Quote of the Day: The Unintended Consequences from China’s Infrastructure Spending

Why aren’t China’s leaders spending much more as they did in late 2008 and 2009 to boost economic growth? It might be because much of what they built was defective as a result of widespread corruption. The 8/4 issue of the London Times reported there were 99 road cave-ins in Beijing between July 21 and August 21 of this year. Roads and bridges are collapsing in other cities as well. Most are relatively new including a bridge that was built just 10 months ago.

The country's former railway minister, Liu Zhijun, was expelled from the Communist Party of China for corruption in May following the high-speed train collision that left 40 people dead and 172 injured near the eastern city of Wenzhou last year. In March of this year, part of a high-speed railway line due to open in May between the Yangtze river cities of Wuhan and Yichang collapsed after heavy rain. Engineers working on some projects have complained of problems with contractors using inferior concrete or inadequate steel support bars. Consider this excerpt from the 2/17/11 issue of the NYT:

“The statement underscored concerns in some quarters that Mr. Liu cut corners in his all-out push to extend the rail system and to keep the project on schedule and within its budget. No accidents have been reported on the high-speed rail network, but reports suggest that construction quality may at times have been shoddy. A person with ties to the ministry said that the concrete bases for the system’s tracks were so cheaply made, with inadequate use of chemical hardening agents, that trains would be unable to maintain their current speeds of about 217 miles per hour for more than a few years. In as little as five years, lower speeds, possibly below about 186 miles per hour, could be required as the rails become less straight, the expert said. Strong concrete pillars require a large dose of high-quality fly ash, the byproduct of burning coal. But the speed of construction has far exceeded the available supply, according to a 2008 study by a Chinese railway design institute.”

This is from Dr. Ed Yardeni on China’s slowdown.

China announced last week a 1 trillion yuan $157 billion infrastructure spending program which is much less than the 2008-2009 version.

Nonetheless, the above serves as further proof that infrastructure spending projects by governments, not only waste taxpayers money, but importantly promotes unethical transactions which results to MORE economic and social problems.

Quote of the Day: Welfare Crisis Aggravated by Demographics

Demography is destiny. If so, then the future will be challenging in many countries around the world where fertility rates have dropped below the replacement rate. At the same time, people are living longer. So dependency ratios--the number of retirees divided by the number of earners--are destined to soar.

Why have fertility rates fallen around the world? There are a few plausible explanations. One of them stands out, in my opinion: Socialism may breed infertility! In the past, people relied on their children to support them in their old age. Your children were your old-age insurance policy. Over the past few decades, people have come to depend increasingly on social security provided by their governments. So they are having fewer kids.

That’s fine as long as the ratio of retirees to workers isn't so high that the burden of supporting our senior citizens crushes any incentive to work resulting from excessively high tax rates. The cost of increasingly generous and excessive entitlements has been soaring relative to taxable earned incomes even before dependency ratios are set to rise in many countries. Governments have chosen to borrow to finance social security and other entitlements, to avoid burdening workers with the extremely high tax rates that are necessary to balance entitlement-bloated budgets.

Median ages are highest in advanced economies with large social welfare states. Among the 45 major countries, Japan has the highest median age (44.7), while the Philippines has the lowest (22.2). Advanced economies tend to have higher median ages than emerging ones because they provide more social welfare, which boosts longevity and depresses fertility.

Bond markets may be starting to shut down for countries that have accumulated too much debt. That’s creating a Debt Trap for debt-challenged governments. If they slash their spending and raise their tax rates, economic growth will tend to slow. If tax revenues fall faster than spending, their budget deficits will widen. There has recently been an outcry about the hopelessness of such “austerian” policies that perversely lead to higher, rather than lower, debt-to-GDP ratios.

The demographic reality is that people around the world are living into their 80s and 90s. Some of them believe that they are entitled to retire in their late 50s and early 60s even though they are living longer. Yet, they didn’t have enough children to support them either directly (out-of-pocket) or indirectly (through taxation). Instead, they expect that their governments will support them. So governments have had to borrow more to fund retirement benefits. That debt is mounting fast and will be a great burden for our children. The result can only be described as the Theft of Generations.

That’s from Dr Ed Yardeni at his blog. To “depend increasingly on social security” has not really been about socialism (government ownership of production) but about the welfare state that has played a significant role in driving today’s debt crisis. The Santa Claus principle is being unraveled.

The Unraveling of Europe’s Wonderland

Dr. Ed Yardeni at his blog, has a superb and eloquent piece on the problems besetting the Eurozone which he calls as Europe’s wonderland (bold emphasis mine)

The Europeans have had the best governments money can buy. Their elected leaders have provided them with all sorts of wonderful social welfare benefits. Many Europeans are employed by their governments to provide those benefits to their needy fellow citizens. Those who cannot find a job, or are too depressed to look for one, are provided with extremely generous unemployment benefits. Retirement benefits are great, and early retirement is the norm. Life has been very good in Europe.

Of course, that all costs lots of money. That’s why income tax rates are so high in Europe. On top of those rates, Europeans pay significant value-added taxes on the goods and services they buy. Yet there has been an ever-widening gap between government spending and revenues. That’s partly because Europeans have responded to their exorbitant tax rates with widespread tax avoidance.

The spending of European governments has ranged between 40% and 60% of GDP for many years. The revenues collected by these governments have ranged between 30% and 50% of GDP. The resulting deficits have led to rapidly rising ratios of government debt to GDP.

Attempts to bring back some fiscal sanity, led by Germany’s Chancellor Angela Merkel, are now widely caricatured as fiscal “austerity.” In my opinion, the only way to fix Europe is to slash government spending, reduce tax rates, enforce tax collection, and deregulate labor markets. Instead, enraged European voters are rising up against austerity and voting for the status quo. They haven’t indicated who they expect will pay the bills. However, they must be counting on either the Germans to pick up the tab or the ECB to implement more rounds of the LTRO.

European politicians who signed on to the “fiscal pact” promoted by Germany late last year are losing their jobs. Those favoring a “growth pact” are winning support, though they have no specific plan yet and certainly no way to finance it once it is specified. Also gaining support are various left- and right-wing fringe groups that tend to promote anarchy as the most effective way of overthrowing the established order and replacing it with their disorder.

Europe is at risk of devolving from an economic and monetary union into a disunion of failed states. The Greeks are unable to form a coalition government after the two major parties lost significant support to fringe parties over the weekend. They may need to have another round of elections. The remote chance of Radical Left leader Alexis Tsipras forming a coalition faded on Tuesday when New Democracy leader Antonis Samaras promptly rejected his demand to scrap Greece’s bailout plan, warning such a move would drive Greece out of the euro: "Mr. Tsipras asked me to put my signature to the destruction of Greece. I will not do this. The country cannot afford to play with fire."

(According to Greek mythology, Prometheus stole fire from Zeus and gave it to mortals. Zeus then punished him for his crime by having him bound to a rock while a great big eagle ate his liver every day only to have it grow back to be eaten again the next day. During the Greek War of Independence, Prometheus became a figure of hope and inspiration for Greek revolutionaries.)

The above is simply commonsense economics which shows that we can NOT spend ourselves to prosperity or that there is NO such thing as a free lunch.

This implies that reversion to the mean would be the natural order from previous overspending that produced high levels of debt. And the logical and commonsensical solution to such predicament would either be to raise revenues by making the economy more competitive or to reduce government spending, or more optimally, having to apply both approaches. The ECB can only kick the can and even worsen the scale of the imbalances.

Unfortunately many people live in dreams. Politicians and their academic and institutional backers pander to such utopianism by imposing the same policies that got them there. They do this by whipping up public’s sentiment by peddling half truths to the gullible and uninformed. A good example is media’s baloney over so-called “austerity” which in reality has been a gross perversion of semantics. Mr. Yardeni’s chart above reinforces my earlier assertions.

Yet Sweden’s anti-Keynesianism policies should serve as a wonderful counterexample where commonsense economics--economic freedom, genuine austerity and tax cuts--have been driving real growth.

Politicians and (parasitical) voters would like to make permanent a life of abundance, by living off someone else’s labors. Unfortunately the reality says that we are bounded by the laws of scarcity, and people’s efforts are constrained by such limits.

Thus when the proverbial rubber meets the road, delusions over Europe’s desired perpetual state of wonderland has been in the process of being unmasked.

Reality, says Libertarian author Robert Ringer, isn't the way you wish things to be, nor the way they appear to be, but the way they actually are.