From American Affairs Journal:
Government responses to Covid-19 will reshape the U.S. economy for the next decade. But why did America’s economy deliver such slow growth during the previous decade, as well as before the 2008 global financial crisis? Why has the U.S. economy consistently generated rising income inequality and sluggish investment for so long? Answering these questions helps establish the baseline for understanding how the Covid shock might change economic structures and outcomes.....MUCH MORE
Most explanations for slow growth, both before and after the financial crisis, focus on singular causes—like aggregate income inequality, or the rise of a shareholder value model for corporate governance, or increased trade competition (globalization), or the financial sector’s disproportionate power and profitability (financialization). These explanations are important, and in many respects correct. Yet they are also largely incomplete because they ignore the sources of profit, even when they discuss the rising share of profits relative to wages, or of “financial sector” profits relative to “manufacturing sector” profits.
In understanding American capitalism, the origin of—and distributional conflict over—profits matters as much as the distributional conflict between profits and wages. Looking at firms’ profit strategies, and the organizational structures they construct to pursue profit, explains the dynamics and malaise of the U.S. economy.
Put simply, changes in corporate strategy and structure from the postwar era to the current era changed the distribution of profits among and within firms and led directly to our present problems. While the distribution of profits across firms was highly unequal in both eras, changes in corporate strategy and structure have concentrated profits in firms with small labor head counts, a low marginal propensity to invest, and relatively easy tax avoidance. Reduced investment and worsening income inequality in turn slow GDP growth and aggravate social and regional tensions. While these changes are generic to the rich countries, they have gone furthest in the United States. As William Gibson has put it, “The future is already here—it’s just not evenly distributed.”
From Fordism to the Information Economy
Broadly speaking, firms in the mass-production era (or as academics like to call it, “Fordism”) sought oligopoly profits by controlling asset-specific physical capital—that is, machinery that could not easily or profitably be redeployed to other uses. This specialized equipment was extraordinarily productive relative to more generic machinery, enabling huge economies of scale. High productivity deterred potential competitors from entering the market, because incumbent firms could easily ramp up production and lower prices, starving potential rivals of profits. Yet with asset-specific physical capital, profitability, to say nothing of profit maximization, required uninterrupted production at near full capacity. Otherwise a firm would have expensive equipment sitting idle and suffer diseconomies of scale. This imperative of uninterrupted production had three important consequences.
First, firms vertically integrated—or brought production of components going into final products in house—to assure a continuous and timely flow of the parts they needed. Even something as simple as a can of soup requires a wide range of inputs. More sophisticated products like the automobiles eponymous of Fordism typically require ten thousand discrete parts. Missing any single part could halt production. After the 2011 Tohoku earthquake and tsunami, for example, shortages of plastic speedometer needles, among other things, caused car assembly factories worldwide to halt production. As late as the 1970s, GM was making 70 percent of the value of its cars inside its own factories.
Second, as a consequence, these large, vertically integrated firms necessarily had many direct employees. But in-house production of components, and even more so the need to run assembly lines continuously, gave workers a credible threat to firms’ profitability: strikes that interrupted production. Sit-down strikes in the 1930s, legislation legalizing collective bargaining, and a second wave of strikes immediately after World War II produced a temporarily stable bargain. Basically, firms agreed to share oligopoly profits with direct employees if workers ceded control over production to management. The 1950 “Treaty of Detroit” between the UAW and GM exchanged a five-year, no-strike contract for wage hikes in line with average productivity growth and inflation.
Third, big capital investments and big unionized workforces had positive macroeconomic consequences. Gross domestic product is conventionally divided into consumption (including government transfer payments, like Social Security), government spending net of transfers, and investment. GDP growth is thus the growth of any or all of these components. Firms’ high labor head counts combined with unionization to flatten the income distribution, boosting aggregate demand as workers consumed more each year. Firms’ strategic use of large fixed investments in physical capital, which served as a barrier to entry, generated continuous investment. This had strong multiplier effects, again bolstering aggregate demand. Finally, as John Kenneth Galbraith argued in 1967, firms’ desire for stable inputs and demand in largely national markets oriented their political behavior towards seeking macroeconomic stability and predictability.1
Capitalism has winners and losers, though; not all firms succeeded in creating an oligopoly or inserting themselves into the public or corporate planning routines that Galbraith charted. Fordist-era firms thus tended to polarize into two groups: larger, more profitable firms with stable markets, and smaller, less profitable firms in unstable or marginal markets. In a complementary fashion, markets and employers also sorted workers into two groups: largely male, white workers with stable, higher-wage employment in large firms, and largely minority, immigrant, and female workers with unstable, lower-wage employment in smaller, less profitable firms.
Planning, rent sharing, and a dual labor market generated tensions that undid the mass-production era. To be sure, advances in automation and communication technologies enabled some of the changes described below, but the major drivers of change were social and political conflicts in the late 1960s and early 1970s. Compliance with corporate routines and the status quo broke down in a wave of strikes and social movements. Put simply, young workers entering factories rejected mindless production routines and constant assembly line speedup; women rejected confinement to marginal labor markets and marriage; African Americans rejected exclusion from normal American civil and economic life; and newly independent oil producers rejected subservience to giant U.S. and British oil firms.
Strikes and resource price shocks in food and energy disrupted corporate planning, highlighting the vulnerabilities of production strategies that relied on large volumes of fixed, product-specific equipment. Of the two, the strikes were more important in motivating firms to change strategies, and companies began looking for ways to shift labor risks away from themselves and onto to other firms.
From 1964 to 1974, the wage share of value-added per U.S. manufacturing employee rose by 5.9 percentage points.2 Firms responded with public and private strategies to reduce the wage share and regain control over the factory floor. U.S. firms became more politically active in promoting business interests, following a strategy outlined in the 1971 Powell Memo, and in supporting the economic policy agenda embraced by the Republican Party over subsequent decades.3 Privately, firms began to disperse concentrated production and shed legal responsibility for their workers by de-merging, moving production offshore, contracting out (both on- and offshore), dispersing production geographically, and adopting variants of the franchise format.
IBM, for example, shed 40 percent of its workforce between 1990 and 1994, abandoning most manufacturing in favor of R&D, software, and patent licensing.4 Similarly, both GM and Ford spun out their parts production as the independent firms Delphi and Visteon in 1999 and 2000. By 2008, both Delphi and Visteon had more Mexican than American employees.5 Where the old GM had generated 70 percent of final value in house, and Ford 50 percent, almost all automobile firms were down to 20 percent by the 2000s. Contracting out created smaller firms and smaller factories, both of which are harder to unionize. Furthermore, the franchise format removed the legal responsibility to provide benefits and protected an emergent group of highly profitable firms from liability for abuses.
Firms’ new profit strategy sought monopoly profit via control over intellectual property (IP) via intellectual property rights (IPRs), like patent, brand, copyright, and trademark, while ejecting workers and physical capital. IPRs convey an exclusive right to extract value from a given production chain. For example, Qualcomm’s patents on the technologies linking cellphones to cell towers and Wi-Fi enable it to levy a 2 to 5 percent royalty on the average selling price of almost all cellphones.
Unfortunately, to steal a phrase, the more IPRs we come across, the more problems we see. These corporate and political responses transformed the two-tier Fordist economy into a new three-tier economy. Since not all firms can succeed in capturing oligopoly or monopoly profits via IPRs, competition produced three different generic firm types: (1) human-capital-intensive, low-head-count firms whose high profitability stems from robust IPRs; (2) physical-capital-intensive firms whose moderate profitability stems from investment barriers to entry or tacit production knowledge; and (3) labor-intensive, high-head-count firms producing undifferentiated services and commodities with low volumes of profit.
Naturally, some firms blend characteristics of each level. Intel, for example, blends the top two levels of IP ownership and a massive physical capital footprint in its semiconductor fabs.
“Tech” is the obvious epicenter of the new, IPR-based economy. But two caveats matter here. First, IPRs are nothing new. Formal IP was also present in the Fordist era and, indeed, before that.
Critically, IP was embedded in large organizations, and generated by the dedicated internal research labs that former RCA Labs engineer Henry Kressel has described.6 Second, many firms outside of tech have pursued an IPR-based strategy. Franchised restaurant chains are the most obvious “low-tech” example, with a high-profit brand owner licensing the use of its brand and production methods to smaller, lower-profit owner-operators in the bottom tier. In both high-tech and low-tech industries, the general pattern is vertical disintegration and the segregation of IP ownership into a small number of legally distinct and highly profitable firms. This largely involves a rearrangement of legal boundaries, not production as such.
The best way to see this is to imagine two different automobile factory tours, one in 1965 and one in 2015. During the 1965 factory tour you would see many different people doing direct and indirect production tasks. The iconic semiskilled workers on the assembly line would loom large. But surrounding them were specialist toolmakers, engineers, designers, janitorial staff, and logistics workers. Farther out—caterers, guards, groundskeepers, accountants, white-collar management, and a second set of logistics workers unloading parts coming from components factories. All these workers were typically legally inside the firm as employees and, white-collar workers aside, union members.
The 2015 tour reveals many of the same kinds of workers—with more racial and gender diversity—doing similar jobs. Automation would have replaced many semiskilled workers, but the logistics personnel, caterers, security, accountants, designers, engineers, and so on remain. The critical differences are largely legal and organizational: where everyone used to be an employee of the core firm, workers doing logistics now might be employees of XPO Logistics, DHL, or UPS; security guards might be employees of Securitas or G4S; caterers might be employees of Aramark or perhaps small local firms. Astoundingly, between 20 and 30 percent of line workers are now typically contracted-in or temporary employees who are technically not employees of the automobile firm, and certainly not unionized. Where firms once did much of the component production in house, they now buy in many parts, some design work, and a considerable volume of the software and electronics (which now constitute about 20 percent of a vehicle’s total cost) from external suppliers. From a production point of view, these essentially legal changes have not impeded increases in productivity.
But from a macroeconomic point of view, or with an eye towards income inequality, the shift in the legal boundaries around workers is enormously consequential.
Franchise-based industries provide an even clearer example....
