Industrial policy was once so out of fashion that it was jokingly called “the policy that shall not be named.” Now it’s back in a big way. On issues ranging from clean energy to semiconductors to Covid-19, governments are trying to improve the performance of key business sectors. Can they manage to do so without subverting competition and subsidizing special interests?
This article is part of ProMarket‘s series on industrial policy. Stay tuned as we publish an article each week this quarter on the topic.
Industrial policy is marketcraft. Contra economic theories of perfect competition, markets never stand outside the public realm: governments are always shaping markets and the complex web of interactions between households and businesses. This shaping can be for the benefit of shareholder primacy-oriented corporations—granting tax breaks and turning a blind eye to “externalities” that are only external when viewed from a very narrow aperture—or public policies can be crafted with a national security or public interest goal in mind.
The question at stake in 2023 is whether the market-shaping activities contained in the rollout of the Biden Administration’s signature industrial policy initiatives—the Bipartisan Infrastructure Law, the CHIPS and Science Act, and most importantly, the (poorly named) Inflation Reduction Act —will seize the opportunity at hand to proactively move U.S. corporations away from a single-minded focus on share price appreciation at the expense of real innovation and productivity gains.
Democratic policymakers have become vocal about the harms of extractive shareholder primacy over the last few years, and the Business Roundtable’s 2019 Statement on the Purpose of the Corporation was framed — by the Roundtable itself — as a move away from shareholder primacy and towards a commitment to all stakeholders. However, immense pressures from financial institutions keep the corporate governance of shareholder primacy in place, such that, for example, companies across sectors with equity traded on open markets spent $6.3 trillion on stock buybacks in the 2010s.
The Biden Administration has been clear that the last forty years of shareholder primacy did not work for the American middle class or for U.S. competitiveness. They have also recognized that stated corporate commitments to “stakeholderism” are not sufficient to ensure that the immense flows of public money going to these firms create widely-shared economic prosperity. Their industrial policymaking has put some guardrails in place such that the public investments create real-world productivity gains, as in the CHIPS Act’s limitations on extractive shareholder payments. It will be in the rollout of the IRA where the real marketcraft will occur over the next year, and where the Administration has a chance to make a real shift in how corporations exercise their productive purpose.
The Commerce Department has been clear from the passage of the CHIPS and Science Act that “CHIPS funds should not create windfalls for the companies that receive them.” The semiconductor industry is a primary example of a sector that focused on shareholder payments to the exclusion of investing in innovation. The largest semiconductor companies—Intel, IBM, Qualcomm, Texas Instruments and Broadcom — spent 71 percent of their net income on stock buybacks alone from 2011-2020, totaling $249 billion—nearly $200 billion more than the federal subsidies proposed in the CHIPS Act. Intel, once the leader in semiconductor production, spent 100 percent of its net income on shareholder payments from 2011-2015, which, as Bill Lazonick and Matt Hopkins put it, resulted in “Intel’s failure in organizational learning (that) lies in the financialized character of strategic control within the company.” Intel CEO Bob Swan, who led the company from 2016-2021, raised buybacks 186 percent as compared to his predecessor. However, in a sign of a reorientation towards productive investment inside the business community, Intel’s current CEO Pat Gelsinger declared upon taking over that “we will not be anywhere near as focused on buybacks going forward as we have in the past.”
The $52 billion of CHIPS Act funds themselves cannot be used for stock buybacks, but money is fungible. That means the details of the conditions put in place are important: The CHIPS Program Office is currently in the weeds of the rulemaking process, in which the law’s intention to “preference companies which commit not to engage in stock buybacks with non-CHIPS funds” must be translated into specific and actionable rules.
The Office’s October 2022 Request for Information asked for feedback on what should be the specific terms of commitments by CHIPS grantees to not engage in stock buybacks. In my Comment Letter, I recommended preferences for companies that restrict buybacks for a ten-year period, as innovation is a long-term and risky process with no certainty of outcomes (I also recommend restrictions on special dividends for the same reasons). The letter of the law included ten-year restrictions on investments in China in order to meet reshoring goals of establishing a strong semiconductor industry in the United States. A ten-year limit on stock buybacks is equally necessary to resist the immense pressure coming from the financial sector for shareholder payments.
Further restrictions are necessary to make sure that the personal incentives of leading corporate decision-makers are aligned with innovation and productivity rather than personal gain. In a recent article, “Do Corporate Insiders use Stock Buybacks for Personal Gain?”, I showed that corporate insiders are able to legally take advantage of the near-total lack of regulations on open-market share repurchases and sell their own personal shareholdings to benefit from stock buyback-induced share price appreciation before such activity is disclosed to shareholders.
Industrial policymaking guidelines should put in place the kinds of common-sense restrictions on insider transactions that use stock buybacks for personal executive gain, which the Securities and Exchange Commission recognized were a problem back in the 1970s. Overall, though, the CHIPS Act implementation so far has demonstrated a tangible commitment to ensuring that public funds are used by corporations in service of real productive gains.
The Inflation Reduction Act has a much wider scope than the CHIPS Act both financially and in terms of the industries that it will affect. Interestingly, it ended up including a limit of stock buybacks through an entirely different mechanism: the last-minute inclusion of an excise tax on stock buybacks. However, as Reed Shaw, Will Dobbs-Allsopp and I discuss in a recently-published Governing for Impact Proposed Action Memorandum, “the federal agencies that will administer IRA-funded grant and loan programs possess the legal authority to establish guardrails.” In the Memo we detail opportunities for agencies like the Departments of Energy and Transportation to put necessary guardrails in place.
Ultimately, policymakers should recognize the flaws inherent in shareholder primacy as a theory of how corporations produce. Corporations are innovative because of the collective and cumulative learning that happens over time and because of the public and collective investments made in their capabilities. Shareholders mainly trade amongst themselves for companies with publicly-traded equity, which means that the money we spend purchasing shares does not go to the company itself, but to the share-seller who sells them to us. The “myth that shareholders are investors” is pervasive and is used to justify corporate governance dominated exclusively by large financial institutions. Down the road, policymakers might recognize the need to put structural reforms in place (like Senator Elizabeth Warren’s Accountable Capitalism Act).
The opportunity at hand in 2023 is to expose the fallacy of shareholder primacy. Because without guardrails, trillions of dollars spent in the name of industrial policy will miss the mark.
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