The revolt of “angry Americans” is now accepted broadly as a major cause of the unexpected victory of Donald Trump in the US presidential election. Trump had various problems, including tax avoidance as well as sexist and racist remarks and behavior, which would have disqualified him as a national leader of a democratic society in a normal situation.
Those angry Americans, however, leaned toward Trump over Hillary Clinton. The presidential election had already become a mudslinging contest that forced them to choose between “two bad guys” instead of determining “who the better guy is.” In this situation, they supported Trump with an expectation that he would at least jolt the current system that had made them angry. They had little hope for change from Hillary because she was a representative of the elite establishment who was responsible for building the system and benefited from it.
However, their hope to jolt the system looks elusive. On the contrary, the system is more likely to be strengthened. Trump claimed that immigrants and US trade partners were the major culprits that deprived them of job opportunities and those angry Americans cheered his rhetoric of “making America great again.” However, there is an unresolvable incongruity between this political rhetoric and the economic reality, at the core of which lies predatory value extraction in the US.
Since the 1980s, US business corporations have been restructuring employment relations and financial behavior. The mantra of the day was that American corporations should recover their international competitiveness against their Japanese and German counterparts through corporate restructuring. American workers then kept hearing the story that the US economy resurged from the 1990s thanks to the success of the restructuring.
Often missing here was the fact that restructuring is a very painful process to individuals as well as to society. Many people lost their jobs and were forced to find jobs in new places. It was often the case that they had to accept cuts in their salaries and benefits. There are also social costs to support those out of work temporarily or permanently. Individuals only feel that it is worthwhile to have undergone this painful process if they get some benefits from the restructuring in the end. Society can enjoy a virtuous circle if the benefit of restructuring is shared broadly by its members.
Let us put aside the debate on whether the US economy as a whole was really successful in its restructuring. I have strong reservations on the dominant view that the US economy represents a success story that other countries should emulate. However, there is no disagreement on the fact that the benefits and costs of the restructuring have been distributed unequally.
For nearly half a century before the 1980s, labor productivity increases were paralleled by wage increases. The US middle-class emerged and prospered during this period. Since the 1980s, however, wage increases have not kept up with labor productivity increases. Under the incessant pressure for restructuring, US workers on average have had to accept less than what they contributed to their companies. From the mid-1990s, they began working longer hours than Japanese workers who they used to deride as “ants.” The proportion of contingent workers in the total workforce also increased sharply from 10.5 percent in 2010 to 15.8 percent in 2015. That was an increase of 9.4 million workers, slightly more than net employment growth in the US during the period. One can say that contingent work accounted for all the net employment growth during the period.1
Who then took most of the benefits from the restructuring? They were a small group of financial investors and top executives whose compensation was tied significantly to stock options and stock awards. This was because the US restructuring was primarily led by the stock market and its focus lay in maximizing shareholder value. In the process, the welfare of workers and the long-term sustainability of corporations were often sacrificed. This “unholy alliance” between financial investors and top executives is evident if one examines how US corporations actually distributed their profits and cash piles.
For the decade 2006-2015, US corporations’ total net equity issues — new share issues less shares taken off the market through buybacks and merger-and-acquisition (M&A) deals — was minus USD 4.16 trillion. The US stock market became a huge money sucker from US corporations although the tendency of net outflow has existed on a smaller scale in other stock markets of advanced countries. (See Figure 1)
Figure 1. Net equity issues of US corporations, 1946-2015
Research by William Lazonick of the University of Massachusetts Lowell and his research team at the Academic-Industry Research Network shows that for the decade 2006-2015 the 459 companies comprising the S&P 500 expended USD 3.9 trillion on stock buybacks, representing 53.6 percent of net income of USD 7.28 trillion.2 USD 3.9 trillion is an enormous amount of money that could have been utilized for job creation and long-term investment for corporations. But US shareholders and top executives drew down the money only to purchase stocks and get rid of them in the name of maximizing shareholder value.
Another 36.7 percent of net income, USD 2.67 trillion, was spent on dividends during the period. US corporations had already maintained higher dividend payout ratios than their counterparts in Western Europe or Asia. But the payout ratio increased even higher during the process of restructuring after the 1990s. Much of the remaining 9.7 percent of net profits was held abroad, sheltered from US taxes.
While pressing for restructuring, financial investors argued that US corporations held on to too much free cash flow that should be “disgorged” to shareholders as buybacks and dividends. However, what the corporations actually gave away was much more than free cash flow. Many of America’s largest corporations routinely distributed more than 100 percent of net income to shareholders. They then generated the extra money by further restructuring of their workforces, selling off businesses, or taking on more debt.
Shareholders are residual claimants who are supposed to get part of profits after expensing wages, business costs, taxes, and so on. However, they have made their claims the first priority and have instead made wages and other business costs residual. What they have engaged in was no more than predatory value extraction.
There are several factors that made financial investors such strong value extractors. One of them is the ever-strengthening trend of fund capitalism. Shareholding by institutional investors in the US passed the 20 percent mark in 1970 and has increased to about a 70 percent level by now. Institutional investors as a group are absolutely the largest shareholders of US corporations and the US is now better described as “investor America” than “corporate America.”
Moreover, the shareholding is extremely concentrated to a small number of investors. The top five institutional investors held 31 percent of US stocks and the top 10 held 42 percent of US stocks in the middle of 2016. BlackRock, the largest institutional investor with USD 4.7 trillion of assets under management, for instance, is the single largest shareholder in one of every five US companies and has 5 percent or higher shareholding in 2,610 companies.
The US economy is now run by “shareholder dictatorships.” The US middle class has been disappearing in the process and the “1 percent versus 99 percent” frame has been solidified.
The power of institutional investors to extract value has increased lopsidedly because US financial regulations were substantially revised in the 1980s and the early 1990s toward strengthening their power. US regulators were heavily influenced by the rhetoric of institutional activism and, ignoring the reality of the rapidly growing power of institutional investors, treated them as weak minority shareholders who should be allowed to act together to challenge “autocratic” corporate management.
Currently, activist hedge funds are an investor group that exploits this gap between financial regulations and actual power most effectively for their own profit. Buying a small fraction of outstanding corporate shares, they criticize incumbent management and request restructuring and cash disbursement to shareholders. More often than not, other institutional investors and proxy advisory firms support their claims. “Wolf pact attacks” and co-investments have rapidly become conventions in the US stock market. It is worthwhile to note the fact that the acceleration of predatory value extraction from US corporations coincided with the rise of hedge-fund activism in the middle of the 2000s.
The US economy is now run by “shareholder dictatorships,” not by “shareholder democracy.” Even among shareholders, only a few take the lion’s share of the benefits of the extraction. The US middle class has been disappearing in the process and the “1 percent versus 99 percent” frame has been solidified.
Trump won the presidential election only because he was in a better position than Hillary to exploit this dismal state of the disappearing middle class, not because he had leadership qualities to correct the current situation. He was born into a family of the “1 percent” and has not refrained from unconventional behavior including large-scale tax avoidance, breaking contracts, and shifting losses onto other participants in his businesses to maintain his luxurious and flamboyant lifestyle.
Trump’s right-wing tendency of attributing major sources of American problems to outsiders can be only understood as a reflection of his inherent limitation in solving the problem of predatory value extraction within the US. He is currently filling his cabinet with “gazillionaires” including Steven Mnuchin, a former Goldman Sachs executive, for Treasury Secretary, and Wilbur Ross, formerly a corporate raider and currently a private-equity investor, for Commerce Secretary, contrary to his criticisms of Wall Street bankers during his election campaign. It looks as though we are more likely to witness the continuing gap between his political rhetoric and the reality of the American economy.
1. Katz, L. F. and Krueger, A. B. (2016). The rise and nature of alternative work arrangements in the United States, 1995-2015. NBER Working Paper No. w22667.
2. Lazonick, W. (2016). How stock buybacks make Americans vulnerable to globalization. AIRNet Working Paper: #16-03/01. Retrieved from http://www.theairnet.org/v3/backbone/uploads/2016/03/Lazonick.BuybacksAndGlobalization_AIR-WP16-0301.pdf