The Next City
March 21, 1998
And why leveraged buyouts will be its undoing
THIS FEBRUARY MARKED THE 150TH ANNIVERSARY of the Communist Manifesto, and the Marx Memorial Library, housed in historic east London, reports that business is brisk: “Ten years ago there were days when not a soul came in through the door. That was one of the low points, but in the last three or four years it has picked up an awful lot,” enthuses its librarian.
In Paris, the French Communist party daily, L’Humanité, published the Manifesto‘s full text, saying the tract is finding new favor among readers baffled by the uncertainties of the global economy. On university campuses throughout the Western world, conferences are celebrating the ideas of arguably the most influential man of the previous two centuries, beseeching all to judge communism by Karl Marx’s original writings — and not by the aberrations of the Soviet Union or Red China. Books underway deliver the same message, and for good reason. Though the Communist Manifesto was written in a long-past era, when kings and queens ruled most of the world, it reads like a contemporary document that is perfectly in step with current concerns. The Communist Manifesto, in fact, continues to define much of today’s political debates, even providing much of the language used by today’s social activists.
In the Communist Manifesto we find Marx’s analysis of globalization, a process then already underway. “Modern industry has established the world market” whose exploitation will destroy “all old-established national industries,” he accurately perceived, explaining that the upshot would be “new wants, requiring for their satisfaction the products of distant lands,” a loss of sovereignty, and “universal interdependence of nations.” The Communist Manifesto described Third World exploitation, the “clearing of whole continents for cultivation” to obtain “the cheap prices of its commodities.” Marx foresaw an era of unfettered competition, of epidemics of overproduction, leading to periodic commercial crises that destroy productive enterprises. He saw that laborers had become “a commodity, like every other article of commerce, and are consequently exposed to all the necessities of competition, to all the fluctuations of the market.” The Communist Manifesto offers up today’s images and today’s clichés: “the concentration of capital and land in few hands,” the exploitation of many by the few, the rich getting richer and the poor poorer, “the crying inequalities in the distribution of wealth.”
In this book and Marx’s other works, we see the fervor and analysis that infuse today’s radicals, but we also see much of today’s status quo. The following table, reproduced verbatim from the Communist Manifesto, shows that 5 of the Manifesto‘s 10 interim goals have become entrenched features of Western society — virtually all of the West’s major political parties are Marxist in wanting his progressive income tax system, a monopoly central bank, state ownership in various industrial sectors, a state role in agricultural policy, lower density cities, free public school education, and an end to child labor. Another 4 of the 10 Marxist goals have partly come to pass, and only 1 — the abolition of property in land — remains far-off (although many would argue, with justification, that the state has made great inroads here, as well).
Contrary to popular belief, Marxism did not fall with the Berlin Wall. Even the heart of Marx’s analysis — that capitalism, left to its own devices, tends to monopoly — is accepted by almost everyone, from our prime ministers and presidents on down. Marx described how increasing economies of scale and unbridled cutthroat competition necessarily lead to larger and larger capitalist enterprises that not only exploit workers but also devour all smaller competitors. Monstrous capitalist monopolies result, hugely exploitative and, ultimately, hugely inefficient.
With the passage of time, history vindicated the thrust of Marx’s analysis. Industry concentrated mightily before the turn of the last century, until government stepped in to bust the huge industrial trusts that had emerged — Canada passed its first federal antitrust act in 1889, to be followed the next year in the United States by the Sherman Anti-Trust Act. Even with antitrust legislation in place, corporate concentration seemed unstoppable. In the 1960s and 1970s, corporate conglomerates controlling everything from soap to submarines dominated industry, despite being so inefficient that many were worth much less than the sum of their parts. Shareholders — in theory the ones in ultimate control— in practice were powerless: Because shareholders were too disparate to discipline top management, top management became self-perpetuating and accountable to no one, and the conglomerates became juggernauts bent on amassing greater and greater empires. A 1969 report of the Federal Trade Commission warned that the trends toward industrial centralization “pose a serious threat to America’s democratic and social institutions by creating a degree of centralized private decision making that is incompatible with a free enterprise system, a system relying upon market forces to discipline private economic power.”
With this evidence of capitalism run amok, governments beefed up their anticompetition staff; all but a few ideologues saw the need to control industry’s cancerous growth, which Marx so clearly foresaw in the previous century.
BUT MARX DID NOT FORESEE — and political scientists and government regulators still do not appreciate — the slam dunk disproof of his theory that landed upon the financial world in the 1980s: the leveraged buyout. Thanks to LBOs, in just one three-year period, from 1985 to 1988, more than 500 underperforming companies, including Hertz, R.H. Macy, Levi Strauss, and Safeway, disappeared from U.S. stock markets — buyout artists had taken them over to be restructured in private. In particularly inefficient industries such as textiles and grocery chains, hardly any big publicly traded companies remained. Through the device of the LBO, the era of the bloated corporate bureaucracy was gone: More profoundly, the giant killers weren’t still bigger giants, as Marx had predicted, but relatively little guys: savvy outside entrepreneurs, the companies’ own managers, even the companies’ workers.
The takeover of tobacco and food giant RJR Nabisco Inc., the biggest ever LBO, illustrates how pin-striped Davids — in this case Kohlberg Kravis Roberts & Co., a buyout firm formed by three financiers and backed by pension funds — can slay Goliaths weilding nothing more than a credible business plan. In 1988, RJR stock traded under $50 a share but was thought to be worth as much as $100. The buyout firm — with little cash of its own — convinced lenders to join it in putting up $20 billion, the lenders getting RJR itself as collateral. The business plan: The conglomerate would shed many of its food businesses, along with much of top management, and retain the core cigarette business. With this financing up its sleeve, it offered RJR shareholders about $90 a share and, after a bidding war, paid $109 a share — more than double RJR’s pre-takeover value.
Many leveraged buyouts are called management buyouts because a subsidiary’s own management — realizing it can do better without directives from head office — leads the takeover. Employees, too, can spot value. When the 635 union members at Omak Wood Products Inc. in the economically battered town of Omak, Washington, realized in 1988 that its multinational owner, Crown Zellerbach Corp., planned to sell the sawmill, it bid for and won the concern, using the company’s assets as its collateral. “We don’t have two nickels to rub together, but we’re going into debt of $40 million,” the business agent for the local Lumber and Sawmill Workers Union explained at the time. Despite its enormous debt and a severe downturn in the wood products industry, the employees managed the buyout well, making painful but necessary decisions. To reduce its debt, the workers sold off 45,000 acres in land holdings and cut its staff by one-quarter, to 470. It also invested in new equipment to increase productivity and soon was getting 3.5 times as much end product out of its logs.
AT THE HEIGHT OF LBO TAKEOVERS in the late 1980s, socialists despised LBOs, seeing in them a mechanism that accelerates the pace of takeovers, leading to the dismemberment of (in Marx’s words) productive forces. In fact, LBOs are the greatest corporate leveller of all time, one that deconglomerates by paring operations down to core businesses, typically by turning managers of smaller corporate units within the conglomerate into independent owners of the businesses they once managed for others.
LBOs didn’t just break up companies directly involved in takeovers: Indirectly, LBOs convinced all corporate giants to justify their size or trim down, leading the entire corporate sector to downsize, decentralize, rationalize, and otherwise restructure their operations on their own, knowing that if they didn’t, some pip-squeak might do it for them. Because of the LBOs’ brutal efficiency, hugely undervalued publicly traded corporations have become rarities, dampening the need for LBOs. In the current wave of corporate mergers — merger mania, as the press often refers to it — the takeovers occur through more traditional purchase arrangements. But whenever mergers go wrong, and the merged companies’ own managements don’t take the steps necessary to return value to shareholders, the LBO will resurrect itself to cut any corporate colossus down to size.
UNTIL THE SIGNIFICANCE OF THE LBO HITS HOME, Marxists will continue to believe history is on their side, and many social reformers will remain stuck in their time warp, importing a 150-year-old mind-set, complete with jargon, into today’s economy. Once society universally understands that corporate concentration is naturally self-regulating, and not an evil in itself, reformers can attack true evils — racism, environmental destruction, weapons of mass destruction — not only with good hearts but also with clear minds.
- Evan Morris, Regina, responds: May 19, 1998
- John A. Gayder, St. Catharines, Ontario, responds: July 1, 1998
- Lawrence Solomon replies
- Paul Geddes, Coquitlam, British Colombia, responds: January 5, 1999
Evan Morris, Regina, responds: May 19, 1998
You state that almost everyone believes “that capitalism, left to its own devices, tends to monopoly.” The remainder of your article explains how leveraged buyouts are a mechanism that prevents conglomerates from getting too large and that corporate concentration is naturally self-regulating due to the existence of leveraged buyouts. My knowledge of leveraged buyouts is limited to the information in your article, and there are a few things I would like clarified.
According to your examples, the leveraged buyout breaks conglomerates into smaller units. Aren’t conglomerates different from monopolies? My understanding of a monopoly is that it is the sole supplier of a specific good or service, while conglomerates are diverse business operations under one ownership, each of which may or may not be a monopoly. Do leveraged buyouts break up monopolies? Are there fewer monopolies in existence now than before the introduction of leveraged buyouts?
You state that many conglomerates have disappeared from U.S. stock markets and that buyout artists had taken them over and restructured them in private. If such companies are now held privately, does this not mean that they are immune from leveraged buyouts? If leveraged buyouts increase the proportion of corporations in private hands, will this not reduce the effectiveness of leveraged buyouts as a self-regulating mechanism for breaking up conglomerates?
Another issue that comes up in your editorial is that of corporate concentration. Your article deals primarily with corporations owning other corporations. One can also ask if corporate wealth in individual hands is becoming more concentrated. According to an article in the Lett Business Observer, there was little change in the concentration of wealth during the 1980s but a large increase in concentration during the 1990s. The report states that wealth is becoming more concentrated among the wealthiest 1 per cent of the U.S. population at the expense of the other 99 per cent.
Finally, I have a question regarding the last sentence of your editorial, where you say that since corporate concentration is naturally self-regulating, reformers should attack other social issues with a clear mind. You seem to imply that the marketplace has little need for reform. In other editorials you have been critical of monopolies, in particular government-run monopolies. What is your position on privately owned monopolies? Should reformers do anything to increase competition in situations where most of the market is controlled by one or a few corporations? If so, what do you suggest?
John A. Gayder, St. Catharines, Ontario, responds: July 1, 1998
In your table “Much of the Communist Manifesto‘s Interim Agenda Has Been Accomplished” you claim “Abolition of property in land and application of all rents of land to public purposes” has not been done. I beg to differ.
My mother owns a house in the country for which she pays close to $5,000 per year in taxes. She has no streetlights, sidewalks, city water, or sewer. All other connections (power and phone) are billed separately.
The tax money she pays is used for “public purposes.”
If she does not continue to pay this money, she will be thrown out of her house.
Sounds like rent to me.
Mr. Morris’s understanding of monopolies and conglomerates is broadly correct — conglomerates are not usually monopolies. But the reverse is not the case; monopolies are usually conglomerates. Microsoft, for example, owns or controls numerous companies and businesses and combines their activities in attempts to dominate many areas of the economy. Electric utilities, until recently considered natural monopolies, are in fact conglomerates of related businesses — generation, distribution, transmission among them — so arranged as to shut out competitors.
Since the introduction of leveraged buyouts in the 1980s, monopolies have become endangered corporate species. In many jurisdictions, major industrial sectors such as gas utilities, power utilities, public transit, communications, airlines, and railways have lost their government-granted monopoly privileges, and because demonopolization has tended to please consumers, other jurisdictions are following suit. The few monopoly sectors that remain intact, for now, include roads, airports, and national currencies. Leveraged buyouts are not solely responsible for this decentralization of industrial power, but without them, the likelihood of corporate reconcentration would often have made demonopolization politically impossible.
Privately held companies (those with a limited number of shareholders) are not immune from leveraged buyouts, except where a company is wholly owned by one individual. To settle disputes among shareholders, shareholders’ agreements generally provide for one party buying out others.
While LBOs may well increase the proportion of corporations in private hands (i.e., companies not publicly traded), such an event would not diminish the role of LBOs as self-regulating mechanisms for breaking up conglomerates. A world of such companies would be deconcentrated because very few privately held companies are large.
Privately held companies that wish to expand are often forced to go public to raise capital. One of the world’s most extreme examples of corporate concentration involves Sweden’s legendary Wallenberg family, whose companies (ABB Asea Brown Boveri, Saab, Scania, STORA, Electrolux among them) account for 43 per cent of the worth of the companies on the Swedish stock exchange. Yet the Wallenbergs’ control is tenuous because their capital in these companies is often a small fraction — less then 10 per cent — of the companies’ worth. Nobody, not the Rockefellers at the turn of the last century nor the Wallenberg’s at the turn of the this century, can control enough capital as the sole owner of an enterprise to perceptively influence an economy. Even Bill Gates, the world’s richest human at about $50 billion, owns only 22 per cent of Microsoft and controls a negligible share of the U.S. economy.
That wealth did not concentrate for the wealthiest 1 per cent in the 1980s (an era dominated by Reagan, Thatcher, and LBOs) as it did in the 1990s (when the ardor for free markets waned under Clinton and Major) is neither surprising nor troubling. The top 1 per cent is not a privileged aristocracy that shuts out the mass of the citizenry but an ever changing group that today includes computer multibillionaires, athletes, and entertainers, many of whom had modest beginnings. Our era is one of immense mobility — both upward and, as seen by the likes of the Reichmanns and Campeaus, downward. The top 1 per cent 10 years from now will look very different from the top 1 per cent today.
But why worry about the top 1 per cent? The same source that Lett Business Observer uses — the Survey of Consumer Finances — shows shrinking disparities in wealth among broader categories. Fewer families were worth less than $10,000 or more than $100,000 (or even more than $250,000) in 1995 compared with 1989. In that same 1989 to 1995 period, more families entered the $10,000 to 24,999, $25,000 to 49,999 and $50,000 to $99,999 categories.
Finally, Mr. Morris asks about my position on privately owned monopolies. If the private monopoly is a natural one, it should be regulated by government; if it is unnatural, as most are, it should be broken up by removing its monopoly privileges. These privileges are invariably disguised as measures to protect consumers — typically the monopolist pledges to ensure a reliable supply of some important good (as if the competitive market refuses to supply consumers) or to provide moderate prices (as if monopolies haven’t raised rates at a far faster clip than have companies subject to competition). In my work over the last 20 years at Energy Probe Research Foundation, my colleagues and I have employed these principles to see to the breakup of public monopolies such as Ontario Hydro and private ones such as Consumers’ Gas.
An economy left to its own devices, we have found, tends not to monopoly but to competition. Reformers who understand that monopolists need to involve government in their business should be leery of asking the government to do so; instead of being concerned with the number of players in the marketplace at any one time, reformers should work to change unfair rules that shut out competitors. Many players in a cartel do not help consumers, while a single provider, fearing the entry of competitors, does. Even state-owned monopolies that fear privatization and competition often become superb at improving service and holding the line on prices.
Paul Geddes, Coquitlam, British Colombia, responds: January 5, 1999
It was good to see Mr. Solomon enter the current Microsoft debate about the definition of a monopoly. Many confuse the concept of monopoly with large size and try to use government power to break up large companies to make markets “more ive.” What a paradox! If a company serves its customers well and starts to grow, the government will punish it and force customers to buy inferior products from inferior competitors, all in the name of protecting competition. This sounds too much like those unfun, uncompetitive games public school teachers fob off on students, than a prescription for running a prosperous economy.
Microsoft is a powerful, successful company, but I have great difficulty calling it a “monopoly” since I can’t find evidence of government laws which favor it over competing companies. On the other hand, both Yellow Cabs of Vancouver or Farmer Joe’s chicken farm down the road may be small and not spectacularly profitable, but both should be labeled monopolies because government licences and privileges prevent newcomers with new ideas from competing with these companies. As a result, the owners of these smallish companies are earning monopoly rents and causing waste in our economy.
I don’t see the purpose of Mr. Solomon’s attempt to distinguish between private monopolies (the example he uses is Consumers’ Gas) and public monopolies (Ontario Hydro). The more important distinction to make is about the source of the monopoly. Did the private Consumers’ Gas become large by serving customers well, or did it become large by manipulating politicians and laws to give it privileged access to customers? If the former, leave it alone. If the later, attack the privileges.
If political entrepreneurs (like Energy Probe) want to help us, rather than agitating about the size of companies, one would hope they would spend their time attacking government privileges directly (zoning laws, labor laws, marketing boards, government mandated professional licencing bodies, and so on). These privileges are harming us by protecting inefficient, bloated companies from entrepreneurs with new ideas.