Sunday, January 29, 2012

Size or Commitment:
What Matters Most?

In response to last week’s blog, a long term and very perceptive reader from a country that is also wrestling with the size of government asked whether I favor large or small government. I believe that size does matter. The single biggest determinate as to whether any current government eventually stays in power is the size of the perceived services it delivers to its people. There is a line that is attributed to a Roman poet that chronicled the need for “bread and circuses.” What went without saying were the primary needs of protection against foreign and domestic enemies. In the current era, the bread and circus line can be translated more simply to “finding and filling satisfying jobs.” I suggest that the size that matters is the size of the demands placed on the current political leaders.

Today’s appropriate size is governed by two constraints, the willingness to pay and the skills to deliver. With the exceptions of some small populations with large amounts of easily delivered but scarce natural resources, deficit production is threatening the current leadership of governments around the world. Whether the government is freely elected or not, it does not seem to matter much. The size of the current deficit is the widening gap between spending and revenue generation. Spending is for the aggregate services provided by the government to fill the perceived needs of the people that tolerate the political leaders. As discussed in last week’s blog, each of us acts as our own special interest group advocating for spending to fit our needs to be added to those of others. This is another size that matters. ‘Austerity’ is the government’s reason for not fulfilling all those current needs. Many societies are at the point that if large scale revenues are increased, it will force the private sectors to cut back their spending, reinforcing the downward spiral of austerity. While the need to sharply curtail spending is increasingly apparent and unpopular, there is some practical recognition that could save the day.

“Too big to fail?”

The first recognition is that there is little to no multiplier effect when government is the direct employer. Job leverage is much better supplied by the private sectors that are likely to bring all sorts of capital and management skills to bear on satisfactory job creation. The second recognition should have come as a result of the whole discussion regarding “Too Big to Fail.” That misplaced focus was on the potential irreparable harm that would have come from the financial failure of some 700 banks, two large American iconic auto companies, and the largest casualty and financial insurer in the world. At the time when poor decisions were made, I believe these groups had begun to manage successfully. If these companies were too big to manage, I suggest that governments, at many levels have become too large to manage. (This is particularly true when most governments cannot count on successfully recruiting the most qualified people at various levels.) Coming from these recognitions is the realization that many activities conducted by the government could and likely would be done better by customer-oriented private companies.

Thus, the answer to my reader’s inquiry: I am in favor of reduced size and scope of activities by various levels of government, but by no means am I advocating a cottage industry government.


As a long-term investor in funds with Asian securities, I have been concerned with the financial/investment news media echoing various investment and economic leaders about the prospects for Asia. These opinions are largely based on too-similar views as to the progress of China. As an analyst, any time I find too much agreement on a topic, I get nervous. I do not like to be in crowded trades.

While it is too early to have a well-defined view of the future, I am happy to share some thoughts prior to reaching any conclusions. These thoughts are about current commitments. On the positive side, in discussions with a couple of managers I learned how they are investing in their own businesses, which are showing their commitment to investing client money in Asia for the long-term. I have been visiting Hong Kong over many years, and with my previous firm, had a fund data and marketing office there. I used to think that in many ways Hong Kong was like a suburb of London. Investment leadership appeared to be plugged into “the great and good” UK investment houses; with some minor leadership from a handful of US firms, often hiring UK ex-pats. This week I learned of one investment house having a dozen local analysts, including three in Shanghai, plus global industry analysts. What was most encouraging for me was the use of a number of business intelligence agencies to verify what many Chinese companies are saying or reporting to shareholders. With this firm’s commitment to investing in consumer goods companies, for the local market, a feel for what is actually happening as distinct from reading and believing press releases becomes critical to produce good relative performance. A second firm, in this case mid-sized, with only twelve investment people, has opened an office in Mumbai and staffed it with four analysts. The leader of this firm believes that this is the best investment that the firm has made, even though they currently have only about 8% invested in India. These two firms are making significant investments with their own operating money, being able to produce “long horizon” investment returns for their clients.

The other set of commitments are even longer-term and much more difficult to produce satisfactory results. Governments in China have not lost power from battles with foreign invaders, but from large-scale social disruptions. With over 50% of the current population living in the cities, with more wanting to live and work in the cities, China's urban development is critical to social stability. The government is particularly focused on the inland cities. With their lower wages, they could become major job creators and socially stabilizing forces. The government has a desire that many of these cities should be able to ship their manufactured product and natural resources to coastal ports within five hours travel time. There is, at least, one problem with the execution of this desire. Most existing railroads generally run in a north-south direction, however east-west routes are needed to bring merchandise to the ports. The recent series of crashes of the “bullet trains” has led to major changes in China’s infrastructure planning, including rail speed and management. To the extent that the central government’s change in emphasis in favor of consumer spending as contrasted to the prior focus on exports, there could be some relief beneath the social surface. The pace of development will need to keep pace with the speed of electronic communication to prevent an increase in the reporting of social disruption.

We need to do more research. What happens in China will impact the rest of the world.

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