Ethics and Culture

E X C H A N G E

The Future of the U.S. Business Model and the Rise of Competitors by Peter Cappelli

Executive Overview For at least two generations, the United States provided the most important model for organizing business activities. Explicit efforts to export U.S. ideas about economics were part of an effort to counter communism, but equally important were lessons about how to structure and operate individual business, transferred in part by U.S. multinationals but also through the power of example. The rise of extremely successful economic competitors operating with different business and economic models in the 2000s provided counterexamples to the U.S. approach and coincided with concerns about the merits of U.S. practices, driven first by accounting scandals in the late 1990s and accelerating with the Wall Street financial crisis of 2008. These twin developments have called into question the future role of the United States as a model for business in the rest of the world. The articles in this Exchange consider the future of the U.S. example in the competition for influence along with other models that are competing for attention from the world business community.

I t is not surprising that the United States emerged as the dominant economic power after World War II and, in turn, the source of the most influential

ideas for the business community around the world. Before the war, multinational companies such as Ford were already exporting the assembly line model and the large-scale manufacturing associated with it that had been developed in the United States. After the war, competition for leadership was swept away because the United States was the only industrial country other than Sweden to survive with its pro- duction base intact. Prewar Japan’s mercantile model for business had some influence before the war but obviously lost influence when it was disman- tled after the war. The Soviet Union represented the most important and influential alternative economic and political model, especially for developing coun- tries, and it would remain a challenger to U.S. mod- els through the early 1980s. But the Soviet Union offered relatively little in terms of ideas to countries

that were not committed to socialist economic mod- els and especially little to businesses (an exception was the planning model, especially five-year plans, which were popular even with U.S. corporations).

It is also fair to note that the U.S. government invested considerable resources to tout U.S. prac- tices and principles to other countries, not just in broad strokes (e.g., democracy and capitalism) but at the level of operating practices. These efforts included programs for teaching U.S. business and management practices overseas, for bringing for- eign visitors to the U.S. to observe, and for hands-on advocacy in other countries, especially in labor policy.1

The important attributes of the U.S. business

1 U.S. government support for U.S.-style trade unions in developing countries, for example, was extensive and was part of a more general effort to counter communist advocacy. Many of these outreach efforts were conducted through the AFL-CIO and various ostensibly independent “Free Labor Institutes.” See, e.g., Herrod, 1997.

Peter Cappelli ([email protected]) is George W. Taylor Professor of Management at The Wharton School and NBER.

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model after World War II are the subject of con- tinuing debate, but there is general agreement on the following:2

● A corporate model of ownership and organiza- tion. This was in contrast to family-owned and smaller-scale operations that were more typical especially in Europe.

● Large-scale production operations based on mass-production principles.

● Open markets and informal oligopolies such as the “Big Three” auto companies. This is in contrast to the many more formal cartels that were common in Europe and to a lesser extent Asia.

● Formal organizational structures relying on hi- erarchies and complex, M-form models. This is, again, in contrast to informal organizational forms associated with smaller, family-based businesses.

● Workplace organization based on collective bargaining with trade unions whose goals were explicitly practical rather than political.

Important elements of this model were imposed on Japan and, to a lesser extent, on Germany after the war. Whether the transfer of practices to other countries represented a true convergence to the U.S. model or a more adaptive process of borrow- ing and tailoring is a subject of some debate.3 But there is little doubt that the most influential busi- ness models for at least a generation after the war came from the U.S.

That changed somewhat after the OPEC oil price shocks of the 1970s. The success of Japanese business, especially its fuel-efficient auto compa- nies, combined with the poor performance of the U.S. economy in the early 1980s, helped spread Japanese management practices around the world. Practices from other countries, perhaps most no- tably apprenticeship programs in Germany and Scandinavia, had influence in the international

community as well. Although it was down, the U.S. model was soon to reinvent itself and stage a substantial comeback.

Financialization

U .S. practices evolved in important ways after the 1980s, in part in response to the shakeups of government deregulation, pursued first by

President Carter in the form of eliminating ex- plicit product market regulations in transporta- tion, finance, and other industries and then ex- tended by President Reagan to reduce all forms of regulation on business. The idea was that the best way for economies to develop was to reduce the role of government—lower taxes and subsidies, less regulation—and encourage private ownership. This model, based on open markets, became known as the “Washington consensus,” reflecting the fact that these principles for stimulating economic growth were shared by the U.S. government and the international institutions over which it had great influence, especially the International Monetary Fund (e.g., Williamson, 1993).

Then Federal Reserve Board Chairman Alan Greenspan articulated the idea that the rest of the world was moving toward this U.S. model in his statement to Congress during the 1998 Asian fi- nancial crisis: “My sense is that one consequence of this Asian crisis is an increasing awareness in the region that market capitalism, as practiced in the West, especially in the United States, is the superior model.” He went on to emphasize the importance of “greater reliance on market forces, reduced government controls, scaling back of gov- ernment-directed investment, and embracing greater transparency” as being central to the U.S. approach (Greenspan, 1998).

These free-market reforms did expand around the world, along with a quite remarkable growth in democratization. The proportion of countries with democratic governments, for example, dou- bled from 1980 to 2000, to 60% (Simmons, Dob- bin, & Garrett, 2006). A reduced role for the state in business and an increased role for individual property rights did seem to go hand-in-hand with an increased role for individual political rights, which contributed to the idea that the U.S.

2 There is a long literature on the attributes of the U.S. model as well as a separate literature, more developed outside the U.S., on the spread of U.S. practices abroad. One of the seminal works in this area is Djelic, 1993.

3 For the convergence view, see Abramovitz (1994). For the view that the process was more about learning and adapting, see Zeitlin and Herrigel (2000). For classic studies about the patterns of business practices around the globe and the forces that shape them, see Guillen (1994) and Whitley (1999).

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model— both of government and the economy— was spreading.

The U.S. business community also argued vo- ciferously that the key to its competitiveness was the ability to restructure quickly when operations proved uncompetitive and, in turn, to be able to start up quickly in a different direction. As a practical matter, that meant having greater ability to lay off workers, close facilities, and move on. Unions and employment regulations were seen as obstacles to competitiveness (Potter & Young- man, 1994). The apparent success of Silicon Val- ley and its model based on constant restructuring with job cuts and outside hiring seemed especially compelling (Saxenian, 1994).

A further evolution of the U.S. model in the 1990s centered on the goal of securing greater importance for profit as the primary goal of busi- ness, in contrast to earlier “stakeholder” models, which asserted that businesses had many stake- holders other than shareholders and that the in- terests of these different stakeholders had to be balanced. This new approach became known as “financialization” because of this emphasis on fi- nancial goals and the pursuit of shareholder value. Many factors contributed to its rise, one of the most important of which was public policy (e.g., court rulings in shareholder-driven lawsuits ex- panding their interests).4 Dore (2006) asserted that the growth of an intermediating financial industry followed from the notion of property rights as transcendent. The newly empowered fi- nancial industry essentially governed business by relying on free market pricing of equity assets to reward or punish businesses based on their profit performance. This industry includes private-sector agencies that rate and evaluate companies based on the assumption of transparent financial infor- mation as well as traders who themselves profit from the buying and selling of and speculation concerning equities. Government policies encour- aged individuals to participate in financial mar- kets through owning stock. An ancillary outcome of financialization was that the financial indus- tries themselves became influential and extraordi- narily wealthy.

The development associated with financializa- tion that was arguably easiest to spot was the rise of financial incentives to encourage executives to operate their businesses to maximize shareholder interests in profit. Ironically, the expansion of financial incentives was encouraged by govern- ment efforts to limit executive pay by prohibiting salaries in excess of $1 million from being claimed as business expenses: Compensation shifted to stock-based components as a result. In the early 1990s, less than 10% of total executive compen- sation at publicly held firms was accounted for by pay that was contingent on stock prices, but by 2003, that figure was almost 70% (Hall, 2003). Evidence suggested that aligning the interests of executives to those of shareholders across coun- tries led to better corporate performance, although that was perhaps not surprising given the lack of any systems for managing executives in some countries (Gugler et al., 2003). The longest eco- nomic expansion in U.S. history and an exploding stock market helped persuade the world that there was something to the U.S. way of doing business. The financial industry itself along with compen- sation consultants pushed to extend the financial- ization model to other countries (Conyon et al., 2009).

Challenges to the New U.S. Model

B y the beginning of the 21st century, it was easy to believe that the United States was once again providing the most important and influ-

ential lessons for running economies and espe- cially for operating businesses. But that perception would not remain unchallenged for long. The first challenge to the dominance of the U.S. approach, especially the financialization practices, came with the unending (as of this date) stream of corporate financial scandals that began in the mid-1990s. The common theme across all these scandals was financial fraud in various forms, at- tempts by executives to manipulate finances in order to improve share prices and enrich them- selves. The most prominent of these were malfea- sance on such a monumental scale that it literally brought the company down, such as Enron, WorldCom, Adelphia, and Global Crossing. But the list of companies where financial malfeasance4 See Epstein, 2005.

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was not quite bad enough to force the failure of the company is much longer, including Xerox, Sunbeam, Waste Management, Tyco, Health- South, and others.

One marker for financial irregularities is earn- ings restatements, in which companies revise earnings that had previously been presented as accurate. These restatements represent serious ac- counting errors. The General Accounting Office calculated that these restatements, once quite rare, grew by 145% from 1997 to 2001, and about 10% of all publicly traded companies restated earnings during that period (GAO, 2002). Fur- ther, all the major accounting firms were involved in cases of audit failure, in which the firms were found not to have followed standard audit proce- dures.

The fact that these scandals were so common in the United States and so much less so in other countries suggests that something about the finan- cialization practices in the U.S. might be to blame. And the compensation systems that reward U.S. executives for improving share prices were a leading candidate (Coffee, 2005). Could the U.S. model be such a good thing if it was associated with so much outright fraud and put so many companies at risk?

The Sarbanes-Oxley Act of 2002 was enacted in response to these financial scandals. The Act extended some of the principles of financialization by pressing for better transparency of information to allow the market-based governance controls to work better: requirements to ensure the quality of financial reporting; substantial penalties for lack of compliance; and greater oversight of audit firms, security analysts, and the other participants in the financial industry who evaluate financial performance. Pressures to extend the arrange- ments associated with Sarbanes-Oxley to other countries were explicit when foreign companies needed to operate in U.S. financial markets and were implicit through arguments that these prac- tices were the new “best practices” in corporate governance (e.g., the Clause 49 reforms in India).5

The second challenge to the U.S. approach began at roughly the same time with the steady

rise of foreign competitors that did not follow the “Washington consensus.” These were led by the “Asian tigers”—South Korea, Singapore, Hong Kong, and Taiwan, fast-growing economies whose strong governments, not traditional democracies, controlled trade practices and used subsidies and industrial policies to build targeted industries and then the economy. The businesses in these coun- tries were sophisticated competitors by the mid- 1990s, but the economies themselves were still relatively small. The real challenge to U.S. busi- ness hegemony would come in the next decade with the economic expansion of the largest coun- tries in the world: Brazil, Russia, India, and China, called the BRIC group.

The Chinese economy grew a blistering 99% from 2001 through 2007, compared to a more anemic 18% in the United States. And it did so with a nondemocratic, communist political system and a government that was heavily involved in managing and regulating all aspects of business, from trade practices to targeted industry invest- ments. India grew by 66% in the same period, fastest most recently, competing more directly than China with the United States in higher skilled industries. While India threw off much of the central planning of its socialist government in the reforms of 1991, the government still plays a much more significant regulatory role than in the United States. India also lacks the influential in- vestor markets, powerful financial intermediaries, and shareholder maximizing goals of the U.S. fi- nancialization model. Russia’s 55% growth rate in this period was attributable mainly to natural re- sources, making its example relevant to fewer countries. But its system of outright government control over large business operations, where fi- nancial transparency is hardly apparent and finan- cial intermediaries are weak, looks nothing like the U.S. approach. Brazil is the most similar to the United States in its more modest rate of growth (24%), although it is innovating and leading in many of the industries where the U.S. has been dominant, particularly agriculture and aerospace. Brazil’s socialist party government has proven to be reasonably centrist with respect to economic and business policy yet still much more activist than the United States.5 See, e.g., Chakrabarti, Megginson, and Yadav (2008).

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As evidence of the changing balance of world economic influence, the United States accounted for roughly 27% of world gross domestic product from 1950 through 1990. By 2008, that figure had dropped to 20%.6 One of the hallmarks of the U.S. model had been large corporations. In 1980, for example, only 2 of the 10 largest corporations in the world were based outside the United States; both were oil companies. By 2008, 6 of the top 10 were foreign-based. When we look within industry categories, the results are even more surprising: Among conglomerates, a category of business per- fected in the United States in the 1960s, only 4 of the top 10 now are U.S.-based; in consumer du- rables (which includes autos), another category the United States had completely dominated, only 1 of the top 10 is U.S.-based (Forbes, 2009).

Other evidence of the change in business in- fluence can be seen in the assessments of business schools. The Financial Times first ranked MBA programs worldwide in 1999 and included only 3 non-U.S. schools in the top 20. By 2008, a ma- jority (11) of its top 20 schools were outside the United States.7

The 2008 Financial Crisis

T he collapse of financial institutions that began with Wall Street investment banks (Bear Stearns, Lehman Brothers, Merrill Lynch)

quickly spread to the banking sector and from there to financial institutions around the world. The credit squeeze that accompanied the sharp fall in the value of financial assets led to a worldwide recession, the worst in the United States since 1982– 83.8

The U.S. Director of National Intelligence ar- gued in 2008 that the biggest threat to U.S. secu- rity and to its long-term position in the world has to do with the current financial crisis. It is leading to “increased questioning of U.S. stewardship of

the global economy” (Mazzetti, 2009). By early 2009, the extent to which much of the rest of the world blamed the United States for the 2008 financial crisis and subsequent world recession— both government policies (e.g., lack of regulation) and business practices (e.g., the focus on share- holder value and incentive-based executive pay)—was palpable at international gatherings (Dougherty & Bennhold, 2009). In response to these criticisms as well as to the growing financial power of other countries, the meetings of the financial ministers of the leading industrialized countries known as the Group of Seven or G-7 expanded in 2009 to 20 countries and is now known as the G-20.

The National Intelligence Council of the U.S. government develops probable scenarios for world events. It argues that the fastest growing econo- mies in the near future will likely follow a “state capitalism” approach that sees a powerful role for government in shaping and controlling business (GPO, 2009), a direct rebuff to the U.S. model.

Given these developments, we asked three prominent researchers of international business to consider the future role of the U.S. model as well as the most likely challengers for influence on the international scene. Their accounts suggest a richer menu of choices and the possibility of greater heterogeneity in the international econ- omy going forward.

References Abramovitz, M. (1994). Catch-up and convergence in the

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Chakrabarti, R., Megginson, W., & Yadav, P. K. (2008). Corporate governance in India. Journal of Applied Cor- porate Finance, 20(1), 59 –72.

Conyon, M. J., Peck, S., & Sadler, G. V. (2009). Compen- sation consultants and executive pay: Evidence from the United States and the United Kingdom. Academy of Management Perspectives, 23(1), 43 –55.

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Dougherty, C., & Bennhold, K. (2009, January 28). Russia and China blame capitalists. New York Times. Retrieved

6 Estimates of world GNP are not necessarily straightforward because they are aggregated from individual country estimates, which are not always accurate or even consistent. There are many sources of world GNP data. This one is taken from the CIA World Factbook.

7 See http://rankings.ft.com/businessschoolrankings/global-mba-rankings. 8 The National Bureau of Economic Research determines recessions

based on trends in a complex set of economic variables. Interestingly, unemployment is not one of those variables, although it is the measure most frequently associated with recessions. U.S. unemployment in 1982 peaked at 10.8% and stands in March 2009 at 8.5%. See http://www.bls.gov/cps/.

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