On June 3, 2003, the Treasury Department’s James Gilleran brought a chainsaw to a photo-op. While speaking to reporters, he promised to cut up piles of paper representing regulations of the financial sector. Joining him were representatives of four other U.S. regulatory agencies in charge of overseeing finance, armed with less formidable (but still sharp) gardening shears. The message was clear: The Bush Administration was tearing down the final pieces of the New Deal regulatory wall.
In hindsight, that publicity stunt was the high point of the deregulation wave that swept over the U.S. economy beginning in the Carter years. The wave is now receding fast: In the aftermath of the collapse of the global financial system, there is a consensus on the need for greater regulation of the financial sector. But it is time as well to assess and reconsider the generation-long deregulation of industries other than finance, including transportation and telecommunications. While many progressives are studying the New Deal for ideas about how to deal with today’s crisis, most have focused on Keynesian countercyclical spending, public works, the social safety net, and what John Kenneth Galbraith called the "countervailing power" of unions and government. They have neglected, however, one of the major achievements of New Deal Democrats between World War II and the 1970s: the use of regulation deliberately to shape certain critical industries, from energy utilities to transportation to telecommunications.
In a number of industries, the New Deal replaced competitive markets with price and entry regulations, common-carrier rules, cartelized markets, and regulated monopolies. The result was a distinctively American version of industrial capitalism–call it "utility capitalism"–in which protection from both competition and antitrust permitted firms in many regulated sectors to pay high wages to unionized workers, provide universal service to rural and poor customers, and, in some cases, fund R&D on a massive scale.
For the last generation, however, the demonization of regulated monopolies and cartels of the kind that the New Deal created has united the small-is-beautiful romanticism of the liberal left with the utopianism of the libertarian right. The assault on regulation has found a powerful constituency among corporations, many of them big firms that are dominant in their fields and seek to shake off regulation. After three decades of well-funded propaganda spreading the views of champions of unregulated markets, the very idea that regulated monopolies or cartels could serve the public interest–in some cases preciselybecause they are protected, to some degree, from competition–is utter heresy.
The heretical truth is that rapid economic growth and unionization may sometimes require markets that are deliberately made less competitive by regulation. Monopolistic and oligopolistic corporations are more likely to invest in breakthrough innovation than firms struggling to break even in highly competitive markets. And cartelized industries are far friendlier to organized labor than ultra-competitive markets. If progressives really want to promote technology-driven growth and a union-based middle class, then they need to reconsider the lessons of the New Deal’s successful experiment in utility capitalism.
The Rise and Fall of American Utility Capitalism
During the first half of the twentieth century, the American center-left was divided on the subject of monopoly and oligopoly in the private sector. Early-century progressives debated whether there could be "good trusts" as well as "bad trusts." Later, New Dealers were divided among trust-busters and those who argued that large, dominant firms be regulated rather than broken up.
On assuming office in 1933, Franklin Roosevelt, like his predecessor Herbert Hoover, sought to prevent further disastrous deflation by stabilizing prices, wages, and production. The National Industrial Recovery Act (NIRA) created the National Recovery Administration, which was charged with overseeing industry-devised price codes. The NRA was declared unconstitutional by the Supreme Court in 1935 in Schechter Poultry Corporation vs. United States, and because of its cumbersome approach, its passing was not even lamented by New Dealers.
The demise of the NRA did not, however, mark the end of New Deal cartelization policies. The second wave was sector-specific; among the regulatory agencies it created was the Civil Aeronautics Board (CAB). The New Deal also gave new powers to Progressive-era agencies like the Federal Trade Commission (FTC) and the Federal Power Commission (FPC). Historian Robert Britt Horwitz writes in The Irony of Regulatory Reform, "The New Deal regulatory agencies created structures of mutual benefit–cartels–among the major interests (often including organized labor) in the industries placed under regulatory oversight. Industries and markets were saved precisely by not permitting marketplace controls to function freely." Price and entry regulations determined the range of rates that firms could charge and the number of firms in a sector. Other laws exempted oligopolies in these industries from antitrust rules. Many regulated industries also were subject to "common carrier" laws, particularly those in what Horwitz calls "infrastructure industries" like airlines, trucking, railroads, telecommunications, banking, oil, and natural gas: "They are ‘infrastructures,’ the basic services which underlie all economic activity. They are central to the circulation of capital and commerce. Historically, regulatory agencies have exercised administrative controls over infrastructure industries as part of the state’s effort to construct a national arena for commerce and to stabilize the essential services upon which commerce depends."
The fact that regulatory agencies permitted firms in regulated industries to charge above-market rates allowed elaborate systems of cross-subsidies in the public interest. For example, AT&T, during its decades as a regulated national monopoly, was able to cross-subsidize rural and poor Americans. Monopoly or oligopoly status also gave some industrial giants like AT&T both the resources and the incentive to engage in sustained and complex technological R&D, at the price of shutting out competitors.
Utility capitalism was central not only to the New Deal but also the thought of John Maynard Keynes, whose reputation is enjoying a post-crash revival. In his essay "Was Keynes a Corporatist?", James Crotty observes that "Keynes…argued that the government should not only accept the current movement toward cartels, holding companies, trade associations, pools and other forms of monopoly power, but should proactively assist and accelerate this trend." In "The End of Laissez-Faire," written in 1926, Keynes noted "the trend of joint stock institutions, when they have reached a certain age and size, to approximate to the status of the public corporations rather than that of individualistic private enterprises."
The economist Edmund Phelps, a critic of the corporatism of the Keynesian kind, concedes: "The increase in hourly productivity and of total factor productivity over both those decades [1920 to 1941] were unprecedented and have not been matched since with the possible exception of the past ten-year span"–that is, the late 1990s and early 2000s, which saw the emergence of quasi-monopolies like Microsoft and Google. The maturity of the New Deal’s system of regulated, utility capitalism coincided with the post-World War II boom and the greatest expansion of the middle class in American history.
Rolling Back the Regulatory State
By the 1960s and 1970s, however, New Deal regulation was being criticized from across the political spectrum. Libertarian economists and radical leftists shared a common understanding of New Deal-era regulation as a conspiracy by rent-seeking industries to gouge consumers. Liberal activists in the "broadcast reform movement" claimed that licensed media companies froze out progressive and minority viewpoints. Political scientists like Theodore Lowi denounced "interest-group liberalism." And populists like George Wallace showed the appeal of denouncing bureaucratic big government and regulatory red tape.
The result, in the years from Carter to Clinton, was the rapid dismantling of most of the system of governing the U.S. economy erected during Roosevelt’s four terms. The Carter Administration supported the deregulation of airlines (1978), rail (1980), and trucking (1980); the bus industry was deregulated in 1982. Telecommunications was partly deregulated in 1996; in 1999 came the Gramm-Leach-Bliley Act, repealing the separation of commercial from investment banking established by the Glass-Steagall Act of 1933. In 1981 the Reagan Administration’s Justice Department broke up AT&T, although other market-dominant firms like Microsoft, Google, and Wal-Mart have been allowed to survive.
The critics weren’t completely wrong; utility capitalism sometimes led to slow diffusion of new technologies and preserved archaic distinctions among industries. But some deregulation arguably went too far in turn. Take airline regulation. The Civil Aeronautics Act of 1938 essentially turned the U.S. airline industry into a regulated utility under the CAB. Like other regulated industries, the airline industry was exempt from antitrust laws so that airlines could set rates together. Among the enlightened regulations of the CAB were prohibitions on charging more for short flights than long ones and rate floors to prevent "fare wars." But by the 1970s, the example of independent local airlines like Southwest in Texas persuaded many analysts that airlines could not only increase routes but also combat inflation by lowering fares. The Carter Administration supported the Airline Deregulation Act of 1978, which eliminated federal controls over entry, routes, schedules, financing, and fares. In 1984, the CAB itself was abolished.
In many cases, lower prices for consumers were indeed achieved–consider today’s no-frills airlines–but at the sacrifice of other goals, like unionization, universal service, and high levels of private R&D in basic science and technology. These goals were not abandoned by Democrats, but neoliberal economists and policymakers argued that they were best pursued not by New Deal-style regulation but rather by direct government outlays to individuals, like wage subsidies and higher social insurance along with higher levels of public R&D. Unfortunately, this academic synthesis of deregulated markets with much higher public spending never prevailed in the political realm, where Congress and state and local governments dismantled New Deal-era utility capitalism without compensating those who lost universal service, union jobs, and high wages.
The Real Meaning of "Creative Destruction"
The problems with the New Deal system were genuine: capture of government agencies by the industries they regulated; corruption; and delays in using or disseminating innovative technologies that leviathans with deep pockets had developed. But New Deal regulatory policies not only created dominant firms able to finance innovation, but also made it much easier for workers in regulated industries to raise their wages and benefits by joining unions.
The first objection that confronts any defender of utility capitalism in the New Deal tradition is the claim that monopolies and cartels, regulated or otherwise, stifle invention and retard economic growth. In a culture in which the popular imagination thinks of technological progress in terms of a fable in which the David of Bill Gates slays IBM’s Goliath, it takes considerable courage to suggest that big is not necessarily bad and that small can be stupid. But when it comes to innovation, Goliaths can be nimble and Davids can be clumsy.
The economist Joseph Schumpeter is known today for a phrase–"creative destruction"–that is more often quoted than understood. Here is the original quote from Schumpeter, in 1942’s Capitalism, Socialism and Democracy: "The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation–if I may use that biological term–that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in." Note that Schumpeter’s example of technological and economic progress is the replacement of small craft shops and factories by industrial titans like U.S. Steel.
Far from celebrating small businesses as the laboratories of innovation, Schumpeter argued that a major incentive for private-sector innovation was the prospect that a business could obtain a monopoly or near-monopoly position on the basis of inventions and be assured that a stream of assured profits would repay its investment. Schumpeter believed that in modern industrial capitalism, which he called "trustified capitalism," the solitary inventor like Alexander Graham Bell or the young Thomas Edison had been replaced by the corporate laboratory like mid-century Bell Labs, which existed only because AT&T was a monopoly. Undercapitalized firms in a competitive market have no money to invest in basic R&D, and the few firms with deep pockets have little incentive to bring about technological breakthroughs that will be shared by their competitors. Schumpeter concluded that the large corporation in an imperfectly competitive market is "the most powerful engine" of economic progress: "In this respect, perfect competition is not only impossible but inferior, and has no title to being set up as a model of ideal efficiency. It is hence a mistake to base the theory of government regulation of industry on the principle that big business should be made to work as the respective industry would work in perfect competition."
Schumpeter’s argument that firm size drives innovation received powerful support in 2002, when one of America’s leading economists, William Baumol, published The Free-Market Innovation Machine. Baumol rejected the idea that economic progress is driven by the competition of firms to lower prices. Arguing that innovation has replaced price as the critical arena of competition, Baumol argued that most important innovations originate from large, oligopolistic firms, not from individual entrepreneurs or small businesses. According to Baumol, the sharing of technology among firms in imperfectly competitive markets can benefit innovation and economic growth.
Most of the major breakthroughs on which the modern technological revolution depends took place before the era of deregulation–and often in the labs of monopolistic corporations like IBM, AT&T, and Xerox. "The approach to R&D is changing because long-term research was a luxury only a monopoly could afford," The Economist observed in 2007. AT&T’s Bell Labs invented the transistor and the laser, while Xerox’s Palo Alto Research Center (PARC) devised the mouse and the graphic user interface. In today’s more competitive market, in which a few vertically integrated firms have given way to outsourced suppliers and kaleidoscopic alliances, the shrunken remnant of Bell Labs focuses on product development for France’s Alcatel-Lucent. Just as Schumpeter and Baumol predicted, corporate R&D has shifted from basic research to product development and marketing research. Many cost-conscious American companies today try to profit from technological breakthroughs in R&D carried out by the federal government, universities, and foreign research labs or foreign corporate allies. Public-sector R & D, more driven by lobbies and political fashions, has not made up for this decline.
Utility Capitalism and Unionism
Innovation is not the only reason why progressives should reconsider the poor reputation of New Deal era regulation. Regulation is good for unions, too.
Several historians argue that New Deal cartelization policies in the late 1930s were necessary for the successful unionization efforts of the mid-twentieth century. In his essay "The Other New Deal and Labor," Daniel Nelson notes that price-and-entry regulations provided regulated firms with a premium they could share with organized labor: "The result…was an upsurge in union organizing and coordinated collective bargaining." Conversely, the disastrous collapse of the union share of the U.S. workforce in the late 1970s and 1980s followed, and in large part was caused by, the deregulation of heavily unionized industries.
On the basis of a similar analysis, Michael Wachter of the University of Pennsylvania Law School predicts that unions are doomed as long as consumer sovereignty and maximum competition guides U.S. economic policies: "Unions still bargain for a fair wage, but antitrust or industrial regulation no longer provides for above-competitive prices to pay those above-market wages." He predicts that "no change in labor law or labor market policies, absent changes in overall industrial policy, will allow unions to become the mass movement they were in 1945." This is a warning that should be heeded by progressives who think that measures like the Employee Free Choice Act (EFCA) by themselves can restore a high level of unionization in the private sector.
The neoliberal alternative to New Deal-style regulated utility capitalism, based on internal subsidies and slightly higher prices for consumers, has been a progressive version of deregulated capitalism in which taxpayers will provide the equivalent of the utility model’s hidden subsidies. If New Deal liberalism preferred regulation to redistribution, Democratic neoliberalism has preferred the opposite. But the discussion is academic. There is simply no chance that the American political system will countenance transfers from the rich to the rest on the scale that the deregulate-and-subsidize school proposes.
Utility Capitalism Today
If utility capitalism in the New Deal made sense in the mid-twentieth century, what are the implications in the twenty-first? Rejecting the conventional wisdom about deregulation does not mean that we should rush to impose New Deal-style price and entry controls on all industries. However, we should ask ourselves whether there are particular sectors of the economy in which versions of utility capitalism make sense. Three immediately come to mind: the banking sector, the capital-intensive traded goods sector, and the commercial infrastructure sector.
Nowhere has post-New Deal deregulation been more discredited than in the realm of national and international finance. Banking deregulation produced first the S&L crisis and then contributed to the subprime mortgage crisis and the spread of toxic assets throughout the American and global financial system. There is growing support for a return to the kind of separation of ordinary, boring retail banking from high-octane speculation that was created by the New Deal with the Glass-Steagall Act and dismantled during the Clinton years.
In February 2009, former Federal Reserve Chairman Paul Volcker argued that "we ought to have some very large institutions…whose primary purpose is a kind of fiduciary responsibility to service consumers, individuals, businesses and governments by providing outlets for their money and by providing credit." In return for being too big to fail, a de facto cartel of a few giant commercial banks would be tightly regulated and forced to be conservative. The argument that this would reduce financial innovation is an argument in favor of regulated oligopoly, not against it. Unnecessary financial innovation is what produced the crisis. The New Dealers, like the progressives and populists before them, thought of credit as a public service. We should do the same.
Then there is the traded goods sector, dominated by heavy industries like automobile, aerospace, and energy. In most industrial nations, the traded sector tends to be dominated by one or a few state-owned enterprises or private "national champions" that are formally or informally supported by the state, like Airbus or the major Japanese car companies. National champions may be incompatible with competition in domestic markets, but because the market for manufactured goods is global, there can be vigorous competition in a state-capitalist world. It just happens to be competition among national companies.
Now that Obama is in effect the CEO of the U.S. automobile industry, he should consider whether the country needs three national champions in the car-making sector, or two, or just one. Likewise, in aerospace and energy, the federal government can use regulations, subsidies, and other policies to encourage the formation and survival of American-controlled firms that have the resources to compete with the state-supported firms of Europe and Asia, engage in innovative R&D, and take advantage of increasing returns to scale in production. The government should also consider policies to promote the "onshoring" of IT manufacturing, much of which has been outsourced by U.S. corporations, whose goal is to maximize short-term shareholder value.
Finally, there are the basic infrastructural industries on which other businesses depend, from telecommunications to transportation and power distribution. The deregulation of these industries in recent decades was supposed to lower prices, and sometimes it did. But it also produced worsening wages, benefits, and working conditions for industry employees and volatile price swings and major blackouts in deregulated electricity markets in California.
The result of airline deregulation has been a chronically sick industry. Other than Southwest, few new entrants to the market have survived the Darwinian struggle. No airline went bankrupt in the era of regulation; since deregulation, more than 160 airlines have gone out of business, including Pan Am, TWA, Braniff, and Eastern. Many cities lack service, and quality has plummeted. Compared with state-supported rivals in Europe, Asia, and the Middle East, America’s air carriers, once the envy of the world, are crowded, unpleasant, and unpredictably priced. The increase in the number of air travelers might be counted as a benefit of deregulation, but this assumes that there would not have been similar growth if the regulated system had been modified rather than abolished. In 2008, Robert Crandall, the former American Airlines chief executive, declared, "Experience has established that market forces alone cannot and will not produce a satisfactory airline industry."
Utility Capitalism in the Service Sector
Utility capitalism might be appropriate in other economic sectors as well. Three out of four Americans work in the service sector. In the first half of this decade, most job growth took place in four domestic, nontraded services: education and health, state and local government, leisure and hospitality, and finance. According to the Labor Department’s projections for 2004--2014, the top ten occupations in which there will be the greatest job growth are likewise largely nontraded domestic jobs, such as retail sales and registered nursing.
The majority of these occupations require no college degree, only a high school diploma and some on-the-job training. If America is once again to become a middle-class society, it will not be because nursing aides and janitors go to college and become software writers, nor will it be because of an exodus into a new, government-subsidized "green economy sector." America will be a middle-class nation again only when these familiar service sector jobs are themselves upgraded–when nursing aides and janitors are paid more and given benefits. That is unlikely to happen as long as these service industries contain many small, struggling firms instead of a few stable and prosperous corporations.
Can low-wage, low-productivity service-sector industries be turned into regulated utilities or cartelized? Any effort in this direction would begin with one immense advantage: These domestic service industries cannot be outsourced. Nor, for the foreseeable future, will automation eliminate the need for human labor.
The lesson of the era of New Deal regulation is that it is easier to unionize a few large, cartelized firms that can pass on costs to consumers than it is to unionize great numbers of fragile, undercapitalized firms that cannot pay higher wages without going under. And if conservatives and moderates block laws like the Employee Free Choice Act that make unionization easier, the default option for progressives will be to mandate that all employers pay benefits as well as a much higher minimum wage. The fact that such unfunded regulatory mandates would drive many small service-sector enterprises out of business might be a blessing, not a curse. After all, what is the point of celebrating job creation by small business if the jobs are awful and unstable? While small businesses play an important role in some parts of the economy, there is no reason to think that small is beautiful when it comes to decrepit, undercapitalized nursing homes, fly-by-night child care centers, and retailers that pay poverty wages.
It is true that in a second age of American utility capitalism, as in the first, the costs of providing above-market wages and sometimes other public goods like universal service and cross-subsidies would be passed on to consumers. Far from being a defect, this kind of internal cross-subsidization, hidden in prices, is more politically sustainable than highly visible after-tax redistribution. Progressives should wonder whether the cost to consumers of slightly above-market wages in regulated, monopolistic, or oligopolistic service industries would not be preferable to the cost to taxpayers of welfare subsidies and trips to the emergency room for a growing number of underpaid and uninsured workers.
The case for utility capitalism should not be mistaken for the theory of Milton Friedman, Robert Bork, and other economic thinkers of the conservative Chicago School that most monopolies and oligopolies are harmless and should be exempt from antitrust prosecution. On the contrary, the premise of utility capitalism is that regulation is needed to make monopolies and oligopolies safe for democracy.<
It is not my purpose to suggest replacing the market-knows-best theory that inspired deregulation with another simplistic one-size-fits-all model. While the government should encourage utility capitalism in some sectors, in others, like many consumer goods industries, promoting competition may be the best policy. Regulation and antitrust are complementary tools and each is appropriate in particular situations.
The prudent, partial reregulation of the economy would not produce utopia any more than deregulation did. There would be trade-offs among conflicting values. But at least policymakers would once again acknowledge that minimizing prices to consumers in the short run should be only one of the goals of economic policy, along with encouraging private technological innovation and private-sector unionization. Whether the free-market ideologues of the right like it or not, we are always going to have some form of corporatism in this country. The only question is whether it will be bail-out corporatism or utility capitalism.