Freeman

ARTICLE

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.

Unbounded Authority

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

Institutionalized Incompetence

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

Induced Indolence

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.

—FOOTNOTES—

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.

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