In this post, I quoted from a Reagan radio address where I thought he created a good mental image of how the private sector and government work together. Here’s the key point from his address:
To sum it up roughly 70 million Americans [working in the private sector] provide a living for themselves and 143.4 [million] additional people.
Those 143.4 million people included the non-working family members of the 70 million Americans and the folks who receive a check from government — be it through a government job or transfer payment. (Though, come to think of it, I think Reagan neglected the private sector jobs that are paid by taxes, like with government contractors. But, perhaps he was simplifying.)
Reagan’s analysis came up in a conversation with an old friend when we discussed the political theater that has been going on in Washington DC. Specifically, how liberals are hostile to the private sector and business, even though the private sector and business pay for government. Or put another way, without the private sector, government wouldn’t exist. And, therefore growing government faster than the private sector is not sustainable.
It then occurred to me that few people seem to understand the value creation process that goes on in the private sector and how that pays for government. They don’t recognize that this value creation process is the very source of our standard of living, which provides for government and that government is just the overhead.
As a rough analogy for economy, let’s consider a business that makes burritos.
The burrito business has two types of costs — direct and overhead.
Direct costs pay for the materials to make the burritos like flour, meat, seasonings, tomatoes, labor and the cost of the space to make the burritos (I’m getting hungry). This might also include the sales force and advertising used to sell the burritos and the cost of the trucks to deliver them.
Overhead are the indirect costs like accountants, lawyers, and HR and IT people and the resources these folks use like space and utilities. These folks aren’t necessarily needed to make the burritos. Their jobs wouldn’t exist without the value created from the burrito making operation.
Now, overhead does perform some useful functions for the business, just as government performs some useful functions for society. It’s much better that the business has an accurate accounting of its financials and pays its bills on time. These sorts of things helps the business remain in good standing with the folks they do business with.
But most people intuitively understand that there’s a limit to the overhead costs the business can support. It’s not an exact number, but they understand that if a business grows it’s overhead costs faster than profits from making and selling burritos, it would not last long. And everyone who depends on the business for a living and for good burritos would be in trouble.
They also understand that if the company’s burrito sales declined, the best strategy to fight this probably is not to expand overhead costs. The best strategy is probably to focus on producing and selling burritos folks will buy.
Yet, when the economy declined, increasing overhead was the idea to save it. Not surprising that it didn’t work.
This is one reason I dislike the equation for economic output or GDP. It treats overhead costs, or government spending, as if it were interchangeable with direct costs, like buying more flour to sell more burritos. And this leads politicians to do crazy things, like increase overhead when what really need to do is make a better burrito.