Speaking of what was called the Greed Decade, with asset-stripping barbarians at the gate, Daniel Henninger writes, in “Bain Capital Saved America” (The Wall Street Journal, January 18, 2012): “Virtually everything about this popular stereotype is wrong. Properly understood, the 1980s, including Bain, were the remarkable years when an ever-resilient America found a way to save itself from becoming what Europe is now—a global has-been.”
What is the basis for such an ironic conclusion?
After World War II, historian Arthur Schlesinger Jr. wrote in “Schlesinger Manifesto,” Partisan Review, May-June 1947 that “there seems to be no inherent obstacle to the gradual advance of socialism in the United States through a series of New Deals.” The Employment Act of 1946 abandoned laissez faire as national policy and committed the federal government to maintaining a maximum level of employment and production. Academic economists argued that the economy could be managed and kept perpetually near “full employment” by stimulative government spending—the New Economics or “advanced” Keynesianism.
But those flawed ideas from academia during the 1960s led to what Washington Post economics columnist Robert J. Samuelson calls The Great Inflation and Its Aftermath (2008). A wage-price spiral contributed to a rise in annual inflation to nearly 15 percent by 1980, driving interest rates above 20 percent. President Nixon, averring “we are all Keynesians now,” had imposed failed price controls and took the nation off the gold standard, worsening inflation. The long-time American beliefs that debt was bad and governments should balance their budgets were dismissed; historically-large government budget deficits became the norm. With inflation-adjusted wages falling, consumers also turned to debt, draining the country’s savings.
During the acclaimed economic prosperity of the 1950s, corporations had made oligopoly profits of 10 percent per year, falling to 9 percent in the 1960s, reports economic columnist Joe Spiers (“The Myth of Corporate Greed,” Fortune, April 15, 1996). During the 1970s and 1980s, profits deteriorated steadily, ultimately to a low of 5 percent in 1992. By the 1970s, profits were not growing enough to keep up with inflation. The stock market stagnated: the Dow Jones Industrial Average was no higher in 1982 than in 1965.
Chairman Paul Volcker and the Federal Reserve System wrung out inflation, and President Reagan refocused fiscal policy on the long run: monetarism to control inflation; reduced marginal income tax rates to induce capital investment and incentivize work; deregulation; and free trade, all aimed at increasing productivity, economic growth, and private sector jobs.
Corporate America had become dominated by large conglomerates, massive enterprises bloated with high-cost bureaucracies and labor contracts in an age of increasing global competition. A wave of layoffs, leveraged buyouts, hostile takeovers, acquisitions, and other proposed restructurings by Wall Street “financial capitalists” began in the 1980s, aimed at improving corporate competitiveness and profitability. This was demanded by financial markets seeking higher returns for stock-market investors, increasingly public and private pension funds.
Private equity firms played a significant role in such restructuring. In “Is Private Equity Bad for the Economy?” (The Atlantic, January 2012), Jordan Weissman cites the work of academic economists who found that in private equity buyouts of shareholders, more jobs were initially destroyed and new jobs then created compared to other businesses, with only a 1 percent net loss. Approximately 6 percent of 17,000 private equity transactions ended in bankruptcy or reorganization, a yearly default rate that was lower overall than the average corporate bond issuer. In 20 industries in more than two dozen countries, those with private equity activity grew 20 percent faster than other sectors. Private equity restructurings taught entire industries to be more efficient.
Historian John Steele Gordon explains in “A Short (Sometimes Profitable) History of Private Equity” (The Wall Street Journal, January 17, 2012) that “the private equity firm is a relatively new beast in the capitalist zoo.” Many venture capital firms helped establish Silicon Valley in the 1970s and 1980s. While scandals regarding individual capitalists sometimes made the headlines (Hollywood eagerly transformed such individuals into stereotypes of capitalism), private equity and venture capital firms “helped fund the technological revolution unleashed by the microprocessor.” The vast majority of such firms “have been involved in no scandal at all, although…their business practices are an easy target for demagoguery.”
Corporate profits returned to the levels of the early 1970s, also for another reason. As profits in the production economy had receded, some corporations, such as General Electric, had turned to the more profitable financing of growing American debt rather than less profitable business investment, as Louis Hyman explains in “The Debt Bomb” (The Wilson Quarterly, Winter 2012, requires subscription).
With improved profits, the Dow Jones Industrial Average grew by a factor of eleven between 1982 and 2006, spawning the super-rich and enriching millions of other Americans. During the Internet (dot-com) bubble, more capital was transferred from corporations to a small number of wealthy individuals through stock options. The Financial Services Modernization Act of 1999 (which removed the bank limits of the Glass-Steagall Act of 1933) and other government actions enabled further transactions by Wall Street (financing of mortgage debt for the housing boom) that proved to be even more consequential.
Capital was deployed by Wall Street investment banks, hedge funds, and others for highly leveraged speculation (gambling) for their own benefit rather than productive investment in businesses. Between 1999 and 2002, the proportion of all corporate profits made by financial institutions grew from 25 percent to 45 percent before declining substantially (“Financial Industry Profits – A Historical View,” ChartingtheEconomy.Com, April 21, 2009). Executive compensation in financial institutions grossly exceeded that in other businesses. The financial house of cards came tumbling down in 2008 with the collapse of the housing bubble and over-leveraged Wall Street “derivative” markets. As in the 1960s and 1970s, the best and brightest elites of the 1990s and 2000s again led America down wrongful, though different, paths to hard times and disappointment.
Timely action in 2008 and 2009 by the Federal Reserve System and the federal government averted a worldwide financial collapse and depression. New financial regulations are being implemented to return to appropriate limits on banks in the form of capital requirements, leverage restrictions, and control or divestiture of proprietary trading operations as urged by Paul Volcker. Hopefully, such regulations will better align private incentives with the public interest—without stifling entrepreneurship and man’s innate drive for innovation.
Banking has contributed immensely to Western civilization. By allocating capital to efficient uses, banking laid the groundwork for the industrial and information revolutions and enables corporations to produce jobs and improve our standard of living. “The country’s largest investment banks, commercial banks, and a few big insurance companies (what we generally refer to as Wall Street) play the crucial role of intermediation—matching borrowers with lenders,” explains Adam Davidson, the co-founder of NPR’s Planet Money “What Does Wall Street Do for You?” The New York Times, January 11, 2012).
The important role of banking to the American economy and historical perspective such as the above should be included in the liberal education that NAS seeks for our colleges and universities.
The financial capitalists of Wall Street have long been the poster boys for greed, feeding the view taught in academia that the rich systematically steal from the poor, a charge wrongly associated with the system of capitalism itself. The leaders of financial capitalism therefore need to support necessary income and tax reform (such as elimination of the carried interest tax preference) before economic populism strips capitalism of its ability to be the wealth creator for ordinary people.
Next week’s article will examine the nature and importance of economic growth in our economy.
This is one of a series of occasional articles applying the lessons of Western civilization to contemporary issues relevant to the academy.
The Honorable William H. Young was appointed by President George H. W. Bush to be Assistant Secretary for Nuclear Energy and served in that position from November 1989 to January 1993. He is the author of Ordering America: Fulfilling the Ideals of Western Civilization (2010) and Centering America: Resurrecting the Local Progressive Ideal (2002).