A Rebirth of Economic Freedom: The De-Bureaucratization of American Business

The independent farmer (“freeholder”) was both the ideal and the overwhelming economic reality in American life until late in the nineteenth century. (After the invention of the cotton gin in 1793 much of the land of the South became large plantations worked by slaves. But Southerners were far outnumbered by Northern freeholders.) These independent farmers were the backbone of the Jeffersonian-Jacksonian “empire of liberty.” Being dependent on no one for their livelihood, as Jefferson argued, they could be counted on to assert their real interests and, thus, to maintain the republican freedoms enshrined in the Bill of Rights.

Jefferson and his successors feared that this republic could not long endure if the freeholder vanished and workers became dependent on others. The corporate concentrations of capital and employment that developed over the century, fueled largely by changes in government laws, especially the introduction of high tariffs after the 1830s, limited liability for corporations and huge land grants to the railroads, and partly by new capital-intensive technologies demanding many workers (as in steel), was a severe challenge to this entire “natural system of liberty.”

It looked to an increasing number of Americans as if the economic freedom of a few Big Businessmen was destroying the economic freedom of the many, turning them from independent freeholders into dependent wage earners, thus threatening liberty in general. While few Amer icans heeded the prophecies of people like Marx, who believed monopoly and its exploitation of workers would be the inevitable outcome of capitalism, ever more of them turned against business because of this Bigness. They turned to government and unions to protect them by con trolling Big Business.

Antibusiness Sentiment

By the early part of this century social thinkers, especially those influenced by the “institutional economists” of Germany, began to see business in general in the form of Big Corporate Bureaucratic Business. Progressives, including such diverse thinkers as the young Walter Lippmann and Herbert Hoover, called for more and more restraint on business and more and more planning by government. In the 1930s the great upsurge in anti-business sentiment triggered by the Great Depression combined with the argument of some economists that Big Business was now thoroughly bureaucratized and divorced from ownership to convince ever more people that government bureaucracies could just as well own and manage them efficiently.

Joseph Schumpeter, originally a member of the extremely free-market oriented Austrian School of Economics (of which Ludwig von Mises and Friedrich Hayek are the best known members), argued in his famous book on Capitalism, Socialism and Democracy that Big Business was successful because it minimized risks (especially those from recessions) and its success through bureaucratization was preparing the way for government bureaucracies to take them over. Big Business, then, had prepared the way for Socialism.

This kind of argument was most successful in the 1930s in Britain, Sweden, Fascist Italy, and Nazi Germany. In Britain the government started intentionally encouraging the so-called “Rationalization” of business, that is, concentration into Big Bureaucracies. In the 1940s government then started nationalizing Big Business, completing the Schumpeter scenario.

By the 1960s, and continuing up to today, our college students, including many of our graduate students of business administration being groomed for Big Business, were looking at business through the socialist-tinted spectacles of John Kenneth Galbraith, who proclaimed in The New Industrial State that Big Bureaucratic Planning was inevitable. “By all but the pathologically romantic, it is now recognized that this is not the age of the small man.” Given his personal preconceptions and wishes, and living in the first great period of corporate conglomeration of the 1960s, Galbraith failed completely to see that the Age of Big Business was already dying.

Revolution of Littleness

The “Revolution of Littleness” had already begun in business around the world, but especially in the United States. This Revolution was first clearly sighted and proclaimed in 1976 by Norman Macrae in The Economist. But its realities are still largely unnoticed. The early realities of even the most sweeping revolutions are normally unseen. Even the scientific and Industrial Revolutions were a hundred years old or more before many people began to realize that something of profound significance was happening. Our traditional preconceptions and our situationally limited views of the broader developments in society conspire to hide the newness and scope of such changes until they are so advanced that they become suddenly obvious.

Our Revolution of Littleness has gone unnoticed by most people both for these usual reasons and because our headlines and network stories paint the opposite picture. Most experts and politicians providing these stories are too versed in and rewarded for the traditional ideas about the Age of Big Business to see how rapidly the tide is now running against Bigness. So are many of our Big Businessmen, but they learn very quickly when the tide starts sweeping them away.

Mega-Mergers versus Little Realities

The great increase in mergers in the last few years has been the most misleading appearance. Businesses last year put up approximately $80 billion for mergers. Many of these were very Big Mergers indeed in which very Big Businesses bought up much smaller ones. U.S. Steel’s $6 billion take-over of Marathon Oil was the Big Headline of business news for weeks. On the surface this certainly shows Big Steel getting much bigger. But look beneath the surface. This move itself shows that, just as the United Steelworkers have claimed angrily, U.S. Steel is trying desperately to diversify away from the steel industry.

The really big story in the steel industry, as Jeff Blyskal shows in Forbes (January 4, 1982), is diversification away from steel and the rapid rise in profitability and growth of the smaller steel companies. The most efficient and rapidly growing steel producers in the U.S. (and in some other countries, like Italy) are generally small and slim-and-trim, with low debt-to-equity ratios and small, highly skilled, highly productive and non-unionized work forces. Over the last five years U.S. Steel has ranked 18th in growth and 21st in return on equity in the American steel industry. Once-huge Kaiser is quitting steel entirely. Some governments, notably Mexico, are pouring billions into huge, centralized steel mills. But these mills will almost certainly be uncompetitive White Elephants kept alive, if at all, by vast subsidies.

This might still mean that, even if steel is getting littler—decentralizing, U.S. Steel will get bigger. But that is not even the plan. U.S. Steel hopes Marathon, with its vast oil reserves, will provide 51% of its corporate sales and 83% of profits. Marathon, they hope, will make up for their overall shrinkage in steel sales. Those of us who believe the market forces unleashed by the deregulation of oil and natural gas will destroy OPEC’s monopolistic pricing suspect this merger will prove as disastrous as most mergers do.

Of course, we must be careful about generalizing from steel to our whole economy. Those still mesmerized by Bigness might insist that steel, tires, and autos are “dying” because of foreign competition, so they are symptoms of the “de-industrialization” of America. Actually, there is no “de-industrialization” going on, not even in the steel industry. There is only change, above all a shift to smaller, more specialized producers and to mills processing the vast quantities of scrap steel. Even basic steel production may eventually resume growth.

Prospects for Growth

Once inflation is wrung out of the economy and interest rates come down, the new tax incentives (decreased marginal rates, more rapid depreciation, and investment credit) will probably lead to investment in new production technologies. But this investment will very likely be in the smaller and newer firms, using much automation and small, nonunionized—thus flexible and productive—work forces. (Even without the new incentives, industries like textiles and watches went through this process in the 1960s and 1970s.)

But the skeptics have a serious point. So let’s look at the other extreme, that of the very new, high technology world of computers. Here there is indeed a giant to fixate the glare of the believers in Bigness. IBM remains huge and formidably creative, efficient and profitable. It is probably the best example one could find in the world today to support—by appearances—the nineteenth-century argument that the economies of scale (of Bigness) give the Big an inherent advantage over the little and doom a free economy to ever greater concentration.

But even IBM is partially a mirage of Bigness power. Though it ranks third in return on equity, probably because of its great backlog of successes, it ranks only ninth in growth over the last five years in the U.S. computer industry. Even in huge and very fast computers, where Bigness gives its greatest advantages because of the vast capitalization and many specialties demanded, companies like Amdahl (7th in growth) have been very successful competitors. A.T. & T., trying desperately to shed organizational fat through divestiture, may soon become a formidable competitor. And so far IBM has been badly bested in the most rapidly growing new realms of computers, such as personal computers, by total upstarts like Apple. Apple was created by two whiz-kids with a bright idea and no bureaucratic planning and budget-allocation committees.

The Big Picture of the Little Trend Is Clear

Because of the long-standing obsession with Bigness, conglomeration and the take-overs of little companics by Big ones get the headlines and airwaves. But deconglomeration and divestiture (selling off parts of a company) go unnoticed by almost everyone except investment bankers. Who noticed when Bendix sold its forest products subsidiary for $425 million? Or its holdings in Asarco for $340 million? Or Skagit? Or United Geophysical Corporation? Almost certainly not Teddy Kennedy or John Chancellor.

Partly because of this lack of concern, and even more because most decentralization (relittling) of business is not reported outside of the companies, we don’t know exactly how much is going on. But we do know a great deal about the trends.

Very importantly, the recent “mega-acquisitions” are not the result of any economies of scale that doom us to more Bigness. As economists like Dan Orr of Virginia Polytechnic Institute have long argued, the conglomeration and general growth of Big Corporations has been due very largely to our tax laws, unions and massive regulations in some segments of the economy (rail road, trucking, air lines) which have severely penalized new and small firms. One of these many incentives, the double-taxation of corporate dividends (first as corporate income and then as individual income), has been very important as an incentive for individuals to let corporations reinvest profits within the company, even when higher rates of return could be gotten elsewhere (say in money funds). This way only corporate taxes are paid until much later (perhaps after retirement). When the individual does receive the dividends or sells the stock he pays the lower tax on capita] gains. Even some of the Reagan economic renewal tax changes compound this government incentive to Bigness. Worst of all, the leaseback provision subsidizes the dying dinosaurs.

High Inflation Encourages Merger Activity

The recent surge in mergers is predominantly a result of high inflation and other investment uncertainties that make it less risky (or make it seem less risky to those who believe inflation, OPEC, and so forth, will continue) to buy already established businesses (or proven reserves) than start new ones or expand old ones. Royal Little, who as Chairman in the 1950s made Textron the first of the famous modern conglomerates, and is now part owner of a venture capital firm helping companies to deconglomerate, has noted, “This [upsurge in mergers] is one of the results of double-digit inflation, which makes it so costly today to go out and buy something new.”

But note that, in spite of these government generated incentives to Bigness, even today outright deconglomeration and divestiture are probably not too far behind the mergers in money terms. The fact is, as Peter Drucker has argued, most mergers do not make good economic sense and are far more the result of vanity than profit motives. Even with the government generated incentives, most mergers fail and are followed by outright divestitures, by partial spin-offs, by radical restructuring which decentralizes decision making, or by bankruptcy.

In an unusual study of the outcomes of mergers, Arthur Lewis (Fortune, May 3, 1982) found that the ten largest mergers among Fortune 500′s largest corporations in 1971 were overwhelmingly failures over ten years: “Most of the acquisitions produced appallingly low re turns during 1981. In three cases . . . the estimated return on investment was less than 5%. In three more cases . . . the return was between 5% and 10% . . . and none of them matched the 13.8% median return for all the companies in this year’s Fortune 500. If we go beyond the statistics and consider the paths of some of these corporate marriages, the case for conglomeration looks even bleaker . . . [Our study] strongly supports the notion that investing in unfamiliar businesses is unduly perilous—just as the critics maintain. Most of the acquirers evidently were lured into buying unstable companies, or into committing foolish mistakes that harmed stable ones. Only two mergers remained trouble-free from beginning to end of the decade.”

The trend to littleness is equally clear even in companies that are growing in the shares of their markets. The old stereotypic view of Big Business as a monolith run by rigidly centralized, top- down command the way an army is thought to be run (but actually is only by the losers) has never been true for many. The dominant form has been the General Motors model of decentralization of most decisions, with centralization only of those (such as auditing and financing) required to keep control. Contrary to some of the popular soul searching going on in the aftermath of the Japanese challenge, a high degree of decentralization and its concomitant of individual decision making has probably always been the dominant form of management in American business, but the degree has varied vastly from one segment to another and over time.

The Revolution Triumphant

This variation in decentralized decision making has probably been due mostly to differences in technology and markets. In general, the more complex and changing a technology, and the more competitive and changing a market, the more the incentives are for littleness, and, thus, the more decentralized the decision making.

American industries, faced with little European or Japanese competition, dominated their markets until the 1960s or, in some cases (like autos), the 1970s. In addition, in some industries, notably steel and autos, technology changed little. When the technology did change in steel man ufacturing, dominance in the domestic market was partially maintained by the union wage at the big firms and then by protectionism—both the result of government. These conditions combined with the government generated inducements to bigness to produce growing Bigness in some segments, especially in autos and steel.

But even in that period competition was so great and technological development so rapid that in general there was no increase in concentration in our overall industry (regardless of the conglomeration headlines and the pronouncements of anti-business ideologues). At the same time autos and some other segments got more concentrated, the more technical and competitive segments, like electronics and cameras, fragmented—littleness was rampant. And within companies like IBM and Polaroid the growing proportion of technical specialists were increasingly free to create their own jobs and work in small teams—and were thus more efficient at creating new products and keeping down costs.

Today, even with those government generated incentives, all really Big corporations are severely threatened by the more slim- and-trim ones, especially the new ones. Even General Motors, which a few years ago seemed a secure Goliath, is severely threatened by the much smaller, highly decentralized and automated automakers of Japan—approximately ten of them, not one. Without the government’s “orderly trade agreements” with Japan, who would bet on this Goliath surviving David’s onslaught?

Meeting the Challenge

The Big Businesses that are meeting the challenge are doing so by systematic decentralization, partial spin-offs, and sub-contracting to small teams both within and outside the company. One of the most efficient and rapidly growing companies, 3M, continually decentralizes even its manufacturing plants (to keep employees down to a few hundred at each plant) and increases its incentives for individual initiative and creativity. Gordon Engdahl, 3M’s vice president for human resources, summed up their view for The Wall Street Journal (Feb. 5, 1982): “We are keenly aware of the disadvantages of large size. We make a conscious effort to keep our units as small as possible because we think it helps keep them flexible and vital. When one gets too large we break it apart. We like to say that our success in recent years is due to multiplication by division.”

In his study of Digital Equipment (Fortune, May 3, 1982), Geoffrey Colvin noted the general principle of diminishing returns—and eventual death—from growing size: “In business, as in nature, there seems to be a law that things slow down as they grow toward the elephantine.” How has Digital maintained its dazzling growth rate this long? First, note that it’s still only 137th on the list of 500, is still reasonably young and a pioneer in the most rapidly growing major segment of the world economy. Beyond those factors, the systematic pursuit of littleness—decentralized decision making—is crucial. They’ve never acquired any company. The corporation is broken down into 18 largely autonomous units. Says security analyst Stephen Dube with Dean Witter Reynolds, “It’s not one big business—it’s 18 small ones.” The heart of any high technology firm is its engineers. Digital keeps them efficient and creative by decentralizing its 5000 into quality teams of about 30, by avoiding almost all bureaucratic rules and forms, and by keeping them in direct contact with the equipment in use and with customers.

Sub-contracting to outsiders is not only the now-famous “secret” of much of the success of Japanese auto makers, but is also growing rapidly in businesses around the world. Much of the programming for computers, especially the new personal ones, is being created by Lone Ranger entrepreneurs in their home studies, and then marketed by the computer firms or retail outlets. Even once arrogant IBM has moved more to use these outsiders and make its products compatible with those of other firms. Today almost all office work could be done at home—or anywhere in the world where a computer console can be plugged into the Worldwide Electronic Net—and thus sub-contracted out to the most efficient.

The Electronic Revolution

The Electronic Revolution is now rapidly transforming business in all economically advanced societies, and most rapidly in the United States. Computers wed to robots are rapidly making it possible for mini-factories to efficiently manufacture products with far greater flexibility than has been possible, thus allowing a far greater variety in the end products. It is also more efficient now for companies that once needed to be centralized because of their specialized products to decentralize. The Electronic Revolution makes decentralization even more efficient and this will quickly eliminate our ancient bureaucratic dinosaurs. This is one major reason why companies have been moving from more expensive cities like New York to less expensive smaller ones, especially in the South and West, and even to non-urban areas.

For years Harcourt, Brace, Jovanovich, a major publisher, has been decentralizing its corporate headquarters from New York City to San Diego, Orlando, Paris, Canada and elsewhere. By 1982 only 2,000 of its 8,300 employees were still in New York. In February of that year William Jovanovich, the chairman and chief executive officer, announced that almost all the remaining 2,000 would leave the City, thus saving an estimated $20 million a year just by moving all publishing functions to San Diego: “The notion that we have to be in New York City to conduct business is a shibboleth. With the modern electronic techniques of instant communication by video terminals, satellite communications and conference calls, it is no longer necessary to be in one place and not another.”

These sub-contractors of bigger businesses are predominantly service workers, by far the most rapidly growing segment of our economy. The Secretariat of the General Agreement on Tariffs and Trade found that “Between 1970 and 1980 there was a net increase of 19 million jobs in the U.S. (24%).” Roughly 87% of these were service jobs and the great majority of these were in small firms—some of one person. One study of data on 5.6 million firms by an MIT group found that, between 1969 and 1976, 66% of new jobs in the U.S. were in firms with fewer than 20 employees.

New Jobs with Small Firms

Since the underground economy has been growing extremely rapidly, and since almost all of these consist of one or only a few individuals, far more than two-thirds of all new jobs are in very small firms. By contrast, the U.S. Census Bureau’s “County Business Patterns” surveys show that the proportion of Americans working for companies with over 500 employees was 27.6% in 1967 and shrank to 22.4% in 1979—a decrease of one-fifth in a mere 12 years. In the 1970s the number of employees at U.S. Steel shrank by one-fourth, from 531,000 to 399,000.

The same thing is happening in the other industrialized nations. In Japan one Japanese worker out of six has his own business and some of these are one-man robot-run factories. Even in the big companies the emphasis is strongly against top-down, bureaucratic decision making and very much on individual and team decision making. As Harvard’s Ezra Vogel notes, “The essential building block of a Japanese company is not a man with a particular role assignment and his secretary and assistants, as might be the case in an American company. The essential building block of the organization is the section. A section might have perhaps eight or ten people. Within the section there is not as sharp a division of labor as in an American company. To some extent, each person in the same section shares the same overall responsibility.”

Vogel errs only in failing to realize that the most creative, efficient, profitable and growing American companies in high technology and with highly competitive markets have been doing this for decades. Thomas Edison, who created the first modern research lab early in this century, ran it entirely on the principles of team spirit and individual initiative. He is continually quoted for his apocalyptic, anti-bureaucratic pronouncements: “Organization! Hell! I’m the organization! . . . Hell! There ain’t no rules around here! We are tryin’ to accomplish somep’n’.” They did and later high technology firms like IBM followed in their path. The Japanese borrowed these ideas and sometimes improved on them. Big Bureaucratized Business in America was al ways partly a figment of the imaginations of socialistic critics and the rest was overwhelmingly due to government mandates on union powers, taxes, regulation and even direct procurement policies by the Defense Department.

In a recent update on his earlier prophecy (The Economist, April 17, 1982), Norman Macrae finds that the Revolution is rapidly gaining momentum. In addition to the accelerating rate of decline of the Big and creation of the little, he finds the remaining Big are seeing the handwriting on the wall and are rapidly introducing “intrapreneurial practices”: that is, more and more firms are breaking themselves up into largely autonomous teams that compete with each other in bidding for company projects.

The New Message

The general point is to internalize losses and profits into the smallest idea-creation and product-manufacturing team possible—bring the market incentives to each individual as directly and immediately as possible, while at the same time optimizing all the powerful motivating forces of team work (“fellow feeling”). As Macrae is well aware, this idea has long been used by very successful American companies like Arthur D. Little. But what is new is the rapid spread of the practices and—even shocking—the spread of the message. There are now consultants in Sweden and the U.S. (such as Mr. Bob Schwartz’s Tarrytown School for Entrepreneurs outside New York) and even professors (such as Reg Revans at Manchester College of Science and Technology) who are propagating the message. And even Prophet Macrae is being honored in his own day, having been invited to give talks on the Revolution of littleness in twenty nations.

As technology and competition increase, what is now an early but powerful trend will become a tidal rush. If the government ever stops mandating inflation and punishing small business, the Revolution of Littleness will sweep all before it. And the Age of Little Business will be an age of greater economic freedom, thus of ever greater creativity, efficiency and growth for all of us.