Economies Of Scale Vs. Scope of Government

One of the greatest mysteries to me is why we see no economies of scale the bigger cities get and the bigger governments get.  And I think that I am on the brink of resolving that mystery for myself finally.

For our example, we will take two municipalities of obviously different size: Johns Creek and Atlanta.  Both have the same state government, operate in the same environmental and economic environments and co-exist 15 miles or so apart.

And without evening providing the numbers that support the statement, we all know that it is much more expensive from a tax perspective to live in Atlanta than Johns Creek.

I have decided to provide the numbers after it was suggested that they were important.

Brief back of the envelope calculations shows that the City of Atlanta spends $1265 per resident while Johns Creek spends $637.  And on property taxes. the City of Atlanta has a millage rate 30% higher than Johns Creek.

As a more or less rational thinker, this has left me puzzled more often than not.  What is it that makes it more expensive per capita to provide services to the public, which seem to defy the concept of Economies of Scale that function flawlessly in other aspects of our life?

And then it hit me.  It’s NOT the economies of scale that are at question.  It’s the scope of government services provided.

At this point I am going to add another city to our conversation.  This one is fictional, but we all have a good understanding of how it is defined: Mayberry.

The city of Mayberry provided the most basic of services for the common good.  Court, jail, police, fire and education.

All the residents were potential beneficiaries of these services.

But when a city gets larger, like Johns Creek has, then more services are provided. Wants seem to morph into needs.   And these services may not benefit all citizens but a sub-section.     At first, it might be that a new service benefits 90% of the public. We tax all for the benefit of those 90%.  And 10% pay for services they never use.

Then the City grows larger.  Soon we add additional services, and then more additional services until the new services aret being used by 10% or less of the population and are being subsidized by the 90% that are not using them.

The larger the city the smaller the beneficiary group as a % of the whole needs to be.

Much to the chagrin of dog lovers, I’ll use the example of dog parks.  (and I love the name of the Chattapoochie Dog Park in Gwinnett so I am not a total grump).  Here’s a service provided by municipalities that only benefits dog owners.  More specifically, it only benefits that sub-segment of dog owners that want to take their dogs to a park to roam around.  If 1 in ten residents in Johns Creek have taken their pooch to the park more than 6 times in a year, I’d be shocked.

Were Johns Creek to get large enough, we’d likely have a different park for small dogs, and big dogs.  Even larger and we would have one for medium sized dogs.

We see the same effect with Arts Centers, Aquatic Centers, Nature Centers (insert the others you know are coming here).  We also see it with other services the City decides that they must provide such as bulk recycling.  The list becomes endless as long as there are funds to start the program.  And they never end. Get a few federal or state dollars to start and it’s a certainty to get started and be with you forever more.

Which brings us back to my original observation.  There are no economies of scale for bigger and bigger cites because the scope of the services these cities provide expand in such a way that there are fewer users as a % of the population, forcing the majority to subsidize them.  By the end the 99% are funding programs for the 1% that use them.

How does one reign in the “service creep” that cities seem to engage in the larger they get?

One answer would be to set a minimal level of actual users that a city expects to see from this service.  Fifty per cent would be a good starting point for discussion’s sake.

Another answer would be to cut the funds flowing into the cities that fund such projects of such a narrow scope.  To do so you will need to be ready to speak up to your local government and say “NO!”.

As a Libertarian, this is exactly why I am for  a smaller government.  Let’s do the things that we need to do for everyone’s benefit, and do them the best we can.

Then we could see economies of scale.  We could lower our taxes, and those with dogs, for instance, could fund their own private dog park with their own dollars.

Otherwise, where does the “Service Creep” end?

That’s my opinion.  I’d love to hear yours.

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This Time, It Is Going To Be Very Different

The Federal Reserve today ended it’s meeting without raising the Fed Funds Rate.  As you can see by the chart below (Time-wise it reads from right to left), the Fed Fund Rate has been near zero for a long time.

So long, in fact that it has seen the peak of our most recent economic upswing (Much shallower than the last peak AND shorter in duration) and our return back to the shores of recession, all without a single rate hike.

Those that have followed my conversations in the past will recall that I firmly and unquestionably believe that the single greatest indicator to the health of the economy is Business Profits After Taxes, as reported by the Bureau of Economic Analysis.  This number cannot be as easily manipulated as GDP.

It does not give the false pretense of improvement because of government spending. Government spending does not produce profit.

What the number does reflect is after all is said and done is what have businesses earned that they get to keep from all of these efforts.   This is where the real motivation to grow, hire and expand your business originates from.

I’ve taken the data from the BEA (which anyone has access to) and created a spreadsheet with both 3 and five year rolling averages of the AGR(Annualized Growth Rates) for business profits after taxes.  This data is so simple to comprehend that I would even bet that you can see without highlighting it the last three recessions that we have had.  You can also see clearly when we exited those recessions.

And, if you look at where we are today, you understand what is about to occur.  Which brings us back to the Federal Reserve.  If you look at the chart carefully you can see that each time we were in a recession( and we admitted it), the Fed cut rates, which has the effect of giving businesses a boost to profits.

This time, it is going to be very different.  The Fed has no room to cut rates.  We are near zero already.  Business profits year over year have plummeted, and the Federal Reserve continues to tell us things are getting better.  Read their latest comments here:

https://www.scribd.com/doc/272962361/FOMC-July-Statement-Blueline

Do you think they are clued in?   I do not think so.  I think if they were, they would know that they are on the cusp of a major crisis.

There are a few more things I’d like to point out here.  The 7.5% line is the approximate level at which year over year profits need to rise in order to stimulate real economic growth.  Anything less and we contract, right-sizing the economy until we begin to grow again.   We have a tendency to always use a baseline of zero as the indicator that things are or are not improving.  This is not the baseline to use in most cases.

Three and Five year AGR for Business Profits After Taxes

Three and Five year AGR for Business Profits After Taxes

This data reflects the most recent data available (Four quarters ending 1st quarter 2015)  Business profits after taxes also represent all businesses across the US from mom and pop down the street to Apple and Amazon.

Were you to accept what I have written, and you agree that businesses do go in business to earn profits, and the goal is indeed higher profits year after year, then what needs to be done for a strong, healthy economy because rather clear.

1)  Create an environment for businesses where the regulatory and fiscal burdens are reduced-not increased- for all businesses.

2)  If new legislation is passed that reduces a company’s bottom line, do so knowing that it will indeed have a negative effect on both business expansion and job creation.  So make damn sure that the reason why you are doing it is worth it.

3) The longer business profits after taxes increase and stay above the 7.5% line, the stronger the recovery.  So it is in our best interest to try to promote that outcome rather than detract from it.  Too often governments see that improvement and decide that they can take some of those dollars with no ill effect.  They are wrong.

If you see the chart as I see it, then you will see what is coming.  Ask yourself what will accelerate profit growth for businesses over the next 1-3 years?  What is the catalyst?  And if the Fed cannot cut rates, how long will this next down turn last?

I encourage you to be prepared.  Yes the markets are near all time highs.  But do not be fooled.  Total dollars of profit by the Dow 30 companies are on track to drop more than 9% year over year.  Hard to spin that as a healthy and growing economy.  The smoke and mirrors are being supplied by-yep you guessed it- The Federal Reserve.  The low rates are fueling record share buybacks, increasing per share earnings and therefore share prices.  I believe that you will agree that this is not a positive chart.

Dow 30 Profits Analysis 20150717

The solution to what ails us is clear.  Government needs to reduce the burden they are generating for businesses, so that if the businesses can meet the market needs of customers, they have the potential for higher profits-not less.

Only then we will see the US economy have an opportunity to restore it’s economic engine to more than idle speed.

These are my opinions.  I would love to hear yours.  Please post or comment or email me any questions.

EJ

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Johns Creek: Foolin’ Ourselves

The residents of Johns Creek, Georgia have lots of things going for it.  Excellent housing, many of the best schools in the state for kids, and income levels that surpass nearly every other community.

Those positive attributes, however, have led to a flow of tax dollars into the City’s Coffers that is now doing more harm than good.

Since 2006, the year the city formed, the City has amassed $54,348,545 at the end of the fiscal year 2014, according to the City’s Certified Audited Financial Report.  That represents an increase of almost $7,000,000 per year of revenue over expenses.  With a population of around 80,000, that works out to more than $670 per every man, woman and child.

That’s an astonishing amount of money to be held per capita, and it’s growing.  Last evening, the City Council, under the lead of Mayor Mike Bodker voted to maintain the City’s millage rate at it’s current level, despite the property valuations rising sharply over the last year.  More money will be flowing into the City’s coffers again in 2016 coming directly out of the pockets of the residents.  And while it may not seem like a big deal to many outside of Johns Creek(after all, they can afford it), it is creating problems that will soon become more and more apparent as time passes.

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