Moving On Up

Geopolitics: A Business Case is moving to a new URL address.  Please click on the below link to check out the new homepage. 

http://the-schmidtblog.blogspot.com/

Those Who Don't Learn from History

The first thing that I learned in business school is how to perform a case study analysis.  For those who have never read a case study, it is an example of a real life company that has been a smashing success or a colossal failure.  The student is then expected to analyze the case and document the best practices of the successful companies or look for lessons learned from the unsuccessful ones.  Harvard Business School has become famous for teaching via the case study analysis and it is now a staple of the business school and corporate worlds.

One place where this methodology is not applied is politics.  With elections coming up this year and politicians on both sides dusting off their ideology and rhetoric, I can’t help but wonder why no one is mentioning policies that have or have not worked in other countries.  More specifically, I wonder why no one is looking at Greece, which is in the midst of imploding economically, for lessons learned.

Since no one seems to be doing this, this post will serve as my own brief case study analysis of Greece’s current economic crisis.

Overview of Greece’s Economic Situation:

Greece just received its second bailout from the European Union (EU).  This bailout was required because Greece did not have enough funds to make the payments on its debt.  As of the writing of this post, Greece’s total public debt is approaching 175% of the size of its economy.  Long story short, Greece owes its creditors almost twice as much as its economy is worth.  This is an untenable situation and it is only a matter of time until the country goes bankrupt.

These economic problems are a direct result of two factors.  First, Greece’s debt load is growing.  This is happening because Greece routinely runs a budget deficit.  A budget deficit means that its government spends more than it earns.  Like any individual, household, or organization that spends more than it earns, Greece has had to offset its deficit with debt.  Over time this debt has grown into the monster that faces Greece today.

The second issue is that Greece’s economy is shrinking.  This is because Greece adds very little to the world economy in terms of value.  Its economic growth was dependent on increased government spending and consumption of imported goods, products, and services by its citizens.  Much of this consumption was financed with debt and, as the availability of debt dries up, the country is left with no more money to spend.  The key economic indicator of this issue is the massive trade deficit that Greece has.

Budget Deficit:
Budget deficits occur when a country spends more than it earns.  Greece’s budget deficit in 2011 was roughly $30B or 11% of the value of its economy.  There are two reasons for this budget deficit.

·         Greek citizens don’t pay their taxes:  It was estimated in 2005 that tax evasion amongst Greek citizens was close to 50%.  This statistic has improved slightly since then to about 40%, but the current Greek Finance Minister still estimates that the Greek citizens and companies owe the country close to $50B (€37B) in unpaid taxes.

·         Greece has one of the most elaborate welfare systems in the world:  Greece’s social welfare expenses accounted for close to 32% of its total expenditures in 2011.  This number doesn’t sound like much, most EU countries have about the same ratio, until you factor in that Greece only reports universal healthcare and pension costs.  Educational subsidies and other social program costs are not reported.  Also, the Greek retirement age of 57-58 is tied with Italy for the lowest in the world, so the government is providing those benefits for a higher proportion of its citizens’ lives.

When you combine the two points above, it is easy to see why Greece continually runs a budget deficit.  Its citizens have grown to expect the state to pay for a large amount of benefits without increasing (or even collecting) taxes to pay for them.  

Trade Deficit:

Similarly, Greece’s trade deficit issues stem from three main problems within the country.  These problems are:

·         Greece joined the EU:  By joining the EU, Greece joined a free trade zone.  This eliminated all trade barriers between the various European countries.  It also placed the Greek workforce in direct competition with work forces in other countries.  This became a problem for Greece and other EU countries because one of the world’s most efficient work forces is based in the EU: Germany.    

·         Greece joined the euro common currency:  By joining the euro, Greece became tied to a currency that was among the highest valued in the world.  This meant that it could no longer compete with other countries based on paying low wages like China does.  It had to either be more efficient than its competitors or go bust.

·        Peculiar Greek economic policies and regulations: Greece has some very usual policies that are aimed at protecting its industries and workforce.  Instead, they stifle growth and produce inefficiencies.  An example is: annual wage increases in Greece are not determined by the companies who pay them.  Instead, they are determined by negotiations between the state and trade unions.  The result is that Greek citizens have enjoyed close to a 10% raise every year for the past decade.

When combined, these three factors have made Greece incredibly uncompetitive from an economic perspective.  The result is that it is cheaper to buy goods produced in other countries than it is to buy domestic goods in Greece.  This means fewer jobs for the Greek citizens and has produced an unemployment rate over 20%.  It also means that the Greek economic decline will continue to mirror cuts in government spending since there is very little else in the country to drive growth.

Lessons Learned:

My big takeaway from this exercise is that all of the root causes of Greece’s economic meltdown are side-effects of running a modern democratic system.  This is because Greece politicians did all of the things that are politically popular in a democratic society.  They cut taxes, reduced the retirement age, increased government spending on social programs and pensions, and put in place numerous policies to protect the interest of trade unions and Greek workers.  Despite the popularity of these programs, Greece is failing.

The lesson learned from Greece is therefore that politicians in democratic governments have a responsibility to their citizens that is similar to the responsibility that parents have to their children.  They need to be the ones who tell the citizens "No", despite how unpopular that may make them.

You Might as Well Face It, You're Addicted to...

….war.  Well, maybe not you personally, but the modern day United States certainly is. 

Don’t believe me, surf the web for an hour or so.  You’re bound to come across articles calling for the US to intervene in Syria or forecasting a coming conflict with Iran.  You can also find stories about the recently completed war in Iraq or the ongoing war in Afghanistan.  Lastly, if you look hard enough, you can find a statistic like the following: the US accounts for 43% of total world military expenditure.  This is larger than the next 14 countries combined.

Prussian military strategist Carl von Clausewitz once stated that "War is the continuation of policy by other means" and no country in history has embraced this theory like the modern day United States.  This has naturally led to series of literature to be generated for and against the US’s aggressive foreign policy.

The “Against” Perspective:

The “Against” perspective can be represented by author and former US soldier Andrew Bacevich.  In his book “Washington Rules”, Bacevich argues that the US leadership in both parties has come to view war as its solution to every problem.  His chief point is that since the start of World War 2, the US has constantly been engaged in a global struggle against some sort of –ism: first Fascism, then Communism, and now Terrorism.  Bacevich presents multiple examples of how US leadership has used covert operations, threat of nuclear war, direct military intervention, and even trading policies to directly support ongoing wars against global enemies. 

Bacevich’s conclusion is that this policy has led to the US being universally feared and resented.  He also calls for the US to renounce its claims on bases like Ramstein in Germany and Okinawa in Japan and to return its troops home to protect sovereign US territory.  Doing this, he argues, will free up billions of dollars in government funds to address domestic issues, as well as improve the US’s standing in the global community.    

The “For” Perspective:

The alternate view to Bacevich is championed by George Friedman of Stratfor and the books “The Next 100 Years” and “The Next Decade”.  This view is that the US, as the dominant global power, has a great incentive to use war as a tool to disrupt potential competitors.

From this perspective, the US goes to war because it can.  It doesn’t have to win every war.  Instead, it just has to “mess up” the other side enough that they are no longer a challenge to the US.  In this light, the wars in Afghanistan and Iraq make perfect sense. 

The Taliban was responsible for the 9/11 attacks on the US and was seeking to use its attack to recreate the Islamic Caliphate.  A reborn Caliphate would have united the Middle East and presented a severe threat to the US’s oil interests in that part of the world.  The US intervened and, despite the war dragging on 10 years later with no end in sight, has prevented the creation of the Caliphate.  It has also disrupted the Taliban by eliminating most of its leadership.

The same story applies to Iraq.  Many of the operatives who participated in the 9/11 attacks came from Saudi Arabia and Iraq.  The US therefore invaded Iraq because it is the central hub of the Middle East.  From there, the US could attack Saudi Arabia, Jordan, Syria, Iran, or Kuwait.  This served a reminder to these countries of the consequences of crossing the US.  It also prevented them openly supporting the Taliban and its goal of creating a Caliphate.

My Take:

I hate to admit it, but I am torn on this issue.  My heart lies with Bacevich’s perspective while my head sides with Friedman.

I agree with Bacevich because war requires the sacrifice of US soldiers and can often result in their death.  It bothers me that US leadership can sacrifice their lives so easily.  I also dislike the fact that these wars syphon off billions of dollars that could be used to address problems on the domestic front.  Lastly, I dislike the fact that this warmongering has created a negative view of Americans abroad.

I agree with Friedman because his view is logical and appeals to the engineer in me.  The current global system works for the US.  These small wars are therefore a form of preventative maintenance on the global system.  They are aimed at isolating and correcting potential problems before they become too large and disrupt the overall system.  While painful and sometimes expensive, they are nothing compared to the pain and expense of a significant system failure.

Conflicted, with my heart fighting my head, I therefore turn to the creators of South Park for their wisdom.  Paraphrasing the message of the “I’m a Little Bit Country” episode, I believe that both sides are needed.  The Friedman’s of the world are needed to keep the global system working for the US and to prevent catastrophes like WW1’s and 2 from happening again.  The Bacevich’s of the world are needed to act as the country’s public conscience and prevent the country from abusing its power.  They also prevent the rest of the world from hating the US for being openly bloodthirsty and ruthless.

As South Park states, this allows the US to be ruthless in pursuing its goals while not seeming bloodthirsty.   This is called “having your cake and eating it too” and it’s the beauty of the American democratic system.       

The United Kingdom Goes Back in Time

Last week, I had lunch with a couple of European friends.  One friend is German and the other Greek, so they argued vociferously about the European Union’s (EU) current debt issues throughout most of the lunch.  The only topic that they seemed to agree on was the recent announcement from the EU leadership regarding changes in the Eurozone’s structure. 

A quick summary of this recent announcement is as follows: 25 of the 27 EU countries recently voted to ratify changes to the EU charter to allow for closer economic and national integration.  The two nations that did not vote to approve the changes were the Czech Republic and the United Kingdom (UK).   The Czech Republic is expected to eventually approve of the changes, while the UK flatly rejected the changes.

This news is important for two reasons:

1.       The United Kingdom has a history of disrupting mainland European attempts at integration.

2.       The attitude that the UK’s actions engender from the mainland.  As my two friends put it, “Damn Brits!  They’d rather be little Americans than real Europeans.” (I paraphrased because their adjectives were slightly more colorful than mine.)

Traditional Perspective:

Traditional historical literature places the UK in the role of the reluctant hero.  Since the start of the 19^th century time, the UK has played the role of protector of freedom in Europe.  It has entered numerous European wars to oppose aggressor nations seeking to dominate the continent and subdue smaller nations.  These wars in include the Napoleonic Wars against France, World Wars 1 and 2 against Germany, and the Cold War against the Soviet Union.  In each case, the British Isles remained unconquered and the UK acted as the lead partner in a coalition that eventually triumphed and liberated the European mainland.

Alternate Perspective:

“The Pity of War: Explaining World War 1” by Niall Ferguson offers up an alternative view on the UK’s role in World War 1.  I think this perspective applies just as easily to all of the wars mentioned above.  Viewed from Ferguson’s alternative, the UK is not the reluctant hero but the meddling outsider who continually prevents European integration and causes the cycle of conflict on the mainland to keep resetting.

From this perspective, 19^th century France, 20^th century Germany, and Soviet Russia were not aggressor nations that were led by megalomaniac emperors or dictators.  Instead, they were all mainland powers that were seeking to use military force to create a version of the current EU under French, German, or Russian leadership.

Modern Day:

This alternate perspective is important because Europe is attempting to integrate again.  This time, the mainland powers have changed their strategy.  France and Germany are cooperating rather than battling each other and Merkozy, German Chancellor Angela Merkel and French President Nicolas Sarkozy, are the unofficial leaders of the EU.  Russia, while not an EU member, is also cooperating with the Franco-German dominated EU.  It is participating in the EU economy by playing the role as energy and raw material provider, much like Canada does with NAFTA.

This cooperation between the three mainland powers is a new twist in Europe and has led to the greatest level of integration that the continent has ever seen.  It will be interesting to see if this integration can continue.  It will also be interesting to see if the European cycle of war gets reset and a new struggle breaks out for control of the continent.  After all, the UK just drew the first battle line by declaring itself not a part of Europe after all.

Too Much of a Good Thing

In my last post, "Tonight We're Going to Party Like Its 1989", I argued that current American economic stagnation and high unemployment rates are a direct result of the trade policy that the US developed during the Cold War.  While I still stand behind this argument, I have begun to feel that it is incomplete.  In my mind, it does not answer the key question of "Why now?"

The Cold War has been over for 20 years.  There had to be another event that took place between the end of the Cold War and now to explain why our economy has descended into economic stagnation and unemployment so quickly.  I found this event this week when I finished "23 Things They Don't Tell You About Capitalism" by Ha-Joon Change.

“23 Things They Don’t Tell You About Capitalism”:
Chang’s book is a collection of 23 distinct case studies that serve as counterarguments to the ideology of free market capitalism.  My favorite is #22, in which he counters the argument that we need a free financial market to increase economic efficiency and kick start growth. 

In this case, Chang argues that the global financial systems have become too efficient.  His argument is that financial markets have been deregulated to the point where they are almost perfectly efficient.  In such an efficient market, investment capital can be instantly transferred from one side of the globe to another in search of a quick profit.  This puts pressure on publicly traded companies to make decisions that prioritize profit today over investment in tomorrow's success. 

His examples are General Electric (GE) and General Motors (GM).  Both have been traditional American industrial powerhouses.  Starting in the late 1990's, each adopted a seperate strategy to deal with the increased demands of the financial markets.   

GE responded to the financial pressures by outsourcing its manufacturing jobs to Asia in the early 2000's to lower production costs and increase margins.  It also acquired GE Capital as a separate business due to the financial markets' higher margins.  It is currently one of the world's most successful companies and, with offices in over 100 countries, a perfect example of a global conglomerate.

GM responded to the financial markets' demands by cutting back on product development.  It kept its manufacturing operations in the US, but funneled more and more funds directly to the bottom line and away from product development and strategy.  This led to GM producing inferior cars when compared to its German, Japanese, and Korean competitors and it had to be bailed out by the US government to prevent bankruptcy.  

My Take:

First of all, Chang's examples of GM and GE prove my original point that globalization has contributed strongly to our current unemployment rates and trade imbalance.  GE responded perfectly to the demands from the financial markets and did so in a way that hurt America's industrial base.  GM refused to do this and almost went bankrupt went pitted against foreign competition.

Next, Chang’s arguments can be taken one step further to identify the specific act that sent globalization and the global pursuit of short-term profit into overdrive.  This act is the Gramm-Leach-Bliley Act of 1999, which effectively removed all financial regulation.  It also combines with the US’s foreign policy strategy of trading to access to the US’s consumer markets for military alliances to explain the US’s current economic woes.

Don’t believe me?  Check out the history of the US’s trade balance below.  It can’t be coincidence that the graphs severe downward trend starts the year that Gramm-Leach-Bliley was passed and does not begin to recover until after the 2008 financial crisis and subsequent government bailout and market re-regulation.

Tonight We're Going to Party Like Its 1989

I just finished watching the South Carolina Republican debate and am left thinking two things:

1.       They didn’t spend enough time talking about unemployment and the economy

2.       When they did talk about unemployment and the economy, they missed the point

I say this because the core issues with the US economy and unemployment rate go much deeper than domestic, partisan politics.  The root of the current US economic issues lies in Cold War strategy.

During the Cold War, the US pursued a two part strategy of trying to defeat the USSR.  This strategy consisted of:

1.       Encircling the USSR with American allies to limit Soviet influence and prevent the spread of Communism.

2.       Make it impossible for the USSR to encircle the US with allies of its own.

The second of these strategies was the easiest to implement.  All North American powers are natural US trading partners.  The economies of US, Canada, and Mexico are complimentary and fit well together.  Canada’s economy is largely built around the export of raw materials such as timber, minerals, foodstuffs, and petroleum products.  Mexico’s is largely built around providing cheap, unskilled labor.  The US economy has a huge appetitive for both of these commodities, so the three economies fit well together.  This arrangement was formalized after the Cold War with the creation of NAFTA and, with the exception of the Cuban Missile crisis, made it impossible for the Soviets to get a foothold in North America.

The US pursued its first Cold War strategy by actively courting military and economic alliances in Europe (NATO), the Far East (Japan, South Korea, Taiwan, and eventually China), and the Middle East (Israel and Saudi Arabia).  It actively pursued countries in these regions that were on the Soviet periphery and enticed them to become US allies by offering them free access to the vast American consumer market.  This strategy encouraged the American allies around the world to adopt democratic, market based economies.  It also strangled the Soviet economy by denying them access to their most natural trading partners.

Now, let’s fast forward to 2012.  The USSR has collapsed and there is no longer a need to use the American consumer market to prop up other countries’ economies.  Despite the fact that the Cold War has been over for 20 years now, we continue to do just that.  Our trade imbalance in 2010 was $650B.  That just doesn’t make sense for a country whose domestic economy has access to plentiful raw materials, access to the most skilled work force in the world, and routinely produces the most innovative and popular products.  

The chart below shows the US's trade balance with its top 15 trading partners.  These partners represent 75% of the US's imports ($1.4T) and 73% of its exports ($940B).  These are the countries who have benefited the most from the US's trade imbalance.

Some will claim that this large trade imbalance is simply a byproduct of globalization and that it is natural to outsource manufacturing of American designed products to countries with lower wages.  I agree that this trade imbalance is a result of globalization, but counter that globalization was a result of the US’s Cold War strategy.  I also point out that with the exception of China, India, and Mexico, all of America’s manufacturing imports come from countries with similar income levels (Japan, Germany, South Korea, and Taiwan).

My conclusion is therefore this: the US has not properly adjusted our economic policy to reflect the new global reality.  The Cold War is over, yet the US continues to trade access to the US market for relationships with foreign countries.  I now find myself wondering if we couldn’t create a few more jobs by moving beyond the Cold War with our economic foreign policy.

The Real Reason Illegal Immigration Matters

Election season in the US is right around the corner and one of the main topics that should be on every candidate’s agenda is how to fix illegal immigration from Mexico to the US.  The reason that this issue should be discussed is because a classic borderland is developing in the Southwestern US.

The current border between the US and Mexico has very little natural barriers.  This is why it is so easy for illegal immigrants to pass over the border into the US.  The only real geographic border of note is the Rio Grande, which runs along the Texas-Mexico border.  Despite its name, the Rio Grande is actually quite shallow.  West of the Rio Grande, there are no natural boundaries at all.  This results in the boundary between the two countries existing only on a map.  This is proven by the fact that the two largest bi-national urban areas in the world (San Diego-Tijuana and El Paso-Juarez) lie directly on this border.    

With more and more illegal immigrants entering the US and settling down just north of the border, the demographics of the Southwest US are beginning to change.  In the 2010 census close to 64M US citizens reported having a Hispanic descent.  This represented only 16% of the total population, but a 40% increase to the Hispanic population since 2000.  This growth far exceeds the 4% increase seen by the rest of the population.

As the graphic to the right shows, a large percentage of the Hispanic population live in states that on the Mexican-American border.  These states, in dark blue, also have a Hispanic population that represents over 30% of their total populations.  If the growth rates mentioned above continue, and they will until illegal immigration is addressed, it won’t be long until the majority of the population is Hispanic.  This creates a potential borderland situation between the US and Mexico.

Complicating the matter is the fact that both countries have claimed sovereignty over the states of California, Texas, Arizona, New Mexico, Utah, Nevada, and Colorado in the past.  The US and Mexico even went to war over this territory in the 1840’s and 1850’s.  This war, which the US won, resulted in the US annexing Texas and the Mexican Cession (highlighted in red).

With the population in these border states expanding to include a sizeable Hispanic and Mexican population, Mexico will be able to press the US for influence over them.  It will have an economic incentive to do so because Texas and California have the two largest economies among the US states ($1.2T and $1.9M in 2010).  It will also have a potential historical claim over the territory since the US originally annexed it from Mexico.  This is the reason why the issue of illegal immigration matters. 

Iraq - Middle Eastern Borderland

A few weeks ago, I wrote an article explaining why Iran is incentivized to be a disruptive force in the Middle East.  Since then, Iran has begun to publicly posture with the US over control of the oil trade through the Strait of Hormuz.  This posturing is the first sign that Iran is seeking to disrupt the status quo in the Middle East.  Along with protecting its oil trade, Iran’s aim is to control the Middle East’s borderland – Iraq.  In this post, I will address why Iraq is a perfect example of a borderland and why I believe Iran will make an attempt to control it.

Geography:

Iraq is the natural borderland between the Arabian Peninsula and Iran.  It also combines with Syria, its western neighbor, to form the borderland between the Arab and Turkic lands.  

Its low terrain and lack of mountains give it very little natural boundaries.  Its position on the Tigris and Euphrates Rivers also makes it a valuable commercial and agrarian resource for its neighbors. 

Lastly, it is located in the middle of the Middle East and shares borders with Iran, Kuwait, Turkey, Syria, Saudi Arabia, and Jordan.  This makes it the logical launching point for any invasion of these countries.   

History:

Iraq has played important parts in many Empires that controlled the Middle East.  These empires included the Persian (Iranian) Empires from 600BC to the 6^th century AD, the Islamic (Arabian) Caliphate from the 6^th to 13^th centuries, and the Ottoman (Turkish) Empire from the 13^th to 20^th centuries.  It was only after the British took control of the Middle East from the Ottomans defeating them in WW1, that modern day Iraq was created out of what had historically been a Middle Eastern province.

Demographics:

Iraq’s population of approximately 30M contains a large proportion of ethnic minorities with 20%-25% of its population being Kurds (Yellow) and Turks (Orange).

Its majority population, which is Arab, is also split along religious lines.  60%-65% of its Arab population is Shiite Muslim (Red), while the other 35%-40% are Sunni Muslim.

This creates the demographic mess that is typically found in borderlands.  The Shiite Arabs are drawn to Iran, which is the only other Shiite country in the Middle East; the Sunni Arabs are attracted to the other Sunni Arab states in the area (Syria, Saudi Arabia, Kuwait, etc); and the Kurds and Turks feel an affinity with their brethren in Turkey.  This makes it possible for all of Iraq’s neighbors to claim rightful sovereignty over a portion of its population. 

Conclusion:

In addition to the traditional borderland complications, Iraq possesses an abundance of a lucrative resource - oil.  It ranks in the top 3 in the world for proven reserves and close to 95% of its 2010 exports were oil related. 

The oil reserves (starred to the right) are located mainly in the Shiite dominated region on Iran’s border.  This gives the Iranian’s an economic, as well as demographic, reason to claim sovereignty over this region of Iraq.  It is also the reason that I believe Iran will move to control this Middle Eastern borderland.

With the US drawdown in Iraq complete, an opportunity has been created for Iran to begin exerting itself in Iraq.  Iran has the geographic, economic, and demographic motivation to press for control over this Middle Eastern borderland and that is why it is making so many aggressive moves in the Middle East.