Identify three key takeaways from the reading
Complex_
Ch3.pdf
3 Historical Development of Government’s Roles with Business
Case Scenario: Zoey’s pet store 70
Introduction: Growth of Government with Democratization of Quality of Life 71
The Anti-Central Government Era (1781–1787) 73
The Small Government Era (1787–1887) 74
The Moderate-Sized Government Era (1887–1933) 83
The Big Government Era (1933–1970s) 86
The Rightsizing Government Era (1970s–Present) 92
Analytical Case: Should government bail out the big financial companies? 99
Practical skill: Accessing resources for starting a business 101
Summary and Conclusion 101
CHAPTER CONTENTS
CASE 3 SCENARIO
Zoey’s pet store Zoey has always been a pet lover, as we have learned from her commitment to her horse, Happy. She has dreamed of owning a pet store ever since she was child, but could never really quite figure out how to make that work. Zoey has now graduated from business college with a bachelor’s degree in entrepreneurial management. She learned a substantive entrepreneurial skillset, including entrepreneurial opportunity analysis, business development, finance, marketing, small business management, and so on. Knowing about her long-time dream, Zoey’s grandma recently gave Zoey her old house near Main Street in the City of Somewhere as a graduation gift. Zoey had been living in the house while going to school and was thrilled that she wouldn’t have to move. In fact, Zoey always thought the house could be turned into an interesting business of sorts. And now it would be—her very own pet store!
Having lived in the house, Zoey knew that there was a lot of adult foot traffic from the veterinarian on the corner and from Splurge, the jewelry store next to it. The U Scream Ice Cream shop next to the jeweler guaranteed a lot of kids coming by. There was ample parking in front of her house, too; the only thing that seemed a little off-putting was the condition of the sidewalk out front and the faded look of the Victorian-style house. But overall, Zoey was thrilled.
Zoey feels that she is ready for her new venture; she wants to name her pet store “Happy Paws,” so she needs to register the business name with the county clerk’s office. As she gathers ideas together for her business, she finds that she has to deal with many more government issues. Zoey wants to run the business legally, so she must obtain all necessary federal and state licenses and permits. She was also told when she first inquired about her business that she cannot use her grandmother’s house as it is right now. Zoey has to contact the municipal planning department to make sure the property and its improvements are compliant with zoning ordinances and regulations. Since Zoey wants her business to be a Limited Liability Company (LLC) as well, she needs to contact the Internal Revenue Service (IRS) about business taxes and obtain an Employer Identification Number (EIN). In addition to the federal government, she also has to contact the state agency for state and local tax registration.
Even though Zoey does not have plans to immediately hire any employees, she still needs to contact government agencies for worker’s compensation insurance, unemployment insurance, disability insurance, and the like. Thank goodness her boyfriend Zach has offered to help out for free after work as much as he can! And she can count on her best friend Tyler to assist a bit after hours as well, especially creating product displays and a website.
Zoey’s list is daunting and continues to grow, and it’s only just after noon today! This makes her idea about the business seem like an extensive undertaking and causes her frustrations. It’s a good thing that U Scream Ice Cream is just a few yards down the street. Zoey grabs her purse and calls Zach to see if he can meet her there.
Zoey is facing issues that are common to business owners today. A good understanding about the government’s roles with business and knowledge about adequate resources will help her achieve her business goals. This chapter introduces the theoretical underpinnings of government institutions and public policies that are relevant to businesses. The development of government’s various roles with business in their historical contexts will be reviewed. The text also teaches fledgling business owners how to access resources and gain the skills needed for successful government interactions.
Introduction: Growth of Government with Democratization of Quality of Life
The benefits of modern life spring from many sources. Science has brought us cures and preventions for innumerable diseases, thousands of new products—from stainless steel to plastic, the ability to predict the weather with satellites, and
Historical Development 71
improved agricultural products, among many other advances and innovations.
Technologies have brought us mass production, progressive modes of transportation,
myriad types of communication, and so on. Yet our improved life is also the result
of higher standards imposed upon the quality of life, and these standards are chiefly
provided by our social expectations as expressed through government. We want
our money system to be secure, our roads to be smooth and free, our food and drugs
to be safe, our products to be sound, our basic opportunities for education to be
available to all, and our businesses and jobs to be protected from unfair competition.
And we expect that all these benefits, and countless others, will be identified,
delineated, and adequately regulated by government today. As discussed in Chapter
1, using the example of disaster assistance, government is much larger today
because the roles we expect it to perform are vastly more substantial and demanding
than even a century ago.
This chapter provides the background of that growth in government, beginning
with the American Revolution, which itself was a consequence of government—
Great Britain’s, that is—imposing oppressive rules on the new American colonies
to benefit the powerful and rich back home. Using the eight roles of government
that most affect business, we examine five historical periods: the Anti-Central Government Era, the Small Government Era, the Moderate-Sized Government Era, the Big Government Era, and the Rightsizing Government Era. These different roles of government were introduced over time and expanded at different rates, and today
some of the roles that government plays are under more pressure to be reduced or
changed (or rightsized) than others.
For example, the federal regulation of business was virtually non-existent for
the first century that the country was in existence. This was largely due to the fact
that businesses tended to be much smaller and more locally focused, and because
of that were far less able to have any noticeable or negative widespread environ -
mental impact, and were also less able to monopolize whole markets. Local
regulation of business was largely limited to the tasks of licensing and taxing. When
these conditions changed dramatically after the Civil War, eventually government
regulation was used to recalibrate an economic system that had fallen victim to
unfairly distorting what was once a fair market.
The Anti-Central Government Era coincided with the Articles of Confederation and was relatively short-lived, stretching from 1781 to 1787.
The Small Government Era lasted from 1787 to 1887, during which time the country grew from 13 small colonies to 38 states spanning the continent. During
the Small Government Era, the population grew to be 15 times the size it had been;
the percentage that was urban versus rural grew from just 3.35 percent to 30 percent
in that century.
The Moderate-Sized Government Era is defined as the period from 1887 to 1933, a time during which the economic GDP expanded greatly and which included the
“age of invention.”
The Big Government Era, from 1933 to the 1970s, was ushered in by the Great Depression (1929–1939), followed closely by the vast and expensive World War
II, but also included a quarter-century post-war boom.
72 Introduction to Business–Government Relations
The Rightsizing Government Era began in the 1970s and presently continues, as the limits of government—to provide the level of services, the number of problems, and degree of governmental protection—began to exceed the expectations that had accumulated and the resources it was likely to get. During this period, GDP growth has slowed, real wages are often stagnant, and tough choices have to be made about addressing old problems, all while envisioning and implementing an ideal for the largely post-industrial society we are becoming.
The Anti-Central Government Era (1781–1787): Very Limited Roles
The origin of the United States began with the rebellion against the British government. On July 2, 1776, the Second Continental Congress, composed of members from the 13 colonies, adopted a Resolution of Independence in a move for separation:
RESOLVED, That these United Colonies are, and of right ought to be, free and independent States, that they are absolved from allegiance to the British Crown, and that all political connection between them and the state of Great Britain is, and ought to be, totally dissolved.
In the Declaration of Independence, the founding fathers of the nation stated their fundamental reasons for creating a new government:
We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.—That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed,—That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government . . .
To the founding fathers, the powers of governments should be derived from the consent of the people governed, and, it follows, the right to change or to abolish those powers of governments should also be in the hands of the people.
During the founding era of the nation, the prevailing sentiment was the strong fear of a forceful central government. This led to the drafting and passage of the Articles of Confederation. The Confederation was a voluntary association, or league, of independent member states who agreed to only a limited number of restrictions on their freedom. Under the Articles, the Congress of the Confederation —a government of the 13 colonial states—was established on March 1, 1781.
Under Article II of the Articles of Confederation, each state still retained its sovereignty, minus several agreed-upon functions that were relinquished to the fledgling central government. All state and municipal governments functioned relatively as they had in the past, in some cases for 150 years. Taxes were collected
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by the state, justice and laws were handled separately by each and, as a local
example, municipalities typically required citizens to maintain their adjacent
sidewalks and streets. The Articles allowed the single-bodied central government,
Congress, to print money, maintain an army for the common defense, appoint
ambassadors, and pay off the national debt of the war, but not much more.
Most critically, Congress did not have the authority to levy taxes; rather, they
could only request proportional levies from the states, which could be, and were
commonly, ignored. Debts from the American Revolution often languished, putting
the credibility of the nation’s government at risk. The inability to raise money also
meant that most of the army was dissolved, allowing incursions from the British in
Canada and the Spanish in Florida to jeopardize the mutual welfare of the states.
An inability to put down a small rebellion in Massachusetts in a timely fashion when
assistance was requested was the last straw as the vulnerability and fragmentation
of the new country became obvious.
The country had a plan for the development of the West, but lacked the
wherewithal to physically carry out the concomitant transportation, communication,
and military needs. A special session of Congress was called in 1786 to consider a
new national charter for government, one that would provide a central government
with enough power to provide core functions such as defense and foreign relations,
and some basic internal government roles. The idea was for a federal system in
which the bulk of governance was to be administered by the states.
The Small Government Era (1787–1887): More Limited Roles
On September 17, 1787, the Constitution was approved by delegates from the
13 states. The Constitution established several fundamental principles, such as
popular sovereignty under the control of the people, and limited central government,
in direct contrast to the powerful British government against which the colonial
states had rebelled. It also provided separation of powers—with checks and balances
among three branches of government—in order to prevent any one of them from
gaining too much power (Bardes, Shelley, and Schmidt 2012).
The Constitution granted the national government a number of powers, including
the ability to tax foreign goods, to print money, to establish a system of federal
courts, to set up agencies for national issues such as foreign affairs and treasury,
and to regulate commerce among the states. Each state still retained the right to
control commerce within its borders. Another important enumerated power was the
ability to create a postal system and accompanying roads, a function that would
become a hallmark responsibility for a country that was growing ever westward
and constantly evolving in its modes of transportation.
The most significant growth of government roles in this era was in those
associated with substantial infrastructure support (primarily transportation) and the
promotion of business through foreign policy. Although the monetary and fiscal
structure role was modest, it was still important and is reviewed first below for
context. Much more modest roles existed in public purchasing, social architecture,
and direct social service provision.
74 Introduction to Business–Government Relations
Provider of Monetary and Fiscal Structure
What we often take for granted today as a central role of government started with Alexander Hamilton, who served as Secretary of the Treasury in the George Washington Administration (1789–1797). With support from President Washington, Hamilton convinced Congress to pass a financial program that funded the debts of the American Revolution, established a national bank, set up a system of tariffs and taxes, and built up friendly trade relations with Britain. See Exhibit 3.1 for a brief history of banking in the United States.
Hamilton’s efforts in building a strong national government with a broad financial base faced resistance from the Republican Party (which differs from the present- day Republican Party), led by Thomas Jefferson (1743–1826) and James Madison (1751–1836). Jefferson argued for strong state and local governments and a weak federal government. To Jefferson, nothing that could possibly be done by individuals at the local level should be accomplished by the federal government. When Jefferson won the election of 1800, in his inaugural speech, he promised a limited government that would preserve the order among the inhabitants but “leave them otherwise free to regulate their own pursuits of industry, and improvement” (Jefferson 1975). By the end of his second term, Jefferson had significantly reduced national debt, the number of executive department employees, and military spending. He set a conservative fiscal path that was generally followed by the federal government in the Small Government Era.
Promoter of Business
Despite President Jefferson’s anti-central government views, he went to war with the Barbary pirates in the northern Mediterranean, and he bought the Louisiana Purchase through executive order, doubling the size of the US. These measures protected American shipping on one hand, and opened up a vast commercial opportunity on the other.
Also during Jefferson’s tenure, the American Industrial Revolution was indirectly stimulated by the Chesapeake–Leopard Affair, a naval incident between the British warship Leopard and American frigate Chesapeake. In short, the crew of the Leopard attacked the Chesapeake. The Chesapeake was caught off guard and quickly surrendered to the British after firing only one shot. The British boarded the American frigate looking for deserters. They seized four men and hanged one for desertion. The affair aroused outrage among Americans and harsh calls for war with Great Britain. As a result, Congress passed the Embargo Act, which stopped the export of American goods, and thus hurt commerce. However, it also stopped the import of goods from other countries, which encouraged American industrial - ization. Eventually, it was also one of a number of aggravations that led to the War of 1812 against Great Britain.
Another important political event was the Monroe Doctrine in 1823. President Monroe declared that foreign powers could not become involved in the affairs of independent countries in the Western Hemisphere, with the implied threat of military intervention by the United States. This doctrine was put forth because
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76 Introduction to Business–Government Relations
EXHIBIT 3.1
First Bank of the United States
The First Bank of the United States was established by the United State Congress on February 25, 1791. It was championed by Alexander Hamilton, first Secretary of the Treasury, with the belief that the bank was necessary to stabilize the economy, improve the nation’s credit, and facilitate the operations of financial business. Hamilton’s idea encountered severe opposition led by Secretary of State Thomas Jefferson, who charged that the bank would benefit merchants and investors at the cost of the general mass.
Unlike commercial banks, the First Bank was a central bank, which is a public institution that assumes the authority to oversee a country’s fiscal and monetary issues, such as national currency, money supply, interest rates, as well as the operation of the commercial banking system.
The First Bank was chartered for 20 years. After its expiration, the Bank was succeeded by the Bank of North America, and later the Second Bank of the United States. When the charter for the Second Bank of the United States ended in 1836, the country did without a central bank for over 75 years. In 1913, under the Federal Reserve Act, the Congress created the Federal Reserve
First Bank of the United States (1797–1811): 116 South 3rd Street, Philadelphia, PA. Source: Wikimedia Commons.
of the fact that most of the Spanish New World colonies had declared independence between 1817 and 1823, and the US did not want Spain or any other world powers to take advantage of these new weak states. It also made the entire North and South American continents part of the special US sphere of influence. This was tested in Mexico during the American Civil War, when French Emperor Napoleon Bonaparte III invaded Mexico for unpaid loans, and persuaded Austrian Hapsburg Duke Maximilian to become its Emperor. After the US Civil War was over, the United States created a blockade of Mexico and massed 50,000 soldiers at the US border. Because of an internal rebellion and the prospect of a war with the US, the French withdrew their forces and the Emperor was deposed without an American incursion.
The US expansionist policies during the nineteenth century were a great boon to American business and not merely limited to the Louisiana Purchase and the Monroe Doctrine. Some other prominent actions of the US government included the purchase of Florida (1819), the annexation of Texas (1845)—which led to the Mexican–American War (1846–1848) and opened the way to the annexation of California (1850) and other western areas north of the Rio Grande—the Gadsden Purchase (1853), and the purchase of Alaska (1867). All in all, albeit indirectly, the United States was a substantial and self-conscious promoter of business interests in the Small Government Era, which is ultimately not surprising given the strong commercial heritage of the former colonies.
After the Civil War, a period called the Gilded Age began. The Gilded Age was a reference to the immense fortunes that were being created. Numerous super- rich industrialists, business people, and financiers emerged, such as John D. Rockefeller, J. P. Morgan, Andrew W. Mellon, Andrew Carnegie, Henry Flagler, Cornelius Vanderbilt, and the Astors. The positive aspects of this period included
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System (also known as the Federal Reserve or the Fed) to be the central bank of the United States, which is still in operation today. Over time, the role of the Federal Reserve has expanded. Current responsibilities of the Federal Reserve system include:
• Conducting the nation’s monetary policy by influencing the monetary and credit conditions of the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates
• Supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers
• Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
• Providing financial services to depository institutions, the US government, and foreign official institutions, including playing a major role in operating the nation’s payments system. (Mission Statement of the Federal Reserve System, November 6, 2009.)
78 Introduction to Business–Government Relations
Crewmen of the Chesapeake prepare one cannon shot during the Chesapeake–Leopard Affair
EXHIBIT 3.2
Source: Wikimedia Commons.
EXHIBIT 3.3
Profile of a Robber Baron: John D. Rockefeller
John D. Rockefeller lived from 1839 to 1937, a period of great commercial change. He received a better-than-average middle-class education, readily absorbed the skills of mathematics and debate, and learned to appreciate music and discipline. Early jobs as a bookkeeper, operations manager, and distributor set him up well for his entry into the kerosene business. When he entered the business, kerosene was just becoming a substitute for the expensive and diminishing lighting fuel, whale oil. By the time he was 24, he and his partners
Historical Development 79
had built their first kerosene refinery. He expanded the refinery business in his late 20s, and proceeded to corner the market in his early 30s. In 1872, his company, Standard Oil, absorbed 22 of 26 local competitors. Thereafter, he used his power with railroads to get exceptional deals, and Standard occasionally dropped pricing below market costs to crush all significant competition. Standard owned its own pipelines, tank cars, and home delivery network. To increase the use of his commodity and often to turn waste by-products to productive use, Rockefeller encouraged Standard Oil to develop (or acquire the license for) dozens of oil-based products including paint, tar, Vaseline jelly, and chewing gum. Standard was refining over 90 percent of the oil in the US by the end of the decade. In 1882, he melded his many companies in the modern diversified corporation, Standard Oil Trust, and invented the futures market by selling rights to stored oil. In the 1880s, Standard Oil was producing 85 percent of world production at its peak, which dropped thereafter; nonetheless, it still maintained nearly 70 percent of overall world refining by the time it was broken up in 1911 into 34 different companies. By 1902 an audit showed Rockefeller’s wealth at $200 million; it rapidly increased to $900 million by the time he retired. Because his oil stock continued to increase in value in retirement, his fortune was valued at approximately $1.4 billion at his death. Not only was he the richest man in the world—estimated by the New York Times as $192 billion in 2007 dollars—it ranks him as the wealthiest man in modern times. Despite his merciless and sometimes unscrupulous business practices, Rockefeller was a devout Baptist, and gave approximately one half of his fortune to philanthropy.
Source: Yergin 1991.
Profile of a Robber Baron: John D. Rockefeller (18 years old). Source: tr.wikipedia.org.
the facts that the economy was booming, real wages were increasing, and the
US was preparing to emerge as a world power. Negative aspects of this period could
be seen in the rampant industrialization that brought poor and sometimes horrific
working conditions for many, and the fact that the South did not participate in the
boom. There was also a growing resentment toward the fabulously wealthy, who
were thought to have gotten much of their wealth in underhand ways, such as
the extensive use of child labor, policies used to keep immigrant labor wages low,
substandard products, and cozy deals with the government. All of these factors
assisted in giving rise to a negative term for this elite class—Robber Barons.
See Exhibit 3.3 for a profile of John D. Rockefeller, an example of a prototypical
Gilded Age Robber Baron.
Government as Infrastructure Provider
During the war with Great Britain in 1812, America realized the importance of an
effective transportation system. As early as 1806, President Thomas Jefferson
authorized the construction of the first national road—Cumberland Road (part of
today’s US Route 40), which connects the Potomac and Ohio Rivers.
With the notable exception of the transcontinental railroads, state and local
governments were the primary supporters of this role. Most state and local infra -
structure projects were small but important in terms of building up municipal
transportation systems. However, a significant number of them changed the nation’s
economy. The construction of the Erie Canal in 1817 was a state government
transportation project that brought an enormous impact to commerce in New York
and Lake Erie. The 363-mile water route now extended from the Atlantic Ocean
all the way to the tip of the Great Lakes. The canal project was championed by
Jesse Hawley, a flour merchant in Geneva, New York, who envisioned selling large
quantities of grain grown on the western New York plains to the eastern seaboard.
New York Governor DeWitt Clinton received approval from the legislature for
$7 million to be used in its construction. Construction started in 1817 and the canal
was officially opened on October 26, 1825. The Erie Canal reduced transportation
costs immensely, fostered a population surge in western New York State, and made
New York City the chief US port and trade center.
A second state-and-local government infrastructure example was the rise of
American bridge building. A classic illustration would be the succession of the
world’s longest suspension bridges completed during the Small Government Era.
Starting with the Wheeling Bridge in 1849, connecting Wheeling, West Virginia
and Ohio, this long suspension construction spanned the Ohio River. The Roebling
Suspension Bridge in Cincinnati took the honor of longest bridge in 1867. The
Brooklyn Bridge, connecting the two New York City boroughs of Manhattan and
Brooklyn in 1883, was the next to be the world’s longest, and held the title for
decades. All are still in active use today, and in fact, regionally funded bridges kept
the record in the US until 1981.
Perhaps the most significant role government played with business during this
era was in the active development of the railroad system. State governments usually
80 Introduction to Business–Government Relations
Historical Development 81
granted charters to create the railroad corporations, which were given a limited right of eminent domain to buy needed land for a railroad project. In assist- ing business corporations in building the railroads, government also provided crucial technical support, especially through detailing officers from the Army Corps of Engineers, the nation’s only repository of civil-engineering expertise. Railroads in the US started with a 13-mile section of the Baltimore and Ohio Railroad in 1830. The second railroad corridor to open in the nation ran 136 miles from Charleston to Hamburg in South Carolina. Though initially slow to begin, starting from 1850, the US railroad system experienced phenomenal growth (see Exhibit 3.4).
By the start of the Civil War, railroads linked the most important Midwest cities with the Atlantic coast. However, it was the massive support from the US federal government in terms of land grants and loans that led to the first transcontinental railroad, which started construction at the end of the Civil War and finally completed work at Promontory Point, Utah in 1869. It connected two railway lines—the Union Pacific’s rail line that originated in Omaha, Nebraska and ran towards the West, and the Central Pacific rail that began in Sacramento, California and ran towards the east. With two additional transcontinental lines being completed in 1883, federal support was no longer needed. In fact, the wealth and power of the railroads would become an issue in the next era.
The expanded transportation system and abundant natural resources of the country, as well as the great acceleration of technological innovations, largely fueled the industrial revolution in the United States. Starting in 1820, the US rapidly evolved from an agrarian state to an industrial power. By 1860, 16 percent of Americans lived in cities with populations of 2,500 or more people, and one third of the nation’s income now came from manufacturing. During the 1870s and 1890s, the United States experienced the fastest economic growth in its history to date.
Railroad mileage increase by groups of states
1850 1860 1870 1880 1890
New England 2,507 3,660 4,494 5,982 6,831
Middle States 3,202 6,705 10,964 15,872 21,536
Southern States 2,036 8,838 11,192 14,778 29,209
Western States and 1,276 11,400 24,587 52,589 62,394 Territories
Pacific States and 23 1,677 4,080 9,804 Territories
Totals 9,021 30,626 52,914 93,301 129,774
Source: Depew 1895.
EXHIBIT 3.4
Modest Roles: Government as Purchaser, Service Provider, and Social Architect
The development of the transportation infrastructure also largely expanded government’s role as purchaser with business. Transportation projects often involved large public funds paid to private corporations for design, construction, operation, and maintenance. In addition to the infrastructure development, government’s role as purchaser was also largely enhanced through military contracts in this time period.
As early as the Revolutionary War, colonial rebels came to know the advantages of purchasing military supplies from business (Weitzel 2011). Robert Morris (1734–1806), whom Congress appointed to be the first Superintendent of Finance in 1871, installed the first sealed-bid system for military contracts. Morris’s system was constantly adapted and modified over the course of the next several decades. By the Mexican–American War of 1846–1848, Army quartermasters became the official contracting agents for the Army, taking on the responsibilities of sustaining remote combat-ready forts across the vast American frontier. In the early years of the Civil War, quartermaster officers used a variety of ways to obtain necessary military supplies, from advertising for large-quantity contracts, to making small direct purchases, to even using the authority to build their own factories for military goods (Weitzel 2011). Military contracts became a critical vehicle for sustaining and supplying US Army forces. Of course, the purchase of supplies escalated dramatically during wars, which included the war of 1812, the Mexican–American War, and the Civil War.
The government’s original role as service provider began with the Post Office, which was an early federal department and the nation’s first communication system. Otherwise, the service provider function was negligible at the beginning of this long period, but later became a modest role as the country grew wealthier. Counties and other local governments sometimes created “poor farms” and/or county hospitals. Poor farms provided a means for orphaned children and the destitute to receive shelter, support, and work at public expense. County hospitals after the Civil War began providing medical care for the indigent or rural care for fees in areas where doctors would otherwise be lacking. Wealthier municipalities started supplying some other services such as public libraries, although all social services were supported more by means of charity than by government in this era.
The government’s role as social architect also started out as virtually non- existent, with no compulsory education, no public education infrastructure, and relatively high illiteracy, as was common at that time in the world. Much elementary education was supported by religious institutions, in particular the Catholic Church. While there were some very early examples of public education being supported by local governments, the practice did not start to become commonplace until mid- century. One of the provisions of the vast government land grants to the railroads was that they set aside land to be used for schools.
In the first half of the nineteenth century, higher education was primarily a privilege for men belonging to the upper class. That started to change with the Morrill Land Grant College Act of 1862. That Act sold off federal lands and gave one-time federal endowments to propel at least one state-level university to accept students of merit with more affordable fees in every state in the union. Dozens of
82 Introduction to Business–Government Relations
these universities rank among the top 100 universities in both the US and world today. The system produced a large number of agricultural scientists and industrial engineers who constituted the crucial human resources of the managerial revolution in government and business. The system also laid the foundation for the educational infrastructure that supported the nation’s technology-based economy.
The Moderate-Sized Government Era (1887–1933): Somewhat Expanded Roles
The political landscape for the US tended to have an internal focus during this time frame, as the economy bustled with Western expansion and settlement, and the incorporation of new inventions such as light bulbs, telephones, automobiles, and airplanes kept business and government busy. Nonetheless, it was an imperialist age, and while the US acquisition of land outside the continental US was more modest than some of its European counterparts, it was generally more strategic in the long-term. The last significant war of land expansion occurred with Spain in 1898; the US was drawn into World War I late and US business did extremely well. The Modern-Sized Government Era inherited the problems of the Gilded Age (1877–1893), which was replaced by the Progressive Era (roughly 1890–1920), a period which focused on both reforming and expanding government.
The most prominent Progressive of the period was President Theodore Roosevelt, who had a longer-term perspective and affected the course of government in many areas by using popular opinion, or what he called his “bully pulpit” (bully at the time meant “superb” and pulpit referred to the White House) to implement earlier legislation, as well as to protect the environment. The era saw widespread expansion of government’s role in the economy and society. The most dramatic increases were in federal government regulation, going from virtually none to substantial regulation of the behemoth organizations that had sprung up since the Civil War. Yet government also grew in financial infrastructure, transportation infrastructure, social architecture, service provision, and risk protection.
Regulator
The expansion of the railroad system also created a handful of large railroad companies that wielded vast power, such as the New York Central, Union Pacific Railroad, Central Pacific Railroad, and the Southern Pacific Railroad. In response to monopolistic practices (such as price fixing, rate discrimination, etc.), under the Interstate Commerce Act of 1887, Congress created the Interstate Commerce Commission (ICC) to regulate the business activities of railroads. This defining piece of legislation started to shift the power of regulating big business from the states to the federal government and became the first in a string of important legislative initiatives to curb the power of monopolies and trading cartels.
During the 1880s and 1890s, a new corporate conglomerate, the so-called “trust” such as Standard Oil (refer back to Exhibit 3.3) emerged in great numbers, some of which engaged in business practices that imperiled free competition. To deal with the monopolies emerging in oil, commodities, and horizontal business cartels,
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anti-trust laws were passed, the most important of which was the Sherman Anti- trust Act of 1890. Famous monopolies that were broken up by this type of legislation included Standard Oil (1911), American Tobacco (1911), Alcoa (1945), and AT&T (1984).
The Clayton Anti-trust Act and companion Federal Trade Commission Act of 1914 not only strengthened the Sherman Anti-trust Act, but also supported the criminalization of unfair trade practices such as price fixing, which had sent many business executives to jail, as exemplified in the famous General Electric and Westinghouse price-rigging scandal that saw seven executives go to prison in 1961. But not all anti-trust and non-competitive prosecution activities moved to the federal level; state attorneys-general have continued to pursue corporate and individual cases. In particular, New York, California, and Virginia have been active.
Other types of business regulation emerged in this era. The Food and Drug Act was initiated in 1906, in part due to the public outrage over unsanitary meatpacking conditions revealed by Progressives such as Sinclair Lewis. To enforce the policy to its fullest, the government later created the Food and Drug Administration (FDA) in 1927.
Not all increases in regulation were at the federal level. A massive new type of regulation, local zoning, had its genesis in this era. While local zoning had long been a prerogative of state and local governments, the need for comprehensive planning and more technically sophisticated zoning regulations became apparent as the country’s population doubled during this period. Cities had to deal with great fires, sanitation, transportation needs, compatible usage, and aesthetics, and they had to channel economic development more rationally.
In 1916, building on a half century of rather disjointed efforts, New York City adopted a modern and comprehensive set of zoning regulations that set the pattern for zoning in the rest of the country. Eventually the constitutionality of zoning ordinances was challenged, but it was upheld by the US Supreme Court in the 1926 case entitled the Village of Euclid, Ohio v. Ambler Realty Co. The government’s right to specify how land could be used, and to require conformance through authorized planning processes, including initial public input, were firmly established in this seminal decision.
Other Areas of Governmental Role Growth
In terms of fiscal and monetary structure, this period included two major events, both occurring in 1913. The first was the re-creation of a central bank, to be known as the Federal Reserve. This was partially a reaction to the fact that the great Panic of 1907 had been personally stabilized by the financier J. P. Morgan, in an age growing more leery of Wall Street bankers and manipulation by the super-wealthy. The second event was the Sixteenth Amendment to the Constitution, which allowed for federal income taxes that were not temporary (as was done during the Civil War), nor that imposed undue implementation issues on the federal government (as intervening Supreme Court decisions indicated would otherwise be necessary for constitutionality).
84 Introduction to Business–Government Relations
The effect of this amendment empowering Congress to levy federal taxes was threefold. First, it shifted substantial taxing authority to the federal government. Up until then, the bulk of taxing authority was reserved for state and local governments, with the exception of during the Civil War. Second, it meant that as tax burdens became heavier with much expanded services in the twentieth century, most of the tax growth was preempted by the federal government. This would eventually provide federal leverage over states in the 1960s through 1980s, but is a position from which the government has generally been retreating in recent decades. Third, it provided the federal government with a way to indirectly distribute wealth when it chose to do so. For example, the federal government had high tax rates for the rich during and immediately following World War I, and from the Great Depression through the 1960s. In fact, during much of these periods the super-rich had special tax categories, which were done away with at the end of the Great Depression, when the rich and super-rich alike were taxed heavily for nearly 30 years. Thus, wealth distribution in the US narrowed considerably from 1940 to 1980, but has been allowed to expand ever since.
Transportation and other infrastructure demands continued to escalate during this period as cities paved more streets and sidewalks, provided electric lighting, built airports, constructed better sewage and sanitation systems, and created other improvements. Counties and state governments followed suit, to a more limited degree, in rural areas and in connecting cities.
In terms of social architecture, public schools at all levels expanded during the moderate-sized government period as an increasing number of states imple- mented compulsory education laws that forced attendance. Though public schools appeared as early as 1635 in the United States, it was during the Progressive Era that the nation started to dramatically expand the public education system. By 1918, every state had enacted compulsory laws requiring students to complete elementary school (Graham 1974). The demand for high schools also proliferated. This in turn accelerated teacher colleges, often called normal schools, which initially were two-year, post-secondary institutions of higher education. Relatedly, service provision beyond physical infrastructure expanded to such things as more public libraries, drinking water for cities, and irrigation water for rural areas. Assistance to the poor during this era started to shift from poor farms to small, temporary welfare subsidies.
Safeguarding against risk was largely limited to attacks by Native Americans, invading forces, or the provision of justice systems. When it came to disasters, local governments were on their own. Sometimes a state legislature might pass special legislation for one-time assistance, but that was a rare occurrence, and even rarer was federal assistance with its tiny tax base. The Army Corps of Engineers would occasionally assist in rebuilding infrastructure, as it did with an extensive levee system after the Great Mississippi Flood of 1927. An example of the minimal government assistance provided in the nineteenth century was the great Johnstown Flood of 1889. Johnstown was a community that was essentially wiped out when a dam broke, but other than the Army Corps rebuilding a bridge and one small state government allocation of funds, the town depended almost entirely on charity. Because the event was so large, dramatic, and sad, relief did come in from around
Historical Development 85
the world, although in smaller crises, local residents would find themselves completely on their own.
US government domestic and foreign policies continued to promote business by protecting growing corporate interests around the world. Domestic policy pursued the settlement of the West and the US Army fought a series of wars with Native Americans, who were required to live in increasingly restricted areas. The appropriation of large tracts of land in the American West opened up incredible development opportunities for business.
The US also acquired a series of strategic footholds around the world during this time period. In the Pacific, in addition to the Philippines and Guam, which were acquired from the Spanish, it annexed Hawaii, Midway Island, Samoa, and Johnston Island. Any residual foreign influence in the Caribbean was largely eliminated by annexing Puerto Rico and making Cuba a US protectorate. Assistance was provided to the break-away Colombia province of Panama, resulting in a 1904 treaty with the new country allowing the US to build, operate, and own the Panama Canal, which it did from 1914 to 1999. When business interests were perceived to be jeopardized, US military forces interceded in a number of Central American and Caribbean countries from the 1890s to 1920, and occasionally did so in other places around the world such as China and Korea.
While the country started the Moderate-Sized Government Era with internal frontiers, it ended it as a fully consolidated continental power, with some trappings of empire. The wilder expansion of the business that had begun in the Gilded Age was somewhat tamed by anti-trust legislation, but the Progressives focused on prohibition (against the use of alcohol) and on implementing the franchise of women (their new right to vote). Thus, the mood of the country relaxed again in regard to business during the heyday of the “roaring twenties.”
The period ended with three Presidents in a row who largely advocated laissez- faire market practices and the reliance on philanthropy and volunteerism for social problems—Harding (a publisher), Coolidge (a lawyer), and Hoover (a veteran politician). These pro-business Presidents gave the business community a much freer hand; so free, in fact, that the over-speculation of stocks, land, and commodities resulted in the perceived need for greater government involvement in the next period.
The Big Government Era (1933–1970s): The Peak of Government
The Wall Street Crash of 1929 triggered a worldwide depression. In the United States, the Great Depression ushered in a period of government intervention in business affairs through President Franklin D. Roosevelt’s New Deal policies, with an expansion in financial infrastructure, and a new and greater emphasis in government as regulator, social architect, and purchaser, effectively enlarging government’s role in safeguarding against risks. The period also experienced World War II, which the US entered more quickly than the previous world war and which was waged on two fronts. The war was not especially profitable for business because of high tax rates, but it did further enhance business capacity vis-à-vis the rest of the world from which it profited greatly after the war ended. The war was
86 Introduction to Business–Government Relations
very expensive for government, which paid for it by maintaining high individual
tax rates for several decades, but nonetheless the post-war economy boomed.
The government also maintained its other roles as infrastructure provider, service
provider, and promoter of business. The success of government in this period was
also partially its downfall, as expectations for greater and sustained intervention,
and for the continuous improvement of the quality of life, continued to rise. At the
same time, however, both personal and government resources began to reach their
limits in an avidly capitalist society.
Fiscal Infrastructure and the New Philosophy Government–Business Relations
As the longest and deepest economic crisis in US history, the Great Depression
lasted over a decade and at its height had an unemployment rate of over 25 percent.
President Hoover, a moderate Republican, was nonetheless a well-documented
humanitarian and likely would have assisted sooner if not for his highly conservative
Secretary of the Treasury, Andrew Mellon. The multimillionaire Secretary held his
position from 1921 to 1932 until Congress started to consider his impeachment. In
1921, he had successfully advocated that the high federal tax rates from World War
I were excessive, and that more moderate rates would lead to less tax evasion. In
boom times, and when the needs for services were at historic lows, he had been
effective at slowly but steadily decreasing the national debt by approximately half,
despite the low tax rates.
When the Great Depression hit, and perhaps because he was never really aware
of its full magnitude, Mellon thought the economic event was just a large market
correction that would “purge the system” and provide new motivation to work harder
after the fiscal and moral dissipation of the 1920s. At the beginning of the
depression, Mellon was able to keep tax rates for the wealthy extremely low and,
most importantly, cut government expenses, which only increased the pressure on
the economy. By the end of his presidential term, Hoover had overridden him,
increased taxes for the well-off, and expanded services for the unemployed, but it
was too late to make a difference in the economy and salvage any chance for his
re-election. Further, the tariff war that had been initiated during Hoover’s presidency
added to the collapse of international trade, which decreased more than two thirds
in the midst of the depression.
Franklin Roosevelt, who overwhelmingly won his campaign against Hoover, did
not have a clear idea of his “new deal” when elected President; however, he soon
realized in office that the Depression was still getting worse and, as bad as the
economy was in 1932 when he was elected, it had not yet hit bottom. He quickly
came to believe that the once-in-a-century event needed government to play the
financial role normally reserved for all-out war. He ultimately introduced long-term
counter-cyclical measures in the economic war, believing that government must
spend and go into debt in times of economic downturn and subsequently pay off
that debt when the economy was once again good. As discussed in Chapter 1, this
belief came to be called Keynesian economics.
Historical Development 87
88 Introduction to Business–Government Relations
Unemployed men queuing during the Depression outside a soup kitchen opened in Chicago by Al Capone
EXHIBIT 3.5
Source: Wikimedia Commons.
Exhibit 3.6 shows the change in government spending as a percentage of the Gross Domestic Product. In 1900, governments in the United States employed slightly more than one million people and spent less than 8 percent of GDP. This figure spiked during War World I and declined again during the tenure of Treasury Secretary Mellon. State and local government expenses soared after the Crash of 1929 and were soon matched by federal expenditures, despite falling revenues. After the spike in WWII spending subsided, government spending continued to creep higher until the downsizing rhetoric finally found its footing in the 1990s and early 2000s. From 1975 to 2007, average government spending was one third of the GDP. However, gigantic counter-cyclical measures to deal with the Great Recession of 2008, occurring at the end of George W. Bush’s presidency and the beginning of Barack Obama’s Administration, again increased the level of government spending to over 40 percent, despite a substantial drop in government revenue.
Government as Regulator
Responding to the Crash of 1929, President Franklin D. Roosevelt established the US Securities and Exchange Commission (SEC) in 1934. This independent, quasi-judicial regulatory agency was given the power to regulate the stock market and prevent corporate abuses in security offerings, sales, and financial reporting. It holds the primary responsibility to this day for enforcing federal securities laws and regulating the securities industry. In addition to the Securities Exchange Act of 1934 that created the regulatory agency, the Commission also enforced other tools to protect investors, including the Securities Act of 1933, the Trust Inden- ture Act of 1939, the Investment Company Act of 1940, and the Investment Advisers Act of 1940.
The American industrial revolution also produced a massive number of working laborers; however, there was virtually no labor legislation in the country. In 1874, Massachusetts passed the nation’s first law to limit the working time of women and children employed in factories to a maximum of 10 hours a day. By the 1930s, child labor was much reduced, as compulsory education laws tended to keep children in school most of the year. As part of the New Deal legislation, the National Labor Relations Act of 1935 granted workers the right to form unions and engage in collective bargaining. In 1938, the Fair Labor Standards Act set the maximum standard work week to 44 hours; it was further reduced to 40 hours in 1950. In 1967, the Age Discrimination in Employment Act prohibited employment bias based on age. In 1970, the Occupational Safety and Health Act was signed into law, which
Historical Development 89
Government spending as percentage of GDP, 1900–2012
EXHIBIT 3.6
55
50
45
40
35
30
25
20
15
10
5
0
P er
ce nt
ag e
G D
P
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Source: www.usgovernmentspending.com.
established the OSHA under the Department of Labor. OSHA’s mission is to
“assure safe and healthful working conditions for working men and women by
setting and enforcing standards and by providing training, outreach, education and
assistance.”1
A variety of laws at both the federal and state levels were passed to regulate
consumer affairs. At the federal level, consumer protection laws included the Fair
Debt Collection Practices Act of 1968, the Truth in Lending Act of 1968, the
Fair Credit Reporting Act of 1970, and the Fair Credit Billing Act of 1975, all
of which are enforced by the Federal Trade Commission and the Department of
Justice. At the state level, many states adopted the Uniform Deceptive Trade
Practices Act to prevent unfair or fraudulent business practices and untrue or
misleading advertising.
The federal government started to regulate water- and land-related pollution in
the 1940s. The regulation effort was extended to air pollution and hazardous waste
in the 1950s and 1960s. Citing rising concerns over environmental protection and
conservation, President Nixon created the EPA in 1970. The EPA serves to protect
human health and the environment by writing and enforcing regulations based on
laws passed by Congress. Today, the EPA oversees and enforces a series of air,
water, land, endangered species, and hazard waste regulations.
Government as Safeguard against Risk
The Great Depression had a devastating effect on people both rich and poor. In the
United States, unemployment rose to 25 percent. The poverty rate of senior citizens
exceeded 50 percent in the early 1930s (Garraty and Foner 1991). In 1935, President
Roosevelt introduced his “second new deal,” especially through the Social Security
Act. Social Security, referring to benefits based on old-age, widowed survivors, and
disability insurance (OASDI), is an insurance program that attempts to limit the
impact of old age on the elderly. This Act was complemented by the Medicare Act
of 1965, which addressed one of the largest expenditures of the elderly—health
care. Today, the combined spending for all social insurance programs, including
Social Security, Medicare, Medicaid, unemployment, and other welfare programs,
constitutes over half of federal government expenditure.
In addition to social insurance programs, the Glass–Steagall Act of 1933 created
the FDIC to provide deposit insurance, which guarantees the safety of deposits
in member banks. As of 2012, the FDIC warrants up to $250,000 per depositor
per bank.
Disaster assistance became a function of the President’s office after World
War II, and special appropriations became a yearly function. This function was
formalized into an agency in 1978 when the Federal Emergency Management
Agency (FEMA) was created and became a more formalized part of the annualized
budget process. Unlike the Johnstown Flood a century earlier, when survivors hoped
for charity and assistance from the Red Cross, the first thing victims in later-day
major disasters had come to ask was, “Where’s the [federal] government?”
90 Introduction to Business–Government Relations
Government as Social Architect
Public parks were largely created in the Progressive Era, but were greatly expanded
in the era of Big Government. In 1916, the National Park Service (NPS) was created
by Congress through the National Park Service Organization Act. The agency is
responsible for the management of all national parks, many national monuments,
and other conservation and historical properties with various title designations.
Though state park systems dated back to 1885, when New York designated Niagara
Falls as a state park, a massive expansion of the system started in the 1930s, when
around 800 state parks across the country were developed with assistance from
federal job-creation programs.
Many of the unemployed were put to work in building these parks by virtue of
the Works Progress Administration (WPA), which also provided massive aid to other
infrastructure projects across the county. At its height, the WPA provided
employment for over three million workers; it was abolished when its job was done
in 1943, and the country experienced a severe worker shortage due to the military
enlistment of over nine million citizens.
The Federal National Mortgage Association, commonly known as Fannie Mae,
was founded in 1938 during the Great Depression—as yet another part of the
New Deal—to expand home ownership by increasing the secondary mortgage
market. This allowed lenders to reinvest their assets into more lending, in effect
increasing the number of lenders in the mortgage market by reducing the reliance
on thrifts.
Government as Purchaser
State and local governments are primarily employers because of the services they
render, and they do a minimal amount of purchasing relative to the GDP.
Historically, the federal government was only a major purchaser during times of war, as Exhibit 3.6 indicates. However, after World War II, despite the initial
reduction of the military and its budget, the expenses of the military became
proportionately greater than they ever had been before. This occurred for two
reasons. First, there was a new sense that the United States was the primary bulwark
of democracy in the world, since World War II had ravaged Europe. Its standing
army requirements were many times greater than in the past, especially after the
Korean War (1950–1953). Second, the technology of war became increasingly
expensive as ships, airplanes, missile systems, and even soldier gear escalated in
price. For example, the famous World War II B-29 cost approximately $750,000,
or $10 million in current dollars, while the cost of the equally famous “stealth
bomber” (the B-2) ran to approximately $750 million dollars each, an increase of
1000 times in nominal dollars, or 100-fold in inflation-adjusted dollars. This
lucrative industry not only provides a huge internal market for American business,
but also adds to the private defense industry’s ability to be the leading arms exporter
in the world.
Historical Development 91
Government’s Other Roles in the Big Government Era
Government continued its huge role in infrastructure. Two examples are particularly important because they meld together the roles of transportation and national security. The first is the Federal Highways Act of 1959, which created the modern freeway system in the US. Although this was not the first federal highway Act, its massive scope and active federal planning transcended previous legislation. The second example was in 1970, when the Nixon Administration and the Federal Reserve provided financial assistance to Penn Central Railroad on the basis that the company provided crucial national defense transportation services. The argument to bail out Penn Central would be used again in future economic crises.
Government’s role as basic services provider was further advanced during the Big Government Era, increasing in rural services, such as rural electrification in 1936 to provide better urban–rural equity. Federal support of state and local welfare assistance programs became a larger part of state budgets. Welfare became more robust, leading to some complaints by the end of this period that it had, in fact, become too institutionalized and was creating a “welfare culture” for a segment of the poor. Corporate “welfare” also grew through a variety of tax incentive programs, sometimes referred to as tax loopholes.
Government’s role as promoter of export business was less obvious, but probably not diminished after World War II, when it became a superpower. A particular area of support was the oil industry, where the bulk of US-owned oil and gas production was on foreign soil after World War II. Domestically, after the Second World War, state and local government began creating economic development agencies (EDAs) to fight urban blight and decay. These agencies grew in size and scope, and eventually expanded to include rural blight, employment support in specialized “empowerment” zones, and even infrastructure.
Even as government still increased in size and scope in the 1970s, there were signs that the world was changing, and the roles of government would need to be shifted, and in some cases reduced, and occasionally even eliminated.
The Rightsizing Government Era (1970s–Present): Resurgence of the Market and Efforts in Shrinking Government
From the end of World War II through the 1960s, the United States was an economic powerhouse, with only the Soviet Union as its political and economic match in the Cold War era (1947–1991), a period of time when capitalist and communist ideologies were in a highly confrontational mode. By the 1970s, the hegemonic economic position (i.e., overwhelming dominance) of the US had eroded for a number of reasons.
First, the unique US economic position immediately after World War II could not be sustained. Because of the massive destruction of the advanced economies in Europe and Asia, the US inherited a manufacturing vacuum that was easy to fill. As world production capacities resumed in the decades after the war, US production returned to more realistic, although still very high, levels.
Next, the second age of colonialism ended (approximately 1860–1960). Even - tually this meant that a number of commodity industries were nationalized. In the
92 Introduction to Business–Government Relations
oil industry, this was particularly dramatic. International oil cartels, that came into existence as newly independent countries bound together, started demanding substantially higher prices, wreaking havoc in the US and other oil-dependent countries and affecting prices starting in 1973. As a result, government leaders attempted to control inflation by limiting spending, resisting tax cuts, and reining in growth in the money supply.
Additionally during this era, a series of government policies was enacted in an attempt to disinvest government responsibilities through deregulation, privatization, and devolution to the state (by the federal government) and to local governments (by the states), thereby reducing its roles as regulator and service provider. However, because of the popularity of government services, benefits and the stability it provides, the era of downsizing has neither been easy to accomplish nor consistent. Sometimes outright downsizing and deregulation has occurred. As frequently, however, government roles have adopted new programs as obsolete ones have been abolished, or it has had to reinstate some programs because of extraordinary needs.
Regulation and Deregulation
Influenced by the changes in the world economy and research at the University of Chicago—led by Milton Friedman (1912–2006), Friedrich Hayek, and others— governments started to deregulate some policy areas in the 1970s. Deregulation refers to the act or process of removing or reducing government regulations of business or industry. Transportation was the first major industry to be deregulated. It was initiated in the Nixon Administration and pursued by several administrations thereafter. It led to the passage of several deregulation Acts by Congress, such as the Railroad Revitalization and Regulatory Reform Act of 1976 during the Ford Administration, and the Airline Deregulation Act of 1978, Staggers Rail Act of 1980, and the Motor Carrier Act of 1980 during the Carter Administration. The movement gained much more momentum during the Reagan Administration. In 1980, Reagan promised an economic revival that would be achieved by cutting taxes and reducing the size and scope of federal programs. Simultaneously, Reagan introduced expan - sionary fiscal policies aimed at stimulating the American economy after a recession; thus federal control was reduced in many areas, but its overall budget was not. He also extensively deregulated banking, finance, and corporate reporting requirements.
Even though the goal of deregulation was to encourage economic growth by greater reliance on market forces, the results of deregulation were full of controversy. Some studies found that transportation deregulation did, in fact, lead to increased competition, communication choices, and creation of new firms and jobs. It was estimated that trucking deregulation alone produced a gain to US industries in shipping, merchandising, and inventories of between $38 and $56 billion per year (Moore 2007).
However, sometimes deregulation led to very poor results as well. In the financial sector, extensive deregulation policies were blamed for several economic crises (Cali, Ellis, and te Velde 2008). The poorly implemented savings and loan crisis of the late 1980s and early 1990s was caused by improperly guaranteeing deposits at savings and loan banks without regulatory controls, which encouraged them to make
Historical Development 93
risky investments. By the time the federal government stepped in, the bank insurance of most states had been wiped out and the number of savings and loans that collapsed skyrocketed to hundreds per year. A special federal agency, the Resolution Trust Corporation (in existence from 1989–1995) was set up with the mission of closing down and selling off the assets of approximately one quarter of all the S&Ls in the US—at a final cost of about $90 billion dollars. The industry was re-regulated.
This was followed by an extensive series of private sector accounting scandals in the early 2000s, which led the Sarbanes–Oxley Act of 2002 to re-regulate fiduciary responsibilities. The Great Recession of 2008 ultimately led to some re-regulation of the investment and commercial banking industry. On July 21, 2010, the Wall Street Reform and Consumer Protection Act was signed into law by President Barack Obama to strengthen the regulation of the financial market. An example of poor implementation of deregulation in the energy sector at the state level occurred in California in 2000. The energy deregulation policies in California led to an artificial spike in consumer costs by Enron that was estimated at between $40 and $45 billion (Weare 2003).
Service Provision
Besides deregulation, privatization was another policy largely pursued by governments in this era. Privatization is the process of transferring government services, functions, and public properties to private sector organizations, which include both for-profit and non-profit businesses. Under Reagan’s Administration, privatization gained its momentum. In 1987, a President’s Commission on Privatiza - tion was established to increase private participation across a broad range of policy areas, including low-income housing, air-traffic control, the postal service, prisons, and schools (Linowes 1988). The policy was also pursued by President George Bush, who carried on the privatization initiatives, especially in support of market mechanisms as the vehicle for school reform. Under the banner of “reinventing government,” the Clinton Administration drove the movement to its peak. With the mantra of “running government like a business,” governments at all levels introduced the private sector into publicly paid-for services. Government services ranging from trash collection to prison management have been increasingly contracted out to business firms, with a relatively high level of success.
Also notable was the 1996 welfare reform, which reversed the trend to increase support to the poor. Many states also reformed their welfare systems, and reduced benefits and services, although some of these services have been restored since the Great Recession in 2008. Unemployment benefits have historically received long “extensions,” both to prevent workers from descending into poverty and homelessness, as well as to help stabilize the economy.
Providing Monetary and Fiscal Control: Mixed Signals
The rightsizing government sentiment in finance accelerated in the last years of the Clinton Administration and during the bulk of the George W. Bush
94 Introduction to Business–Government Relations
Historical Development 95
Administration. In 1999, President Clinton signed the Graham–Rudman–Hollings Act, which repealed the Glass–Steagall Act of 1933, separating investment banking from deposi tory commercial banks. George W. Bush’s Administration implemented the new Act forcefully by downsizing the remaining oversight function. However, the 2008 financial crisis halted this “hands-off” trend, at least temporarily.
Recent government policies, especially those related to business affairs passed during and after the crisis, demonstrated once again the rationale of Keynesian economics. During the crisis, in order to bail out the failing financial industry, the federal government had to nationalize Fannie Mae and Freddie Mac, the two largest mortgage insurance companies that were created and privatized by Congress. The Federal Reserve System injected $85 billion to take the world’s largest insurance company, American International Group (AIG), under its control. It also injected over a trillion dollars of liquidity into the financial system to keep it from collapsing. In addition, Congress passed a $700 billion bailout bill to stabilize the whole financial system.
Meanwhile, the automobile industry, most notably the “Big Three”—General Motors, Chrysler, and Ford—also received a bailout of $35 billion to allow them to restructure and jettison their legacy debts. Following the crisis, Congress passed the Housing and Economic Recovery Act of 2008 to restore confidence in the domestic mortgage industry. Under the Act, the Federal Housing Finance Agency was established as a new regulator and endowed with expanded powers and authority.
Safeguard Against Risk
Contrary to the rightsizing trend, government expanded its role in healthcare reform with the passage of the Patient Protection and Affordable Care Act (PPACA) on March 23, 2010. With the intent to decrease the number of uninsured Americans, PPACA requires insurance companies to cover all applicants and offer everyone the same rates, regardless of pre-existing conditions or gender. Although sometimes criticized as a government takeover of the healthcare industry, it is more accurate to characterize it as an increase in the regulation of the industry, whose proportional costs exceed those of other advanced democracies.
Other Roles
While the government’s role as social architect/service provider increased with healthcare reform, it has decreased dramatically in education. States have tended to put less money into K-12 education as prison costs have soared, and have been steadily defunding their universities and community colleges for the last quarter century, a trend that accelerated after 2008. As a consequence, tuition at many public institutions has been rising rapidly to make up for the shortfall.
The role of promoter of business has been more mixed. On one hand, govern - ments at all levels have been keenly aware of increased global competition and have opened trade offices and sharpened their export skills. Domestically, however, the growth of economic development agencies has been questioned. Although California
96 Introduction to Business–Government Relations
EXHIBIT 3.7
Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac are known as government-sponsored enterprises, which refer to legal entities created by Congress to undertake commercial activities on behalf of government.
In 1938, President Roosevelt created the Federal National Mortgage Association (FNMA or “Fannie Mae”) to facilitate home sales and reduce bank failures during the Great Depression. Fannie Mae purchased, held, and insured mortgages from banks. This allowed lenders to create more mortgages at lower prices because the risks associated with mortgage defaults were shifted to Fannie Mae. The creation of Fannie Mae largely contributed to the home- ownership increase after World War II.
In 1968, the federal government privatized Fannie Mae, which became a publicly traded company. Two years later, Congress established the Federal Home Loan Mortgage Corporation (FHLMC or “Freddie Mac”) to provide loans and loan guarantees, which facilitated the emergence of a market for mortgage- based securities (MBS). Freddie Mac purchased a large quantity of mortgages,
The Colonial Revival headquarters of Fannie Mae, located at 3900 Wisconsin Avenue, N.W., Washington, DC. Source: Wikimedia Commons.
was the first state to create economic development agencies in 1945, it was also the first to withdraw all state support in 2012 in an effort to localize redevelopment and to reduce the diversion of tax monies from education to economic vitality. It remains to be seen whether this becomes a national trend. See Exhibit 3.8 for a synopsis of the eight roles of government (excluding defense and justice).
Ongoing Debate
The debate about the proper roles for government often gets heated, and sadly is often driven more by ideology than by facts and clear logic. As reviewed in Chapter 1, government and the private sector do have some overlap, but they have two different rationales. Each sector tends to have areas in which it is inherently stronger, but exceptions are not difficult to point out.
Overgeneralizing for clarity, government tends to be better at functions that call for democratic input, due process, a long-term perspective, equity, justice, and protection of the less fortunate. Business tends to be better at paying attention to market signals, creative destruction, a short-term perspective, customized oppor - tunities, wealth creation, and incentivizing individuals.
Of course, government should be business-like and business should be ethical. Yet government will never fully act as a business, because it is not a business and is expected to act like a government, with transparency, accountability, wisdom, fairness, and other democratic virtues. Nor should business be expected to act like a government, because that is not its function.
Historical Development 97
pooled them together, and sold mortgage-backed securities to investors. The guarantees of mortgages, as well as the pooling of mortgages, reduced the risk and encouraged more investment into the mortgage-backed securities and, subsequently, more bank lending. To compete with Freddie Mac, Fannie Mae adopted the same business strategy. Following the track of these two corporations, more and more private financial institutions entered the MBS market.
The 2008 subprime mortgage crisis hit Fannie Mae and Freddie Mac most severely, as they had been the major players in the mortgage market. As the two companies’ bonds were massively distributed among the public, including the retirement funds of hundreds of millions of people, general money market funds, domestic bonds owners, as well as foreign governments, their bank - ruptcy could lead to a global upheaval.
On September 7, 2008, the federal government took Fannie Mae and Freddie Mac under the control of the Federal Housing Finance Agency (FHFA). To advance funds for stabilizing the two corporations, the federal government had to increase the national debt ceiling by $800 billion, to $10.7 trillion, in order to accommodate the regulatory authority of the Treasury over the two firms.
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When the argument gets too heated, with one side asserting that government can do no wrong and the other asserting it can do no right, the argument becomes unsophisticated and misses the point. The important questions we want to ask are: Given our democratic and economic system, what do we want government to do? Given what we want it to do, how, then, can we ensure that it does as good a job as possible?
The first question is the scope-of-government question, which is primarily policy focused. We do not, for instance, have to have a city-run trash pick-up system, nor do we have to have a standing army. The issue is how well we understand the consequences so that we may plan accordingly. It is easy to privatize the city-run trash collection, and the consequences of poor implementation are relatively modest: increased costs and more littered streets. The consequences of privatizing the military, however, may result in not only increased costs, but national security concerns.
Rightsizing the scope of government is an appropriate cycle if the policy areas are considered carefully. Timing is also important in this question. Special support for the Post Office for 180 years made sense because of the vital need of the country to have a secure communication system. It made little sense in an age of multiple communication systems including the Internet, and when there were now other mail services such as Federal Express and UPS. Thus, it was privatized.
Providing financial regulations makes little sense unless, without those regulations, cheating and fraud become easy, common, and detrimental to the survival of the financial system itself. This came to pass after the collapse of Wall Street in 2008, and in a responsive measure, the securities market has now been some what re-regulated. Because of the complexity of financial regulation, it is difficult to see if the scope has been too much, too little, or just enough in the short-term.
Yet, as important as the scope is the question about the quality of government. Like business, sometimes it does a better job and sometimes it does not. Just as business is constantly evolving and reinventing itself, government needs to constantly change, too. However, generally we call business change “innovation,” and government change “reform.” So it is important not only to ensure that government’s roles fit the current times and needs, but is essential to assist it to do well in those roles. This book, Building Business–Government Relations, will enable you to look at both these complex issues more analytically, and give you the skills to critique both government and business, as well as arrive at your own more sophisticated ideas about the matters that surround the basis of our society.
ANALYTICAL CASE: SHOULD GOVERNMENT BAIL OUT THE BIG FINANCIAL COMPANIES?2
The 2008 financial crisis is thought by many to be the worst financial crisis since the Great Depression. The crisis was triggered by the burst of the housing bubble, a result of a complex interplay of government policies that encouraged home ownership and borrowing. Such government policies, in the absence of regulatory framework keeping up with new financial practices, led to irresponsible underwriting
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practices of both lenders and borrowers. These actions provided easier access to mortgages for subprime borrowers and contributed to the expansion of subprime lending.
The crisis started on March 10, 2008 when the Dow Jones Industrial Average plunged to its lowest level since October 2006, falling 20 percent from its peak just five months before. The downturn swept the whole of Wall Street. Bear Stearns, a global investment bank and securities trading and brokerage business, was among the worst affected. The company was interconnected with other banks up and down Wall Street. Fearing systemic risks that may affect the financial system as a whole, should Bear Stearns go bankrupt, Ben Bernanke, the Chairman of the Federal Reserve, determined the risks were too great to allow a Bear Stearns bankruptcy. The worry was also shared by Henry Paulson, the Secretary of the Treasury Department. In pondering whether to bail out Bear Stearns, Paulson posed the question of moral hazard: If you bail someone out of a problem caused by themselves, what incentive will they have to avoid making the same mistake in the future?
Anticipating the system risk, the Federal Reserve Bank of New York provided an emergency loan to Bear Stearns; however, it still could not avert the collapse of the company. Finally, the company was forced to be sold to JPMorgan Chase for a price far below its pre-crisis market value.
This was just the prelude of the crisis. Within six months of the federal takeover of Fannie Mae and Freddie Mac, as well as the selling of Merrill Lynch to Bank of America, Lehman Brothers started to collapse. This time, moral hazard trumped system risk. Bernanke and Paulson, under the pressure of exhausting bailout funds, decided not to intervene, in the hope that the risk of Lehman Brothers’ bankruptcy could be contained. Lehman Brothers’ bankruptcy, however, triggered a market avalanche. The stock market dropped by hundreds of points right after the opening bell. The company was far more interconnected than Bernanke and Paulson had thought. Systemic risk became a reality. Banks stopped lending in the fear that other banks would not be able to pay them back. The credit markets became frozen and commerce ground to a halt.
Meanwhile, the world’s largest insurance company, American International Group (AIG) was plunging to the rim of bankruptcy. AIG had invested tens of billions in risky investments that were tied to the housing market. The precipitous failure of such a big organization can be extremely disruptive. Fully aware of the potential risk, the Fed decided to lend AIG $85 billion and took the world’s largest insurance company under government control.
As one firm after another crumbled, systemic risk kicked in and a fear of losing control swept over Wall Street. Bernanke was afraid that the meltdown could no longer be handled on a case-by-case basis and the Fed reached its limit. They had to get government involved in a broader rescue.
On September 18, Paulson and Bernanke met with key legislators to propose a $700 billion emergency bailout through the purchase of toxic assets. On October 3, 2008, President George W. Bush signed the Emergency Economic Stabilization Act and approved the $700 billion bailout bill.
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Questions for Discussion and Analysis
1. Should government rescue these big financial companies? What are the implications of the bailout?
2. How would Adam Smith and Alexander Hamilton view the bailout? 3. How could we effectively prevent such a crisis from happening in the future?
PRACTICAL SKILL
Accessing resources for starting a business
If you want to start a business legally and smoothly, like Zoey is trying to do, you need to deal with many issues. Many people who start a business may not be as lucky as Zoey, who earned an entrepreneurial management degree. The good news is that government provides abundant resources to help small businesses to start and to grow.
A very useful resource for business starters is the Small Business Administration (SBA). The agency’s official website (www.sba.gov) offers comprehensive guidelines for starting a business. The agency also runs over 300 district offices across the country, providing professional counseling, training, and business development services. Special assist - ance is also offered to women, veterans, and export-oriented business owners. Most small businesses rely on lenders to provide the capital they need to either open a business or to finance capital improve ments. Even though the SBA does not loan money directly to small business owners, it offers extensive loan assistance and loan programs to help them finance or grow their business. Information about its loan programs and services is available at the website.
Skill Exercise: Government’s roles in starting a business
Study the guidelines for starting a business on the SBA website. Create a list of things you need to deal with when starting a business, highlight the issues that concern government, and link the issues to the various government roles introduced in the chapter.
Find the SBA district office in your community. Search for programs the office offers to businesses.
SUMMARY AND CONCLUSION
1. Government plays many roles with business.
2. Under the prevailing Anti-Central Government sentiment, the powers of govern - ment were initially extremely limited at the founding of the republic under the Articles of Confederation.
102 Introduction to Business–Government Relations
3. The government was reformulated under the Constitution to allow a greater, but still balanced, role for a central government whose powers were shared with states and citizens, as well as its own branches. For one hundred years, the Small Government Era demonstrated a substantial role in transportation infrastructure and the promotion of business, but less in fiscal and monetary infrastructure, purchasing, and social architecture, and virtually none in business regulation and risk protection.
4. The Moderate-Sized Government Era developed the role of regulator most forcefully to deal with the growth of the modern monopoly. Almost all other roles expanded as well.
5. The Big Government Era was shaped by the Great Depression and World War II. Financial infrastructure, purchasing, social architecture, and risk protection all reached very high levels by the end of the period.
6. Starting from the late 1970s, the resurgence of the market model pressed government into considering Rightsizing through deregulation and privatization. Government generally reduced its roles as regulator and service provider and was considered successful and moderately popular. However, some deregulation had dire consequences and had to be reinstituted.
7. The 2008 economic crisis brought the nation into a heated debate about the many roles of government and exactly which ones should be reduced, shifted, or even increased. Sometimes lost in this discussion is the importance of the quality of those policies. If well done, an appropriate assortment of regulation and deregulation policies can lead to balance, stability, and a healthy market, or, if not done well, can lead to a bloated governmental structure or encourage private sector corruption.
The Confederation Deregulation Moral hazard
Privatization System risk
KEY TERMS
STUDY QUESTIONS
1. What do you think is the proper role of government in business affairs? What role(s) of government should be enhanced or reduced?
2. According to the theories of Smith, Hamilton, Keynes, and Hayek, what are the proper roles of government in the economy? What were the historical conditions that led to the popularity of their theories, respectively?
3. Consider what might have happened if there had been no anti-trust regulations in the United States. What would subsequent American history have been like? Would the eventual popular sovereignty have been destroyed or advanced?
4. Despite the historical preference for small government, American governments’ roles and responsibilities are constantly expanding. Why did this happen? What are the factors that lead to government expansion? What do you think are the effective ways of rightsizing or shrinking government?
Notes
1 See the OHSA website: http://www.osha.gov/about.html.
2 The case is developed largely based on the PBS Frontline documentary Inside the Meltdown at http://www.pbs.org/wgbh/pages/frontline/meltdown/.
References
Bardes, B., Shelley, M. C., and Schmidt, S. W. (2012). American Government and Politics Today: The Essentials, 2011–2012 edn. Boston, MA: Wadsworth Cengage Learning.
Cali, M., Ellis, K., and te Velde, D. W. (2008). The Contribution of Services to Development: The
Role of Regulation and Trade Liberalization. Overseas Development Institute, Project Briefing,
No. 17, December 2008. URL: http://www.odi.org.uk/resources/docs/2382.pdf.
Jefferson, T. (1975). First Inaugural, in M. D. Peterson (ed.) The Portable Thomas Jefferson (p. 290). New York: Penguin Books.
Depew, C. (ed.) (1895). One Hundred Years of American Commerce 1795–1895 (p. 111). New York: D.O. Haynes & Co.
Graham, P. A. (1974). Community and Class in American Education, 1865–1918. New York: Wiley. Garraty, J. A. and Foner, E. (1991). The Reader’s Companion to American History. New York:
Houghton Mifflin.
Linowes, D. F. (1988). Privatization: Toward More Effective Government. Report of the President’s Commission on Privatization. Urbana: University of Illinois Press.
Moore, T. G. (2007). Trucking Deregulation, in D. R. Henderson (ed.) The Concise Encyclopedia of Economics. The Library of Economics and Liberty. URL: http://www.Econlib.org/ library/Enc1/TruckingDeregulation.html.
Weare, C. (2003). The California Electricity Crisis: Causes and Policy Options. San Francisco, CA: Public Policy Institute of California. URL: http://www.ppic.org/content/pubs/report/r_103
cwr.pdf.
Weitzel, M. (2011). History of Army Contracting. US Army. URL: http://www.army.mil/ article/54337/History_of_Army_Contracting/. April 4, 2011.
Yergin, D. (1991). The Prize: The Epic Quest for Oil, Money, and Power. New York: Simon and Schuster.
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