Inside Job (41 page)

In the remainder of this book, I shall examine first the causes, and then the implications, of our recent political-economic decline. Then I will describe the emergence of America’s
political duopoly—the system by which both the Democratic and Republican parties are now dominated by the new economic oligarchy, and how the parties handle this situation strategically. I
will examine the consequences of this situation, including the Obama administration’s personnel and policies. I will then consider the current and future determinants of economic
competitiveness, using US broadband communications, Internet services, and information-technology hardware as examples. Finally, I will offer some ideas about what the future holds, what the most
critical goals for reform are, and whether we can pull ourselves out of this morass.

I will begin by examining the beginnings of American industrial decline in the 1970s, and how America’s major industries responded to this decline. Faced with growing challenges,
America’s business elites found a cheap way out—one that has turned into our biggest problem.

WHY DO WE
see, over and over, the cyclical rise and fall of companies, national industries, nations? The British Empire, General Motors, U.S. Steel,
Microsoft, the United States—we see the same pattern over and over again. An initially small, powerless company or nation devises a superior way to run itself; it becomes enormously
successful, vanquishing all rivals; but then, at the height of its apparent power, it begins
to decay from within. It starts to coast. It becomes lazy, politicized,
complacent, dysfunctional, corrupt; and eventually, after a period of internal decay, it collapses under its own weight or falls prey to some aggressive new competitor.

The US has now entered such a systemic decline, and the rise of the new economic oligarchy and money-based political system is both a cause and a symptom of it. As is typical in such situations,
the decline of America’s political and economic systems began at the height of national power. Money-based politics was not the initial cause of the decline, but it was the way that
America’s largest industries responded when they were threatened. It turned out to be easier and more effective (more effective for
them
, not for the country) to pay people off than to
undertake real, painful, internal reform.

The initial source of this decline was the complacency of American industry, permitted by the concentration and global dominance of what then constituted the core of the world economy. In part
because World War II had devastated most potential competitors, and in part due to the enormous size of the US domestic market, American industry faced no serious competition, either foreign or
domestic, for a quarter century after the war. During this time, America’s largest and most important industries gradually became complacent, rigid, highly inefficient oligopolies or even in
some cases monopolies. They also came to have complacent, low-quality corporate governance and, in some cases, unions that contributed to systemic rigidity. They were not attuned either to
innovation or to competitive threats, either domestic or foreign. Many senior managers also deliberately resisted innovations that would have rendered their skills obsolete, and would have reduced
their internal power and status.

The industries displaying this pattern in the 1970s and 1980s included cars, steel, telecommunications, mainframe computers, minicomputers, photocopiers, cameras and film, semiconductors, and
consumer electronics. Together they formed the core of the American economy. They accounted for a major fraction of GNP, and they were among the wealthiest, most powerful industries in the US and
in the
world. They dominated US and often world markets, and were either regulated monopolies, oligopolies, or industries dominated by a single firm whose competitors lived
in its shadow.

In the car manufacturing industry, the Big Three (GM, Ford, Chrysler) dominated the US market and held roughly half the total global market. An oligopoly of a half dozen integrated steel
companies, led by U.S. Steel, similarly dominated the domestic steel market. IBM held about two-thirds of the total global computer market, with smaller mainframe producers (the so-called
“Seven Dwarfs”) and a half dozen minicomputer producers holding most of the rest. AT&T was a regulated monopoly that controlled over 90 percent of all US telephone and data
services. Kodak dominated the film and camera industries; Xerox held a patent monopoly on photocopying for many years.

The growing inefficiencies of these industries also affected their suppliers and customers. The stagnation of the American car industry contributed significantly to the decline of car parts
suppliers and of the machine tool industry. By the late 1980s, Japan had definitively surpassed the US not only in the car industry but also in machine tools and robotics, as well as in their
advanced use in a variety of manufacturing sectors. Similarly, Japanese excellence in producing commodity semiconductors and liquid crystal displays pulled along its semiconductor capital equipment
industry.

America’s largest industries had always wielded political influence, but for the first quarter century of the postwar period they did not wield it very aggressively, because they did not
need to. They were naturally successful and profitable, with an almost leisurely dominance of both their domestic and international markets. Because their industries were mature, entry into their
markets by small start-ups was for the most part impossible due to scale, capital requirements, and systems effects. In some cases, such as telecommunications, the media, and parts of financial
services, new competition was legally limited or even prohibited. In a few cases (AT&T, IBM), antitrust actions were undertaken to limit the incumbents’ power. But for the most part
American
industry and the US government left each other to their own devices for the three decades following the Second World War.

Over time, however, oligopoly and lack of competition led to complacency, which in turn led to inefficiency. By the 1980s, these inefficiencies were so severe that the productivity and product
price-performance ratio delivered by the dominant firms in major US industries came to lag best practice by enormous margins—factors of two or more in productivity for traditional
manufacturing industries, and up to an order of magnitude in the price-performance ratio of high-technology products such as computers.

One of the most striking demonstrations of this occurred in Fremont, California. General Motors opened an assembly plant there in 1962 and then closed it as unprofitable in 1982, in part because
the UAW-unionized workforce was regarded as unmanageable. By this time GM’s inefficiency was obvious, and it was facing intense competition from the Japanese. Under enormous political
pressure from the US government, in 1984 Toyota agreed to form a joint venture with GM and to reopen the Fremont plant under Toyota management. The unstated but clear intent was to force Toyota to
save GM from itself by teaching GM how to use Toyota’s “just-in-time” or “lean” production system. The result was a stunning indictment of GM. Using the same unionized
workforce that GM had written off as hopeless, Toyota rapidly doubled productivity and sharply increased the quality of the cars that Fremont produced. But despite Toyota-organized tours of the
plant for GM managers and videotaping of plant activities, the rest of GM learned very, very slowly.

This was not an isolated situation. Careful studies conducted by MIT and Harvard in the 1980s and 1990s demonstrated that Japanese car companies were approximately twice as productive as their
American (and some European) competitors in both design
and
manufacturing.
²
Similar results were found when American integrated steel firms were
compared with the Japanese industry and American start-up “minimills”. Even stronger results were found when comparing
American to Japanese manufacturers in their
use of robots and computerized flexible manufacturing systems (FMSs).
³

By the early 1990s, an even more remarkable situation held within the US computer industry. The price-performance ratios of microprocessor-based personal computers, workstations, and servers
were twenty to fifty times superior to those of the mainframe computers and minicomputers that constituted the core business of IBM, the Seven Dwarfs, and most of the minicomputer industry. But in
the case of the computer industry, the vastly superior challengers were predominantly American. The US venture capital industry and Silicon Valley are superb at creating new start-ups, and entry
costs for companies based on new information technologies are generally relatively low. In those cases, the system largely self-corrected through domestic start-up entry. IBM deteriorated and most
of the others went out of business. But in their place we got Intel, Microsoft, Compaq, Dell, and Apple. Alone among the earlier generation of firms, IBM was able to reform itself, after falling
into a deep crisis in the early 1990s.

But IBM was an exception; most of America’s declining giants failed to reform themselves. And in more mature sectors such as cars, steel, machine tools, photographic film, and
photocopiers, start-up entry was and is impractical. To create a new competitor would require a gigantic, lengthy commitment. And the financial and industrial system, unlike those of Japan, South
Korea, and China, is not good at creating new companies in mature industries that require large initial capital investments.

In contrast, the Japanese (and later, South Korean and Chinese)
did
finance new entry into these industries. This was because the Japanese business sector was dominated by six
diversified, vertically integrated financial-industrial complexes (
keiretsu
) that could create new companies even in mature industries. Japanese industry also engaged in large-scale
technology licensing, copying, and intellectual property theft, aided by Japanese industrial policy. South Korea had a similar system (based on the
chaebol
). In China the central government,
the People’s Liberation Army, provincial governments, and state-owned
enterprises are now playing a similar role in technology extraction, financing of new domestic
entry, and protection of the domestic market from uncontrolled foreign competition.

The comparative ability of different national economic systems to generate new competition in large, mature industries is a subject that the economics discipline has mostly ignored. But the
inability of the system to create major new competitors in mature industries is extremely important, because it means that the US faces a very limited set of options when large companies and
concentrated industries go into decline. If start-up entry is feasible, as in most IT and Internet markets, American industry renews itself and remains healthy. But if start-up entry is
not
feasible, then there are only three possibilities. They are:

The result has usually been some combination of the second and third options. Since the 1970s, in case after case—GM, Chrysler, most mainframe and minicomputer companies, major steel
companies, nearly the entire consumer electronics industry—the failure to adjust has eventually led to wrenching crises, downsizings, bankruptcies, or acquisitions at fire-sale prices.
Whether the challengers were foreign or domestic, the incumbents generally resisted change as long as they could, often through political activities, and consequently suffered even more severely
when reality could no longer be denied. In many cases, including cars, steel, and telecommunications, incumbents were able to retard both competition and reform sufficiently that they imposed major
costs on the American economy. And now,
to those costs we must add the impressive damage caused by powerful predatory industries—especially financial services.

Indeed, seen in the context of broader industrial decline, the financial services industry is not
entirely
exceptional. While much of the damage it caused was rationally, amorally
predatory, some of it came from the same kind of managerial decadence that ran GM and Chrysler into the ground. Jimmy Cayne, Stan O’Neal, Chuck Prince, Richard Fuld—these were people
way above their rightful pay grade, kept there by complacent boards of directors, just the way things worked at GM, Chrysler, U.S. Steel, Kodak, and IBM before 1993. The principal difference was
that finance can be
really dangerous
. In contrast to the car industry, people in finance were able not only to loot their companies but also to bring the global financial system to its
knees.

The rise of China, India, and other Asian nations had another effect on the calculation of industrial executives, of course. It provided a gigantic new pool of extremely low-cost labour to their
multinational firms. This meant that even a very efficiently run company (in fact, perhaps
especially
a well-run company) no longer needed, or even wanted, high-cost local workers for many
low-skill jobs, ranging from manual labour in manufacturing to call centre personnel used in routine customer service. Outsourcing and offshoring were much more effective.

Such changes mean that a nation can only remain economically healthy, and provide high-wage employment, if it radically improves the education and skills of its population, as well as its
attractiveness as a location for high-technology activities. In fact, the reverse has occurred. As a result, manufacturing has all but disappeared from the US as well as the UK and similar
economies; it now accounts for 12 percent of GDP in America. High-skill custom manufacturing (such as for machine tools) is dominated by Japan and Germany, while labour-intensive mass manufacturing
is dominated by China, Vietnam, Bangladesh, and other low-wage nations. This has rendered an enormous number of workers all but unemployable, except in minimum-wage service occupations.