1. Definition of a Legal Structure

“In this present crisis, government is not the solution to our problem, government is the problem...”

-Ronald Reagan

Experts in economics and political science define two types of legal structures: socialism and capitalism. Under socialism, government owns and controls all society’s property, land, buildings, and machines. Literally, the state produces and distributes all goods and services to its citizens. Communism is the extreme form of socialism and the government controls all aspects of its citizens’ lives. Communism was used in the Soviet Union and currently being used in China, Cuba, and North Korea. Socialistic governments do not use markets to direct economic activity. Instead, a central government committee determines production levels and prices, which they conveniently call “collective decision making.” Further, the definition of socialism could be expanded to include a system where government maintains private property, but extensively uses taxes, subsidies, price controls, and regulations to control an economy.

The other extreme is laissez faire capitalism. Laissez faire means leave it alone and capitalism allows citizens to own property, land, buildings, and machines. Citizens produce and distribute goods and services to other citizens. Capitalism is synonymous with free markets, because citizens use markets freely to transfer resources and property. Free, of course, means minimal interference from government and a market is where many private sellers and buyers meet, exchanging products and services for money. However, capitalism still needs a government! The government establishes the legal structure or the “rules of the game.”

Which system is better? This is very easy to prove. The Soviet system did propel a backwards Russia into a world power during the 20th century, but it came at a great cost. Under Communism in the Soviet Union, the state produced all goods and services. The government produced a limited amount of consumer goods, such as two types of T.V. sets: color, and black and white, about 5 types of soda, several types of bread, and three car models: Lada, Moskvich, and Volga. Many of these products were in short supply, so not all citizens could buy and own cars. The Soviet system had a pecking order: Communist party members came first, academe and scientists were second, and everyone else was last. Further, some products had quality problems like the color T.V. sets tended to explode and the Moskvich was junk. Other Soviet products were okay.

During the 1980s, the Soviet economy stagnated, creating severe shortages throughout the economy. Literally, consumers would shop in stores with bare shelves. Note the pecking order, communist party members had their own special stores that were stocked first. In addition, the Soviet Union had a large prison system, the Gulag, and Stalin executed millions of Soviet citizens through his purges. On the other hand, the United States was very capitalistic during the 19th century. The U.S. became a world power at the beginning of the 20th century with a high standard of living. As the United States progresses toward the 21st century, our society has become much more socialistic and highly regulated. Are we better off or is our society starting to crumble?

The problem with socialism is government wants everyone to be equal. The famous socialistic quote is, “From each according to his means, to each according to his needs.” Unfortunately, this is antithesis of humankind’s nature. Humans are born with different talents, work ethics, and values. Pure socialism will never work. For example, if a hard-working farmer produces 100 bushels of apples and a lazy one produces 20 bushels, then government will take 40 bushels of apples away from the hard-working farmer and give it to the lazy one. Thus, each has 60 bushels of apples and thus, they are equal. Consequently, the hard-working farmer will start producing 20 bushels of apples, preventing the government’s seizure of his apples and indirectly his hard work. Thus, socialism tends to reduce everyone to the lowest common denominator. The slowest, laziest people set the standards in society. Of course, the government bureaucrat will not give all 40 apples to the poor farmer. The bureaucrat has to eat too, feeding off the hard working and industrious.

Under a market system, the hard-working farmer could sell his excess supply of apples to the market, earning profits. Hence, the farmer is compensated for his hard work. Consequently, capitalism, hard work, and self-interest work together, creating a strong backbone for an economy.

Capitalism is not a perfect system. However, it is the best that man has given his nature. A problem with capitalism is whether businesses want to earn short-run profits or long-run profits. If businesses or people are trying to earn short-run profits, they will do anything to sell the product. They are likely to sell defective, bad, or even dangerous products. Their goal is to get the cash and run. Consequently, society does need some regulations to protect the consumers from the short-run profiteers. On the other hand, businesses and people that want to earn long-run profits enter into a long-term relationship with the consumers. They will try to appease the consumer and satisfy his needs. As you will see in Chapter 10, Wall Street’s pursuit of short-run profits led to the 2008 Financial Crisis.

A major problem with the United States is creeping socialism. Each passing day, our country becomes a little more socialistic. The local, state, and federal government perpetually expand their size, scope, and mission. Unfortunately, both political parties, Democrats and Republicans help contribute to this expansion of government. The Democrats tend to be spendthrifts, expanding government social programs and increasing taxes. Their intent is to help the disadvantage. On the other hand, supposedly the Republicans support limited government, limited taxes, and growth of businesses. However, numerous cases show Republicans doing the opposite. For instance, President George Bush opened the government’s checkbook to bail out Wall Street in October 2008, starting the trend of government ownership of corporations. Governor Rick Perry started the franchise tax in Texas. It is an income tax on businesses without calling it an income tax; thus circumventing the voter’s right to vote and pass an income tax in Texas. Governor Mitt Romney passed a universal health care program in Massachusetts. Hence, both political parties tend to expand government, regardless of political philosophy.

Many politicians have forgotten one important detail about capitalism. Not only are people allowed to own property, but they also have the freedom to change, alter, or sell that property with minimal interference from government. This is one of the problems in the United States. Private property has been under assault from the federal, state, and local governments for the last 40 years. For example, citizens and corporations can currently own property in the United States. Do we really own property here? What if you wanted to build a house? Then the government imposes many conditions on you. You have to adhere to building and zoning codes, you have to get approval from government (i.e. permits), you cannot build on a wetland or endanger a near extinct species’ habitat, you may be forced to join a homeowners association that watches your property like a hawk, et cetera. Then if you actually build your house, then government forces you to pay property taxes. In some states like in New Jersey, this can be quite high. Do you really own that house? What if you have trouble paying your high property taxes? Does it come as a surprise that many experts are predicting the housing market to start growing again by 2020? In China, this country is supposed to be a communistic country, where the government owns all the property. However, they essentially appear to be more capitalistic, allowing free markets. When shopping at a store, every product you buy, look on the package and see where it was made. Most likely, a Chinese corporation made that product. Asian countries tend to be economically free, but not politically free.

The important premise of this book is the type of political system is not important. For instance, communism in Russia did not fail, because of communism; it failed because the government tried to control its whole economy. The same disastrous failure would occur if a democracy tried to control completely its whole economy. The important issue is whether private individuals or businesses are making decisions or whether government is controlling everything. With people and businesses, their goals are simple: to better themselves or earn profits. With government, their goals can be convoluted, vague, and/or constantly changing. You will find out that politicians and bureaucrats also have self-interest and want to better themselves, but it comes at the expense of everyone else. Thus, what really matters is how government defines its relationships among government institutions, businesses, and people. A country’s legal structure defines these relationships.

Components of a Good Legal Structure

The legal structure is the glue that holds society together. The legal structure influences how people work, save, and consume, and also determines how much freedom people and businesses enjoy. The United States became the world’s richest country, because the founding fathers instituted a good legal structure that encouraged Americans to be independent and allowed them to keep their fruits of labor. Free enterprise created America's immense wealth, and not the government! The only thing the U.S. government did was to stand back and let its citizens create this wealth.

What is a legal structure? The only way to define legal structure is to compare it to its opposite: chaos. If there is chaos, then we could not have a society or an economy. As people organize themselves, a legal structure evolves that defines the rules, rights, and expectations of its citizens. Some entity must evolve that becomes the enforcer and protector of the rules, rights, and expectations. This enforcer and protector becomes the omnipotent government.

The main function of government is to establish the legal structure of an economy, thus creating the “rules of the game.” A good legal structure helps citizens settle disputes, protects private property, and helps citizens to interact harmoniously and peacefully. Further, a good legal structure encourages the growth and expansion of businesses. Thus, private enterprise increases a society’s wealth. On the other hand, a bad legal structure divides people, encourages rancor and hatred among groups, and creates overly complicated rules and laws. Thus, a bad legal structure chokes and suffocates businesses, eventually annihilating society’s wealth.

What is a legal structure? A legal structure is the rules, practices, laws, regulations, customs, and habits of society. A legal structure always imposes limits and boundaries on human behavior, but at the same time, allow citizens to react together in predictable ways [1]. For example, zoning laws imposes limits on residential neighborhoods. One neighbor cannot build a factory in the center of a residential neighborhood. However, the residents of the neighborhood benefit, because they are not affected by the pollution, noise, and traffic of a factory. When a new person moves into the neighborhood, he has the expectation that no factories will be built there. Even though laws impose limits on human behavior, laws allow people to predict behavior and easily make future decisions.

Governments are always changing the laws and regulations. When government creates new laws, the new laws always create winners and losers. Some citizens benefit while other citizens are penalized. For example, government imposes a speed limit for cars and trucks. To the speeders, this law imposes a limit. However, to everyone else, having people drive at a lower speed increases public safety, making the roads safer for other cars and pedestrians. Thus, a changing legal structure benefits some groups and penalizes others. The trick is to change the law so the benefits always outweigh the costs.

As government changes the laws and regulations, the benefits to society have to outweigh their costs. A natural question is what constitutes a good legal structure? A good legal system requires four things: Equality, order, predictability, and stability.

The laws have to apply to everyone equally. If some groups were given preferential treatment, then the legal system could be viewed as capricious and corrupt. Furthermore, the disadvantaged groups could become bitter and lose faith in the legal system, possibly becoming criminals or violators. For example, what if courts always ruled in favored of women for cases that involved women versus men? Men would harbor bitter feelings against women and the legal system. (As we will see in the second chapter, domestic violence laws and sexual harassment suits may be fueling such a division between men and women).
The legal system must create order. Laws inform people how they interact with each other. Laws should be simple, clear, and to the point. Not only does society need common sense laws, but government should keep the number of laws to a minimum. For example, the 10 Commandants are straight forward and to the point. “Thou shall not steal,” encompasses a wide variety of crimes. Stealing is stealing. It makes no difference if a person steals someone’s car or a person’s identity to obtain credit. For all countries, laws originally emanated from religion, which scholars refer to as natural laws. As you read this book, our laws have become so complicated, even the experts have trouble understanding them.
Laws must create predictability. When people know the laws and regulations, they can predict relationships and reduce their uncertainty. For example, if you agree to buy land, you exchange cash for the deed. What if you bought the land, where you exchanged cash for the deed, but government did not transfer the land to your name? This example seems foolish, but it happens in Northern Mexico. Something as basic as land transfer would hamper economic growth and development.
The legal system must be stable. How would you feel, if every morning after awaking, the government changed the laws? How would you know if you were in compliance with the laws? Again this example seems foolish, but this is happening in the United States. The federal and state governments constantly change the laws, rules, and regulations. The stability condition does not mean rules become rigid and fixed. As society changes, the rules and regulations for the legal structure has to change with society [1].

If laws create equality, order, predictability, and stability then these laws are efficient. What are efficient laws?

Everyone driving on the same side of the road. Someone driving on the opposite side of the road could cause in accident, endangering the public.
Protecting people’s private property. A person works and buys things with his hard-earned money. If a thief can come along and steal that person’s things and the person has no legal recourse, what is the incentive for a person to work? He could also become a thief, steal things, and not earn them by working! This is a simple example, but professionals within the legal system have become good at stealing from the people that is legally in the confines of law.
Punishing drivers who drive their vehicles while drunk. Alcohol impairs a person’s ability to operate machinery properly. Thus, a drunk driver could injure, maim, or kill innocent bystanders by driving while intoxicated.

Knowing and understanding the laws do not create an orderly society. Humans can be opportunistic. Some humans are driven to violate society’s rules with the most severe being theft, rape, and murder. Thus, the legal system has to impose sanctions and punish violators [1]. Punishment informs people about the rules and regulations, and encourages citizens to stay within the confines of the law.

A problem arises. A legal structure has a potential, severe flaw. All legal structures have a legal language. A legal language describes the circumstances and transactions of its citizens. As circumstances and society become more complicated, the legal language becomes more complicated, giving birth to more complicated rules, laws, and regulations [1]. Over time, a more complicated legal structure requires more bureaucrats and better-educated bureaucrats. Here is where the problem lies. What happens when government bureaucrats become a dominant class in society? They can artificial expand their power and salaries by expanding the rules and regulations, or creating a more complicated legal structure than is necessary. This rising class of bureaucrats could aid the growth and intrusiveness of government. Hence, this is why the title of this book is “The Rise of the Insane State.” Bureaucrats pursuing their self-interest can work against the economy, destroying wealth, which of course is insane!

Creeping Socialism

Bureaucrats, politicians, and legislators are increasing the size, scope, and mission of government. The U.S. federal, state, and local governments are passing laws at such a furious rate, it is as if a legal atomic bomb has been detonated. More laws, rules, and regulations require more bureaucrats. Thus, government is continually expanding or creating new bureaucracies. Government has to pay for its army of bureaucrats and has three sources of funding:

Government could collect taxes, fees, and fines. However, excessively high taxes, fees, and fines can stifle a market economy, causing incomes and wealth to decrease. Unfortunately, the public does not like tax increases; thus, politicians and bureaucrats resorted to a variety of taxes, fees, and fines. It is like a painful death from a million paper cuts.
The government could borrow money. Borrowing money creates future tax liabilities, because government has to pay the money back plus interest. When governments borrow money, they hope the economy grows, increasing the tax base. Then government pays the debt back from higher future tax collections. This can be disastrous if the economy is going through a period of contraction. Some people believe the United States will enter an extended recession like Japan did during the 1990s.
The government can print money. This option is only available to the federal government through our central bank, the Federal Reserve System. However, printing money is not a good option, because it leads to inflation. As prices are increasing, wage increases tend to lag behind prices increases, squeezing the workers. Sometimes, this is referred to as the inflation tax. Further, a high inflation rate weakens a currency, causing the currency to depreciate.

The federal government has not been able to exercise any restraint in its spending and has operated with large budget deficits since the 1960s. This is unusual because politicians before the 1960s only accumulated debt when we were at war. Then during times of peace, politicians would start to pay down the public debt. During the 1960s, President Johnson started the War on Poverty and escalated the Vietnam War. Since then, the United States has been plagued with perpetual budget deficits and the steady increase in our public debt. The U.S. federal debt is shown in Figure 1.1 starting with the 1950s and currently passing the $10 trillion mark in 2008. The U.S. debt is expected to attain new heights with President Obama’s $787 billion economic stimulus package. (Also do not forget President Bush’s $700 billion Wall Street bailout package in October 2008). Unfortunately, the public debt is exponentially growing at 7.4% per year for the last 60 years.

Figure 1.1. U.S. Federal Government Debt

U.S. Government Debt as of 2008

Examining government debt does not provide enough information. One important question is who holds the debt? The Federal Reserve System holds approximately $470 billion as of October 29, 2008 [2]. The Federal Reserve buys U.S. Government Securities to expand the money supply. Moreover, U.S. government agencies held about $4 trillion in 2007 or approximately 44% of the U.S. national debt. Social Security Administration and federal retirement accounts invest their funds and budget surpluses back into the government. You have heard that Social Security has had surpluses for the last 20 years in its account. However, Congress actually spent this money and in its place, put U.S. Treasury Securities [3]. This is the same as putting money in a cookie jar. Then you decide to spend it and in its place you put in IOUs into the jar. This trick only works if you do not dig yourself in a large financial pit.

A second question is how the tax base is changing? A growing economy increases the government’s tax base, so government can finance more debt. Furthermore, a growing economy requires more infrastructure and bureaucrats, such as more roads, highways, schools, and other services from government. Economists use Gross Domestic Product (GDP) to measure the size of an economy. If GDP is growing, then it indicates our society is producing more goods and services, and also incomes are rising. The U.S. federal government debt relative to the gross domestic product (GDP) is shown in Figure 1.2. During the 1950s, government debt was quickly dropping as government was paying off its war debts. Since the 1980s, government debt started to take off from President Reagan’s massive government deficits. Currently, the debt-GDP ratio has exceeded 70%. Investors usually shy away from investing in government debt when the debt-GDP ratio exceeds 100%. A large government debt indicates potential instability, because government may have a hard time paying its bills.

Figure 1.2. U.S. Federal Government Debt relative to GDP

U.S. Federal Debt relative to GDP

Government debt is not completely negative. The following cases illustrate the positive impacts from government debt:

Government spending has an expansionary impact on the economy. For example, the U.S. government funds NASA. In turn, NASA buys billions of dollars in parts from high-tech industries. These high-tech industries hire more scientists and engineers, and expand their research and development. Thus, white-collar jobs flourish in our economy.
If government is investing in infrastructure, education, or research, then public spending does not only benefit the current generation, but also benefits future generations. Future citizens benefit from more knowledge, highways, libraries, and universities.
Government can transfer funds among different groups and sectors in the economy that benefit society. For example, government can tax rich areas and then use this tax revenue to redevelop blighted neighborhoods. Further, government can transfer funds to poor students to help them obtain training or an education. More people that are educated benefit society.

Society can benefit if government spends and invests its money wisely. However, a large government debt has three potential problems. First, future generations are saddled with paying back this debt. If government wastes money on wars that cannot be won, incarcerates people for minor crimes, or bails out corporations that made bad financial decisions, then this money is wasted and future generations get no benefits. Second, a large government debt crowds out private investment. Each investor buying a U.S. Treasury bond cannot use that same money to buy stocks and bonds from private businesses. Hence, a large, expanding government that heavily borrows can squeeze out private investment for businesses. Finally, a large government debt increases the interest a government has to pay. As the debt becomes larger, the amount of interest that government has to pay also becomes larger. The interest on the debt is currently the third largest item in the federal budget. When interest on the debt becomes the largest item in the budget, then government debt becomes out of control. Congress will have less money for other governmental programs.

State and local governments are expanding furiously like the federal government. However, government debt and future liabilities are difficult to analyze because governments at all levels in the United States created a variety of quasi-government agencies, authorities, nonprofit organizations, and public corporations. Some refer to this as hidden government, because these institutions are free from government oversight, independent from the voters, and can issue debt through the government’s name. Some of these institutions were found to be riddled in corruption, mismanagement, bid rigging, or maintaining the “good ole boy system” [4]. Some examples of these institutions are:

Local and state governments created a variety of organizations to operate airports, seaports, toll bridges, low-income housing, parks, schools, and universities [4].
Some city governments setup utility service for its residents like water, electricity, or natural gas as public corporations whose profits are funneled back into local government.
The federal government created public corporations like Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac), and Student Loan Marketing Association (SallieMae). Fannie Mae and Freddie Mac grant mortgages to low-income households while SallieMae grants loans to college students.

Governments created these institutions to benefit their citizens. However, these institutions may not act like private businesses. The purpose of a private business is to earn profits. If a private business is mismanaged, provides low quality products, and/or terrible customer service, then that business could fail and bankrupt. The threat of financial failure causes a business to pay attention to the market, to its customers, and to its products and services, or the business fails. Unfortunately, financial failure provides little feedback to public institutions. Public institutions can run to government and beg for subsidies, tax breaks, or favors to keep inefficient, mismanaged public corporations operating.

Another problem of having a large number of these public corporations is the financial exposure to changes in a market or an economy. For example, the housing market bubble popped in 2007, causing housing prices to tumble. Moreover, the U.S. economy entered a recession in 2007, causing unemployment and foreclosures to soar. This puts financial hardship on banks. When families stop paying their mortgages, then banks lose money as they foreclose on homes. The banks pay legal fees and court costs to acquire a home, and takes possession of a house that is losing market value. The problem is Fannie Mae and Freddie Mac hold approximately half of the mortgages in the United States, which is valued approximately $12 trillion. The U.S. government is already spending billions of dollars to bail out these two financial institutions [5]. As of January 2010, the losses may exceed $400 billion [6] , which is $1,333 for every man, woman, and child in the United States. Furthermore, a long recession could cause college graduates not to find jobs. Then the federal government may have to bail out SallieMae, as students default on their loans.

Conclusion

This book emphasizes the takeover of the U.S. economy from an ever-expanding government and its bureaucrats. An expanding government is creeping socialism, but it is not the traditional socialism where government has a plan to build a better society or provide benefits to its citizens, like free healthcare or free college education. Instead, the United States is evolving to a more virulent type of socialism. The government allows individuals and businesses to own property, but the use of the property is subjected to massive government oversight. This rising class of bureaucrats believes they have the right to interfere in all society’s affairs from family matters to private business decisions. Literally, no issue is too small or private that does not elicit the scrutiny of the bureaucrats. The bureaucrats in government today believe in active government interference in families, businesses, and all private matters.

The impact of using government to solve its social and economic problems through larger government is the negative impact on wealth. Government cannot create wealth. Otherwise, the Soviet Union would have been the richest country in the world, and it would not have collapsed in 1991. Everyone has heard of Soviet people standing in lines for hours to receive their bread ration or how the Soviet state industries produced low-quality goods, like color television sets that occasionally exploded. Therefore, the government cannot create wealth; only citizens and businesses through private markets can create wealth.

This book takes a close look at the current U.S. legal structure and how the bureaucrats and politicians are ruining the economy. This book is composed of 11 chapters. These chapters artificially dissect the U.S. legal structure and help readers understand the problems with an expanding, virulent legal structure and its impact on the U.S. economy.

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References

[1] Bromley, Daniel W. 1989. Economic Interests and Institutions: The Conceptual foundations of Public Policy. New York: Basil Blackwell. Chapter 3, “The Nature of Institutions”

[2] Federal Reserve Statistical Release. October 30, 2008. “Factors Affecting Reserve Balances.” Available at http://www.federalreserve.gov/releases/H41/20081030/h41.htm (access date 01/09/09).

[3] Treasury Direct. December 2008. “Monthly Statement of the Public Debt of the United States.” Available at http://www.treasurydirect.gov/govt/reports/pd/mspd/mspd.htm (01/12/09).

[4] Searcey, Dionne. July 19, 2004. “Hidden government.” Newsday.com

[5]Goodman, Peter S. July 14, 2008. “Government as the Big Lender.” The New York Times.

[6] Liu, Betty and Matthew Leising. December 31, 2009. "U.S. to Lose $400 Billion on Fannie, Freddie, Wallison Says." Business Week. Available at http://www.businessweek.com/news/2009-12-31/u-s-to-lose-400-billion-on-fannie-freddie-wallison-says.html?source=patrick.net (access date 01/04/2010).