An Access Advertising EconBrief:
More of What Went Wrong with ‘America: What Went Wrong?’
BS devoted a quarter of the chapter to airline deregulation, which proceeded nearly in tandem with its surface-transportation counterpart beginning in 1978. Their arguments echoed those for trucking. “Since …1978, a dozen airline companies have merged or gone out of business. More than 50,000 employees have lost their jobs.” Sorrowful anecdotes of employees forced to take jobs “at reduced pay” are recounted. The false premise that deregulation would “stimulate competition, reduce fares, open up air travel to more Americans” is contrasted with the “reality” of “less competition,” higher fares on particular routes such as Philadelphia-Pittsburgh and Washington, D.C.-New York City and loss of air service to small communities. And just as BS claimed that deregulation “wrecked” the trucking industry, their picture of the “airline industry’s increasingly grave financial condition” and its aging, decrepit aircraft implies that monopoly, government subsidy or foreign takeover must soon occur.
It is now 36 years after the onset of airline deregulation. We know that no such fate occurred or is in prospect. We also know BS were as wrong about airline deregulation’s effects as they were about trucking deregulation. Rather than stand accused of exercising hindsight, we can cite the authority of Alfred Kahn, economist-godfather of airline deregulation and its leading scholar. Kahn wrote in 1993, just one year after BS, and the evidence he cites was available to them as well. “Most disinterested observers agree that airline deregulation has been a success. The overwhelming majority of travelers have enjoyed the benefits that its proponents expected… The best estimates…are that deregulated fares have been 10 to 18 percent lower, on average, than they would have been under their previous regulatory formulas. The savings to travelers have been in the range of $5 billion to $10 billion per year… In 1990…91 percent of all passenger miles traveled were on discount tickets, at an average discount of 65 percent from the posted coach fare.” [Typically, business travelers made up the bulk of the remaining 9%.]
As with trucking, airline deregulation vastly increased industry productivity by allowing airlines to operate much more efficiently. The greatest productivity increase was the improvement in the “load factor.” “Carriers have put more seats on their planes – the average went up from 136.9 in 1977 to 153.1 in 1988 – and succeeded in filling a greater percentage of those seats – from an average of 52.6 percent in the ten years before 1978 to 61.0 percent in the twelve years after.” Kahn also cited better equipment utilization via use of small-prop and jet-prop planes for short hops and the wider variety of destinations made possible by the hub-and-spoke mode of routing flights. These are clear examples of the superiority of deregulation over the previous regulated regime.
What about airline safety? Contrary to the insinuations of BS, Kahn notes that “accident rates during the twelve-year period from 1979 to 1990 were 20 to 45 percent (depending on the specific measures used) below their average levels in the six or twelve years before deregulation. Moreover, by taking intercity travelers out of cars, the low airfares made possible by deregulation have saved many more lives than the total number lost annually in air crashes. [Emphasis added]”
To be sure, Kahn noted a number of problems experienced during the first decade of deregulation – “congestion and a limited reemergence of monopoly power” – but he called it “a mistake …to regard these developments merely as failures of deregulation: in important measure they are manifestations of its success.”
In the subsequent 20 years, Kahn’s verdict has been reinforced by events. The principal failure of airline deregulation was its incompletion. Major airports remained government-owned and operated; landing and loading have remained significant bottlenecks due to inadequate space and lack of a pricing mechanism to allocate it.
BS failed to inform their readers on airline deregulation as they did on truck deregulation, and for the same reasons. Now, we divide the remainder of the book into analytical categories to suit our purposes.
Fear of the Foreign
BS’s emotive style plays to common fears, one of which is the fear of the foreign. Foreign nationals, foreign businesses, foreign mores and culture are presumptively suspect, hence an excellent scapegoat for authors purporting to reveal “what went wrong” with an entire nation. Two chapters, 2 and 5, play to this fear.
BS press the emotional buttons of their readers using familiar institutions as their explanatory fall-guys. Government – specifically, non-regulatory elected officials in Congress and the Executive branch – arbitrarily decided to bias its rules against ordinary, middle-class Americans (that is, readers of BS). Corporations took advantage of loopholes in the “government rule book” and acted in “their” interest and against the interests of the middle class.
Chapter 2, “Losing Out to Mexico,” follows this format. The introductory page warns that “American corporations are closing plants or slashing work forces in the U.S. and shifting the jobs to Mexico,” to the tune of “1,800 plants employing more than 500,000 workers,” mostly relocated by U.S. corporations. The entire chapter – at nine pages the book’s shortest – consists of anecdotal cases involving companies and people.
BS presume that this southward shift is a bad thing. It is bad because “the new plants are replacing facilities that once provided jobs for U.S. workers.” BS ascribe this specifically to low tariffs (taxes) on goods assembled in Mexico and shipped back to the U.S. To add insult to injury, foreign companies (BS specifically name the Japanese) have the effrontery to “dump” their manufactured goods on our markets at prices that are too low. (As authority for this evaluation, they cite the U.S. Tariff Commission’s claim that Japanese television receivers were sold in the U.S. at “less than fair value.”)
BS also pinpoint low wages earned by Mexican workers as a lure leading American firms to Mexico. Not only are Mexican wages unconscionably low compared to U.S. wages (BS conduct a monetary comparison, presumably with the aid of an unnamed exchange rate), but they are too low to enable the Mexican workers to buy U.S. products – thereby eliminating the only possible rationale BS could think of for allowing this sort of free international commerce.
In Chapter 5, “The Foreign Connection,” BS ramp up their assault on the foreign. Once again, government starts the rot by greatly increasing the number of years during which corporations can take a deduction for “net operating loss (NOL).” Not surprisingly, corporations respond by actually taking the deductions they are offered. This affects not just American corporations but foreign ones, too, since the U.S. NOL deductibility period now greatly exceeds those available abroad. Foreign corporations take up residence in the U.S. This tends to bias the corporate migratory inflow towards money-losing companies with deductions to take, which allows BS to pejoratively compare foreign corporate deductions taken and taxes paid to the figures for U.S. firms (which are higher and lower, respectively).
This is the springboard from which BS paint the 1980s as a period during which the government deliberately set out to benefit foreign companies at the expense of the American middle class. In addition to the NOL-deductibility expansion, BS also cite several other alleged examples of global finance as a game rigged against ordinary Americans. Net foreign investment, particularly the purchase of American assets by foreign investors, is portrayed as inherently prejudicial to our interests. As always, BS make their points by anecdote. They cite case after case in which American industry has merged with or been subsumed within foreign industry – then conclude with “once, all were American-owned.” They do not mention that Americans have been investing abroad throughout the 20th century in exactly this same manner.
Why is all this bad? BS expect their readers to find it suspicious on its face. “So it is that corporations constantly shift their costs to countries with high tax rates, in order to maximize their deductions, while they shift their profits to low-tax havens in order to keep their tax payments down.” BS contrast corporate behavior with the tax reporting of individuals, who lack the capacity to repatriate profits so as to duplicate the tax optimization practiced by corporations.
Then, of course, there is also the corporate practice of “exporting jobs” – illustrated copiously by BS with lavishly appointed anecdotes of individuals whose lives were ruined, blighted or otherwise made unpleasant by business decisions of which BS do not approve. Once again, BS top all this off by using crime as their piece de resistance. Here, their villain is an international businessman named Marc Rich, who operates international businesses with apparent impunity despite various outstanding felony warrants bearing his name issued by U.S. courts.
The Truth About Foreigners and Corporations
As usual, BS cite no economists or economic sources – the word “economic” is used advisedly to distinguish between a valid system of logic and mere numerical data or aggregated information. Reference to basic economic theory would have cast their findings in an entirely different light.
It is no surprise that corporations – more particularly, corporate owners and managers – act to protect their interests in light of circumstances. They are obliged to do so even were it not in their interest. Thus, BS cannot in good conscience call their information investigative reporting. But BS owe their readers coherent presentation. That is utterly lacking unless they recognize the economic significance of the corporation.
A corporation is an idea or concept, given form on a piece of paper filed with government. This piece of paper does not eat, sleep, make love, raise children, pay taxes or enjoy subsidies. Only people can do those things. More formally, tax incidence requires a forfeiture of utility or satisfaction from a reduction in consumption and/or saving. Only people consume and save.
BS imply – implicitly assume – that what is good for corporations is bad for their readers. Why? BS must first explain what people gain or lose from the effects felt by corporations. Since nobody knows, say, the actual incidence of the corporate income tax – that is, nobody knows who actually pays it – nobody can say for sure whether it is good or bad for particular people. The people who might pay it are corporate shareholders, corporate employees and corporate consumers. They constitute the rich, the middle class and even a big slice of the poor.
BS imply that government is willfully benefiting the rich at our expense. It is true that corporations constantly change their operations to benefit their shareholders. But in a competitive market, any changes in profits will be short-run changes, because movement of firms will tend to equalize rates of profit in industries and across geographic areas. It is consumers and input suppliers, not owners, who tend to be long-run beneficiaries of change. That means that the multifarious changes pointed to with such alarm by BS are mostly just waste – roundabout ways of transferring money from one pocket to another with only short-term net gains or losses. The waste derives from the overhead costs of effecting and administering all the moving around – changing rules and compliance costs and monitoring. The long-run beneficiaries of the waste are not corporate fat cats but rather BS’s hero class of government; namely, regulators and civil servants whose jobs exist because of all this wasted motion.
Of course, actual organic incentives exist to move companies and jobs to Mexico. If iron ore (let’s say) were cheaper to mine in Mexico, it would make perfect sense to move steel companies to Mexico or to import the ore to America. The same holds true for wages; if labor is cheaper in Mexico, it is economically proper to bring the companies to the labor or bring the labor to the companies. After all, that is what we do within the U.S. – we don’t let the artificial boundary lines separating states or cities stop us from producing goods efficiently. The economic logic of efficient production is unaffected by international boundary lines.
BS don’t introduce any economic expert testimony here because economists have traditionally favored free international trade; that is, they would reject the BS case completely.
The bogey of “job exportation” is a product of the “lump of labor” fallacy – the presumption that only so many jobs exist to be distributed among existing workers. Ironically, this attitude is encouraged by the myriad of disincentives to job creation and hiring established by U.S. labor laws supposedly designed to protect the worker. By making it more difficult and costly to hire, these laws defeat their own object.
From BS, we learn none of this.
The Paper Pushers
In addition to corporations, BS also introduce other villains who were empowered by government in the 1980s. One of these is a composite group best described as paper-pushers. BS treat them as inherently unproductive individuals who collect large amounts of money for doing things that have little or no value.
In Chapter 4, “The Lucrative Business of Bankruptcy,” BS lament the 1978 change to Chapter 11 of the U.S. Bankruptcy Code that made it easier to companies to declare bankruptcy but continue to operate in an effort to resolve their business problems and get out from under debt. This change produced the largest surge in annual bankruptcy filings since the Great Depression.
According to BS, this is ad because it “has been a bonanza for …the lawyers, accountants and other specialists who charge up to $500 an hour for their time.” They spend half of this chapter, some 10 pages, recounting in gruesome detail the activities of a corporate turnaround artist named Stanford Sigoloff, who specialized in managing bankrupt firms. Sigoloff charged $500 for his time. BS devote pages to listing the fees charged by him and his colleagues in managing the L.J. Hooker Company, the bankrupt subsidiary of a large Australian corporation.
In addition to high fees, bankruptcy liberalization is also responsible for the runup of corporate debt that occurred in the 1980s. The ability to reorganize in bankruptcy gave companies an incentive to borrow in an effort to stay afloat. When corporate turnaround specialists acquired the assets of failing companies by borrowing, they then often applied this debt to the company’s balance sheet. Debt came to be viewed as a disciplinary force, tightening up company spending by imposing constraints. The deductibility of corporate interest on debt encouraged this attitude.
In Chapter 7, “Playing Russian Roulette With Health Insurance,” BS explore additional consequences of corporate bankruptcy in the 1980s. They enumerate the shrinking fraction of employees in large companies who are fully covered by employer-provided health-insurance benefits. Employee plan contributions rose during the 1980s. Part-time employment also rose, undoubtedly because part-time employees are normally not eligible for health benefits. And in bankruptcy, employer-provided health insurance may be one of the first casualties of reorganization, subject to bankruptcy-court approval. (Of course, in the case of Chapter 7 bankruptcy liquidation, health benefits are lost along with the employee’s job, subject to the qualification that Cobra plans can provide a temporary life-support plan for those benefits.)
In this chapter, BS’s paper-pushing villain is the financier. In contrast to the production manager, the financier in inherently unproductive because he produces nothing real. In Chapter 7, the CEO of Heck’s chain of department stores, Russell Isaacs, rose from financial officer to CEO. “…Aside from a grasp of the numbers… he had little understanding of the business he was running or what made it work.” BS spend the chapter juxtaposing the actions of Isaacs with the travails of four employees who lost their jobs in the chain’s bankruptcy.
Paper-pushers Under Competition
BS never explain how or why the paper-pushers wield their influence. The outsize fees charged by bankruptcy managers are approved by the bankruptcy court because they comport with fees charged by lawyers in general practice. Because the firms in question are in bankruptcy, the managers do not have to meet the productivity standard to which employees of competitive firms are held; namely, that the discounted value of the output they produce is greater than or equal to their wage. Thus, the only applicable standard for judging the outcome is the bankruptcy process itself.
Bankruptcy is a process for reallocating resources to get more out of them. The fact that more firms declared Chapter 11 bankruptcy following the Code change is unremarkable, since its purpose was to encourage firms to remain active and work out their problems. The question is, can we improve the allocation of resources by altering the balance between liquidation and reorganization?
BS do not even attempt to answer this question. Indeed, they do not even pose it. Nor do they explain why corporate boards would continue to select chief financial officers as CEOs if a background in production were a necessary prerequisite for the job.
The Fear of Takeover
Another fear exploited by BS is the fear of loss of control. BS personalize this fear in the form of the corporate takeover. Having established corporations in imagination as bad guys, they next link the pejorative adjective “corporate” with the fear-object “takeover.” A takeover is a loss of control, something to be feared. That makes a corporate takeover bad by definition; readers are conditioned to fear it. In two chapters, BS proceed to link it with a reign of terror and destruction worthy of a Mongol conqueror.
In Chapter 8, “Simplicity Pattern – Irresistible to Raiders,” BS paint this picture in lurid colors. Simplicity Pattern Co. was a peaceful, successful company in 1981, “as much a part of the American home as the radio and the sewing machine.” It “was sitting on tens of millions of dollars in cash and investments.” But, according to BS, “it was too good to pass up.” So “over a decade six different moneymen made runs at the dowager company. When they were done, the money was gone. And Simplicity was drowning in debt.”
BS devote the entire chapter to this one company, taking it through its dealings with the various corporate raiders, including Carl Icahn and Victor Posner. (One subhead is entitled “The Raiders Attack.”) This is the BS implicit theory of journalism taken to its logical extreme: investigating reporting via anecdote and extended appeal to emotion.
The Truth About Corporate Takeovers
In the 1930s, two academic students of business, Adolf Berle and Gardener Means, made names for themselves by theorizing that American corporations suffered from the “separation of ownership from control.” Because shareholders were cut off from actual operation of the companies they owned, they were forced to rely upon corporate managers to secure shareholder interests by maximizing company profits. Instead, those managers were running the companies to benefit themselves, the managers. They were maximizing company size and managerial salaries to increase their own prestige and income, but allowing profits, investment and innovation to lag. It was problem of “agency;” shareholders had no agent upon whom they could rely to safeguard their interests. Indirectly, consumers also suffered from this lackluster corporate performance.
Believers in free markets saw flaws in this theory. Astute entrepreneurs could borrow money and bid up the company’s share price to acquire its stock – thereby benefitting the stranded shareholders. They could depose the delinquent managers, cut the bloat and high costs, innovate and increase firm earnings, thereby earning the profits to pay off the debt they incurred to buy the company. Then they could sell the company, whose share price now reflected its lean status and elevated earning power. Now they have paid themselves back for their shrewd evaluation of the firm’s condition. So much for the “separation of ownership from control!”
And according to academic researchers like Michael Jensen, that is exactly what corporate raiders like Carl Icahn and Ivan Boesky did beginning in the late 1970s and continuing to the present day. Of course, they didn’t succeed with every venture. Sometimes the laggard managers saw their pink slips written on the wall and paid the corporate raider to stop buying the company’s stock – “greenmail,” it was called. Sometimes, the debt burden taken on by the raider proved too great and the company later succumbed to bankruptcy. Of course, if the company couldn’t earn enough to pay off a loan, there may have been problems with its operations. That takes us back to the BS case study.
BS told their readers that Simplicity Patterns was the picture of health. But companies do not “sit on millions of dollars in cash” without a reason. “As with many mature businesses, the earnings from Simplicity’s major business, the sale of [sewing] patterns, had begun to trail off in the late 1970s, a problem the company’s management had yet to deal with.” No kidding. Simplicity was in a dying business. Once, sewing patterns were ubiquitous. Today the proliferation of ready-made clothes and foreign competition has relegated them to hobby status. This, not the rapacity corporate raiders, was the company’s ultimate undoing. Simplicity’s shareholders were repaid when raider number one, John Fuqua of Triton Industries, bought it for $64 million in 1984. He resold the company in 1987 for $117 million, proof that the logic of the raid had been sound enough as far as it went. The fact the Simplicity “couldn’t sell patterns fast enough to pay the interest on its bonds and loans” was due to the fact that both sewing machines and sewing machine patterns were on the same road previously trod by the horse-drawn carriage.
In fairness to BS, they couldn’t be expected to foresee all this in 1992. But the economic theory outlined above had been developed well before their articles and book were written.
The Disappearing Pensions
In Chapter 9, “The Disappearing Pensions,” BS follow their modus operandi of using one case study as a proxy for an entire industry, country or era. Corporate raider Victor Posner “raided” the pension assets of companies he controlled. This was facilitated by changes in the “government rule book,” which permitted companies to withdraw pension assets provided sufficient assets remained to fund the plan.
In this chapter, however, BS undercut their own method by admitting that the real problem confronting America is “pension chaos” – the steady dissolution of an unsustainable system. They point with alarm to the decreasing number of workers receiving pensions and the falling average size of those pensions. The disparity between the number and size of corporate pensions relative to those provided by state and local governments is particularly distressing to BS. Last but not least, BS find the relative pension security of members of Congress outrageous.
As usual, BS cite no authoritative sources for their contentions. Their professional and analytical shortcomings are never more painfully evident. For example, BS proclaim that “women who retire from jobs in business receive smaller pensions than men.” They ascribe this to male discrimination, aided and abetted by lacunae in the “government rule book.” But any financial professional could have told them that most pensions are distributed in the form of a life annuity, which – by definition – pays out a smaller annual amount of a given total distribution the longer is the life expectancy of the recipient. Women live longer than men on average; thus, smaller annual pension payouts are an actuarial given, not an artifact of discrimination. Incredibly, BS note longer average female longevity, but nevertheless ascribe lower female pensions to “Congress,” whose “tax-writing committees have heavily skewed the tax law against most women.”
This chapter highlights our purpose in reviewing BS in retrospect. From today’s perspective, it is easy to see where BS went wrong – and why they were right to be concerned about pensions. The corporate pension steadily lost favor as a vehicle for retirement security because corporations could not fund pensions reliably. By definition, the income used to fund corporate pensions is a business residual. It is subject to the highest form of risk. It cannot form the basis for secure funding because it is not sufficiently diverse. That is the reason why defined contribution retirement systems have left defined benefit (i.e., pension) systems in the dust. Defined contribution systems allow recipients to tailor the mix of investments to suit their own risk preferences and to greatly modify that mix as they age in order to reduce the risk of loss.
Insurance companies are the exception to this principle. They can and do sell annuities because their core income is so stable and reliable and their investment portfolio is so diverse. In this respect, they are diametrically opposed to the single-purpose company, all of whose eggs are nested in its own basket.
BS never pause to question the security of government-worker pensions – they use them as the standard by which corporate pensions are found wanting. We now know that government pensions are the shakiest, least sustainable of all. Politicians have faced no constraints on their willingness to give in to union demands. The entire system of government retirement benefits is unfunded, “pay as you go;” this puts pensions in permanent jeopardy even if they are nominally funded. Political promises are the most worthless currency of all. The current financial and political instability in Europe is merely the overture to the coming collapse. BS’s fixation on the peccadilloes of an individual corporate raider seems quaint today in light of subsequent developments.
Markets are vehicles for accomplishing the possible. They also reveal what is impossible. Markets have revealed that corporate pensions are untenable and government-employee pensions are impossible. Insurance companies are the proper vehicle for providing pensions and they are doing it. BS are disconnected from reality. Not only do they approve of government-worker pensions – they want government to reinsure corporate pensions! As it stands, corporate pensions are now “guaranteed” by a quasi-government agency, the Pension Benefit Guaranty Corporation. Like all such government promises to pay, it is only worth the political will that stands behind it.
There are three chapters of America – What Went Wrong? that we have not discussed. Chapters 1 and 3 deal with taxes and tax policy. Chapter 1 also makes sweeping assertions about the distribution of income in America and the disappearance of the middle class. These issues are either too complicated (taxes) or complex (income distribution) to warrant discussion here. Once again, BS follow their standard procedure of eschewing expert assistance; in effect, they are acting as their own experts. Considering the difficulty of these issues, this willingness is baffling and disheartening.
Chapter 10 lines up the special-interest villains that BS blame for ruining America during little more than a decade. In a concluding Epilogue, they unveil their solutions: Pass more laws, tighten up regulation and make big government much, much bigger by re-writing the government rule book.
Reviewing BS in retrospect is a cautionary exercise. BS were the crème de la crème of journalism, yet these results show that they could not be trusted to report or analyze. They were unaware of their own limitations. They had an agenda that took precedence over fact and logic. This agenda was clearly left-wing and “progressive” in orientation. Their solutions were to regulate, restrict and pass laws in profusion to thwart “special interests.” They may have escaped censure because they were careful to criticize Democrat lawmakers and elected officials as well as Republicans.
Today, America is in the throes of a political divide. It is easy to see how the work of BS sharpened this divide. Left-wing readers were emotionally charged by its omnibus indictment of the “Reagan era” – one might suppose that those were years of deep Depression rather than the biggest postwar expansion. Right-wing readers were shocked and startled, but finally brought to realization that the mainstream print media were ideological opponents rather than neutral purveyors of journalism.
The right-wing half of the audience began to look for the exits. That was the beginning of the end of newspapers; the Internet merely ratified the decision made earlier by customers.