Corporate Culture and America’s Unraveling

Not just rising inequality

In a previous article, I reviewed data presented by French economist Thomas Piketty in his best-selling 2014 book, Capital in the Twenty-First Century. That data showed that income inequality in the United States had fallen sharply starting in 1940, and then rose sharply starting in 1980 to reach, in 2007, its previous, early 20th century heights. Stanford economist Mordecai Kurz, as the article explained, in his book published last January, The Market Power of Technology: Understanding the Second Gilded Age, accounted for that fall and rise as being largely a story of the fall and rise of corporate monopoly power.

In Leonhardt’s book, published in October, he gave a completely different account of this fall and rise. His account has common themes with Kurz’s, but it is a very different story. Where Kurz’s book presented a dry, technical economic thesis, Leonhardt’s is an engaging, historical, highly readable sociological account of the fall and rise, and how and why they happened. It is replete with fascinating, pivotal historical characters about whom we should know more, such as Paul Hoffman, the unlikely “woke” capitalist who sparked the economy in the post-World War II years, and A. Philip Randolph, who did as much for the union movement as any man and for the advancement of Black people in the United States.

Income inequality does not, of course, necessarily produce the other ills from which the U.S. is suffering. And the 30 years after World War II during which income and wealth inequality were low while economic growth and, paradoxically, tax rates were high, were not necessarily an ideal time. There was stifling conformity; McCarthyism; and the terror of nuclear war. But it was a time when the United States, says Leonhardt, after turning the tide in two world wars, “developed the polio vaccine, built the automobile industry, created the modern computer, launched the jet age, landed astronauts on the moon, pioneered mass high school and college education, and forged the world’s largest middle class.”

But then he adds, “The accomplishments of the past half century have been much less exceptional.”

Reading Leonhardt’s book one might think – because so much of the book focuses on the rise of unions in the mid-30s and their later fall, coinciding roughly with the fall and rise of inequality – that the reasons for the fall and rise in inequality and the rise in other ills can be drawn mainly from the union story.

But one could also read the history as a story of:

1. a transition from an atmosphere in which government was central to creating fairly distributed and rapidly increasing economic welfare to one in which government was unwilling or unable to perform the economy-driving functions of which only government is capable; and

2. a transition from a corporate culture that – in words Leonhardt attributes to Hoffman – stopped, in the late 40s, looking out only for its narrow interests and started caring about America as a whole, to one that believed the only proper way for business to conduct itself was to look only to maximizing its own profits.

The transition in government

Much of the pendulum-swing to more government involvement in the economy in the 1930s to 1960s from its former laissez-faire stance can be attributed to the global economic and political circumstances of the time: the Great Depression, followed by World War II and the Cold War. All of these called for greater intervention by government in the economy than previously.

First, desperate poverty and unemployment in the Great Depression were partially alleviated by Franklin D. Roosevelt’s New Deal in the 1930s. Then in 1940-45 World War II mobilization called for a unified national response coordinated by government. The Cold War with the Soviet Union continued this mobilization, though at a lower level.

U.S. government-funded research and development, purchases of technology, and building of infrastructure during this period – particularly during World War II and the Cold War – produced most of the miracle technologies from which the U.S. and the world have benefited ever since. One must remember that the largest infrastructure project of the modern era, Eisenhower’s highway development program that created the U.S. network of safe, high-speed interstate highways, was justified in the name of national defense, specifically in response to the perceived need for city-dwellers to escape quickly by road in case of a nuclear attack on their cities.

Either due to less of a perceived need as time wore on for these government involvements (the expected nuclear war with the Soviet Union had not happened and seemed less likely), or because of a fatigue with government programs, a trend toward lesser government began in the 1970s.

This lessening of government involvement, and the change in the corporate culture, together with a new or reinterpreted economic philosophy all combined to produce an unraveling of the United States that had for some time been incredibly materially productive for the benefit of all.

The change in corporate culture

The first change in corporate culture started in the 1940s, helping to prolong the steep reduction in inequality begun during the war years. Prior to that, before the Great Depression, the capitalism was of the “rough-and-tumble” kind, in which, as Leonhardt says, “taxes are low, corporations behave largely as they want, and a laissez-faire government allows market forces to dominate.”

As the U.S. emerged out of World War II, it was corporate leaders themselves who drove a change in the capitalist culture from rough-and-tumble to one that we might describe now as more “woke.” Starting while World War II was still raging, Hoffman, the president of Studebaker, a major automobile company, formed, with help from the University of Chicago and the U.S. Department of Commerce, a business group composed of corporate executives called the Committee for Economic Development (CED) to plan the post-war economy.

There was at the time widespread concern that when the war ended, and millions of soldiers came home there would be mass unemployment and another depression. Hoffman and his CED colleagues disagreed. They thought that if the corporate culture believed there was massive, suppressed demand waiting to be unleashed, and if they prepared for it by investing in creating the products it would demand, there would be strong economic growth. But it could not be the rough-and-tumble corporate culture of the early 20th century. It would have to benefit the ordinary man and woman, not only the corporate elite like themselves, and it would have to provide high wages.

The titans of the CED proved correct in their assessment of the potential for the future economy, and in their belief that they could create it while spreading the benefits widely. Their new corporate culture prevailed for at least 30 years during the period of the highest and most equally distributed economic growth in American history.

No better example of that paleo-woke corporate culture exists than that of George Romney, Mitt Romney’s father, who had been chairman of American Motors and briefly, in 1968, a leading candidate for the U.S. presidency. At American Motors he had developed an unusually small car, the Nash Rambler, which became a smash success. However, in Leonhardt’s telling:

As pleased as he was with its success, Romney also started to grow uncomfortable with all the money flowing into the company. He worried that executives might become distracted by what he called the “temptations of success” rather than focusing on the business’s long-term health. To avoid that problem, he went to the board of directors with a suggestion: The company should establish an annual cap on pay of $225,000 for any executive. That seemed like plenty of money. It was roughly forty times as much as a typical American household was earning at the time.

Leonhardt adds, “He was not the only executive to turn down higher pay during these years… They were acting in accordance with the culture, rejecting the ostentation that could have caused their fellow executives and citizens to lose respect for them.”

The corporate culture pendulum swings back

Beginning in the 1970s there was a swing back to rough-and-tumble capitalism. One of the leading proponents of that swing was University of Chicago economist Milton Friedman, who argued in a famous 1970 article in The New York Times that the only responsibility a business had was to maximize the wealth of its owners.

Friedman gave a series of lectures that were made into videos. In one of them, he ridiculed certain government agencies for their mission of protecting the consumer against bad products. Friedman stated in a slightly exasperated tone what he presumed was obvious, that if the products are bad the consumers won’t buy them and therefore soon enough, the producers won’t sell them. Sheer self-interested economic incentives will cause those products to be very short-lived in the marketplace.

But what of products that the consumer can’t tell are bad, or not worth the price paid for them? What if assessment of the value of the product is very difficult or impossible? And what if a pervasive and self-interested deceptive information-generating system tending to impute great value to that product extends not only through the product’s providers but through the providers’ consulting and evaluation industry arms and through its ancillary academic arms too? If the product doesn’t in fact have value, or if the price demanded for it is far greater than its value, will it still be very short-lived in the marketplace as Friedman so blithely assumed it would be? Or could it extend its life for a long time, even indefinitely?

What industry does that?

What I have just described fits perfectly the vast bulk of the offerings of the securities industry; the securities industry being – in the nomenclature of Harvard researchers Robin Greenwood and David Scharfstein – the large part of the financial industry that includes investment management and advisory services and brokerage.

That industry’s revenues increased by more than tenfold from 1980 to 2007 according to Greenwood and Scharfstein.

In my 2007 book, The Big Investment Lie, I mentioned a wealthy acquaintance named Bud for whom I had done some computer programming while I was in graduate school. Bud made his money in the credit life insurance business, a business that vastly overcharged for its product, but it was difficult to evaluate or to avoid for the reasons explained above. Bud stated flatly that “the way to make money is to handle money.” And this is true. In my book I spoke of people in the securities industry who scrape off “golden crumbs” while passing on huge chunks of “golden cakes,” charging in golden crumbs what sounds like only a small percentage of the cake. For most customers of the securities industry, it is very difficult or impossible to tell if they are getting commensurate value for the golden crumbs that they pay.

But to give only one of many examples of the misvaluation of the services those golden crumbs provide, let’s take the public pension fund investment management business in the United States. As I have pointed out, while the product those managers provide fails completely in its mission – to provide a higher return on investment than could be obtained with ultralow-cost index funds – the additional fees they levy, in exchange for no value whatsoever delivered for them, cost the average U.S. taxpayer $500 a year.

How many taxpayers know in this case that the product they are paying for is bad, and how much they are paying for it, or even that they are paying for it, and how many of them therefore stage an outcry to protest or refuse paying for it, as Milton Friedman would have assumed they would do?

The damage done to the United States by the financial industry

What damage does this do to the United States as a whole? Much of this industry serves no productive purpose in the U.S. economy, yet it occupies a large percentage of the most productive people. This may help account for the fact that the U.S. seems unable to do large engineering projects anymore. For example, it has problems with its trains while China has built 15,000 miles of high-functioning high-speed rail; its infrastructure is deteriorating; it has struggled in nuclear power unlike some other countries; now even its airline industry is showing cracks. The security industry’s revenues are mostly transfer payments – a result of what would ordinarily be called rent-seeking, in other words unproductive transfers of wealth – mostly from the less wealthy to the far wealthier, exacerbating inequality.

In short, while it may seem absurd to so focus the blame, and there are of course many other factors involved, the rise of the securities industry in the last 50 years is in significant part responsible for much of the decline that the United States has experienced and continues to experience. Its role in the globally destructive financial crisis of 2007-2009 is only exhibit A of the reasons for its indictment. The fact that this industry has not been properly reined in is due to both the dissipation of the post-war corporate culture of responsibility to every man and woman, not only to business owners, which prevailed for too short a time in the 30 years following World War II, and to the inability of government to leash so overgrown and influential a business sector, especially given the atmosphere of distrust of government.

Decades ago, the tobacco industry was also an industry the net benefits of whose product were difficult for the consumer to assess. When it turned out that they were strongly negative, it was not the overwhelming statistical evidence that ultimately curbed the industry; it was government action. It is more difficult for government action to curb the securities industry, partly because the industry is a detriment not to consumers’ health but to their finances – though it has negative consequences far beyond its own consumers – and partly because it is necessary to distinguish between that small part of the industry that does provide products and services that are beneficial and necessary, and the bulk of it that is detrimental. Nevertheless, it is important for the health of the country to rein in this industry.

The securities industry has spread a web of deceptions that have become conventional wisdom. It has legitimized untruth as a standard way of doing business. It has helped to plant a seed of distrust in the proclamations of elites. For all these reasons, something must be done about it.

Economist and mathematician Michael Edesess is adjunct professor and visiting faculty at the Hong Kong University of Science and Technology. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler. His new book, The Three Simple Rules of Investing, co-authored with Kwok L. Tsui, Carol Fabbri and George Peacock, was published by Berrett-Koehler in June 2014.

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