Whither North Korea?

North Korea is once again in the news. And that is exactly where Kim Jong Il wants it. There are many who say he is crazy. He is, in fact, many things: horribly evil, manipulative, maliciously calculating and cold-blooded. But crazy he most certainly is not. In fact, in the sense that every move he makes is thought out well in advance and designed to fit into a well-knit master strategy, I would suggest that he is the single most rational actor on the international scene today, and for most of the last two decades.

Kim Jong Il was elevated to the number two position in North Korea by his father more than two decades ago. At the time North Korea had already entered into a period of economic decline – from which they have yet to emerge (more later). The country, a nation of more than 20 million people, had a GDP of roughly $20 billion and a per capita income of less than $1000 (though it must be recognized that the economy is completely controlled by the central government and thus equating their economic statistics to the outside world is difficult at best and certainly overstated.)

At the same time the nation spends nearly half of that GDP on the military. That military includes an army of well over 1 million, but one that uses equipment that is from 10 to 50 years old, most of their tanks having been obsolete for three decades or more, and their airmen are flying aircraft that, for the most part were obsolete by the time of the Vietnam War. Can they still do damage? Certainly. Could they fight and win a conventional war against the modern, well trained, and well equipped Republic of Korea (ROK) army and air force? Not likely. Could they fight and win a war against a ROK military supported by the US? Certainly not. Is there reason to be concerned? Certainly. Even though the outcome of a conventional war would be certain, the cost in lives and material would be immense.

North Korea suffers from a severely depressed economy. There are few meaningful industries, agriculture is antiquated, harvests have fallen short nearly every year for the past 25 years, health conditions for the average North Korean are deplorable, and the average citizen lives with year-round brown-outs and black-outs and a per capita intake of less than 1400 calories per day.

In fact, when Kim took over day-to-day operations of the government in the early 90s (before his father died), the routine assessment from various Asian analysts was that his father – Kim Il Song – was still pulling the string and that the nation would collapse as soon as the father died. It must be remembered that this is a country with no margin for error. Simple mistakes that can be corrected in nearly any other country on the planet cannot be corrected in North Korea. Simply put, every facet of the economy is on verge of complete collapse and has been for two decades.

And so, when Kim Il Song died in July of 1994 the almost universal assessment was that Kim Jong Il would not be able to hold it together. A wide range of scenarios sprung up, each with multiple variations: there would be a military coup, there would be a collapse into anarchy, there would a war of conquest south in order to distract the people and capture the wealth of the ROK. None of these things happened.

Instead, Kim Jong Il has proven to be every bit as capable of leading the country as his father. Without going into any detail about the seemingly endless series of crises and diplomatic overtures of the last 16 years, consider this: one small country (North Korea), led by a man everyone keeps calling crazy and insinuating that he isn’t too swift, has managed to lead five other nations around in a whirl, keeping them off balance even while managing to balance his own heavily handicapped nation. And which nations has he led around seemingly by the nose? The USA, Russia, China, Japan and the Republic of Korea; the smallest of these countries – the ROK – has a population of 50 million and a GDP that is rapidly approaching $1 trillion - 50 times the size of North Korea’s, while the USA has a population 15 times as large and an economy 750 times as large. This seemingly insignificant country, led by this seemingly insignificant figure, has kept off-balance five countries, each of which is massively more capable then North Korea.

Kim Jong Il is not the charismatic figure that was his father (who was equally dictatorial and heavy handed, but nevertheless charismatic). The senior figures in the government follow him out of a combination of fear and reward, with the very senior figures living very well indeed, but subject to constant close observation and the fear of being accused of some act that somehow threatened Kim.

All that being said: what does he want?

Simply put: he wants to survive. Everything that he does centers on one clear goal: survival of his ‘regime,’ which was, until a little while ago just one man deep (himself). Now he has included his son, and the central issue is to insure that he and now his son retain their position of power, at whatever cost to the nation. Everything else is subordinate to that goal.

Why does he engage in all these actions that seem to bring his nation closer to war and thus to the inevitable defeat?

First, he wants to scare the international community in general and the five powers specifically into thinking that war is imminent. To engage in acts that scare the five major powers that he faces is to shock them and the international community into actions that lead to de facto strengthening of his regime: grants of fuel, food and hard currencies that allow him to buy the goods he needs to stay afloat. By raising the specter of a madman sitting atop a huge army, he has repeatedly and successfully coerced various elements in the international community to give him support – fuel, food and money - that he needs to keep afloat.

Second, he is reasonably certain that he has the veto on war. The US and the ROK are not likely to start a war; even thought they would win such a war, the cost would be too high. He knows for a certainty that any war would result in the destruction of his country and with equal certainty his death. There is no upside to starting a war.

Third, in the last analysis he wants international recognition; he wants a settlement to the war and embassies in Pyongyang from the major powers, in particular the US. Simply put, it would represent two great victories: he would present it to his people that the US had finally given in to him – he beat the US; and it would mean that he would be able to appeal for aid from a wide range of foreign capital sources, both public (the World Bank, the International Monetary Fund, etc.) and private – corporations in the US, Japan and the ROK who would be interested in developing various resources in North Korea, where labor would be cheap and some resources remain underdeveloped – and where such funds and development would mean he could keep his regime intact for years to come.

What does the ownership of nuclear weapons give him? In Kim’s eyes he sees nuclear weapons as providing further standing in the international community and a greater certainty that there will be no pre-emptive decapitation attack from the US or the ROK.

Is there a chance for war? Certainly. There can always be miscalculations and mistakes, even though he has yet to make a major mistake in 16 years of rule. The rise of his son as the third member of the Kim dynasty raises concerns, as it remains to be seen whether the son will have the skills and evil intellect to control both his country and the international community. But it would seem likely that as long as Kim Jong Il lives and is competent that there is little chance of his actions going too far.

What then should we do? The answer of course depends on what end result is desired. And for various countries that answer varies. For the ROK and the US, the desired end game is a united Korean Peninsula, under the governance of the ROK, with the people in the north joining the people of the south in a single, free, economically strong republic. Such a step will not be easy and the cost of rebuilding the north so that it can economically, politically and socially reintegrate with the south will likely run into trillions of dollars, a more expensive and lengthy problem then the reintegration of East and West Germany during the last 21 years.

For the Chinese such an outcome is probably not desired: a united, democratic ally of the US sharing a common border with China? Nor is it likely that Russia would welcome such an outcome. Japan probably finds themselves torn between these two options, with a strong pro-democracy bent and a desire for expanded economic activities in the region countered by a centuries old animosity between the Koreans and the Japanese.

For the rest of the international community there is mainly a desire to see the 60 year old war ended, the peninsula stepping back from its current level of military preparedness, and the north opened to international economic development.

My own belief is that the only answer for the US is to work with the ROK and the North Koreans to develop a solution that steers around the problem. As horribly unpleasant as it might sound, perhaps one solution would be to place the Kim family in the role of a constitutional monarch, with ceremonial but no real power, a healthy yearly stipend and a string of official residences. Make Pyongyang the twin capital of the country and begin a gradual reintegration process of the two halves of the peninsula. This would require modification of the ROK Constitution, but that is difficult, not impossible. What is certain however is that something new must be done. We have a very smart, completely amoral figure, armed with nuclear weapons, sitting on the top of a badly decayed state. No matter how clever he his, that situation cannot last forever. And continuing to do the same thing that we have done for the last 57 years and hoping for a different outcome IS crazy.

Creating Jobs - What About Now?

A friend of mine, an excellent doctor, often says that long-term planning is good, but never forget that patients die in the short-term. What he is saying, in the medical sense, it does no good to develop a plan to help a patient live another 10 years if your long-term plan doesn’t also include immediate resuscitation. In the same sense, creating jobs in two years or five or ten doesn’t help the worker who needs a job now or he will lose his house. So, what can be done now to create jobs this year?

First, we need to take a look at what we mean by jobs.

With nominal unemployment stuck at over 9% and real unemployment somewhere in the neighborhood of 11 - 15% (depending on which set of data used), there has been quite a bit of talk about what needs to be done to create jobs. The answers usually involve some sort of ‘Jobs Program,’ the spending of tax revenues or borrowed money, to stimulate economic activity and spur the creation of new jobs. Unfortunately, little that is being said will have any real positive impact on the problem. Here’s why.

First, there are, in fact, five kinds of jobs. And only three of them are worth anything.

Job type one: some businessman (big or small really isn’t important at this point) makes an investment in his business and hires another worker. This worker then produces revenue, the business grows, pays salaries, taxes, etc.

Job type two: a government (Federal, state or local, again it doesn’t matter) with a real task (police, fire, military, ambassador – tasks that the citizenry recognize as tasks that the government does that benefit society) hires someone to perform that task. This worker does so and we all derive benefits from their efforts and society is better for it, which also directly or indirectly stimulates the economy and the business environment.

Job type three: the government (again, at any level) hires someone to perform a task for which there is no need, and from which society derives no benefit. This is equivalent to a handout, but it is called a job anyway. A good deal of public infrastructure falls into this category, as when the government funds a road or a bridge for which there is no need.

Job type four is when the government spends money in the private sector, hiring a contractor to perform a task which is in support of Job type two – DOD contractors and most infrastructure jobs (building roads) are examples of this type of job. Finally,

Job type five is when the government spends money in the public sector to hire a contractor to perform a task which is in support of Job type three – some DOD contractor and infrastructure jobs are also found in this category.

Job one produces real wealth, job types two and four provide and support the environment and infrastructure that allows the free market to create real wealth. Job types three and five do not produce or support the creation of real wealth and are net drains on the economy and society. So, what we really want in any ‘jobs program’ (no matter what it entails) is to create jobs that either create real wealth or support the creation of real wealth, and avoid those jobs which don’t really support the economy and instead act as a net drain on the economy. But the government has shown itself to be, on the whole, incapable of making that differentiation on the one hand, and at too high a cost on the other. In short, any job creation answer is going to be found not in government but in the free market. (This will be discussed more in a future article.)

Second, there is the issue of costs. The current gross national product (the value of all goods and services) is a bit over $14 trillion per year, and the US currently has roughly 165 million people in or wishing to be in the economy. There are 155 million currently employed in the US, and of those, 2.5 million are employees of the federal government and 12 million work for state and local government, so that not quite 140 million actually produce real wealth. This works out to $100,000 in goods and services per worker in the market place. So, how much does it cost to create an average job in the private sector? A recent article in the Wall Street Journal by a small businessman from New Jersey – Michael Fleischer – gives a brief glimpse at the numbers.

The numbers – for his median employee (and remarkably consistent with the national averages) – look like this:

Nominal pay (per year):                                                             $59,000

(Nominal pay and benefits: +/- $72,000)

Employee contribution to medical and dental coverage:         2,376

State unemployment insurance (tax)                                               126

State disability insurance (tax)                                                          149

Medicare                                                                                                856

State income tax                                                                                1,893

Federal Income Tax (Withholding)                                              6,250

Social Security                                                                                   3,661

Total:                                                                                                  15,311

Take-home pay:                                                                             43,689

Company expenses associated with this employee:

Medical and Dental insurance                                                      9,561

Company paid Life insurance                                                           153

Federal unemployment                                                                       56

State disability insurance                                                                  149

Workman’s comp                                                                               300

State Unemployment insurance                                                      505

Medicare                                                                                              856

Social Security                                                                                 3,661

Total                                                                                                 15,241

Total Company Outlays for this employee:                             74,241

In fact, the problem is a bit worse than this. What is left unsaid is that there is an administrative overhead for each employee, a cost to manage them in time and people, from managing their careers, ensuring that they have the proper work climate, etc., to the straightforward cost of keeping their paperwork straight. That cost varies in every single organization but is, at a minimum 5% and more commonly equal to as much as 10% of employee pay. In other words, just to manage his people, their paperwork and the accounting associated with each of his employees (he has 83 people in his company), Mr. Fleischer is going to spend at least another $4-5,000 per year.

That means each new job costs roughly $80,000 per year. But no one is going to create a new job that can only pay for itself. For any businessman to hire another worker there has to be a reasonable expectation of additional revenue; that is, the productivity of the new employee will exceed not only the cost of hiring that person – the costs above – but provide some additional margin to support the additional cost of that new position and provide some return to the owner. And there has to be some margin of profit for the company. If the above job generates a total of $100,000 per year, that would leave $20,000 to pay for additional operational costs: electricity, water, office supplies, etc., as well as the costs of actually doing business: additional capital equipment, additional raw materials, etc. And then there is the ‘simple’ question of profit: the investors/owners need some return on their investment. All in all, $20,000 isn’t a huge margin, but let’s assume it is an acceptable one.

Now we come to the other side of the equation: what does it take to convince the leader to not hire another worker? Remember that to hire a new worker at $59,000 per year (nominal salary), the business must not only have an expectation of that worker generating the $80,000 necessary to meet all pay and other compensation, the business must have an expectation a meaningful profit, nominally at least 25% gross return (pre-tax), or $20,000, for a total of $100,000 in new business activity. But, if there is going to be an additional expense, say from new taxes on the business itself, or additional costs for hiring, then the new worker’s margin is reduced until that new worker represents at best a zero gain, and if there is any dip in either demand or productivity the new worker becomes a net loss. So, in the end, for an average business to add one medium income employee there must be an expectation of $100,000 in new business, but to “kill” a new hire there must only be a marginal increase in associated costs – or taxes or other government driven expenses – to the small businessman, that will vary from company to company. It will be from as little as a few thousand dollars to as high as $20,000, but it means simply that the gross (pre-tax) profit can’t reach the amount required to invest in the new worker. We will use the most conservative number - $20,000 – four this discussion, but it is probably closer to half of that.

There is one further facet to this problem: the real expenditures government makes to create the average government job. Currently, the Federal government average expenditure for all non-uniformed personnel – pay and benefits - is $106,000 per person per year (as of 2008.) (For uniformed (military) personnel the average in 2008 was $94,000 per person.) There are additional government expenditures for personnel, for example payment to retired personnel, that are not included within that figure as the government pays retirements out of current accounts, there being in fact no ‘lock boxes’ into which the government places money for payment of future retirement accounts, so this number should be indexed up. Nevertheless, we will use the simple number - $106,000 per year – as our reference number. Note that this is an average and, as recent news has shown, government creation of new jobs often comes at a much higher cost.

The market creates new jobs that are controlled by clearly discernible margins and the creation of real wealth, that is, the creation of real goods or services. The business owner hires based on analysis that doing so will result in real income. The government agency hires because it must spend the money; one is creating wealth, one is consuming it.

There are now two separate numbers: $106,000 for each job the federal government creates, of which a certain percentage, perhaps as high as 20% (if the Grace Commission was correct), produce no benefit to the nation; and $80,000 for an average private sector job, each of which will produce approximately $100,000 of goods or services.

Where does all this leave us with regard to Job creation? Business has always claimed, and both economic theory and simple common sense confirm, that taxes on business represent a cost to business by forcing higher prices and thereby reducing demand. While it can be asserted that businesses do not pay taxes, that they simply pass the additional cost on to their customers, the fact is that there will always be both an impact on their demand and a time lag as the market adjusts to the higher prices. Thus, while the business needs to pay taxes (and they must pay withholding taxes this year for next year) the impact of the additional tax is felt as soon as it goes into effect. But the market adjustment and eventual rebound in demand can take place immediately, next week, next month, next year or not at all. Thus the business is left with a reduced demand and increased cash outflows. It is not surprising then that the normal response by any sane businessman is to be fairly certain that there will be adequate cash flow before they hire a new employee.

And so what about Job Creation? Last year the Federal Government collected $295,000,000,000 in corporate taxes. What would this equate to if, instead of being taxed, it were left in the free market and businesses were allowed to use this money to increase their own purchases of goods and services, hire new workers and increase productivity? Would the retention of this money within the free market equate to nearly 3 million jobs (one for every $100,000 retained), or would the number be larger or smaller than that?

Assuming that most businesses are already operating with unused capacity – and that is born out by US government figures – new workers can be hired without buying new office space or new factory space, etc. More importantly, for each dollar that each business retained, that money has a multiplier effect: it is spent by one business for certain goods or services and the receiving business will likewise use that dollar. A common estimate is that each dollar will be exchanged at least five times, meaning that $295 billion left in the free market would multiply into $1,475,000,000 in market activity, a 10% increase in the GDP.

Of course, this would actually require a year to 18 months to take place as businesses changed their processes and expanded their production. But the implications are huge: 10% real GDP growth would mean approximately 10% employment growth, or the creation of more than 14 million real jobs. And 14 million new jobs would mean, within another year as the market expanded with this larger work force, a significant increase in both overall personal income in the US and an increase in personal income taxes collected, more than offsetting the reduced revenue from the elimination of corporate income taxes.

But let’s go back to our small business. What happens when this or that government program levies an additional set of costs on the business? Assume a business has 20 employees and the owner is considering hiring one more worker, at a total cost of $80,000 (as above) in the expectation of generating another $100,000 in revenue. But now a new expense of $1,000 per employee is levied against the business, a total of $20,000. All profit from the new worker has just been consumed. While one might argue that by hiring the new worker he creates the additional revenue to pay for this new worker, that is the logic of a government accountant. The owner must look at it as a bill he must first pay. It is more likely that he will not only defer hiring another employee, he will also look at whether he must let someone else go to maybe free up some additional cash.

Politicians may talk of ‘creating jobs,’ but any significant real job creation can only take place within the market place. And that requires available liquid assets – cash. There is a ready pool of that cash, one that would repay the nation and the economy within a year or two with both massive job growth and substantial tax revenue growth. It’s time to end the taxation of business and leave that money in the hands of the businesses where it will create real jobs and real wealth.

Next: Is this growth rate even possible?