Fixing capitalism--THE PURPOSE OF CORPORATIONS REVIEWED
CO AUTHORS DTMS ET AL D T M S AS WELL AS MANY OTHER ANAGRAMS
HARRIS ( K O N S T A N T I N O S ) NOTTAS2019, various
Fixing capitalism CEO compensation has grown 940% since 1978 Typical worker compensation has risen only 12% during that same time (see separate PDF) Even for those wary of the intentions and sincerity of the world’s leading CEOs, the recent statement on “the Purpose of a Corporation” from the Business Roundtable represents an extraordinary shift for the business leaders. Signed by 181 CEOs, including Apple’s Tim Cook and Amazon’s Jeff Bezos, it commits their companies to go beyond looking at maximizing shareholder value to more broadly investing in employees, communities, and generating long-term value for the shareholders. Obvious stuff, you might think. But it represents a break with the sole purpose of maximizing shareholders’ profits, a strategy that has dominated corporations since the late 1970s (remember “greed is good” and Gordon Gekko). Andrew Ross Sorkin provides an excellent explanation and background to just how radical the shift is in corporate history, tracing the obsession with, as he calls it, shareholder primacy back to Milton Friedman and his “gospel of profits-as-purpose.” The shift has not been sudden, though. Alan Murray provides some more insight and background in his Fortune piece. Though he notes that “Friedman must be turning in his grave,” Murray explains how the turnaround came about after the 2007-2008 financial crisis and questions over the role of capitalism and rising inequality. Also, some good analysis here as part of Business Insider’s series on “Better Capitalism.” But to truly understand what’s at stake here, it is worth looking at two upcoming books on the last 50 years of economic history: Nicholas Lemann’s “Transaction Man” and Binyamin Appelbaum’s “The Economists’ Hour.” A great review of the books is in the latest issue of the Atlantic. An extended excerpt from Lemann’s book is compelling reading. Of course, it’s easy to question the sincerity of the CEOs signing the statement and how much they are willing to push for change. For one thing, it said nothing about their soaring levels of pay and how that has damaged corporate America’s credibility. The numbers are staggering and map almost precisely to rush to maximize shareholder profits in the late 1970s; from 1978 to 2018 CEO compensation grew by 940% while that for typical workers rose by 12%. So, yes, the CEOs did maximize something, but not necessarily shareholder value. SEE SEPARATE PDF However, something is missing from much of this discussion. The shift to maximizing shareholder profits also marked the beginning of the death of corporate R&D—or at least the kind of science-based research that was common in the 1960s and 1970s (pdf). Short-term profits had no room for such investments and today we’re suffering from this lack of corporate research. We will see if the new commitment to “generating long-term value” will also renew investments in R&D. So far, there is little sign of it.
Related papers
The political economy of CEO compensation [International Bernheim workshop on Fair CEO Compensation, Louvain-la-Neuve, 2012]
Unpublished Working Paper
A Hierarchy Model of Income Distribution
Based on worldly experience, most people would agree that firms are hierarchically organized, and that pay tends to increase as one moves up the hierarchy. But how this hierarchical structure affects income distribution has not been widely studied. To remedy this situation, this paper presents a new model of income distribution that explores the effects of social hierarchy. This 'hierarchy model' takes the limited available evidence on the structure of firm hierarchies, and generalizes it to create a large-scale simulation of the hierarchical structure of the United States economy. Using this model, I conduct the first quantitative investigation of hierarchy's effect on income distribution. I find that hierarchy plays a dominant role in shaping the tail of US income distribution. The model suggests that hierarchy is responsible for generating the power-law scaling of top incomes. Moreover , I find that hierarchy can be used to unify the study of personal and functional income distribution, as well as to understand historical trends in income inequality.
Capitalist Income and Hierarchical Power: A Gradient Hypothesis
This paper offers a new approach to the study of capitalist income. Building on the 'capital as power' framework, I propose that capitalists earn their income not from any productive asset, but from the legal right to command a corporate hierarchy. In short, I hypothesize that capitalist income stems from hierarchical power. Based on this thinking, I hypothesize that the capitalist fraction of an individual's income is a gradient function of hierarchical power (which I define as the number of subordinates under one's control). Using data from US CEOs, I find evidence that this is true. Furthermore, a hierarchical model of the United States that generalizes this data accurately reproduces many aspects of the US distribution of capitalist income, including the relation between income size and capitalist income fraction. This evidence suggests that the ownership structure of US society is closely linked to the hierarchical structure of firms. This has important implications for the study of income distribution.
Executive Compensation: A Survey of Theory and Evidence
This paper reviews the theoretical and empirical literature on executive compensation. We start by presenting data on the level of CEO and other top executive pay over time and across …rms, the changing composition of pay; and the strength of executive incentives. We compare pay in U.S. public …rms to private and non-U.S. …rms. We then critically analyze three non-exclusive explanations for what drives executive pay –shareholder value maximization by boards, rent extraction by executives, and institutional factors such as regulation, taxation, and accounting policy. We confront each hypothesis with the evidence. While shareholder value maximization is consistent with many practices that initially seem ine¢ cient, no single explanation can account for all facts and historical trends; we highlight major gaps for future research. We discuss evidence on the e¤ects of executive pay, highlighting recent identi…cation strategies, and suggest policy implications grounded in theoretical and empirical research. Our survey has two main goals. First, we aim to tightly link the theoretical literature to the empirical evidence, and combine the insights contributed by all three views on the drivers of pay. Second, we aim to provide a user-friendly guide to executive compensation, presenting shareholder value theories using a simple unifying model, and discussing the challenges and methodological issues with empirical research. (JEL
Growth and distribution after the 2007–2008 US financial crisis: who shouldered the burden of the crisis?
The post-1980 era witnessed an increase in the frequency and severity of financial crises around the globe, the majority of which took place in low-and middle-income countries. Studies of the impacts of these crises have identified three broad sets of consequences. First, the burden of crises falls disproportionately on labor in general and low-income segments of society in particular. In the years following financial crises, wages and labor share of income fall, the rate of unemployment increases, the power of labor and labor unions is eroded, and income inequality and rates of poverty increase. Capital as a whole, on the other hand, usually recovers quickly and most of the time gains more ground. Second, the consequences of crises are visible not only through asset and income distribution, but also in government policies. Government policies in most cases favor capital, especially financial capital, at the expense of large masses. In addition, many crises have presented opportunities for further deregulation and liberalization, not only in financial markets but in the rest of the economy as well. Third, in the aftermath of financial crises in low-and middle-income economies, capital inflows may increase as international capital seeks to take advantage of the crisis and acquire domestic financial and non-financial assets. The 2007–2008 financial crisis in the US provides an opportunity to extend this analysis to a leading high-income country and see if the patterns visible in other crises are also visible in this case. Using the questions and issues typically raised in examinations of low-and middle-income countries, we study the consequences of the 2007–2008 US financial crisis and complement the budding literature on the 'Great Recession.' In particular, we examine the impacts of the crisis on labor and capital, with a focus on distributional effects of the crisis such as changes in income shares of labor and capital, and the evolution of inequality and poverty. We also analyse the role of government policies through a study of government taxation and spending policies, and examine capital flow patterns.
Public sector austerity and its spill-over effects
THE WAGES CRISIS IN AUSTRALIA: What it is and what to do about it, 2018
This chapter describes the impact of public sector austerity in Australia in recent years, with a particular focus on its spill-over effects on broader labour markets. The chapter begins by reviewing the traditional justifications for public sector austerity — arguments that, since the Global Financial Crisis (GFC) and the Great Recession, have increasingly been called into question. The next section of the chapter outlines several specific austerity policies that have been applied to public sector employment and wage determination in Australia. These mechanisms have included the privatisation of public services, marketisation of public services, outsourcing of public sector work, downsizing of public services and administration, the application of so-called efficiency dividends to departmental budgets, and explicit caps on public sector wage growth. The chapter then considers the ‘chilling effects’ that these forms of public sector employment and wage austerity have had: not only directly on public sector employment and remuneration, but also indirectly on broader labour market outcomes (including in the private sector). These spill-over effects are especially visible in the years since the end of the mining investment boom around 2012 — which is exactly the time period that witnessed the unprecedented deceleration of overall wage growth in Australia. The final section of the chapter makes the case for treating public sector employment and wage decisions as both a key instrument of macroeconomic policy, and a means to creating a ‘good society’. The chapter concludes with several specific policy recommendations that, if implemented, would constitute a decisive break with the logic and practice of public sector austerity, and would help to ameliorate the broader problem of wage stagnation in Australia.
Executive Compensation, Fat Cats and Best Athletes
SSRN Electronic Journal, 2000
The Growth of US Top Income Inequality: A Hierarchical Redistribution Hypothesis
What accounts for the growth of US top income inequality? This paper proposes a hierarchical redistribution hypothesis. The idea is that US firms have systematically redistributed income to the top of the corporate hierarchy. I test this hypothesis using a large-scale hierarchy model of the US private sector. My method is to vary the rate that income scales with hierarchical rank within mod-eled firms. I find that this model is able to reproduce four intercorrelated US trends: (1) the growth of the top 1% income share; (2) the growth of the CEO pay ratio; (3) the growth of the dividends share of national income; and (4) the 'fattening' of the entire income distribution tail. This result supports the hierarchical redistribution hypothesis. It is also consistent with the available empirical evidence on within-firm income redistribution.
How the Rich Are Different: Hierarchical Power as the Basis of Income and Class
SocArXiv, 2019
What makes the rich different? Are they more productive, as mainstream economists claim? I offer another explanation. What makes the rich different, I propose, is hierarchical power. The rich command hierarchies. The poor do not. It is this greater control over subordinates, I hypothesize, that explains the income and class of the very rich. I test this idea using evidence from US CEOs. I find that the relative income of CEOs increases with their hierarchical power, as does the capitalist portion of their income. This suggests that among CEOs, both income size and income class relate to hierarchical power. I then use a numerical model to test if the CEO evidence extends to the US general public. The model suggest that this is plausible. Using this model, I infer the relation between income size, income class, and hierarchical power among the US public. The results suggests that behind the income and class of the very rich lies immense hierarchical power.
CEO compensation has grown
940% since 1978
Typical worker compensation has risen only 12%
during that time
Report • By Lawrence Mishel and Julia Wolfe • August 14, 2019
• Washington, DC
View this report at epi.org/171191
Summary
What this report finds: The increased focus on growing inequality has led to an
increased focus on CEO pay. Corporate boards running America’s largest public
firms are giving top executives outsize compensation packages. Average pay of
CEOs at the top 350 firms in 2018 was $17.2 million—or $14.0 million using a
more conservative measure. (Stock options make up a big part of CEO pay
packages, and the conservative measure values the options when granted,
versus when cashed in, or “realized.”) CEO compensation is very high relative to
typical worker compensation (by a ratio of 278-to-1 or 221-to-1). In contrast, the
CEO-to-typical-worker compensation ratio (options realized) was 20-to-1 in 1965
and 58-to-1 in 1989. CEOs are even making a lot more—about five times as
much—as other earners in the top 0.1%. From 1978 to 2018, CEO compensation
grew by 1,007.5% (940.3% under the options-realized measure), far outstripping
S&P stock market growth (706.7%) and the wage growth of very high earners
(339.2%). In contrast, wages for the typical worker grew by just 11.9%.
Why it matters: Exorbitant CEO pay is a major contributor to rising inequality that
we could safely do away with. CEOs are getting more because of their power to
set pay, not because they are increasing productivity or possess specific, highdemand skills. This escalation of CEO compensation, and of executive
compensation more generally, has fueled the growth of top 1.0% and top 0.1%
incomes, leaving less of the fruits of economic growth for ordinary workers and
widening the gap between very high earners and the bottom 90%. The economy
would suffer no harm if CEOs were paid less (or taxed more).
How we can solve the problem: We need to enact policy solutions that would
both reduce incentives for CEOs to extract economic concessions and limit their
ability to do so. Such policies could include reinstating higher marginal income
tax rates at the very top; setting corporate tax rates higher for firms that have
higher ratios of CEO-to-worker compensation; establishing a luxury tax on
compensation such that for every dollar in compensation over a set cap, a firm
must pay a dollar in taxes; reforming corporate governance to give other
stakeholders better tools to exercise countervailing power against CEOs’ pay
demands; and allowing greater use of “say on pay,” which allows a firm’s
shareholders to vote on top executives’ compensation.
1
Introduction and key findings
Chief executive officers (CEOs) of the largest firms in the U.S. earn far more today than
they did in the mid-1990s and many times what they earned in the 1960s or late 1970s.
They also earn far more than the typical worker, and their pay has grown much more
rapidly. Importantly, rising CEO pay does not reflect rising value of skills, but rather CEOs’
use of their power to set their own pay. And this growing power at the top has been
driving the growth of inequality in our country.
About the CEO pay series and this report
This report is part of an ongoing series of annual reports monitoring trends in CEO
compensation. In this report, we examine current trends to determine how CEOs are faring
compared with typical workers (through 2018) and compared with workers in the top 0.1%
(through 2017). We also look at the relationship between CEO pay and the stock market.
To analyze current trends, we use two measures of compensation. The first measure
includes stock options realized (in addition to salary, bonuses, restricted stock awards, and
long-term incentive payouts). Because stock-options-realized compensation tends to
fluctuate with the stock market (as people tend to cash in their stock options when it is
most advantageous to do so), we also look at another measure of CEO compensation, to
get a more complete picture of trends in CEO compensation. This measure tracks the
value of stock options granted (in addition to salary, bonuses, restricted stock awards, and
long-term incentive payouts).1
Trends over the past two years
Using the measure that includes stock options realized, we find that CEO pay fell by 0.5%
from 2017 to 2018, to $17.2 million on average in 2018. CEO compensation using another
measure, which captures the value of stock options granted (whether exercised or not),
grew last year by 9.9% to $14.0 million. Both measures show strong growth in CEO
compensation over the last two years, up 7.1 and 9.2%, respectively, for compensation
measured with options exercised and options granted. Compensation grew strongly
because of increasingly large stock awards given to CEOs; these stock awards averaged
$7.5 million in 2018, making up nearly half of CEO compensation.
Long-term trends
CEO compensation has grown 52.6% in the recovery since 2009 using the optionsexercised measure and 29.4% using the options-granted measure. In contrast, the typical
workers in these large firms saw their annual compensation grow by just 5.3% over the
recovery and actually fall by 0.2% between 2017 and 2018.
2
Average CEO compensation attained its peak in 2000, at the height of the late 1990s tech
stock bubble, at $21.5 million (in 2018 dollars) based on either measure—368 or 386 times
the pay of the typical worker, depending upon the measure used.2 CEO compensation fell
in the early 2000s after the stock market bubble burst, but mostly recovered by 2007, at
least for the measure using exercised stock options (the measure using options granted
remained substantially below the 2000 level). CEO compensation fell again during the
financial crash of 2008–2009 and rose strongly over the recovery since 2009 but still
remains below the 2000 peak levels. CEO compensation continues to be dramatically
higher than it was in the decades before the turn of the millennium. CEO compensation
was 940.3% higher in 2018 than in 1978 using the options-exercised measure and 1,007.5%
higher using the options-granted measure. Correspondingly, the CEO-to-average-worker
pay ratio, using the options-exercised measure, was 121-to-1 in 1995, 58-to-1 in 1989,
30-to-1 in 1978, and 20-to-1 in 1965.
The relationship between CEO pay and the
stock market
CEO pay has historically been closely associated with the health of the stock market,
although this connection loosened over the last few years when CEO compensation did
not correspond to rapid stock price growth. The generally tight link between stock prices
and CEO compensation indicates that CEO pay is not being established by a “market for
talent,” as pay surged with the overall rise in profits and stocks, not with the better
performance of a CEO’s particular firm relative to that firm’s competitors.
The relationship between CEO pay and the pay
of other top earners; the rise of inequality
Amid a healthy recovery on Wall Street following the Great Recession, CEOs enjoyed
outsized income gains even relative to other very-high-wage earners (those in the top
0.1%); CEOs of large firms earned 5.4 times that of the average top 0.1% earner in 2017, up
from 4.4 times in 2007. This is yet another indicator that CEO pay is more likely based on
CEOs’ power to set their own pay, not on a market for talent.
To be clear, these other very-high-wage earners aren’t suffering: Their earnings grew
339.2% between 1978 and 2017. CEO pay growth has had spillover effects, pulling up the
pay of other executives and managers, who constitute more than 40% of all top 1.0% and
0.1% earners.3 Consequently, the growth of CEO and executive compensation overall was
a major factor driving the doubling of the income shares of the top 1% and top 0.1% of U.S.
households from 1979 to 2007 (Bakija, Cole, and Heim 2012; Bivens and Mishel 2013).
Income growth has remained unbalanced. As profits and stock market prices have
reached record highs, the wages of most workers have grown very little, including in the
current recovery (Bivens et al. 2014; Gould 2019).
3
Key findings
The report’s main findings include the following:
CEO compensation in 2018 (stock-options-realized measure). Using the stockoptions-realized measure, we find that the average compensation for CEOs of the
350 largest U.S. firms was $17.2 million in 2018. Compensation dipped 0.5% in 2018
following a 7.6% gain in 2017. CEO compensation measured with realized stock
options grew 52.6% over the recovery from 2009 to 2018.
CEO compensation in 2018 (stock-options-granted measure). Using the stockoptions-granted measure, the average compensation for CEOs of the 350 largest U.S.
firms was $14.0 million in 2018, up 9.9% from $12.7 million in 2017 and up 29.4% since
the recovery began in 2009.
Growth of CEO compensation (1978–2018). From 1978 to 2018, inflation-adjusted
compensation based on realized stock options of the top CEOs increased 940.3%.
The increase was more than 25–33% greater than stock market growth (depending
on which stock market index is used) and substantially greater than the painfully slow
11.9% growth in a typical worker’s annual compensation over the same period.
Measured using the value of stock options granted, CEO compensation rose 1,007.5%
from 1978 to 2018.
Changes in the CEO-to-worker compensation ratio (1965–2018). Using the stockoptions-realized measure, the CEO-to-worker compensation ratio was 20-to-1 in 1965.
It peaked at 368-to-1 in 2000. In 2018 the ratio was 278-to-1, slightly down from
281-to-1 in 2017—but still far higher than at any point in the 1960s, 1970s, 1980s, or
1990s. Using the stock-options-granted measure, the CEO-to-worker compensation
ratio rose to 221-to-1 in 2018 (from 206-to-1 in 2017), significantly lower than its peak of
386-to-1 in 2000 but still many times higher than the 45-to-1 ratio of 1989 or the 16-to-1
ratio of 1965.
Changes in the composition of CEO compensation. The composition of CEO
compensation is shifting away from the use of stock options and toward the use of
stock awards, which now average $7.5 million for each CEO and make up roughly half
of all CEO compensation. Stock-related components of compensation—stock options
and stock awards—make up two-thirds to three-fourths of all CEO compensation,
depending on the particular measure used. The shift from stock options to stock
awards leads to an understatement of CEO compensation levels and growth in our
measures as well as in other measures, including the measure prescribed in SEC
reporting requirements.
Changes in the CEO-to-top-0.1% compensation ratio (1989–2018). Over the last
three decades, compensation for CEOs based on realized stock options grew far
faster than that of other very highly paid workers (the top 0.1%, or those earning more
than 99.9% of wage earners). CEO compensation in 2017 (the latest year for which
data on top wage earners are available) was 5.40 times greater than wages of the top
0.1% of wage earners, a ratio 2.22 points higher than the 3.18 average ratio over the
1947–1979 period. This wage gain alone is equivalent to the wages of more than two
4
very-high-wage earners.
Implications of the CEO-to-top-0.1% compensation ratio. The fact that CEO
compensation has grown far faster than the pay of the top 0.1% of wage earners
indicates that CEO compensation growth does not simply reflect a competitive race
for skills (the “market for talent”) that also increased the value of highly paid
professionals: Rather, the growing differential between CEOs and top 0.1% earners
suggests the growth of substantial economic rents in CEO compensation (income not
related to a corresponding growth of productivity). CEO compensation appears to
reflect not greater productivity of executives but the power of CEOs to extract
concessions. Consequently, if CEOs earned less or were taxed more, there would be
no adverse impact on the economy’s output or on employment.
Growth of top 0.1% compensation (1978–2017). Even though CEO compensation
grew much faster than the earnings of the top 0.1% of wage earners, that doesn’t
mean the top 0.1% did not fare well. Quite the contrary. The inflation-adjusted annual
earnings of the top 0.1% grew 339.2% from 1978 to 2017. CEO compensation, however,
grew three times as fast!
CEO pay growth compared with growth in the college wage premium. Over the last
three decades, CEO compensation increased more relative to the pay of other veryhigh-wage earners than did the wages of college graduates relative to the wages of
high school graduates. This finding indicates that the escalation of CEO pay does not
simply reflect a more general rise in the returns to education.
Analysis
This section provides detailed analysis of our findings. We examine several decades of
available data to identify recent and historical trends in CEO compensation.
Trends in CEO compensation growth
Table 1 presents recent trends in CEO compensation and for the key underlying
components over the 2016–2018 period. It shows the average compensation of CEOs at
the 350 largest publicly owned U.S. firms (i.e., firms that sell stock on the open market)
based on two different ways to incorporate stock options into compensation. Each
measure includes salary, bonuses, stock awards, and long-term incentive payouts, shown
in columns (3) through (6).4 The first measure, shown in column (1), tracks how much the
average CEO received in a given year by “realizing,” or exercising, his or her stock options
(buying stocks at a previously set price and reselling them at the current market price).
This options-realized measure, shown in column (7), reflects the value of options exercised
that CEOs report on their W-2 form and represents what they actually earned in a given
year from exercising those options. The second measure of compensation, shown in
column (2), includes the value of the stock options granted in a given year using the fair
value of stock options awarded, shown in column (8). This measure is not influenced by
the timing of CEO decisions to cash or not cash in their options. (For details on the
5
Table 1
Change in CEO compensation and components, 2016–2018
Components of compensation (thousands)
CEO annual compensation
(thousands)
Year
Options
realized
Options
granted
(1)=3+4+5+6+7 (2)=3+4+5+6+8
Stock options
Salary
Stock
awards,
Fair
fair
Value
Nonequity
value
Bonus incentives value exercised awarded
(3)
(4)
(5)
(6)
(7)
(8)
CEO compensation levels (2018$)
2016
$16,045
$12,775
$1,327
$402
$2,733
$6,339
$5,243
$1,973
2017
$17,270
$12,698
$1,284
$342
$2,866
$6,120
$6,658
$2,086
Projected
2018
$17,180
$13,952
$1,267
$258
$2,898
$7,549
$5,248
$2,006
Change, 2016–2017
Level
$1,226
-$77
-$43
-$60
$133
-$220
$1,415
$113
7.6%
-0.6%
-3.2%
-14.9%
4.9%
-3.5%
27.0%
5.7%
Level
-$90
$1,253
-$18
-$84
$32
$1,429
-$1,410
-$80
Percentage
-0.5%
9.9%
-1.4%
-24.6%
1.1%
23.4%
-21.2%
-3.8%
$1,135
$1,177
-$61
-$144
$165
$1,210
$5
$33
7.1%
9.2%
-4.6%
-35.9%
6.0%
19.1%
0.1%
1.7%
Percentage
Change, 2017–2018
Change, 2016–2018
Level
Percentage
Notes: CEO average annual compensation is measured for CEOs at the top 350 U.S. firms ranked by
sales. Two measures are computed, differing in the treatment of stock options: One uses “options
realized,” and the other uses the value of “options granted.” Both series also include salary, bonus,
restricted stock awards, and long-term incentive payouts for CEOs. Projected value for 2018 is based on
the percent change in CEO pay in the samples available in June 2017 and in June 2018 (labeled first-half
[FH] data) applied to the full-year 2017 value. Projections for compensation based on options granted and
options realized are calculated separately.
Source: Authors’ analysis of data from Compustat’s ExecuComp database, the Bureau of Labor Statistics’
Current Employment Statistics data series, and the Bureau of Economic Analysis NIPA tables
construction of these measures and benchmarking to other studies, see Sabadish and
Mishel 2013.)
Note that Table 1 provides a projection for data for 2018. The data now available for 2018
are limited to the executive compensation disclosed by firms filing proxy statements
through June of 2018. To provide data for CEO compensation in 2018 that are consistent
with the historical data, we construct our estimates by looking at the growth of
compensation from 2017 to 2018 using the first-half-year samples of data available each
year and then applying that growth rate to the compensation for 2017 based on the fullyear sample. This method corrects for the fact that full-year samples show higher average
CEO compensation than samples for the first half of a year. It allows us to avoid artificially
lowering the estimated change in this year’s CEO compensation relative to last year’s and
earlier years’.5
Using this method, we find that average CEO compensation (based on stock options
realized) was $17.18 million in 2018, down $90,000 (0.5%) from the $17.27 million average
in the first half of 2017. Using the value-of-options-granted measure reveals a 9.9%
increase, from $12.7 million in 2017 to $14.0 million in 2018. The two measures also show
6
changes from 2016 to 2017, though over that year the options-realized measure grew 7.6%
while the options-granted measure fell slightly, by 0.6%. Looking at CEO compensation
growth over the entire two-year period from 2016 to 2018, avoiding the seesaw growth
patterns, one can see that CEO compensation grew strongly, up 7.1 or 9.2% depending on
the measure used.6
Table 2 presents the longer-term trends in CEO compensation for selected years from
1965 to 2018 using the same two measures used in Table 1.7
For comparison, Table 2 also presents the average annual compensation (wages and
benefits of a full-time, full-year worker) of a private-sector production/nonsupervisory
worker (a group covering more than 80% of payroll employment), allowing us to compare
CEO compensation with that of a typical worker. From 1995 onward, the table also
identifies the average annual compensation of the production/nonsupervisory workers
corresponding to the key industry of the firms included in the sample. We take this
compensation as a proxy for the pay of typical workers in these particular firms and use it
to calculate the CEO-to-worker compensation ratio for each firm.
The history of CEO compensation since the 1960s is as follows: Although the stock
market—as measured by the Dow Jones Industrial Average and S&P 500 Index and
shown in Table 2—fell by roughly half between 1965 and 1978, CEO pay increased by
78.7%. Average worker pay saw relatively strong growth over that period (relative to
subsequent periods, not relative to CEO pay or the pay of other earners at the top of the
wage distribution). Annual worker compensation grew by 19.9% from 1965 to 1978, only
about a fourth as fast as CEO compensation growth.
CEO compensation (realized stock options) grew strongly throughout the 1980s but
exploded in the 1990s. It peaked in 2000, at about $21.0 million, a 261% increase over just
five years earlier in 1995 and a 1,205% increase over 1978. This latter increase exceeded
even the growth of the booming stock market (513% for the S&P 500 and 439% for the
Dow) between 1978 and 2000. In stark contrast to both the stock market and CEO
compensation, private-sector worker compensation increased just 0.7% over the same
period.
The fall in the stock market in the early 2000s after the bubble burst led to a substantial
paring back of CEO compensation. By 2007, however, when the stock market had mostly
recovered, average CEO compensation reached $20.0 million, just $1.5 million below its
2000 level, using the options-realized measure. However, CEO compensation measured
with options granted in 2007 remained down, at $14.0 million, substantially below the
2000 level.
The stock market decline during the 2008 financial crisis also sent CEO compensation
tumbling, as it had in the early 2000s. After 2009, CEO compensation measured using
options realized resumed an upward trajectory. It stalled from 2013 to 2016 (rising in 2013
but falling in 2015 and 2016), grew 7.6% in 2017, and then remained flat, down 0.5% in
2018. After 2009, CEO compensation measured using options granted also shot up until
2013 and then leveled out over the 2013–2017 period before the 9.9% growth in 2018.
7
Table 2
CEO compensation, CEO-to-worker compensation ratio,
and stock prices (2018$), selected years, 1965–2018
CEO annual
compensation
(thousands)
Based on
options
realized
Based
on
options
granted
Private-sector production/
nonsupervisory workers
annual compensation
(thousands)
Workers
in the
All
firms’
private-sector
industries*
workers
Stock market
(indexed to 2018$)
S&P 500
Dow
Jones
CEO-to-worker
compensation ratio
Based
on
options
realized
Based on
options
granted
15.5
1965
$924
$705
$41.9
n/a
616
6,360
19.9
1973
$1,206
$920
$49.2
n/a
544
4,681
22.2
17.2
1978
$1,652
$1,260
$50.3
n/a
340
2,909
29.7
23.1
1989
$3,077
$2,347
$47.9
n/a
633
4,922
58.1
45.1
1995
$5,975
$6,628
$47.9
$53.8
889
7,385
120.6
129.4
2000
$21,549
$21,542
$50.6
$56.5
2,087
15,681
368.1
386.4
2007
$20,027
$14,000
$52.7
$58.8
1,793
15,999
345.9
241.1
2009
$11,255
$10,785
$54.7
$61.2
1,112
10,425
195.3
182.3
2016
$16,045
$12,775
$55.8
$63.8
2,192
18,759
262.6
209.0
2017
$17,270
$12,698
$56.0
$64.6
2,509
22,280
280.8
205.7
Projected
2018
$17,180
$13,952
$56.2
$64.5
2,746
25,047
278.1
221.0
2017 FH
$16,760
$12,298
$56.0
$64.6
2,509
22,280
272.7
200.4
2018 FH
$16,672
$13,511
$56.2
$64.5
2,746
25,047
269.9
215.7
n/a
-44.7%
-54.3%
9.8
Percent change
Change in ratio
1965–1978
78.7%
78.7%
19.9%
7.6
1978–2000
1,204.8%
1,610.1%
0.7%
n/a
513.0%
439.1%
338.3
363.4
2000–2018
-20.3%
-35.2%
11.1%
14.1%
31.6%
59.7%
-90.0
-165.4
2009–2018
52.6%
29.4%
2.7%
5.3%
146.9%
140.3%
82.8
38.7
1978–2018
940.3%
1,007.5%
11.9%
n/a
706.7%
761.1%
248.4
198.0
2017–2018
-0.5%
9.9%
0.5%
-0.2%
9.5%
12.4%
-2.7
15.3
* Average annual compensation of the workers in the key industries of the firms in the sample.
Notes: CEO average annual compensation is measured for CEOs at the top 350 U.S. firms ranked by
sales. Two measures are computed, differing in the treatment of stock options: One uses “options
realized,” and the other uses the value of “options granted.” Both series also include salary, bonus,
restricted stock awards, and long-term incentive payouts for CEOs. Projected value for 2018 is based on
the percent change in CEO pay in the samples available in June 2017 and in June 2018 (labeled first-half
[FH] data) applied to the full-year 2017 value. CEO-to-worker compensation ratios are based on averaging
specific firm ratios in samples and not the ratio of averages of CEO and worker compensation. Ratios prior
to 1992 are constructed as described in the CEO pay series methodology (Sabadish and Mishel 2013).
Source: Authors’ analysis of data from Compustat’s ExecuComp database, the Federal Reserve Economic
Data (FRED) database from the Federal Reserve Bank of St. Louis, the Bureau of Labor Statistics’ Current
Employment Statistics data series, and the Bureau of Economic Analysis NIPA tables
We use the projected 2018 CEO compensation (described above) as the basis for
examining changes in CEO compensation over the longer term. For the period from 1978
to 2018, CEO compensation based on options realized increased 940.3%—between onefourth and one-third faster than stock market growth (depending on the market index
used) and substantially faster than the painfully slow 11.9% growth in the typical worker’s
compensation over the same period. CEO compensation based on the value of stock
options granted grew 1,007.5% over this period. CEO compensation in 2018 remained
8
CEO realized direct compensation and the S&P 500 index
(2018$), 1965–2018
$25
3,000
S&P 500 index
CEO compensation (millions, 2018$)
20
2,000
15
10
1,000
5
0
S&P 500 index (adjusted to 2018$)
CEO compensation (millions, 2018$)
Figure A
0
1970
1980
1990
2000
2010
2020
Notes: CEO average annual compensation is computed using the “options realized” compensation series,
which includes salary, bonus, restricted stock awards, options realized, and long-term incentive payouts
for CEOs at the top 350 U.S. firms ranked by sales. Projected value for 2018 is based on the percent
change in CEO pay in the samples available in June 2017 and in June 2018 (labeled first-half [FH] data)
applied to the full-year 2017 value.
Source: Authors’ analysis of data from Compustat’s ExecuComp database and the Federal Reserve
Economic Data (FRED) database from the Federal Reserve Bank of St. Louis
below its 2000 peak, which occurred at the end of a strong economic boom that included
huge growth in the stock market that many believed reflected a technology stock bubble.
The run-up in stock prices had a corresponding effect on CEO compensation. When the
bubble burst, CEO compensation was deflated as well.
Figure A shows how CEO compensation measured using realized stock options
historically fluctuated in tandem with the stock market, as measured by the S&P 500
Index, confirming that CEOs tend to cash in their options when stock prices are high and
accumulate unexercised options when stock prices are low. The financial crisis of 2008
and the accompanying stock market tumble knocked CEO compensation based on
realized stock options down 43.8% from 2007 to 2009. By 2014 the stock market had
recouped all of the ground lost in the downturn. Not surprisingly, CEO compensation
based on realized stock options also made a strong recovery. The close connection
between stock market growth and CEO compensation has loosened a bit in the years
since 2014: As seen in the figure, CEO compensation based on realized stock options has
not followed the sharp upward trajectory of the stock market over the past four years, a
departure from earlier periods.
Nevertheless, the normally tight relationship between overall stock prices and CEO
compensation, as shown in Figure A, casts doubt on the theory that CEOs are enjoying
high and rising pay because their individual productivity is increasing (e.g., because they
9
head larger firms, have adopted new technology, or for other reasons). CEO compensation
often grows strongly when the overall stock market rises and individual firms’ stock values
rise along with it. This is a marketwide phenomenon, not one of improved performance of
individual firms: Most CEO pay packages allow pay to rise whenever the firm’s stock value
rises; that is, they permit CEOs to cash out stock options regardless of whether the rise in
the firm’s stock value was exceptional relative to comparable firms in the same industry.
The slight loosening of the relationship between overall stock market growth and CEO
compensation growth does not alter this conclusion.
The rising importance of stock awards
Analyses of the underlying components of CEO compensation over the 2016–2018 period
in Table 1 showed a strong growth in stock awards, which are simply stocks granted to
employees. Stock awards can increase or decrease in value depending on the trend in the
firm’s stock price. Stock awards, which are included in both definitions of CEO
compensation, rose to $7.5 million in 2018, a substantial amount of income alone. The
composition of CEO compensation has been shifting toward stock awards and away from
stock options since the end of the last cycle in 2006–2007. These two stock-related
items—stock options and stock awards—together still make up the bulk of CEO
compensation, at 74% and 68%, respectively, of options-exercised and options-granted
CEO compensation measures in 2018.
Figure B has two stacked graphs: Each shows the contribution of stock awards and stock
options to total CEO compensation, the top graph using realized stock options and the
bottom graph using stock options granted. Both graphs show the total contribution of
stock awards and options in total CEO compensation. Stock awards have risen from about
22–26% of compensation in 2006–2007 to 44% of all compensation in 2018 in the
options-exercised measure (top graph) and a rise from 30–37% in 2006–2007 to 54% in
2018 for the options-granted measure (bottom graph). Stock awards now make up about
half of all CEO compensation.
The role of stock options has correspondingly declined. The top graph in Figure B shows
that exercised stock options (options realized) made up roughly half of CEO compensation
in 2006 and 2007 but have fallen to 31% in 2018. The value of stock options awarded has
fallen from 25–29% of compensation in 2006–2007 to just 14% in 2018 (bottom graph). It
is also important to note that while there has been a shift in the composition of CEO
compensation it remains the case that stock-related components (either awards or
options) make up between 68 and 74% of all CEO compensation.
An examination of trends in the number and value of unexercised stock options for the
same sample of executives confirms that there has been a shift away from options awards
rather than an accumulation of unexercised stock options being held to cash in as stock
prices rise further. After the tech stock bubble burst in the early 2000s, there was a
decline in the value of stock options exercised along with a corresponding increase in the
number and value of unexercised stock options. These dynamics suggest a hoarding of
options in a down stock market rather than a shift away from options as a compensation
10
Figure B
Comparison of option and stock components of CEO pay,
2006–2018
Options realized and stock awards as a share of CEO
compensation based on options realized
100%
Stock awards
75
76%
70%
22%
70%
62%
26%
36%
50
25
Options realized
48%
72%
73%
73%
72%
72% 74%
33%
35% 37%
37%
40%
39%
38% 36%
35%
33% 39%
74%
64% 65%
36%
34% 35%
27%
29% 29%
35%
44%
50%
34%
31%
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
(proj.)
Options granted and stock awards as a share of CEO
compensation based on options granted
100%
Stock awards
75
65%
67%
37%
39%
30%
68%
61%
60% 62%
63%
64% 64%
63% 65%
37%
37%
38%
43%
46% 49%
49%
50% 48%
54%
23% 24%
19%
19%
14%
15%
16%
14%
55%
50
Options granted
65%
25
25%
29%
28% 24%
15%
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
(proj.)
Notes: CEO average annual compensation is measured for CEOs at the top 350 U.S. firms ranked by sales. Two
measures are computed, differing in the treatment of stock options: One uses “options realized,” and the other uses
the value of “options granted.” Both series also include salary, bonus, restricted stock awards (fair value), and
long-term incentive payouts for CEOs. Projected value for 2018 is based on the percent change in CEO pay in the
samples available in June 2017 and in June 2018 (labeled first-half [FH] data) applied to the full-year 2017 value.
Projections for compensation based on options granted and options realized are calculated separately. Totals are
computed using unrounded numbers. Numbers may not sum to totals due to rounding.
Source: Authors’ analysis of data from Compustat’s ExecuComp database, the Bureau of Labor Statistics’ Current
Employment Statistics data series, and the Bureau of Economic Analysis NIPA tables
11
tool. Balsam has noted that other factors also led to a reduced use of options: Enron and
WorldCom scandals being blamed (incorrectly) on stock options; SOX reporting
requirements, which basically took away any opportunity for backdating of options; and
then, finally, SFAS 123R (Statement of Financial Accounting Standards No. 123), which
required the expensing of options (FASB 2004).8 In contrast to the early 2000s trend, the
decline in the role of stock options in the aftermath of the financial crisis of 2008–2009
suggests that firms have shifted composition away from options and toward stock awards:
The average decline in the value of stock options in compensation was accompanied by a
continued decline in the number of unexercised stock options, from an average of 1,519 in
2007 to just 561 in 2018, and a substantial 31% fall in the inflation-adjusted value of
unexercised stock options over the 2016–2018 period to a level just half that of the
2006–2007 period. These trends confirm that there has been a reduction in stock options
granted in recent years and not just an accumulating inventory of unexercised options.
There is a simple logic behind companies’ decisions to shift from stock options to stock
awards, as Clifford (2017) explains. With stock options, CEOs can only make gains: They
realize a gain if the stock price rises beyond the price of the initial options granted and
they lose nothing if the stock price falls. The fact that they have nothing to lose—but
potentially a lot to gain—might lead options-holding CEOs to take excessive risks to bump
up the stock price. Stock awards, on the other hand, promote better alignment of a CEO’s
goals with shareholders’ goals. A stock award has the value when given, or vested, and
can increase or decrease in value as the firm’s stock price changes. If stock awards have a
lengthy vesting period, say three to five years, then the CEO has an interest in lifting the
firm’s stock price over that period while being mindful to avoid any implosion in the stock
price—to maintain the value of what they have.
As the share of CEO compensation represented by stock options declines, and the share
represented by stock awards grows, CEO compensation levels and growth will possibly be
increasingly understated in our measures as well as in other measures, including those
used by companies to construct the CEO-to-worker ratios reported to the SEC. The reason
is this: The exact compensation earned through stock options is measurable—the
exercised-options measure of compensation captures any rise in the stock price from the
time the options are granted. But for stock awards, the value is determined at the time
stocks are granted; any future gains in the value of the stock that accrue to the CEO are
not captured by data disclosed by the firms. Nor are they captured in the SEC measure.
Because stock awards have become more important, and stock options less important,
there is increased likelihood that measures of CEO compensation will not fully capture
CEOs’ gains going forward. This increased understatement of CEO compensation in turn
tamps down measures of CEO compensation growth.
Unfortunately there are not currently any analyses available that assess the extent of the
bias toward lower compensation and less compensation growth. One possible way to
assess this would be to use the value of stock awards when vested rather than when
granted, as this would capture the growth of the value of the stocks in the three- or fouryear window before awards become vested. An analysis of the value of vested stock
awards indicates that the stocks awarded do indeed gain value between when they are
granted and when they are vested. If these gains were included in a CEO compensation
12
measure, it would show an additional $2 million (in 2018 dollars) in growth of CEO
compensation between 2006 and 2018.
Trends in the CEO-to-worker compensation ratio
Table 2 also presents historical and current trends in the ratio of CEO-to-worker
compensation, using both measures of CEO compensation. This ratio, which illustrates the
increased divergence between CEO and worker pay over time, is computed in two steps.
The first step is to construct, for each of the 350 largest U.S. firms, the ratio of the CEO’s
compensation to the annual average compensation of production and nonsupervisory
workers in the key industry of the firm (data on the pay of workers at individual firms are
not available).9 The second step is to average that ratio across all 350 firms.
The last two columns in Table 2 show the resulting ratio for both measures of CEO pay. We
adjust the ratio for 2018 to reflect the percentage-point growth between the ratios in the
first-half-year samples in 2017 and 2018 and add that growth to the ratio estimated for the
full-year sample in 2017 to derive the 2018 ratio consistent with the historical data. Trends
before 1995 are based on the changes in average top-company CEO and economywide
private-sector production/nonsupervisory worker compensation. The trends are presented
in Figure C.
The Securities and Exchange Commission (SEC) now requires publicly owned firms to
provide a metric for the ratio of CEO compensation to that of the median worker in a firm,
as mandated by the Dodd-Frank financial reform bill of 2010 (SEC 2015). Those ratios differ
from those in this report in several ways. First, because of limitations in data availability,
the measure of worker compensation in our ratios reflects workers in a firm’s key industry,
not workers actually working for the firm. The ratios reported to the SEC will reflect
compensation of workers in the specific firm. Second, our measure reflects an exclusively
domestic workforce; it excludes the compensation of workers in other countries who work
for the firm. The ratios reported to the SEC may include workers in other countries. Third,
our metric is based on hourly compensation annualized to reflect a full-time, full-year
worker (i.e., multiplying the hourly compensation rate by 2,080). In contrast, the measures
firms provide to the SEC can be and are sometimes based on the actual annual (not
annualized) wages of part-year (seasonal) or part-time workers. As a result, comparisons
across firms may reflect not only pay differences but also differences in annual or weekly
hours worked. Fourth, our metric includes both wages and benefits, whereas the SEC
metric solely focuses on wages. Finally, we use consistent data and methodology to
construct our ratios; our ratios are thus comparable across firms and from year to year. The
SEC allows firms flexibility in how they construct the CEO-to-median worker pay
comparison; this means there is not comparability across firms—and ratios may not even
be comparable from year to year for any given firm, if the firm changes the metrics it uses.
There is certainly value in the new metrics being provided to the SEC, but the measures
we rely on allow us to make appropriate comparisons between firms and across time. Box
A provides more information on the ratios firms are providing to the SEC.
13
Figure C
CEOs make 278 times more than typical workers
CEO-to-worker compensation ratio, 1965–2018
500
CEO-to-worker compensation ratio based on options realized
CEO-to-worker compensation ratio based on options granted
386.4
368.1
400
345.9
300
278.1
241.1
200
100
0
221.0
58.1
31.6
24.5
19.9
15.5
1970
1980
45.1
1990
2000
2010
2020
Notes: CEO average annual compensation is measured for CEOs at the top 350 U.S. firms ranked by
sales. Two measures are computed, differing in the treatment of stock options: One uses “options
realized,” and the other uses the value of “options granted.” Both series also include salary, bonus,
restricted stock awards, and long-term incentive payouts for CEOs. Projected value for 2018 is based on
the percent change in CEO pay in the samples available in June 2017 and in June 2018 (labeled first-half
[FH] data) applied to the full-year 2017 value. Projections for compensation based on options granted and
options realized are calculated separately. “Typical worker” compensation is the average annual
compensation of the workers in the key industry of the firms in the sample.
Source: Authors’ analysis of data from Compustat’s ExecuComp database, the Bureau of Labor Statistics’
Current Employment Statistics data series, and the Bureau of Economic Analysis NIPA tables
BOX A
CEO-to-worker pay ratios: The new SEC rule and
EPI’s methodology
As of 2018, all publicly traded companies are required to disclose CEO total
compensation alongside the median annual total compensation for all
employees other than the CEO in annual proxy statements submitted to the
Securities and Exchange Commission. In addition, they are to provide the ratio of
CEO-to-worker compensation (SEC 2015).
Advocates, investors, and researchers alike have welcomed the disclosure of
this information, because these disclosures offer previously unavailable insight
into compensation inequality within firms. Historically, constructing a firm-specific
CEO-to-worker pay ratio was impossible without the cooperation of the firm,
14
although sector-specific estimates were possible (see Mishel and Schieder 2018).
The new CEO-to-worker compensation ratios contained in proxies in 2018 and in
2019 shine a ray of sunlight onto the compensation of the typical worker.
According to the authors of a report titled Rewarding or Hoarding? An
Examination of Pay Ratios Revealed by Dodd-Frank, from the office of former
Congressman Keith Ellison (D-Minn.), “These new data give us a much clearer
picture as to which corporations are sharing the wealth and which are not” (Staff
of Congressman Keith Ellison 2018).
However, fierce business resistance to the mandate to report the CEO-to-worker
compensation ratio has watered down their potential use. Many corporations
have implausibly contended that constructing these ratios is too difficult. The
SEC has given these claims far too much credence, providing firms tremendous
leeway in how to construct the ratios. This SEC capitulation diminished the utility
of these new median worker compensation measures for making comparisons
across firms and will affect the utility of comparing them over time when
additional years of data are available.
Specifically, the SEC’s rule grants firms significant discretion in reporting median
worker pay, which makes the reported ratios incompatible across firms. A
company’s reported “median worker” may, for example, work part time or full
time, reside in the U.S. or abroad, and have worked for the firm for a limited
number of weeks during the previous year. The data on median compensation
are not provided on a per-hour basis or annualized to that of a full-time, full-year
worker. Without such information, or simply the annual hours worked by the
median worker, it is not possible to standardize the compensation for
comparisons across firms. In addition, firms may not adhere to the same metric
each year, limiting the ability to make historical comparisons in the future.
Given the limitations of the metrics used for SEC reporting, the SEC
compensation data do not and cannot replace our annual CEO compensation
series. Our examination of CEO compensation continues to provide crucial data
points for evaluating current CEO compensation trends as well as trends in CEO
compensation over time. Our methodology (described in Sabadish and Mishel
2013) has a number of advantages over the SEC-prescribed methodology for
constructing ratios. First, our methodology compares CEO compensation to the
compensation of the typical worker in the main industry of the CEO’s company
rather than just within one specific firm. It thereby eliminates artificial reductions
in a company-reported CEO-to-worker pay ratio that could arise from the
extensive use of subcontracting.
Second, our worker compensation series reflects annualized compensation
(multiplying an estimate of hourly compensation by 2,080 hours), eliminating the
ambiguity that arises when weeks worked and hours per week are not specified
or when they differ across firms (as can be the case for the SEC ratios). This
15
assumption also likely makes our ratio a more conservative estimate of the true
ratio than the ratios reported to the SEC. Third, our analysis captures the ratio of
CEO compensation to compensation of U.S. domestic workers only, which makes
the ratios comparable in a way that the SEC-required ratios are not (given that
they may or may not include workers in other countries). Fourth, our series is
able to extend back to 1965, allowing us to analyze trends in executive
compensation over time. The consistent basis of the measurement of our ratios
permits historical comparisons on a year-to-year basis. These (and other)
benefits are why we continue to produce our CEO-to-worker pay
series—although it is our hope that with time the ambiguities of the SEC ratio will
be addressed and adjusted, to produce a reliable time series for investors and
the public to use going forward.
In terms of CEO compensation based on realized stock options, CEOs of major U.S.
companies earned 20 times more than the typical worker in 1965. This ratio grew to
30-to-1 in 1978 and 58-to-1 by 1989. It surged in the 1990s, hitting 368-to-1 in 2000, at the
end of the 1990s recovery. The fall in the stock market after 2000 reduced CEO stockrelated pay (e.g., realized stock options) and caused CEO compensation to tumble in 2002
before beginning to rise again in 2003. CEO compensation recovered to a level of 346
times worker pay by 2007, almost back to its 2000 level. The financial crisis of 2008 and
accompanying stock market decline reduced CEO compensation between 2007 and
2009, as discussed above, and the CEO-to-worker compensation ratio fell in tandem. By
2014 the stock market had recouped all of the value it had lost following the financial
crisis, and the CEO-to-worker compensation ratio in 2014 had recovered to 296-to-1. The
fall in CEO compensation between 2014 and 2016 caused the CEO-to-worker pay ratio to
fall. The ratio bumped up in 2017 and basically was stable in 2018, dipping a bit to 278-to-1.
Although the CEO-to-worker compensation ratio remains below the value achieved in
2000, at the peak of the stock market bubble, it is far higher than it was in the 1960s,
1970s, 1980s, and 1990s.
The pattern using the CEO compensation measure that values stock options as they are
granted is similar. The CEO-to-worker pay ratio peaked in 2000, at 386-to-1, even higher
than the ratio with the stock-options-realized measurement. The fall from 2000 to 2007
was steeper than for the other measure, hitting 241-to-1 in 2007. The stock market decline
during the financial crisis drove the ratio down to 182-to-1 in 2009. It recovered to 221-to-1
by 2014 and, after dipping a bit over the next three years, ended back up at 221-to-1 in
2018. This level is far lower than its peak in 2000 but still far greater than the 1989 ratio of
45-to-1 or the 1965 ratio of 16-to-1.
16
Dramatically high CEO pay does not simply
reflect the market for skills
This section reviews competing explanations for the extraordinary rise in CEO
compensation over the past several decades. CEO compensation has grown a great deal
since 1965, but so has the pay of other high-wage earners. To some analysts, this suggests
that the dramatic rise in CEO compensation has been driven largely by the demand for the
skills of CEOs and other highly paid professionals. In this interpretation, CEO
compensation is being set by the market for “skills” or “talent,” not by managerial power or
rent-seeking behavior.10 This explanation lies in contrast to that offered by Bebchuk and
Fried (2004) or Clifford (2017), who claim that the long-term increase in CEO pay is a result
of managerial power.
One prominent example of the “market for talent” argument—based on the premise that “it
is other professionals, too,” not just CEOs, who are seeing a generous rise in pay—comes
from Kaplan (2012a, 2012b). In the prestigious 2012 Martin Feldstein Lecture at the
National Bureau of Economic Research, he claims:
Over the last 20 years, then, public company CEO pay relative to the top 0.1% has
remained relatively constant or declined. These patterns are consistent with a
competitive market for talent. They are less consistent with managerial power.
Other top income groups, not subject to managerial power forces, have seen
similar growth in pay. (Kaplan 2012a, 4)
In a follow-up paper for the Cato Institute, published as a National Bureau of Economic
Research working paper, Kaplan expands this point:
The point of these comparisons is to confirm that while public company CEOs earn
a great deal, they are not unique. Other groups with similar backgrounds—private
company executives, corporate lawyers, hedge fund investors, private equity
investors and others—have seen significant pay increases where there is a
competitive market for talent and managerial power problems are absent. Again, if
one uses evidence of higher CEO pay as evidence of managerial power or capture,
one must also explain why these professional groups have had a similar or even
higher growth in pay. It seems more likely that a meaningful portion of the increase
in CEO pay has been driven by market forces as well. (Kaplan 2012b, 21)
However, the argument that CEO compensation is being set by the market for “skills” does
not square with the data we analyze. Bivens and Mishel (2013) address the larger issue of
the role of CEO compensation in generating income gains at the very top and conclude
that substantial rents are embedded in executive pay. According to Bivens and Mishel,
CEO pay gains are not the result of a competitive market for talent but rather reflect the
power of CEOs to extract concessions. The data presented in Table 3 shows that the
evidence does not support Kaplan’s claim that “professional groups have had a similar or
even higher growth in pay” than CEOs: The very highest earners—those in the top 0.1% of
17
all earners—had their wages grow far less than the compensation of the CEOs of large
firms (note that the gains from exercised stock options are taxed as W-2 wage income and
so are reflected in measures of wages in the data we analyze).
Here we draw on and update the Bivens and Mishel (2013) analysis to show that CEO
compensation grew far faster than compensation of very highly paid workers over the last
few decades, which suggests that the market for skills was not responsible for the rapid
growth of CEO compensation. To reach this finding, we use Kaplan’s series on CEO
compensation and compare it with the wages of top wage earners, rather than the
household income of the top 0.1% as Kaplan did.11 The wage benchmark seems the most
appropriate one because it avoids issues of changing household demographics (e.g.,
increases in the number of two-earner households over time) and limits the income to
labor income (i.e., it excludes capital income, which is included in household income
measures). We update Kaplan’s series beyond 2010 using the growth of CEO
compensation (based on options exercised) in our own series. This analysis finds that,
contrary to Kaplan’s findings, the compensation of CEOs has far outpaced that of very
highly paid workers, the top 0.1% of earners.
Table 3 shows the ratio of the average compensation of CEOs of large firms (the series
developed by Kaplan, incorporating stock options realized) to the average annual earnings
of the top 0.1% of wage earners (based on a series developed by Kopczuk, Saez, and Song
[2010] and updated by Mishel and Wolfe [2018]). The comparison is presented as a simple
ratio and logged (to convert to a “premium,” defined as the relative pay differential
between two groups). Both the simple ratios and the log ratios understate the relative pay
of CEOs, because CEO pay is a nontrivial share of the denominator, a bias that has
probably grown over time as CEO relative pay has grown. If we were able to remove top
CEOs’ pay from the top 0.1% category, it would reduce the average for the broader
group.12
For comparison purposes, Table 3 also shows the changes in the gross (not regressionadjusted) college-to-high-school wage premium. This premium, which is simply how much
more pay is earned by workers with a college degree relative to workers with just a high
school diploma, is useful because some commentators, such as Mankiw (2013), assert that
the wage and income growth of the top 1% reflects the general rise in the return to skills,
as reflected in higher college wage premiums. (The comparisons end in 2017 because
2018 data for top 0.1% wages are not yet available).
CEO pay was 5.40 times the pay of the top 0.1% of wage earners in 2017, similar to 2016
and substantially higher than the 4.36 ratio in 2007. CEO compensation grew far faster
than that of the top 0.1% of earners over the recovery since 2009, as the ratio spiked from
4.61 to 5.40. CEO compensation relative to the wages of the top 0.1% of wage earners in
2017 far exceeded the ratio of 2.63 in 1989, a rise (2.77) equal to the pay of almost three
very-high-wage earners.13 The log ratio of CEO relative pay grew 72 log points with
respect to wage earners in the top 0.1%.
Is this increase large? Kaplan (2012a, 4) concludes that CEO relative pay “has remained
relatively constant or declined.” He finds that the ratio “remains above its historical
18
Table 3
CEO-to-top-0.1% and college-to-high-school ratios,
1979–2017
Ratio
CEO
compensation
to top 0.1%
wages
1979
Log ratio
College-to-high-school
wages
CEO
compensation
to top 0.1%
wages
College-to-high-school
wages
3.26
1.41
1.18
0.35
1989
2.63
1.59
0.97
0.46
1993
3.05
1.64
1.11
0.49
2000
7.77
1.75
2.05
0.56
2007
4.36
1.77
1.47
0.57
2009
4.61
1.74
1.53
0.55
2016
5.41
1.84
1.69
0.61
2017
5.40
1.82
1.69
0.60
1979–2007
1.10
0.35
0.29
0.22
1979–2017
2.13
0.43
0.50
0.25
1989–2017
2.77
0.26
0.72
0.13
Change
Note: The college-to-high-school wage ratios compare hourly wages of workers who have a college
degree with hourly wages of workers who have only a high school diploma.
Source: Authors’ analysis of data on top 0.1% wages from the EPI State of Working America Data Library,
Mishel and Wolfe 2018, and extrapolation of Kaplan’s (2012b) CEO compensation series
average and the level in the mid-1980s” (2012b, 14). His historical comparisons are
inaccurate, however. Figure D compares the ratios of the compensation of CEOs to
compensation of the top 0.1% of wage earner ratios back to 1947. In 2017 this ratio was
5.40, 2.27 points higher than the historical average of 3.18 (a relative gain in wages earned
by the equivalent of 2.22 very-high-wage earners).
That CEO compensation grew much faster than the earnings of the top 0.1% of wage
earners is not because the top 0.1% did not fare well. The inflation-adjusted annual
earnings of the top 0.1% grew 339.2% from 1978 to 2017. CEO compensation, however,
grew three times faster!
The data in Table 3 also provide a benchmark of CEO compensation to that of the collegeto-high-school wage premium. Since 1979, and particularly since 1989, the increase in the
logged CEO pay premium relative to other high-wage earners far exceeded the rise in the
college-to-high-school wage premium, which is widely and appropriately considered to
have had substantial growth: The logged college wage premium grew from 0.46 in 1989 to
0.60 in 2017, a far smaller rise than the logged ratio of CEO-to-top-0.1% earnings, a rise
from 0.97 to 1.69. Mankiw’s claim that top 1% pay or top executive pay simply corresponds
19
Comparison of CEO compensation with top 0.1% wages,
1947–2017
Ratio of CEO compensation to top 0.1% wages
Figure D
7.5
5.40
5
Ratio of CEO pay to top 0.1% wages
1947–1979 average ratio: 3.18
2.5
0
1950
1960
1970
1980
1990
2000
2010
2020
Source: Authors’ analysis of data on top 0.1% wages from Mishel and Wolfe 2018 and extrapolation of
Kaplan’s (2012b) CEO compensation series
to the rise in the college-to-high-school wage premium is unfounded (Mishel 2013a,
2013b). Moreover, the data we present here would show even faster growth of CEO
relative pay if Kaplan’s historical CEO compensation series (which we use as the basis for
the ratios in Table 3) had been built using the Frydman and Saks (2010) series for the
1980–1994 period rather than the Hall and Liebman (1997) data.14
If CEO pay growing far faster than that of other high earners is evidence of the presence
of rents, as Kaplan suggests, one would conclude that today’s top executives are
collecting substantial rents, meaning that if they were paid less there would be no loss of
productivity or output in the economy. The large discrepancy between the pay of CEOs
and other very-high-wage earners also casts doubt on the claim that CEOs are being paid
these extraordinary amounts because of their special skills and the market for those skills.
It is unlikely that the skills of CEOs of very large firms are so outsized and disconnected
from the skills of others that they propel CEOs past most of their cohorts in the top onetenth of 1%. For everyone else, the distribution of skills, as reflected in the overall wage
distribution, tends to be much more continuous.
20
Conclusion
Some observers argue that exorbitant CEO compensation is merely a symbolic issue, with
no consequences for the vast majority of workers. However, the escalation of CEO
compensation, and of executive compensation more generally, has fueled the growth of
top 1.0% and top 0.1% incomes, generating widespread inequality.
In their study of tax returns from 1979 to 2005, Bakija, Cole, and Heim (2010) establish that
the increases in income among the top 1% and top 0.1% of households were
disproportionately driven by households headed by someone who was either a
nonfinancial-sector “executive” (including managers and supervisors, hereafter referred to
as “nonfinance executives”) or a financial-sector worker (executive or otherwise). Fortyfour percent of the growth of the top 0.1%’s income share and 36% of the top 1%’s income
share accrued to households headed by nonfinance executives; another 23% for each
group accrued to households headed by financial-sector workers (some portion of which
were executives).
Together, finance workers (including some share who are executives) and nonfinance
executives accounted for 58% of the expansion of income for the top 1% of households
and 67% of the income growth of the top 0.1%. Relative to others in the top 1%, households
headed by nonfinance executives had roughly average income growth; those headed by
someone in the financial sector had above-average income growth; and the remaining
households (nonexecutive, nonfinance) had slower-than-average income growth. These
shares may actually understate the role of nonfinance executives and the financial sector,
because they do not account for increased spousal income from these sources in those
cases where the head of household is not an executive or in finance.15
High CEO pay reflects economic rents—concessions CEOs can draw from the economy
not by virtue of their contribution to economic output but by virtue of their position. Clifford
(2017) describes the Lake Wobegon world of setting CEO compensation that fuels its
growth: Every firm wants to believe its CEO is above average and therefore needs to be
correspondingly remunerated. But, in fact, CEO compensation could be reduced across
the board and the economy would not suffer any loss of output.
Another implication of rising pay for CEOs and other executives is that it reflects income
that otherwise would have accrued to others: What these executives earned was not
available for broader-based wage growth for other workers. (Bivens and Mishel 2013
explore this issue in depth.) It is useful, in this context, to note that wage growth for the
bottom 90% would have been nearly twice as fast over the 1979–2017 period had wage
inequality not grown.16 Most of the rise of inequality took the form of redistributing wages
from the bottom 90% (whose share of wages fell from 69.8% to 60.9%) to the top 1.0%
(whose wage share nearly doubled, rising from 7.3% to 13.4%).
Several policy options could reverse the trend of excessive executive pay and broaden
wage growth. Some involve taxes. Implementing higher marginal income tax rates at the
21
very top would limit rent-seeking behavior and reduce the incentives for executives to
push for such high pay. Another option is to set corporate tax rates higher for firms that
have higher ratios of CEO-to-worker compensation. Clifford (2017) recommends setting a
cap on compensation and taxing companies on any amount over the cap, similar to the
way baseball team payrolls are taxed when salaries exceed a cap. Other policies that
could potentially limit executive pay growth are changes in corporate governance, such as
greater use of “say on pay,” which allows a firm’s shareholders to vote on top executives’
compensation. Baker, Bivens, and Schieder (2019) review policies to restrain CEO
compensation and explain how tax policy and corporate governance reform can work in
tandem: “Tax policy that penalizes corporations for excess CEO-to-worker pay ratios can
boost incentives for shareholders to restrain excess pay,” but, “to boost the power of
shareholders [to restrain pay], fundamental changes to corporate governance have to be
made. One key example of such a fundamental change would be to provide worker
representation on corporate boards.”
Acknowledgments
The authors thank the Stephen Silberstein Foundation for its generous support of this
research. Steven Balsam, an accounting professor at Temple University and author of
Equity Compensation: Motivations and Implications (2013), has provided useful advice on
data construction and interpretation over the years. Steven Clifford, former CEO
compensation consultant and author of The CEO Pay Machine: How It Trashes America
and How to Stop It (2017), has also provided technical advice.
About the authors
Lawrence Mishel is a distinguished fellow and former president of the Economic Policy
Institute. He is the co-author of all 12 editions of The State of Working America. His articles
have appeared in a variety of academic and nonacademic journals. His areas of research
include labor economics, wage and income distribution, industrial relations, productivity
growth, and the economics of education. He holds a Ph.D. in economics from the
University of Wisconsin at Madison.
Julia Wolfe is a research assistant at the Economic Policy Institute. Prior to joining EPI,
Wolfe worked at the Bureau of Labor Statistics as the retail and manufacturing
employment analyst for the Current Employment Statistics program. She holds a B.A. in
political science and international development from Truman State University.
22
Endnotes
1. We use Compustat estimates of the fair value of options awarded; these estimates are determined
using the Black Scholes model. See Sabadish and Mishel 2013 for more information about our
data sources and methodology.
2. It may seem counterintuitive that the two ratios for 2000 are different from each other when the
average CEO compensation is the same. It is important to understand that (as we describe later in
this report) we do not create the ratio from the averages; rather we construct a ratio for each firm
and then average the ratios across firms.
3. There were 38,824 executives in publicly held firms and 9,692 people in the top 0.1% of wage
earners in 2007, according to the Capital IQ database (tabulations provided by Temple University
professor Steve Balsam).
4. Each year’s sample includes the largest 350 firms for which ExecuComp provides data.
5. Most Fortune 500 companies release annual financial data in early spring; the data are included in
samples limited to the first half of the year. However, the data we present for previous years
include all of the data that were released during each calendar year. This creates a bias in
comparing data for the first half of the year relative to the full year’s data in the prior or earlier
years: Compensation levels for the full year’s data are higher than compensation in the data
limited to the first half. A comparison of data available in June thus shows a smaller increase when
compared with the previous year’s full data than a comparison with the data that were available at
the same time a year earlier. We analyze the impact of this bias and find that the vast majority of
top firms remain unchanged between the samples for the first half and the full year. However,
there is churn among the smaller firms in the sample. Among firms with lower net annual sales,
average CEO compensation tends to be higher in the full-year sample. Additionally, in recent years
firms reporting later in the year have tended to be firms with lower worker compensation levels
and therefore higher CEO-to-worker compensation ratios.
6. ExecuComp had flaws in the measure of fair value measure of stock awarded in the data used in
our last report (as detailed in Box A in Mishel and Scheider 2018) that required an adjustment to
the data. The data have now been corrected by ExecuComp. We reported that compensation
using options realized grew 17.5% over 2016–2017, far more than the corrected data show—a rise
of 5.2%. Similarly, our reported growth of the options-granted measure of 1.7% exceeded that in
the corrected data, where this measure of compensation fell 4.9%.
7. We chose which years to present in the table in part based on data availability. Where possible, we
chose cyclical peaks (years of low unemployment).
8. Email communication on July 10, 2019. Balsam also reviewed these trends in his earlier book
(Balsam 2007).
9. There are a limited number of firms, which existed only for certain years between 1992 and 1996,
for which a North American Industry Classification System (NAICS) value is unassigned. This
makes it impossible to identify the pay of the workers in the firm’s key industry. These firms are
therefore not included in the calculation of the CEO-to-worker compensation ratio.
10. The managerial power view asserts that CEOs have excessive, noncompetitive influence over the
compensation packages they receive. Rent-seeking behavior is the practice of manipulating
23
systems to obtain more than one’s fair share of wealth—that is, finding ways to increase one’s own
gains without actually increasing the productive value one contributes to an organization or to the
economy.
11. We thank Steve Kaplan for sharing his CEO compensation series with us. The series on the
income of the top 0.1% of households that Kaplan used is no longer available. Moreover, as we
discuss, the appropriate comparison is to other earners, not to households, which could have
multiple earners and shifts in the number of earners over time.
12. Temple University professor Steve Balsam provided tabulations from the Capital IQ database of
annual wages of executives exceeding the wage thresholds (provided to him) that place them in
the top 0.1% of wage earners. The 9,692 executives in publicly held firms who were in the top 0.1%
of wage earners had average annual earnings of $4.4 million. Using Mishel et al.’s (2012) estimates
of top 0.1% wages, we find that executive wages make up 13.3% of total top 0.1% wages. One can
gauge the bias of including executive wages in the denominator by noting that the ratio of
executive wages to all top 0.1% wages in 2007 was 2.14 but the ratio of executive wages to
nonexecutive wages was 2.32. We do not have data that would permit an assessment of the bias
in 1979 or 1989. We also lack information on the number and wages of executives in privately held
firms; to the extent that their CEO compensation exceeds that of publicly traded firms, their
inclusion would indicate an even larger bias. The Internal Revenue Service Statistics of Income
(SOI) Bulletin reports that there were nearly 15,000 corporate tax returns in 2007 of firms with
assets exceeding $250 million, indicating that there are many more executives of large firms than
just those in publicly held firms (IRS 2018).
13. A one-point rise in the ratio is the equivalent of the average CEO earning an additional amount
equal to that of the average earnings of someone in the top 0.1%.
14. Kaplan (2012b, 14) notes that the Frydman and Saks series grew 289% whereas the Hall and
Liebman series grew 209%. He also notes that the Frydman and Saks series grows faster than the
series reported by Murphy (2012).
15. The tax data analyzed categorizes a household’s income according to the occupation and
industry of the head of household. It is possible that a “secondary earner,” or spouse, has income
as an executive or in finance. If the household is in the top 1.0% or top 0.1%, but the head of
household is not an executive or in finance, then the spouse’s contribution to income growth will
not be identified as being connected to executive pay or finance sector pay. The discussion in this
paragraph draws on Bivens and Mishel 2013.
16. This follows from the fact that over 1979–2017 annual earnings rose by 22.2% for the bottom
90%, while the average growth across all earners was 40.1% (Mishel and Wolfe 2018). That means
that the bottom 90% would have seen their earnings grow 17.9 percentage points more over the
1979–2017 period if they had enjoyed average growth (i.e., no increase in equality, 40.1 less 22.2).
24
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25
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26
The changing structure of American innovation: Some
cautionary remarks for economic growth
Ashish Arora∗
Sharon Belenzon†
Andrea Patacconi‡
Jungkyu Suh§
August 20, 2019
Abstract
A defining feature of modern economic growth is the systematic application of science to advance
technology. However, despite sustained progress in scientific knowledge, recent productivity
growth in the U.S. has been disappointing. We review major changes in the American innovation
ecosystem over the past century. The past three decades have been marked by a growing
division of labor between universities focusing on research and large corporations focusing on
development. Knowledge produced by universities is not often in a form that can be readily
digested and turned into new goods and services. Small firms and university technology transfer
offices cannot fully substitute for corporate research, which had integrated multiple disciplines
at the scale required to solve significant technical problems. Therefore, whereas the division of
innovative labor may have raised the volume of science by universities, it has also slowed, at least
for a period of time, the transformation of that knowledge into novel products and processes.
∗
Duke University, Fuqua School of Business and NBER
Duke University, Fuqua School of Business and NBER
‡
University of East Anglia
§
Duke University, Fuqua School of Business
†
1
Introduction
A defining feature of modern economic growth is the systematic application of science to advance
technology. Many innovations that spurred economic growth in the twentieth century, including synthetic fibers, plastics, integrated circuits, and gene therapy, originated from advances in the natural
sciences, engineering and medicine. Science, by producing “a potential for technology far greater than
existed previously,” clearly distinguishes modern economic growth from previous economic epochs
(Kuznets, 1971).
However, despite sustained increases in the quantity of scientific knowledge, productivity growth
in most advanced economies has stagnated in recent decades in comparison to a “golden age” in the
mid-twentieth century. Using data from the United States, Gordon (2016) shows that real GDP per
hour (i.e., labor productivity) grew substantially in the middle of the twentieth century, from 1.79
percent per year between 1870 and 1920 to 2.82 percent per year between 1920 and 1970. However,
in the most recent period (1970-2014), productivity grew by a modest 1.62 percent per year. Gordon
concludes that productivity rose between 1920 and 1970 largely because of significant technological
progress, but more recently technical advance has been much less potent in spurring growth. This
slowdown is surprising given the sustained expansion of scientific input (measured in terms of research
dollars spent) and output (measured by academic articles published) from American academia, as
shown in figure 1.1
Gordon attributes the rapid pace of technological progress in 1920-1970 to the development and
extension of earlier fundamental technologies, such as the internal combustion engine and electricity.
This process, which was often accompanied by important advances in science and engineering, was
largely carried out by researchers working in corporate labs, which, by the 1920s, had replaced
individual entrepreneurs as the primary source of American invention. As Gordon (2016, p.571-2)
1
Indeed, Bloom et al. (2017) present evidence across a number of sectors showing that research productivity in the
U.S. has declined since the 1970s. For instance, maintaining the exponential growth in semiconductor performance
(otherwise known as “Moore’s Law”) in 2014 required around 18 times the number of researchers it used to take in
1971. While growth rates for yields per acre for corns, soybeans, cotton, and wheat have averaged around 1.5 percent,
the number of researchers in the agriculture sector has grown by a factor between 3 (wheat) and 25 (soybeans), a
research productivity decline of about 4 to 6 percent per year. In the life sciences, the number of researchers has
been rising by 6 percent annually, while research productivity measured by the discovery of new molecular entities per
number of researchers has been falling by 3.5 percent per year.
1
Figure 1: U.S. Scientific Investment and Output (1980-2013)
Notes: Doctorates Awarded in S&E are calculated from the NSF’s Survey of Earned Doctorates and excludes degrees in the Social
sciences. Number of S&E Publications are from the Clarivate Web of Science and includes all scientific articles in the Science Citation
Index-Expanded (SCI-EXPANDED) and Conference Proceedings Citation Index-Science (CPCSI-S) with a U.S. author from 1980 to
2013. U.S. Research Expenditure figures are calculated from the National Patterns of R&D Resources: 2014-15 Data update. NSF
17-311. tables and includes both basic and applied research expenditure. Figures are adjusted to 2016 dollars using GDP deflator from
the World Bank National Accounts dataset.
writes:
“Much of the early development of the automobile culminating in the powerful Chevrolets
and Buicks of 1940-41 was achieved at the GM corporate research labs. Similarly, much of
the development of the electronic computer was carried out in the corporate laboratories
of IBM, Bell Labs, and other large firms. The transistor, the fundamental building block
of modern electronics and digital innovation, was invented by a team led by William
Shockley at Bell Labs in late 1947. The corporate R&D division of IBM pioneered most
of the advances of the mainframe computer era from 1950 to 1980. Improvements in
consumer electric appliances occurred at large firms such as General Electric, General
Motors and Whirlpool, while RCA led the early development of television.”
By the 1980s, however, many corporations began to look to universities and small start-ups
for ideas and new products.2 Large corporations’ reliance on externally sourced inventions grew,
and many leading Western corporations began to withdraw from scientific research (Mowery, 2009;
2
A good example is IBM, which on November 6, 1980 signed a contract with a then small firm, Microsoft, for
the development of its operating systems. Microsoft itself developed its operating system (eventually named the IBM
PC-DOS) building on the operating system of another small company, Seattle Computer Products.
2
Figure 2: Business funded and performed research in the United States (1953-2015)
Notes: Data for this graph is sourced from the National Patterns of R&D Resources: 2014-15 Data update. NSF 17-311. from
the National Science Foundation, National Center for Science and Engineering Statistics. 2017. Arlington, VA. Available at
https://www.nsf.gov/statistics/2017/nsf17311/.
Arora et al., 2018). Some corporate labs were shut down and others spun-off as independent entities. Bell Labs had been separated from its parent company AT&T and placed under Lucent
in 1996; Xerox PARC had also been spun off into a separate company in 2002. Others had been
downsized: IBM under Louis Gerstner re-directed research toward more commercial applications in
the mid-90s (Bhaskarabhatla and Hegde, 2014).3 A more recent example is DuPont’s closing of its
Central Research & Development Lab in 2016. Established in 1903, DuPont research rivaled that
of top academic chemistry departments. In the 1960s, DuPont’s central R&D unit published more
articles in the Journal of the American Chemical Society than MIT and Caltech combined. However, in the 1990s, DuPont’s attitude toward research changed and after a gradual decline in scientific
publications, the company’s management closed its Central Research and Development Lab in 2016.4
These examples are backed by systematic evidence. NSF data indicate that share of research
(both basic and applied) in total business R&D in the U.S. fell from about 30 percent in 1985 to
below 20 percent in 2015 (figure 2). The figure also shows that the absolute amount of research in
industry, after increasing over the 1980s, barely grew over the 20 year period between 1990 to 2010.
Other data show the same decline. Utilizing data on scientific publications, Arora et al. (2018) show
3
According to personal communications with Ralph Gomory (former research director and Senior Vice President for
Science & Technology at IBM), IBM even downplayed to investors the discovery of the scanning tunneling microscope
(which earned Gerd Binnig and Heinrich Rohrer of the IBM Zurich Research Laboratory the Nobel prize in physics in
1986), for fear of a drop in share price.
4
https://cen.acs.org/articles/94/i1/DuPont-Shutting-Central-Research.html
3
that the number of publications per firm fell at a rate of 20 percent per decade from 1980 to 2006 for
R&D performing American listed firms. The authors also find that the drop is even more dramatic
for established firms in high quality journals. For articles within the top quartile of Journal Impact
Factor scores, the magnitude of the drop increases to over 30 percent. Large firms’ withdrawal from
science can also be gleaned from the list of R&D 100 awards winners. Fortune 500 firms won 41
percent of the awards in 1971, but only 6 percent in 2006 (Block and Keller, 2009). Over the same
period, total industry R&D and patenting grew steadily, as did university performed research (see
figure 6 below). This evidence points to the emergence of a new division of innovative labor, with
universities focusing on research, large firms focusing on development and commercialization, and
spinoffs, startups, and university technology licensing offices responsible for connecting the two.
In this chapter, we suggest that this division of innovative labor has not, perhaps, lived up to its
promise. The translation of scientific knowledge generated in universities to productivity enhancing
technical progress has proved to be more difficult to accomplish in practice than expected. Spinoffs,
startups, and university licensing offices have not fully filled the gap left by the decline of the corporate
lab. Corporate research has a number of characteristics that make it very valuable for science-based
innovation and growth. Large corporations have access to significant resources, can more easily
integrate multiple knowledge streams, and direct their research toward solving specific practical
problems, which makes it more likely for them to produce commercial applications. University
research has tended to be curiosity-driven rather than mission-focused. It has favored insight rather
than solutions to specific problems, and partly as a consequence, university research has required
additional integration and transformation to become economically useful. This is not to deny the
important contributions that universities and small firms make to American innovation. Rather, our
point is that large corporate labs may have distinct capabilities which have proved to be difficult to
replace.
Large corporate labs, however, are unlikely to regain the importance they once enjoyed. Research
in corporations is difficult to manage profitably. Research projects have long horizons and few
intermediate milestones that are meaningful to non-experts. As a result, research inside companies
can only survive if insulated from the short-term performance requirements of business divisions.
However, insulating research from business also has perils. Managers, haunted by the spectre of
4
Xerox PARC and DuPont’s “Purity Hall”, fear creating research organizations disconnected from the
main business of the company. Walking this tightrope has been extremely difficult. Greater product
market competition, shorter technology life cycles, and more demanding investors have added to this
challenge. Companies have increasingly concluded that they can do better by sourcing knowledge
from outside, rather than betting on making game-changing discoveries in-house.
The way forward, therefore, probably involves improving the efficiency of the existing division
of innovative labor because science remains a vital input into invention. Arora et al. (2018) find that
the decline of scientific research in corporate R&D after 1980 was mirrored by a drop in the implied
value of scientific capability, as measured by stock market valuation and acquisition price. As they
also stress, however, whereas the private value of investing in scientific research in-house declined,
there is no evidence that the social value of science declined. Patents continue to build upon scientific
knowledge (as measured by citations) and, if anything, the relevant science is more likely to be new
rather than old science. In other words, not only is science relevant for invention, but advances in
science continue to be useful. This is especially true of corporate research. Where company research
is significantly advantageous, due to complements such as specialized equipment or proprietary data,
companies will continue to invest in research, especially if they can appropriate enough of the benefits
by restricting spillovers to rivals.5
The remainder of this chapter is organized as follows. Sections 2 and 3 describe the rise of
the U.S. scientific-industrial complex. Section 4 explains how this ecosystem has changed in recent
times. Interestingly, this rise and fall of the large corporate lab matches quite well the rise and fall
of American productivity. Section 5, therefore, explores the idea that corporate labs may be an
important engine of economic growth, even when research produced by universities is at a record
high. Section 6 briefly discusses some effects of public policy on the American innovation ecosystem,
and Section 7 concludes.
5
Arora et al. (2017) show that companies remain engaged in research when they can use the research in internal
inventions, and can restrict spillovers to product-market rivals.
5
2
The old innovation ecosystem: 1850-1940
Our discussion builds on accounts by Mowery (2009), Mowery and Rosenberg (1998), and others.
These authors note that, while in the late nineteenth and early twentieth centuries independent
inventors were the primary source of American inventions, the locus of innovation shifted during
the interwar years from such inventors and small firms to large corporations and their labs. After
World War II, corporate labs reached their zenith, with corporate scientists winning a number of
Nobel prizes. By the 1980s, however, small firms (often founded by university scientists) regained
their advantage, because the postwar period also saw the rise of the research university. Universities
went from merely the producers of human capital to becoming the dominant producers of scientific
knowledge.
2.1
The age of independent inventors and the market for technology:
1850-1900
Up until the late nineteenth century, American academia was considered backward. The main application of scientific knowledge was in agriculture, and the pursuit of more abstract natural phenomena
were limited. For instance, the American Academy of Arts and Sciences had stated in 1780 that it
was devoted to “improvements in agriculture, arts, manufactures, and commerce” (Reich, 1985,
p.14). Even the Smithsonian Institutions did not pursue or support basic scientific research during
this era (Shils, 1979, p.22). The Land Grant Institutions established after the Morril Act of 1862
were intended to pursue research in “agriculture and [the] mechanic arts,” which did not include
physics or chemistry. By 1897, a mere 56 PhDs had been earned by Americans in mathematics, 73 in
physics, and 101 in chemistry. Full-time research jobs were rare and U.S.-based authors had seldom
published in major international journals, with only 39 papers in mathematics, 154 in physics, and
134 in chemistry (Kevles, 1979, p.170). Naturally, American inventions in this period relied upon
individual creativity, mostly in mechanical design. Lamoreaux and Sokoloff (1999) show that in the
1840s and 1850s, patents were mostly held by individuals such as Charles Goodyear (vulcanized
rubber patent (1844)) and Henry Bessemer (Bessemer process patent (1855)). Research consulting
6
activities were contracted by the petroleum and telegraph sectors. Standard Oil employed Herman
Frasch to lower the sulfur content of its newly opened Ohio fields in the 1880s, and Western Union
employed Thomas Edison for various technical solutions in the 1870s (Birr, 1979). By the turn of
the century, as the inventive process itself became more science-based, firms began to invest more
directly in science. Even so, independent inventors remained an important source of inventions in
the first half of the twentieth century.
Independent inventors were supported by an active market for technology. By the 1870s, technology transactions were common, particularly in the northeastern part of the United States. Lamoreaux
and Sokoloff (1999) estimate that ratio between patents assigned in 1870 to patents granted in 1870
was 0.83. In 1890 and 1911, the ratio was somewhat lower, at 0.71.6 On the other hand, if one examines patents assigned at issue, the share grew from 18.4 percent to 31.1 percent, with an increasing
share of assignments going to companies. In other words, a growing share of inventions were being
commercialized by selling the patents, especially to existing producers. Simply put, there was an
active market for technology in the latter half of the nineteenth century.
The number of individuals specializing in inventions grew as well, consistent with Adam Smith’s
dictum that specialization is limited by the extent of the market. The share of occasional inventors
(who filed one or two patents over their lifetime) from all inventors fell from over 70 percent in 1830
to less than 35 percent in 1870. In 1870, specialized inventors, who filed ten or more patents over
their lifetime, accounted for 5 percent of all patents. By 1911, their share, of a much larger patent
pool, had grown to 25 percent. These specialists were also more likely to assign their patents to
others, consistent with the view that a growing market for technology and greater specialization in
invention went hand in hand during this time.
Corporate engagement in research began modestly. The leading American firms of the 1870s
and 1880s largely relied on external inventions; the railroad companies did not invent steam engines
or breaking systems, nor did Western Union invent telegraphy. Instead, Railroads and other large
firms relied upon acquiring inventions from inventors. In many instances, these inventors worked
for the railroad but were not hired to invent (Usselman, 1999). These leading firms did, however,
establish their own industrial labs to evaluate the quality of these external inventions and other
6
In absolute terms, the number of patents assigned more than doubled over this period, but the number of patents
granted grew even faster.
7
inputs, to perform materials testing and quality control, and to trouble-shoot production. The patent
department of the American Bell Telephone, a high tech enterprise of its day, was responsible for
evaluating ideas submitted to it for patenting. Much of its efforts were spent on evaluating external
inventions, even though the company acquired only a small fraction of such inventions. Only in 1907
the emphasis shifted to internal R&D, with the appointment of Theodore Vail as president.
Corporate attitude towards the organization of science in for-profit corporations was well expressed in 1885 by T. D. Lockwood, head of American Bell Telephone Company’s patent department:
“I am fully convinced that it has never, is not now, and never will pay commercially, to keep an establishment of professional inventors, or of men whose chief business it is to invent” (Lamoreaux and
Sokoloff, 1999). Wise (1985) argues that Westinghouse and Edison Electric followed similar strategy
during the late nineteenth century. In short, these leading companies were purchasing patents and
consulting services from independent inventors, rather than developing their own R&D facilities.
2.2
2.2.1
The innovation ecosystem in transition: 1900-1940
The beginnings of corporate research
Several pushes and pulls propelled American corporations to create large R&D laboratories. First,
there was the German precedent of industrial research in chemical firms that allowed for firms such
as BASF, Bayer, and Agfa to thrive in organic synthetic dyes in a highly competitive international
market (Reich, 1985, p.41). Second, the strategy of acquiring patents was becoming harder because
of rising complexity of technologies. For example, DuPont had repeatedly failed in its attempt to use
the Bevan, Cross and Topham patents from the United Kingdom to start a viscose rayon process in
the United States in the 1910s. It lacked the internal technical and scientific capability to understand
these patents and know-how to use them. Eventually, a joint-venture with Britain’s Samuel Courtauld
& Company (which had the know-how and manufacturing expertise) was necessary to start viscose
rayon production in America (Hounshell, 1988). Third, American inventions were challenged by
science-based competition across the Atlantic. GE’s control over electric lighting in the 1890s, for
instance, was solely based on the carbon-filament high-vacuum incandescent variety, first invented
by Thomas Edison in 1879. German chemists such as Carl Welsbach and Walther Nernst (the 1920
8
Nobel Laureate in Chemistry) respectively invented incandescent mantels for gas lamps (a substitute
product) and a glower which required no vacuum to operate and was 50 percent more efficient. Patent
rights to the Nernst glower in turn were first sold to the German firm AEG for $1 million and then
sold to GE’s rival, Westinghouse in 1894 (Wise, 1985). GE management took notice of this “pandora
effect” of innovative activity that was difficult to circumscribe and control, and thereby approved
electrochemist Charles Steinmetz’s proposal to establish the GE Research Laboratory (GERL) in
1900. The payoffs were not long in the coming: William Coolidge (1906) would develop a method
using tungsten instead of carbon filaments to increase bulb life, and Irving Langumir (1913) would
invent the inert gas-filled lightbulb to reduce blackening, which became the industry standard.
The result was a sustained growth in corporate research. The chemical industry, perhaps the
most scientifically grounded industry of the first half of the twentieth century, employed 1,102 scientists in corporate labs in 1921, and grew to 3,255 in 1933 and to 14,066 by the end of World War
II (Mowery and Rosenberg, 1999). Later, the wartime experiences of being part of the National
Research Council cemented the faith of managers that science could be effectively put to practical
applications (Geiger, 2004). This process gained momentum as corporations grew larger and more
keen to “routinize” innovation; that is, to originate and manage it instead of relying on an uncertain supply of external inventions (Maclaurin, 1953). Stronger antitrust enforcement also convinced
managers that buying other firms would be a costlier way to grow than by introducing new products
derived from in-house research. In the 1950s, firms such as AT&T, DuPont, IBM, and Kodak employed tens of thousands of scientists whose chief objective was to conduct research to support the
companies’ existing products and to develop products that would open up new markets.
It is important to emphasize that the science conducted even within the most university-like
corporate labs was still aimed at some form of economic problem solving, and hence fell under
the category of “mission-oriented” research. Steinmetz’s application of complex exponentials to
decompose sinusoidal signals, for instance, was motivated by the need to better understand impedance
and control alternating currents (Kline, 1992). Of course, the mission-orientedness of industrial
research does not detract from its scientific sophistication (Stokes, 2011). Indeed, even at the early
stages of industrial research, Steinmetz earned himself the presidency of the American Institute of
Electrical Engineers, while Langumir collected his Nobel prize in Chemistry in 1932 for work done at
9
GERL.7 The scientific quality of corporate research remained high even as quantity grew. Quality,
as measured by forward citations by scientific peers, kept up with (and at times exceeded) research
at top universities, as seen in figure 3.
Figure 3: Scientific Citations per Publication, by Sector (1920-1940)
Notes: This graph plots the number of forward scientific citations per publications in Clarivate Web of Science, by the sector of the
author’s affiliations. “Top Research Universities” refer (in alphabetic order) to UC Berkeley, Brown, Bryn Mawr, Caltech, Chicago,
Clark, Columbia, Cornell, Harvard, Hopkins, Illinois, Iowa, Lafayette, MIT, Michigan, Minnesota, Missouri, Nebraska, North Carolina,
NYU, Penn, Princeton, Stanford, Wisconsin, and Yale. The “Corporate” sector includes parents and subsidiaries of 200 large industrial
firms included in Kandel et al. (2018). We fuzzy-match these university and firm names to the address column of Web of Science
publications and count the number of forward scientific citations these publications receive until 2016.
2.2.2
The rise of research universities
As shown in figure 4, universities in this era relied heavily on state and industry funding, rather than
federal funding (Geiger, 2004; Bruce, 1987). According to the Biennial Survey of Education compiled
by the Department of Education, the share of federal funding as a source of university revenue had
hovered around 4-7 percent between 1909 and 1939. The share of state funding, on the other hand, was
somewhere between 20-30 percent in the same period (Snyder, 1993). As a result, colleges developed
specialties specific to industrial activity relevant to their location. The University of Oklahoma, for
instance, pioneered innovations in petroleum engineering such as reflection seismology. The University
of Akron and the University of Cincinnati respectively trained specialists that could be employed by
the local rubber and tanning industry (Mowery and Rosenberg, 1991). Federal institutions paid
very little attention to the pursuit of fundamental knowledge – most federal research was conducted
7
Industry executives took a keen interest in the world of science as well. AT&T Bell Labs president Frank Jewett
was instrumental in persuading Princeton physicist Karl Compton to take up his presidency at MIT, and later served
as president of the National Academy of Sciences from 1939 to 1947.
10
Figure 4: Sources of University Revenue in the United States (1889-1954)
Notes: This graph plots the sources of revenue for the institutions of higher education in the United States. Data is sourced from
Snyder (1993), Table 33 and is based on the U.S. Department of Education’s Annual Report of the Commissioner; Biennial Survey of
Education in the United States. The figure for federal funding sources in 1919-20 is included under state government funding for those
years.
through agencies with clear short-term objectives such as the Coastal, Geological Surveys and the
Permanent Commission of the Navy Department (Shils, 1979). These form the origins of the missionoriented tradition in U.S. universities.
The alternative view of the university as a fundamental research institution driven by intellectual curiosity had been pioneered by Alexander von Humboldt, who founded Humboldt University of
Berlin in 1809 (Atkinson and Blanpied, 2008). American returnees from these German universities
such as Evan Pugh and Samuel Johnson advocated for fundamental research at universities (Shils,
1979). The subsequent establishment of research universities such as Johns Hopkins (1876), Clark
(1887) and the University of Chicago (1892) made possible the recruitment of prominent mathematicians such as James Sylvester, who founded the American Journal of Mathematics in 1878, and
chemists, such as Ira Remsen, who founded the American Chemical Journal in 1879 (Kevles, 1979).
These early successes spurred established schools to follow suit, with Harvard opening the Jefferson
Physical Laboratory in 1884. German-trained physicists and chemists such as Henry Rowland (at
Berlin under Hermann von Helmholtz) and Arthur Noyes (at Leipzig under Wilhelm Ostwald) took
up prominent positions at Johns Hopkins and MIT respectively, and diffused the norm of curiosity-
11
driven science (Reich, 1985). Rowland, for instance, authored the Plea for Pure Science in 1883
for the AAAS address that year, in which he demanded “what must be done to create a science
of physics in this country, rather than to call telegraphs, electric lights, and such conveniences by
the name of science?” (Rowland, 1883). In the view of Rowland and other like-minded scientists,
applied science “drives out” basic, making it imperative for universities to defend the latter type
(Bush, 1945). Federal reforms such as the Hatch Act of 1887 and the Adams Act of 1907 allowed
federal funds to reach original research that was not immediately applied.
Between 1870 and 1893, 39 articles by Americans had appeared in mathematics publications, 144
in physics publications, and 134 in chemistry publications. Between 1894 and 1915, those numbers
rose to 372, 303, and 403, respectively. There is evidence of an increase in quality as well as quantity.
Over the same period, the number of papers by American scientists published in prestigious foreign
journals such as Nature and Comptes Rendus (the proceedings of the French Academy) doubled
for physics and chemistry and jumped almost eightfold for mathematics (from 39 to 303). The
total number of doctorates in these three disciplines also increased from 230 to 820. Perhaps most
tellingly, the number of doctoral students in the sciences studying abroad decreased from 189 to 90
(chemistry saw the steepest decline, from 116 to 32). These patterns are consistent with American
science catching up to European standards.
As research universities entered the interwar period, the twin norms of mission-orientation and
discipline-orientation became a source of increasing tension within, and a demarcator between, these
institutions. On the one hand, universities were receiving industrial contracts for research that
were focused on specific problems. For instance, the National Rock and Slag Wool Association
financed building insulation studies from the University of Minnesota. MIT’s electrical engineering
department maintained close ties with AT&T from 1902, which supported departmental research and
teaching. At MIT, the Research Laboratory of Applied Chemistry (RLAC) led by William Walker
aggressively pursued industrial contracts. An endowment fund drive that began at the Institute
in 1919 resulted in the “Technology Plan,” which would secure corporate financing in exchange for
tailor-made conferences and access to alumni files for recruitment.8
Another incentive for university faculty to collaborate with industry was that many of the ex8
Sponsored industrial research at MIT exceeded $100k in 1920-21 and rose to over $270k by 1930 (Geiger, 1986,
p.179)
12
citing research areas required expensive equipment (vacuum tubes, catalysts) often more abundantly
found in industrial laboratories. For instance, as the demand from the electrical industry drove MIT
to offer its first degree in electrical engineering in 1882 (Reich, 1985, p.24), some of the best academic
researchers at the time, such as MIT’s Willis Whitney and William Coolidge, went to General Electric to continue their research. William Carothers, the inventor of nylon, was drawn away from his
position at Harvard to DuPont, which could offer him more time for research and greater experimental resources. Synthesizing complex polymers required expensive instruments, such as the molecular
still which eliminates excess water in chemical reactions, which were critical to the synthesis of large
polymers such as nylon. Large companies also helped found many scientific associations; for example, the Optical Society of America was founded in 1916 by a group at Eastman Kodak while the
Acoustical Society of America was founded in 1928 at Bell Labs (Weart, 1979, p.321).
Research universities in this era therefore seem to have become not only more able, but also
more willing to provide inputs to corporate inventions. Indeed, the employment characteristics of
American Physical Society members in figure 5 shows that compared to 1905, the share of physicists
working in industry and government had increased to around 10 percent in the 1930s. National
Research Council data on scientific employment figures show a similar growth over a slightly later
period: Scientists and engineers employed in manufacturing industries grew more than sixteen-fold,
from 2,775 to 45,941 between 1921 and 1946 (Mowery and Rosenberg, 1999, p.22).
Figure 5: Employment of American Physical Society Members
Notes: This figure is based on data on the employment affiliations of members of the American Physics Society from Weart (1979), and
plots the annual employment share of each destination sector.
However, this pattern of willing university research for industry faced a backlash from within.
13
Chemist G.N. Lewis left MIT for Berkeley citing “industrial intrusions into university research” as a
reason. Arthur Noyes (former acting president of MIT and NRC member) also departed from MIT
for Caltech after a dispute with Walker about industrial research. MIT’s replacement of Richard
MacLaurin with physicist Karl Compton from Princeton, and the subsequent shutdown of individual
industrial research programs, shows universities defending their institutional logic as builders of scientific disciplines. The operation of the newly founded California Institute of Technology epitomizes
this “correction.” Advocacy by scientists such as George Hale led Caltech to shun direct consultancies with firms, and to only accept “fluid” grants from foundations and firms that could be used for
general research. A stark demonstration of universities’ willingness to avoid mission-oriented research
tasks comes from the closure of flagship government laboratories after World War II. For instance,
Harvard informed the Navy in 1944 that it did not wish to house an underwater sound lab. Chicago
similarly wished to withdraw from managing the Metallurgical Lab, which designed an experimental
reactor for plutonium production (Geiger, 1986, p.32). It was largely due to lobbying efforts by lab
management and funding by federal agencies that Caltech’s Jet Propulsion Laboratory or Applied
Physics Lab were able to persist.
3
3.1
The postwar period: 1950-1980
Growing federal support for university research
The evolution of American research universities since the mid-nineteenth century shows a pendulum
swing between mission-oriented and discipline-building research goals. While the beginnings of research universities had been to serve practical purposes, the infusion of German-trained expatriates
imbued a new goal of pursuing science for its own sake in these institutions. The postwar federal
research expansion enabled universities to free themselves of the need for industry support. By the
1960s, faculty at top research universities were largely pursuing agendas of their own without having
to coordinate their efforts with industry.
The war years saw large increases in Federal R&D expenditures rising from $83.2 million in
1940 to a peak of $1,313.6 million in 1945 (Mowery and Rosenberg, 1999, p.28). Figure 4 also shows
14
that beginning from 1940, the university sector has been an important beneficiary of this spending
increase. Synthetic rubber, mass-produced penicillin, radar, and the atomic bomb demonstrated
to policy makers the possible returns that federal investment in science could yield. Universities
functioned as hosts of such research efforts. For example, before being moved to Los Alamos, the
principal scientific work for the Manhattan project was conducted by academics such as Ernest
Lawrence and Robert Oppenheimer at Berkeley, Harold Urey at Columbia, and A.H. Compton at
Chicago Metallurgical lab. Cyclotron experiments were run at Minnesota, Wisconsin, Harvard, and
Cornell. The Radiation Lab, which studied improvements in radar technology vital to the Allied war
effort in the Battle of Britain, had been located at MIT (Geiger, 1993, p.27-9).
The onset of the Cold War and the “Sputnik Shock” gave further justification for federal academic
support. Starting with the founding of the Atomic Energy Commission (which largely inherited the
infrastructure for the Manhattan Project), wartime projects were re-organized under mission-agencies
such as the ONR, NIH and NASA, while the National Science Foundation was established by 1950
to oversee and coordinate these efforts. As a result, federal research dollars for the university sector
grew from an estimated level of $420 million (1982 dollars) in 1935-1936 to more than $2 billion (1982
dollars) in 1960 and $8.5 billion in 1985. Between 1960 and 1985, the share of university research of
GNP grew almost twofold from 0.13 to 0.25 (Mowery and Rosenberg, 1993, p.47). This injection of
federal support implied that research universities did not need to rely as much on industrial funding.
Moreover, much of the investments by the federal government during the postwar years — even those
funded by mission-oriented agencies such as the Department of Defense or the Department of Energy
— were aimed at building up stocks of human capital and provided support for faculty-originated
research. Thus, federal research support steadily distanced universities from the specific innovation
needs of industry.
3.2
The golden age of the corporate lab
This extensive investment in science enabled firms to exchange personnel and ideas with the university sector in the postwar era. Corporate labs, which had been growing substantially during the
1920-1940 period, grew even further after World War II. For instance, at its peak in the late 1960s,
AT&T’s Bell Labs employed 15,000 people, of whom about 1,200 had PhDs (Gertner, 2013). Four15
teen Bell Labs alumni were awarded the Nobel Prize, and five were recipients of the Turing Award.
DuPont also dramatically expanded its research program in the late 1940s, following the discovery
and successful development of neoprene and nylon in the 1930s and investigations by the Justice Department’s Antitrust Division in the 1940s (Hounshell, 1988). DuPont’s early successes at innovating
cemented the view within the company that research, particularly of the fundamental type, was key
to profitability and growth. Antitrust pressures convinced management to invest in internal research,
rather than relying on technology markets. By the early 1980s, DuPont employed about 6,000 people
in its labs, with a research and development budget exceeding a billion dollars supported by sales
of about $30 billion. This constituted a ten thousand-fold growth in research expenditures and a
thousand-fold growth in sales since the early 1900s (Hounshell and Smith, 1988, p.9).
Although experimentation and trial-and-error remained key elements of the innovation process,
one fundamental change over this time period was the enhanced role of scientific knowledge in guiding
new product development. Arguably nowhere was this change more evident than in the pharmaceutical industry. From the late nineteenth century, drug discovery had relied on large-scale, “random”
screening of chemical compounds, followed by attempts to improve the molecule and then to test
the potential drug candidate for safety and efficacy. However, in the 1960s and 1970s, advances in
basic knowledge, instrumentation and computational capability had made it increasingly valuable for
pharmaceutical firms to invest in the fundamental understanding of drugs (Arora and Gambardella,
1994; Gambardella, 1995). By isolating and understanding the structure of crucial enzymes, for instance, researchers could greatly increase the chances of discovering a chemical agent that would stop
a sequence involved in a disease process.
The development of Lovastatin, a breakthrough statin medication used to treat high blood
cholesterol and reduce the risk of cardiovascular disease, illustrates how this more science-based
approach to drug discovery was adopted at Merck Research Laboratories (MRL) in the 1970s (Vagelos
and Galambos, 2004). Researchers at various laboratories had identified an enzyme, HMG-CoA
reductase, controlling the slowest reaction in the cholesterol synthetic sequence. This rate-limiting
enzyme was a natural target for inhibition because it controlled the rate of the entire sequence.
Through random screening, MRL researchers had also identified a product candidate, halofenate,
that lowered blood cholesterol and had advanced it to clinical testing in patients. Many researchers
16
at MRL were optimistic about halofenate, but Roy Vagelos, the newly hired MRL president, did
not share their optimism. First, this product candidate did not seem to inhibit any of the specific
enzymes involved in the cholesterol synthesis. Second, clinical trials had showed that, besides lowering
cholesterol, halofenate also had several poorly understood side effects. Vagelos, therefore, decided
to prioritize the work of a group of scientists recently hired from Washington University who were
targeting the HMG-CoA reductase enzyme. In 1978, the team discovered that aspergillus terreus, a
common soil microorganism, was producing something that was active against the target enzyme.
In 1979 Lovastatin was patented and in 1987 was approved for medical use under the brand name
Mevacor. In 1986 and 1987 alone, thanks to this more efficient approach to drug discovery, Merck
launched seven major new drugs. The gains from these science-based drug discovery methods also
translated to improvements in Merck’s bottom line — between 1960 and 1989, annual sales increased
thirty-fold from $218 million to $6.6 billion.
Science-based innovation required corporations to hire larger numbers of scientists, and universities provided the necessary human capital. The first substantial influx of scientists took place during
the 1930s and 1940s, as pharmaceutical firms grew in size and technical sophistication (Mahoney,
1959). Furman and MacGarvie (2009) provide evidence that, from 1927 to 1946, research-oriented
pharmaceutical firms actively hired from local scientific doctoral programs. Lee (2003) documents
very large differences in innovative outputs between the firms that invested in R&D after 1940 and
those that did not. Moreover, these differences persisted in the succeeding period between 1940 and
1960.
Even in this “golden age,” interactions between corporate labs and other components of the
innovation ecosystem – government agencies, universities and startups – remained strong. The history of Xerox’s Palo Alto Research Center (PARC) provides an illustration of the importance of
these interactions (Rao and Scaruffi, 2013). Xerox PARC was arguably the most innovative corporate research lab in the 1970s, pioneering modern office technology. PARC researchers created the
first personal computer with a graphical user interface, the laser printer, and Ethernet networking
technology. However, many elements of PARCs innovations came from outside, most notably the
ARPA-funded Augmentation Research Center (ARC) at the Stanford Research Institute (SRI). The
ARC had developed bit-mapped screens, the mouse, hypertext, collaborative tools and precursors to
17
the graphical user interface in the mid-1960s, long before the private sector had. PARC, which hired
many ARC researchers such as Robert Taylor, benefited greatly from the early absorption of these
technologies (Hiltzik and others, 1999). Subsequently, however, PARCs innovations also spilled over
to other organizations. The story of the twenty-four-year-old Steve Jobs visiting PARC in 1979 is
well known. Jobs incorporated many key PARC innovations into the Apple Lisa and the Macintosh.
Charles Simonyi, who had developed the first user-friendly word processor for PARC (the Bravo),
also left PARC to take a job at Microsoft, where he oversaw the creation of Microsoft’s Office suite
of applications. With the benefit of hindsight, Xerox often failed at commercializing technology from
PARC. The exception was when the inventions were closely related to its core business (e.g., the
laser printer). In those cases, the firm was able to profit handsomely from PARC inventions. Such
inventions, at least for a time, allowed the firm to recoup its investment in PARC, despite the errors
and spillovers.
Another illustration of the interactions between elements of an innovation ecosystem is provided
by the early development of laser technology. The main theoretical work leading up to the laser
was co-authored by a university scientist (Columbia’s Charles Townes) and a corporate researcher
(Bell Lab’s Arthur Schawlow) (Schawlow and Townes, 1958). The ammonium gas maser, invented by
Charles Townes at Columbia’s Radiation Lab in 1953, was part of a natural progression in academia
toward higher frequencies, from radio to microwave to infrared and visible light. But the private
sector also saw the potential in achieving stimulated photonic emission at the visible light range
— AT&T and RCA, for instance, recognized that the information content of visible light was far
richer than in the microwave range (Gertner, 2013; Hecht, 1992). Universities, on the other hand,
were slower to follow up on the “maser paper” by Schawlow and Townes. Many university scientists
such as Gordon Gould (who drafted the “laser memo” at Columbia) left academia to join firms such
as Technical Research Group (TRG). With both significant defense and civilian funding available,
lucrative positions were available at AT&T, Hughes Aircraft, TRG, IBM, and the American Optical
Company. This personnel exchange manifested in active scientific publication activities by industry in this area. A bibliometric analysis of peer-reviewed scientific journals in Physics Abstracts
for 1963 revealed that 71 percent of American-authored papers on lasers were written by industrial
scientists (Bromberg, 1991, p.98). Complementary engineering skills such as semiconductor doping,
18
vacuum chamber construction, and crystal pulling involved a substantial amount of tacit knowledge.
Therefore, firms with the structures for preserving and passing on such knowledge contributed to
subsequent breakthroughs. For example, although the IBM group was a latecomer to laser development, their accumulation of knowledge and know-how over the years would yield the invention of dye
lasers and semiconductor lasers in the 1960s, a crucial step in miniaturizing laser devices and used
today in fiber optic datalinks (Guenther et al., 1991).
In summary, the innovation ecosystem that emerged after World War II saw a sustained growth
of the research university sector, spurred by the infusion of federal funding. Throughout this period,
corporate labs maintained high-caliber scientific personnel and made complementary investments in
instrumentation and experimental equipment. This helped firms to readily absorb the newest scientific developments and accommodate university scientists in their labs. During this time, corporations
were also, perhaps unfairly, often blamed for failing to exploit the many inventions created in their
labs. As research universities continued to expand, corporations’ ability to source inventions from
outside also grew. These changes made it increasingly difficult for firms to justify large investments in
internal research. A drastic transformation of the American innovation ecosystem ensued, beginning
in the last quarter of the twentieth century.
4
The “new” innovation ecosystem: 1980-2016
The new innovation ecosystem is characterized by a deepening division of innovative labor between
universities and corporations, with the former focusing on research and the latter dedicating their
efforts to development. Freed from specific commercial objectives, individual scientists subdivided
problems into sub-problems, with each sub-problem more amenable to scientific investigation. From
an industry perspective, however, using the output of university research still required significant
coordination and integration. The task of converting scientific insights into inventions that could
be the basis of new products and processes became a specialized one. Universities were not well
placed to “translate” research findings into executable solutions. Corporations – especially those
which lacked internal labs familiar with mission-oriented research – also found it difficult. Thus,
although specialization had its benefits, the separation between upstream research and downstream
19
applications also presented formidable challenges.
4.1
Universities, the division of innovative labor and the market for
technology
During the 1980-2016 period, the research university sector continued to grow at a sustained pace.
Academic institutions spent $61 billion on basic and applied research in 2015. Their share of total
research in 1985 was 23.8 percent and rose to 33.6 percent in 2015 (Boroush, 2017). Universities
participated in the division of innovative labor by producing scientific insights, as well by directly
producing inventions to be developed. In support of such a division of labor, the U.S. Congress passed
the National Cooperative Research Act in 1984, which reduced the risk of antitrust prosecution by
the Department of Justice for firms engaging in R&D collaborations. Perhaps the most widely
commented on reform of this era was the Bayh-Dole Patent and Trademark Amendments Act of
1980, which allowed the results of federally funded university research to be owned and exclusively
licensed by universities. Since World War II, the federal government had been funding more than
half of all research conducted in universities and owned the rights to the fruits of such research,
totaling in 28,000 patents (Markel, 2013). However, only a few of these inventions actually made it
into the market. One of the expected benefits of the Bayh-Dole Act was to facilitate the development
of these underutilized resources by transferring property rights to the universities, which would then
be able to independently license at the going market rate. Licensing, joint ventures, or spinoffs from
university research were of course not new. As early as 1934, Arnold Beckman, a physical chemist at
Caltech, spun off his pH meter invention into what would become National Technical Laboratories
(now Beckman Coulter) – the nation’s foremost scientific instrument manufacturer. What was new
with this reform was that the uncertainty related to licensing federally funded research was now
significantly reduced.
Universities responded by deepening their participation in invention. The share of universities
in patenting activity increased from 1 percent of total patents in 1975 to 2.5 percent in 1990. The
ratio of patents to R&D spending in universities almost doubled during this period, from 57 patents
per $ billion to 96 patents per $ billion. Because the rest of the economy saw a decrease, from
20
Figure 6: U.S. Applied & Basic Research Expenditure by Performing Sector (1980-2015)
Notes: This figure plots the aggregated annual basic and applied research expenditure by performing sector from the NSF National
Patterns of R&D Resources (2014-15) tables 3 and 4. Figures are adjusted to 2016 dollars using GDP deflator from the World Bank
National Accounts dataset.
780 to 429 patents per $ billion of R&D spending (Henderson et al., 1998), it is unlikely that this
increase in patent intensity reflected changes in patent office practices or other reductions in the cost
of patenting. Over a longer period of time, the number of patents granted exhibits an even starker
contrast: 380 patents were awarded in 1980, while 3,088 were awarded in 2009 (Markel, 2013). The
increases in university patent applications and gross licensing income shown in figure 7 underlines this
upward trend. The number of university patent applications more than quintupled between 1995 and
2015 from around 2,700 to over 15,000 per year. A similar trend is observed for university licensing
income, which jumped from $.6 billion to $2.3 billion in the same period. University scientists have
found it increasingly attractive to start their own businesses, with high-powered incentives and fast
decision-making that are difficult to replicate in large, established firms. Changes in the institutional
and legal environments complemented these trends. Start-ups can now get financing from venture
capitalists and from SBIR and other government programs (Lerner, 2000; Mazzucato, 2015). Indeed,
many firms have been spun-off from non-profit research institutions bringing forth such innovations
as the MRI, recombinant hepatitis B vaccine, atomic-force microscope and the Google pagerank
algorithm.
Cultural changes in whether university research should be used in industry were also important in
shaping university participation in markets for technology (MFT). In the 1960s and 1970s, universityindustry collaborations were seen with suspicion. Geiger (1993) argues that the student protests
21
Figure 7: Patent Applications and Gross Licensing Income by Universities (1995-2015)
Notes: This plot graphs university participation in technology markets using survey data from the Association of University Technology
Managers (AUTM). The bar graph shows the number of patent applications filed by universities. The line graph shows gross licensing
income received by universities. Units are in millions of 2009 dollars (deflated using GDP figures from Bureau of Economic Analysis,
National Economic Accounts, Gross Domestic Product, http://www.bea.gov/national/)
of 1968 engendered a widespread antipathy toward “programmatic” or mission-oriented research.
National reports published during the 1970s urged universities to emphasize their teaching functions
and contributions to society at large. Aversion toward commercial engagements with firms can
be gleaned from disclosures of university-industry collaborations (or lack thereof). For instance,
Monsanto’s $23 million, 12-year research deal with Harvard university in 1974 was kept private
until press attention forced Monsanto to reveal the terms of the agreement. NIH investigations and
hearings at the House Science and Technology Committee also followed similar deals between Hoechst
and Massachusetts General Hospital’s new genetics department (affiliated with Harvard University)
in 1981.9
Gradually, however, appreciation for use-inspired research and industry collaborations was rediscovered, due to several factors. First, major government initiatives such as the “War on Cancer”
(The National Cancer Act of 1971) indicated that key societal goals could be achieved through scientific research. To support practical applications of basic science, the NSF also created the program
on Research Applied to National Needs (RANN). Second, stagnant growth in the 1970s, combined
with competitive threats from West German and Japanese manufacturing firms, arguably enhanced
9
https://www.thecrimson.com/article/1981/7/3/biotechnology-and-the-faustian-dilemma-pscientists/
22
the value of using research as an input to economic growth. For instance, state governments in
Georgia and North Carolina looked to universities for regional economic development by inducing
co-location of research contracting firms. Later, other policies encouraged co-location of spin-offs
based on technology developed in academia (Geiger, 2004).
4.2
The expansion of the market for technology and smaller firms
A key characteristic of the new innovation ecosystem is the emergence of small, specialized research
organizations that trade ex ante (research and consulting projects) and ex post (patents, software
licenses, chip designs) knowledge products. These smaller firms either directly commercialize their
ideas by introducing new products to the market or indirectly by selling them on to larger firms with
downstream capabilities, in sharp contrast to the earlier system, where large firms originated their
own inventions.
While venture capital-backed startup firms had been around since the 1950s (for instance in the
laser industry for defense contracts), their rise to prominence in the American innovation ecosystem
occurred only after the emergence of the semiconductor and biotechnology industries. Mowery and
Rosenberg (1998) emphasize that while large firms such as IBM and AT&T were responsible for
devising more general purpose hardware such as the IBM 360 and the transistor, antitrust pressures
from the Department of Justice (e.g. the 1956 settlement between the DOJ and AT&T) made it very
difficult for them to enter downstream markets using those technologies. Aided by liberal licensing
policies that resulted from this pressure, small firms such as Microsoft, Apple, Texas Instruments and
Fairchild Semiconductors rapidly developed improved iterations of the original products (Malerba,
1985; Tilton, 1971). For instance, Flamm (1988) counts at least 80 computer startups in the mid1950s that were catering for defense contracts and later consolidated and re-purposed for civilian
use. The role of firms such as Genentech, which successfully commercialized a university invention
into mass produced human insulin, was crucial in encouraging entry by private equity firms into
the biotechnology sector, which lent capital to scientist inventors that specialized in monoclonal
antibodies and DNA splicing (Pisano, 2006).
Intellectual property rights were significantly strengthened (Guellec and de La Potterie, 2007;
Jaffe and Lerner, 2006). At the national level, the Federal Courts Improvement Act of 1982 estab23
lished the U.S. Court of Appeals for the Federal Circuit, streamlining judgment on patent-related
cases. Select sectors have also received added attention: the Semiconductor Chip Protection Act of
1984 for instance strengthened IP protection for chip designs. Also, while software was unanimously
ruled by the Supreme Court as unpatentable in 1972, successive cases since then have reopened aspects of the Court’s decision and allowed for hardware embodying software and software embodying
industrial processes to be patented (Arora et al., 2004, p.61). Globally, the office of the U.S. Trade
Representative has consistently pushed for stronger enforcement of intellectual property rights, and
was integral in inserting the Agreement on Trade-Related Aspects of Intellectual Property Rights
(TRIPS) agreement into the Uruguay Round of 1995.
Table 1: U.S. Distribution of technology licensing receipts by sector for 2002 & 2011 (in
billions of dollars)
Sector
Technology Royalty and License Fee Income (2011)
Licensing of IP
Protected as Industrial
Property (2002)
Total
Tech and Ind
Software
Process
Manufacturing
Wholesale, retail, transport
Information
Finance and Insurance
Professional and bus. services
Other industries
59.5
1
1.9
0.2
3
1
25.7
49.6
27.7
1.6
4.5
1.2
24.8
49.4
2.1
1.3
2
1.1
0.9
0.3
25.6
0.3
2.5
0.1
Total
66.6
111.2
81
30.2
Notes: This table shows the distribution of technology licensing receipts in the United States. The figures for 2002 are from Robbins
(2009) Table 4.10. The figures for 2011 are from the Census Enterprise Statistics Program (ESP) 2011 Table 3: Royalty and License
Fee Income from Rights to Use Intellectual Property (Detail). https://www.census.gov/econ/esp/historical.html
As a result, American corporations reported $92 billion of income from licensing intellectual
property in 2002, and the supporting IRS data show an annual growth of 11 percent from 1994 to
2004, which outpaced average GDP growth (3.42 %) in the same period (Robbins, 2009). The number
of transferred patents as measured by reassignments between firms has also risen substantially from
around 7,000 to over 12,000 cases per year between 1987 and 2014.10 Moreover, business models
specializing in selling intellectual property without engaging in downstream manufacturing and sales
10
Authors’ calculations based on data from the USPTO Patent Assignment Dataset (Graham et al., 2018), replicating cleaning procedures in (Serrano, 2010) to identify patent reassignments that qualify as market transactions.
24
have been validated by firms such as Exponent (chemicals), Genentech (biotech), and ARM (fabless
semiconductor design). What is significant about the latter two firms is that unlike traditional
research consulting firms such as SRI, which carry out contract research on behalf of clients, they
are able to provide technology products in a disembodied form (patents and chip design blueprints).
4.3
The decline of corporate research
Another transformation of the American innovation ecosystem was the decline of the large corporate
lab. This decline was especially pronounced given the increase in the average size of America’s leading
corporations. For example, net turnover for GE and IBM in 1980 hovered around $25 billion and
$26 billion respectively, and grew to $100 billion and $82 billion in 1998. In 1979, GE’s corporate
research laboratory employed 1,649 doctorate holders while IBM employed 1,300. The comparable
figures in 1998 were 475 doctorate holders for GE and 1,200 doctorate holders for IBM (National
Research Council, 1980; 1998). U.S. public firms whose sales grew by 100 percent or more between
1980 and 1990 published 20.6 fewer scientific articles per year. This contrast between sales growth
and publications drop persisted into the next two decades: firms that doubled in sales between 1990
and 2000 published 12.0 fewer articles. Publications dropped by 13.3 for such fast growth firms
between 2000 and 2010.11
A prominent example of corporate withdrawal from science is given by DuPont. The firm closed
its Central Research & Development Organization and merged it with its Engineering division in 2016.
In the early and mid twentieth century, the DuPont Central Research & Development Organization
was run on par with top academic chemistry departments. However, in the 1990s, DuPont’s attitude
toward research changed as the company started emphasizing business potentials of research projects.
As a result, the number of first-authored journal articles fell from around 749 to 245 between the
years 1994 and 2015, while the number of patents filed with the USPTO increased from around 1,600
in 1994 to close to 3,500 in 2012, reflecting a shift to downstream development activities. Following
pressure from activist investor Nelson Peltz, on January 4, 2016, DuPont’s Central Research lab
ceased to operate as a research unit.
11
Calculations based on authors’ data on Compustat firms matched to Clarivate Web of Science and EPO Patstat.
Details in Arora et al. (2017).
25
Aggregated data from the NSF show a similar pattern of corporate research decline, whereby the
ratio of basic to applied research in corporate R&D declined from 50.7 percent in 1985 to 42.5 percent
in 2015 (Boroush, 2017, Tables 3 and 4). Arora et al. (2018) disaggregate this trend further and find
that, while a significant fraction of corporate publication decline can be attributed to entry by firms
that publish very little, incumbents with established research programs also markedly decreased
their research. The decline in publications is most evident in publications in high impact scientific
journals. The implied private value of scientific capability (measured by stock market valuations or
by the acquisition price in M&A deals) also declined. By contrast, patenting by large American firms
increased, and the implied private value of patents, including the premium paid for patents in M&A,
increased.
Figure 8: Scientific Publications and Patents by Compustat Firms (excluding life sciences)
Notes: The solid lines represent the average number of publications in Clarivate Web of Science matched to Compustat firms with over
$10 million of R&D Stock and in industry classes excluding the life sciences sector. The broken lines represent the same for patents
(details on matching procedure in Arora et al. (2017)).
We use corporate publications data from 1980 to 2015 to explore these trends in more detail.
Our sample consists of all R&D performing public firms headquartered in the U.S. and available
in Compustat from 1980 to 2015. We match the names of these firms to the author addresses of
scientific articles found in the Clarivate Web of Science’s Science Citation Index files. We also match
these firm names to the assignee names for U.S. utility patents available from EPO Patstat. Details
26
on the matching process are available from Arora et al. (2017).12 The results in Arora et al. (2018)
are summarized in figure 8, which graphs scientific publications and patents by Compustat firms with
at least $10 million of R&D stock. Consistent with their finding, publications by firms approximately
halved from around 20 to 10 between 1980 and 2015. In contrast, patenting by firms increased from
around 10 to over 70 patents per year in the same period. Among large U.S. public firms with over
$100 million in R&D stock, 184 out of 201 firms (91.5%) published at least one scientific article in
1980. This number dropped to 73.6 percent in 2015 (528 firms out of 717 published). The decline
is more pronounced for the most research active firms: the ratio of firms that publish more than 10
articles per year dropped from 55.2 percent (111 out of 201 firms in 1980) to 29.8 percent (214 out
of 717 firms in 2015). The average number of scientific publications per $1 million of R&D spending
also declined from 0.46 articles between 1980 and 1985 to 0.40 articles between 2010 and 2015. The
decline also seems to be more pronounced for older firms. For instance, there were 109 firms out of
131 (83.2%) listed on the stock market on or before 1980 that published in 2015. This ratio rises to
78.9 percent (15 out of 19) for firms listed in 1995, and 75.7 percent (28 out of 37) for firms listed in
2000.
Figure 9: Scientific Publications per $Thousand Sales for new IT Sector Firms
Notes: This plot graphs the normalized number of scientific publications by large U.S. firms in the IT sector. Scientific publications of
Apple, Amazon, Facebook, Google, Microsoft, and Netflix found in Clarivate Web of Science are summed each year and divided by $
thousand sales. Details on matching procedure in Arora et al. (2017)
Firms in the IT sector did not buck this trend toward declining corporate publications. Figure
12
We thank Lia Sheer and Honggi Lee for their excellent assistance on constructing the dataset.
27
9 shows publications per $ thousand sale for Facebook, Amazon, Apple, Google, Microsoft, and
Netflix. Firms in this group did publish more than other firms: in 2015, they published on average
304.7 articles, which is around twenty-four times the average for all firms in that year (21.5 articles).
However, Google and Microsoft are the dominant contributors to journals, together publishing close to
90 percent of all articles from these six firms. Moreover, except for Microsoft, publications normalized
by sales fell over time between 1992 and 2015.
Of the 341 public firms publishing at least one scientific article in 1980, 223 (65.4%) saw a drop in
publications in 1990. Similarly, 280 out of 470 firms (59.6%) publishing at least one scientific article
in 1990 saw a drop in 2000. The comparable figure for the 2000-2010 period is even higher: 671 out of
902 (74.4%) firms publishing in 2000 produced fewer publications in 2010. To investigate this trend
further, Table 2 summarizes publication and patenting trends for the ten firms that published the
most scientific articles in the 1980s, 1990s, and 2000s. We explore how the publishing and patenting
behavior of these firms changed in the following decade. As expected, firms such as GE, Xerox, and
AT&T exhibited some of the sharpest declines. Table 2’s “Top publishers in 1980-99” section indicates
that GE saw a drop of 132 articles between 1980s and 1990s (from 603 to 471), while articles by Xerox
declined from 343 to 310. Also, IBM’s publishing trend in the 1990s (a 9% decline) contrasts with
a doubling in patenting in the same period. This result is consistent with the evidence presented by
Bhaskarabhatla and Hegde (2014), which shows that IBM’s pro–patent policies introduced by James
McGroddy in 1989 incentivized researchers to patent rather than publish research results.
Table 2 also shows several anomalies to this overall pattern that deserve mention. First, the
absolute number of publications declined sharply (by 73%) at AT&T from the 1990s to the 2000s,
consistent with the firm’s restructuring efforts. However, AT&T’s R&D budget fell even more drastically, from $4,083 million in 1995 to $640 million in 1996, since it had spun off Bell Labs to Lucent
technologies. As a result, AT&T’s papers normalized by R&D actually rose. Second, DuPont registered an increase in publications between the 1980s and 1990s. However, the growth promptly
reversed in the following decade, where there is a drop of 339 articles, from 762 in the 1990s to 423
in the 2000s.
Third, firms in the life sciences such as Pharmacia, Lilly, Bristol Myers Squibb, Pfizer, and
Amgen significantly increased publications. In the case of Pfizer and Amgen in the 2000s, this increase
28
Table 2: Changes in Publications and Patents by top 10 Publishers for each decade from 1980 to 2015
Publications Per Year
Rank
Top 10 publishers in 1980-89
1980-1989
1
2
AT&T CORP
INTL BUSINESS MACHINES CORP
GENERAL ELECTRIC CO
DU PONT (E I) DE NEMOURS
EXXON MOBIL CORP
XEROX CORP
PHARMACIA & UPJOHN INC
CBS CORP -OLD
PHARMACIA CORP
ROCKWELL AUTOMATION
1,889
1,612
603
600
554
343
336
321
302
279
3
4
5
6
7
8
9
10
Rank
Top 10 publishers in 1990-1999
29
1
2
3
4
5
6
7
INTL BUSINESS MACHINES CORP
LUCENT TECHNOLOGIES INC
AT&T CORP
DU PONT (E I) DE NEMOURS
BRISTOL-MYERS SQUIBB CO
SCHERING-PLOUGH
PHARMACIA & UPJOHN INC
8
9
10
LILLY (ELI) & CO
ABBOTT LABORATORIES
GENERAL ELECTRIC CO
Rank
Top 10 publishers in 2000-2009
1
2
3
4
5
6
INTL BUSINESS MACHINES CORP
PFIZER INC
JOHNSON & JOHNSON
LILLY (ELI) & CO
GENERAL ELECTRIC CO
LUCENT TECHNOLOGIES INC
7
8
9
10
MERCK & CO
BRISTOL-MYERS SQUIBB CO
INTEL CORP
ABBOTT LABORATORIES
1990-1999
1,929
1,421
1,028
762
582
565
532
508
474
471
2000-2009
1,754
1,616
1,014
884
762
748
648
632
625
600
1990-1999
Patents Per Year
% Change
% Change
(R&D Normalized)
1980-1989
1,028
1,929
-46%
20%
-58%
-16%
372
538
471
762
401
310
532
108
383
188
-22%
27%
-28%
-10%
58%
-66%
27%
-33%
-43%
-25%
-23%
-41%
-52%
-47%
-43%
-63%
908
350
252
271
101
410
146
181
% Change
% Change
(R&D Normalized)
1990-1999
-9%
-47%
-73%
-44%
9%
-1%
N/A
-21%
-9%
119%
-31%
-56%
-71%
N/A
1,495
799
422
506
135
99
56
74%
26%
62%
-44%
-48%
-11%
138
138
876
% Change
% Change
(R&D Normalized)
2000-2009
-3%
25%
36%
-2%
31%
N/A
-11%
19%
-3%
-33%
-23%
N/A
3,522
318
378
97
1,269
770
34%
34%
12%
-5%
-36%
-4%
-44%
-23%
307
158
1,463
128
2000-2009
1,754
748
279
423
632
557
merged with
Pfizer (2003)
884
600
762
2010-2015
1,703
2,022
1,382
868
997
merged
with Alcatel
(2006)
866
844
702
568
1990-1999
% Change
% Change
(R&D Normalized)
422
1,495
13%
178%
-13%
96%
876
506
245
718
56
233
173
171
-4%
44%
-3%
165%
-45%
-43%
18%
-6%
-29%
-15%
3%
73%
-83%
-11%
-47%
-49%
% Change
% Change
(R&D Normalized)
136%
-4%
-32%
-6%
17%
11%
N/A
104%
66%
450%
17%
-53%
-67%
N/A
-30%
-7%
45%
-78%
-62%
-20%
% Change
% Change
(R&D Normalized)
93%
-47%
106%
-28%
53%
N/A
76%
-50%
47%
-51%
-10%
N/A
76%
9%
23%
316%
-16%
-21%
-39%
240%
2000-2009
3,522
770
288
475
158
111
merged with
Pfizer (2003)
97
128
1,269
2010-2015
6,800
167
781
70
1,945
merged
with Alcatel
(2006)
541
172
1,793
532
Notes: This table describes annual patenting and publication activities of Compustat firms that are the top publishers for each decade from 1980 to 2015 (1980-1989, 1990-1999, 2000-2009,
2010-2015). We divide the total number of publications by number of years in every decade for U.S. headquartered firms in Compustat after matching them to the address information in
each Web of Science article. After ranking the top 10 publishers each decade by publications per year (first column), we calculate the percentage change between the previous decade and
the next decade (fourth column). We also divide the number publications each year by $ million R&D spending and average over each decade for each firm. The percentage differences
between each decade in this measure is presented in the sixth column. The same is done for patents from the seventh to tenth columns.
Figure 10: Ratio of Publications per Firm to Patents per Firm, by Industry
Notes: This graph plots the ratio of publications to patents per firm in three industrial sectors. The number of publications per firm is
calculated by matching publications in Clarivate Web of Science to Compustat firms with over $10 million of R&D Stock. The number
of patents per firm is calculated by matching assignee names in EPO Patstat to the same firms (details on the matching process is
available in Arora et al. (2017). Publication to Patent Ratio is calculated by dividing the number of publications per firm by the
number of patents per firm.
in publishing kept up with changes in R&D expenditures. One key feature of the pharmaceutical
industry during this time period was the strong merger activity. However, comparisons with other
sectors that also experienced strong merger activity suggests that the publishing behavior of firms in
the life sciences was not simply an artifact of merger activity. Figure 10 plots the ratio between the
number of scientific publications per firm and patents per firm by main industrial sector. The figure
shows that, in the life sciences, this ratio grew from close to one in the 1980s to between three and five
in more recent years. By contrast, publications to patent ratios for both the computer/IT/software
and electronics/semiconductor sectors more than halved over the same period.
Apart from the rise in average firm size, there are several other plausible reasons why the
pharmaceutical and biotech sector bucked the trend toward declining scientific publications. First,
the commercial applicability of upstream research, such as that conducted in universities or published
in scientific journals, is much more apparent in the life sciences than in other manufacturing sectors.
For example, in the mid-1990s, 58 percent of industrial R&D lab managers in the pharmaceutical
sector reported that research conducted in academic or government labs suggested new project ideas,
30
well above the manufacturing average of 32 percent (Cohen et al., 2002). Second, patents are generally
viewed as more effective in protecting the sale and commercialization of knowledge in the drug
industry than in other sectors. Relatedly, technology markets are very active in pharmaceuticals. As
a result, returns to investments in research may be higher in the life sciences than in other sectors.
In particular, large pharmaceutical companies may have to carry out some research in-house to be
competent buyers of technology. Third, drugs require regulatory approval and scientific publications,
by demonstrating the efficacy of new products, can facilitate this process. Pharmaceutical products
also require the cooperation of physicians who prescribe the products to patients. This implies that
drug adoption also depends on convincing these intermediaries of their quality through, for instance,
scientific publications (Azoulay, 2002; Hicks, 1995).
Figure 11: Federal Obligations by Selected Subfields, FY 1980-FY 2015
Notes: This graph replicates figure 4 on Merrill (2018) using data from the Federal Funds for Research and Development Data
series, available from https://www.nsf.gov/statistics/srvyfedfunds/ Biology excludes environmental sciences. Other includes chemicals,
computer sciences, materials engineering, metallurgy and electrical engineering.
Finally, there has been a general increase in federal funding for biomedical research through the
NIH, from $2.5 billion in 1980 to $15 billion in 2001 and $29 billion in 2015. Figure 11 shows that
this steep increase in federal funding for life sciences has not been matched in other sectors such as
chemistry, computer sciences, materials, and electrical engineering. This plausibly increased publication output by firms, not only those that made use of NIH funds, but also those that could freely
access newly available public resources such as genome sequences to increase research productivity.
31
However, this confluence of factors was unique to the life sciences, which may explain why this sector
has stood out among other sectors.
In summary, the new innovation ecosystem exhibits a deepening division of labor between universities that specialize in basic research, small start-ups converting promising new findings into
inventions, and larger, more established firms specializing in product development and commercialization (Arora and Gambardella, 1994). Indeed, in a survey of over 6,000 manufacturing- and
service-sector firms in the U.S., Arora et al. (2016) find that 49 percent of the innovating firms between 2007 and 2009 reported that their most important new product originated from an external
source. In this view, smaller firms have a comparative advantage in generating inventions, whereas
larger firms have an advantage in exploiting them. Large firms therefore invest in scientific capability
not so much to generate knowledge as to be effective buyers of knowledge.
4.4
Why has corporate science declined?
The withdrawal from science by large corporations resulted from the confluence of several factors.
As competition intensified and the interval between invention and commercialization narrowed, it
became increasingly difficult for corporations to profit from their in-house research. Standard theory
implies that firms reduce research when the knowledge spills out, particularly to rivals. This intuition
is supported by the results in Arora et al. (2017) who further document that spillovers to rivals have
greatly increased between 1980 and 2015.13 As former Bell Labs researcher Andrew Odlyzko (1995,
p.4) notes:
“xerography was invented by Carlson in 1937, but it was only commercialized by Xerox
in 1950. Furthermore, there was so little interest in this technology that during the few
years surrounding commercialization, Xerox was able to invent and patent a whole range
of related techniques, while there was hardly any activity by other institutions. This
enabled Xerox to monopolize the benefits of the new technology for over two decades. [...
By contrast,] when Bednorz and Mueller announced their discovery of high-temperature
superconductivity at the IBM Zurich lab in 1987, it took only a few weeks for groups
at University of Houston, University of Alabama, Bell Labs, and other places to make
13
Spillovers in this study are measured by citations to corporate publications received from patents filed by rivals.
32
important further discoveries. Thus even if high-temperature superconductivity had developed into a commercially significant field, IBM would have had to share the financial
benefits with others who held patents that would have been crucial to developments of
products.”
Another factor that may have reduced large firms’ ability to profit from their in-house research was the
trend toward narrower firm scope. Starting from the 1980s, Wall Street investors increasingly pushed
large public firms to “stick to their knitting” and divest unrelated units. However, diversified firms
may be precisely the ones best positioned to exploit the unpredictable outcomes of scientific research
because, as Richard Nelson (1959, p.302) noted, “[a] broad technological base insures that, whatever
direction the path of research may take, the results are likely to be of value to the sponsoring firm.”
Thus, as firms concentrated on their core markets, their incentives to invest in scientific research may
have declined. Trade, outsourcing, and the offshoring of manufacturing may also have reduced the
incentives to invest in research. For instance, moving manufacturing to locations far from where R&D
takes place could reduce interactions between research and production, which may hinder innovation.
Large firms also started to invest less in internal research, not only because these investments
became less valuable, but also because tapping into external sources of knowledge and invention became increasingly easy. Historically, many large labs were set up partly because antitrust pressures
constrained large firms’ ability to grow through mergers and acquisitions. In the 1930s, if a leading
firm wanted to grow, it needed to develop new markets. With growth through mergers and acquisitions constrained by anti-trust pressures, and with little on offer from universities and independent
inventors, it often had no choice but to invest in internal R&D. The more relaxed antitrust environment in the 1980s, however, changed this status quo. Growth through acquisitions became a more
viable alternative to internal research, and hence the need to invest in internal research was reduced.
The growth of university research likely also contributed to the ease of external knowledge
acquisition. Corporate labs historically operated in an environment where university research and
start-up inventions were scarce. To generate a steady flow of high-quality inventions, large firms
had to develop them in-house, typically by setting up a large lab. As discussed above, however,
universities and small firms became over time more reliable sources of invention. As the volume
of external research increased, corporate labs also found it difficult to keep up with the pace of
33
technological progress.
The attractiveness of external technology markets relative to internal research also increased.
Greater protection of intellectual property rights in the 1980s reduced the risk of expropriation
in technology transactions. The diffusion of online platforms (e.g., Procter Gamble’s Connect +
Develop) and the growth of technology market intermediaries (e.g., yet2.com Marketplace, InnoCentive) rendered contracting for innovation easier and less expensive, reducing frictions in technology
markets. All these developments made technology markets more attractive, and internal research
correspondingly less so.
5
The large corporate lab and the innovation ecosystem
We began this chapter by noting the rise and fall of American productivity growth in the twentieth
century. We also noted that the rise and fall of American productivity growth largely coincided with
the rise and fall of the large corporate lab.
In this section, we suggest that the large corporate lab may be an important (and often unappreciated) component of a healthy innovation ecosystem. While we do not deny that there might
be gains from specialization when innovative labor is more finely subdivided, we also point out that
there might be social costs associated with the demise of the large corporate lab. Although large
corporations are withdrawing from internal research because it is no longer privately profitable, this
change may not be positive for society.
5.1
Inventions originating from large corporate labs are different
There are several reasons why large corporate labs may develop inventions that are different from
those produced by universities and startups.
5.1.1
Corporate labs work on general purpose technologies
Because corporate labs are typically owned by large integrated incumbents, they may have strong
incentives to focus on systemic or architectural innovations. Consistent with this, Kapoor (2013)
finds that, following vertical disintegration in the semiconductor industry, integrated incumbents
34
reconfigured their activities more towards systemic innovations (which require extensive coordination
and communication across different stages of production and actors) and less towards autonomous
innovations (which require relatively little adjustment). Lecuona Torras (2017) also finds that large
firms were more likely to leverage general purpose technologies to introduce architectural innovations
in mobile telephony handsets. Anecdotal evidence support this behavior: Claude Shannon’s work
on information theory, for instance, was supported by Bell Labs because AT&T stood to benefit
the most from a more efficient communication network (Gertner, 2013). IBM supported milestones
in nanoscience by developing the scanning electron microscope, and furthering investigations into
electron localization, non-equilibrium superconductivity, and ballistic electron motions because it
saw an opportunity to pre-empt the next revolutionary chip design in its industry (Gomory, 1985;
Rosenberg, 1994, p.258). Finally, a recent surge in corporate publications in Machine Learning
suggests that larger firms such as Google and Facebook that possess complementary assets (user
data) for commercialization publish more of their research and software packages to the academic
community, as they stand to benefit most from advances in the sector in general (Hartmann and
Henkel, 2019).
5.1.2
Corporate labs solve practical problems
Research conducted in corporate labs is directed toward solving specific practical problems. This
orientation toward specific missions can restrict researchers’ freedom, but also reduces the risk of
purely theoretical ruminations and hastens the translation of science to commercial applications.
Moreover, unlike small firms that often scramble for survival, large labs can provide researchers with
resources and some slack, which may lead to truly path-breaking research. Thus, corporate labs may
integrate the best of both worlds. On the one hand, their research is connected to real problems,
so that their results are likely to have important industrial applications. On the other hand, this
connection is not so strong that the results lie towards the most applied end of the spectrum and have
only limited scientific value. Andrew Odlyzko underlines the importance of commercial necessity at
Bell:
“It was very important that Bell Labs had a connection to the market, and thereby to
real problems. The fact that it wasn’t a tight coupling is what enabled people to work
35
on many long-term problems. But the coupling was there, and so the wild goose chases
that are at the heart of really innovative research tended to be less wild, more carefully
targeted and less subject to the inertia that is characteristic of university research.”14
5.1.3
Corporate labs are multi-disciplinary and have more resources
Inventions by large corporate labs may differ from inventions by universities or start-ups because
large firms have access to greater financial resources and can tackle multidisciplinary problems by
integrating multiple knowledge streams and capabilities (Tether, 1998; Pisano, 2010). The transistor,
for instance, would not have been possible without the blend of theoretical prowess and engineering
skills available at Bell Labs. Attempts at solid state electronics had been made since the early
1940s by Purdue physical chemist Karl Lark-Horovitz, General Electric, and others. Only Bell Labs,
however, had the interdisciplinary team of physicists, metallurgists and chemists necessary to solve
the many theoretical and practical problems associated with developing the transistor.
Because MIT’s Radiation Lab during World War II had selected AT&T’s Western Electric
to manufacture back-voltage rectifiers for radars, metallurgists at the firm had gained first-hand
experience in purifying and doping semiconductors. Bell metallurgist Henry Theurer later developed
the method of zone refining in 1951, which processed germanium crystals to impurity levels as low as
one part in ten billion. It was also at Bell that Gordon Teal’s crystal “pulling” method fabricated the
positive-negative junctions in silicon rods, and Shockley’s transistor would not have been possible to
invent without either one of these two in-house achievements in material sciences (Gertner, 2013).
Similarly, Holbrook et al. (2000) note that it was cross-functional coordination between R&D and
manufacturing that led to Fairchild’s two major breakthroughs: the planar process and integrated
circuits. In contrast, fabless firms, which specialize on the design of integrated circuits while avoiding
the high costs of building and operating manufacturing facilities, would arguably find it hard to come
up with these types of innovations.
Artificial Intelligence (AI) research is an example that the difference between large corporate lab
research from university and startup research. Since the beginning of this decade, large corporations
such as Google, IBM, and Facebook have invested heavily in AI research. Hartmann and Hankel’s
14
Letter to the Wall Street Journal, available at http://www.dtc.umn.edu/ odlyzko/misc/wsj-bell-labs-20120326.
Accessed 18/02/2019
36
(2019) recent study shows that the share of corporate publications in top AI journals such as the
International Conference on Machine Learning (ICML) have tripled between 2004 and 2016. Firms
have pioneered research in specialized fields such as deep neural networks (DNNs). Google has
published landmark papers such as the “Cat Paper” (Le et al., 2011) and the “Google Translate
Paper” (Wu et al., 2016) that validated the effectiveness of new algorithms such as LSTM (LongShort Term Memory) for image recognition and language translation respectively. While many
scientists working at Google for these projects (such as Andrew Ng at Stanford or Geoffrey Hinton at
Toronto) had joint appointments at universities, it is unlikely that either universities or VC-backed
startups would have produced research output on par with Google for three reasons.15
Scale — In 2018, Google employed more than 1,700 AI researchers, and made a string of startup
acquisitions specializing in the field, starting with Geoffrey Hinton’s firm (DNN research) in 2013
and following with Demis Hassabis’s Deep Mind in 2014. Large firms such as Google also collect and
maintain proprietary datasets that dwarf the sizes of publicly available ones collected at universities.
In the field of machine learning, larger datasets allow for the empirical validation of algorithms that
are difficult to solve analytically. This implies that the cutting-edge empirical work in AI necessarily
occurs in firms, where the data are available. Sun et al. (2017) show that Google uses the JFT-300M
dataset which has more than 375 million labels for 300 million images (Stanford’s Imagenet dataset,
one of the largest datasets made publicly available by a university, contained around 1 million images)
and empirically show that increases in data size correspond to significant performance improvements.
This result was intuitively plausible but difficult to test at scale.
Multi-disciplinarity — Researching neural networks requires an interdisciplinary team. Domain specialists (e.g. linguists in the case of machine translation) define the problem to be solved
and assess performance; statisticians design the algorithms, theorize on their error bounds and optimization routines; computer scientists search for efficiency gains in implementing the algorithms.
Not surprisingly, the “Google translate” paper has 31 coauthors, many of them leading researchers
in their respective fields (Wu et al., 2016). This seems to be a broader trend separating university
research from industry research in this area: using data from Marx (2019), we examined the average
15
Hinton (a co-laureate of the Turing prize in 2018 with Facebook’s Yann LeCunn and McGill’s Yoshua Bengio)
was a pioneer of neural networks and supervised the execution of Alexnet, the first algorithm to bring error rate in
the Imagenet competition down to under 25 percent in 2012.
37
number of coauthors in the five leading machine learning conferences in Hartmann and Henkel (2019)
from 2011 to 2018 and found that research by large firms features on average one more co-author
(4.3) than non-large firm papers (3.4).16 These firms make up 10 percent (2,168 out of 20,989) of
the papers published with fewer than eleven authors, but comprise 28 percent (22 out of 79) of the
papers published with more than eleven authors. High-quality papers show the same difference in
the size of teams. Among ML conference papers in the top decile by citations received, corporate
publications involve 4.4 authors, while non-firm publications involve 3.6. This pattern holds for the
top 1 percent of cited publications — firm publications (4.4) involve more coauthors than non-firm
publications (3.6).
Complementary equipment — The collaboration between science and engineering is also an
advantage at Google Brain that is hard to replicate in universities or VC-backed startups. To implement code written by Quoc Le (one of the leading scientists on the Google translate project), software
engineers converted Le’s code into Google’s newly developing Tensor Flow language, while hardware
engineers debugged Google’s proprietary Tensor Processing Units (TPUs) that were custom-built by
Google for inference tasks in neural networks.17 Google has continuously improved on these chips,
with four generations of TPU chips being introduced in the span of two years. A few universities such
as MIT (Eyeriss), Georgia Tech, ETH Zurich (Nullhop), and IIT Madras are conducting research on
such “AI-accelerator” chips, but their products are yet to be fielded widely on the market.
A consequence of large corporate research being i) more general purpose ii) closely coupled with
practical problems and iii) more multidiscplinary is that on average, corporate scientific research
will be more useful to inventors than university research. If this is the case, then we should observe
inventors of patents, for instance, devote more attention to them than to academic counterparts.
Anecdotal evidence suggests that neural network research published by Google brain has been
implemented by follow-own research at firms. It is now standard practice among researchers to test
their algorithm’s performance against Alexnet or LSTM — both of which were refined at Google. We
16
The five conferences are Knowledge Discovery and Data Mining (KDD), the Association for the Advancement
of Artifical Intelligence (AAAI), the International Conference on Machine Learning (ICML), the International Joint
Conferences on Artifical Intelligence (IJCAI), and the Conference on Neural Information Processing Systems (NIPS).
The “large firms” are Microsoft, Google, IBM, Yahoo, Toyota, Baidu, NEC Corporation, Facebook, Adobe, LinkedIn
and rank as the top publishers in the field of AI in Hartmann and Henkel (2019)
17
TPUs are custom Application Specific Integrated Circuits (ASIC) specifically designed for deep neural networks.
The first TPUs were deployed in Google data centers in 2015, and performed up to 26 times faster than existing GPUs.
https://cloud.google.com/blog/products/gcp/an-in-depth-look-at-googles-first-tensor-processing-unit-tpu
38
Figure 12: Patent Citation to University vs. Corporate Publications
Note: The sample includes publications from the top 100 U.S. universities and corporate publications of our sample firms that were
published over the sample period (1980-2006) and covered in Web of Science “Science Citation Index” and “Conference Proceedings
Citation Index-Science.” Patent citations per publication is measured by total citations (internal and external) per publication by
corporate and non-corporate patents granted between 1980 and 2014. Figure A presents mean comparison for university vs. corporate
publications by patent citation received per publication. Figure B, plots the cumulative distribution of patent citations received per
publication, by corporate and university publications. Number of patent citations per publication is presented with a proximity value
in the 99th percentile of the sample. Analysis is from Arora et al. (2017)
find that ML papers published by large firms are cited more often in patents than other ML papers:
large firms published 12 percent of the papers in KDD, AAAI, ICML, IJCAI, and NIPS between
2011 and 2018, but accounted for 32 percent of the papers that are cited by patents.
Bikard (2015) finds corporate publications to be 23 percent more likely to be cited than university
publications one the same scientific discovery. We add wider correlational evidence in support of this
prediction by comparing the likelihood of a U.S. utility patent issued between 1980 and 2006 citing
a corporate scientific publication versus a university counterpart in its non-patent literature section.
Using a linear probability model, we estimate that corporate publications are on average 11 percent
more likely to be cited as a university publications. We control for the possibility that these results
are driven by lower-quality universities, “applied” journals, or industry level differences in scientific
quality, and find that the results hold. Panel (A) of figure 12 visualizes the citation likelihood
differences between these two groups, while panel (B) shows that corporate publications first order
stochastically dominate university publications in terms of the number of citations they receive from
patents.
39
5.1.4
Large corporate labs may generate significant external benefits
Beside developing inventions that may not be created otherwise, large corporate labs have also
generated significant external benefits. One well-known example is provided by Xerox PARC. Xerox
PARC developed many fundamental inventions in PC hardware and software design, such as the
modern personal computer with graphical user interface. However, it did not significantly benefit
from these inventions, which were instead largely commercialized by other firms, most notably Apple
and Microsoft. While Xerox clearly failed to internalize fully the benefits from its immensely creative
lab (especially when the industries affected were unrelated to Xerox’s core business), it can hardly
be questioned that the social benefits were large, with the combined market capitalization of Apple
and Microsoft now exceeding 1.6 trillion dollars.
Another potentially important class of external benefits generated by corporate labs is spin-off
activity. Klepper (2015) systematically documented the importance of spin-offs in the U.S. innovation
ecosystem. He found that in many high-tech industries, including the early automobile industry,
semiconductors and lasers, spin-offs were exceptional performers. Agrawal et al. (2014) also find a
large innovation premium in regions where numerous small patenting entities coexist with at least
one large patenting entity.
A surprising implication of this analysis is that the mismanagement of leading firms and their
labs can sometimes be a blessing in disguise. The comparison between Fairchild and Texas Instruments is instructive. Texas Instruments was much better managed than Fairchild but also spawned
far fewer spin-offs. Silicon Valley prospered as a technology hub, while the cluster of Dallas-Fort
Worth semiconductor companies near Texas Instruments, albeit important, is much less economically significant. Arguably, spin-off driven growth encouraged diversity and innovation far more than
the efforts of a well-run Fairchild could have. Similarly, attempts to centralize and direct innovation
activity may backfire. This was the case for Xerox’s spin-offs. As documented by Chesbrough (2002,
2003), the key problem there was not Xerox’s initial equity position in the spin-offs, but Xerox’s
practices in managing the spin-offs, which discouraged experimentation by forcing Xerox researchers
to look for applications close to Xerox’s existing businesses. Again, the coexistence between islands
of centralized control—the large corporate labs—and markets populated by a variety of start-ups
40
and spin-offs, seems most conducive to fast experimentation and growth.
6
The policy environment
In this section, we briefly discuss some effects of public policy on the American innovation ecosystem.
6.1
Antitrust
As noted in sections 2.2.2 and 3.2, one factor that historically motivated many large firms to establish or expand their labs was antitrust pressure. In the early and mid-twentieth century, concerns
about excessive concentration of economic and political power in the hands of dominant firms helped
constrain the ability of large firms to grow through mergers and acquisitions. During this period, if
large firms wanted to grow, they often had little choice but to invest in internal R&D.
Antitrust policy not only encouraged large firms to invest in internal R&D, but also occasionally
promoted technology diffusion. A leading example is the 1956 consent decree against the Bell System,
one of the most significant antitrust rulings in U.S. history (Watzinger et al., 2017). The decree forced
Bell to license all its existing patents royalty-free to all American firms. Thus, in 1956, 7,820 patents
(or 1.3 percent of all unexpired U.S. patents) became freely available. Most of these patents covered
technologies that had been developed by Bell Labs, the research subsidiary of the Bell System.18
Compulsory licensing substantially increased follow-on innovation building on Bell patents. Using patent citations, Watzinger et al. (2017) estimate an average increase in follow-on innovation of
14 percent. This effect was highly heterogeneous. In the telecommunications sector, where Bell kept
using exclusionary practices, there was no significant increase. However, outside of the telecommunications sector, follow-on innovation blossomed (a 21 percent increase). The increase in follow-on
innovation was driven by young and small companies, and more than compensated Bell’s reduced
incentives to innovate. In an in-depth case study, Watzinger et al. demonstrate that the decree accelerated the diffusion of transistor technology, one of the most important technologies of the twentieth
century.
18
Moser and Voena (2012) also find that compulsory licensing spurs innovation. They examine compulsory licensing
after World War I under the Trading with the Enemy Act to identify the effects of compulsory licensing on domestic
(U.S.) invention. Their analysis of nearly 130,000 chemical inventions suggests that compulsory licensing increased
domestic invention by 20 percent.
41
This view that the consent decree was decisive for U.S. post-World War II innovation, particularly
by spurring the creation of whole industries, is shared by many observers. As Gordon Moore, the cofounder of Intel, notes: “[o]ne of the most important developments for the commercial semiconductor
industry (...) was the antitrust suit filed against [the Bell System] in 1949 (...) which allowed the
merchant semiconductor industry “to really get started” in the United States (...) [T]here is a direct
connection between the liberal licensing policies of Bell Labs and people such as Gordon Teal leaving
Bell Labs to start Texas Instruments and William Shockley doing the same thing to start, with the
support of Beckman Instruments, Shockley Semiconductor in Palo Alto. This (...) started the growth
of Silicon Valley” (Wessner (2001, p.86) as quoted in Watzinger et al. (2017)).
Scholars such as Peter Grindley and David Teece concur: “[AT&T’s licensing policy shaped by
antitrust policy] remains one of the most unheralded contributions to economic development possibly
far exceeding the Marshall plan in terms of wealth generation it established abroad and in the United
States” (Grindley and Teece (1997) as quoted in Watzinger et al. (2017)).
Starting from the 1980s, antitrust pressures abated and growth through acquisitions returned to
be a viable alternative to internal research. The incentives to invest in internal research correspondingly declined. However, as giants such as Google, Facebook and Amazon continue to grow and amass
market power, political backlash and more intense antitrust scrutiny may return. Just like DuPont
and Bell in the twentieth century, these new economy giants may view research and its military
and/or geopolitical implications as an insurance policy against aggressive antitrust enforcement.
6.2
Bayh-Dole and university research
There are a slew of policy inducements to research, development and commercialization. Here, we
focus on one that relates to commercialization of university research: the Bayh-Dole Act. Dubbed
“[P]ossibly the most inspired piece of legislation to be enacted in America” by The Economist, the
Act was enacted by Congress in 1980 with the goal of facilitating the commercialization of university
science.19 The law eliminated U.S. Government claims to university-based innovation, giving U.S.
universities the rights to inventions that were federally funded. While we remain agnostic on the
extent of inspiration (or lack thereof) behind legislations enacted in America, it is unlikely that
19
https://www.economist.com/technology-quarterly/2002/12/12/innovations-golden-goose
42
Bayh-Dole will be sufficient to fill the gap left by the withdrawal of corporations from research.
The evidence on whether altering the property rights associated with an invention encourages
the commercialization of university science is mixed. For instance, despite U.S. university patenting
rates being approximately five times larger in 1999 than in 1980, Mowery and Sampat (2004) find
no evidence that Bayh-Dole caused a structural break in the preexisting trend. Using a larger
dataset than previously available, Ouellette and Tutt (2019) reexamine the question of whether higher
inventor royalty shares lead to greater patent-related activity. They do not find that increasing the
inventor’s share of patent licensing revenue in official royalty-sharing policies causes academics to
patent more. They also examine moves between universities by the most active university patenters.
Based on 130 lateral moves for which they could calculate the expected share at both the old and
new institution at the time of the move, they reject the hypothesis that high-patenting academics
tend to move to schools with a higher expected share.
In contrast, Hvide and Jones (2018) find that the allocation of property rights have an important
effect on innovation. They examine the end of the “professor’s privilege” in Norway. Upon implementing the reform, Norway effectively moved from an environment where university researchers had
full ownership of their inventions (the “professor’s privilege”), to a system where inventors, just like in
the U.S. today, only hold a minority of the property rights (and the university holds the remainder).
The reform had the opposite effect as intended. The shift in rights from researcher to university
reduced both the quantity and the quality of inventions. It led to an approximately 50 percent drop
in the rate of start-ups by university researchers. Patent rates fell by broadly similar magnitudes.
University start-ups exhibited less growth and university patents received fewer citations after the
reform, compared to controls. Overall, the reform, by reducing researchers’ ownership stakes, appears
to have discouraged university innovation.
Although Bayh-Dole may well have enhanced engagement in commercialization activity by university researchers, the effect appears to have been small. Further, the proposed mechanism relies
heavily on startups and university spinoffs being responsible for developing university inventions,
relying upon private investors or venture capital for support. In so doing, not only is the rate of
technical advance affected, but also its direction.
43
6.3
Mission oriented agencies
Corporate labs play an important role in the U.S. innovation ecosystem because their research is
directed toward solving specific practical problems. This focus on the potential applicability of
research results, however, is not a unique feature of corporate labs.
Mazzucato (2018, p.804) defines mission-oriented policies “as systemic public policies that draw
on frontier knowledge to attain specific goals.” These goals are advanced by agencies such as the
National Institutes of Health (NIH), the Defense Advanced Research Projects Agency (DARPA), and
the Advanced Research Projects Agency-Energy (ARPA-E). Mission-oriented agencies have grown
to dominate public funding of science in the U.S. (Mowery, 1997; Sampat, 2012). For instance, in
2008 the NIH alone was responsible for funding nearly 30 percent of all U.S. medical research.
Azoulay et al. (2019) discuss the distinguishing features of the “ARPA model” for research funding. First, it must be possible to organize the domain of research around a technology-related mission
or a set of overarching goals. The mission of DARPA, for instance, is “to make pivotal investments in
breakthrough technologies for national security.”20 Azoulay et al. (2019, p.88) note that “the ARPA
model is optimized for technical areas that reside in nascent S-curves — the technology exists, is
relatively unexplored, and has great potential for improvement.” ARPA-ble research is distinct from
basic research because it is mission-oriented, and also different from pure applied research because
its focus is not on incremental advances, but “transformational change.” ARPA-funded projects may
involve advancing the scientific frontier, but this is incidental to the main goal — to make significant
technological advancements.
To achieve their goals, ARPA agencies collaborate with universities, government labs, and small
and large firms in the innovation ecosystem. DARPA funding has been instrumental in supporting
the growth of small technology firms, which were quick to recognize the importance of innovation
for their viability and tended to be more responsive to small grants than larger defence contractors
(Mazzucato, 2015). Military procurement more broadly played a key role in spurring spinoff and
startup activity in many science-based industries, such as semiconductors and lasers. In the 1960s,
DARPA even supported the creation of scientific and technological human capital by funding the
20
https://www.darpa.mil/about-us/mission
44
establishment of new computer science departments in various U.S. universities, such as Carnegie
Mellon. Also important, “DARPA officers engaged in business and technological brokering by linking
university researchers to entrepreneurs interested in starting a new firm; connecting start-up firms
with venture capitalists; finding a larger company to commercialize the technology; or assisting in
procuring a government contract to support the commercialization process” (Mazzucato, 2015, p.77).
Mazzucato concludes that, by taking advantage of this new ecosystem, “the government was able
to play a leading role in mobilizing innovation among big and small firms, and in university and
government laboratories” (Ibid., p.77).
Evaluating the impact of mission-oriented agencies and their funding on technological change is
difficult. DARPA has been praised not just for the development of important military technologies
(e.g., precision weapons, stealth technology), but also for having contributed to fundamental civilian
innovations such as the Internet, automated voice recognition, language translation and Global Positioning System receivers. As argued earlier, the significant increase in federal funding for biomedical
research through the NIH, from $2.5 billion in 1980 to $29 billion in 2015, also likely contributed to
U.S. life science companies not withdrawing from scientific research, unlike firms in other sectors.21
In an environment where large firms are withdrawing from internal research, it is likely that
the importance of mission-oriented agencies in supporting public and private research may grow
even further. Mazzucato (2018) and Azoulay et al. (2019) provide valuable insights on how missionoriented agencies should be staffed, organized and managed to produce maximum societal impact.
7
Conclusion
During the so-called Golden Age of American Capitalism, large corporate labs were important loci of
research, and important sources of scientific and technical advances. At the start of the period, the
university research sector was small (certainly compared to the current period) and uneven in quality.
Over time, university research grew, bolstered by significant support from the federal government.
21
Azoulay et al. (2018) find that NIH funding spurs the development of private-sector patents: an additional $10
million in NIH funding for a research area generates 2.7 additional private-sector patents. Fully half of the patents
resulting from NIH funding are for disease applications distinct from the one that funded the initial research. Using
estimates for the market value of patents taken from the literature they find that a $10 million increase in NIH funding
yields $30.2 million in firm market value. Using mean present discounted value of lifetime sales for new drugs, they
estimate that a $10 million increase in funding would generate between $23.4 and $187.4 million in sales.
45
This period also coincided with (and perhaps this was more than a coincidence) incumbent firms
enjoying significant market power but restrained by aggressive anti-trust actions.
Despite the apparent successes, corporate research, and the large corporate labs in particular,
fell out of favor with investors, and eventually, also with managers. The focus shifted to university
research, and startups, often venture funded, that aimed to capitalize on the scientific and technical
advances in university labs. Corporations turned to sourcing ideas and inventions from the outside,
hoping to combine it with their downstream development and commercialization abilities.
These hopes have not been fully realized, at least not yet. Even as this division of innovative
labor has progressed, so have the challenges it faces become more evident. University research is
different from corporate research: it is less likely to be mission-driven. Its smaller scale and greater
disciplinary focus mean that university research typically produces insights which then need further
development and integration to produce commercializable inventions. This requirement of converting
insight to product has proved more onerous and challenging than commonly appreciated.
It seems unlikely that corporate research will rediscover its glory days. The boost in employment
of data scientists, machine learning experts, and even economists, in large firms would appear to
prognosticate a different future. We disagree. For some time, quick wins from low-hanging fruit
(such as optimizing auction or advertising formats) may cover up the problem, but the fundamental
challenge of managing long-run research inside a for-profit corporation remains a formidable one.
Put differently, although there are significant efficiency gains that companies have realized from
hiring data scientists and economists, there are only a handful of cases of significantly new markets
created from such efforts, and incumbent firms continue to rely on outside inventions to fuel their
growth. In the longer run, therefore, university research will remain the principal source of new
ideas for such inventions. And therefore the ongoing economic experiments of discovering efficient
ways to translate scientific insights in universities into technical advances that eventually manifest
in productivity growth will remain crucial to our future prosperity.
46
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Fixing capitalism
CEO compensation has grown 940% since 1978
Typical worker compensation has risen only 12%
during that same time
see separate PDF
Even for those wary of the intentions and sincerity of the world’s leading CEOs, the recent statement on “the Purpose of a Corporation” from the Business Roundtable represents an extraordinary shift for the business leaders. Signed by 181 CEOs, including Apple’s Tim Cook and Amazon’s Jeff Bezos, it commits their companies to go beyond looking at maximizing shareholder value to more broadly investing in employees, communities, and generating long-term value for the shareholders.
Obvious stuff, you might think. But it represents a break with the sole purpose of maximizing shareholders’ profits, a strategy that has dominated corporations since the late 1970s (remember “greed is good” and Gordon Gekko). Andrew Ross Sorkin provides an excellent explanation and background to just how radical the shift is in corporate history, tracing the obsession with, as he calls it, shareholder primacy back to Milton Friedman and his “gospel of profits-as-purpose.”
The shift has not been sudden, though. Alan Murray provides some more insight and background in his Fortune piece. Though he notes that “Friedman must be turning in his grave,” Murray explains how the turnaround came about after the 2007-2008 financial crisis and questions over the role of capitalism and rising inequality. Also, some good analysis here as part of Business Insider’s series on “Better Capitalism.”
But to truly understand what’s at stake here, it is worth looking at two upcoming books on the last 50 years of economic history: Nicholas Lemann’s “Transaction Man” and Binyamin Appelbaum’s “The Economists’ Hour.” A great review of the books is in the latest issue of the Atlantic. An extended excerpt from Lemann’s book is compelling reading.
Of course, it’s easy to question the sincerity of the CEOs signing the statement and how much they are willing to push for change. For one thing, it said nothing about their soaring levels of pay and how that has damaged corporate America’s credibility. The numbers are staggering and map almost precisely to rush to maximize shareholder profits in the late 1970s; from 1978 to 2018 CEO compensation grew by 940% while that for typical workers rose by 12%. So, yes, the CEOs did maximize something, but not necessarily shareholder value. SEE SEPARATE PDF
However, something is missing from much of this discussion. The shift to maximizing shareholder profits also marked the beginning of the death of corporate R&D—or at least the kind of science-based research that was common in the 1960s and 1970s (pdf). Short-term profits had no room for such investments and today we’re suffering from this lack of corporate research. We will see if the new commitment to “generating long-term value” will also renew investments in R&D. So far, there is little sign of it.
https://go.technologyreview.com/-temporary-slug-07cdd6e4-3fb6-4e38-9336-78b7f5ba977b?hs_preview=YXpQCGim-10108962981&ecid=&utm_campaign=fwd_economy.unpaid.engagement&utm_source=hs_email&utm_medium=email&utm_content=2&_hsenc=p2ANqtz-_Xp-JWH_Y_xz7qwyphVemJWz-HBbZsGr9awi0E9HnnNJ7U2JiVm8pJsK6I76qkKct1gG_3IiL1Z8ayjdwOGiX58A6VLHieGzAHiGzalfi2tVPU6yY&_hsmi=2&_hsenc=p2ANqtz--MIfRJbufuwSOg8G2nnEA6P8aarBZrgWc4TRCMNr22Q1qbw2F_zPCaK28VFAxh1lNtiWfgZNlBXd3U8rGnMpdzVCZ0jg&_hsmi=76020766
Interestingly, one of the last great corporate hold-outs still doing science-based research has been GE. Sadly, its CEO, though a member of the Business Roundtable, did not sign the recent statement.
Getting it right: Another big economic question shaping today’s political discussions is the need for industrial policies. We’ve discussed this before in fwd: Economy; many progressives, including advocates for the Green New Deal, are pushing for such policies, losing faith in the ability of the markets to fix really big problems like climate change and rising levels of inequality. And the debate is certainly not going away. In fact, it’s interesting how industrial policy—long a much-disparaged economic idea—has emerged in both liberal and conservative circles as an acceptable course. Indeed, Julius Krein argues it is one thing that Alexandria Ocasio-Cortez and Marco Rubio agree on; “governments should intervene to help the industries and technologies of the future.”
https://www.nytimes.com/2019/08/20/opinion/america-industrial-policy.html?utm_campaign=fwd_economy.unpaid.engagement&utm_source=hs_email&utm_medium=email&utm_content=76020766&_hsenc=p2ANqtz--MIfRJbufuwSOg8G2nnEA6P8aarBZrgWc4TRCMNr22Q1qbw2F_zPCaK28VFAxh1lNtiWfgZNlBXd3U8rGnMpdzVCZ0jg&_hsmi=76020766
Oren Cass, who was an advisor to Mitt Romney’s presidential campaign in 2012, delivered in late July a talk to the National Conservatism Conference called “Resolved: That America Should Adopt an Industrial Policy.” First point he makes: “market economics do not automatically allocate sources well across sectors.” Wow! This is a Romney conservative talking here.
https://www.lawliberty.org/2019/07/23/resolved-that-america-should-adopt-an-industrial-policy/?utm_campaign=fwd_economy.unpaid.engagement&utm_source=hs_email&utm_medium=email&utm_content=76020766&_hsenc=p2ANqtz--MIfRJbufuwSOg8G2nnEA6P8aarBZrgWc4TRCMNr22Q1qbw2F_zPCaK28VFAxh1lNtiWfgZNlBXd3U8rGnMpdzVCZ0jg&_hsmi=76020766
Of course, there was some conservative pushback, as in this piece published by the Cato Institute, and a more strident version by George F. Will in the Washington Post, who lumps Cass with “other socialists” and connects the arguments of Elizabeth Warren with conservative calls for industrial policies.
https://www.cato.org/publications/commentary/do-oren-cass-justifications-industrial-policy-stack-up?utm_campaign=fwd_economy.unpaid.engagement&utm_source=hs_email&utm_medium=email&utm_content=76020766&_hsenc=p2ANqtz--MIfRJbufuwSOg8G2nnEA6P8aarBZrgWc4TRCMNr22Q1qbw2F_zPCaK28VFAxh1lNtiWfgZNlBXd3U8rGnMpdzVCZ0jg&_hsmi=76020766
The debate over industrial policy is just getting started, but it’s already confusing the lines between progressives and conservatives. It’s hard to know how this will turn out, but like the earlier economic shifts, the consequences could be long-lasting and hard to perceive as they happen.
EmTech 2019: A reminder that EmTech is coming up and among the roster of great speakers will be Joseph Coughlin, director of MIT AgeLab, who will be speaking on "a new social contract around aging and technology." To read more about Coughlin's ideas, see his piece in the latest issue of the magazine.
https://www.technologyreview.com/s/614155/old-age-is-made-upand-this-concept-is-hurting-everyone/?utm_campaign=fwd_economy.unpaid.engagement&utm_source=hs_email&utm_medium=email&utm_content=76020766&_hsenc=p2ANqtz--MIfRJbufuwSOg8G2nnEA6P8aarBZrgWc4TRCMNr22Q1qbw2F_zPCaK28VFAxh1lNtiWfgZNlBXd3U8rGnMpdzVCZ0jg&_hsmi=76020766
The Purpose of
a Corporation
Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans’
AUG 19, 2019
Updated Statement Moves Away from Shareholder Primacy, Includes Commitment to All Stakeholders
WASHINGTON – Business Roundtable today announced the release of a new Statement on the Purpose of a Corporation signed by 181 CEOs who commit to lead their companies for the benefit of all stakeholders – customers, employees, suppliers, communities and shareholders.
Since 1978, Business Roundtable has periodically issued Principles of Corporate Governance. Each version of the document issued since 1997 has endorsed principles of shareholder primacy – that corporations exist principally to serve shareholders. With today’s announcement, the new Statement supersedes previous statements and outlines a modern standard for corporate responsibility.
“The American dream is alive, but fraying,” said Jamie Dimon, Chairman and CEO of JPMorgan Chase & Co. and Chairman of Business Roundtable. “Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term. These modernized principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans.”
“This new statement better reflects the way corporations can and should operate today,” added Alex Gorsky, Chairman of the Board and Chief Executive Officer of Johnson & Johnson and Chair of the Business Roundtable Corporate Governance Committee. “It affirms the essential role corporations can play in improving our society when CEOs are truly committed to meeting the needs of all stakeholders.”
Industry leaders also lent their support for the updated Business Roundtable Statement, citing the positive impact this commitment will have on long-term value creation:
“I welcome this thoughtful statement by Business Roundtable CEOs on the Purpose of a Corporation. By taking a broader, more complete view of corporate purpose, boards can focus on creating long-term value, better serving everyone – investors, employees, communities, suppliers and customers,” said Bill McNabb, former CEO of Vanguard.
“CEOs work to generate profits and return value to shareholders, but the best-run companies do more. They put the customer first and invest in their employees and communities. In the end, it’s the most promising way to build long-term value,” said Tricia Griffith, President and CEO of Progressive Corporation.
“This is tremendous news because it is more critical than ever that businesses in the 21st century are focused on generating long-term value for all stakeholders and addressing the challenges we face, which will result in shared prosperity and sustainability for both business and society,” said Darren Walker, President of the Ford Foundation.
The Business Roundtable Statement on the Purpose of a Corporation is below and the full list of signatories is available here.
Statement on the Purpose of a Corporation
Americans deserve an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and dignity. We believe the free-market system is the best means of generating good jobs, a strong and sustainable economy, innovation, a healthy environment and economic opportunity for all.
Businesses play a vital role in the economy by creating jobs, fostering innovation and providing essential goods and services. Businesses make and sell consumer products; manufacture equipment and vehicles; support the national defense; grow and produce food; provide health care; generate and deliver energy; and offer financial, communications and other services that underpin economic growth.
While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders. We commit to:
Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations.
Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions.
Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.
Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.
Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities and our country.
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AN EXCERPT
TRANSACTION MAN
The Rise of the Deal and the Decline of the American Dream
Nicholas Lemann Farrar, Straus and Giroux
1 INSTITUTION MAN
Some of history’s great consequential events are easy to take in, even many years later: wars, the creation of new nations, the triumphs of social movements. One that isn’t so easy, but was no less consequential, was the sudden and unexpected rise of big business to a position of great economic and political power in the decades following the Civil War. The founding ideas of the United States concerned the power of the state, not of private economic interests, because it was hard to imagine that those interests could ever become full rivals to the national government. But now here they were, dominating nearly every aspect of the life of the country. Industrial capitalism gave rise not only to extremes of wealth and poverty but also to big cities, mass immigration, political machines, and other developments that upended everyone’s assumptions about how the country worked. For two or three generations, what to do about big business was the central question of American life.
In 1911, Justice John Marshall Harlan of the U.S. Supreme Court, who was born in 1833 and was only a few months away from the end of his life, wrote an opinion in the case that affirmed the government’s breakup of John D. Rockefeller’s Standard Oil Company. He recalled the situation, two decades earlier, that led to the country’s first major law limiting the power of big business, the Sherman Act:
All who recall the condition of the country in 1890 will remember that there was everywhere, among the people generally, a deep feeling of unrest. The nation had been rid of human slavery—fortunately, as all now feel—but the conviction was universal that the country was in real danger from another kind of slavery … namely, the slavery that would result from aggregations of capital in the hands of a few individuals and corporations controlling, for their own profit and advantage exclusively, the entire business of the country, including the production and sale of the necessaries of life.
It was into this situation that Adolf Augustus Berle, Jr., was born, in 1895. Solving the problem of big business would be the dominant concern of his life. Berle was an overwhelmingly ambitious man who spent his long career jousting with the major figures of his time over the business question, wanting to be recognized as the one who had come up with the best solution to the most vexing problem of the twentieth century. How, exactly, could concentrated economic power be counteracted in a way that preserved freedom and prosperity and offered a decent life to most people? He felt that he was competing, at home and abroad, and before and after the early New Deal period that represented the peak of his political influence, with socialists and communists, with fascists and free marketeers, with antitrusters and economic technicians. By the time he died, in 1971, Berle, who was never modest, felt that he had, indeed, solved the problem. The solution was the corporation, which for Berle’s generation represented an astonishing new kind of economic institution, the advent of which, at least to Berle’s mind, rivaled in importance the earlier advents of the church and the state. Initially all-powerful and threatening, the corporation, Berle felt, had by the middle of the twentieth century been tamed by government to the point that it could play the central role in a good society dominated by large, stable institutions that would provide people’s material needs, protect them from economic shocks, and generate cohesion. That was what he saw as his life’s achievement.
Berle’s father, also named Adolf Augustus Berle, was born in 1866, the son of a German immigrant who died of the long-term effects of wounds he had suffered as a soldier under the command of Ulysses S. Grant in the Union Army. A physically tiny man with no inherited resources or connections, the elder Berle had somehow by his early adulthood, in the closing years of the nineteenth century, acquired a superpowered personal force and drive. As a student at Oberlin College in Ohio, he met and married Mary Augusta Wright, the daughter of one of the most renowned members of the faculty, George Frederick Wright, a Congregationalist minister and professor of religion who was also, improbably, an accomplished geologist. Berle himself studied theology, first at Oberlin and then at Harvard Divinity School, and became a Congregationalist minister. The Berles had four children. Adolf Jr. was the second, their first son.
Adolf Berle, Sr., was a brilliant man with a very grand conception of his place in the world. This meant, on one hand, that he regularly alienated the congregations of the churches over which he presided, so he wound up moving around, never having long-term control of a major pulpit; on the other hand, he somehow knew everybody worth knowing, especially if the person was a prominent liberal. Vastly ambitious for his children, he taught them all at least the rudiments of Latin, Greek, and Hebrew, plus some mathematics, at the age of three. Years later, after the children had grown, Berle used them as instructors in a summer school he operated at his house in New Hampshire, which promised “to instruct a small number of superior children in such a way as will make them natural companions of knowledge.” He also wrote a book called The School in the Home and another called Teaching in the Home: A Handbook for Intensive Fertilization of the Child Mind for Instructors of Young Children, both meant to make his prodigy-producing techniques widely available.
Adolf Jr. was admitted to high school at the age of nine and to Harvard College at the age of thirteen (his father didn’t think he was quite ready then, so he actually enrolled at fourteen). As a small child, he was taken to meet the most celebrated social reformer in the United States, Jane Addams, a friend of his father’s, at Hull House in Chicago. At eighteen, through another friend of his father’s, he had an audience at the White House with President Taft. By the age of twenty-one he had acquired three Harvard degrees: a bachelor’s, a master’s in history, and a law degree, the last of which made him the second-youngest graduate in the history of Harvard Law School. Then he got a job in the Boston law office of another of his father’s exalted friends, Louis D. Brandeis, the crusading lawyer and future Supreme Court justice, who was the only person to have graduated from Harvard Law School at twenty—at an even younger age than Berle. A few years later, the elder Berle testified at Brandeis’s Senate confirmation hearing, conferring the blessing of a Christian man of the cloth on the first Jewish justice.
When the United States entered the First World War, Adolf Jr. enlisted in the army. At twenty-three, still in uniform, he managed to get himself assigned to the American delegation at the peace talks in Paris that followed the armistice ending the war. He arrived in Paris in December 1918, having crossed the Atlantic on a converted cattle boat, but within a day he was staying at the Hotel Crillon, “a palatial palace with Marie-Antoinette furnishings” (he wrote in his diary) whose lobby was filled with “hosts of minor retainers, gold-plated secretaries swaggering in splendid and unused uniforms … Many are intriguing for themselves, but most are endeavoring to find themselves in a rather inchoate mess.” During his first week in Paris, Berle witnessed President Woodrow Wilson being greeted by a cheering throng as he entered the Place de la Concorde and took in “a naughty show” at a burlesque house. He also had an opportunity to encounter some of the most brilliant young men of his generation who were serving as junior staff members at the peace conference: John Maynard Keynes, the British economist; Walter Lippmann and William Bullitt, the American journalists; Samuel Eliot Morison, the historian; and the Dulles brothers, John Foster, the future secretary of state, and Allen, the founding director of the Central Intelligence Agency.
Soon Berle was in a more modest hotel but with a definite assignment—he would join the American delegation’s Russian section, which was charged with deciding what stance the peace treaty would take toward the newly empowered Bolshevik regime headed by V. I. Lenin. By the spring of 1919 Berle had become thoroughly disillusioned with the negotiations, which to his mind had strayed a great distance from the inspiring Fourteen Points that Wilson had put forth in advance as the basis for peace. On Russia, he thought his superiors were too unwilling to work with the Bolsheviks and too caught up in the idea that some form of the old regime could be restored. The broader terms of the armistice, he felt, were too punitive toward Germany, too generous toward France, and too unwilling to guarantee the rights of the Jews of Eastern Europe, the Latvians and Lithuanians, and other oppressed people. The result would be, he believed, that in a few years Germany and Russia might “start the whole game of competitive armaments on a bigger scale than ever.”
In May 1919 Berle, assuming the stagy veneer of cynicism of a disappointed crusader, wrote his father, “I have come to the conclusion that no statement of ideals by anybody will ever get any reaction from me again. If I can trust myself I shall be happy; if I trust anyone else I shall be a fool.” And then, a few days later, “The quiet intoxication of a really big row is stealing over me, and I should like nothing better than to tell the truth about the peacemaking to the Senate Committee [that would have to ratify the Versailles treaty]; after which I could retire for life.” And a few days after that, Berle and a group of his young colleagues resigned from the delegation in protest. When he was back in the United States, Berle—still only twenty-four—wrote a stinging article in The Nation, “The Betrayal at Paris,” in which he called the treaty an “abortion of compromise and hate” that “pointed the world back to the path of terror and tears.” This was not, of course, the work of someone who was renouncing public life forever.
Berle settled in New York and became a corporation lawyer on Wall Street, first in the office of yet another friend of his father’s, then, beginning in 1924, in a firm of his own. Today this would be the safe career for a young lawyer, but Berle didn’t see it that way; large corporations were new, the coming thing, and he thought that by understanding how they worked, he could hold the key to shaping the country’s future. He was being relentlessly prodded to do something important by his domineering and personally disappointed father, the semi-itinerant minister, who dreamed that Adolf Jr. might become president of the United States one day. What he chose to do was not meant to be safe, but to propel him into the stratosphere. Berle always projected complete confidence, veering into arrogance, but privately there was a measure of desperation in the way he experienced his father’s aggressively asserted expectations. One miserable day in the fall of 1922 he wrote in his diary,
For the ghastly fact is that our family … is being wrecked by my Father’s curious egomania which takes the most brutal form and is mainly directed (God forgive) against my mother. When it began to be acute in 1919 she spoke of possible euthanasia suicide as a remedy. Now that is possible; or desertion is possible; I have thought myself that by sacrificing two lives I might free my mother for quiet evening years and liberate my sister … Father of course is convinced that he is an aggrieved vicar of God.
Besides practicing law, Berle was frequently publishing articles in such prominent liberal magazines as The Nation and The New Republic, and in the leading law reviews; he was expanding his impressive array of well-known friends; and he was actively engaged in a number of social reform movements. Dressed in the elegant double-breasted suits he had begun wearing, his hair neatly parted and slicked down, he commuted to Wall Street from an apartment next door to the Henry Street Settlement on the Lower East Side, whose director, Lillian Wald, became a mentor of his. His job was part of, not separate from, a life dedicated to liberal reform.
* * *
The Industrial Revolution did not fully arrive in the United States until after the Civil War, so it was not until the last quarter of the nineteenth century that Americans began thinking seriously about what it meant to live in a world of big businesses, big cities, and, for a few people, vast personal fortunes. The country’s founding documents did not envision such things. The census of 1880 was the first to show that the United States had a city, New York, with a population of more than a million. In 1890 Congress passed the Sherman Act. In 1896 the Democratic Party nominated a presidential candidate of populist inclinations, William Jennings Bryan of Nebraska (whom it nominated again in 1900 and 1908), on a platform of hostility to unbridled capitalism.
Educated middle-class people such as the young Adolf Berle had been raised on the idea that American civilization was at heart one of small-town merchants and independent farmers. Now, as the historians Charles and Mary Beard put it,
the isolated establishment under the ownership of a single master or a few masters had surrendered to the corporation. At the end of the century three-fourths of the manufactured products came from factories owned by associations of stockholders; in each great industry was a network of federated plants under corporate direction; by 1890 combination was the supreme concept of the industrial magnate.
It wasn’t just Americans who were noticing the magnitude of this sudden change in the national economy. In 1903 Liang Qichao, a pioneering Chinese journalist and intellectual, visited New York and reported to his countrymen about the trusts: “In essence, this monster, whose power far exceeds that of Alexander the Great or Napoleon, is the one and only sovereign of the twentieth-century world.”
Berle’s generation was heavily influenced by the historian Frederick Jackson Turner’s ominous declaration in 1890 that the opportunity-providing American frontier had closed and so the essential nature of the society had to be remade (Berle was a student, and then a research assistant, of Turner’s at Harvard). How to do that, especially in light of the sudden and unexpected dominance of big business, was the great career-defining question for reform-minded Progressives. One answer was the conservative one: celebrate capitalism. Berle was uncomfortable with that. Another was to import European socialism to the United States. Berle was uncomfortable with that too. For people like him, the real choice was a narrower but highly consequential one between two varieties of liberalism. This choice was most obviously on display in the 1912 presidential campaign, when Berle was a precocious college student, in the difference between Theodore Roosevelt’s economic program, which he called the New Nationalism, and Woodrow Wilson’s, which he called the New Freedom. These are terms that don’t communicate much today, so let’s give them more vivid and cinematic names: Clash of the Titans liberalism and Middle-earth liberalism.
The combative, wealthy, power-loving Roosevelt was naturally drawn to the idea of the federal government’s assuming enough new force and size to be able to fight big business as an equal. His historic reputation as a “trustbuster” is misleading; he was not against large economic units per se, only against their excesses. Government’s job was to check the excesses, not to break up the businesses. Roosevelt expanded government’s power to regulate railroads, food, and medicine, but it was during the presidency of his successor, Taft, that the government broke up the steel trust (a decision Roosevelt publicly opposed) and Standard Oil. Roosevelt had no patience for the traditional constitutional suspicion of concentrated state power. The urgent necessity before the U.S. government was to project its might, against private economic power at home and against hostile governments abroad.
Among the leading intellectual proponents of Roosevelt’s form of liberalism were the three brilliant young founders of The New Republic, Herbert Croly, Walter Lippmann, and Walter Weyl—all slightly older friends of Adolf Berle’s. In 1909 Croly published a Progressive Era manifesto called The Promise of American Life. “The net result of the industrial expansion of the United States since the Civil War,” Croly wrote, “has been the establishment in the heart of the American economic and social system of certain glaring inequalities of condition and power … The rich men and big corporations have become too wealthy and powerful for their official standing in American life.” He asserted that the way to solve the problem was to reorient the country from the tradition of Thomas Jefferson (rural, decentralized) to the tradition of Alexander Hamilton (urban, financially adept). Weyl, in The New Democracy (1913), wrote that the country had been taken over by a “plutocracy” that had rendered the traditional forms of American democracy impotent; government had to restore the balance and “enormously increase the extent of regulation.”
To liberals of this kind, these were problems of nation-threatening severity, requiring radical modernization that would eliminate the trace elements of rural nineteenth-century America. Lippmann, in Drift and Mastery (1914), argued that William Jennings Bryan (“the true Don Quixote of our politics”) and his followers were fruitlessly at war with “the economic conditions which had upset the old life of the prairies, made new demands on democracy, introduced specialization and science, had destroyed village loyalties, frustrated private ambitions, and created the impersonal relationships of the modern world.” A larger, more powerful, more technical central government, staffed by a new class of trained experts, was the only plausible way to fight the dominance of big business. The leading Clash of the Titans liberals were from New York City, but even William Allen White, the celebrated (in part for being anti-Bryan) small-town Kansas editor who was a leading Progressive and one of their allies, wrote, in 1909, that “the day of the rule of the captain of industry is rapidly passing in America.” Now the country needed “captains of two opposing groups—capitalism and democracy” to reset the balance away from the capitalists’ current dominance.
The Berle family’s friend Louis Brandeis was the intellectual leader of the other camp, the Middle-earth liberals. Brandeis agreed with the Rooseveltian liberals that the rise of the trusts posed a dire threat to the health of the republic, but his remedy was quite different: break up the trusts into smaller units. The idea of an economic future in which big centralized businesses battled with a big centralized government did not appeal to him. Brandeis was not a Jeffersonian, exactly—his preferred America was one where economic power was more regional than local, and where businesses that were medium-size to large, rather than either small or enormous, were at the heart of American economic life. Brandeis was focused on the rights of nonplutocratic businesses, such as local banks or stores or manufacturers that weren’t part of national chains, in the new industrial economy, far more than on the rights of consumers, who in those days were not yet a category in the public debate. His best-known antitrust case involved protecting a regional railroad line from being taken over by J. P. Morgan. Most of the leaders of Brandeis’s strain of liberalism were from the provinces—especially provincial cities. Most members of Congress, because they represented geographic areas, were naturally in the Brandeis camp, unless they were from New York. (It may be pertinent that around the time Brandeis was becoming preoccupied with what he liked to call “the curse of bigness,” he was also, well into middle age, becoming a passionate convert to Zionism, which he saw as another form of legal protection for a vulnerable group. The elder Adolf Berle was another early Zionist.) Brandeis was an adviser to Woodrow Wilson during the 1912 presidential campaign. Trying to frame the difference between his man and Roosevelt, he wrote in a private letter to Wilson that Roosevelt “does not fear commercial power, however great, if only methods for regulation are provided,” but that “we believe that no methods of regulation ever have been or can be devised to remove the menace inherent in private monopoly and overweening commercial power.”
During the campaign, Wilson gave speeches that took the Brandeis approach on economic issues. He spoke on behalf of “the little man … crushed by the trusts.” Trusts, he asserted, were by no means the natural and healthy products of market forces. They had been economically manufactured by underhanded, albeit legal, means, and they stifled competition. “I take my stand absolutely,” Wilson declared, “on the proposition that private monopoly is indefensible and intolerable … And I know how to fight it.” As president, Wilson passed the second major federal antitrust law, the Clayton Act, and established the Federal Trade Commission, a new regulatory agency meant to ensure open economic competition. When he established the country’s central banking system, the Federal Reserve, it was as a system of twelve regional banks, in order to avoid the danger of the control of credit by the “money trust” in New York. And he put Louis Brandeis on the Supreme Court.
Though Adolf Berle was still a college student, and an unusually young one at that, during the 1912 campaign—too young to be a direct participant in these struggles—he entered adulthood fully persuaded that taming the power of centralized business was the overwhelming task facing the country. Playing an important role in that struggle would enable him to become the great man he desperately wanted to be. Now he would have to figure out how—and that meant deciding what kind of liberal he was.
* * *
The Progressives were sincere in their convictions, but they also had psychological motives for committing themselves to the cause of political reform. As the historian Richard Hofstadter put it,
In a score of cities and hundreds of towns, particularly in the East but also in the nation at large, the old-family, college-educated class that had deep ancestral roots in local communities and often owned family businesses, that had traditions of political leadership, belonged to the patriotic societies and the best clubs, staffed the governing boards of philanthropic and cultural institutions, and led the movements for civic betterment, were being overshadowed and edged aside in the making of basic political and economic decisions … They were less important, and they knew it.
That description roughly fits the Berle family and most of the upper-middle-class people they knew; indeed, Hofstadter cited the Berles specifically as an example of the Progressive mentality. Adolf Berle’s wife, Beatrice Bishop, came from a different group, which also resented the sudden rise to dominance of people whom the industrialization of the United States had made rich: they were from the class that had been rich and dominant before the rising group surpassed them.
Beatrice Berle’s father, Cortlandt Bishop, whom she adored, was the scion of a prominent New York family that had substantial real estate holdings. A brilliant man who had earned four degrees from Columbia University, he did not hold a job, as it was considered vulgar for a gentleman of his class to work for pay. Instead, he was an early automobile and aviation enthusiast, bibliophile, art collector, and investor (he helped bankroll the Wright brothers’ invention of the airplane) who spent six months of every year in France and the other six months traveling back and forth between an estate in the Berkshires and a grand stone house just off Fifth Avenue in New York City that housed an institution-size private library that he had created. Beatrice’s mother, Amy Bend Bishop, whom she did not adore, was a late-to-marry society beauty, the daughter of a former president of the New York Stock Exchange. She was supposedly the real-life model for Lily Bart, the heroine of Edith Wharton’s The House of Mirth (Wharton’s house in the Berkshires wasn’t far from the Bishops’, and they knew each other). The Bishops, Beatrice wrote in her memoir, looked down on such families as the Vanderbilts and Rockefellers as nouveau riche.
Even though it was a hundred years ago, it’s hard to imagine that Americans ever lived the way the Bishops did. They spoke French at home—Beatrice was raised by a French governess—and dressed for dinner every night, the men in starched collars, white tie, and tails, the women in gowns, the food and wine always grandly French. They were surrounded by servants. They were fantastically snobbish. Beatrice had to fight to be permitted to go to college (Vassar, then populated exclusively by proper young ladies), for her mother thought a higher education might give her an unacceptable tincture of the middle class. Her parents rejected, one by one, the impressive series of suitors she attracted, as each of them was below the family’s standing. In one especially painful case, her mother, learning that she was seeing a young man named Carl Binger, who went on to become a prominent psychiatrist, told her, as Beatrice recorded it in her diary, “I must never invite a Jew to the house, that this house was hers and that she would never tolerate a Jew inside it.” Beatrice acquiesced: “I cannot imagine happiness coming from a total break with those I have loved best so far and I believe to cause them such pain is unnecessary. It means sacrificing Carl to other people’s prejudices.” But even if she wanted to avoid it, the total break was coming.
Beatrice was an only child. Her mother, at least as Beatrice told the tale, had wanted a boy, partly because she had an overpowering fear of losing her husband’s affection to a female rival as her looks inevitably faded, despite her copious use of treatments meant to defy aging. (Amy Bishop’s fear wasn’t unjustified, though directing it at her daughter was: the family had twice discovered that Cortlandt Bishop was having extramarital affairs.) In 1925, when Beatrice was in her early twenties, her mother turned violently against her and told her that she never wanted to see her again. Beatrice went to see a cousin of hers, also a neighbor in the Berkshires, Austen Riggs, a prominent psychiatrist who had founded a clinic in Stockbridge that still operates under his name. He told her that her mother had a mental disorder called paranoia and there was nothing to be done about it. Over the next year or so, Amy Bishop made it clear to her husband that he would have to choose between her and Beatrice; he chose his wife. In 1926 Beatrice received a curt note from Cortlandt Bishop: “I would like you to remove your goods and chattels and not to return to the place thereafter. Do it as quickly as possible.” When she arrived at the house to take her things away, her father was not there. She never saw him again.
While this drama was unfolding, Beatrice met Adolf Berle; it’s impossible not to notice the exact coincidence of the abrupt and painful loss of her relationship with her father and the start of her relationship with her husband. One of the suitors her parents had forbidden her to see was a friend of Adolf’s, and he had introduced them one spring evening in Washington Square. She always remembered her first impression: “Erect, an irrepressible little wave on top of his head, rimless glasses, a small moustache … precise, reserved, and courteous.” The three of them had gone to dinner in Greenwich Village. “Adolf spoke rapidly,” she wrote later, “the ideas following each other one after another with the force and speed of a mountain brook in the spring.” They talked about the Crusades, Napoleon, Columbus; economics, religion, politics. At that moment there was still enough left of her relationship with her parents that she was able to arrange for Adolf to come over for dinner as part of a small group and not as an announced beau. On Beatrice’s instruction, he wore a top hat. A little later, Adolf arranged for Beatrice to meet his parents over a Jewish Sabbath dinner at the Henry Street Settlement, with Lillian Wald presiding.
Adolf had the wit not to press his case during the worst of Beatrice’s family turmoil. On the day before Easter 1927, a suitable time after Beatrice and her parents’ final break, they visited Vassar together. After an afternoon rain, Beatrice remembered, “we walked around the lake, and the delicious smell of wet earth and the pattern of the trees in flower, mirrored in the water through the lamplight, were suddenly obliterated as Adolf took me in his arms and murmured, cras amet qui numquam amavit.”* They were married not long afterward in a small ceremony her parents refused to attend. They bought an old white farmhouse and forty acres of adjoining land in the Berkshires and, by way of a statement of Beatrice’s intention to depart from her parents’ mores, hung a tile next to the front door that read
My house has the most noble coat of arms
To receive without distinction rich and poor
All available evidence would indicate that the Berles had a blissful marriage. On their wedding night, as Beatrice wrote in her diary, “through the exploring and the marriage of our bodies, we reach states of bliss and ecstasy previously unimaginable. It is as when man discovered fire!” They had two daughters and a son. They bought a large town house near Gramercy Park in New York, where Beatrice installed a master bathroom with aquatic murals painted on the walls and two conjoined tubs—as a New Yorker profile of Adolf sarcastically put it, “so that she wouldn’t miss any of his sudsy wisdom.” And their graves, just down the road from their farm in the Berkshires, have conjoined headstones that bear the legend FORTIS ET DULCIS: strong and sweet.
Adolf encouraged Beatrice to pursue her own interests to an extent that many of their contemporaries found almost peculiar. She became a social worker and then, after the children were born, a doctor. She operated a clinic in Harlem. And she transferred to Adolf all the admiration she was unable to give to her father, or maybe more. In one characteristic diary entry she exclaimed, “He has one of the few creative minds in the domain of public affairs—and this brilliance is tempered with a great humanity.” From Beatrice, Adolf got his father’s sky-high expectations minus the elder Berle’s oppressive need to dominate. They were mutually certain that he was going to do something remarkable, a grand intellectual achievement that would also have an effect on the world; at various times over the years, privately to Beatrice, Adolf compared himself to Shakespeare, Napoleon, Adam Smith, and Karl Marx. He wanted, Beatrice wrote, to be “a social prophet.” It was just a question of exactly how and where he would find the opportunity.
One winter night early in their marriage Adolf didn’t come home for dinner. Finally, at 9:30, he turned up. He explained that he had been in a law library and had lost track of time. Beatrice asked him what he’d been working on, and she found his answer puzzling because it didn’t seem to be on the grand plane of Adolf’s philosophical interests: the relationship between corporate executives and stockholders.
* * *
The liberal reaction against big business had been going strong for nearly half a century, having taken a number of different forms, but mainly it had identified its target as a coterie of men who made themselves very rich by building up the kind of business empires that people in the Progressive Era called “trusts”: Cornelius Vanderbilt in railroads, Andrew Carnegie in steel, Thomas Edison in electric power, John D. Rockefeller in oil, J. P. Morgan in finance. Now, in the 1920s, these people were dead or fading. Berle’s legal career on Wall Street, which put him in the middle of a lot of detailed work on stock and bond offerings, proxy votes, and so on, allowed him to come to what became the great insight of his career: the old trusts were being succeeded by corporations that did not have identifiable owners.
Business corporations had existed for a long time. What struck Berle as new and alarming was that a relatively small number of American corporations had rather suddenly become very large, very rich, and very dominant. They had outlived their founders. Although most of them had shareholders, they were really accountable to nobody. To Berle they looked like permanent, unstoppable institutions. As he wrote a few years later, “The huge corporation … has come to dominate most major industries if not all industry in the United States … There is apparently no immediate limit to its increase. It is coming more and more to be the industrial unit with which American economic, social, and political life must deal.” Therefore, it was time to do something to counteract the corporation:
The economic power in the hands of the few persons who control a giant corporation is a tremendous force which can harm or benefit a multitude of individuals, affect whole districts, shift the currents of trade, bring ruin to one community and prosperity to another. The organizations which they control have passed far beyond the realm of private enterprise—they have become more nearly social institutions.
Berle believed that they could no longer be permitted to have their way with every aspect of the country’s life.
He persuaded a research organization to give him a grant to make a detailed study of the corporation, hiring an economist named Gardiner Means—someone he’d known in the army, also a Harvard-educated son of a Congregationalist minister, married to a Vassar graduate who was a friend of Beatrice Berle’s—to work up statistical evidence about how big and powerful corporations had become. In 1932, when Berle was thirty-seven, the study was published: The Modern Corporation and Private Property, which became a classic almost instantly and still stands as the main intellectual achievement of Berle’s life.
Other intellectuals besides Berle had noticed how trusts and robber barons had been succeeded by corporations that operated on an even grander scale and that aspired to permanence. The final book by the radical economist Thorstein Veblen, Absentee Ownership: Business Enterprise in Recent Times (1923), was mainly about corporations. So was Main Street and Wall Street (1927), by William Z. Ripley, a professor at Harvard Business School who was a mentor of Berle’s. Both of these books were essentially hostile to corporations, focusing on the shenanigans—or, to use Ripley’s memorable language, “prestidigitation, double shuffling, honey-fugling, hornswaggling, and skullduggery”—that they used to disadvantage their investors. They diluted their shares, gave sweetheart contracts to their directors, took away shareholders’ voting rights, and were, as Ripley put it, “cloaked and hooded like the despicable Ku Klux Klan” when it came to issuing information about their economic performance.
What Berle brought to the subject was the combination of a much broader historical and social perspective, and detailed evidence in the form of the charts and tables that Means had worked up. And Berle’s timing was better: Veblen’s and Ripley’s books came out when the rise of the corporation was generally seen as a great achievement and as a delirious moneymaking opportunity for the growing American middle class. The Modern Corporation and Private Property was published in the wake of the 1929 stock market crash, with the Great Depression under way and the country coming to the view that the economic arrangements of the 1920s had utterly failed and needed to be replaced.
The Modern Corporation and Private Property had two central arguments: first, that a relatively small number of corporations had rapidly come to dominate the American economy, and second, that because these corporations had so many shareholders (the biggest one, American Telephone and Telegraph, had more than half a million), they represented a historically new kind of economic institution that was not under the control of its owners. Means’s research showed that of three hundred thousand American corporations, two hundred of them controlled half of the national wealth—and their proportionate power, being relatively new, was sure to increase in the future. They were ubiquitous and inescapable, Berle wrote:
Perhaps … the individual stays in his own home in comparative isolation and privacy. What do the two hundred largest companies mean to him there? His electricity and gas are almost sure to be furnished by one of the public utility companies; the aluminum of his kitchen utensils by the Aluminum Co. of America. His electric refrigerator may be the product of General Motors Co., or of one of the two great electric equipment companies, General Electric and Westinghouse Electric.
And so on.
What Berle called the corporate revolution was every bit as significant as the Industrial Revolution, or maybe even more so: “It involves a concentration of power in the economic field comparable to the concentration of religious power in the medieval church or of political power in the national state.” And unlike the church, the state, or earlier-stage industry, the corporation had severed the tie between control and ownership. As Berle put it, “The dissolution of the atom of property destroys the very foundation on which the economic order of the past three centuries has rested.” Adam Smith’s conception of the market no longer applied, because the owners of businesses, the shareholders, were no longer vigorous entrepreneurs. They were passive and distant from the enterprise. Control lay in the hands of managers and directors who were not significant owners. There was not yet a theory or practice of economics or government big enough to encompass these developments. Therefore, the task ahead was clear:
The recognition that industry has come to be dominated by these economic autocrats must bring with it a realization of the hollowness of the familiar statement that economic enterprise in America is a matter of individual initiative. To the dozen or so men in control, there is room for such initiative. For the tens and even hundreds of thousands of workers and of owners in a single enterprise, individual initiative no longer exists. Their activity is group activity on a scale so large that the individual, except he be in a position of control, has dropped into relative insignificance. At the same time the problems of control have become problems in economic government.
It would have been possible to take the same set of economic facts and arrange them differently from the way Berle did. Twenty years before The Modern Corporation and Private Property, Louis Brandeis wrote a searing series of articles for Harper’s Magazine, later published as a small book called Other People’s Money and How the Bankers Use It, that noted the widespread dispersion of ownership of stocks and bonds but treated it as a minor point. That was because, to Brandeis, it didn’t matter who nominally owned shares in big companies—the real control was in the hands of the “money trust,” meaning bankers, especially J. P. Morgan. They assembled the great corporations and then sat on their boards of directors and pulled the strings from there. Berle, in The Modern Corporation and Private Property—or for his entire life, really—barely mentioned banking and finance. His focus was on the industrial corporation.
Berle believed that the public’s widespread buying of government war bonds during the First World War had greatly accelerated the habit of small-scale ownership of financial instruments. That continued during the stock market boom of the 1920s. And bankers, he thought, had become less important because, by the early 1930s, the major corporations were fully formed independent entities, so financially powerful on their own that they didn’t much need bankers’ help. Still, there was something almost fetishistic about his preoccupation with the corporation as the dominant element in society. In this way Berle was influential: the corporation still looms large in the liberal mind.
It wasn’t entirely clear in The Modern Corporation and Private Property what Berle wanted to do with the corporation. At the end of the book he called, rather vaguely, on “the community” to “demand that the modern corporation” serve “all of society.” But what did that mean? Many years later, Berle wrote a book that he wanted to be considered as major an achievement as The Modern Corporation and Private Property. It was called, simply, Power. The book didn’t take hold, but the title indicates what Berle was always most interested in. What drew him to the corporation as a primary concern was that it was so powerful and was evidently free of any external control. What he wanted was for its power to be reined in.
It soon became clear to Berle that the institution by far best suited to control the corporation was the federal government. That he was wary of corporate power did not mean he was wary of power per se, in the manner of the Founders or Brandeis. He liked centralized government power just fine. At heart he was what political scientists would call a corporatist, a believer in a highly structured society in which big business would dance to a tune called by government—forced to provide economic benefits to the rest of society as the price of its extraordinary prosperity and stability. In a sense he wanted to use the power of the corporation as a pretext for a great expansion of the power of the government. Back in 1912, when Theodore Roosevelt and Woodrow Wilson were arguing between the New Nationalism and the New Freedom, Berle was too young to take sides officially. By the 1930s he had taken a side. He was a New Nationalist—a Clash of the Titans liberal.
Because Berle’s intellectual milieu was a highly enclosed world in which law professors debated technical questions of corporate governance and ownership, he was not immediately understood as what he understood himself to be—a big thinker about power. The one immediate challenge to Berle’s writing about corporations came from a Harvard law professor named E. Merrick Dodd. From the law review articles Berle had published before The Modern Corporation and Private Property was finished, Dodd got the impression that Berle’s main complaint about the corporation was that its managers weren’t running it solely for the economic benefit of their shareholders. He thought Berle was looking for a way to restore the shareholders’ power over management—to reclaim their rights as owners. Understanding this to be Berle’s position, Dodd then argued against it, saying that corporations had a broad “social responsibility” to their employees, their communities, their customers, and the public, not merely an economic responsibility to shareholders. The executives of the great new corporations should see that “they are guardians of all the interests which the corporation affects and not merely servants of its absentee owners,” and the law should see to it that they be permitted to follow this impulse even if their shareholders objected.
But if Berle ever had any genuine concern for shareholders, he had moved away from it by the time he was writing The Modern Corporation and Private Property. Their disempowerment was merely a piece of evidence used by Berle to sound the alarm about the excessive power of the men who were running corporations—and therefore, really, the country. (It also differentiated his theories from those of the thinkers he thought of as his competition, Adam Smith and Karl Marx, since they both had posited that capital controlled capitalism; Berle was saying that was no longer the case.) He believed that the big corporation itself was the problem, and that government had to be empowered to counteract it. As early as 1929, just as he was homing in on the full extent of corporate wealth, Berle wrote to a friend, “This is a problem of government rather than finance.”
Berle did disagree with Dodd, but that was because he did not believe the corporation’s immense power could be exercised independently, voluntarily, and benignly for the benefit of the whole society—not because he thought shareholders were being denied their economic rights. He felt that Dodd was naïve if he believed the corporation would ever behave responsibly unless it was forced to. In a published response to Dodd’s criticisms, he wrote, “The industrial ‘control’ does not now think of himself as a prince; he does not now assume responsibilities to the community; his bankers do not now undertake to recognize social claims; his lawyers do not advise him in terms of social responsibility. Nor is there any mechanism now in sight enforcing accomplishment of his theoretical function.”
In The Modern Corporation and Private Property, there was no discernible remnant of the argument Dodd thought Berle was making. It was an attack on the corporation not for the way it treated its shareholders, but for the fact of its power. Shortly after it was published, the book’s original publisher, a financially oriented firm called Commerce Clearing House, “discovered that they had harbored a viper in their bosom,” as Berle later put it, because it did not want to be associated with dangerous sentiments like Berle’s. Berle always believed that the most powerful corporation, General Motors, had somehow exercised its influence over Commerce Clearing House to put an end to the book’s publication. But the publisher’s unionized printers in Chicago filched the book’s plates and sent them to New York, where it was republished by a trade publishing house.
After the book was finished but before it was published, Berle wrote a letter to Louis Brandeis, perhaps by way of preparing him for the news that he was just about to depart publicly from the justice’s preferred solution to the power of corporations, which was to break them up into smaller parts. “Rereading your collected essays not so long ago, I was struck with your opposition to the tremendous corporate concentration,” Berle wrote.
You were writing in 1915. Now the concentration has progressed so far that it seems unlikely to break up even in a period of stress. I can see nothing at the moment but to take this trend as it stands endeavoring to mold it so as to be useful. If the next phase is to be virtually a non-political economic government by mass industrial forces, possibly something can be done to make such government responsible, sensitive and actuated primarily by the necessity of serving the millions of little people whose lives it employs, whose savings it takes in guard, and whose materials of life it apparently has to provide.
It may have been that, as he wrote to Brandeis, he had taken a position at odds with the justice’s simply in response to changing conditions, but his position on corporations also suited his large ambitions. A society that had been broken down into smaller units that engaged in constant mundane quarrels was much less appealing to Berle than a society devoted to grand struggles between great forces—especially if he could be a significant participant on the side of the national government, which was the only entity potentially more powerful than the biggest corporations. Now he had to find a way to do that.
* * *
Just as he was finishing The Modern Corporation and Private Property, Berle joined a group of “younger men in the statistical departments of banks” (as he put it years later) who met regularly, and secretly, to discuss the growing crisis in the financial system and what to do about it. In the spring of 1932 Berle began writing a memorandum that summarized the group’s views. (Only Berle’s name and that of one other man were on the memorandum; the other members of the group were afraid they would be fired if their association with it was known.) Berle called it “The Nature of the Difficulty.” The combination of the economic crisis and the increasing concentration of economic power meant that “for the first time, the United States has come within hailing distance of revolution along continental European lines.” Dramatic new measures were required. These included pumping more money into the economy through tax cuts; offering government guarantees of job security and of savings deposited in banks; creating a new federal agency that would regulate the stock market; developing a new system of federal old-age pensions and health and unemployment insurance; and relaxing the antitrust laws and the traditional restrictions on the size of banks in exchange for imposing greater regulation on them. To register the full meaning of reforms like these when they were still new and unfamiliar ideas, it is necessary to recall that, as Berle put it, “the then revolutionary conception was simply this: for the first time in its history the federal government had to assume responsibility for the economic condition of the country.”
One weekend during the period when Berle was composing “The Nature of the Difficulty,” he and Beatrice went for a walk in the woods behind their house in the Berkshires. As she remembered it later, “It was one of those rare Spring days in New England when Spring dispels Winter and has not been overtaken by Summer. Patches of snow dotted last year’s brown leaves, a warming sun came through the maple trees in tiny leaf, yellow-chartreuse, banks of wild violets coming into flower lined the road.” Adolf was talking nonstop in his customary low, rapid confidential mumble about how dire the situation in the country was and how important he thought his ideas were. Beatrice went on: “As Adolf was talking, I suggested that he needed a ‘prince’—somebody who could make real the ideas he so freely spawned.”
Providentially, not long after that conversation, the prince appeared. For the past several years Berle had been teaching corporation law part-time at Columbia. One of his faculty colleagues, a political scientist named Raymond Moley who knew about the work he had been doing, approached him to say that he had been informally advising the presidential campaign of Franklin D. Roosevelt, the governor of New York. Would Berle be willing to come with him to Albany and have dinner with the governor? At that point Berle was officially a Republican, though not firmly identified with either political party, and Roosevelt’s views on what to do about the economic crisis were unknown; a previous visitor dispensing economic advice was Irving Fisher, a Yale professor about the age of Adolf Berle, Sr., who was the country’s leading free-market economist. But Berle’s visit to Albany in May 1932 went splendidly.
“I took my memorandum in my hot little hand and we went up there,” Berle remembered years later.
I was a bit dismayed, and stopped being dismayed three minutes after I met Franklin Roosevelt. He was not a man who dismayed people. He was a man who took you into camp almost at once, and we had a pleasant dinner and went to the library, and then he said, “All right now, do you want to say something?”
I said, “I have a memorandum here and I wonder if I could make a short speech?”
The Governor said, “No, make a long one, you can’t do this with a short speech.”
Soon Berle, Moley, and a few other advisers were set up in a hotel suite in New York, working for the Roosevelt campaign, and Berle was often called to meet with Roosevelt in person. As Beatrice put it in her diary, “A. has been in great & constant demand at Albany and Hyde Park.” She sometimes accompanied him on these trips. On one visit to the Roosevelt homestead in the Hudson Valley, Sara Roosevelt, the governor’s mother, took Beatrice aside and told her that she had known both of Beatrice’s grandmothers and that it was a great relief to know that her son “had one gentleman at least working for him.” She asked Adolf, “Are you very radical? I hope not. I am an old conservative.”
Berle may not have been a radical—if that meant being a socialist or a communist—but he knew that this was his great opportunity to see the ideas he had formed put into effect, and he was determined to take maximum advantage of it, to push as hard as he could for as much change as he could get. As he later put it, “For an intellectual this was the golden period of being able to state a case with a fair hope that if it stood up it would be adopted. Further, it was a situation in which the normal political resistance was not likely to apply. The country was too badly off. Something had to be done.” In August 1932 he wrote a memorandum to Roosevelt pressing his case more insistently than he had done before. He reminded Roosevelt that even a losing presidential candidate could become a significant figure in American life, but only if he could “quite definitely become the protagonist of an outstanding policy.” Otherwise he would be forgotten. It was time for Roosevelt to create such a policy. Berle ran through the major points in The Modern Corporation and Private Property and “The Nature of the Difficulty” and then suggested that Roosevelt propose “a policy by which the government acted as regulating and unifying agency, so that within the framework of this industrial system, individual men and women could survive, have homes, educate their children, and so forth.”
Roosevelt asked Berle to draft a speech for him that would lay out this new idea. Over the next few weeks, the Berles sat at their dining room table in the Berkshires and wrote draft after draft in longhand, Beatrice rewriting Adolf’s work and Adolf rewriting Beatrice’s. When they had a draft they felt was ready for Roosevelt to see, Adolf, in a state of high excitement, sent off the speech text to Roosevelt’s campaign train by air mail, along with a long telegram describing its contents, so that Roosevelt could get a sense of the main ideas right away. It began: “Fundamental issue today adaptation old principles to new and probably permanent change in economic conditions which can only be done by enlightened government stop.”
Roosevelt delivered the speech on September 23, 1932, at the Commonwealth Club in San Francisco. It’s worth bearing in mind that up to that point, Roosevelt, whose governing vision is firmly fixed in our minds today, was widely regarded as a charming and high-spirited man who didn’t stand for anything in particular. He was intelligent, but not an intellectual, and he never wrote a manifesto in his own hand. People who met him were always impressed by his curiosity and his ebullience, but they rarely came away with a clear sense of what he thought. So the Commonwealth Club address stands as the best prospective blueprint for the enormous change in the American political order, which the public hadn’t yet started calling the New Deal.
The address displayed the Berle touch in the way it put an argument about what needed to be done right now into the context of the broad sweep of American history, so that to question what Roosevelt was proposing now would seem to be standing in the way of progress. The Berles had Roosevelt locate himself in the political tradition of two of his party’s great figures: Jefferson, the champion of democracy and enemy of centralized power, and Wilson, the opponent of big business whose agenda was left unfinished because of the exigencies of the First World War. In the early nineteenth century the United States had protected its citizens from despotic political power and had provided them with opportunity through the open frontier. Then came the Industrial Revolution. In order to develop its full potential, the country had empowered “a group of financial Titans” and had conceived of government’s role as “not to interfere but to assist in the development of industry.” But now the frontier was closed, the railroads and factories were built, and the great threat to the freedom and welfare of the individual was not the kind of oppressive political power the Founders had feared, but super-concentrated economic power. This had become “the despot of the twentieth century, on whom great masses of individuals relied for their safety and their livelihood, and whose irresponsibility and greed (if it were not controlled) would reduce them to starvation and penury.”*
The Berles had Roosevelt note that recently, “a careful study was made of the concentration of business in the United States”—meaning The Modern Corporation and Private Property—whose implication was that, if nothing were done, “at the end of another century we shall have all American industry controlled by a dozen corporations, and run by perhaps a hundred men.” These men would be—this was a phrase Beatrice was especially proud of having written into the speech—“not business men, but princes—princes of property.” The only way to forestall the onset of this “economic oligarchy” was to develop “an economic declaration of rights, an economic constitutional order.” Roosevelt’s program would be a kind of sequel to the founding of the United States, in which government protected the yeoman (who was now likely to be a city dweller) from the excesses of economic power instead of the excesses of political power.
On very close inspection, the address rejected Brandeis’s dismantling impulses toward business: there was a line about the impossibility of trying to “turn the clock back, to destroy the large combination and to return to the time when every man owned his individual small business.” But this was easy to miss because Roosevelt so enthusiastically praised Jefferson and Wilson and so ardently held up individualism as the most sacred American value. Adolf Berle was more candid about what he had in mind for the Roosevelt administration in a letter he wrote just after election day to a friend who was a federal judge in Boston and also a friend of Brandeis’s:
Brandeis dreams of turning the clock backward. His constant phrase is “the curse of bigness”—who shall say he is not right?—but from the puzzled position of mid-career, I cannot see how the tide can be turned back. Like you, I am afraid we are doomed to an era of big business, and possibly even to State socialism. The line that I am working on is a vague dream that the commercial organizations which we have built up may be used, more or less as they stand, without being destroyed, in the public interest … It cannot be individualism, pure and simple, as we used to know it.
In a letter to another friend the next month, Berle sketched out some of the ideas he had put forth in “The Nature of the Difficulty” and, by way of putting a label on them, said, “These measures … give all the machinery for a controlled capitalism as against an uncontrolled capitalism.”
In those days, presidents were not inaugurated until early March. By that time in 1933, the banking system had substantially collapsed; since the 1929 stock market crash, thousands of banks had gone out of business, and now thousands more were simply closing their doors so that the depositors could not withdraw their funds. With the banks frozen, lending to businesses and consumers, which might have put some life into the dead economy, was impossible. The best-remembered line from Roosevelt’s inaugural address—“We have nothing to fear but fear itself”—was specifically meant to give people the confidence not to take their savings out of banks, and hence out of the economy, from sheer panic.
On the day before Roosevelt’s inauguration, Berle attended an emergency meeting of bankers at the Fifth Avenue apartment of the incoming secretary of the Treasury, William Woodin. The Berles then took the train to Washington for the inauguration ceremony, which Beatrice remembered as being rather grim: “As for it being a good show, there was no show,” she wrote in her diary. “We have lost all color and all sense of pomp and ceremony … There was no thrill in the crowd, only idle curiosity.” Adolf went directly from the ceremony to another emergency meeting at the White House, not leaving there until late in the evening. He spent the next day, Sunday, at a second all-day meeting of bankers at the Treasury. “I never saw a more disorderly meeting in my life,” he recalled later; one banker was weeping, another “drawing ladies and crescent moons” on a piece of paper. Just after midnight on Sunday night, Roosevelt ordered that all the banks in the country be closed for a few days. During that time, Congress passed emergency legislation authorizing the reopening of the stronger banks and the reorganization of the smaller ones. By the middle of March the immediate crisis had passed, and the federal government had become involved in operating the American economy as it never had been before.
William Woodin offered Berle a job in the Treasury. He considered it (Beatrice wrote that he said to her that “pulling out from the government now may be declining a place in history—shall I be Alexander Hamilton?”) but decided not to take it. Berle believed he could have more influence if he was a member of Roosevelt’s informal Brain Trust, not a full-time government employee with a specific job. Roosevelt presided over the executive branch in the manner of a politician, not a businessman. He liked keeping his options open until the last minute, maintaining in his head a private accounting, which was exclusively his, of who the actors were and where they stood. He consulted all sorts of people constantly about all sorts of matters that may or may not have been their official responsibility. This was an atmosphere in which somebody like Berle, whom FDR liked, could thrive. He was closer to power without a formal assignment than he would have been with one; he was one of a small group of people who had permission to telephone Roosevelt at any hour on his private line. At the same time, Berle had forged a close advisory connection to Fiorello La Guardia, who was mayor of New York during the time Roosevelt was president. Under the quaint-sounding official title of city chamberlain, Berle was a one-man Brain Trust for La Guardia’s administration. As Beatrice put it in her diary, “Before the Brain Trust days I felt that he would die a disappointed man if he did not have a finger in the pie. Now he has had a finger in all the pies there are.”
It would be hard to think of anyone who managed to make a tighter connection between formulating big ideas and having a big effect than Berle did in the early 1930s. As Beatrice observed, intellectual life did not satisfy him; he wanted his ideas to “govern and change the course of history … He was not satisfied with emitting wisdom from a distance in a detached and unemotional manner.” But he lacked the temperament to obtain and exercise power in the manner of Roosevelt and La Guardia. Beatrice went on: “He is a man of unlimited ambition … but he is too sensitive, not sufficiently ruthless and outwardly aggressive to gratify this ambition comfortably.” Therefore, and necessarily, “his great genius consists in supplying the ideas for other people.” Berle was fully aware of how large, and how unlikely ever to be repeated, the opportunity before him was. As he told an interviewer many years later, “Suddenly you find yourself connected with the unlimited voltage of a government the size of the United States, when handled by as forceful and determined a man as Roosevelt was—the power became enormous.”
It’s necessary to keep in mind that because the country was in a state of near chaos, and because Roosevelt had a chaotic governing style anyway, nothing about the New Deal was inevitable or uncontentious. Outside of Washington, communism and fascism had more serious support than they have had before or since; inside Roosevelt’s administration, fierce disagreement among the president’s advisers was constant. How much power Berle had can’t be calculated with mathematical precision. All we can know is what Berle wanted to happen at this great turning point in American history and what actually did happen—not the precise relation between the two.
Within the first few months of Roosevelt’s presidency, three economic reforms Berle had been advocating for years became law: the legal separation of commercial and investment banking, federal insurance of the bank deposits of working-class and middle-class Americans (along with federal regulation meant to prevent the insured banks from using their depositors’ money in ways that put them at risk of failure), and federal regulation of stock and bond offerings by corporations. The first of these reforms was aimed at eliminating one of the leading corrupt financial practices of the 1920s: banks lending money to companies and then ensuring that their loans would be repaid by selling stocks and bonds in these companies to unsuspecting customers. The second restored enough confidence in the safety of banks so that people would start putting their money into them again, so that banks could make loans. The third required corporations to provide prospective investors with basic financial information. During the campaign, Berle had written a speech that Roosevelt never delivered, about the problem of “masterless money.” He wanted Roosevelt to exclaim, “Look about you in the whole financial system for anyone who assumes responsibility for the little man, or his little savings.” Now that Roosevelt was president, the government had assumed that responsibility, no matter whether the little man’s savings were deposited in banks or invested in stocks and bonds.
That left as an open question what would come next in the great enhancement of the government’s role in the economy. Would Roosevelt abandon capitalism entirely or merely reform it? And what would reform mean, exactly? Berle knew what he believed: that the government should directly control the economic life of the corporation to the greatest possible extent. In those early years of the New Deal, Berle found himself in constant battle with other liberals who did not share his view. He had hoped, for example, that when the new agency regulating stocks, the Securities and Exchange Commission, was created, it would not only require public information but also regulate financial behavior—for example, banning margin trading, short selling, and the practice of banks trading stocks for their own accounts rather than those of their customers. Instead, his rivals holed up in a suite at the Mayflower Hotel to draft the SEC’s charter without informing Berle, and none of that happened.
Berle enthusiastically supported the National Industrial Recovery Act, a law passed during the early days of Roosevelt’s presidency that gave the federal government the power to regulate specific companies’ prices, wages, and basic economic decisions, as another aspect of its new role as an economic power fully equal to the corporation. The idea of the government as grand economic planner and regulator, its power extending fully into the suites where the largest corporations made their decisions, appealed deeply to Berle. The larger the economic units, the easier it would be for the government to enact Berle’s concept of controlled capitalism, so he had no sympathy for the antitrust movement. All this was the antithesis of what Brandeis believed, but Berle had kept up his respectful connection with the justice, who may not have realized how completely Berle’s views had by now departed from his own.
In April 1934 Berle fired off a letter to Roosevelt. “Dear Caesar,” it began. “Mr. Justice Brandeis has been revolving matters in his head and I think requires some attention.” Brandeis did not feel that his seat on the Supreme Court should constrain him from making his views known to the president, though he usually did so through intermediaries such as Berle. “His idea was that we were steadily creating organisms of big business which were growing in power, wiping out the middle class, eliminating small business and putting themselves in a place in which they rather than the government were controlling the nation’s destinies.” Brandeis wanted Roosevelt to know, Berle went on, that “unless he could see some reversal of the big business trend, he was disposed to hold the government’s control legislation unconstitutional from now on”—including specifically the National Industrial Recovery Act. Roosevelt replied to Berle typically—he was charming but cryptic: “As to our friend of the highest court, I expect to have a good long talk with him within the next few days. The difficulty is that so many people expect me to travel at a rate of one hundred miles an hour when the old bus cannot possibly make more than fifty miles an hour, even when it is hitting on all eight cylinders.”
Neither Berle nor Roosevelt, evidently, was shocked that a Supreme Court justice would, in effect, try to blackmail a president into changing his policies with the threat of overturning them as unconstitutional. Berle always claimed to admire Brandeis—he kept a portrait of the justice on the wall of his office for decades—and to have become opposed to Brandeis’s anti-bigness liberalism only reluctantly, with sincere regret, because it had become unrealistic in the modern world. Whatever resentment of Brandeis he may have been inclined to feel, he transferred to Brandeis’s chief protégé in Washington, Felix Frankfurter, who was the New Dealer Berle hated most. As enemies often are, Berle and Frankfurter were a lot alike: both of them were diminutive, brilliant former child prodigies; both were professors at Ivy League law schools; both were active liberals who liked taking controversial public positions; and both had chosen to spend the early years of the New Deal mostly out of Washington, as advisers to Roosevelt without a specific portfolio. Twenty years earlier, when Berle was an unusually young student at Harvard Law School and Frankfurter an unusually young professor, Berle took one of Frankfurter’s classes and rose constantly from his seat to offer an improved version of what Frankfurter was saying; at least according to legend, the next year he appeared in the same class again, in order, he told Frankfurter, to see whether Frankfurter had corrected the errors he had pointed out the year before.
By the time of the Roosevelt administration, Berle saw Frankfurter as a highly effective schemer—operating through a web of former students he had placed in important jobs in Washington—who was somehow more allied than Berle both with Brandeis’s brand of small-bore liberalism and with European socialism. (Decades later, a historian discovered that while Brandeis was on the Supreme Court, he had paid Frankfurter a retainer for receiving from him—and trying to promote—the policy views Brandeis was not permitted to express openly.) It was Frankfurter’s protégés who had taken control of the design of the Securities and Exchange Commission and given it less regulatory power than Berle thought it should have. Frankfurter was also skeptical of the National Industrial Recovery Act’s expansive powers. It was a bitter pill for Berle to swallow when the Supreme Court, in May 1935, unanimously declared the NIRA to be unconstitutional, with Brandeis concurring—and another bitter pill when, in 1939, Roosevelt nominated Frankfurter to join Brandeis on the Supreme Court.
Roosevelt reacted to changes in the economy and in the political atmosphere by constantly tacking this way and that on economic policy, which only inflamed the rivalries between planning- and regulation-oriented liberals like Berle and power-mistrusting liberals like Frankfurter. In 1938 Roosevelt appointed an old-fashioned crusader, Thurman Arnold, to run the antitrust division of the Justice Department in an especially aggressive way; Berle continued to believe that bigness in the corporate world was not a curse, but an occasion for empowerment of the government to involve itself deeply in corporations’ affairs. In the wake of the Supreme Court decision invalidating the NIRA, he wrote to a friend in New York, perhaps a little disingenuously, “I wish I could agree that a decline in centralized economy will be possible … Life under a small unit society would satisfy both you and me a great deal better than life under the present system does. As someone said in dismissing Mr. Brandeis’s views: I feel with sympathy for decentralization and will support it whenever I can with the hopeless feeling that all bets are the other way.”
Berle was so focused on Brandeis that he failed to appreciate that a much more profound and enduring liberal challenge to his economic views had arisen. In 1936 John Maynard Keynes published The General Theory of Employment, Interest, and Money, proposing a new and more technical way for government to solve economic problems: by managing interest rates, the money supply, and the overall level of government spending. Berle knew Keynes slightly; they had met during the peace negotiations after the First World War, and he and Beatrice had even quoted Keynes in one of the many drafts of the Commonwealth Club speech. But he didn’t take Keynes as seriously as he should have. That was partly because Berle felt he had, on his own in “The Nature of the Difficulty” memo, arrived at the key point of Keynesian economics—the way out of a depression was to give ordinary people the means to spend more. He advocated such ideas all through the New Deal. Also, Keynes was close to the hated Frankfurter, who had arranged for him to meet with Franklin Roosevelt in the White House even before the General Theory was published. Berle’s old writing partner, Gardiner Means, who was working in one of the New Deal planning agencies, instantly recognized Keynes’s importance. In the summer of 1939 Means traveled to England and spent a day conferring with Keynes at his country house in Sussex, leaving with the conviction that the two of them weren’t really so different.
That was wishful thinking. Berle and Means were focused on government, as an institution, directly participating in the operations of business institutions, especially large corporations. The NIRA may have died, but Franklin Roosevelt had created dozens of other new agencies of the federal government that lived on and that told corporations what to do. The National Labor Relations Board could force corporations to negotiate with unions, the Social Security Administration could make them set aside money for their employees’ retirement, the Securities and Exchange Commission could tell them whether they were permitted to issue new stock, and so on. Keynes, as a macroeconomist, was primarily concerned with the economy overall, not with specific institutions, even ones as big as the great American corporations.
Keynesian economics offered liberals in government an entirely different set of tools from the ones Berle and Means were attracted to. Keynes’s American admirers were not particularly interested in the main battles of the past ten years of Berle’s life: the clash between government and the corporation, and the question of whether the biggest businesses should be broken up into smaller units. When Berle and Means were writing together, the leading economics departments in universities were filled with people who studied institutions—microeconomists. Within a generation, macroeconomists, who studied economies as a whole rather than specific businesses, dominated economics, and the whole question of government’s relationship to the corporation—whether to control it or break it up—began to be succeeded by what might be called Macro Liberalism, which focused on managing the economy rather than on taming big business. Berle thought of his version of liberal economics as being about power; the macroeconomists thought of their version as being about science.
As the New Deal’s main attentions began to shift from economic reform to fighting the Second World War, it was still not entirely clear whose economic vision had prevailed. Keynes’s followers could say that the war demonstrated the truth of their economic prescriptions: lots of new government spending finally ended the Depression. But Berle, too, had plenty of evidence at hand that he could use to show that he’d been proved right. Capitalism had survived, and so had the large corporation as its giant institution. The war had given the government the pretext to institute Berle-style policies that would have been inconceivable during the 1930s. It was directly setting the prices of consumer goods and telling General Motors and U.S. Steel and the others exactly what to produce in their factories. The results were wonderful, both for the great global struggle and for the economic well-being of ordinary Americans. Why couldn’t that continue after the war?
* * *
In 1935 the Berles got word that Cortlandt Bishop, Beatrice’s father, was dying and that he had told one of his nurses that he wanted to see his daughter. One day they drove to the grand Bishop house in Lenox, from which Beatrice had long been banished, and knocked on the door. Amy Bishop appeared, “looking like an old hag with eyes that were not there,” as Beatrice remembered it, and said, “Your Father does not want to see you alive or dead.” They left, and soon Cortlandt Bishop was gone. “It hurts,” Beatrice wrote in her diary. “I have lived now for nine years without seeing him. I have made a home and a full life and in back of my mind I have always felt that some day I would see him again; that some day he would come to know Adolf and be proud and happy about his daughter.”
Cortlandt Bishop left Beatrice nothing in his will. She and Adolf hired lawyers, went to court, and wound up succeeding in receiving some family money that her father had inherited and held in trust. This meant that the Berles no longer needed the income Adolf had been earning by practicing law on Wall Street. In 1938 he was appointed assistant secretary of state, with a special responsibility for Latin American affairs, and the family moved to Washington for the rest of the Roosevelt years. Berle had been interested in Latin America ever since he’d spent time in the Dominican Republic as a young army officer back in 1918; and by now, with war imminent, the State Department was becoming the center of the action.
The Berles lived in a series of rented mansions, entertained constantly, and knew everybody. Compared with most assistant secretaries, Adolf was hugely influential. He drafted Roosevelt’s declaration-of-war message to Congress after the attack on Pearl Harbor, in addition to several other important speeches. He helped create the St. Lawrence Seaway in Canada and the modern system of commercial airline regulation. He was the person Whittaker Chambers came to see in 1939 to report that there were Communist Party spies working in government. He continued to see Roosevelt regularly. He tried to make himself part of just about everything in Washington, and sometimes he succeeded.
But Berle was never as influential as an official full-time diplomat as he had been as an informal economic adviser in the early days of the New Deal. His grandiose and earnest conception of himself, his closeness to Roosevelt, his self-promotion, and his propensity for feuding made him one of Washington’s most disliked figures. In a typical incident, in 1940, annoyed about the editing of a draft of a speech he had written for Roosevelt, he gave the original version to two Washington journalists, Joseph Alsop and Robert Kintner. “Berle is always more literary, more formally eloquent, and less guarded than the President,” they reported. Behind Berle’s back people called him, not fondly, Little Atlas, or The Brain. The New Yorker’s two-part profile of him in 1943 ended by saying, “It is a big job to plot the future of the world, but Berle gives many onlookers the impression that he is up to it.” Felix Frankfurter, whose appointment to the Supreme Court in no way diminished his dislike of Berle or his competition with him for Roosevelt’s favor, wrote in his diary in 1942, “There is not one iota of doubt that Berle is almost pathologically anti-British and anti-Russian, and his anti-Semitism is thrown in, as it were, for good measure, though probably derived through certain personal hostilities and jealousies.” Talk of that kind around Washington—along with Berle’s hesitancy about the United States entering the Second World War as soon as Britain did and, later, about giving the Soviet Union a free hand on the Eastern Front—got him a reputation for being an appeaser and a too-ardent anticommunist.
After Roosevelt was elected to his fourth term, in 1944, his closest aide, Harry Hopkins, flew out to Chicago, where Berle was attending a conference, and told him his service as assistant secretary of state was over. As a consolation prize, Berle was made ambassador to Brazil. He had one final private audience with Roosevelt in the White House, to discuss the shape of the postwar world, only a little more than a month before Roosevelt died. In 1946 he resigned from government, and the Berles moved back to New York.
* * *
Some people start out as optimists, seeing the world as a shimmering field of unrealized possibilities, and as they age, they become pessimistic, preoccupied with everything that can go wrong. Adolf Berle had an opposite progression. In his twenties, at the peace talks in Paris, he thought he was watching the creation of arrangements that could bring civilization to an end. In his thirties, in New York, he perceived in the rise of the corporation a basic threat to American democracy. But in his fifties and sixties he believed he was living under a strong, benign, lasting social order, one he had helped to create: domestically and economically, the apotheosis of the tamed, socialized corporation; internationally, an all-powerful United States presiding over an expanding free world.
Although Berle never again experienced the kind of extraordinary confluence of the publication of The Modern Corporation and Private Property and his role as a key adviser to Roosevelt at the moment of his ascension to an unusually consequential presidency—who ever does?—he spent the last quarter century of his life, after he returned to New York, being treated as a liberal sage. The Berles moved back into their town house on Gramercy Park. Although both of them were conducting demanding careers, they entertained relentlessly—usually in the form of black-tie dinner parties, held once a week or even more often, with the guest lists and menus meticulously planned and recorded by Beatrice, for politicians, professors, novelists, musicians, diplomats, scientists, and whoever else struck them as prominent and interesting. At one dinner, during the period of guided discussion the Berles always initiated over the main course, a socialist guest announced, “If there is a lower class, I want to be in it!” After he had left and only the family remained, Beatrice said, “Well, if there is an upper class, I want to be in it.”
Adolf Berle was a founder and longtime chairman of the Liberal Party of New York City, which tried to throw its support to whichever of the major parties was more in favor of generous government social programs while also being staunchly anticommunist. He advised Adlai Stevenson, the Democrats’ presidential nominee in 1952 and 1956, and Nelson Rockefeller, the governor of New York in the 1960s and the leader of the liberal wing of the Republican Party. Adolf constantly contributed articles to prominent newspapers and magazines, gave lectures all over the country, and was often cited in books, law review articles, and judicial decisions. He served briefly as an adviser on Latin American policy to President John F. Kennedy. If there was an obvious way in which Berle’s views were becoming out of date as he aged, it was on foreign policy. He didn’t see any problem with the United States exerting its power maximally everywhere, and he had trouble perceiving the aspirations of left-wing movements around the world as anything but attempts by the Soviet Union to extend its influence. He supported the disastrous Bay of Pigs invasion of Cuba in 1961, which tried to depose Fidel Castro in his early years in power; the United States’ military invasion of the Dominican Republic in 1965 to help the regime there put down a rebellion; and the Vietnam War. But until the end of his life—he died in 1971—The Modern Corporation and Private Property was treated as a classic, and his insights about the corporation, rather than being controversial as they had been when he first stated them, had become part of the way everybody thought.
What made Berle famous was his alarmed criticism of the power of the corporation, but his attitude toward this power was more complicated than pure opposition. That became clear during the New Deal, when he was battling with Brandeis and his protégés. All through the 1930s Berle argued against the kind of aggressive enforcement of antitrust laws that would entail breaking up big corporations. In 1937, when Brandeis and his allies had the idea of imposing a big new tax on corporations’ profits, Berle convened a small group of powerful men—including the chairman of General Electric, a partner of J. P. Morgan’s, and the presidents of the steelworkers’ and mine workers’ unions—to oppose the new tax and, for good measure, the Roosevelt administration’s antitrust program. When Congress created a new body to study economic concentration, called the Temporary National Economic Committee, in 1938, Berle came before it to testify against antitrust actions and in favor of national economic planning. In 1949, when Congress began considering what wound up being the last major piece of American antitrust legislation, the Celler-Kefauver Act of 1950, Berle again testified in favor of keeping big corporations big. “I do not think we are going to get rid of big units,” he wrote Congressman Emanuel Celler of New York, the cosponsor of the law (and, naturally, a friend of Berle’s). “The real question is whether … we need have a real piece of work done permitting an appropriate Federal agency to do industrial planning.”
To Berle, in the mid-twentieth century and as far as the eye could see into the future, the triumph of controlled capitalism was inevitable. The Nazis and the Italian Fascists had had planned economies, and so did the Soviet Union. Any thought that the United States could avoid having one was nothing but a sentimental fantasy on the part of either blindly doctrinaire free-market purists or backward-looking Brandeis-style liberals. The real fight was between the other systems and an American one that would preserve democracy and individual rights. Hadn’t economic planning gotten the country out of the Depression? Hadn’t an even higher level of economic planning—with Washington setting wages, prices, consumption levels of goods, and factory production schedules—won the war?
All the angry younger Berle had really wanted was to enhance the power of government to the point where it could outmatch the power of the corporation. The direness of his warnings about corporate power could obscure the fact that he actually had no quarrel with centralized power, as long as it was used for good, by the state. The drama of his career was the harnessing of the corporation, not its destruction; indeed, in order to work, his vision of a good society actually required that corporations be as big and powerful as possible. Berle’s was a not quite Oedipal dream in which the corporation, the domineering father of the national economy, rather than being slain, would be civilized and made benign. Now that government was so much bigger and exercised so much more power over big business, he was discovering that he rather liked the corporation.
During the 1950s and 1960s, Berle wrote several books and essays meant to bring up to date the themes of The Modern Corporation and Private Property. None of these made as much noise as his first book, but they all showed that he hadn’t lost his special talent for transforming the technical details of corporate law and finance into a series of large, attention-grabbing assertions that presented the advent of the modern corporation as one of the milestones of human history, ranking with the Magna Carta or the Russian Revolution. By now, though, to Berle’s mind, it had become a positive development, not an alarming one. “Its aggregate economic achievement is unsurpassed,” he wrote about the American corporate economy in 1954. “Taking all elements (including human freedom) into account, its system of distributing benefits, though anything but perfect, has nevertheless left every other system in human history immeasurably far behind. Its rate of progress shows no sign of slackening.”
By Berle’s reckoning, the economic dominance of the corporation had only increased since the 1930s: now, only 135 corporations owned 45 percent of the country’s industrial assets, and 25 percent of the world’s. The reason this did not trouble him as it once had was that government had become powerful enough to control the corporation; government in fact owed a debt to the corporation, for providing it (via Berle’s writings) with the justification to enlarge itself. The United States now had “a mixed system in which governmental and private property are inextricably mingled … not the result of any creeping socialism. Rather it is a direct consequence of galloping capitalism.” It had all worked out so splendidly, from the point of view of democracy and social justice, that Berle was sure that even Louis Brandeis, by now long dead, “would be the first to deal with the facts and the last to fetter his views with fiction”—meaning that Berle felt empowered to convert the justice posthumously to his form of pro-corporate liberalism.
It was unimaginable to Berle that the role of government as master planner of the economy would not increase. Already, government controlled vast regions of the economy: banking through the Federal Reserve Board, airlines through the Civil Aeronautics Board, trucking through the Interstate Commerce Commission, electric power and natural gas through the Federal Power Commission, broadcasting through the Federal Communications Commission. All in all, he estimated, about half the economy was in government’s warm embrace. Surely there would be more such agencies in the future. The public would not stand for any attempt to diminish government’s role in the economy, and therefore neither would politicians: to abandon planning “meant risking unemployed workers, failure of supply of consumer goods, deterioration of standard of living, possible political disorder, in brief, a step backward in civilization.”
Also, the corporation had become so powerful that it could easily afford to step into the role government had forced upon it, as the “conscience-carrier of twentieth-century American society.” Berle still firmly believed in the central finding of The Modern Corporation and Private Property: because the corporation’s stockholders were so widely dispersed (by now AT&T had more than a million shareholders), there was no relationship between ownership and control. The financial markets had become irrelevant. By Berle’s calculations, corporations were so profitable that they were able to pay for nearly two-thirds of their investments with their own cash, and this trend too would surely continue. One could now simply write off Wall Street, the great villain for Brandeis and other economic liberals in Berle’s youth, as vestigial: “The capital is there, and so is capitalism. The waning figure is the capitalist. He has somehow vanished in great measure from the picture.” Berle recalled his pre–New Deal argument with Professor Merrick Dodd of Harvard Law School and magnanimously acknowledged that Dodd had won: “Stockholders do not hold the center of the corporate stage right now.” Corporations safely could, and had, become socially responsible in the way Dodd had envisioned.
Sentiments such as Berle’s were everywhere in the 1950s. In 1953 David Lilienthal, former head of the Tennessee Valley Authority and the Atomic Energy Commission and a student of Frankfurter’s who had converted to Berle’s side in the arguments about bigness, published a book called Big Business: A New Era, which was a full-throated celebration of the corporation and an attack on Brandeisian sentiments. “Bigness is … a way of thinking,” Lilienthal wrote. “We think negatively. We are preoccupied with restraints, prohibitions, antitrust, antimonopoly, anti-this and anti-that. This should not be the mood of sanguine and confident Americans.” Lilienthal one-upped Berle’s declaration that Brandeis, if he were alive, would now be in favor of bigness, asserting that even Walt Whitman, if he were alive, would be an admirer of the corporation.
Another of Berle’s many friends had a voice that rose above the low general murmur of assent about the corporation-dominated postwar economy, to the point of attracting real public notice—more, in fact, than Berle himself ever did. That was John Kenneth Galbraith, who was more than just a protégé of Berle’s, though he was that; he was the leading champion of the liberal idea that the corporation, properly handled, could provide the economic foundation for a benign social order. Galbraith was a Canadian agricultural economist who had wound up in Washington during the Second World War, helping to run the government’s Office of Price Administration—which is to say that he came of age as a government official directly intervening in the economic lives of big companies. He met and befriended both Berle and Gardiner Means. In the 1950s, as an economics professor at Harvard, Galbraith wrote a series of books (funded partly through Berle’s lobbying some wealthy patrons he knew) that made him famous, all of which follow in the line of The Modern Corporation and Private Property—especially the first of the books, American Capitalism, published in 1952.
Galbraith accepted most of Berle’s basic tenets. He believed that corporations completely dominated the American economy, that bankers and financiers had become irrelevant, and that using antitrust law and other Brandeisian means to weaken corporations would not be productive. Liberals should be trying to make corporations behave in socially useful ways, not to reduce their power. Writing at a time when, not so long after the Great Depression, the American economy seemed almost miraculously prosperous, Galbraith added a new dimension to the influence of the corporation: using advertising in the mass media, it could now manipulate consumer demand for its products almost at will. The corporation wasn’t just protected from its owners, as Berle had been saying for years; it was also protected from its customers’ whims. That made the need even more urgent for a large role for government, on behalf of the public, in the affairs of these institutions, the most powerful and unaccountable in history.
In two important ways, Galbraith’s ideas about the American economy were different from those of Berle. He could see, far better than Berle did, that management of the economy along the lines of John Maynard Keynes’s theories posed a threat to the government’s ability to direct the specific activities of corporations, always Berle’s preference. That was because the Berle method was confrontational—therefore inevitably controversial—and the Keynes method was invisible. As Galbraith put it, under Keynesian government management of the economy, “to the naked eye, the scope of private business decision remained as before. General Motors still decided what cars to produce, what prices to charge, how to advertise and sell them, when to build a new assembly plant and how many workers to employ.” Keynesian economic management had no immediate natural enemies; Berle’s style of planning did.
Galbraith was also a shade less comfortable than Berle with unadulterated Clash of the Titans liberalism, in which the federal government would take the field as the corporation’s sole all-powerful opponent. Berle, by now, had lost whatever measure he may once have had of the traditional American mistrust of concentrated power—and anyway, it wasn’t much to begin with. His objection had been to corporate power unadulterated by government power. Galbraith had somewhat more Jeffersonian instincts. The big idea he promoted in American Capitalism was “countervailing power,” in which other organized groups—labor unions, consumers, farmers, smaller business competitors—would bring the corporation to heel, forcing it to attend to society’s needs. Government had to play a part in this, because it had to create a system in which these groups could become powerful enough to take on the corporation; indeed, Galbraith wrote, “the provision of state assistance to the development of countervailing power has become … perhaps the major domestic function of government.” Galbraith’s ideal world was one of political bargaining and compromise, and the willingness to sacrifice the purity of a big idea like economic market efficiency (the preoccupation of most of his fellow economists) or state power (Berle’s preoccupation) in order to achieve social peace and attend to the needs of smaller players. But the goal was the same: accept the dominance of the corporation and find a way to turn it to the benefit of society.
* * *
“I find it very difficult to join with people who like to yammer about the American system,” Berle told an audience of students in 1960, “because by the time you get all through yammering, you still have to recognize that it has done more for more people and it has done a better job for a great block of the population than any system in history.” It’s easy to imagine the identities of some of the yammerers he had in mind. On the right, there was the Austrian economist Friedrich Hayek, who had relocated to the University of Chicago after the war and had begun to attract a passionate band of followers to his view that markets did a far better job than governments of responding to changing conditions. Any major enhancement of the power of the state in response to perceived social needs wasn’t just unnecessary; it represented an unpardonable step in the direction of totalitarianism. To Berle it was understandable that Hayek, who had watched the Nazis take over his country, would think this way, but there was no actual danger of this in the United States. Hadn’t democracy and liberty remained strong in the decades since the coming of the New Deal? Hadn’t markets failed and government succeeded during the Great Depression?
On the left, there was a group of social critics who shared Berle’s preoccupation with the corporation but saw it as a kind of disease to be overcome rather than an unstoppable force to be managed. David Riesman, the lawyer turned sociologist whose 1950 book The Lonely Crowd was an influential bestseller, identified the fundamental shift in the American character from inner-directed to other-directed as the great national peril. The rise of the corporation had turned a country of independent individuals into one of company men for whom the need for approval was an “insatiable force.” Then there was Berle’s Columbia colleague C. Wright Mills, the radical sociologist who followed in Riesman’s path but raised the temperature of alarm about the corporation even higher. In White Collar, published in 1951, he had this to say to corporate employees:
You are the cog and the beltline of the bureaucratic machinery itself; you are a link in the chains of commands, persuasions, notices, bills, which bind together the men who make decisions and the men who make things; without you the managerial demiurge could not be. But your authority is confined strictly within a prescribed orbit of occupational actions, and such power as you wield is a borrowed thing. Yours is the subordinate’s mark, yours is the canned talk. The money you handle is somebody else’s money; the papers you sort and shuffle already bear somebody else’s marks. You are the servant of decision, the assistant of authority, the minion of management.
All through the 1950s and 1960s, journalists, novelists, and filmmakers struck this kind of note—including of course William Whyte in The Organization Man. Psychologists conducted ominous experiments that showed the danger of conformity. The Port Huron Statement (1962), the founding document of the student radical movement of the 1960s, reads as a kind of thirty-years-later sequel to The Modern Corporation and Private Property, sounding again and again the alarm about the dominance a few dozen corporations had established over American society. Norman Mailer, in his 1965 novel An American Dream, had his hero, Stephen Rojack, interrupt a lovemaking session to pluck out and fling away his partner’s diaphragm because it was a “corporate rubbery obstruction.” By 1970 Charles Reich, a Yale law professor who was another popular social critic of the day, took the argument to its logical conclusion by declaring, in The Greening of America, that by now the United States “can be thought of as a single vast corporation, with every person as an involuntary member and employee.”
Berle didn’t take opinions like these seriously. The new social critics’ central insight—that corporations dominated American life, economically and otherwise—was one Berle had had decades earlier. Now, all these years later, they were missing what to him was the overwhelming, undeniable main point about American society in the twentieth century—the success of the political and economic order he had helped to introduce in the early years of the New Deal. The Depression had been conquered, the Second World War had been won, and the great competition with the Soviet Union was moving toward the inevitable triumph of American capitalism. There had not been a financial crisis for decades. The standard of living for working- and middle-class people was rising, and the kind of widespread severe material deprivation Berle had seen firsthand as a young man had almost disappeared. Against all this, it was hard for him to perceive some sensed but unprovable increase in conformity as a menace to the republic.
Also, the new critics of the corporation didn’t seem to have a plan, as Berle had had in his younger days. It looked as if they were dreaming of creating a neo-Jeffersonian world in which there would be no large organizations at all; they made Brandeis look hardheaded and practical. The Commonwealth Club address the Berles wrote for Roosevelt in 1932 was framed as a defense of “individualism” in the age of the corporation, but choosing that label was only a tactic, so it wouldn’t seem that Roosevelt was being too radical. (Roosevelt’s opponent, Herbert Hoover, often used individualism as a slogan; the Berles may have wanted to counter his monopoly on the term.) The truth was that Berle thought, back then and even more now, that the age of individualism had ended, succeeded by an age of institutions. He had no sympathy for the idea that the country should make individualism its premier value.
What would we notice now as looming challenges to the peaceable kingdom where Berle imagined himself to be living—challenges that were not so apparent to him, as they didn’t originate in his immediate world of liberal politicians and professors? One was the deep dissatisfaction of the excluded. Like many white American liberals during the first two-thirds of the twentieth century, including Franklin Roosevelt, Berle, through a lifetime of producing grand, morally concerned tours d’horizon of the state of American democracy, almost never noticed that racism was a big problem. When the civil rights movement became inescapably apparent to people in his world, he of course supported it, but he didn’t see how deeply it countered his view of the United States as a high-functioning society that provided opportunity to everybody, or how powerfully it would inspire additional social movements dedicated to other problems he didn’t much notice.
Another challenge was the growing prestige and influence of Keynesian economics, which was skeptical of the kinds of economic remedies—direct regulation of the activities of corporations—that Berle and his allies had been advocating for decades. Probably the most important economics publication of the 1950s was a paper called “Existence of an Equilibrium for a Competitive Economy.” Using dozens of dense mathematical formulas, its authors, Kenneth Arrow and Gerard Debreu, endeavored to demonstrate that under the right economic conditions, prices will always find their natural level—which made their findings a far cry from Berle’s, Means’s, and Galbraith’s argument that it was a good idea for government to set prices. No one who was not an academic economist may have read the Arrow-Debreu article, but from 1948 on, millions of college students learned about economics from an introductory textbook by Arrow’s relative by marriage, Paul Samuelson, which presented Keynesian economic management as gospel and was highly skeptical of Berle-style planning (and, in later editions, specifically made fun of Galbraith for being an unrigorous popularizer). After the war, academic economists, who usually thought in terms of how well markets functioned rather than how much power corporations had, had their own permanent office in the White House, the Council of Economic Advisers.
Still, the rise of the corporation was a massive, undeniable reality, and so was the government’s establishment of some measure of dominion over it. After the war, President Harry Truman had proposed another major ratcheting up of government’s role in American life, which he called the Fair Deal. The country was not in the kind of economic crisis that allowed for the institution of anything the president wanted, as it had been in 1933, so major elements of the Fair Deal did not materialize: national health insurance, federal funding of public education, new laws that would strengthen the hand of organized labor. The United States declined to create the kind of comprehensive welfare state most European countries had. This meant that the corporation, when it could be successfully pushed into behaving like a social institution, was the American welfare state, at least for its many millions of employees, their families, and to some extent the much wider circle of its small-scale suppliers, service providers, and retail outlets for its products. Liberals were the natural champions of the welfare state, but not many liberals younger and less established than Berle thought of the corporation as either a central institution in a good society or as vulnerable to attack for the social aspect it had taken on. All the grumbling about corporations made it easy to miss that they were now bearing a heavy noneconomic load, and if that changed, there wasn’t a real plan for what would take their place.
In the summer of 1970, a chest X-ray picked up an “infiltration” on one of Adolf Berle’s lungs. Because Beatrice Berle was a doctor and Adolf a lifelong heavy smoker, they had no illusions about what the infiltration might be. The Berles decided to forgo any aggressive medical treatment for Adolf. Instead, they would try to enjoy the time they had left together. They kept up their usual routine as much as they could: lectures, short vacation trips, holidays in the Berkshires. One morning in February 1971, in their house on Gramercy Park, as Beatrice remembered it, “Adolf and I sat down together hand in hand, enjoying a pink hyacinth brought down from the country.” He was feeling better than he had recently. They had houseguests, a prominent doctor and his family visiting from Brazil. There was a lively lunch. When it was over, Adolf rose from the table and collapsed. Beatrice recorded what happened next: “I picked up his right arm, then all four limbs—they were paralyzed. I ran upstairs to get adrenaline and a needle and shot the hormone into his heart, but in ten minutes, he was gone.”
There was one more challenge that Berle hadn’t seen—the most significant challenge of all, as it turned out—to the corporation and to his idea of its proper role. It came from the market forces to which Berle, and most other liberal thinkers of his day, believed the corporation had become invulnerable. The biggest corporations could afford to operate large research labs; that, along with their supposedly effortless dominance of the mind of the American consumer, ensured that nobody but they could develop important and successful new products. They were not vulnerable to competition from abroad; as Berle had insisted for decades, no national government, including that of the United States, would ever permit unimpeded access to its markets by foreign companies or permit domestic companies to make their products overseas simply in order to reduce their labor costs. They were even more immune to pressure from stockholders than they had been back in the 1930s, when Berle first proposed his theory of the corporation’s historic separation of ownership and control. In 1959 Edward Mason, the dean of Harvard’s public policy school, published a book of essays by prominent liberals, The Corporation in Modern Society, which reads as a kind of collective homage to Berle (who contributed a brief foreword). In his introduction, Mason summed up the situation this way: “Innovation at the hands of the small-scale inventor and individual entrepreneur has given way to organized research. The role of government in the economy persistently increases. The rugged individualist has been supplanted by smoothly efficient corporate executives participating in the group decision. The equity owner is joining the bond holder as a functionless rentier.”
https://us.macmillan.com/excerpt?isbn=9780374277888&utm_campaign=fwd_economy.unpaid.engagement&utm_source=hs_email&utm_medium=email&utm_content=76020766&_hsenc=p2ANqtz--MIfRJbufuwSOg8G2nnEA6P8aarBZrgWc4TRCMNr22Q1qbw2F_zPCaK28VFAxh1lNtiWfgZNlBXd3U8rGnMpdzVCZ0jg&_hsmi=76020766
Adolf Berle, Sr., lived well into his mid-nineties: he was born in the 1860s and died in the 1960s, never ceasing to prod his son to offer more of the benefits of his insights to the world. Had Adolf Jr. lived as long, he would have seen the economic certainties of a lifetime—everything he was so celebrated for perceiving—blown apart. Perhaps it was better that he did not. Copyright © 2019 by Nicholas Lemann
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