How Greedy Corporations Are Destroying America's Status as 'Innovation Nation'

Jul 28, 2011William Lazonick

money-and-greed-150In the latest installment of his series “Breaking Through the Jobless Recovery,” economist William Lazonick explains how corporations obsessed with stock buybacks and maximizing shareholder value are scamming Un

money-and-greed-150In the latest installment of his series “Breaking Through the Jobless Recovery,” economist William Lazonick explains how corporations obsessed with stock buybacks and maximizing shareholder value are scamming Uncle Sam and killing our chances to compete in the 21st Century.

The US economy is a mess. Over two years since the Great Recession officially ended, the unemployment rate is over nine percent, the foreclosure crisis rages on, and households remain loaded up with debt. The fiscal situation of federal and state governments is dire, in part because free-market ideologues think that low taxes are a God-given right.

Much of the mess is the result of an economy in which the forces for extracting value have come to dominate the forces for creating value. The most visible venue for value extraction is the gambling casino known as Wall Street. But it is going on throughout the corporate economy as major industrial companies employ most or even all of their profits to do massive stock buybacks for the sole purpose of jacking up their stock prices.

In the process, industrial innovation -- the generation of higher quality, lower cost products that provide the foundation for economic growth -- is suffering from neglect. And yet we need new technologies to solve economic, social, and environmental problems more than ever. For a (still) rich country like the United States, the only way to revive prosperity is through industrial innovation that results in significant job creation.

At first sight, the innovation remedy may appear natural and easy. Throughout its existence, the US has been an innovative nation, and today still hosts many of the world's leading industrial corporations as well as the most advanced institutional set-up for new firm formation in high-tech fields. It has an extensive system of higher education that for a century has provided high-tech personnel and knowledge to the business sector. It has governments at the federal, state, and local levels that support business through investments in infrastructure, knowledge, and all manner of subsidies.  Entrepreneurial individuals are everywhere, ready to engage in innovation as employers, employees, and consultants.The 20th century was the "American century" because the United States was the world's foremost innovation nation.

Yet in the 21st century our reputation as innovators is rapidly slipping away. What happened?

To get innovation, you need something other than entrepreneurial individuals. You need government funding of the knowledge base. The US government commits massive expenditures on new military technologies. And through the National Institutes of Health (NIH), it also funds life sciences research to the tune of over $31 billion per year. In recent years the NIH budget has been, in real dollars, triple its level in the mid 1980s and double its level in the early 1990s. As another important example, in 2001 the US government launched the National Nanotechnology Initiative (NNI) and has pumped just over $12 billion into it over the past decade, with a 2011 budget of almost $1.9 billion.

The leaders of many of the country's most profitable industrial corporations often lobby the US government to spend more on the nation's high-technology knowledge base, even as their companies under-invest in basic research. For example, at a press conference that the Semiconductor Industry Association organized in Washington, D.C., in March 2005, Intel CEO Craig Barrett warned:

"U.S. leadership in the nanoelectronics era is not guaranteed. It will take a massive, coordinated U.S. research effort involving academia, industry, and state and federal governments to ensure that America continues to be the world leader in information technology."

Yet, in that same year, 2005, Intel's expenditures on stock buybacks of $10.6 billion was nine times the NNI budget of $1.2 billion, while this one company's expenditures of $48.3 billion on buybacks for 2001-2010 were four times the total that the US government spent on NNI over its first decade of existence.

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The information and communication technology industry in general -- and Intel in particular -- have benefited enormously from decades of US government investment in the high-tech knowledge base. If Barrett (or Paul Otellini, his successor as Intel CEO) really wanted "to ensure that America continues to be the world leader in information technology", then over the past decade Intel could have allocated to basic nanotechnology research a portion of the massive funds that it has used to manipulate its stock price through buybacks.

As another example, in June 2010, the self-styled American Energy Innovation Council (AEIC), made up of current and former heads of Cummins Engine, Du Pont, General Electric, Lockheed Martin, and Xerox as well as John Doerr, partner in the venture capital firm, Kleiner Perkins Caufield & Byers, put out a plan for "America's Energy Future" that called for the US government to increase spending on clean energy innovation to $16 billion annually, up from a current annual government investment of $5 billion.

In a press release, entitled "American Business Leaders Call for Revolution in Energy Technology Innovation", Doerr, the venture capitalist in the group, stated:

"When our company [Kleiner Perkins] shifted our attention to clean energy, we found the innovation cupboard was close to bare. America has simply neglected to support serious energy innovation. My partners and I found the best fuel cells, the best energy storage, and the best wind technologies were all born outside the United States. Other countries are investing huge amounts in these fields. Without innovation, we cannot build great energy companies. We need to restock the cupboard or be left behind."

The corporate executives who constitute AEIC are looking for the US taxpayer to foot the bill for restocking the cupboard. What about contributions to a national clean energy effort by business corporations that ultimately stand to profit from these new technologies? Over the decade 2001-2010, the six corporations whose current or former leaders are represented on AEIC wasted a total of $185 billion -- an average of $18.5 billion per year -- buying back their stock, including $110 billion by Microsoft and $48 billion by General Electric. For these six companies over the past decade repurchases were 54% greater than R&D expenditures.

Innovation requires complementary investments by business and government. The government can only do so much, especially with free-market ideologues ranting that the government is already doing too much. A prime reason why the United States is no longer the "innovation nation" is because its major industrial corporations have been obsessed with "maximizing shareholder value" rather than investing in basic technology research.

To slightly paraphrase John F. Kennedy, ask not what your country can do for your corporation but what your corporation can do for your country.

William Lazonick is director of the UMass Center for Industrial Competitiveness and president of The Academic-Industry Research Network. His book, Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States (Upjohn Institute 2009) was awarded the 2010 Schumpeter Prize.

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How the SEC Let the Wolves into the Stock Market Chicken Coop

Jul 22, 2011William Lazonick

wolfIn the latest installment of his series “Breaking Through the Jobless Recovery,” economist William Lazonick explores how the agency meant to protect stock market investors has instead promoted stock-price manipulation and stratospheric executive compensation.

wolfIn the latest installment of his series “Breaking Through the Jobless Recovery,” economist William Lazonick explores how the agency meant to protect stock market investors has instead promoted stock-price manipulation and stratospheric executive compensation.

In 1991, well-known compensation consultant Graef S. Crystal published In Search of Excess: The Overcompensation of American Executives in response to an explosion in executive pay that occurred in the US in the 1970s and 1980s. How, Crystal asked, did it make any economic sense for the CEOs in his sample of 200 large US corporations to be making 130 times the pay of the average American worker? And why were they making about seven times the compensation of their CEO counterparts at Japanese companies, many of which were out-competing their US rivals?

Yet the surge in top executive pay that Crystal observed 20 years ago pales in comparison to the volcanic eruption that has occurred since then. In the mid-2000s, top executive pay in the United States was about three times higher in real terms than the levels of the early 1990s. And the ratio of the average compensation of the CEOs of the largest corporations to that of the average worker climbed as high as 525:1 in 2000 before declining to what has become the "new normal" of about 350:1 in 2010. The gains from exercising stock options represent both the largest and most variable component of top executive pay, giving CEOs, CFOs, and other top dogs a huge interest in allocating corporate resources in ways that jack up their companies' stock prices -- most notably through stock buybacks that can run into billions of dollars per year.

Large corporations use buybacks to manipulate the stock market. And the fact that top corporate executives can sell the shares that they acquire from exercising stock options without any delay means that, avoiding any risk, they can capitalize on the short swings in their company's stock price that their corporate allocation decisions help to create. Nice work if you can get it! And guess how they got it? A gift of the regulator of US stock markets, the Securities and Exchange Commission (SEC).

In 1982 and 1991 the SEC - the US government agency which is supposed to protect stock-market investors from stock-price manipulation and short-swing profits by insiders -- promulgated rule changes that gave the wolves free access to the chicken coop.

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Under the Securities Exchange Act of 1934, large-scale stock repurchases can be construed as an attempt to manipulate a company's stock price. In November 1982, however, SEC Rule 10b-18 changed all that. The new rule provided companies with a "safe harbor" that assured them that manipulation charges would not be filed if each day's open-market repurchases were not greater than 25% of the stock's average daily trading volume for the previous four weeks and if the company refrained from doing buybacks at the beginning and end of the trading day. Under these rules, during the single trading day of, for example, July 13, 2011, a leading stock repurchaser such as Exxon Mobil could have done as much as $416 million in buybacks, Bank of America $402 million, Microsoft $390 million, Intel $285 million, Cisco $269 million, GE $230 million, and IBM $220 million. And, according to the rules, buybacks on these scales can be repeated day after trading day.

Stock-buyback programs -- say, $10 billion over four years -- require the approval of a company's board of directors. But, with a program in place, the company is not required to disclose the dates on which buybacks are actually done (a 2004 amendment to Rule 10b-18 only requires that a company report in its 10-Q filing repurchases in the previous quarter, well after the fact). So top executives who make decisions to do buybacks are privy to inside information that, as holders of stock options, can be very valuable to them.

Why did the SEC pass Rule 10b-18 back in 1982? According to a Wall Street Journal report dated November 10, 1982 on the new regulation, Rule 10b-18 "made it easier for companies to buy back their shares on the open market without fear of stock-manipulation charges". SEC Chairman John Shad, who had previously been a top executive at the Wall Street investment bank E. F. Hutton, was an advocate of the rule change. He argued that large-scale open market purchases would fuel an increase in stock prices that would be beneficial to shareholders. One of the SEC Commissioners, John Evans, argued that as a result of Rule 10b-18, some manipulation would go unprosecuted. But then he agreed to make the Commission's vote for the rule change unanimous.

Coincidentally, it happens that November 1982 was the start of what would be the longest stock-market boom in US history, lasting until the Internet bubble burst in late 2000. In the process, both stock buybacks and stock options became the yin and yang of US corporate executives.

As a complement to Rule 10b-18, in 1991 the SEC made a rule change that enabled top executives to make quick gains by exercising their stock options and immediately selling the acquired shares, thus avoiding any risk that the price of the acquired stock would decline before being sold. Under Section 16(b) of the 1934 Securities Exchange Act corporate directors, officers or shareholders with more than 10% of the corporation's shares are prohibited from making short-swing profits through the purchase and the subsequent sale of corporate securities within a six-month period. As a result, top executives who exercised stock options had to hold the acquired shares for at least six months before selling them.

Treating a stock option as a derivative, however, in 1991 the SEC deemed that the six-month holding period required under Section 16(b) was from the grant date, not the exercise date, of the option. Since all stock options take at least one year to vest from the grant date, the rule change meant that executives could now immediately sell the shares acquired by exercising options. The new rule eliminated the risk of loss between the exercise date and the sale date, and gave top executives flexibility in their timing of option exercises and immediate stock sales so that they could personally benefit from, among other things, stock-price boosts from buybacks.

In 1987, after leaving the SEC, John Shad donated $20 million to Harvard Business School (HBS) to fund the teaching of business ethics courses that could curb abuses on Wall Street. HBS subsequently had difficulty putting that money to its intended use. But it did manage to spend $20 million to build Shad Hall, an ultra posh fitness center designed especially for executives who attended the School's advanced management courses.

One does need to stay in shape to do buybacks and exercise options.

William Lazonick is director of the UMass Center for Industrial Competitiveness and president of The Academic-Industry Research Network. His book, Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States (Upjohn Institute 2009) was awarded the 2010 Schumpeter Prize.

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Sky-High Executive Compensation Kills Jobs, Innovation, & Prosperity

Jul 14, 2011William Lazonick

money-and-greed-150In the latest installment of his series “Breaking Through the Jobless Recovery,” economist William Lazonick explores how excessive executive pay weakens our economy.

money-and-greed-150In the latest installment of his series “Breaking Through the Jobless Recovery,” economist William Lazonick explores how excessive executive pay weakens our economy.

Focusing on shareholder return is a very bad way for companies to govern the allocation of their resources. Public shareholders simply trade outstanding stock, but taxpayers and workers make risky investments in the innovation process and should be able to lay claim to a fair share of the returns. Yet since the 1980s, top executives of major US business corporations have invoked the flawed obsession with maximizing shareholder value to justify the exclusion of taxpayers and workers from sharing profits. Instead, they have been intent on increasing not only cash dividends -- the traditional way of distributing value to shareholders -- but also stock buybacks, which are used to manipulate their company's stock price. So shareholder return has become the measure of success of the publicly traded corporation.

This kind of financialized corporate behavior contributes to both the government deficit, as corporations look for every opportunity to avoid paying taxes, and income inequality, as corporations favor payouts to shareholders over investment in innovation and job creation. Ultimately, by neglecting investment in the productive capabilities of the labor force, the corporate pursuit of shareholder return undermines the ability of a rich country like the United States to maintain its standard of living.

So why do they do it?

All you have to do is look at how US corporate executives are paid. According to AFL-CIO Executive Paywatch, the ratio of the average pay of CEOs of 200 large US corporations to the pay of the average full-time US worker was 42:1 in 1980, 107:1 in 1990, 525:1 in 2000, and 343:1 in 2010. Over the past two decades, gains from exercising stock options have been by far the most important component in the outsized pay of top corporate executives. The average annual compensation in 2009 dollars of the 100 highest paid corporate executives named in company proxy statements was $20.6 million in 1992-1995, of which 63% came from exercising options; $77.8 million in 1998-2001, with 79% from options; and $61.8 million in 2004-2007, with 73% from options. For the top 500 in executive pay, average annual real compensation increased from $9.0 million in 1992-1995 with 51% from options to $29.5 million in 1998-2001 with 72% from options to $27.2 million in 2004-2007 with 60% from options (see my paper, "The Explosion of Executive Pay and the Erosion of American Prosperity").

But doesn't stock-based compensation of executives reflect the real productivity gains of their companies, translated into higher stock prices? Answer: no.  Most of the gains from exercising stock options are the result of stock-price speculation and manipulation. The price yields on S&P 500 stocks averaged 13% per annum in the 1980s, and 15% per annum in the 1990s, rates of increase that far outstripped productivity growth in even the most dynamic sectors of the US economy. Especially in the Internet boom of the last half of the 1990s, stock-market speculation drove up stock prices -- and executive pay. In the 2000s, however, stock-price yields averaged minus 2% per annum, with considerable volatility. A massive manipulation of stock prices through stock buybacks pushed the S&P 500 Index even higher in 2007 than it had been at the zenith of the speculative boom in 2000 -- again to the great benefit of the stock-based pay packages of the corporate executives who made these resource-allocation decisions.

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The problem is that in the United States, the practice has been to grant executives stock options that are unindexed to the productive performance of their company. If the stock price soars as a result of speculation, such as it did in the late 1990s, then executive pay explodes. If the stock price is manipulated through a multiplication of stock buybacks, as occurred especially in 2003-2007, executive pay rises as well.  With a system that permits top corporate executives to be rewarded by stock-market speculation and manipulation, what need do they have for innovation and job creation?

The "Say-on-Pay" provision of the Dodd-Frank, sanctioned by the Securities and Exchange Commission in January 2011, has given public shareholders the right to express their opinion to corporate management on issues related to executive compensation.  According to a report from Institutional Shareholder Services, during Say-on-Pay's first months in operation, stock-market investors endorsed over 90% of company board executive pay proposals. In my view, the impact of "Say-on-Pay" will be to encourage corporate boards and executives to disgorge even more cash flow to shareholders, with all its negative effects on the health of the US economy.

A case in point that I have analyzed in an article in The Globalist is an agreement on the conditions that, under Say-on-Pay, General Electric (GE) shareholders placed on the stock options of GE CEO Jeffrey Immelt. One of the conditions is that Immelt only gets to exercise some of his options if, over the next four years, GE generates at least $55 billion in cash from operations from its industrial businesses, as distinct from its financial arm, GE Capital Services. This provision creates the impression that GE's shareholders want Immelt to invest in real productive assets. Indeed, upon being named chair of President Obama's Council on Jobs and Competitiveness, Immelt declared that "there is nothing inevitable about America 's declining manufacturing competitiveness if we work together to reverse it."

Really? Over the past four years GE generated almost $73 billion in cash from its industrial operations.  In effect, therefore, armed with Say-on-Pay, GE's shareholders are willing to reward CEO Immelt if he oversees a 25% reduction in GE's industrial businesses. So much for working together to reverse the nation's declining manufacturing competitiveness.

The only effective counter to the explosion of executive pay and the erosion of American prosperity will be a social movement of people, as taxpayers and workers. It's time to demand that US business corporations be governed according to the principles of innovative enterprise, and not by the anti-innovation principle of maximizing shareholder value.

William Lazonick is director of the UMass Center for Industrial Competitiveness and president of The Academic-Industry Research Network. His book, Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States (Upjohn Institute 2009) was awarded the 2010 Schumpeter Prize.

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How 'Maximizing Value' for Shareholders Robs Workers and Taxpayers

Jul 7, 2011William Lazonick

stockmarket-1500001In the latest installment of his series "Breaking Through the Jobless Recovery," economist William Lazonick challenges the assumption that shareholders are the only ones taking risks in a business -

stockmarket-1500001In the latest installment of his series "Breaking Through the Jobless Recovery," economist William Lazonick challenges the assumption that shareholders are the only ones taking risks in a business -- and therefore deserving of rewards.

Want to solve the mystery of the American economy's current employment and competitiveness problems? Take a close look at the current corporate obsession with "maximizing shareholder value." It sounds like a sound business principle, but in reality, it's based on a flawed ideology that leaves something crucial out of the business equation -- workers and taxpayers.

Let's review the decade of 2000-2009. During this time, companies in the S&P 500 index, accounting for about 75% of the market capitalization of publicly listed corporations in the United States, distributed 99% of their profits -- almost $4.3 trillion -- to shareholders.  Cash dividends were 41% of profits, while stock buybacks absorbed 58%. This left companies with precious little left over to invest in innovation and job creation (for more on this, see my paper on Innovation and Financialization).

At the most basic level, the rationale for maximizing shareholder value is that shareholders own the company's assets, and therefore have exclusive claim on its profits. A more sophisticated argument is that that among all stakeholders in the business corporation, only shareholders bear the risk of getting a positive return from the firm, while all other participants receive guaranteed returns for their productive contributions. If we want risk-bearing, so the argument goes, we need to return value to shareholders.

This argument sounds logical -- until you question its fundamental assumption. Especially in a "knowledge economy" that can generate innovation, the productive assets of a business enterprise reside in human capital as well as physical capital. And while shareholders may presume to own physical capital, they can't claim to own human capital (we no longer permit slavery, which is why we do not show human, or intangible, assets on the firm's balance sheet). And if you think about it, shareholders are the only participants in the business enterprise who make investments in productive resources without a guaranteed return. In an innovative economy, workers and taxpayers make these risky investments all the time!

When you work for a company, you may contribute your time and effort over and above the levels required by your current remuneration to a collective and cumulative innovation process. By definition, this innovation process can only generate returns in the future (otherwise it would not be innovation), and because the innovation process is uncertain, it may not in fact generate returns. As a member of the firm, therefore, you bear the risk that your extra time and effort won't yield the gains to innovative enterprise from which you can be rewarded. But if the innovation process does generate profits, then you, as a risk-bearer, have a claim to a share in the forms of higher earnings and benefits.

Taxpayers also invest in the innovation process without a guaranteed return. Through government agencies, taxpayers fund infrastructural investments that, given required levels of financial commitment and inherent uncertainty of economic outcomes, business enterprises would not have made on their own. These state agencies also provide businesses with subsidies that encourage investment in innovation.

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In terms of investment in new knowledge with applications to industry, the US has been the world's foremost developmental state. It is impossible, for example, to explain US dominance in computers, microelectronics, software, and data communications without recognizing the role of government in making investments that developed new knowledge and facilitated its diffusion. As another prime example, the 2010 budget of the US National Institutes of Health (NIH) for life sciences research was $30.9 billion, almost double in real terms the budget of 1993 and triple that of 1985. Since the founding of the first national institute in 1938, NIH spending has totaled $738 billion in 2010 dollars (for further discussion, see my paper on Biopharmaceutical Finance).

More generally, the US government has made investments to boost the productive power of the nation through federal, corporate, and university research labs that have generated new knowledge as well as through educational institutions that have developed the capabilities of the future labor force. Businesses have taken full advantage of this knowledge and capability. In funding these investments, taxpayers have borne the risk that the nation's business enterprises would further develop and utilize these productive capabilities in ways that would ultimately redound to the benefit of the nation, but with the return to taxpayers in no way contractually guaranteed.

And there's more: Federal, state, and local governments often provide cash subsidies to businesses, both established and new, to develop new products and processes. The public has funded these subsidies through current taxes, borrowing against the future, or by making consumers pay higher product prices for current goods and services than would have otherwise prevailed. Multitudes of business enterprises have benefited from subsidies without having to enter into contracts with the public bodies that have granted them to remit a guaranteed return from the productive investments that the subsidies help to finance.

So the ideology of maximizing shareholder value provides a flawed rationale for excluding workers and taxpayers from sharing in the gains of innovative enterprise. To turn this idea on its head, ask yourself: What risk-bearing role do public shareholders play in the innovation process? Do they confront uncertainty by strategically allocating resources to innovative investments? No. As portfolio investors, they diversify their financial holdings across the outstanding shares of existing firms to minimize risk. They do so, moreover, with limited liability, which means that they are under no legal obligation to make further investments of "good" money to support previous investments that have gone bad. Even for these previous investments, the existence of a highly liquid stock market enables public shareholders to cut their losses instantaneously by selling their shares -- what has long been called the "Wall Street walk".

The modern corporation has brought about a fundamental transformation in the character of ownership, as Adolf Berle and Gardiner Means recognized almost 80 years ago in "The Modern Corporation and Private Property." As property owners, public shareholders own tradable shares in a company that has invested in productive assets. In an innovative enterprise, however, the most important productive assets are human. In a free society, human assets can't be owned by others. Through massive distributions to shareholders, dominated by stock buybacks, the ideology of maximizing shareholder value is robbing taxpayers and workers of returns to the risks that they took -- and in the process undermining the innovative capability of the US economy.

William Lazonick is director of the UMass Center for Industrial Competitiveness and president of The Academic-Industry Research Network. His book, Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States (Upjohn Institute 2009) was awarded the 2010 Schumpeter Prize.

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How Stock Buybacks Strangle Innovation and Job Creation

Jun 30, 2011William Lazonick

jobless-man-150Conventional wisdom says that the job crisis stems from a mismatch in the labor market or lack of business confidence.

jobless-man-150Conventional wisdom says that the job crisis stems from a mismatch in the labor market or lack of business confidence. But in his special ND20 series, "Breaking Through the Jobless Recovery", economist William Lazonick points the finger at stock manipulation.

Where have all the good jobs gone? As I outlined last week, the disappearing act of decently-paid and stable "middle class" employment opportunities in the US economy over the last three decades is the result of the triple-whammy of plant closings ("rationalization"), the end of career employment with one company ("marketization), and offshoring ("globalization").

In a world of rapid technological change and global development, our economy, with its heritage of capabilities for knowledge creation by government, academia, and business, should have been able to replace these lost jobs with even better ones. Through a combination of business and government investment, a "knowledge economy" can generate plenty of opportunities for educated and experienced workers, and many US corporations have been and remain world leaders in innovation.

And yet the jobs aren't here. Because increasingly, over the past three decades, the executives who run major US business corporations have become far more concerned with allocating corporate resources to boost their companies' stock prices than to invest in innovation in the United States.

The main instrument for boosting stock prices is the stock buyback (or stock repurchase).  With the prior approval of the company board for a program of buybacks of, say, $10 billion, over, say, four years, executives can then do open market repurchases at their discretion.  Stock buybacks can be very useful for meeting the quarterly earnings-per-share targets so closely watched by Wall Street analysts. Buybacks can also help to offset a stock-price decline from bad news such as a failed product. Or they may be used to counter short sales by stock-market speculators, as was done by Wall Street banks just prior to the 2008 financial meltdown.

In other words, buybacks can be used to manipulate the stock market.

In the United States, stock buybacks are huge. From 2000 through 2009 S&P 500 companies -- which account for about 75 percent of the market capitalization of all US publicly-listed corporations -- spent more than $2.5 trillion on stock buybacks, equal to 58 percent of their net income. In addition, these companies distributed dividends equal to 41 percent of net income over the decade, bringing the total payout ratio (buybacks plus dividends) to 99 percent. The average buybacks per S&P 500 company more than quadrupled from less than $300 million in 2003 to over $1.2 billion in 2007, before falling to around $700 million in 2008 and $300 million in 2009. Average buybacks rebounded to $600 million in 2010, however. And they're on pace to total at least $700 million per company in 2011, or $350 billion for the S&P 500 as a whole.

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Executives like to say that buybacks are financial investments that signal confidence in the future of their company as measured by its stock-price performance. In fact, however, companies that do buybacks never sell the shares at higher prices to cash in on these investments. To do so would be to signal to the market that its stock price had peaked, something that no executive would ever do. But at the same time, these same executives use the stock boosts from buybacks to enrich themselves by exercising their very ample stock options and immediately selling the acquired stock to lock in the gains. And guess what? The gains from exercising stock options represent the most important component of outsized executive pay.

In short, as US business corporations have profited from the trends of rationalization, marketization, and globalization, top executives have used those profits to engage in a massive manipulation of their stock prices at the expense of job creation and innovation. From this perspective, the primary cause of the current jobless recovery is neither a mismatch in the labor market nor a lack of business confidence -- two conventional arguments for explaining the sluggishness of reemployment operating, respectively, on the supply-side and the demand-side of the labor market.

The "mismatch" argument is that the skills that workers possess do not match the skills that employers need. But this argument does not explain how, for the vast majority of workers, a "match" is made. The prime reason why the US economy gets a match between the capabilities of labor supplied and labor demanded is because business corporations invest in the capabilities of the types of workers whom they require. From this perspective, a so-called mismatch results from a failure of business corporations to make these investments in the training -- both formal and on-the-job -- of the US labor force. On top of that, as globalization continues, already-educated and trained US workers undergo permanent job loss in their areas of specialization. Valuable human capital quickly atrophies. The decline of middle-class jobs stems from the changed employment practices of US business corporations, exacerbated by their financialized behavior that leads them to favor buybacks over job creation.

It is this financialized corporate behavior, not a lack of business confidence, that stands in the way of a renewal of high-quality employment opportunities in the US economy.  Highly profitable US corporations are currently sitting on almost $1 trillion in cash, even after a sharp rebound in stock repurchases in 2010 and the first quarter of 2011. Rather than manifesting a lack of business confidence, these cash hoards reflect a desire by corporate executives to have funds available for stock repurchases in the years ahead as companies compete through an escalation of repurchases to boost their stock prices as was the case in 2003 to 2007.

The globalization of the labor force for educated and experienced workers is here to stay. But, for the sake of sustainable prosperity, the financialized business corporation has to go. In the absence of a change in corporate financial behavior, the future of the US economy is more booms, busts, and jobless recoveries, with each boom more speculative, each bust more devastating, and each recovery more jobless than the one before.

William Lazonick is director of the UMass Center for Industrial Competitiveness and president of The Academic-Industry Research Network. His book, Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States (Upjohn Institute 2009) was awarded the 2010 Schumpeter Prize.

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Where Have All the Good Jobs Gone?

Jun 23, 2011William Lazonick

jobs-letters-150In a brand-new series, economist Bill Lazonick takes on the structural changes and reforms needed to create good jobs in the U.S. First question: what happened to the jobs we had??

jobs-letters-150In a brand-new series, economist Bill Lazonick takes on the structural changes and reforms needed to create good jobs in the U.S. First question: what happened to the jobs we had??

It's now two years since the official end of the Great Recession. Yet the US unemployment rate in May was 9.1 percent, and even college grads are having trouble finding jobs. The US economy is mired in its third, and worst, “jobless recovery” since the early 1990s.

Things look pretty bleak for the foreseeable future. So how did it come to this?

Let's take a look. The scarcity of good jobs, even in an economic recovery, reflects the cumulative impact of three structural changes in the employment practices of US industrial corporations, going back three decades to the early 1980s. These changes are the result of a triple-layered process of 1) rationalization, 2) marketization, and 3) globalization. Together, these trends have taken a permanent bite out of the quantity of well-paid and stable middle-class jobs in the US economy.

From the beginning of the 1980s, the trend of rationalization, which is characterized by plant closings, tended to jettison the jobs of unionized blue-collar workers. And from the beginning of the 1990s, marketization, which brought the end of the one-company-career norm, has placed the job security of middle-aged and older white-collar workers in jeopardy. Finally, from the 2000s, globalization, which drove the offshoring of jobs, left all types of members of the US labor force -- even those with advanced educational credentials and substantial work experience -- vulnerable to displacement.

In each case, the structural change in employment took root in a cyclical downturn: rationalization in the double-dip “blue-collar” recession of 1980-1982; marketization in the “white-collar” recession of 1900-1991; and globalization in the “Internet” recession of 2001. Looking back, we now know that the recoveries that followed the recessions of 1990-1991 and 2001 were “jobless” as marketization and globalization, along with ongoing rationalization, continued after the recoveries. Indeed, in terms of blue-collar employment, the recovery from the recessionary conditions of 1980-1982 was also jobless because of the continuation of plant closings in 1983 and beyond. In 1985, for example, the number of machine operators, inspectors, and assemblers in the US economy was down 22 percent from 1980. For the economy as a whole, however, these blue-collar job losses in the first half of the 1980s were offset by new employment opportunities for white-collar workers created by the microelectronics boom and the rise of what would come to be known as the New Economy.

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Initially, you could justify these structural changes in employment in terms of changes in industrial conditions related to technologies, markets, and competition. The plant closings that came with rationalization were a response to the superior productive capabilities of Japanese competitors in consumer durable and related capital goods industries that employed significant numbers of unionized blue-collar workers. The erosion of the one-company-career norm among white-collar workers that characterized marketization was a response to the dramatic technological shift from proprietary technology systems to open technology systems that was integral to the microelectronics revolution. The offshoring of the jobs of well-educated and highly experienced US members of the labor force that went along with globalization was a response to the emergence of large supplies of highly capable workers in nations such as China and India, many of them with graduate degrees and work experience in the United States.

But once these structural changes in employment had gained legitimacy as responses to new industrial conditions, US corporate executives often pursued them purely for financial gain. Some companies closed manufacturing plants, terminated experienced workers, and offshored production to low-wage areas of the world simply to increase profits, often at the expense of not only the jobs of long-time US employees who had helped to make a company successful but also, going forward, investment in the company’s long-term competitive capabilities. As these changes became embedded in the structure of US employment, business corporations declined to invest in new, higher value-added job creation on a scale that could at least offset the job losses.

At first sight, the Great Recession of 2008-2009 appears to be detached from these changes in employment practices, given its origin in the casino-like activities on financial firms in the subprime mortgage market. Yet the very existence of a large body of subprime borrowers derived in large part from the failure of US industrial corporations since the 1980s to invest in innovation and high-quality job creation while middle-class jobs were permanently lost through rationalization, marketization, and globalization. Through subprime lending, Wall Street sought to exploit the vulnerability of a working-class population to whom industrial corporations no longer delivered middle-class employment opportunities. And, as I will explain in a later post, the current dismal employment situation and outlook reflects the ongoing investment and employment practices of US industrial corporations that, over the past three decades, have become thoroughly financialized.

William Lazonick is director of the UMass Center for Industrial Competitiveness and president of The Academic-Industry Research Network. His book, Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States (Upjohn Institute 2009) was awarded the 2010 Schumpeter Prize.

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