Friday, February 06, 2009

Middle Class: big trouble (long post)


I found it interesting that President Obama has already identified the pressing need to rescue the middle class. Without a middle class, then government ceases to exist, because from the Roman Empire to the present, it is the middle class which pays the bulk of the taxes. The wealthy find waivers and exceptions via corruption and guile, while the poor pay little or nothing but extract much.


I am wondering if the American middle class is crumbling for structural reasons even beyond taxation and government-sponsored degradation of the currency. As destructive as those forces most certainly are, I wonder if the "de-scaling" of the U.S. economy isn't the larger factor.

By "de-scaling" I mean the loss of large organizations capable of generating office towers full of people profitably manipulating information. Simply put: small businesses have no need for HR (human resources) managers, facilitators, project managers, coordinators, assistants to the second vice president of marketing, etc.

The entire edifice of "middle class jobs" depends on large-scale enterprises in need of massive bureaucratic management. The smaller the enterprise, the more actual productive work is done by everyone and the less essentially unproductive "managerial" and "reporting" work is done by anyone.

If we boil down management to its essence, it is this: trying to get recalcitrant workers to do their jobs efficiently while putting the best possible face on things to superiors via reports, meetings, balance sheets, etc.

But all this management requires stupendous sums of money to support. Interestingly, as the Roman Empire lost its grip, its many edicts to the crumbling provinces were largely ignored; without an Imperial presence to track and punish slackers and corrupt officials, then all the reports, demands and communications were essentially one-way: ignored.

Basking in the afterglow of 25 years of prosperity (as bogus as it might have been), we have perhaps forgotten that huge enterprises with all the layers of management beloved by business schools have vanished without a trace: DEC and Wang, to name but two.

In previous recessions, as corporations lost money, they were forced to either strip out layers of management via ESSA--eliminate, simplify, standardize and automate--or go under. It is now widely held that U.S. corporations are "lean and mean" after all this "flattening" of management, but for every reduction in overhead costs a new one has popped up: for instance, Sarbanes-Oxley (SOX), a vast system of costly reporting which was supposed to collar corporate malfeasance.

Instead, the greatest thievery has occured under the nose of SOX. It is in effect a gigantic unproductive tax on large enterprises.

Other regulatory "reporting" systems also exact a staggering toll on private enterprises, and most of it is never questioned: it is truly useful? Now that thousands of jobs depend on it, there is bureaucratic resistance to any trimming of regulatory reporting.

One way to get out from underneath such onerous bureaucratic systems is to leave the country or shut down all but a skeleton crew. Those with no understanding of private enterprise bemoan the loss of "good-paying American jobs" without looking at what it costs to maintain the overhead of the enterprise, never mind its actual production costs.

In general, if you want to pay an employee $50,000, the position will cost at least another $50,000 in overhead. To actually make a profit, the company needs to get $150,000 of value out of the employee whose salary is $50,000.

Thus a reduction in sales will quickly lead to the need to shed not just the salary but all the overhead costs: the medical insurance, the reporting, accounting, etc.

The Federal Government, of course, has no need to turn a profit, and being able to borrow or print unlimited sums of money gives it elbow room no other enterprise can afford. In other words, the regulators and edict-givers can continue to grow even as their tax base shrivels.

We are fast approaching the point, in my view, where global corporations will have only "show" staffs in the U.S. because there is simply no way to make a profit in a global Depression with a high-cost U.S. workforce and regulatory structure to serve.

Goliaths like IBM already have more non-U.S. employees than U.S. based employees, and there is absolutely nothing on the horizon to suggest this trend will reverse: as the government raises the cost of overhead with ever more edicts and regulations and taxes, the pressure to leave the U.S. entirely only increases.

We would do well to recall that businesses of all scales must make a profit; losses will eventually take them down. The higher their overhead, the more likely their demise.

On the other end of the scale, small businesses are like the provinces of the crumbling Empire: they mostly ignore the Imperial edicts because they have no choice financially but to do so.

This is the essence of why I have predicted the blossoming of the informal economy: once the costs of a "legitimate business" with all its reporting, overhead and taxes becomes too high to bear, the entrepreneur has no choice but to slip beneath the radar and work out of his/her home/garage.

The government, of course, will attempt to seek out and punish these miscreants, demanding they pay fines, licensing fees, meet various regulatory codes, etc. But an interesting feedback loop is now in play: the more government squeezes business via higher fees and taxes, the more business owners will simply give up/be driven bankrupt.

To reiterate: the higher the overhead burden, the likelier the bankruptcy. Once the overhead reaches a certain level, cutting staff isn't enough to bring expenses down to match shrinking revenues: as absurd as it sounds, the enterprise could lay off every single worker and still have expenses above revenues due to fixed overhead costs.

As these once-prosperous business close, the government collects less tax, and at least at the local level, eventually this loss of revenue crimps their ability to chase down those who have slid into the informal economy.

You see where this leads. At the global-enterprise scale, corporations will continue to downsize costly, high overhead U.S. offices and staff in favor of lower-cost, lower overhead workforces elsewhere. At the other end of the scale, small businesses will disappear by the tens of thousands, and entrepreneurs who once paid huge sums of rent, taxes, medical insurance, fees, etc. will no longer be paying anything but their own living expenses.

At some point, local government will have to face the reality that their expenses will have to be aligned with diminished revenues. The city of New York has some 330,000 employees (if I recall correctly). Perhaps the economy of the city can only support 250,000. Now the city can attempt, like the Roman Empire, to raise more revenues by taxing the remaining middle class.

But given that small business already faces very high overhead costs, the proper metaphor is a rowboat so heavily loaded that the waves are already lapping over its gunwales. It won't take much more weight to sink it, and right now we see local government desperately shoveling more weight into everyone's sinking rowboat: higher sales taxes, higher fees, and ever more edicts and penalties.

Is there any recognition that higher sales taxes, fees and taxes are not exactly incentives to buy more or start new businesses? Apparently not.

So what happens to "middle class jobs" as private enterprise is de-scaled at both the global-enterprise and small-business levels? They vanish. And as tax revenues plummet in a never-ending down-spiral, then local and state governments will face the same constraints as private enterprise: something has to give, and it can't be the guys and gals picking up the trash every week. It has to be the private drivers of the police captains, and all the other layers of essentially unproductive labor on the public payroll.

Sadly, there is little evidence that we recognize the danger of taxing and regulating the productive middle class out of existence. Instead, all the feedback loops are in place to hasten its crumbling.

6 Comments:

Anonymous Anonymous said...

An interesting post. However, the idea of "taxing the middle class out of existence" is a bit flawed. When you look at truly middle class jobs, most of them are actually SUPPORTED by taxes and regulations nowadays. Lawyers and accountants exist almost solely to comply with government regulations. Doctors thrive solely because the government restricts the number of residents, medical schools, and doctors, thereby effectively setting supply and regulating health care. A lot of consulting, banking, insurance, and finance work involves government regulations and taxes, if you believe it or not. Same with architecture and engineering, much of it is about satisfying government regulations. The tens of millions of tradespeople like mechanics, electricians, plumbers, welders, elevator installers, and other similar trades only make decent money because they are protected by various quasi-governmental associations and safety regulations. In light of this, I don't see how you can possibly say that regulations themselves are destroying the middle class.

The way that businesses deal with regulations is different than what you say. Corporations did not deal with SOX by eliminating their accounting departments! SOX actually gave a comparative advantage to small businesses by imposing millions in fees on publicly traded but not small private businesses, which is why fewer companies went public. That regulation made thousands more middle class jobs. Likewise, OSHA regs, discrimination regs, other workplace regs, consumer safety regs, accounting regs, whatever, businesses are FORCED to comply, and to comply they have to add middle class jobs. The environment in which the government has lost the power to enforce compliance and businesses can ignore regulations simply does not exist for most companies.

Your theory seems to turn on the loss of the ability to enforce compliance by governments: "The government passes regulations, businesses first eliminate middle class jobs, then businesses disregard them, and then the middle class is regulated out of existence." I've already argued that increased regulation is not necessarily harmful to the middle class. But answer me this: In some Mad Max scenario, if businesses simply disregard regulations, why would those regulations even impact the middle class at all? If nobody pays attention to them, they should have no effect. How does something that have no effect destroy the middle class???

I am more sympathetic to your argument that information technology and lower business costs overseas will lead to increasing outsourcing. I believe in free trade, and there is substantial evidence that outsourcing has created more jobs in USA than it has eliminated. As more jobs are added in India, the wages in India go up. Then businesses search for workers in Bangladesh, and hire there, and wages go up in Bangladesh, and so on and so forth throughout the world. Empirically, we can see that this is happening throughout the world. As wages in the other developing countries increase, American workers because of their higher productivity become more competitive with increasingly higher priced Asian workers. It isn't a zero sum game.

Information technology does decrease the number of middle class workers needed in management in any one company. This decreases costs of doing business. If business costs decrease, more people will start businesses! Ideas that weren't profitable with 10 middle class employees may become profitable with only 3 middle class employees. So perhaps the decrease in management jobs in any given company will be offset by more businesses starting.

Your argument seems to me inconsistent. "Regulations are bad for the middle class because they INCREASE the cost of doing business; IT and outsourcing is bad for the middle class because they DECREASE the cost of doing business." What??? Higher costs=bad; lower costs=bad. That doesn't make sense from a broader perspective.

There are lots of other benefits of free trade that DO help the middle class. Richer world=more markets for American companies, more jobs for American people. Lower prices on consumer goods that the middle class buys!

So, when the world is flat and its just as easy to higher an Indian manager as an American manager, why should a business locate in America? Productivity of its workers, which SHOULD be ensured by greater taxes and spending on education, as well as numerous reforms. Infrastructure like reliable power,utilities, roads, internet, etc., which is paid for by taxes. Safety, justice, the rule of law, private property rights, strong national defense and security, all of which are paid for by...hmm, I think taxes. Regulations on accounting and business practices that safeguard investors, ensure consumers of safe and reliable products, protect against false advertising, etc, the administration of which is paid for by... taxes. A good environment and the security of our natural resources, which costs money, which is raised by ...taxes! Why do you think IBM and all those other companies still have ANY workers in America at all? All the above reasons.

Bottom line, education, law, safety and security, infrastructure and a stable society that is conducive to business are good for America, and the reasons why America is still competitive. That's all paid for by taxes and enforced by regulations. The idea that the concept of taxation and regulation is bad for America and its middle class is truly shortsighted. It is an idea propounded by ignorant and uneducated people, or by those who lack the curiosity and drive for knowledge to actually think things through. Too much taxation and regulation is bad. But we probably need more than we have right now to remain competitive, and to ensure a healthy middle class. Obama agrees, which is why he is talking about spending tons of money, which will ultimately be paid for by taxes. I'm sorry to go after you so much, I'm sure you are intelligent but simply made a reflexive post that you did not think through, or have another perspective that I have not yet heard but would really like you to expound upon.

Accountant

9:16 AM  
Anonymous Anonymous said...

I'd say the author seems confused on what "Middle Class" is and what "Middle Management" is.

Those type folks were described as trying to keep "workers" productive while issuing glowing reports to upper management.

Let me correct you: Those "workers" needing prodding (in your mind) ARE the "Middle Class." Those prodding: Middle management.

They are an anachronism, a holdover of "make work" from high school and college: unproductive and expendable, unlike "tradespeople" that actually MAKE SOMETHING OF VALUE.

As far as "high paid Americans" being detrimental to America's global ability to compete: I say FAIR TRADE practices remedy any ills there: Why should an American worker, in an economy based on GROWTH and ever INCREASING PRICES, have to accept LOWER wages because some D.C. politician took money from some corporate lobbyist (that also wants "tax breaks" for moving our jobs off-shore), have to compete with a Chinese, Thai or Malaysian worker in an economy where the cost of living is half or less what we have in the US?

That's why God made TARIFFS, folks.

And Mr. "accountant": "Tens of millions of tradespeople like mechanics, electricians, plumbers, welders...only make decent money because they are protected by various quasi-governmental associations and safety regulations" is GIBBERISH.

They earn a decent wage because they do important, PRODUCTIVE jobs, not just searching for one more tax break for some millionaire/billionaire. Don't take it personally. Or do, I could care less.

Me? I like paying mechanics good wages: I like to see the planes I fly on STAY UP IN THE AIR. Call me stodgy and rigid, but there it is. I like knowing the well-paid welder on a nuclear power plant containment vessel can lay down metal without flaws to x-ray quality. Others might prefer he can't, should get paid less, and these types also enjoy glowing in the dark.

Explain to me HOW an OSHA regulation requiring a welder wear safety glasses and respirator INCREASE THAT WORKER'S rate of pay?

Nonsense. How much regulation is in a Mcdonald's kitchen? How well-paid are Ronald's workers???

Reality: Government passes regulations. Some might lead to additional costs.

BUT. SOMEONE, SOME BUSINESS is STILL going to bid that work, and just add it to the cost (and a little *extreee* for the boss, I guarantee) of doing business, and the "tradespeople" won't see a dime of the increased costs.

Think it through a bit longer before you post such foolishness.

farang

11:17 AM  
Blogger Doug said...

95% of taxes are paid by the top 5% earners.

So the middle class isnt being taxed that much, just the upper middle class.

Its not the 50k guys who are getting raped, its the 250k guys.

10:55 AM  
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