Sep 24, 2018

Sam Hammond on Co-Determination, Corporate Governance, and the Accountable Capitalism Act

As the need for welfare reform becomes more apparent, creating universal safety nets may be one of the most tenable policy solutions.
David Beckworth Senior Research Fellow , Sam Hammond

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Sam Hammond is policy analyst and covers topics in poverty and welfare for the Niskanen Center. Sam joins the Macro Musings podcast to discuss his new article in the National Review which addresses Senator Elizabeth Warren’s new proposal, the Accountable Capitalism Act, and its potentially negative effects.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu

David Beckworth: Sam, welcome to the show.

Sam Hammond: Thanks for having me back.

Beckworth: It's good to have you on. Your article's title was Elizabeth Warren's Corporate Catastrophe. So, I think the title tells where you stand on her proposed legislation.

Hammond: The original title was Elizabeth Warren's Bad Idea. I told the editor that was overdetermined, people wouldn't know which bad idea.

Beckworth: So, he came up with the Corporate Catastrophe. All right, but it definitely captures the spirit of your article. We want to be fair in this podcast and present the other side, but at least listeners know where you're coming from as we get into the show. Before we do that, let's talk about the bill itself before we get into the good and the bad about it. Let me just lay out what I understand to be the bill, and you can correct me or maybe flesh it out some when I'm done. But currently, if you want to start a corporation, you need to get permission from the state government in the form of corporate charter. Critics like Matt Yglesias, and I listened to their podcast The Weeds about this legislation. But he would argue there's a race to the bottom, the state with the least requirements is going to get all the corporate charters. That happens to be Delaware, so a lot of corporations charter in Delaware.

Beckworth: So, their critique is look, it's a race to the bottom. Senator Elizabeth Warren's proposal would eliminate this race to the bottom because it would be now a federal government charter. So, it's not that radical to say because state governments do it already. However, there would be some big changes. First, it would require businesses with more than $1 billion in revenue to obtain a federal charter. Then they would be directed, the leaders of the company would be directed to consider the interest of all relevant stakeholders. So, shareholders who own the stock, customers, employees, the communities in which they operate when making a decision. So, you'd have now all these different people weighing in on decisions. You spoke to that in your piece, and we'll get to that later, some of the problems that would create.

Beckworth: To make this very concrete, they would have to have 40% of their directors on the board elected by the workforce, and another 60% from shareholders. So, you would have the workers being represented on the board. 40% is not a trivial number, it's pretty large. There are some other things that would be included as well, such as corporate executives would be required to hold onto the shares of stock for at least five years after they receive them. This would all be overseen by a new federal agency or a new part of the government, which would open in my mind a whole can of worms there, too. But is that a fair portrayal of what this proposal is trying to do?

Hammond: Yeah, that sounds about accurate.

Beckworth: Okay. Again, to put this in the best light possible before you tear it apart, Senator Elizabeth Warren had this to say about capitalism recently. She said, "I am a capitalist. I believe in markets. What I don't believe in is theft, what I don't believe in is cheating. That's where the difference is. I love what markets can do, I love what functioning economies can do. They are what makes us rich, they are what create opportunity. But only fair markets, markets with rules. Markets without rules is about the rich take it all. It's about powerful get it all, and that's what's gone wrong in America."

Beckworth: So she's saying, "Look, I'm not the far left. I'm the reasonable left who believes in capitalism, I just want to make capitalism better. I want capitalism to thrive, to survive." That's kind of the spirit I think she's trying to sell this. Of course, maybe this has to do with positioning for presidential run. Now, she generally believes in what she's proposing, right?

Hammond: Oh, absolutely. I don't disagree with that sort of broad strokes of what capitalism is. Capitalism is a system of rules. Corporations are creatures of the state, they do obtain a charter from the government. They're given certain privileges, like limited liability, that are unique protections that other corporate, or other organizational forms don't get. So, there is a prerogative. The state does have a prerogative to set the rules according to some end. My critique is that that end should be some view of efficiency, social welfare, productivity, and not necessarily this stakeholder model. Which I think has a lot of intrinsic problems with it. But in terms of that paragraph you just read from her, I don't have any iota of disagreement with it.

Beckworth: I think we all would. I think all the listeners, every hardcore capitalist out there would agree. There needs to be rules of the game. Capitalism is what makes us rich, it made the world rich, pulled us out of poverty. But she believes there's a problem that exists now with capitalism, in particular shareholder capitalism. So, let me just lay out a few of their arguments that they make and people who take her side would make, and then have you respond. Then later we'll get into more detail of your arguments.

Hammond: All right, let's go.

Beckworth: Okay, let's do it. So, the first one I already mentioned is that shareholder capitalism hasn't worked. So, the idea behind shareholder capitalism, and I think this was always there to some degree but with more emphasis in the past three or four decades, is tying performance to share prices. So, if you're an executive, your pay is in shares of the company stocks. You get extra stocks, so you have this incentive to do well, to invest wisely, to run things efficiently. Also, outside investors, there's these active hedge funds who might come in and try to discipline a corporation who doesn't behave well, misspends funds. The argument is that would lead to more innovation, new things, new products, ultimately faster economic growth.

Beckworth: Yes, there might be a little more inequality. Maybe there are some really rich people who own these shares, but the nice trade off would be we get faster, more robust economic growth. The Elizabeth Warrens of the world would say, "Hey, we didn't get that. We didn't get the robust economic growth. We've had some periods of nice growth, but we didn't get the sustained growth. So, shareholder capitalism simply hasn't worked." How do you respond to that?

Hammond: I heard Matt Yglesias make the same point. I think this goes to the problem of a lot of things happening at the same time in history.

Beckworth: Okay.

Hammond: So, a lot has happened since the late 1970s, and I don't think you can attribute economic stagnation to an op-ed that Milton Friedman wrote in the New York Times. Because Milton Friedman did write an article saying that shareholders have one responsibility, which is to maximize profit. But really, he was just echoing a kind of norm that already was pervasive prior to that. He didn't rewrite the law. So, attributing paradigm shift in capitalism to a libertarian economist making an argument doesn't quite follow. In terms of, there has been an explosion in executive compensation, which Elizabeth Warren has been a target of before in the past. That does trace its origin to a kind of revolution in how to structure compensation.

Hammond: Part of the irony there is that Warren is proposing this bill in part because of her view that shareholder capitalism is focused on the short term, quarterly profits or whatever. Whereas the trend in the last 20 years has been for using these compensation schemes to incentivize longterm behavior among managers, including rewarding employees with stock options and so on. The second point is that it's not the main driver in inequality. So, she's also a critic of... she also thinks that the shareholder model has driven inequality. She cites in her press release that record corporate profits have been leading to a declining labor share of income in the global economy, the national economy. But that's not true, that's just not true.

Hammond: As I pointed out in my piece, when you disaggregate capital income and labor income, the driver of labor shares decline has been rising rents. So, this is something that you've had other people on to discuss. But when rents increase, it eats into labor income and is counted in the statistics as capital income. We have this housing crisis across America where there's not enough being built. So, that is another thing that's happened since the 1980s, and it has been sort of a coincidence with shareholder capitalism. But I think she's barking up the wrong tree.

Beckworth: So, there's a lot of confounding developments that are hard to disentangle. So, globalization would be one.

Hammond: True, yeah.

Beckworth: Big development globally. But the supply side on housing is a big issue. We had Kevin Erdmann on recently and he talked about how some of the developments leading to the Great Recession were tied into the supply of housing, which now is a hot topic left and right. There's shortage of housing relative to the demand.

Hammond: And it's something Matt Yglesias has written about. I actually...

Beckworth: That's a good point.

Hammond: I kind of have a subtle jab in my piece because I have two citations. One to an actual rigorous study, and one to his Vox piece saying, "Blame housing on inequality."

Beckworth: Yeah, so there's these other things going on that can explain some of what we observe and what we see.

Hammond: On top of that, so Scott Sonner has a few posts from way back looking at the comparative performance of the United States to other countries, particularly European countries. Yes, there has been a general stagnation across the globe for reasons that people like Tyler Cowen have written about, the secular decline of productivity growth. But relative to the rest of the world, the U.S. has performed better.

Beckworth: Yes, on a relative basis, maybe shareholder capitalism has worked well. It has done things, but yeah, I liked Tyler Cowen argument when I read his book, the most recent one where he talks about this. The basic argument is, as we become wealthier, as we become successful, we become more risk averse. That's the key takeaway I get from it, and it affects all these different areas of our lives. So, it's kind of a natural byproduct of our success and we're wrestling with that.

Hammond: There's just a truism that when productivity slows down, people feel dissatisfied, right? It doesn't feel like the pie is growing and they look for scapegoats. One of the things I say in my piece is that when you have a populist politician using the general malaise of society to call out her favorite scapegoat. That's essentially populism, is most Trumpian. In Trump's case, it's immigrants or foreigners, and in this case it's the mega corporations. When really, there are red herrings in both cases.

Beckworth: So, what we need them to solve all our problems is more rapid productivity growth.

Hammond: I think it would solve a lot of things.

Beckworth: Yeah, we can all hope for that. Okay, so that kind of is the first critique, shareholder capitalism hasn't worked. Related to that I guess, maybe we've kind of touched on this, is the growing market concentration. That seems to be a big topic in the past few years. How do we think about that?

Hammond: So, I think that in my piece, I cite the book Big Is Beautiful by Michael Lind and Robert Atkinson. They have a whole chapter kind of debunking the notion of industry concentration as a major trend.

Beckworth: I highly recommend that book to our listeners. We'll put a link to it on the webpage, but go ahead Sam. Talk about what it says.

Hammond: Part of one way of seeing Warren's bill within a kind of common thread of things that she's been focused on is a kind of anti-bigness. It ties in with her sort of anti-trust revival, her going after corporate malfeasance, the biggest corporations. When you break down the stats industry by industry, there have been some industries that have consolidated, so for instance, manufacturing. But is that because of anti-competitive behavior, or is it because of trade relations with China leading to greater competition at the bottom end? So, one of the standard predictions of trade theory is that when you open up markets, the competition will lead to some level of efficient consolidation. Because the global market is a bigger playing field and the smaller fries that can compete domestically will no longer be able to compete.

Hammond: So, we have seen consolidation in areas like that. In other areas, we've seen deconsolidation. So, my critique of the structure of this bill, because it kicks in at billion dollar revenue companies, is it's very clearly going after bigness. And not really discerning the things that she cares about, so she says that she cares about wages or short term behavior or monopsony power, stuff like that. But the biggest firms in the country pay their workers more, they are responsible for two thirds of employment growth. They're responsible for almost half of R&D investment, so these aren't the targets. If you care about productivity growth in particular, it shouldn't be the targets because those are the ones driving productivity growth.

Beckworth: Yeah, it was really interesting to read their work. It really touches on a myth if you can call it that, in America that small business is where it's at, right? We need small businesses because they create the jobs. But as you just mentioned and articulated in the book and in a related article in The Atlantic, big businesses are the ones that create the most net jobs, right? They're the ones, look at job creation and destruction, they're creating more jobs. Overall, working conditions are better in these bigger corporations. They get more time off, more benefits, more stability relative to if you think about a small mom and pop store, apparently there's more turnover, more churn. The survivability is less.

Hammond: There's also worse compliance. So, she talks about theft and fraud. The end runs of the world notwithstanding, large corporations invest much more in compliance. They don't run a cash economy as many mom and pop stores do, and are in many ways better corporate citizens. That's not going to win you an election to say that.

Beckworth: Right, right. The other big thing though, going back to the productivity point, is they do most of the R&D, the big corporations. For better or for worse, they're in a position to do it. I think of the patent troll issue we see. It shouldn't be, but it's hard for smaller businesses to innovate when they have to pay huge legal fees against patent trolls and other hurdles. I think a valid critique of big business, and you've made this and your colleagues at the Niskanen Center made this, is that there is this incentive for big businesses to embrace regulations.

Hammond: Yeah.

Beckworth: That maybe empower them and keep out small. I think that's legitimate, but that's not what she's addressing in this bill necessarily is it? Or may it?

Hammond: In the past, Elizabeth Warren has, one of her quotes is, "Complexity is a subsidy." Which is something my colleagues at the Niskanen Center 100% agree with.

Beckworth: Okay, so she would agree with you on that point.

Hammond: Yeah, my point is that this is adding complexity.

Beckworth: Unnecessary complexity. But the R&D, yeah, so it's a really, really neat book. We have this myth that small businesses is where it's at, there's innovation there. But the innovation, better working conditions, they all relate to bigger businesses. They make a point about some of the concentration measures aren't so clear. One example they give and one that comes to mind for probably many people is retail.

Hammond: Right.

Beckworth: Because they see retail. One of the demons out there is supposedly Amazon, and it's true. I mean, you hear Toys R Us has gone under or Best Buy. I'll have to go window shopping at Best Buy, look at all the neat latest toys out there. My kids like to go with me too, they like to look as well. But then we go online and buy it on Amazon, maybe it's a little bit cheaper. So, you get this impression that Amazon is taking over the world, right? It's demonized, but they mention in the article that the largest retailers out there actually control a small part of the overall retail market. That includes Walmart, in fact, Amazon isn't on the top five lift of retailers. I think they said it's number seven in terms of the market share. But Walmart, Kroger's, they have a big list here. But there's a number of retailers that are bigger.

Hammond: Oh yeah, totally.

Beckworth: Much bigger than Amazon. So, we pay a lot of attention to Amazon, and it may have some of these effects. But there are other retailers that are bigger, and even the bigger ones are not taking up 90% of the market.

Hammond: Yeah. I mean, that's absolutely right. One of the things I find most striking with the American economy contrasting with the European economy is that European economies are capitalistic. They are innovative in their own way, but the striking feature that the American economy is for the ability of a firm like Amazon to, within two decades, go from a small online book retailer to the second largest employer in the United States. Employed in warehouses and now they own Whole Foods, so it's that incredible rise. One of the things, when you look across the ocean, is European countries have much less churn at the top.

Hammond: So, one of the most surprising stats that I read in recent days has been that of the top 100 companies by market cap, 40% of American companies are less than 40 years old. Whereas in Sweden, Denmark, and Germany, only 7% of their top 100 market cap companies are under 40 years old. So, they're dominated by large legacy firms. In the case of Germany, we know a name like Volkswagen.

Beckworth: Yeah.

Hammond: They do have some startup stories, but their startups tend to hit a ceiling it seems. They don't have the ability that American firms do to go from small, innovative fringe firm to a new dominant firm. Part of the resistance to fetishizing the small over the big is that startups aren't good in and of themselves. Startups are good to the extent that they're able to scale, right? Innovation follows this lifecycle where, sometimes called the S curve, where early in innovation you have a lot of small competitors. But then a few dominant ones, the most productive ones, end up scaling up rapidly. So, in the early 1900s, there will over 100 automobile startups. By the end of the 20th century, there were the big three automakers.

Hammond: Innovation tends to run through this cycle. What you kind of see in European economies, which is kind of disconcerting, is the bigger firms seemed to have calcified. There isn't that churn at the top, and os I lay some of that blame on corporate governance. It's much harder in European markets due to the shallowness of the capital markets, and because of worker representation on boards and so on, to do the kind of restructurings and to do the kind of, sort of visionary kind of things that end up displacing the giants at the top.

Beckworth: So, a Steve Jobs couldn't come along and change the industry. We'll come to that, but you mentioned VW, Volkswagen, there's other German firms. But what you're saying is that most of the big corporations over there have been there a long time and they don't change quickly. You mentioned VW and the workers who sit on the board or they help shape policy in corporations. So, this term codetermination comes up, and I want to tell a story about, or this was at least attempted, tried in the United States. It didn't go over so well. Maybe you can speak to it and in general speak to what codetermination is.

Beckworth: VW established a plant in Chattanooga and I have a lot of connections to Chattanooga. Family, my wife is from Chattanooga, so it was a big deal. When this plant came, people were excited. Politicians were thrilled, but then VW, operating under the German model, they tried to unionize it. Politicians about flipped out there in Tennessee, because this is Tennessee. This is the south, unions aren't very well liked down there. So, they were shocked to see VW do this, but this is something that's common to capitalism in Germany, to plants in Germany.

Beckworth: What's interesting is they took a vote and it wasn't... the union didn't win. It was not able to represent there, although there was a smaller part of the workforce, I believe the machinists or some of the technical folks on the floor who operate the machines and stuff. They got a union, and now VW is actually going to court, going to legal battles with this small micro-union within that Chattanooga plant. They want the whole plant unionized, not just one piece of the plant unionized. So, it's an interesting story that's still ongoing.

Beckworth: But what was striking, I guess the bigger point is that the Germans, for them it was normal to have the unions involved with the management of the plant. This goes back to the idea of codetermination, which we see in Germany. So, explain to our listeners, what is codetermination and why would it present problems here in the U.S.? This gets to one of your big critiques about maybe death by committee type arguments.

Hammond: Right. So, codetermination just means worker representation on the board of directors of a corporation. In Germany, I think it's over 2000 employees. If you have over 2000 employees, you're supposed to have 40% of your board appointed our elected by employees. It's actually not 100% enforced, so when I looked into this, nearly half of German companies that fit that definition aren't under codetermination.

Beckworth: Okay.

Hammond: Partly because it has to be forced by employees. So, if employees don't really care, it doesn't really get enforced. There's other ways around it, so when I looked across other countries that have codetermination like Denmark or Sweden, there's a lot of games going on with incorporating in Luxembourg or sheltering your companies in multiple different nonprofits and stuff like that to avoid.

Beckworth: Interesting.

Hammond: Partly because it goes to this point that, yeah, having owners of the firm having some direct control over what the firm does is incredibly valuable to owners and incredibly incentive compatible with their goals. So, the alternative version of this is codetermination, which says in the words that Warren chose that there are multiple stakeholders. There's the community, there's employers, and that they should have a representation in firm decision making.

Hammond: Now, part of the problem here is that there are many worker controlled firms. There's nothing stopping somebody from creating a worker's cooperative or a producer's cooperative. There are many ways to structure a firm. The reason corporations are dominant goes to this theory put out there by Henry Hansmann, who is a famous business ethicists, where he pointed out that in the shareholder model, ownership tends to flow towards the lowest cost owner.

Hammond: His insight was that the homogeneity of interests is relevant to the contractual cost of ownership. For instance, there's many dairy producer co-ops. A dairy producer co-op is a firm that's run by the producers, it's run by the dairy farms, and they sell their milk to the firm at a below market price. Because in the end they get a profit share, right? But part of what makes that viable is the relative homogeneity, pardon the pun, of milk.

Beckworth: Right.

Hammond: The more complex a firm gets, the harder it is to structure around that model. Because then how do you defy the profit share, right? In some ways capital, financial capital, is sort of at the limit of homogeneity. It's money, money can be divided up, it's totally fine to be used on anything. So, the Hansmann argument is that we should be looking at corporations as no different than the producer co-op or the lender's co-op or the worker's co-op. The difference is that they're a lender co-op. They're lending the firm money at potentially zero interest, and what they get in return is both an ownership stake and a profit share.

Hammond: So, it has the exact same structure, but that comes with costs, right? If you own your condominium, you have certain risks that you don't have when you rent, right? Part of the way owners are compensated is through electing a board of directors. So, out the gate, I think it's based on a faulty model. It's based on this idea of well, why should employees have corporate representation? They are choosing to have a contractual relationship with the firm rather than ownership relationship with the firm.

Hammond: The second point is that stakeholder theory kind of breaks down when you realize just the multiplicity of stakeholders. Why employees, why not suppliers? Why not customers, or why not any other sort of way you can divide the pie? Employees are kind of picked arbitrarily. When you start dividing loyalties, you both dilute the formal control of the corporation. You dilute its mission. Ironically, you make it less accountable. So, her bill is called the Accountable Capitalism Act, but one of the virtues of the shareholder model is you have a very clear directive. Maximize profits within the bounds of the law and within the bounds of market efficiency. You don't want to exploit market imperfections, that should also not be something you do, like pollute.

Hammond: But within those bounds, we give firms the permission to maximize profits because it leads to an efficient market outcome. It leads to market clearing prices, it leads to investment and growth. When firms deviate from that, like when they pour oil into rivers or they defraud their customers or they lie about their balance sheet, we have a very clear line of accountability and a very clear criteria for judging that. As soon as you start dividing loyalties, it both becomes hard to know what a firm should be doing and hard to know who to blame when things screw up.

Beckworth: So, if I can summarize your two points there, one is corporations have kind of organically emerged out of a voluntary basis because it's the least costly way to organize economic activity in a very focused manner. The second point is, I call it death by committee, that you get too many people on the committee. Too many different interests, nothing gets done, nothing gets accomplished.

Hammond: Right. So, one of my, if I can throw a bone to codetermintaion, it's that there's one view of it which is we need to stack the board with stakeholders. I reject that view. I think it's based on a mistaken view of business ethics. But there are other alternative ways of looking at it. So, if there are market failures, if there are persistent market failures, that's a totally justified way for corporate law to structure to account for market failure.

Hammond: So, Elizabeth Warren is big on the issue of monopsony, that there are these one industry towns that basically reduce wages for their workers because they have no other firms to compete with. If that were the criteria of codetermination, if your firm of your establishment was in a single commuting zone and didn't have any competing firms and had demonstrably, you could demonstrate monopsony in the same way you demonstrate markup, sort of the inverse of that. Then that could be a... you could point to the market failure theory and say, "There's a market failure here. There's a lack of competition that's not leading to the optimal market clearing price for wages." So, codetermination could be part of anti-trust enforcement on those particular establishments. Instead, she's chosen to use codetermination to target the country's biggest firms in a kind of blunderbuss manner that has nothing to do with whether they're the only employer in a small town.

Beckworth: Yeah.

Hammond: So, I don't see any, as a public policy guy, I don't see any public policy rationale. A public policy rationale means, what market failure is it solving? Or is it just based on having a different ethical theory of how corporations should behave?

Beckworth: Okay. Sam, on a related note, I read a study from the Roosevelt Institute written by Marshall Steinbaum, Ioana Marinescu, Jose Azar, and a new author they added, Bledi Taska if I said the name correctly, where they look at monopsony. They look at the study of labor market concentration and they look at online listings of job vacancies. They find that there is market power. This monopsony going on, and they have this real colorful map. It was real interesting looking at it.

Beckworth: When I got to the findings though, it's kind of surprising given all the lead up to it. It's kind of a bit of a let down to be quite frank with you. What they found was that 70% of workers are in highly concentrated markets. If you look at the map, they have a real neat map. It's color coded by kind of ZIP codes or counties, and what you find is where all of the market concentration is located is in rural areas. If you look at the urban areas, there's very little. So, that's 17%. Graphically, it looks huge. There's a lot of market concentration, that's because most people live on the coast around cities. There's a big open space kind of in the middle. So, the study quite frankly was surprising. How does this tie into what we've been talking about?

Hammond: So, if the issue is monopsony power, which she could construe as a real market failure because there's not competitors in the area, there's a case I could make for codetermination in that context. But I think it conflates a couple issues. So, for starters, it doesn't explain the time trend. So, the study that you're citing looks at a cross section of the United States and finds all these rural areas that are essentially one company towns. And then conflates it with the issue of wage stagnation over time or declining labor share of income over time. Where actually if you take them literally if not seriously, urbanization is acting against them.

Beckworth: That's a good point.

Hammond: Because urbanization is pulling employees and pulling workers from the rural area, where there is much less firm competition, into metropolitan areas where there's a lot of competition for the same set of skills. The second problem with conflating the two issues is often when you read these papers or the blog posts about them they'll say, "Look, there's all this industry concentration. At the same time, nationwide consolidation is going up because there's fewer startups or because there's mergers in acquisitions."

Hammond: But that again is conflating two things. What they're looking at for market concentration and market power are things like one industry towns, not mega firms becoming bigger. When you look at firm by firm size, the largest firms in the economy, firms of over 500 employees, pay about 56% wage premium compared to firms with fewer than 100 employees. Not only that, but within those larger firms, everyone makes more money compared to the smaller firm. Clerical workers, administrative workers, they make more than their counterparts in small firms.

Hammond: So, there's a kind of two step that goes on where people will cite, oh, there's monopsony power in all these rural areas because of industry concentration. Then take that term, industry concentration, and then jump to a new context that has nothing to do with the geographical issues that explain the first issue.

Beckworth: All right, so we need to be careful interpreting these studies. Okay, we had Jesse Eisinger on the show a wild back. One of the... he had a book that talked about how many of the big financial firms were not prosecuted, no executives went to jail. And it was a focus on the financial crisis and financial firms, but the general point of this book is that some of these big corporations have gotten away more and more with just settlements with the government as opposed to punishments and signals for better behavior.

Beckworth: I know Elizabeth Warren probably thinks about that a lot. Your response would be codetermination is not the right solution to a problem. That's a real problem, yes, but there are better ways to deal with it. Is that what you would say?

Hammond: Yeah, 100%.

Beckworth: Okay.

Hammond: So, I'm with Elizabeth Warren when she talks about the need for oversight of big corporations. One term she uses is that there needs to be a referee, right? There needs to be someone calling balls and strikes, and when you lose that then yeah, fraud happens. Like the Wells Fargo case, where they're just inventing customers, right? That's not... that has nothing to do with soaking employees or something like that. In fact, one of the issues with codetermination is it can, in theory if not in practice, lead to behavior like labor hoarding. It can lead to all the same malpractice because employees have their own pecuniary interests.

Beckworth: Right.

Hammond: That come at the expense of social welfare. So, I see no particular reason why stacking a board with employees would make it more responsible to the ultimate directive, which is welfare of all society.

Beckworth: Okay, so going back to where this conversation started on this particular point, just because they do it in Germany does not mean that codetermination is going to work in the U.S. There's a lot of reasons to believe it wouldn't carry over at all.

Hammond: Yeah, and on that specific point, Germany, Denmark, Sweden, these companies have determination because they have a long history of voluntary labor associations, collective bargaining. In Germany's case, it tends to be sort of integrated with their entire educational system, right? So, the apprenticeship system is regulated by these industry associations that give out the credentials. They're tied directly in with the firms, the manufacturing companies they'll end up hiring. So, it's an entire cohesive system.

Hammond: In Denmark, they have a long history of voluntary labor associations. Codetermination, when it became statutory in Denmark, it was really just codifying existing arrangements and sort of leveling the playing field. One of the fallacies of the Warren bill is that it's taking... it's trying to copy and paste a kind of superficial outcome, a superficial policy that exists at the surface level of German or Danish society, and trying to superimpose it in the United States. Which as you point out in Chattanooga, we don't have these underlying...

Beckworth: Social norms that would support it, right?

Hammond: You don't have the underlying social norms, you don't have the underlying labor organization. I'm fully in favor of stronger collective bargaining, right? Maybe down the road that would lead to more worker representation from a bottom up manner. But what's most disconcerting is how top down this is, and how stark of a discontinuity it is from a precedent.

Beckworth: Okay, so we've touched on the arguments one can make for it and you've pushed back. You've touched on some of the reasons you've written about in your National Review piece, but you also have another critique and it's a great story, a great counter-factual critique I guess, if we could call it that. You tell a story about Steve Jobs, so tell us that interesting story, what might've been had this been in place back when he was around.

Hammond: Yeah, so Steve Jobs is a bit of the cliched example, but it's still probably...

Beckworth: It's a good one.

Hammond: It's one everyone knows too, so it's useful. But in 1996, Apple was... people were predicting its bankruptcy. Steve Jobs, who had previously left Apple, came back at the behest of the owners. One of his first acts was to force the resignation of the entire, most of the board of directors. He ended up appointing close friends. With that sort of consolidation of power, proceeded to lay off about 3000 employees. He ended a series of product lines, sort of focused Apple on a couple key products, which ended up becoming Macintosh and iPhone and the iPod and everything that came after that, and focus on those core competencies. It took Apple from a failing company to this year, it's officially the United States' first trillion dollar company by market cap. So, that's an epic turnaround.

Beckworth: Right.

Hammond: Could he have done that with constant stakeholder management and worker negotiation? I tend to think not.

Beckworth: Right, I think that's a reasonable interpretation of the counter of actual history, that would be a very different story. Basically, we need a little cowboy capitalism once in a while to shake things up and move things in different directions.

Hammond: And this is part of my deeper sort of ethical critique of the Warren bill, is you have to have a theory of capitalism. Why do we have a system that has this adversarial... it's kind of yucky. A lot of people don't like capitalism because competition feels gross, and it feels like these predatory corporate dudes that are undercutting each other. But the moral status of profit is based on the fact that the pursuit of profit and undercutting your competitor and investing in the better mousetrap to beat your competitor, is based on the social outcome of lower prices, better quality products, market clearing prices.

Hammond: So, it's the competition. In a sense, business ethics has to account for the fact that we specifically carve out the capitalist economy as a sphere for acceptable adversarial behavior. In fact, when you're not being adversarial enough, it becomes implicitly collusion or tacit collusion and we sanction that. So, I see a lot of category errors being made where we're trying to apply the norms of, me and you are not in a direct competition across the table. I'm not trying to undercut you.

Beckworth: Right.

Hammond: Because we're in a friendly conversation. But if we were... if you were Apple and I was Samsung, if we weren't competing, that would actually be a violation of the norms.

Beckworth: Right. From one of my critiques of this proposal, and I think it's related to what you just said, is that it would if anything create more, potentially more collusion, less competition in the two following ways. One, it would in some ways empower big corporations because there would be these huge new compliance costs. Who can meet big expensive compliance costs? Well, the big corporations. So, it might prevent firms from being able to grow and becoming... it might create a barrier. You often see this if there's a new regulation that comes out. Usually it's the bigger corporations that embrace it because they know in the long run, it might serve to their benefit and keep out competition. So, that would be a concern I have. The other one though is just creating this new federal government agency that would issue the charters. To me, that would be rife with revolving doors and all kinds of...

Hammond: Right.

Beckworth: Potentially corrupting influences that we see already occurring.

Hammond: So, one of the disconcerting things for me about her bill is that it has a kind of vague language that a corporation that has this charter has to act in the interest of the community and multiple stakeholders. So, how is that enforced? Is that enforced through legal action? Can someone sue Apple because they're not maximally looking out for Seattle or wherever they're based? That's going to open up a lot of legal headaches. When you think about how having the option to choose what state you can be chartered in, and the principle behind general incorporation. In the early 1800s and prior, incorporation was relatively discretionary.

Hammond: The movement to general incorporation where anyone can apply for incorporation if you meet some basic standards, you can get your company off the ground, was a revolution. Not simply because it opened up this new institutional form, but because it enabled a relative rule of law where you didn't have the king or the president having discretion over what companies could be opened or closed. This bill provides an avenue for the Department of Commerce to remove a charter for a major corporation if they're not acting according to a vague standard, which any president could easily construe a rationale for acting on.

Beckworth: So, for example, if this bill were law and President Trump were still in office, and Harley Davidson had ticked him off because they were moving a plant overseas, he could be a stakeholder.

Hammond: Right.

Beckworth: And maybe in his mind pull the charter, right?

Hammond: Yeah, they're screwing the American worker. Maybe some company had a big layoff because it was the efficient way to restructure the company. But that didn't represent the stakeholders of those employees, who are now on employment insurance. Sorry, you lost your charter.

Beckworth: Right, right. Just again to speak to this issue, which I think is underappreciated, is that even now, the Commerce Department, they're weighing all these exemptions to tariffs. So, all these companies who maybe... because a lot of our tariffs are on intermediate goods. So, if you're producing nails and you have aluminum or steel or whatever it is, there's a lot of raw materials that come in and then produce into final goods in the U.S. It's really hurting some businesses, and so the government said, "Okay, you can apply for an exemption."

Beckworth: There are literally thousands of exemptions out there, and who's making the decision? Who gets a yes, who gets a no? That just opens the door for lobbying, for crony capitalism. It just seems like a dangerous place to go. Now, I want to go back to the point you mentioned earlier. The point of capitalism is to have this adversarial kind of space which leads to these efficient outcomes. Some listener might say, "Man, Sam, you have no heart. You're just this... you believe in just pure, unfettered capitalism," within the rules of course. But I want our listeners to know, if you go back and listen to the previous episode, because Sam has a very fascinating paper where he actually argues for a better run social safety net, right?

Hammond: Mm-hmm (affirmative).

Beckworth: So, maybe you can speak to that real quick just so they can see that other side of you on the show as well.

Hammond: So, one of my phrases is that the firm is an optimal unit of production, not an optimal unit of social insurance, right?

Beckworth: Okay.

Hammond: One of the revolutions of the 20th century is the move towards more universal systems of social protection, partly because it remains agnostic to firm structure. So, the old system of guilds where the family or the kin or the guild system was simultaneously your employer and your safety net was incredibly sclerotic. Because you couldn't, if industrial production changed, the winds shift, you can't shut down that firm without also shutting down your healthcare or your family benefits, whatever. So, part of I think the trade off, and I think a justifiable trade off, is to have this sort of unfettered capitalist system. It really does require more universal safety nets. In part because when you lack those things, you end up diverting energy towards, let's force firms to pay a higher minimum wage. Or let's force firms to... let's mandate certain benefits at the firm level. Let's have employee provided healthcare. All these things end up leading to less efficient outcomes, so...

Beckworth: Yeah, I like that. So, firms are the optimal place for production, but not the optimal place for social safety net provision. So, this great article, and go back and listen to the episode. But it's a real interesting article, and you mentioned how historically the emergence of social insurance occurs alongside the Industrial Revolution in different stages, in different levels of progression. But that's what you see historically, and the U.S. just happens to be one of the outliers in terms of these paths going together.

Beckworth: Okay, going back to Senator Warren's proposal with the time we have left, this observation I had about the bill is it seemed to set points for the cutoff that might be viewed as arbitrary.

Hammond: Sure.

Beckworth: Why billion? Why 40%? To me, those numbers aren't necessarily magical, is that right?

Hammond: Yeah, I think these were just chosen as round numbers.

Beckworth: It's not some universal constant or anything? Okay, so another observation about this proposed legislation came from Aaron Klein at Brookings. He looked at it and I don't want to say he said it's a nothing burger, but he wasn't sure it would make that much difference anyways potentially. His comment was, "Well, how important are boards now anyways? Would it really make that much difference?" You mentioned earlier in Europe, some of these organizations find ways around it.

Hammond: Yeah.

Beckworth: They circumvent the rules, they charter over in Luxembourg or something. So, he wasn't sure. One of his critiques is he wasn't sure that it would really change that much. If you do think there's a problem, it wouldn't change that much anyways. But do you think this bill would fundamentally change and impose huge costs? Do you see it as, or...

Hammond: Yeah, I do.

Beckworth: Okay.

Hammond: I infer that from firm behavior. So, if these things were costless, firms wouldn't try so hard to avoid them.

Beckworth: Okay, good point. So, what we observe... yeah.

Hammond: For instance, in Sweden, Sweden has one of the weaker codetermination laws where the firms that are eligible have to have a fixed number of board members appointed. So, it tends to be about two, but there's no cap on the board size. There's a great study that looks at this and finds that in response, Swedish board sizes have grown. Compared to Finland, which doesn't have codetermination or Denmark or Germany, Swedish boards are a few members larger.

Beckworth: Interesting.

Hammond: Right, so they maintain a veto proof majority. So, the member, the worker representative, tends to just be a kind of information conduit for workers.

Beckworth: Okay. The voice is heard, but it doesn't have an overriding vote on the board.

Hammond: Right. One of the studies that Matt Yglesias cited does this sort of cross sectional look at market valuations and the strength of codetermination laws. Just doing a kind of naïve imputation of what American market valuations would do if we adopted German style codetermination laws suggests that the total market capital stock market would fall about 25%. So, that's not insignificant.

Beckworth: Yeah, that's not trivial. So, you have a great line here in your paper where you mention this fact. Again, this is like you're inferring behavior from what organizations are doing. You put, "Forget if you like your doctor you can keep your doctor." Which is what President Obama said before Obamacare, right? So, it's kind of a funny liner. So, "Forget if you like your doctor, you can keep your doctor. Warren's plan will have you asking if you can keep your retirement savings. As Matthew Yglesias notes in his piece, codetermination could cause average share prices to plummet by as much as 25%. But don't worry, says Matt Yglesias. Quote, 'Cheaper stock would be offset by higher pay and more rights at work.' Maybe, or maybe after the dust settles we will find ourselves in a new lower equilibrium. One with less inequality perhaps, but even lower productivity as America's corporate unicorns are converted into glitter glue." Very graphic, but that's, I mean, the ultimate concern here. Our real solution is faster productivity growth, and this could possibly actually further undermine that attempt to revive it, right? It could actually pull us back.

Hammond: Yeah, absolutely. In every era, most innovative productive firms have been at the frontier of both size and employment growth. It's true today, so the main drivers of innovation for the world over is Silicon Valley, is New York, the Boston area, where they're producing these firms that become mega firms because of how successful they are. It's a real problem in Europe. I was over in Berlin in February talking with representatives from the government, and their failure to really make a dent in the tech economy is a strong, ongoing concern. They haven't quite figured it out. It might have something to do with codetermination and the shallowness of their capital markets, which is directly tied into this lower valuation issue. So, the U.S. is kind of creating a public good for the rest of the world by having a more cutthroat capitalist system.

Beckworth: Interesting, so the world is free riding off our R&D, our innovations.

Hammond: Oh yeah, totally.

Beckworth: Okay.

Hammond: I think that's hard to dispute. Even the innovations that have sort of transferred to Europe originate here.

Beckworth: So, do they have anywhere else in the world that kind of... is there a Silicon Valley equivalent other places in the world, or is Silicon Valley truly only Silicon Valley?

Hammond: The number two is China.

Beckworth: Okay.

Hammond: So, in terms of tech unicorns, the United States accounts for about half. I'd say like 30% to 40% of the remainder is China, and that's partly because China also has absolutely no qualms about scale.

Beckworth: That's right.

Hammond: Say what you will about the government, say what you will about whether they're playing fair on the international stage. A company like Alibaba is a global competitor to Amazon in many ways, same with their social networks. It's because they've allowed these companies to grow.

Beckworth: Yeah. So, Tyler Cowen and his book The Complacent Class we were talking about earlier, his argument is if anything we have a chance of falling behind and losing out because China does embrace bigness, it does embrace change. He mentioned, I don't know if it's in his book or somewhere else, how we could never build the Hoover Dam again. We're too risk averse now, that's one example of this complacency. Everything has to be safe, protected. But Silicon Valley still kind of stands out as an exception to that.

Hammond: Right.

Beckworth: For complacency. It's something that we should be happy to have and want to promote. What you're saying is, China is another place that has it. I his book, I think it's his last chapter or so in there, he mentions, where do you see a place where we don't see complacency? He mentions China. Yes, it comes at a cost. I mean, they have some real social issues and environmental issues over there, but they are rapidly transforming and allowing these big businesses to emerge.

Hammond: Right. So, in the '50s, John Kenneth Galbraith said that the mega corporations of that era, he called it the planning sector. Because these were the companies that were investing in R&D, were doing complex coordinate investments. In many ways, China, the government, is the planning sector. China has these five year, 10 year plans. For us to compete on the level of industrial policy, I don't think the United States has the sort of state capacity if you will to do what China does in terms of direct government involvement in the market. But we do it indirectly through the permissions we give to our largest firms, to have a degree of market power, to have a degree of corporate labs. Google has enormous profits, but they also have a ton of moonshot programs, developing balloons that could provide internet to the world, stuff like that. Just crazy stuff, and that's accomplished within the private sector.

Hammond: It's accomplished partly because of bigness, and so this is one of the trade offs. If we want to do more direct industrial policy, maybe we don't need the big corporate giants. But until the government can prove itself competent, this is the way America does it.

Beckworth: Okay. With that, our time is up. Our guest today has been Sam Hammond. Sam, thanks for coming on the show.

Hammond: Thanks for having me.

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