David Warsh: Scott Walker: Political asset stripper

SOMERVILLE, Mass..

This appeared in economicprincipals.com last spring.

Republican Party business interests and  centrists have rallied around Jeb Bush. Tea Party conservatives so far seem to prefer Wisconsin Gov. Scott Walker to the rest of the list of would-be contenders – Chris Christie, Ted Cruz, Mike Huckabee, Rand Paul, Rick Perry, Marco Rubio, and Rick Santorum. {Editor's note: This was written before the recent rise of Donald Trump.}

The first state primary is still  months away.  But to understand the appeal of Bush and Walker to their respective constituencies, it helps to know something about the situation on the ground in Wisconsin.

Walker, 47, who rose from state legislator in 1993 to county executive for Milwaukee to governor, achieved national prominence in 2011 when he successfully campaigned to strip the state’s public unions of most of their collective bargaining rights.  He survived a recall election and, in 2014, won a second term.

Recently he picked a new fight with organized labor when he said he would sign “right-to-work” legislation on the verge of passage in the Republican-led legislature. The measure would deprive unions of their right to charge non-member workers the equivalent of dues.

Robert Samuels, of The Washington Post, spent time in the state recently and found the public unions reeling. Describing an ill-attended meeting in a union hall in a small town in central Wisconsin, his report began:

The anti-union law passed here four years ago, which made Gov. Scott Walker a national Republican star and a possible presidential candidate, has turned out to be even more transformative than many had predicted.

Walker had vowed that union power would shrink, workers would be judged on their merits, and local governments would save money. Unions had warned that workers would lose benefits and be forced to take on second jobs or find new careers.

Many of those changes came to pass, but the once-thriving public sector unions were not just shrunken — they were crippled….

The state branch of the National Education Association, once 100,000 strong, has seen its membership drop by a third. The American Federation of Teachers, which organized in the college system, saw a 50 percent decline. The 70,000-person membership in the state employees union has fallen by 70 percent.

The story artfully hints at the disparities in job security, wages, and benefits that exist between union and non-union jobs.  Statistics are hard to come by, but where government workers 50 years ago routinely accepted lower levels of compensation in return for greater job security and reliable pension benefits, anecdotal evidence suggests that government salaries in recent decades have tended to equal and often surpass comparable private-sector employment opportunities.

Samuels writes,

While some union members have been energized by the fight, they say they notice a new, more vocal animosity toward them. It has been particularly pronounced in rural areas, where public-sector jobs were some of the most prized gigs in town.

In King [Wis], population 1,700, [union steward Terry] Magnant said she couldn’t change a sign at the union hall without someone giving her the finger. Farther west, in Stanley, prison workers said they ditched their favorite pizza pub because the owner stood by while other customers called them “leeches.”

In Reedsburg, that tension surprised Ginny Bourgeois, 52, who clerks at a local Kwik Trip. The community had always been divided, defined as much by the factories manufacturing car parts as it was by cornfields now blanketed in snow. Still, it was a place where the community got together for spaghetti and corn feeds and filled bleachers to watch the Reedsburg Beavers play. Now, she said, people were fighting over politics at gas stations.

Still, she felt unions needed to sacrifice.

“Everyone knows teachers’ insurance was some of the best you could get,” Bourgeois added. “They do fairly well around here, and they do a good job teaching. But everyone in this town has had to tighten their belts. They should too.”

Judy Brey, a 58-year-old speech therapist who taught in the community for 22 years, said such sentiment hurt teachers’ morale. She said she grew up admiring her dad, who put six children through college on his union-supported job as a forester. “I don’t make a lot, but we’ll be okay with retirement, ” she said he told her. That, she was taught, was the reward for public service in Wisconsin.

“Now I’m always nervous that everyone will think they’re moochers,” Brey said. “That I’m a moocher.”

The history of the union movement can only be understood in the larger context of American business in the 20th Century – but it seldom is,   Even the broad outlines of the story of American business are not well understood.

Alfred Chandler, the great historian of business, who spent his last 40  years at  Harvard Business School, worked tirelessly to demonstrate the importance for economic growth of giant corporations – not just in the US, but in Britain, Europe and Japan, too.  First in Structure and Strategy: Chapters in the History of American Industrial Enterprise (MIT, 1962), then in The Visible Hand: The Managerial Revolution in American Business, (Harvard, 1977) and finally in Scale and Scope: The Dynamics of Industrial Capitalism (Harvard, 1990), Chandler described and analyzed the stability that arose when industries became oligopolies, markets dominated by a handful of first-movers, each with substantial power to set prices, all determined to compete on other grounds.

But when the time came for an international conference in 1994 to celebrate what was clearly a triumph of empirical economics, Big Business and the Wealth of Nations (Cambridge, 1997), European unions were barely mentioned. and American unions had no place at all in the index. Moreover, it was already apparent that market conditions had changed dramatically since the 1970s  – that the twin forces of innovation and globalization were undermining familiar arrangements of enterprise that had begun taking shape more than a hundred years before.

No comparable economic history of the labor movement exists, though Atlantic Crossings: Social Politics in a Progressive Age (Harvard, 1998), by Daniel T. Rodgers, of Princeton University, made a very good start.  Steven Greenhouse, for  19 years a labor reporter for The NewYork Times, contributed The Big Squeeze: Tough Times for the American Worker (Knopf, 2008) before he retired earlier this year to begin another book. In the mid-1950s, 35 percent of American workers belonged to unions, Greenhouse writes; in 2008, the number was 12.1 percent and declining, just 7.5 percent in private sector unions -- the lowest proportion since 1901.  But those numbers come toward the end of the book, not the beginning.

The story of the last  40 years has been one of pell-mell corporate  restructuring in industrial economies and newly industrializing ones around the world.  Call it what you like: deregulation, a Big Bang, the Leap Outward, Perestroika. Private unions have been intimately affected by the turmoil, public unions somewhat less so.

In the US, the   Employment Retirement Security Act of 1974, known as ERISA, spelled out rules under which companies could legally freeze their pension plans.  Few have hesitated to do so.

But no such measure was undertaken for public pensions.  As Mary Williams Walsh, the dean of pension reporters, wrote recently inThe New York Times,  cracks have started to appear in the legal foundation of government pensions, the  doctrine of “vested rights:”

First in Detroit, then in Stockton, Calif., now in New Jersey, judges and other top officials are challenging the widespread belief that public pensions are untouchable.

Walker is clearly part of this evolution.  He should be seen to have begun doing something that needs to be done – albeit in an especially combative way.  Just as corporate restructuring called forth a gallery of types over the years – entrepreneurial geniuses and private equity kings, roll-up artists and spin-off wizards, merger mavens and makeover masters – so the restructuring of labor markets eventually will be seen to have produced a few basic sorts of innovative leaders.  Walker is one such rxample..

Among corporate chieftains, the lowest rung is reserved for those known as asset-strippers, a term of no great precision, except that the community knows one when it sees one —  raiders who borrow heavily and then sell off assets to pay down debt with no clearer goal than the accumulation of riches. My hunch is that is the category in which Walker will come to be placed – a political asset-stripper of uncommon ambition, who sought to convert a policy of smug confrontation to personal gain.

It’s Wisconsin, a state of sharply divergent traditions, not Indiana or Michigan; maybe it could not have been done any other way. But Scott Walker is very unlikely to become the Republican nominee, much less president of the United States.

David Warsh, proprietor of economicprincipals.com,  is a  longtime economic historian and financial journalist.

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David Warsh: Knowledge economy superstars and hollowing of middle class

SOMERVILLE, Mass.

It is one of the great explications of economics of modern times:  Written in 1958 by libertarian Leonard Read and subsequently performed by Milton Friedman as The Pencil, a couple of minutes of Free to Choose, the 10-part television series he made with his economist wife, Rose Director Friedman, broadcast and published in 1980.

Friedman comes alive as he enumerates the various products required to make a simple pencil: the wood (and, of course, the saw that cut down the tree, the steel that made the saw, the iron ore that made the steel and so on), graphite, rubber, paint (“This brass ferrule? I haven’t the slightest idea where it comes from”).

Literally thousands of people cooperated to make this pencil – people who don’t speak the same language, who practice different religions, who might hate one another if they ever met.

This is Friedman as he was experienced by those around him, sparks shooting out of his eyes. The insight itself might as well have been Frederic Bastiat in 1850 explaining the provisioning of Paris, or Adam Smith himself in 1776 writing about the economics of the pin factory.

There is a problem, though. None of these master explicators have so much as word to say about how the pencil comes into being. Nor, for that matter, does most present-day economics, which remains mainly prices and quantities. As Luis Garicano, of the London School of Economics, and Esteban Rossi-Hansberg, of Princeton University, write in a new article for the seventh edition of the Annual Review of Economics:

Mainstream economic models still abstract from modeling the organizational problem that is necessarily embedded in any production process.Typically these jump directly to the formulation of a production function that depends on total quantities of a pre-determined and inflexible set of inputs.

In other words, economics assumes the pencil.  Though this approach is often practical, Garicano and Rossi-Hansberg write, it ignores some very important issues, those surrounding not just the companies that make the products that  make pencils, and the pencils themselves, but the terms under which all their employees work, and, ultimately, the societies in which they live.

In “Knowledge-based Hierarchies: Using Organizations to Understand the Economy,” Garicano and Rossi-Hansberg lay out in some detail a prospectus for an organization-based view of economics.  The approach, they say, promises to shed new light on many of the  most pressing problems of the present day:  evolution of wage inequality, the growth and productivity of firms, the gains from trade, the possibilities for economic development, from off-shoring and the formulation of international teams, — and, ultimately, the taxation of all that.

The authors note that, at least since Frank Knight described the role of entrepreneurs, in Risk, Uncertainty, and Profit, in 1921, economists have recognized the importance of understanding the organization of work.  Nobel  laureates Herbert Simon and Kenneth Arrow each tackled the issue of hierarchy.  Roy Radner, of Bell Labs and New York University, went further than any other  in developing a theory of teams, especially, the authors say, in “The Organization of Decentralized Information Processing,” in 1993.

But all the early theorizing, economic though it may have been in its concern for incentives and information, was done in isolation from analysis of the market itself, according to Garicano and Rossi-Hansberg. The first papers had nothing tp say about the effects of one organization on all the others, or about the implications of the fact that people differ greatly in their skills.

That changed in 1978, the authors say.  A decade earlier, legal scholar Henry Manne had noted that a better pianist had higher earnings not only because of his skill; his reputation meant that he played in larger halls. The insight led Manne to conjecture that large corporations existed to allocate the production most efficiently of managers, like so many pianists of different levels of ability.

It was Robert Lucas, of the University of Chicago, who took up the task in 1978 of showing precisely how such “superstar” effects might account for the size of firms, with CEOs of different abilities hiring masses of undifferentiated  workers – and why scale might be an important aspect of organization. He succeeded, mainly in the latter, generating fresh interest among economists in the work of  business historian Alfred Chandler.

It was Sherwin Rosen, of the University of Chicago, with “The Economics of Superstars,” in 1982, who convincingly made the case that the increasing salaries paid to managers had to do with the increase in scale of the operations over which they preside (and, with athletes, singers and others, the size of the audiences for whom they perform). A good manager might increase the productivity of all workers; the competition among firms to hire the best might cause the winners to build more and larger teams; but Rosen didn’t succeed at building hierarchical levels into his model.  He died in 2001, at 62, a few months after he organized the meetings of the American Economic Association as president.

Many others took up the work, including Garicano and Rossi-Hansberg.  It was the '90's, not long after a flurry of work on the determinants of economic growth spelled out for the first time in formal terms the special properties of knowledge as an input in production. The work on skills and layers in hierarchies gained traction once knowledge entered the picture.

At the meetings of the American Economic Association this weekend in Boston, a pair of sessions were  devoted to going over that old ground, one on the “new growth economics” of the Eighties, another on the “optimal growth” literature of the Sixties. Those hoping for clear outcomes were disappointed.

Chicago’s Lucas; Paul Romer, of New York University; and Philippe Aghion, of Harvard University, talked at cross purposes, sometimes bitterly, while Aghion’s research partner, Peter Howitt, of Brown University, looked on.But Gene Grossman, of Princeton University, who with Elhanan Helpman, of Harvard University, was another contestant in what turned out to be a memorable race, put succinctly in his prepared remarks what he thought had happened:

Up until the mid-1980, studies of growth focused primarily on the accumulation of physical capital. But capital accumulation at a rate faster than the rate of population growth is likely to meet diminishing returns that can drive the marginal product of capital below a threshold in which the incentives for ongoing investment vanish. This observation led Romer (1990), Lucas, (1988), Aghion and Howitt (1992) Grossman and Helpman (1991) and others to focus instead on the accumulation of knowledge, be it embodied in textbooks and firms as “technology” or in people as “human capital.” Knowledge is different from physical capital inasmuch as it is often non-rivalrous;  its use by one person or firm in some application does not preclude its simultaneous or subsequent use by others.

My guess is that “Knowledge-based Hierarchies: Using Organizations to Understand the Economy” will mark a watershed in this debate, the point after which arguments about the significance of knowledge will be downhill. “If one worker on his own doesn’t know how to program a robot, a team of ten similar worker will also fail,” write Garicano and Rossi-Hansberg. The only question is whether to make or buy the necessary know-how.

What’s new here is the implication that as inequality at top of the wage distribution grows, inequality at the bottom will diminish less, as the middle class is hollowed out.

[E]xperts, the superstars of the knowledge economy, earn a lot more while less knowledgeable workers become more equal since their knowledge becomes less useful.  Moreover, communications technology allows superstars to leverage their expertise by hiring many workers who know little, thereby casting a shadow on the best workers who used to be the ones exclusively working with them. We call this the shadow of superstars.

For a poignant example of the shadow, see last week’s cover story in The Economist, Workers on Tap.  The lead editorial rejoices that a young computer programmer in San Francisco can live like a princess, with chauffeurs, maids, chefs, personal shoppers.  How? In There’s an App for That, the magazine explains that entrepreneurs are hiring “service pros” to perform nearly every conceivable service – Uber, Handy, SpoonRockert, Instacart are among the startups. These free-lancers earn something like $18 an hour. The most industrious among them, something like 20 percent of the workforce, earn as much as $30,000 a year.  The entrepreneurs get rich. The taxi drivers, restaurateurs, grocers and secretaries who used to enjoy middle class livings are pressed.

Work on the organization-based view of economics is just beginning:  Beyond lie all the interesting questions of industrial organization, economic development, trade and public finance.  Much of the agenda is set out in the volume whose appearance marked the formal beginnings of the field,  The Handbook of Organizational Economics (Princeton, 2013), edited by Robert Gibbons, of the Sloan School of Management of the Massachusetts Institute of Technology, and John Roberts, of Stanford University’s Graduate School of Business. Included is a lucid survey of the hierarchies literature by Garicano and Timothy Van Zandt, of INSEAD.

The next great expositor of economics, whoever she or he turns out to be, will give a very different account of the pencil.

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Andrew W. Marshall retired last week after 41 years as director of the Defense Department’s Office of Net Assessment, the Pentagon’s internal think-tank. A graduate of the University of Chicago, a veteran of the Cowles Commission and RAND Corp., Marshall was originally appointed by President Nixon, at the behest of Defense Secretary James Schlesinger, and reappointed by every president since. He served fourteen secretaries with little external commotion.

A biography to be published next week, The Last Warrior: Andrew Marshall and the Shaping of Modern American Defense Strategy (2015, Basic Books), by two former aides, Andrew Krepinevich and Barry Watts, is already generating commotion. Expect to hear more about Marshall in the coming year.

David Warsh, a longtime financial columnist and economic historian, is proprietor of www.economicprincipals.com.