EDITOR’S NOTE: This essay was prepared for the Free Economic Society of Russia's 50th anniversary commemoration of the publication of The New Industrial State .
The New Industrial State was my father’s great work of theory. First published in 1967, nearly a decade after the triumph of The Affluent Society, The New Industrial State went beyond criticism of orthodox economics, beyond Marx and beyond Keynes—toward a full alternative, a complete substitute for neoclassical thought. In this book, John Kenneth Galbraith forged a vision of the business firm as an organization, and of an economics of organizations that together form the “planning system.”
The economics of organizations stands in opposition to the economics of markets. In what Galbraith called “the accepted sequence,” consumer preferences come first. Firms place their products before a discerning public, sell what they can, discount the rest, and then repair to study how it might be done better next time. In his own “revised sequence,” large firms start with the design and technology of new production. They see what is possible, they conduct “market research,” they decide what they like. They then engage their advertising and consumer-finance staffs to ensure that the result can be sold.
For Galbraith, this was reality; he did not oppose it. Complex technology dictates that markets must be controlled. The products that define modern life—automobiles, jet aircraft, electric power, microchips, and cable television—cannot be produced except over long lead times and by the integration of vast networks of engineering talent. This requires planning. Sometimes the planning goes wrong, and sometimes a company must strike out into the unknown. But not often. Had Boeing doubted that the 787 Dreamliner could be sold, that airplane would not have been built.
Large business firms often replace the market altogether. They do this by integration: replacing activity previously mediated by open purchase and sale with activity either internal to the corporation, or between a large, stable enterprise and its small, specialized suppliers, to whom risk is transferred. People reduce uncertainty neither through clairvoyance (“perfect foresight”), nor by confident exploitation of probability (“portfolio diversification”). They do it by forming up into structured groups large enough to forge the future for themselves. In politics these are countries and parties; in economics, corporations.
Once control passes to the organization, Galbraith wrote, it passes completely; the economics developed to describe the small firm and its owner-entrepreneur becomes obsolete. That form of economics celebrates the rational act of maximization, which consists of finding the shortest path to a given destination. But organizations do not have destinations. They have members, participants, stakeholders, all with a diversity of talents, interests, and purposes. Decisions are made by committees; the leadership of those on top is circumscribed by the need to get the underlings to go along. Individuals, the very focal point of traditional economics, no longer matter very much. Power in the firm belongs to what Galbraith called the “technostructure.”
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Like all human entities, the technostructure works mainly for itself. All members of a committee can (usually) agree on the primacy of organizational survival, the need to keep the enterprise operating as a going concern. Beyond that, many things are possible; in general, the minimal conditions of every critical interest must be satisfied, which means that the maximal interests of none will be achieved. Organization is a matter of compromise; who is served depends on who is at the table.
The technostructure does not maximize profits merely to pass them along to the corporation’s legal owners, those who hold its shares. They are not at the table; their claims are therefore not likely to be heard. To think otherwise, Galbraith wrote, “one must imagine that a man of vigorous, lusty and reassuringly heterosexual inclination eschews the lovely and available women by whom he is intimately surrounded in order to maximize the opportunities of other men whose existence he knows of only by hearsay.” Years later, when mainstream economists began to pay attention to this issue, they called it the “principal-agent problem.”
Organizations are dynamic, both internally and externally. Much of The New Industrial State is taken up with descriptions of how corporations form, how they develop and hold the loyalty of their staffs, how they plan, and how they coordinate and compete with their rivals. They do this in the first instance by coordinating prices. My father first rose to fame as a price-fixer for the American government during World War II, and he understood a great truth regarding prices: it is easy to fix them when they are already fixed.
Where products are standard and pricing open, oligopoly fixes them with ease; sometimes price wars break out, but they can be ruinous and so they are rare. Occasionally, the technical diversity and complexity of products makes fixing prices harder, and it is only here that we observe violations of law. He described this process in The New Industrial State:
Thus in the early nineteen-sixties, General Electric, Westinghouse, Allis-Chalmers, Ingersoll-Rand and other manufacturers of electrical equipment were prosecuted for conspiring to fix the prices of heavy electrical apparatus. A number of senior executives in several of these companies were lodged very briefly in the common jail, a fate from which, quite correctly in light of all experience, such executives, whatever their breach of law, are believed to be immune…. The error of the executives was not in fixing prices but in being engaged in a branch of the business where price-fixing involved such exceptional difficulty. Prices were equally regulated for electric motor or household appliances but there it could be done without collusion.
The reach of the planning system and the technostructure extends far beyond the fairly simple matter of pricing. With considerable though imperfect success, firms manage the “specific demand” for the products they design and sell. (Economists devoted to consumer sovereignty were shocked by this suggestion, but Galbraith took a tolerant view. Where people are affluent and the goods unimportant, manipulation of tastes is not the gravest social ill.) In dealing with the state, especially in the matter of advanced weapons, the technostructure finds an ideal relationship: a stable customer, long horizons, protection against loss. More broadly, the planning system forges political consensus around the holy objective of economic growth: steady expansion in total demand implies positive profits and therefore stable growth for business firms. Growth serves the organization first; its other clienteles come after that.
The planning system gives us our peculiar devotion to modern higher education, with the emphasis on generalized business arts, and the devaluation of higher technical skills (science, mathematics, engineering) as well as of older talents such as design, music, draftsmanship, and the fine arts. These we import. As Galbraith explained, the technostructure does not generally need craftsmen. It needs flexible young men and women willing to be molded to the goals and mores of the organization, and to do whatever it may ask. Here the corporation resembles the foreign service, or the army, and not at all the medieval guild. Contrary to a common theme in recent labor economics, education does not impart skill; it imparts acceptability.
Galbraith admired Karl Marx, but his work supersedes many Marxian doctrines. Where affluence prevails, class conflict is bound to diminish. Where planning succeeds, even ordinary workers come to identify with the goals of the firm; unions then lose their vanguard status. All this points toward a need for new forms of dissent, focused on the problem of social balance—private affluence and public squalor—as well as related environmental, aesthetic, and cultural concerns. It is possible that in their desires for accessible education, decent health care, and reliable jobs, working people in the wealthy countries around the world are often more Galbraithian than those who claim to speak for them.
John Maynard Keynes believed in the management of aggregate demand in order to produce full employment. But once full employment was achieved, he thought the classical economics of the free market system might come into its own. Galbraith entertained no such illusion. The difference owed much to the fact that, although Keynes mostly ignored technological change, Galbraith (who had seen more of it) understood something of its nature. Galbraith therefore realized that in some form the planning system was a permanent feature of the scene. In this respect, Galbraith broke with orthodoxy more deeply than Keynes did.
When The New Industrial State appeared, American Keynesianism was in its glory days; the years of decline still lay ahead. And yet Galbraith saw that Keynes’s doctrines had been distorted by his followers. The planning system had absorbed Keynes, adapting demand management to its own purposes. As already noted, economic growth instead of full employment had become the paramount policy objective. Fluctuations in growth would receive immediate public policy attention; increases in unemployment would not, unless they threatened the political stability of the system. The planning system contrived to favor rapid enough growth to assure stability for its constituent firms, yet not so rapid that it would restore the power or perhaps the lost militancy of the unions. Growth generated by tax cuts might therefore lead toward full employment, but it might never get there.
Fifty years later, the main charge against The New Industrial State is that it did not anticipate the thrashing that American business has received in the decades since 1970. This came in four phases. First, there was the Japanese challenge, especially in automobiles and steel. Then came the industrial collapse of the 1980s. In the 1990s, there was the technology bubble, which (it is said) reasserted the controlling role of the owner-capitalist, personified by Bill Gates and Steve Jobs. Finally, there came the corporate scandals, involving Enron, Tyco, and WorldCom, among other corporate giants.
That a book failed to foresee the future is an easy criticism to level; Marx is often denied his greatness for believing that proletarian revolution would triumph everywhere, when it obviously has not. Galbraith wrote of the American corporation at the pinnacle of its power, while his critics pretended that corporate power didn’t exist. Then they pilloried him for failing to predict the decline of particular firms—the decline somehow proving, in the peculiar logic of the critics, that the power had never actually existed. For his part, my father moved on, did not reply vigorously, and The New Industrial State faded from view. This was a shame, for although the lights of his book were trained on the planning system as it then existed, they still illuminate beautifully more recent transformations, crises, and decline.
The Japanese challenge of the late 1970s did not prove that competitive markets rule. It resulted, rather, from the intrusion of one planning system onto the turf of another. Did the Japanese have a planning system? Of course they did: one that combined that country’s traditional alliance of government and keiretsu (corporate networks) within a system, established by the American occupation, in which Galbraith himself had played an early role. The Japanese planning system grew over the decades to follow, until it was strong enough to challenge American producers on their home turf.
And how did Americans meet that challenge? It was done politically, with “voluntary export restraints” administered—ironically enough—by Ronald Reagan’s self-described free-marketeers. One has to give Reagan’s people credit. Rather than open America to the free market, which would have been catastrophic for American business, they cut the Japanese into a new bargain, permitting them to increase their market share and to upgrade their products over time. The result was a managed defeat for the American firms, which was bad, but far better than an unmanaged one would have been. That disaster came later, with the “free-trade” agreements inaugurated with NAFTA under Bill Clinton and pushed, assiduously until the end, by Barack Obama.
It is true that The New Industrial State didn’t anticipate the broader industrial crisis of the early 1980s. As late as the third edition of 1978, Galbraith argued that the traditional powers of the financial sector to ration capital, and therefore to decide who lives and who dies in industry and trade, were in eclipse. He made this argument because it was true at the time. That the forces of high finance were preparing a massive counterattack did not become clear to anyone—not even to most bankers, so far as we know—until a year later, when Paul A. Volcker ascended to the chairmanship of the Federal Reserve. And Volcker did not launch his Armageddon of sustained 20 percent interest rates until after Ronald Reagan took office in 1981.
Reagan and Volcker set out to restore the world that existed before the New Deal—before the unions, before countervailing power, and above all before the planning system. Markets, and specifically capital markets, would be made to rule. High interest rates would sort the adept from the inadequate business firm. Bankers would lend to the best, squeeze the rest, and force the survivors to higher standards of productivity. Galbraith thought this utterly Quixotic. The bankers were powerful but they were not fit to govern. Far from being a blown-up version of the avuncular small-town specialist in local business acumen, the modern banker bestrode the corporate and the political worlds without understanding much of either. In particular, he could not understand much of the technical work at the heart of the major corporation, and therefore he could not exercise practical control over strategy or performance. The banker’s power was mainly of a destructive kind: he could squeeze business or he could wreck business, but there was no magic whereby from the rubble a better business would emerge. In the collapse of socialism a few years later, the peoples of the Soviet Union learned a similar lesson. Markets construct nothing by spontaneous generation.
With real interest rates higher than any conceivable rate of economic growth, normal business operations could not adequately service debts. And so, quite predictably, the rules of corporate financial governance broke down. It is a basic proposition in human psychology that when impossible conditions are imposed with no means of verification, people will cheat. Firms would cook their books and would then be rewarded—and certainly not punished—by the markets, not only enhancing their position but undermining that of any honest competition. Only later would the deceptions be discovered. It should have been easy to predict that the age of high interest rates would end in corporate and banking disaster. Galbraith did predict this, when in the early 1980s the policies took shape; the only failing of The New Industrial State a few years earlier was its optimistic confidence that no government would be crazy enough, or atavistic enough, to raise interest rates that high.
The Reagan-Volcker methods produced a debt crisis that reverberated around the world for two decades, with harsh effects on Latin America, Africa, Eurasia, and ultimately the Far East, along with a deindustrialization of the American heartland. Much of the planning system as it had existed through 1980 succumbed. But not all. What emerged afterward, when the economy finally recovered in the 1990s, was as much a planning system, as much controlled by its technostructure, as before.
The 1980s weakened the large industrial firm and made it clear that, for some people at least, brighter futures could be had outside industry. Finance beckoned the rapacious. A bit later technology called to those with exceptional imagination, scientific talent, mechanical wizardry, or the skills to persuade venture finance that one possessed these traits. Those parts of the technostructure associated especially with electronic computing broke away from the big industrial firm. Unlike, say, wind tunnels, microprocessors and software have applications across many fields. Their potential was greater if production was not tied to any particular platform, such as IBM’s mainframe computer division. And their profitability would be much higher if they could be freed of debts, pensions, and the like built up by the large corporations in the days when unions were strong and capital was cheap.
Thus the technology boom: a surge of new, venture-financed firms serving the worldwide market for silicon chips and software. And with that boom there came a new attack on Galbraith’s vision of technological change. Was it really a matter of engineers and organization men? Wasn’t there now a new breed of that oldest and most celebrated economic archetype—the ruggedly independent entrepreneur? In other words, what about Bill Gates?
There is, however, a Galbraithian explanation for Bill Gates. Microsoft needed marketing. It needed “cool.” The image of the young geek-genius served the purposes of the organization. The superstar myth helped to prettify a firm whose success rested at first on an exclusive franchise (with IBM, for whose early PCs Microsoft supplied the operating system), on patent protections, and later partly on much-questioned manipulations of market power. Later on, Gates’s personal wealth came to exemplify Microsoft’s power; later still, his foundation helped soften and revive his reputation with good works around the world. Each of these had, and has, its business uses. For Microsoft, the CEO was always the chief businessman and never the scientific leader; the technical products of the corporation were always the work of large and awkward committees—and it showed.
In this way, the technostructure evolved. The new economy had a different shape and a different balance of power, with a renewed role for the investment banker and the financial raider, and therefore less stability than had been true in the 1960s. And it was centered in other parts of the United States, which ultimately became a country of bi-coastal prosperity, dominated by its financial and engineering elites, while the vast industrial regions decayed and were opened to forms of corporate predation not unfamiliar in the post-Soviet lands. In this way, over decades, the groundwork was laid for Donald Trump.
Though Galbraith did not expect the modern corporation to be as vulnerable to looting as it has proved, The New Industrial State foresaw the possibility. While reputable economists blamed the savings-and-loan crisis on deposit insurance (“moral hazard,” or when the presence of insurance allegedly fosters risky behavior), for Galbraith the failures lay in the subversion of social and legal norms. As William K. Black, our leading expert on “control fraud,” argues, one can either believe that Enron was the innocent product of a badly-made market, or one can believe the market was suborned with criminal intent. Enron was a complex organization, and it was precisely that complexity, intrinsic to the technostructure, which made it possible to conceal or obscure the frauds. Yet in the final analysis, prosecutors, juries, and Galbraithians have no difficulty passing judgment. More than one thousand felony convictions followed the savings-and-loan fiasco; after Enron collapsed, the top executives were eventually indicted and convicted. Alas, following an even larger wave of financial frauds in the run-up to the financial crisis of 2007-2009, the government took a more lenient view. They tried and convicted no one, and, as a result, confidence in the financial system was never restored.
Why did the government, in this instance, fail to govern? One may argue that in the new millennium, the model of the large corporation passed into the government, and that we in the United States came to live in a “corporate republic,” where the methods, norms, and culture of government have become those of the corporation:
- In a government by committees, many of them operating in secret, we have the client-driven character of decision making, which can lead to a capture of strategic direction—in national security, finance, regulation, and other areas—by cliques claiming authority and shouldering outsiders out of the way.
- We have the public relations apparatus with the distinct characteristic of a corporate propaganda machine, namely, an inability or studied unwillingness to tell a truthful story that is consistent from one day to the next.
- We have the board of directors, uninformed and accommodating, a rubber stamp—the modern Congress.
- We have the shareholders, also called voters, nominal owners and participants in occasional elections, which the management usually arranges not to lose.
All of these characteristics have analogs in the corporation of The New Industrial State.
There are variations, of course. The “corporate cool” of the Bush-Cheney government came to a spectacular end in the financial collapse. It was succeeded by a more traditional administrative state under Barack Obama, lasting eight years, a government-by-technostructure, and specifically by the new stars in the technostructural sphere: in economics the key roles were taken largely by bank-friendly economists and by lawyers for bankers. This drew the relentless ire of other corporate interests no matter how much they were appeased and accommodated on every matter of practical policy. And in the end, the financial and professional elites came to be seen by the broad public as governing in nobody’s interest save their own.
In the end, in a dramatic development, resentment morphed into a popular revolt against the professionals, and in an electoral contest pitting one against the other, politico-bureaucratic rule was overthrown. It has been succeeded, as of early 2017, by direct rule of the great American oligarchs, a cabinet of billionaires interspersed with generals and led by a businessman of the old school, specialist in casinos and hotels, a one-man brand, the opposite of an “organization man.” Galbraith would have doubted that the new breed will prove especially well-suited to their tasks. And therefore in due course real power, under Trump, will come to be exercised by those in lower-ranking positions, provided they are drawn, as they may or may not be, from a technostructure of their own sort. Otherwise, the entire structure of government may eventually crumble, leaving the United States in a position not altogether different from that of the Soviet Union in its final years—that is, with a governmental apparatus whose costs so far exceed the benefits that it becomes impossible to defend.
The Galbraith paradox is that the great theorist of organizations worked alone: he was an intellectual entrepreneur. Meanwhile, the academic phalanx that scorned his ideas was comprised of organization men, conformist in their views, careful tenders of their academic franchise. Few of them will be remembered as individuals; yet their hold on reputable thought remains absolute. Galbraith’s heresies triumphed in the open market; within the university they were repressed by close analogs of modern corporate public relations.
Galbraith foresaw this. “The captious,” he wrote, “would be critical of any description of the social geography of the United States, which, by assuming away New York, Chicago, Los Angeles and all other communities larger than Cedar Rapids, was then able to describe the country as essentially a small-town, front-porch community.” But that’s how undergraduates in economics are still largely taught. They imagine that if they stick with the subject, then sometime in graduate school they will at last get to study the world of big firms and complex organizations. The few who make it that far are eventually disillusioned.
The New Industrial State is not a perfect book. It is largely a book about the United States and the American corporation in the postwar era; the complexities of advanced capitalism in Asia, the confederal capitalism of Europe, and the post-Communist firms of Russia had not yet emerged. It is a bit harder to read, and somewhat less entertaining, than his other work. I find in it a few orthodoxies from which I wish he had escaped—such as on the limits placed by saving on investment in poor countries, something which tends to excuse the failures of India and is radically contradicted by the example of China.
And yet The New Industrial State is a landmark. In it the organization replaces the market, not merely in the world around us, but in the subtle processes of apprehension and understanding. Among economists it is an ill-kept secret that in the fifty years since this book appeared in 1967, the robust faith that once surrounded the concept of the free market as an organizing principle has collapsed. Yet nothing much has emerged to replace it. The New Industrial State remains the doorway through which economics must pass before progress starts up again.