate as more people pursue their passions, requiring both corps and govs to compete for talent, which also leads to better overall outcomes.

4.  I fear that universal basic income (experimental) pilot programs miss the point. They use too little money (the minimum in the U.S. should be 700 USD/mo), and/or they increase costs rather than cutting programs and diverting the savings into the UBI pilot. Such pilot programs would probably work best in cities with higher unemployment relative to the rest of the population and would need to be funded through foundations rather than governments. Some current UBI-like programs cut hours but not employee pay, requiring more expenditures--the exact opposite of a properly administered plan.

The idea behind UBI is to eliminate the gov's hand in direct welfare completely, and in doing so, make the citizen less dependent on the gov's moral and political whims, while focusing the gov's attention on providing essential services in a sustainable way, such as healthcare.  (Perhaps politicians forced to focus on decreasing health problems and/or escalating medical prices to prevent the implosion of a healthcare system are less likely to meddle in taxpayers' personal lives.)

In addition to lowering dependency, the goal of any UBI program should be to encourage cities to compete for residents rather than chaining them to specific places using housing inflation (through the mortgage tax deduction) as a lure. Note that our current tax system cannot adapt quickly to changing demographics or macroeconomic upheavals, encouraging boom-and-bust cycles (for example, Detroit, MI) or holding cities hostage to corporations playing them off against each other for tax incentives.

To prevent escalating UBI costs and political temptation to tamper with the amounts and recipients, the program ought to apply to everyone 22+ years old and cap the amount per adult, with an additional amount for each child, up to two children from ages 0 to 18. (Yes, there's a 4-year gap, which encourages college enrollment.)  Governments may publish the names of millionaires not donating their UBI to charity but must still provide the UBI to them.  The amounts provided must relate rationally to the amount the gov has saved by eliminating food aid, subsidized housing, direct payments, etc.  (But hopefully not unemployment insurance, an excellent program for employers above a certain revenue and employee threshold.)  The major source of revenue to divert would be from phasing out the Social Security program and from reasonable defense cuts.  If done judiciously, hundreds of billions would be available, and younger voters would not be at a disadvantage against older voters. Even on a local and state level, combining the myriad of welfare programs into a single UBI program that applies to everyone--thereby reducing enforcement and other administrative costs--and also reducing K-12 funding by eliminating employee pensions for new employees or linking the pension ROI to 10 or 20-year Treasury rates would help generate the financial equilibrium desired.

The UBI calculation and revenue-sourcing are the easy parts because they're ultimately math problems that reverse long-tail programs and shift revenue back into the present-day and to a broader class of citizens.  The hard part is also accounting for the amounts the gov must spend on persons who spend their UBI irrationally and in doing so, cause additional hospital and other law enforcement costs. Thus far, I've seen no article that accounts for the latter problem. (One idea of a good pilot program would be to require a city's citizens to only spend their UBI within the borders of the city and render the UBI card ineligible for "sin" purchases, such as alcohol and cigarettes anywhere.)  In short, current UBI pilot programs are a good start, but so incomplete that the main conclusions will be psychological rather than economic.

Looking ahead, after some time--no more than 5 years after the start of a permanent program--the amount of the UBI should be adjusted downward if GDP declines. It may be adjusted upward if GDP increases, but only if the increase in GDP is not due to increased debt issuance or financial alchemy.

Why? The only way any UBI program can sustain itself is if voters and recipients understand that the program, if poorly managed, will sap resources from other necessary expenditures, especially ones promoting innovation.  The goal isn't to create an entitled class of layabouts, but to create less dependency on larger forces, whether governmental, banking, or corporate; to mitigate criticism of citizens currently receiving some form of government assistance by eliminating the ability to "game" welfare programs; to increase time for pursuing happiness (making it easier to raise children on a one-income household, traveling the world, etc.); to promote entrepreneurship; or to promote some other endeavor that creates a positive impact.  Thus, strong checks and balances are needed, and pegging UBI amounts to some formula of GDP growth and decline, but removing the impact of artificial boosters like debt when calculating the numbers, is one way to handle voter temptation.  As you can see, honest accountants are necessary for such programs to work, and the CBO--or some other permanent, independent body--will need to be given some form of veto power over Congressional attempts to increase or lower UBI amounts.  Like any government program, UBI will be subject to corrupting and political forces, so economics and finance must be rigorously taught from sixth grade and up.

If implemented properly and with appropriate discipline, UBI in countries with strong currencies might reduce internal conflict and shift "culture wars" to practical matters, creating healthier societies.  There's no way to tell whether such an option is possible, however, if pilot programs are done in ways that fail to capture the entire point of UBI.  Mild efforts will surely create uninspiring results.

Update: I just realized phasing out or minimizing the mortgage interest tax deduction would also allow funds to be used for UBI, though my idea is to minimize future projected expenditures, especially in ways that promote political tampering (i.e., COLA adjustments, age limit changes, etc.). (On a related note, as long as the military's budget and appropriations are unaudited or enabled by "risk-off" central bank printing, they present a clear target for fiscal conservatives.)

The idea behind phasing out Social Security isn't just to free up money for UBI--it's to shift long-tail, unpredictable obligations applying to a small segment of society (e.g., seniors) to a broad-based, easier-to-manage program that removes "gaming" as well as the risks in long-term accounting and life expectancy calculations.  Why is the government in the business of calculating life expectancies in the first place without adequate health data on each potential Social Security recipient/creditor? 

Globalization: a Counterargument based on Love and the Individual

I have always supported globalization, but with caveats--including that the process from old to new not only consider, but protect the ones left behind.  Furthermore, government spending drives much of the modern economy, and its inefficient allocation of tax revenue has created mega-cities, which are easier to control and influence, but which do not necessarily increase individual or marital happiness.  Such inefficient spending almost forces established politicians to focus on larger cities rather than small ones, creating opposition from newer players in smaller cities who feel left behind and who have little incentive to cooperate with existing players.  Somehow, globalization has made it easier for international megacities to cooperate with each other than larger and smaller cities in the same state or country.

Even with this disconnect, why aren't people in developed economies happier? Part of it must be due to the lessening influence of the individual, and the individual's difficulty in actualizing the power of sincere and selfless contribution as cities grow larger.  Another part is more basic--the difficulty of finding compatible relationships.  I recently watched La La Land (2016)--a wonderfully bittersweet movie based in L.A.--and realized yet another issue with prevailing forces in developed economies: people, especially men, must often choose between careers and love.

Why do I focus on men? I suppose it's because women may not necessarily find true love, but they are rarely alone if they choose not to be.  Men who want to be fathers, on the other hand, seem to have resigned themselves to conforming to a world where their productivity and agreeableness are prized over their own self-discovery and needs.  Other men who see their roles diminishing on all fronts have decided they won't go gently into that good night and have found succor within fringe political groups.  Others just opt out.

In short, the 21st century is in danger of becoming a tragedy by forcing most of the most idealistic people to compromise their ideals to fit in or to find companionship.  Interconnectedness is breeding contempt and dissension as more people realize principles matter less than someone else's overall end goal. When individuals are not supreme--even if right--a sense of decency becomes too readily sacrificed on the altar of reasonableness.  Such compromise, if done by fiat, renders the populace prone to rebellion--first in small ways, then in larger ways that finally become too noticeable for the mainstream to ignore. At that point, as if by design, the disenchanted men and women, the ones left behind by forces outside their control, flee to places where they can feel free--or worse, they stay and withdraw.

In La La Land, the Ryan Gosling character drives away his true love and attempts to get her back, only to lose her again.  He ends up successful but alone.  The Emma Stone character ends up successful and married, but not with her true love.  No one has fled anywhere, but the moral seems to be that large cities force people to choose between being broke and idealistic, or settled and compromised.  If this is a reflection of modern love in America, it's time for a change in the economic system, which requires political changes.

Governments are realizing that happiness might not be easily measured in officially reported data, but tax revenue is often driven by whether people feel as if they can achieve their relationship goals in x rather than y city.  Indeed, taxpayers don't need to leave to new countries to disengage--they can simply move to other areas within the same country, up-ending local economic projections drastically, as so many cities--burdened with debt--depend on sales and other taxes requiring constant economic growth or at least a non-declining working population. Those new high rise condos going up in every major city? Who will buy them from existing and secondary owners without a steady influx of younger workers?

Economic projections, once disturbed, require more debt and thus fewer choices, or pit existing players against younger and newer ones, such as immigrants.  Worse yet, taxpayers who don't leave and who stay in areas that don't reflect their values tend to disengage emotionally from others not within their own groups, decreasing the positive impacts of diversity and dooming efforts to create cohesive communities.  Without community, what is the point of working 60 hour weeks or taking out $50,000 in student loans?

How governments interact with each other will determine whether worldwide prosperity is merely academic well-wishing or the next stage of cultural evolution.  Since it's obvious more ideas result from greater rather than less interaction, my wager's already been placed--as have the bets of trillions of investments and debt.  Democratic governments are quickly learning that if they desire to help their citizenry stay in their current globalized trajectory, they cannot ignore the individual, and they cannot talk down to those who do not share their opinions.   To protect continued migration of people and ideas, the future requires empathy as much as productivity.  Which countries will be up to the challenge?  Which ones will win the battle to create a place where Ryan Gosling and Emma Stone's characters meet, fight, fall in love, and stay together? 

© Matthew Mehdi Rafat (2017)

Bonus: "We are an urban species. Homo urbanis is actively reshaping geopolitics, economics and climate action in the 21st century. And with good reason. While the world’s cities cover just 2% of the earth’s surface, they account for 55% of its population. What’s more, they generate 80% of the world’s GDP and over 90% of its patents. Yet they are also responsible for 75% of all energy consumption and 80% of CO2 emissions." -- from World Economic Forum, Katherine Aguirre from the Igarapé Institute, and others from the Global Parliament of Mayors and C40.