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Why Expansionist Central States Inevitably Implode

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    January 20, 2013

    The Expansionist State is on the path to insolvency and systemic political crisis.

    The S-Curve usefully charts the gradual development, explosive rise and eventual stagnation and collapse of complex systems. Remarkably, natural phenomena such as the spread of bacteriological diseases and financial dynamics both follow S-Curves as they mature, stagnate and collapse. I have described the dominant dynamic of our era (1981-present), financialization, with the S-Curve: Financialization’s Self-Destruct Sequence (August 16, 2012)

    Financialization and Crony Capitalism Have Gutted the Middle Class (July 13, 2012)

    The S-Curve also helps us understand why the Expansionist Central State is doomed to inevitable implosion/collapse. This chart displays the key dynamics:


    In its initial “boost phase,” State investment in the low-hanging fruit of public infrastructure offers a high yield. Examples include rural electrification, the rapid expansion of the railroad system, the construction of the Interstate Highway system, and the publicly funded research and development of science and technology that enabled the basic protocols and software infrastructure of the world wide web.

    These investments of public tax revenues acted as multipliers of private investment and leaps in productivity.

    We can see in the chart that modest fiscal deficits when public monies are leveraging fast growth in the overall economy have little consequence, for tax revenues are climbing more or less alongside State expenditures as the economy rapidly expands.

    The key dynamic in State spending is this: the allocation of public capital is intrinsically a political process, not a market or communal process. Thus politically powerful cartels and guilds will secure State funding for their vested interests, and potentially higher-value investments will go begging.

    This is the opportunity cost of any financial decision: the opportunities left behind in the decision-making must be weighed along with the purported benefits of the chosen avenue of spending.

    As the State expands its share and control of the economy, this political allocation of capital and national income also expands. As the State grabs an ever-larger share of the economy and extends its Central Planning to every layer of the economy, the “best game in town” inevitably becomes lobbying the State for funds and perquisites.

    Private investment decisions start being made on the basis of State subsidies and tax loopholes rather than market-based metrics. This dynamic is especially pernicious: not only does the State increasing choose to fund projects with diminishing returns as a result of political allocation, the State’s expansion of command and control distorts private investment as well.

    The Expansionist State thus distorts the investment decisions of the entire economy, public and private. Households don’t buy a home because it is a fruitful investment, they buy it to obtain the mortgage interest deduction. Corporations buy medical-supply companies because they see Medicare as low-risk cash-cow, and so on.

    State expenditures cease to yield productive returns as spending increasingly goes to politically favored cartels. Did the billions of dollars spent on the B-1 Bomber in the 1980s yield a weapons system that provided leverage amd dominance? No, it was a horrendously costly and inefficient jobs project, with the defense cartel skimming millions of dollars off a program that had been terminated by those who realized the money would be better spent on other defense needs.

    Has higher education improved dramatically as a result of the vast increase in spending on higher education? Has the health of American improved dramatically as a result of the vast increase in spending on healthcare? The answer in both cases is obviously no. Increasing spending simply increases systemic friction and unproductive skimming.

    Central State spending has reached the point of negative returns: money is dumped into cartels but the yield on the investment is near-zero. This is the point of stagnation, where spending keeps rising but tax revenues are no longer keeping pace because the State has become an enormous drag on the economy.

    Political allocation of the national income knows no bounds. Politically, there are never any limits. If tax revenues aren’t keeping pace, then the State must borrow increasing sums of money to fund its spending. Politicians and their State fiefdoms/private-sector masters, the cartels of finance, defense, healthcare, education, construction, etc. are screaming for more funding; where it comes from is secondary to easing the political pain.

    So the political class raises taxes on all but the parasitic class (finance) and wealthy cartels and corporations buy loopholes and exclusions to the new taxes. The burden falls on higher income households, who then have less to invest in the private sector.

    We are at the inflection point indicated on the chart where the lines cross, just before the crisis: tax revenues are lagging spending in an enormous structural deficit; the State dominates the economy and its spending cannot possibly be contained, due to the political promises made to entitlement constituencies, fiefdoms and cartels, and the drag of unproductive State spending has sent the economy into systemic decline.

    Each constituency, cartel and fiefdom is convinced that they are acting in their own best interests in demanding more State funding and subsidies. As a result, they are blind to the consequence of everyone becoming dependent on the Expansionist State: the collapse of a system that is now yielding a highly negative return on State spending.

    When State spending is expanding faster than tax revenues (which are a function not just of tax rates but of economic expansion) and the underlying productive (non-State, non-finance) economy, then the gap can only be filled by borrowing money. This works until the interest on the fast-rising debt begins to crowd out spending on entitlements and other politically protected programs.

    Progressives assume all State spending is productive; this is clearly a false assumption. Some State spending may be productive, but when it is allocated by a corrupting political process, the inevitable outcome is most State spending devolves to unproductive transfers from the politically weak to the politically powerful.

    Tweaking tax policy or raising the debt ceiling will not change any of these dynamics.The Expansionist State is on the path to implosion (insolvency) and collapse, i.e. a political crisis. If we understand the core dynamics of the Expansionist Central State–the political allocation of scarce national income to favored constituencies and cartels–we understand why this process is inevitable.

    France offers an illuminating example of this path to implosion and collapse, but every Expansionist Central State from China to the U.S. is also on the same path. France, the Hidden Zombie in Europe (Mish).

    I describe these dynamics in more detail in my book Resistance Revolution Liberation: A Model for Positive Change.

    Images: Flickr (licence attribution)

    About The Author

    Charles Hugh Smith writes the Of Two Minds blog (www.oftwominds.com/blog.html) which covers an eclectic range of timely topics: finance, housing, Asia, energy, longterm trends, social issues, health/diet/fitness and sustainability. From its humble beginnings in May 2005, Of Two Minds now attracts some 200,000 visits a month. Charles also contributes to AOL’s Daily Finance site (www.dailyfinance.com) and has written eight books, most recently “Survival+: Structuring Prosperity for Yourself and the Nation” (2009) which is available in a free version on his blog.