.

At the time of this writing Dwight R. Lee was Ramsey Professor of Economics at the University of Georgia at Athens. Richard B. McKenzie was Gerken Professor of Enerprise and Society in the Graduate School of Management at the University of California, Irvine. The authors have written widely on social and economic issues, separately and together. Their most recent collaboration was Quicksilver Capital: How the Rapid Movement of Wealth Has Changed the World,/i>.

In the 1950s John Kenneth Galbraith wrote American Capitalism in which he argued that big government is a predictable response to the power of big business. As business became more concentrated with fewer, but larger, firms dominating the market place, Galbraith saw a larger government as the natural and most effective source of "countervailing power."

It is doubtful that big business ever possessed the power Galbraith believes it did and debatable whether big government is more effective at countering or augmenting the power that big business does have. However, for reasons which Galbraith did not anticipate, his thesis is more powerful than even he realized, but in reverse. There are good reasons to believe that it was the structure of business which prompted government to grow in size and power during most of this century. But those same reasons also explain why government is now in the beginning stages of decline.

Growth in government power was indeed a predictable consequence of the accumulation of large concentrations of industrial wealth. But the connection between government power and the accumulation of industrial wealth had more to do with the desire to enhance the former than to protect against the latter. Concentrations of industrial capital provided a target of opportunity that proved irresistible to those who derived benefit from government growth.

While business capital continues to grow in value, the nature of this capital is being transformed in ways that reduce its vulnerability to political exploitation. Technology is changing the size, mobility, and the very nature of capital, and by doing so, it enables business to respond to the demands of consumers and to ignore the demands of government. Even if government did serve as a desirable countervailing power to the power of business, the importance of this power diminishes as does government's ability to exercise it.

Countervailing Power

The hallmark of the Industrial Revolution was the growth of capital (plant, equipment, and machinery) that permitted people to produce more than is possible with muscle (human and animal) power. As capital innovations allowed the power contained in flowing water, expanding steam, wood, and coal to be focused on such tasks as lifting, spinning, grinding, and digging, the ability to convert human effort and natural resources into valuable products increased dramatically. Economic productivity has continued to increase through improvements hi our ability to employ capital, to tap and harness old energy sources and convert previously useless resources into new sources.

Greater productivity meant investment in larger machines, bigger furnaces, and longer assembly lines, all of which required bringing more people together into ever larger productive units. In other words, the productive process was characterized by escalating economies of scale. By the late nineteenth century, firms had reached truly gigantic proportions and the trend toward larger firms continued well into the twentieth century as conglomerates and multinational corporations produced a growing share of domestic output and employed an increasing share of the domestic work force. Not surprisingly, Galbraith's concern with what he saw as the growing economic power of the "New Industrial State," and the need for the "countervailing power" of government struck a popular chord, as evidenced by the robust sales of his books.

It is easy to prompt debate on the question of whether or not public concern over the size of firms and industries has ever been justified. There is no doubt that people, both as consumers and as workers, benefitted enormously in the last half of the nineteenth century as those industries in which the greatest economies of scale could be realized became dominated by a few large and extremely productive firms. Although the most concentrated, and therefore visible, result of the productivity of these firms was the enormous wealth of a few entrepreneurs (pejoratively referred to as robber barons), by far the greater portion of the wealth created was distributed widely in the form of better products, lower prices, higher salaries, and improved working conditions.

Of course, for the very reason that the general public realized so much benefit from large enterprises, they may have possessed some measure of power over customers and workers. The firm that produces a better product at a lower cost than the competition has the power to attract eager customers, while charging a higher than minimum cost price. Likewise, firms that use labor more productively than the competition have the power to attract eager workers, while paying a wage lower than that which reflects the full productivity of those workers in those firms.

Whether or not the increased size of business enterprises made a larger government desirable is debatable, but it surely made it possible. Large firms may have possessed some market power by virtue of then-large concentrations of capital, but they also found themselves more vulnerable to the power of government as a result. Concentration of business capital motivated by large economies of scale. The wealth thus created was highly visible and securely anchored hi place. The greater part of a firm's assets was hi the form of large machines and productive facilities, which were practically immobile both because of their size and their dependence on proximity to markets, natural resources, navigable rivers or harbors. By committing themselves to investments in large concentrations of capital, businesses increased their ability to produce what Marxists call "surplus value." By making those capital commitments, businesses reduced their ability to avoid sharing that surplus with government.

Concentration of capital not only created economies of scale in the production of wealth, they also created economies of scale hi the taxation of wealth. It is far more costly per dollar collected to tax the profits and wages generated by many small and scattered firms than it is to tax the profits and wages generated by a few large and concentrated firms (especially since the withholding system requires businesses to do much of the work of tax collection). And because large firms with major commitments to plant and equipment are less mobile, and therefore more captive, than smaller, less capital-intensive firms, government can take advantage of economies of scale in taxation with a significant degree of impunity.

Also, by offering increasingly attractive and plentiful employment opportunities, larger, more efficient firms attract large numbers of people out of self-employment, further easing the task of the tax collector. The earnings of those who are employed by a firm are easier to tax than are the earnings of those who are self-employed, if for no other reason than the firm has a strong motivation to report accurately, as costs, the salaries and wages they pay. This vulnerability of the employees of large firms to higher effective taxes is equivalent to yet additional vulnerability of large firms to government exploitation.

Concentration of capital created economies of scale in production and taxation of wealth.

Economists stress the fact that corporations do not pay taxes, people do. Higher corporate taxes reduce the wealth of people who have an economic interest in the corporation, either as customers, workers, or investors. But it is equally true, although economists rarely make the connection, that a tax on people, as employees of a corporation, is also a tax on the corporation (albeit paid by those who are investors in and customers of the corporation). The higher the effective tax imposed on those who work for a corporation, the more the corporation has to pay its employees, and this additional payment is reflected in some combination of lower returns to investors and higher prices to customers.

As large corporations emerged at the end of the nineteenth and the beginning of the twentieth centuries, the federal government took what today would be considered an insignificant percentage of Gross National Product (GNP). Consider the fact that in 1902 the federal government spent 3 percent of the GNP (compared to about 24 percent today), with most of the revenue coming from import duties and excise taxes. The federal government was not oblivious, however, to the revenue enhancing opportunities big business offered. The political pressure to impose a tax on corporate profits gathered strength and a corporate income tax went into effect in 1909. A federal tax on personal income was enacted in the late 1800s to take advantage of the increasing percentage of the work force receiving visible salaries and wages, but was declared unconstitutional. Wages and salaries soon represented such a mother lode of wealth, however, that the United States Congress initiated a constitutional amendment permitting a personal income tax, which was ratified in 1913. The corporate and personal income taxes quickly became the dominant sources of federal tax revenue and powerful engines for propelling rapid growth in the federal government.

Global mobility of products reduces government control over business.

The corporate income tax accounted for 11 percent of federal government tax revenue hi 1916, and this percentage escalated quickly, in part due to the demand of the First World War, but with the escalation continuing after the war. In 1925, 35.5 percent of federal revenues came from the corporate income tax, with the percentage reaching 46.7 percent in 1928. Revenue from the personal income tax followed a similar pattern. In 1916 this tax accounted for 13.3 percent of federal revenues, with this percentage increasing to 32.7 percent in 1925 and 33.7 percent in 1930. Not surprisingly, as the highly lucrative corporate and personal income taxes became the dominant sources of federal revenue, the federal government increased rapidly in size as measured by the share of the national income it captured through taxation.

Additional tax revenue was not the only source of greater government power the growth of big business made possible. Control over resources and securing tax revenue is not the only way government exercises its power. By regulating private-sector decisions in general, and business decisions in particular, government can direct resources just as surely as through the expenditure of tax revenue. Large firms with large concentrations of fixed capital enabled governments to realize economies of scale in regulation just as they made possible economies of scale in taxation.

As it is more difficult for government to tax small businesses that are widely scattered, and unanchored with large capital commitments, so it is more difficult for government to regulate business decisions under these conditions. Certainly, it was after the emergence of large business firms that the regulation of business by government, in the form of market entry controls for transportation, production restrictions for agriculture, and safety management in mining and construction, began in earnest, with regulation escalating as businesses continued to expand.

Conventional wisdom has it that, with the emergence of big business, government regulations multiplied because public demand for regulation increased. There is an element of truth in this. But how great could the demand for government to protect the public against business have been as large businesses began springing up in the late nineteenth century, given that those who purchased from and worked for these businesses benefitted enormously from the economies of scale being realized? There was, is, and always will be demand for government to provide benefits in any number of ways and under any number of guises, but the supply of these benefits is always limited by constraints on government's ability to control resources. The demands may vary over time, but changes to demand cannot completely account for changes hi the size of government. Even if the emergence of big business did increase the demand for government in its wake, it did far more to augment the supply of government by making it easier, that is, less costly, for government to capture and control resources and thus spur its growth.

Vanishing Power

If business was made more vulnerable to government exploitation as its greater size increased its ability to exploit consumers, this trend are now being reversed. If big business ever had much power over consumers, that power is currently fading. Witness the financial difficulties of such Galbraithian giants as Eastern Airlines, LTV, W.T. Grant, and Sears, Roebuck & Company, the decline of the big four automakers and of U.S. Steel (or USX). Consider the downfall of "Big Blue" (IBM) whose market share has been eroded over the past decade by a horde of upstart computer firms - most notably Apple, but more recently by Dell and Gateway 2000.

With the emergence of a global economy, product markets have expanded geographically. As a result consumers are not as dependent on local suppliers as they once were. Technology furthers world-wide mobility of products and productive resources, and it multiplies opportunities for consumers in the process. While mobility of resources in the global marketplace is reducing the control business may once have had in local markets, it is also reducing government control over business. Technology has, in several key respects, made capital more mobile, making it less captive and more fugitive with respect to the taxation and regulatory efforts of government.

Consider that the mobility of much capital is inversely related to its size: the smaller the size, the more mobile it will be. Then, consider the continuing effect of technology on the size of capital. The most dramatic example of the downsizing of capital occurs in the computer field. When universities bought their first mainframe computers in the early 1960s, they would fill suites of offices and may have had a meager 8 K of memory. Today a good desktop computer can have 15,000 K (or more) of memory and tiny calculators, the size of business cards, have more memory than those big university mainframes had less than thirty years ago. When new data storage devices, called "flash cards," start replacing hard disk drives in 1993, "notebook computers" may have to be renamed because they may then be no larger and weigh no more than two or three legal pads.

With the miniaturization of computers has come the downsizing of other types of capital. In textile production, airjet looms have replaced flying-shuttle looms with the result that twice the amount of fabric can be produced in one-third the space. Metal-producing plants used to require large numbers of workers and long production runs in order to achieve a maximum efficiency that is now realized with six machines and six people. In addition, the floor space for some "flexible manufacturing systems" has been reduced by more than half. Even the need for inventory and storage space has diminished as "just-in-time" delivery, made possible by better communications and more flexible production techniques, is becoming the norm.

Technological advances not only allow production to take place within less space, they allow production to take place on a smaller scale. Realizing economies of scale used to require massive runs of identical, or nearly identical, products. This is no longer the case. McGraw-Hill Book Company, for example, can justify printing individualized texts for classes with as few as ten students by making use of advances in computerized printing. A Texas computer manufacturer, whose slogan is "Mass Production in Runs of One" allows customers to phone in orders for computers with detailed specifications that are transmitted immediately to the assembly line.

With less space required for production, and economies of scale diminishing, the efficiency of small firms increases relative to that of larger firms. Greater relative efficiency of smaller firms also reflects improvements in transportation and communication that reduce the advantage of bringing large numbers of workers together under one roof. A company may now consist of many small plants, scattered around the globe, operating with the same degree of productive coordination and efficiency that, in the past, required the close proximity of people and equipment. More and more firms are turning to "outsourcing" products and services that were once supplied "in-house" as an efficient practice. According to a 1988 survey conducted by the American Electronics Association, 41 percent of corporate planners surveyed intended to increase their outsourcing. Technology creates more opportunities for individuals to operate independently out of their home and provide services to larger companies who, in the past, would have had to employ them directly to fully utilize their talents.

As a result businesses are becoming smaller, less dependent on location and proximity to population and industrial centers. Operations, entirely or in part, can be shifted to locations worldwide. Indeed, it is becoming difficult to identify many companies with any particular country. Major portions of the operations of many companies that were traditionally thought of as American are now located in other countries, where their employees are overwhelmingly non-American. Many companies traditionally identified with other countries now have extensive operations in the United States and employ large numbers of Americans.

Technology creates opportunities for individuals to operate businesses out of their homes.

Technology is also changing the mobility and diffusion of capital by changing its very nature. Increasingly, it is information, knowledge, and creativity that are the most important components of capital in the productive process. One measure of the increasing importance of the capital, commonly referred to as human capital, is the increasing premium being paid to more educated workers. Knowledge is not only the major productive input in many firms, it is often the primary output as well. As George Gilder has stated, "The displacement of materials with ideas is the essence of all real economic progress."

Few things are as elusive and less subject to control by taxing and regulating authorities as ideas and knowledge. Information, knowledge, and ideas can be moved around the globe literally at the speed of electrical impulses, which means, compared to physical capital like plant and equipment, which are fixed in place, the new forms of capital can escape taxation and regulation with relative ease by going to other hospitable climes. Attempts by government authorities to tax, control, and manipulate the creative process, which is the source of all knowledge and ideas hamper this process and diminish the productivity on which the tax base ultimately depends.

Consequently, the ability of government to impose tax and regulatory burdens on business diminishes also. Business is becoming a more productive source of wealth and a less productive source of government revenue and power. Global competitive pressures are forcing business to be more responsive to the demands of consumers. It also forces government to avoid policies that make it difficult for business to provide quality products at low prices.

Governments around the globe are increasing competition with each other.

As never before, governments have to worry that their taxation and regulation will force domestic businesses to move all, or part, of their productive activity off-shore, reducing the domestic tax base in the process. Global competitive pressures on businesses also mean global competitive pressures on governments. Governments are increasingly engaged in competition with other governments around the globe. Competition favors countries whose governments do the most to enhance, rather than exploit, the productivity of the private sector.

Consider the corporate income tax of 1909 and the rapid growth of federal revenue raised by this tax in the 1920s. But as big business became less captive and more fugitive as the century wore on, the federal government found itself less able to rely on the corporate income tax. Since 1928, when 46.6 percent of the internal revenue collected by the federal government came from the corporate income tax, this tax has become less and less important as a source of federal revenue. In 1950 the corporate income tax generated 27.9 percent of the internal revenue of the federal government, 24.2 percent in 1960, 17.9 percent in 1970,12.5 percent in 1980, and 10 percent in 1989.

Of course, federal spending as a percentage of GNP grew during most of this period, and the reduction in the share of revenue obtained from the more mobile component of the tax base (business capital) was shifted to a less mobile component (earned income). The 33.7 percent share of total federal revenue generated by the personal income tax in 1930 increased to 44.0 percent in 1950, to 49.0 percent in 1960, and to 53.0 percent in 1970. However, even if no worker is driven out of the United States because of high income taxes, these taxes still have adverse effects on the productivity of labor and increase the cost of doing business in the United States, and so personal income taxes are not immune to the competitive pressures on government policy. In 1980 the share of federal revenue generated by the personal income tax had declined to 47.2 percent; in 1985 it had declined to 45.6 percent; and in 1988 it had declined to 44.1 percent.

Not all sources of government revenue can decline as a share of total revenue, of course, no matter how much the competitive pressure on government While corporate and personal income taxes were yielding less in percentage terms, government came to rely more on deficit financing. During the decade of the 1960s, the federal budget deficit, as a share of federal tax revenue, averaged 5.2 percent. This percentage increased to 12.4 during the decade of the 1970s. By 1983, the budget deficit as a share of federal tax revenue reached 34.6 percent, settled to slightly over 30 percent for 1984, 1985, and 1986, and was 21.3 percent in 1988. Beginning in the late 1960s, continuing through the 1970s, and becoming even more pronounced in the 1980s, the federal government substituted the disguised and deferred taxation of deficits for direct taxation as a means of financing its expenditures. Not only has increased competition put pressure on governments to keep taxes down, it also created pressure to reduce the distortions caused by taxes. This is consistent with the move toward lower marginal tax rates on income during the 1980s, with the tax cuts of 1981, and the tax reform of 1986.

The competitive pressures that influence U.S. fiscal policy necessarily influence fiscal policies in other countries as well. Indeed, tax reform has been a worldwide phenomenon. In almost all major industrialized countries, and in many countries whose economies are best described as emerging, the marginal tax rates on income have been reduced significantly. World-wide tax reform has been associated with yet another worldwide fiscal phenomenon: increasing constraints on the growth of government spending. After a period of rapid growth in government spending, as a percentage of GNP during the 1960s and 1970s, the relative size of governments around the world began to stabilize, and in some cases actually began to decline slightly.

There were exceptions to this trend (most notably France and Italy), but it is sufficiently widespread to suggest that some common force, such as global competition between governments, is at work.

Competitive Deregulation

Through regulation, governments can exercise power and exert control over resources without taxing and spending. Even in the areas of regulation, however, evidence suggests that government power has peaked and is declining. It is well known that reduction in the regulation of business was a prime objective of the Reagan administration, and many believe this indicates that deregulation is nothing more than an ideologically motivated phenomenon which will not long outlast the Reagan era. Certainly there are pressures to re-regulate, but this will always be the case. No matter how much regulation is in place, there are always economic and ideological interests to be served by more regulation. But the view that deregulation is little more than a temporary outgrowth of the Reagan years overlooks two important considerations.

First, it is important to recognize that the move toward deregulation in the United States received its initial momentum under the Democratic administration of Jimmy Carter, with crucial leadership provided in the Senate by Edward Kennedy. It was Carter and Kennedy, not Reagan, who pushed successfully for deregulation of the airline industry and who began the push for less regulation of the railroad, trucking, financial services, and pharmaceutical industries, efforts that initiated the ongoing deregulation movement in the United States.

Granted, formal congressional efforts to deregulate other industries was slowed, if not halted altogether, in the late 1980s. By expanding government's efforts to regulate plant closings, the environment, and the hiring of the disabled, Congress has of late demonstrated a penchant for reversing the deregulatory gains of the 1970s and 1980s. However, more than anything else, Washington-based politicians are governing by pretense, or the appearance of extended control. While the federal government has continued to spend more real dollars and employed more people in its regulatory efforts, its expenditures and employment figures have not kept pace with the growth in the national economy. Hence, the federal government has been forced to stretch more thinly its regulatory resources over the economy which it is supposed to regulate more carefully, but seems unable to do.

The extent to which Congress appears to be governing by pretense can be most dramatically seen in the absolute decline of the workforce of important regulatory departments and agencies. From 1982 to 1988, the number of inspectors at the Food and Drug Administration contracted by 40 percent, from 33,000 to under 20,000. In spite of a population that is aging and is more concerned than ever with the quality of food, the workforce at the Social Security Administration fell by 21 percent, from 80,000 to 63,000, while the number of meat inspectors at the Agriculture Department dropped by 15 percent, from 8,400 to 7,100.

World-wide, the movement is toward less government involvement in business.

Moreover, between 1980 and 1988, employment at the Housing and Urban Development Department dropped 24 percent. Employment at the Department of Education went down 38 percent; Labor, down 22 percent; Agriculture, down 7 percent; Commerce (excluding the Census Bureau), down 29 percent; Energy, down 21 percent; Health and Human Services (excluding Social Security), down 24 percent; and Transportation, down 12 percent. The only departments, not associated with defense, where employment grew significantly during the 1980s were Justice (associated with the growth in crime) and Treasury (associated with expansion of tax collection by the Internal Revenue Service). This count of the government workforce does not reflect the likely "brain drain," spurred by the fact that government service no longer has the romantic aura it had in the 1960s. Most federal workers face the daunting task of coping with a flow of new laws and demands endemic to a larger economy - with, relatively speaking, fewer resources.

Second, deregulation is a worldwide movement which is altering the economic landscape in countries with widely different economic traditions. In country after country around the world, the movement is toward less government involvement hi the economy, and the pressure is not coming solely from those traditionally in favor of limited government.

According to political scientist Seymour Martin Lipset, "[D]uring the last decade, almost all overseas parties of the Left have explicitly reversed their traditional advocacy of state ownership and domination of the economy. Today these parties openly espouse the virtues of the market economy, of tax reduction, even of monetarism and deregulation." Lipset continues by examining this tendency to downsize the role of government in such countries as Australia, New Zealand, Greece, Italy, Portugal, Spain, Argentina, Chile, Mexico, Bolivia, France, Germany, Austria, Sweden, Britain, Japan, Israel, and others.

Only the most incredulous can believe that the widespread move toward a less active economic role for government is the coincidental outcome of isolated political activity. Some common influence is clearly at work, reversing longstanding political and economic trends on a global scale. One such common influence, and an important one, is the intensifying competitive pressure on government to implement policies that promote economic efficiency and to jettison those that do not. Much government regulation of business has been of the latter type, doing little to protect the consumer and much to protect politically influential businesses against the discipline of market competition.

Countervailing Impotence

Assuming that big business once exercised significant power over consumers and workers, this power has diminished, and continues to do so, in the face of global resource mobility and the global competition that results. But die same global competition that is undermining the power of big business is also undermining the power of government. As business has become more subject to the whims of its customers, it has become less subject to the whims of government. Reversing the Galbraithian phraseology, diminishing business power accompanied by diminishing government power can be described as a phenomenon of "countervailing impotence." A Galbraithian theory of countervailing impotence would see a responsible government doing what it should in response to changing economic needs. With business more effectively regulated by the forces of market competition, there is less need for government regulation, with government responding appropriately to this reduced need.

But surely the power relationship that existed between big business and big government had much less to do with "countervailing power" than it did with cooperating power. As business units grew in size and many industries became more concentrated, business not only became a source of increased government power, government also became a source of increased business power. Despite the conventional wisdom, business never had much power over the consumer by virtue of increased size alone. Competition, and the threat of competition, applied persistent pressure on businesses to pursue efficiencies and pass the benefits on to consumers in the form of better products and lower prices. It has been well documented that much, if not most, of the government regulation of business that began at the end of the past century was initiated in response to demands by the business interests, and shaped and implemented hi accordance with those interests. Not surprisingly, much regulation had far less to do with protecting consumers against the power of business than with protecting the power of business against the discipline of competition. In essence, a cooperative exchange sprang up between big government and big business. Big business aided the expansion of the role of government through the wealth it was creating. In return government used its expanded power to provide business certain privileges, of which increased protection against competition was an important one.

Because of widening global mobility of resources and capital, this pattern of cooperation between business and government is breaking down through a process of countervailing impotence. More accurately, we are witnessing the beginning of a process best described as a mutually reinforcing cycle of impotence. The globalization of economic activity that is undermining any economic power that business may have been able to exercise through unregulated markets is also undermining the power of government to protect business with regulation. How can government protect domestic firms against competition in a world where it is no longer clear-cut which firms are domestic and which are foreign? With less protection from government, businesses will become increasingly integrated into the global economy and will be subjected even more to the competitive demands of that economy. The result is further erosion in the market power of big business and further limitations on the power of government to arrest that erosion.