Economic Life After The Corporation.

Corporations are a major protagonist in the capitalist system. We think of them as the source of the goods and services we accumulate and combine to power our businesses, furnish our homes, enable our communication and mobility, aid our productivity, entertain us, clothe us, protect us, and generally provision us both as businesspeople and consumers. 

When we think of individual items that make up the categories of these goods and services, we often think in terms of innovation: the new iPhone that didn’t exist 20 years ago, or AI chatbots and electric cars, or new clothing styles and fabrics, online shopping with same day delivery, fiber optic cable and cloud computing, streaming video and CRM systems and Quickbooks and run-flat tires. Innovation is the output of corporations.

But corporations themselves have not always been a part of the economy, or central to economic functioning. They were, in fact, a capitalist innovation. Prior to their introduction, in the second half of the 19th century, the more usual form of economics organization was the partnership. This was generally an arrangement of two individuals, sometimes a few more, who came together to collaborate temporarily on a single-purpose business undertaking. The partners typically invested their own money, and did so at one time, since they would expect to finance any future expansion out of the positive cash flow from the business. Mostly, these were small, local businesses although some proved able to generate broader appeal. 

A great example is Josiah Wedgwood, who, along with his partner Thomas Bentley, established his company as a leader in pottery, producing innovations such as creamware and Jasperware (often in the distinctive shade of Wedgwood Blue). The company had an international clientele, including Catherine the Great of Russia and the Queen of England, as well as a large base of affluent households as customers. But the partnership was not a corporation and it was never a big business. 

With the introduction of the limited liability corporation, new vistas of scale and scope emerged. Indeed, the mass production, mass distribution, mass marketing businesses of the late nineteenth and early twentieth century required the new corporate structure to make them possible. The new corporations could recruit investors widely when investors knew that their liability was limited to the amount of their investment. Eventually, stock exchanges, funds and investment clubs would become institutional supports for the growth of large corporations. The emerging corporations could contract with each other for scale implementations never before dreamed of – Standard Oil contracting with railroads to bring affordable illumination in the form of kerosene to every household in America, and Carnegie Steel (and eventually US Steel) contracting for ever more technologically advanced steelmaking equipment to raise the quality and lower of the price of steel for the construction boom across the US. The corporation was an emerging benefit for customers and consumers throughout the world economy.

But all systems can decay. Science calls the process entropy – the leakage of productive work in the form of waste and the loss of clear direction and defined purpose. In the case of corporations, we can detect several forms of entropy. The first is found in their management systems. The corporations were founded by entrepreneurs, purpose-driven individuals aiming to serve the needs of customers and receive the market’s rewards for doing so. These entrepreneurs found that the new scale and scope of operations they had brought into being required a lot of co-ordination that they could not oversee entirely on their own, so they invented management (e.g. supervisors to oversee workers) and specialized departments (e.g. for construction, operations, marketing and sales, accounting, and so on – individuals focused on specialized tasks via division of labor).

After the entrepreneurs passed on and the managers took over the reins, they transformed management systems into command-and control systems. The goals became prediction (planning and projecting business outcomes in advance), precision (no surprises), and power (coercive and administrative sway over the behaviors of employees). These command-and-control systems were dominant in corporate management in the twentieth century.

These systems, in turn, bred three more distortions of the corporate form. The first is bureaucracy, the mechanism for corporate control. Bureaucracy is not externally focused on production for customer value, but internally on control via compliance and procedures, accounting, regulations, and process management. One of the outcomes is that bureaucracies spawn more and more of the jobs and methods of control, to the point where researcher David Graeber (a professor of anthropology at London School of Economics) coined the term “bullshit jobs” to describe them: jobs that have no point implemented by individuals who recognize them as pointless and totally lacking meaning and purpose.

The second distortion takes the form of entanglement with government. This phenomenon was greatly accelerated by the war economies of the First World War and the Second World War. In these periods, government took it upon itself to allocate resources in the economy to serve war purposes rather than customer needs. One of their methods was to appoint “czars” for munitions production and the production and distribution of supplies for the armed forces, and to import CEO’s and senior executives from the private sector to put them in the czar role with command power over the productive firms in the economy. After the wars, the executives returned to the private sector, but their relationship, and that of the corporations they managed, with government had been irreversibly changed. Corporations now found that they could benefit from government protection via regulations, tariffs and laws, and actively sought them in return for considerations such as political donations, subsidized research and construction contracts, and mutually designed policies. Companies like Amazon, Microsoft and Palantir are entangled with government via their contracts for developing government IT and security and AI systems. Banks accept government subsidies and bail-outs. GM was another that accepted government funds and conceded greater compliance. The separation between the private and public sectors is no longer clear.

The third distortion can be encapsulated in the concept of financialization: the financial sector of the economy (what Americans often call “Wall Street”), which corporations initially utilized productively to fund R&D, internal investment and innovation, becomes an extractive, counter-productive and quite dominant influence, eclipsing the productive sector. Corporate priorities shift to financial quantification and away from the purpose of fulfilling the qualitative needs of customers. The financial sector demands predictable, consistent earnings on a quarterly horizon, compromising the investment firms must make in longer-term projects that may not have a pay-off for years rather than this quarter. Firms use stock buybacks to transfer their profits to hedge funds and institutional shareholders rather than fund current innovation projects. Financial markets prefer cost-cutting and budget control to meet quarterly earnings targets over creative innovation. 

These three distortions of the corporate form will lead to a much different economic landscape in the future. Today’s landscape is dominated by the major global corporate entities and their supply chains, and the financial structures that support them including not only stock markets but megabanks, giant pension funds, hedge funds and corporate finance behemoths like Goldman Sachs. Here are three vectors of change.

1. The ascendancy of the dynamically flexible network.

Customers drive markets. They identify their own needs and then evaluate all the alternative ways of meeting them, ultimately selecting one or more as the best alternative(s) while continuously remaining open to the next new alternative that emerges from the churn of market dynamics. Increasingly today, customers have the option and ability to sort through all the possible business connections to find the suppliers and partners they prefer. They can close off one connection and switch to another and build a customized, dynamic network. Some of the connections may be to big business, but, increasingly, they will be able to connect to innovative new small and emerging firms with novel solutions. They’ll be able to shape these novel solutions to meet their own distinctive needs. The result will be a flatter network of small to medium-sized firms, highly specialized in serving customer needs, interspersed with a few big businesses providing relatively undifferentiated utility services.

2. A new relationship with financial markets.

The conceptual size of the statistically dominant corporations today is inflated by their relationship with stock markets. It’s convenient for investors and money managers and CFO’s to bundle multiple businesses together in a single stock. Berkshire Hathaway is the poster child. According to Liberated Stock Trade Berkshire Hathaway owns 65 distinct companies divided into a complex web of over 260 subsidiaries. Why? So as to trade Berkshire Hathaway as a single stock. Amazon, Google, and Microsoft are, to a large degree, similarly structured: they operate multiple businesses under a single brand and stock umbrella. They are financial brands rather than operating brands.

Yet stock markets are no longer fundamental for the capital needs of the largest companies. Investors are trading the stock, but the companies are not raising new capital there. They’re actually pumping capital out of the corporation into the coffers of investors via dividends and stock buybacks. Stock markets are drains on the economy’s productive investment in innovation. They serve the interests of the financial sector not the productive sector. Over time, they’ll become less relevant as corporations fund R&D from free cash flow or from private sources other than stock market investors.

3. A rise in entrepreneurship

Bureaucratization and financialization exert a significant brake on innovation in large corporations. The cost of innovation has gone up for corporations – the cost in time and administrative burden, as well as the sheer deadweight of size that compels the undertaking of larger and larger projects to move the behemoth’s needle. The opposite is true for entrepreneurial projects in smaller and more nimble companies. The cost of entrepreneurship is coming down in small and medium size businesses. Without the bureaucratic overhead, small and medium businesses can quickly experiment with new value propositions, test and explore with real customers, respond to feedback and expand and grow agile new businesses and brands quickly. The cost of operations is greatly reduced by the advent of AI and plug-in supply chains from the Internet. A new business can be tested, launched, expanded and made profitable before the large corporations have completed their budget meeting.

These three shifts will not herald the end of the presence of the corporation in the economy, but will relegate corporations to a subsidiary, residual role.