Government Intrusion & The Erosion of Economic Freedom

February 8, 2016

By: Bobby Casey, Managing Director GWP

In a not-too-surprising turn of events, the United States has slipped out of the top 10 most economically free nations. I say “not surprising” because it’s been a downward trend for the past seven years for the US. The “Obama recovery” is a hoax. Without economic freedom, there is no economic recovery, of that we can be certain.

You may or may not be familiar with Heritage Foundation’s annual evaluation of 186 countries around the world, and their Economic Freedom Index. This index weighs four major components to each countries’ economy: Rule of Law, Limited Government, Regulatory Efficiency, and Open Markets.

Where the US falls short in their overall score is in Regulatory Efficiency:

“The regulatory burden continues to increase. Over 180 new major federal regulations have been imposed on business operations since early 2009 with estimated annual costs of nearly $80 billion. Labor regulations are not rigid, but other government policies, such as excessive occupational licensing, restrict growth in employment opportunities. Damaging monetary policies, tangled webs of corporate welfare, and various subsidies have bred economic distortions.”

The US overall economic freedom score was 75.4. Keep in mind, 100 is a perfectly free economy, and no one in the world scored in the 90’s.  A few glaring things are anchoring that score:

• Government spending – They’ve not been economically free in this category. In fact, it was only (and shockingly) under the early Bush administration pre 9/11 that they even broke into the 70 range. During the Obama administration they hit what is considered “repressive levels” with an all-time low score of 46.7 in 2012, and only last year did the US manage to eek its way into the “mostly free” range of 51.8. Their current score here is 54.7.
• Fiscal Freedom – Another area where the US is uncharacteristically low in its ranking. For a country that claims to be the land of the free, the US has not, for the past 20 years this data has been tracked, ever been more than “mostly free” (i.e. between the 60 and 70 range).
• Investment Freedom – This peaked at 80 just before the housing crisis of 2008 and 2009, after which point we freefall to 70 which teeters on the cusp of “mostly free” and “moderately free”.

While the overall reporting of the United States “Rule of Law” index remains flat, a subcategory of that component is “Property Rights”, and the US has plummeted in the past eight years dramatically: from 90 to 80. Could this be due in part to their various expropriation schemes ranging from eminent domain to asset forfeiture?

Is it a coincidence that these three things are the weakest links in their score? If these three were to turn around to 80, they’d be solidly in the top 10 again, if not the top 5. It is my theory that these three are inextricably linked, and their desperate policies are spiraling downward due mainly to political posturing.

The political answer to everything is to expand government and spend our way out of it. The US is a hotbed of welfare and warfare states, and the spending is out of control. Without a doubt they have a spending problem and that is creating the revenue problem.

Enter the fiscal freedom issue, or what is also known as the tax burden. The US is one of only TWO countries in the world who tax offshore earnings. They also have the highest corporate tax rate of 35% in the world. In truth, the math has already been done and no amount of taxation can sustain the spending levels they have now, while still addressing their near $20 trillion dollars in national debt.

Enter investment freedom. Of course they still have the ability to invest in some things other than US treasuries… at least for now. But that could change soon, due to a ruling last May by the US Supreme Court of Appeals. A panel of former lawyers, now judges, who have probably NEVER learned a thing about how investing works, made an interesting determination in Tibble v Edison Int’l. This is based on the Employee Retirement Income Security Act of 1974 (ERISA), which makes employers responsible for the prudence of 401k investments:

“A fiduciary must discharge his responsibilities ‘with the care, skill, prudence, and diligence’ that a prudent person ‘acting in a like capacity and familiar with such matters’ would use.”

The Department of Labor elaborates:

“The primary responsibility of fiduciaries is to run the plan solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits and paying plan expenses. Fiduciaries must act prudently and must diversify the plan’s investments in order to minimize the risk of large losses. In addition, they must follow the terms of plan documents to the extent that the plan terms are consistent with ERISA. They also must avoid conflicts of interest. In other words, they may not engage in transactions on behalf of the plan that benefit parties related to the plan, such as other fiduciaries, services providers, or the plan sponsor.”

Here we have some rather vague guidance, but the issue in this particular case had to do with mutual fund offerings at retail costs rather than industrial costs, whereby incurring “unnecessary administrative fees”. The typical difference between the two is 25 basis points (or 25 one-hundredths of 1%).

It’s true, there are fees, and they are greater on a retail level than on the industrial level. It is likewise true that on average 85% of those costs are incurred by the individual account holders. There are several reasons for this premium, and the likely case for Edison was to discourage overinvestment and give the fund managers some flexibility in the market. The markets are NOT unlimited. You can’t do with $100 billion what you can do with $100 million.

What does this have to do with investment freedom? The obvious issue is the fixation on administrative fees. If you read the opinion, there’s no mention of the investments performing poorly. So they were sound mutual funds. With new attention and possibly scrutiny of fees, what they’ve essentially done is made the link between prudence and fees, rather than prudence and performance. So what? What happens when you try to cut corners to keep the government at bay? You needn’t look any further than an HMO to know how professions are adversely affected qualitatively when government starts defining what is a prudent cost/fee and what is not. The quality of fund managers will go down as fees are reduced.

Quality costs money! Sorry folks! That’s why a Hyundai Accent is $12,000 and a Volvo is as high as $40,000. One is a soda can on wheels the other is a tank. You pay for performance.

The less obvious issue is the potential back door the federal government is building into pensioner fund management, and ultimately to control pensions universally. I didn’t see it at first, I’ll admit, but it is there. It starts with scrutinizing the pricing model and schedule. Next determining what the priorities of fund managers should be. Next applying the vague guidance of a 44 year old law arbitrarily. After all, can you concretely define what “care, skill, prudence, and diligence” are exactly? And can you universally define it for all people “acting in a like capacity and familiar with such matters”?

I look at issues like “climate change” and see NO consensus amongst those scientists in the field. I look at economics and see everyone from John M. Keynes to Ludwig von Mises and everyone in between. Hell, don’t people seek second opinions from different doctors when they are diagnosed? Do doctors always agree? Nope. So how can we honestly expect a universal consensus on investment prudence?

Finally, the government will determine that the private sector just isn’t fit to keep the people’s interests at heart. And they will assume the task of investing. Maybe it’ll be like our banking industry: maintain the face of private industry, but really be government run and controlled. Remember, the Federal Reserve, Freddie Mac, and Fannie Mae are all “private”. Once they seize control of the industry, consider your pension another government slush fund. Right now total US pension holdings are around $22.1 trillion (Source: Towers Watson). Still think this is all coincidence? None of these dots connect?

Government is ubiquitous, and it ruins everything it touches. That’s why there is no silver bullet solution to investing or stores of wealth. The important thing here is that you keep as MUCH of your wealth as you can, and that means not being low hanging fruit for the government or the litigious. I can help you with that.  If any of this has you wondering, or if you feel like you have more questions than answers, click here and shoot me an email!