John Engler was elected the 46th governor of Michigan in 1990. He immediately launched the “Taxpayers’ Agenda,” a bold strategy to cut taxes, downsize government, create jobs, and improve Michigan’s business climate and public education. He was reelected in 1994 with 62 percent of the vote—the biggest victory for a Republican governor since 1928 and the second biggest for any governor in Michigan history. He has signed more than 100 anti-crime bills, dramatically cut property taxes, reformed state welfare programs, and won approval for one of the nation’s most ambitious charter school experiments.
Governor Engler holds degrees from Michigan State University and the Thomas M. Cooley School of Law. He served for eight years in the Michigan House of Representatives and 12 years in the Michigan Senate, where he was majority leader from 1983-1990. He and his wife, Michelle, are the proud parents of triplets.
Michigan Governor John Engler demonstrates how free market ideas can be put into practice in everyday life. And he cites his state’s remarkable turnaround from economic decline to economic growth as evidence that free market ideas work better than any others.
His remarks were delivered during the Center for Contructive Alternatives seminar, “The Future of American Business,” in March 1996 on the Hillsdale College campus.
“It’s the economy, stupid.” The slogan is as fresh today as it was during the presidential campaign four years ago that cost Republicans the White House. Why? Because, despite White House press releases to the contrary, the performance of the American economy in the 1990s continues to be of concern. The U.S. Commerce Department reports that the nation’s gross domestic product (GDP) expanded by only 2.3 percent in the first quarter of 1996. Stephen Moore of the Cato Institute observes that if the GDP sputters ahead at this pace through the year 2000—which is what most economists are forecasting—then the 1990s will go down as this century’s second poorest decade for economic growth and income growth. Only the 1930s were worse.
Further, the American middle class is feeling the pinch. According to the Bureau of Labor Statistics, real average weekly wages are 5.5 percent lower today than during the Reagan administration. As a result, many families are in debt. Spouses are entering the workforce to help make ends meet, and they raise total family income by about onethird. Yet these same families must pay almost 28 percent of their income to the federal government. In effect, mothers are having to work just to pay off Washington, D.C.
It is useful to put the burden on our families in historical perspective. Washington, D.C. has not always been so greedy. Back in 1954, the last year Republicans were in control of the White House and both houses of Congress, federal taxes amounted to less than the tithe to one’s local church—8 percent of total family income. Quite often both parents did not have to work unless they chose to do so. But that’s the point: Families were free to choose.
Given the tough going for many middle class families, our nation must ask: What is to be done? At the very least, we should take note of the ideas that do work. As National Center for Neighborhood Enterprise founder Bob Woodson says, “We must study success.” There is no better place to study success than in the states, those laboratories of democracy where ideas can be tested.
Perhaps no state in the 1990s has had more success in solving its economic woes than Michigan. The “old” Michigan of the 1970s and 1980s could have been the poster child of the “Rust Belt.” In fact, Michigan unemployment was above the national average for 192 months in a row (1978-1993). By contrast, it has been at or below the national average for the past 28 months. Now, we are being hailed as the center of the nation’s “Growth Belt.” A Wall Street Journal headline summed up the turnaround: “Go Midwest, Young Man!”
Under Republican leadership in the last five years, Michigan has made a dramatic turnaround by:
Michigan is living proof that what the liberal establishment has decreed is impossible is possible. We aren’t just talking about “supply-side theory” anymore; we are talking about “supply-side success.”
One of our most popular and innovative projects is our newly established Office of Regulatory Reform, which in its first year has cut 1,000 obsolete, burdensome, and often contradictory rules and regulations from the rollbooks of state government. By the time you read this, 1,000 more will be on the chopping block.
Of the 21 tax cuts in our first 60 months in office, the most dramatic was cutting school operating property taxes from an average 36 mills to 6 mills. This was the biggest tax cut in Michigan history, amounting to $3.6 billion. Associated with this cut is a cap that keeps assessments from rising more than the inflation rate. The effect? When I took office in 1991, our property tax burden was the third worst in the nation. Now, our property taxes are below the nation’s, and our average millage rate is the lowest it has been in three decades.
We also axed Michigan’s erstwhile “intangibles tax” because it was really a capital gains tax, and as such, it had a serious negative impact on savings, dividends, and investment. When we first proposed cutting this tax, liberals went on the attack. Across the state, slanted newspaper, magazine, and television editorials accused Michigan Republicans of trying to help the rich at the expense of the poor and the middle class. They failed to mention that one of their patron saints, President John F. Kennedy, supported tax cuts because, he said, “a rising tide lifts all boats.”
But it is reality, not rhetoric, that has proved the liberals wrong. Here is what Michigan’s real-life experience has demonstrated: When citizens pay lower taxes on dividend income, they invest more. Their investment pumps more money into the economy and spurs banks to cut interest rates, since there is more cash chasing new projects out there. When the cost of borrowing money is cheaper, manufacturers not only create more jobs and hire more workers but they can buy better equipment, which increases productivity. Greater productivity results in lower costs for consumers and higher wages for workers.
Have Michigan’s 21 tax cuts helped or hurt our economy? You be the judge:
Ever since the Reagan Revolution, liberal journalists, economists, and politicians have tried to convince Americans that tax cuts are “wacky” and doomed to failure. But in Michigan we have tried them, and we know this: Tax cuts not only work; they work wonders.
The states have been called “laboratories of democracy” for good reason. As I indicated earlier, they are the proving grounds for ideas. Compared to the federal government, they are more responsive to the electorate, more efficient when it comes to fulfilling legitimate government functions, more flexible when it comes to trying new approaches, and—let’s all cheer—more economical. But for decades now, the states have lost out to an increasingly unresponsive, inefficient, inflexible, and expensive bureaucracy in Washington, D.C. One reason is that this bureaucracy is able to confiscate more and more tax dollars to finance its power grabs.
This confiscation isn’t just about the loss of money either. It is about the loss of one of the most precious resources of all: time. Currently, the Internal Revenue Service estimates that Americans spend about 1.7 billion hours on tax-related paperwork by the time their returns are completed. Businesses spend another 3.4 billion hours. As Arizona Senator John Kyl has observed, “If that is not evidence that our tax code is one of the most inefficient and wasteful ever created, I do not know what is.”
Restoring money, time, and authority to individual citizens is called “devolution.” Its agenda is twofold: First, Congress must balance the budget and reduce taxes. Second, in welfare, Medicaid, job training, and education, Congress must free the states. It must send revenues back, hold us accountable, and judge us by one criterion—performance.
The states will do far better by their citizens than the federal government. How can I be so sure that there won’t be a “race to the bottom” once devolution is set in motion? I am sure because I have seen what has already happened in Michigan. “Exhibit A” is our state’s extraordinary progress in the area of welfare reform:
The states are also our best hope for genuine education reform—reform that is desperately needed. Each year, America spends almost $300 billion on education. A student who graduates from a Detroit public school represents an investment of $75,000—that’s how much taxpayers spend on his elementary and secondary education. Yet there is good evidence to suggest that many of our graduates are illiterate, and others can only read at a 4th-grade level. It is no wonder that today’s businesses are forced to spend an additional $30 billion—in effect, a 10 percent surcharge on what has already been spent—on remedial education for their employees.
Michigan’s answer is to improve public schools by introducing market forces that will give families more freedom of choice and inject competition into a monopolistic system. In 1993, the Michigan legislature passed one of the best charter school laws in the nation. In the last three years, more than 40 charter schools have opened their doors. As a result, our state has the third highest number of such schools in the U.S. The demand to enter these schools is proof positive of parents’ desire for more choice. The effect is already being felt. One school superintendent told me that the mere possibility of charter schools in his district was encouraging reform throughout the system.
Why is the fight for more school choice and educational quality so important? A recent University of Michigan survey shows that the Big Three will hire as many as 129,000 new workers in our state by the year 2003. They don’t need strong backs to do their jobs—they need strong academic skills. Our choice is stark: We either train young people in Michigan today or we lose jobs in Michigan tomorrow. It is that simple. We must do better and we must establish benchmarks for our neighborhood public schools in order to know what the best schools look like and how they get the job done. We must reward excellence and foster competition. And we must make sure our schools measure up to parents’ standards and traditional, time-tested values.
Above all, we must find ways for all our state governments to help strengthen our moral patrimony. Only if we are a moral people can we be a free and prosperous people. The 18th-century philosopher Adam Smith made this point forcefully in The Wealth of Nations and A Theory of Moral Sentiments. So, too, have 20th-century writers like economist Ludwig von Mises in Human Action and historian Russell Kirk in The Roots of American Order.
But the wisdom of the ages reveals that our moral compass cannot ultimately come from Lansing or from any other state capital, any more than it can come from the nation’s capital, or Hollywood, or the United Nations, or some abstract liberal conception of the “Village.” It comes from deep within us—it comes from our character, which is forged in our families and our faith and tempered in the arena of decisionmaking and action.
As chairman and chief executive officer, Charles Koch has presided over the dramatic growth of Koch Industries. Under his leadership, this energy-based firm has grown from $177 million in sales in 1966 to over $20 billion today, and it ranks as the second largest privately held company in America.
Mr. Koch is dedicated to developing market-based management, an approach that draws insight from the productivity of the free marketplace. He has helped establish centers to study market-based management at the University of Kansas and George Mason University. His commitment also carries over to his philanthropic interests, which include funding programs that apply market solutions to social problems. He was instrumental in founding the Cato Institute and Citizens for a Sound Economy. He serves as chairman of the board of the Institute for Humane Studies and the Center for Market Processes.
At the March 1996 Center for Constructive Alternatives seminar, “The Future of American Business,” Charles Koch outlined his strategy for success called Market-Based Management.™ What follows are excerpts from his remarks.
The shelves of most bookstores are crowded with best-selling business books. But business owners should not limit their reading to these. They ought to be studying the classic works of Austrian School economist Ludwig von Mises. Mises championed the principles of free enterprise, and he was one of the principal sources of the ideas that changed the course of my life and that led to the development of Market-Based Management,™ the framework that I credit with the enormous success of Koch Industries.
Market-Based Management™ is based on four main assumptions. The first assumption is that today’s world is characterized by an unprecedented rate of change—change driven by an accelerating accumulation of knowledge. The second assumption is that prospering in this environment requires a well-founded and internally consistent framework that enables us to interpret and apply new knowledge. The third assumption is that from both theory and history we know that the best framework for dealing with rapid change, especially knowledge-driven change, is one based on economic freedom. The fourth assumption is that this framework should also have five key dimensions: (1) vision, (2) values, (3) incentives, (4) decision rights, and (5) knowledge systems. Here I would like to focus on those five key dimensions:
Our vision controls the way we think and, therefore, the way we act. If we try to apply Market-Based Management™ without changing our vision and without acquiring sound economic principles, we end up doing the same old things in a different way with a different language. We change the form but not the substance. And when that happens, we don’t get results.
But when we actually change our vision, we typically get remarkable results. Major improvement or growth in any of Koch Industries’ businesses has always been preceded by a change in vision. The same is true for the vision our employees have of their jobs. An example—one repeated many times over—involves an employee whose job was operating one of the process units at a refinery. In the past, his job primarily consisted of following detailed instructions, such as: “Turn the valve when the pressure reaches a certain level.” Once the vision of his job was changed from following instructions to optimizing his unit, and he was given the information and the freedom to do it, the employee improved the performance of his unit by over 20 percent. Clearly, the vision we have of our jobs determines what we do and the opportunities we see or don’t see.
Change destroys jobs. But it also creates new ones. Candlemakers have been replaced by electricians and natural gas manufacturers. Blacksmiths have given way to automobile and airplane mechanics. And here is a more recent instance of how change can bring unexpected benefits: Employees at one Koch Industries plant thought of so many new and better ways to improve performance that we were able to cut our maintenance force by 20 percent, or about 50 employees. But we didn’t lay them off. Instead, we offered them the chance to create their own new jobs. The employees in question got together and decided to form an internal construction service group that would compete against all outside contractors. The group has been a terrific success, providing better, faster, and cheaper service. Imagine if AT&T and other American businesses that have recently resorted to massive layoffs tried this innovative, market-based approach. Who knows what new companies, products, and services they might create!
It is also possible to minimize resistance to change and greatly reduce hardship by establishing a culture based on certain core values, which is the second key dimension of Market-Based Management.™ Values, like vision, help determine behavior:
We must acknowledge our weaknesses, identify what we don’t know, and learn from others. Humility is essential to social progress since learning begins with the recognition that none of us has all the answers. Arrogance, the opposite of humility, has been one of man’s greatest stumbling blocks. As historian Daniel Boorstin notes, “The greatest obstacle to discovery is not ignorance, it is the illusion of knowledge.” Columbus’s voyages were delayed for years because those in power “knew” the earth was flat. More recently, many people “knew” that airplanes would never fly.
In business, arrogance is equally destructive. In the 1960s and 1970s, American car manufacturers “knew” what American car buyers wanted and how to make the best cars. But the Japanese had different ideas. Likewise, many oil companies in the 1970s “knew” that the price of oil was going to $100 per barrel and made huge investments relying on that certainty. As the old saying goes, it isn’t so much what we don’t know that hurts us as it is what we know that isn’t so.
Dealing honestly and honoring commitments are also prerequisites of social progress and economic prosperity. The trust that integrity creates lowers the transaction costs of human interaction and is necessary to the exchange of knowledge. We must face reality rather than delude ourselves. There are several factors that make this more difficult than it sounds. The first, as I have pointed out, is the role of vision in learning. Until we open up our vision of what is possible and how the world works, it is impossible for us to see reality and learn from it. Albert Einstein wrote: “Whether you can observe a thing depends on the theory [vision] you use”—not the other way around. Another factor is self-interest. We all tend to rationalize away unpleasant or threatening ideas and facts.
Intellectual honesty and truth are at a minimum in command systems. The rulers develop a vision that the truth is whatever they say it is; the ruled initially are afraid to speak their minds but soon accept the vision of infallibility of the rulers. The creation of knowledge grinds to a halt, and progress ceases. This is as true for command-based business organizations as for political regimes.
Truth should be what stands the test of evidence and criticism, not what authorities say is true. A discovery culture based on honesty, openness, and constructive challenge improves and expands our knowledge, thinking, and vision.
Tolerance means treating others with dignity and respect. We cannot have a civil society unless we are willing to cooperate and learn from those with different kinds of knowledge and different perspectives. For example, it is easy to dismiss folk medicine as silly superstition. But medical researchers have discovered some truth in what we tend to dismiss as “old wives’ tales.” People in Peru used to chew the bark of the cinchona tree to reduce the effects of malaria. Today, we know that this bark contains quinine, which, until fairly recently, was the standard medical treatment for malaria.
In business, tolerance allows us to learn from others and improve—to share and integrate knowledge. To be successful, a company cannot forego ideas and talent just because they are different.
Taking responsibility for our own actions—rather than blaming others or being victims— is also vital to social progress. Only if we have the self-discipline to accept responsibility for our mistakes will we learn from them.
When, in response to deteriorating business, a company blames outside forces or covers up its problems by changing its accounting methods or by using other tricks, it ensures failure. When an employee covers up or blames others for problems, both trust and knowledge are lost, and the employee fails to develop and improve.
Making a real contribution requires passion, initiative, and dedication. It also requires the discipline to profit only by economic rather than political means—that is, by the creation rather than the transfer of wealth. Economic profits are a measure of the value created in society, a sort of receipt for public service. In contrast, political profits—profits from government subsidies, restrictions on competition, or barriers to entry—are an indication of the destruction of value and of public disservice.
The same principles apply to employees as to firms. Employees must believe they have potential, that they can and want to contribute, and that they should be rewarded accordingly. They must look at their jobs not as routine tasks to endure but as opportunities to contribute, develop, and grow.
Being willing to make sacrifices or investments to build a better future is also important. In the history of this country, immigrant families have risen from poverty largely to the extent they sacrificed by working and saving to educate their children. Learning and self-development likewise involve sacrifice and require putting a higher value on the future than on the present.
The same is true for business. To last, a company must strive to add long-term value rather than going for the quick buck. This means that its behavior must be guided by the desire for continued relations with its principal constituencies— employees, customers, suppliers, stockholders, and communities. For example, at Koch Industries, we have made it a practice to reinvest 90 percent of our profits back into our companies.
Core values build trust, stimulate experimentation, and encourage the development of knowledge. They make people want to contribute. They are reinforced by hiring, training, mentoring, promotion, and compensation. Most of all, they are reinforced by strong examples. The leaders of the companies with core values tend to practice what they preach. It is hardly surprising, therefore, that a recent study found that the companies with core values grew sevenfold over an eight-year period, while those that didn’t had zero growth.
The third dimension of Market-Based Management™ is an incentive system that rewards accomplishment—a system that, just as for entrepreneurs in society, enables employees to participate in the value they create. To be effective, incentives must be based on more than employees’ contributions to current profits. They must also consider contributions to long-term success, including contributions to our culture and our communities.
As employees contribute to long-term success, they acquire “decision rights.” Decision rights, the fourth dimension of Market-Based Management,™ refers to the level of responsibility and authority employees have to allocate their firms’ resources. In the marketplace, when entrepreneurs contribute they earn profits that give them additional property rights—that is, the ability to direct more scarce resources. Market-Based Management™ attempts to duplicate this powerful market process of moving control of resources to those who successfully satisfy customer needs.
This framework provides insights that are particularly significant in a world characterized by rapid change. For instance, it has become quite common in management literature to critique topdown decisionmaking as inefficient. And, indeed, centrally-driven command and control corporations do experience the same type of problems as centrally planned economies. However, universal decentralization has its own set of problems. There is no question that a firm wants to capture the ideas and creativity of all its employees. But decisions should be made by those with the best knowledge, which will vary with the type of decision. For example, in the oil business, decisions on how to operate a pipeline to get the most “throughput” should be made locally, but decisions about how to integrate that pipeline with supply, sales, and trading need to be made by others with broader knowledge.
The fifth and final dimension of Market-Based Management™—knowledge systems—is based on a woefully under-appreciated mechanism for creating knowledge: market transactions. In a free economy, a primary function of prices and of profits and losses is to reveal what consumers value and the availability and utility of resources. Likewise, companies must have profit signals, or “discovery measures,” so that employees can see what creates value and what doesn’t. Just as for entrepreneurs in society, these will expand employees’ vision, change their thinking, and enable them to make new discoveries. And they must include contributions to the whole, not just to one part. For example, measures that track the cost of failures in reliability, including lost profit from “down time,” loss of credibility with customers, and environmental and safety problems, provide employees with a vision that is vastly superior to the typical one of controlling maintenance costs.
But, as important as knowledge systems are in bringing to bear the best knowledge, they won’t work unless decisionmakers possess core values. Modern technology transmits information with incredible speed, but that doesn’t do much good in a culture that stifles learning. Anticipating or even keeping up with rapid change requires the effective integration of knowledge, and that can only be done in an open, sharing, and adapting culture. From our efforts to apply this integrated framework at Koch, we have a new vision of employees. In this vision, employees don’t have jobs; rather, they have a set of rights, responsibilities, and rewards that enable them to best contribute.
What Market-Based Management™ is all about is helping people fulfill their potential. It is about helping everyone develop the vision, values, and desire to better their lives by making a contribution. It is about enabling people to do good by doing well.
As you might suspect, understanding and implementing Market-Based Management™ is not easy, and we at Koch Industries are far from where we want to be. In fact, I would say that we are about a “4” on a scale of 1 to 10. But even that modest progress has enabled us to grow over one hundred-fold in the last 30 years and to be growing and hiring today while many of our competitors are shrinking and laying people off.
And Market-Based Management™ is not just for large companies or even for adults. As we have learned in our work with at-risk high school students, everyone has the potential to develop and contribute. One of the students in our Young Entrepreneurs program, April Sheldon, says:
“When I was younger, I had some people tell me there were certain things I couldn’t do because I already had three strikes against me. I was black, I was female, and I didn’t have any money. I don’t believe that anymore… Now I know that I can become financially independent if I apply the entrepreneurial concepts I have learned and if I work hard.”
April’s path is open to everyone, given the right environment. We have the opportunity to help create that environment and to clear that path. I have taken this as a personal challenge and welcome those who would like to join me.
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