Government is overhead

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.

18 thoughts on “Government is overhead

  1. Good post. Your burrito analogy lends itself to a further comparison.

    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.

    It also challenges the Keynesian assumption that it will be good for laid off burrito makers for the company to hire more tax accountants, especially since it will be burrito makers who must pay for the accountant’s wages when they finally get rehired.

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  6. A very interesting post. I agree with your premise that government is overhead. However, if you look at government expenditures relative to GDP, they are lower than the average overhead rates of successful companies. Currently this rate is 19 percent or so (gov/gdp) and for companies this number is in the high twenties. Why is it that anti-tax folks presume that the correct level for our national enterprise is even lower than the faultless private sector can achieve?

    • Thanks for the comment Edward. I commend you for using data to back your position. I plan to write a new blog post to answer you, very soon.

  7. This post implies the inherent issue with macroeconomics and Edward’s comment highlights the challenge. For GDP is in itself an inappropriate measure of civilizations and economies.

    Consider for instance, that a young 18 year old may actually add less to GDP by choosing to apprentice in an office instead of going to school. Education is also overhead, and while the private sector ‘arguably’ under-spends on education, that does not justify a frozen government monopoly adverse to all innovation and which by now subsidies supply, demand, financing and regulates delivery down to the smallest item.

    Edward has the right idea, but misses both the overhead paid by debt and the casual negative externalities that government causes. A more accurate calculation of economic overhead would be to include most government bureaucracy (e.g., the post office is arguably NOT overhead since it produces a service, albeit at exorbitant cost) along with a major portion of private legal, insurance, tax and accounting staffs who concern themselves with regulative compliance. As to company overheads, I have never seen any that approach 20% unless one includes ALL management and/or all R&D and say, advertising, which I would humbly suggest is inaccurate.

    Some overhead is needed to measure and uphold hopefully simple laws that help guarantee a safe and honest society. I suggest those overhead costs, especially in the private sector, have exploded since the 1970s. The opportunity costs are incalculable and gargantuan.

    • I am ill equipped to parse what is rightly or wrongly attributed to overhead in the private sector context. I was quoting a PWC study that gave figure for overhead (26 percent) but did not define what was included. The text seemed to indicate that the items James mentioned were not included.

      I’m not going to defend debt as being an advisable inclusion into overhead either. Unless you are a start-up, you probably shouldn’t be putting your HR function on a credit card, right? LOL! Government should not have been doing this kind of thing for all these years.

      The negative externalities however are accompnied by the positive benefits associated with compliance to regulation (e.g. cleaner air and water, safe buildings for public accomodation, fair and relatively free markets). Granting that overhead costs have increased since the 1970s (I had no idea…have they?), I would submit that cars and buildings are more safe, the air is cleaner, and the accoutability of publicly traded companies to the…public is much improved as well. I think these benefits make the balance of these externalities significantly less negative.

    • On GDP validity, I’m sympathetic to the arguments against it. I leave it to the economists to come up with a better measure, provided it accounts for the equity we take out of the planet in environmental damage.

      • Edward, I think the confusion comes in on what GDP means exactly. Economists aren’t quite in a agreement on this either.

        In my opinion, GDP isn’t a bad measure of total economic activity, but it is not a measure of economic health. I elaborate on this more in my “government is an expense” post that I linked to in a previous comment.

        As far as a measure that takes account of the environmental toll, I don’t have much confidence that can be done and I’m not sure it would matter. On the first point, it would be too open for political manipulation and subjective interpretation. You’d say it should be higher, I’d say lower. We’d never agree because we have no data true measure on which to base it.

        On the second point, how would that measure change any one’s behavior? Just like GDP, it would be a number on the computer screen and not really related to the decisions that you and I make on a daily basis.

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