Government Regulation and Business Management
MAY 01, 1978 by JOHN SEMMENS
Mr. Semmens is an economist for the Arizona Department of Transportation and is studying for an advanced degree in business administration at Arizona State University.
A “managerial revolution is now underway, a silent bureaucratic revolution, in the course of which much . . . of the decision-making in the American corporation is shifting . . . from the professional management selected by the corporation itself to the vast cadre of government regulators who are influencing and often controlling the key managerial decisions of the typical business firm.”1
The State’s invasion of managerial prerogatives has occurred on virtually every conceivable front. The government has not shied away from deciding what shall be produced (i.e., tobacco shall be produced, even subsidized, but cigarette commercials shall not), how it shall be produced (i.e., electricity shall be generated by burning coal, though a few years ago power companies were induced to switch from coal to oil for environmental reasons), who shall produce it (i.e., between firms via monopoly franchise grants and within firms via affirmative action programs), where it shall be produced (i.e., by granting offshore leases in the Gulf of Mexico, but not off the Atlantic Coast), and even why a product shall be produced (i.e., air bags for automobiles shall be produced for passenger safety regardless of whether the consumers want them or not).
This invasion has not come as the result of one massive onslaught. Rather, it resembles more a war of attrition in which business has been gradually surrounded, its perimeter growing smaller by degrees. Perhaps if the government lunge into capitalist territory had been concentrated and overt, the business community could have devised a better defense. Instead, like the frog that never jumps from water brought slowly to a boil, business management has been unable to decide at what point the destruction of managerial options will be fatal to the business enterprise.
The power of the federal government to regulate business derives from the U.S. Constitution.2 This provision allows the U.S. Congress to regulate commerce between the states as well as between the United States and foreign entities. The scope of this interstate commerce authority is broad enough to cover virtually any economic activity. In a famous case in 1942, Wickard versus Filburn,3 the distinctions between commerce and manufacture or agriculture and between intra- and interstate were dissolved when the Supreme Court determined that any goods or services which might be in competition with goods and services actually crossing state lines, were subject to federal regulation.
These powers of regulation are exercised primarily by executive agencies which in many cases have taken on a life of their own. Congress’s authority to delegate such broad powers was upheld by Supreme Court decisions in 1939.4 (It may be a matter of significance that these key court decisions were rendered in agricultural disputes. Corporate business showed little resistance to the increasing role of government in economic matters.) This delegated authority is typically a carte blanche grant of power to do all things necessary to insure that the regulated environment is “just and reasonable.”5 In case any loopholes are left in the federal regulatory net, most states have established supplemental regulatory agencies of their own. In Arizona, for example, the State Corporation Commission is empowered to “do all things . . . necessary and convenient” in exercise of its regulatory mandate.6
Theoretically, the expanding power of government regulations ought to be making the tasks of business managers easier. The consolidation of decision-making power within government agencies capable of perceiving the broader requirements of the national interest has, indeed, been one of the selling points of the regulatory philosophy. Following the grand plan of the central government ought to be a simple matter for business managers.
Such, however, is not the case. Regulatory guidelines have been unclear. The “just and reasonable” dictum has proven so elusive that the courts in reviewing regulatory actions have dispensed with the necessity to define the phrase’, that the determination of what is “just and reasonable” is completely at the discretion of the regulatory agency,8 and that the “burden of proof” is a matter for the regulators to decide on a case-by-case basis.9
Erratic changes in regulatory policy defy prediction. Inflexibly enforced conformity robs the business system of its ability to plan for the future and adjust to changing circumstances. As a consequence, the economy is beset by a continuous series of crises, of crash projects, drives attempting to cope with the most immediately observable or fashionable problem. Such a management technique is, according to Peter Drucker, “an admission of incompetence.”10
Nowhere has the cost of this system of mismanagement been more dramatically portrayed than in the rates of return on investment. The government-business collaboration (or partnership, as some are wont to call it) has succeeded in increasing economic uncertainty, raising the cost of meeting consumer wants, and consuming scarce resources.
Uncertainty is, of course, an inescapable circumstance of any dynamic environment. In a business sense, uncertainty exists in varying degrees based upon the nature of the firm’s source of income. High levels of uncertainty mean increased risk. Increased risk means that the enterprise must yield higher returns in order to justify taking that risk. Competent management will seek to reduce risk born of uncertainty. This is accomplished primarily through superior planning that attempts to anticipate future requirements and conditions and to compensate for them.
Management foresight is, however, frequently frustrated by regulatory interventions. The entitlement program of the Federal Energy Administration effectively removes managerial incentives to secure supplies of crude oil at favorable prices by removing the gains that would have been enjoyed by firms whose managements had obtained longer term commitments of crude oil at low prices. The Federal Energy Regulation Commission’s curtailment procedures routinely reward profligacy while penalizing conservation. Like the fabled ant who labored in the summer that he might survive the winter, firms which show the initiative to line up additional sources of supply to offset the predictable shortages of natural gas are likely to find themselves candidates for further curtailment. Meanwhile, the grasshoppers who fiddled away the summer are the more frequent beneficiaries of extra allotments, since the regulators seek to equalize suffering, not opportunity.”
Eating the Seed Grain
As the incentives of managerial perspicacity and planning are eroded, the tendency to await governmental decrees in lieu of independent action will undoubtedly grow. This lapsing of the business system into the management by crisis syndrome has not gone unnoticed by the investment community. This rising indolence of management is reflected in the greater apprehension with which the providers of capital view the elements of business risk.
The most heavily regulated industries have experienced significant increases in their cost of capital. Interest rates on corporate debt have tripled in the last 20 years.” Earnings have been unable to keep pace. As a consequence, many American businesses have been consuming their capital. The foolhardiness of such a practice is obfuscated by all manner of excuses from both government and industry. The current administration’s position on energy seems to imply that it would be “unfair” for consumers to bear the full cost of the services they enjoy. The power industry’s position, to judge from a number of their comments, seems to be that it is impractical to require that consumers bear the full cost of the services they consume.” This viewpoint has been implemented via extensive borrowing of funds. Apprised of this method’s close resemblance to a Ponzi scheme, one power company official placed his trust in the hope that the impending collapse could be postponed to a distant future when some miracle of technology might save the day.14
The fact of the matter is that U.S. industry in aggregate has been unable to generate sufficient cash flow to cover its investment since 1965.15 Contrary to popular myth, increased costs brought on by government regulations are not all passed on to the consumer. In recent years great amounts of the increased costs have come out of profits. Real corporate profits peaked in 1966. Corporate management has been unable to maintain them save through accounting methods that transform capital into phantom earnings.
The Enemy Within
The erosion of investment capital does not speak well of management’s performance of its responsibility as conservator of the owners’ assets. Capital is the pillar upon which the modern industrial society is founded. It is the repository of stored effort which has enabled humanity to obtain more and more by way of less and less direct labor. We have been, for the last decade or more, embarked upon a course bound to dissipate this capital.
This dissipation has received its crucial impetus from government intervention into the conduct of business activity. Management can hardly be faulted for obeying the law. However, the role of business management in the attenuation of the entrepreneurial system is more than that of an unwilling victim. Time after time, the initial agitation for government intervention has come from business itself. From the very beginning of the so-called Progressive Era, it has been at business’s invitation that the government has imposed regulation.16 The corporate community was a willing and active participant in the New Deal NRA—a program of government-directed cartelization of industry.17 Today, business invitations for government collaboration grace the pages of our newspapers almost every day.
Prices of sugar down? The industry is quick to demand subsidies, tariffs, and controls. Steel industry beset by hard times? Management is vociferous in its demand for special relief and import quotas. Possibly the most galling example of management’s tunnel vision occurs in the oil industry. At the very moment that the chief executives are bemoaning President Carter’s attack on their integrity, the oil lobby is simultaneously pushing for deregulation of prices and imposition of tariffs on imported petroleum products.
In its quest to have the best of both worlds, business has gone a long way toward the establishment of the worst of all worlds. Managerial latitude has been severely circumscribed. Corporate leadership seems anxious to abdicate and many executives are well on the way toward becoming mere bureaucratic functionaries.
The Death of Managerial Enterprise
The key element in making management work is the entrepreneurial nature of the private enterprise system. Its gradual transformation into a quasi-public enterprise via increasing regulation dilutes the motivating elements and introduces a greater measure of irresponsibility. Bureaucrats can be urged or exhorted to produce better results, but the reality is that they bear little, if any, of the consequences (good or bad) of their managerial decision-making.18
A final piece of evidence that the growing reliance upon and dominance of regulation has eviscerated managerial vision and ambition comes from one of the participants in the federally supported Wesco Coal Gasification Project: “federal loan guarantees are necessary because of the large amount of capital required, but more importantly because coal gasification, on the scale proposed by Wesco, has never been attempted in the U.S.”19 The belief that government backing is imperative for great undertakings is not the same spirit of enterprise that made American business the envy of the rest of the world.
1. G. T. Bowden, “Book Review: Business, Government, and the Public,” The American Spectator (December 1977), pp. 37-38.
2. U.S. Constitution, Article I, Section 8, paragraph 3.
3. 317 U.S. 111, 1942.
4. United States v. Rock Royal Co-operative, 307 U.S. 533; and Hood and Sons v. United States, 307 U.S. 588.
5. U.S. Code 49-1.
6. Arizona Revised Statutes 40-202.
7. City of Chicago v. Federal Power Commission, 1971, 458 F2d 731.
8. Pennsylvania Railroad v. U.S., CA, Pa. 1963, 315 F2d 460.
9. Commonwealth of Pennsylvania v. U.S., D.C., Pa. 1973, 361 F. Supp. 208.
10. Peter Drucker, The Practice of Management (New York: Harper & Row, 1954), pp. 62-65, 126-129.
11. “Gas Regulation Stymies Planning,” Purchasing (June 17, 1975), p. 13.
12. Alexander Paris, The Corning Credit Collapse (New Rochelle: Arlington House, 1974), p. 82.
13. Correspondence with Southern California Gas Company (November 4, 1977), Arizona Public Service (November 2, 1977), and Transwestern Pipeline Company (November 16, 1977).
14. Conversation with Arizona Public Service (November 11, 1977).
15. Paris, op. cit., p. 88.
16. Gabriel Kolko, The Triumph of Conservatism (Chicago: Quadrangle Books, 1963).
17. Ronald Radosh, “The Myth of the New Deal,” A New History of Leviathan (New York: Dutton, 1972), pp. 146-87.
18. Armen Alchian, Economic Forces at Work (Indianapolis: Liberty Press, 1977), pp. 127-150, 227-257.
19. Correspondence with Southern California Gas Company, op. cit.