Federal support for energy in FY 2010 alone includes the following activities:

Direct Expenditures to Producers or Consumers – $14.3 billion. Federal programs involving direct cash outlays that provide a financial benefit to producers or consumers of energy.

Tax Expenditures – $16.3 billion. Provisions in the federal tax code that reduce the tax liability of firms or individuals who take specified actions that affect energy production, consumption, or conservation.

Research and Development (R&D) – $4.4 billion. Federal expenditures aimed at a variety of goals, such as increasing U.S. energy supplies or improving the efficiency of various energy consumption, production, transformation, and end-use technologies.

Loans and Loan Guarantees – $1.6 billion. Federal financial support for certain energy technologies.  .  .  [in particular] innovative clean energy technologies. ¹

Electricity programs serving targeted categories of electricity consumers in several geographic regions of the country – $0.6 billion. Theses are primarily activities of the Tennessee Valley Authority (TVA) and the Power Marketing Administrations (PMAs), which include the Bonneville Power Administration (BPA) and three smaller PMAs.

Of this total of over $37 billion, about $21 billion went to energy production, the remaining $16 billion was spent on electricity transmission & distribution, conservation and efficiency and automobile programs.  This paper focuses on federal subsidies to energy production.

False Administration Propaganda on Energy Subsidies

To listen to the current administration, and its renewable energy cheerleaders, one would think that the oil and gas industries were basking in federal largesse, unable to operate even minimally without the kind hand of the federal government.  Renewable sources of energy, on the other hand, are starved of resources, and, therefore, unable to complete with the “subsidized” conventional energy sources. 

The facts do not support this view.  Fully two thirds of federal production-related expenditures in FY 2010 went to non-hydro renewables – biomass, wind, solar, and geothermal.

Most of the federal money went to direct expenditures ($4.7 billion) and tax “expenditures” ($11.2 billion) – 61% of total production-related expenditures.  In the dreaded tax “expenditure” category, that sink of favoritism and corruption purportedly benefiting only the oil and gas plutocrats, the largest recipient of federal favors was (drum roll, please) biomass (ethanol and “biofuels”), with 56% of total “expenditures” ($6.8 billion).  Throw in another $1.4 billion for wind and solar and the share of renewables comes to just over 66%, roughly two thirds of the total.  Oil, gas and coal together took just over 26% of these tax “expenditures.”

Direct expenditures, monies that the federal government pays to producers, are tilted even more heavily toward renewables.  Oil, gas and coal take less than 1% of production-related direct expenditures of $4.7 billion.  Wind was responsible for fully 76% of direct expenditures ($3.56 billion), and solar got another $496 million, or 10.6% of this category.

Bad News Energy – Federal ’Dry Holes’

Federal government subsidies for energy production in FY 2010, at about $37 billion, were roughly twice as high as in FY 2007, and about four times the FY 1999 level.  Added to the overall increase in subsidies is the reduced productivity of such expenditures.  In 2007 each million BTU of wind energy converted to electricity cost the taxpayers $6.85 ($23.37/MWh).  By FY 2010 subsidies for wind had increased so much that the federal outlay per million BTU of output had risen to $15.44 ($53/MWh).  For solar the trends are even more alarming (unless you are a solar energy company).  In 2007 each million BTU of energy from solar cost taxpayers about $7.13.  By 2010 the taxpayers were supporting solar energy to the tune of $274 per million BTU (Solyndra, anyone?).  As a baseline the market price for natural gas at the Henry Hub hovers around $4/million BTU while crude oil costs about $15/million BTU from OPEC and domestic sources.

Subsidies for Energy Production in FY 2010

As the table indicates, the unit subsidies for oil, gas and coal are negligible relative to production, less than 10¢ per million BTU.  Even nuclear is hardly subsidized compared to renewables.  For non-hydro renewables in general subsidies cost the public almost $3 for every million BTU produced.  Comparing expenditures and production by energy source the 2010 figures look like this:

As shares of total energy output or subsidy expenditure the figure shows that most of the money goes to relatively insignificant energy producers and most of the energy production comes from unsubsidized sources.  Hmmm, is there a message is there somewhere?

Now for the Good News

Some forms of energy received less money from the federal government in 2011 than they did in 2007.  Support for coal use and transformation dropped by more than 60%, from $3.3 billion to $1.36 billion.  Support for oil and gas has hardly risen in real terms since 1999. 

Nuclear energy-related expenditures have increased by only $1 billion since FY 2007.

Where Does the Money Go?

According to a recent article in the New York Times, many of the recipients of federal renewable energy subsidies can be found among the largest banks, investment houses and industrial companies in the country.  As the article notes, “When the Obama administration and Congress expanded the clean-energy incentives in 2009, a gold-rush mentality took over.”

“The beneficiaries include financial firms like Goldman Sachs and Morgan Stanley, conglomerates like General Electric, utilities like Exelon and NRG — even Google.

A great deal of attention has been focused on Solyndra, a start-up that received $528 million in federal loans to develop cutting-edge solar technology before it went bankrupt, but nearly 90 percent of the $16 billion in clean-energy loans guaranteed by the federal government since 2009 went to subsidize these lower-risk power plants, which in many cases were backed by big companies with vast resources.”

In words reminiscent of Citicorp’s Charles “when the music is playing you gotta get up and dance” Prince, Excelon’s CEO, David W. Crane, told Wall Street analysts early this year the government’s largess was a once-in-a-generation opportunity.  Government loan guarantees secured $5.2 billion for four large solar projects by Excelon.  State government mandated purchase agreements anchored the income side of the transaction as well.

“I have never seen anything that I have had to do in my 20 years in the power industry that involved less risk than these projects,” he said in a recent interview. “It is just filling the desert with panels.”

Political Capitalism Does Not Produce Useful Energy For The US Economy

Aside from higher deficits it is hard to see what all this spending has produced for the US.

1. Are we better off as a result?  The answer would have to be no, for we have spent much more to produce energy from renewables than we needed to spend to produce higher quality energy such as natural gas.
2. Is the air cleaner on account of these subsidies for wind and solar?  Hard to say, but both wind and solar require hydrocarbon generation mirroring and backup, so any reductions in emissions are minimal, if at all.
3. Are more Americans working at adding value to the US economy as a result of these subsidies?  Not likely, studies elsewhere have shown quite conclusively that subsidized renewable energy jobs lead to a net loss of jobs in other parts of the economy.  This is a normal result of value subtracting activities – i.e., industrial processes that turn labor, machinery and materials into a product that is worth less than the value of the labor, materials and machinery that went into its production.
4. Is the energy system more reliable or robust?  No, in fact increased reliance on intermittent sources of energy reduces the reliability of electric power supply and increases the reliance on long distance transmission lines to provide the needed backup and mirroring for wind and solar.

Is this the road to robust energy supply and increasing independence?  As the man in Maine said, “if I wanted to go there I wouldn’t  start from here.”

The Chamber, in fact, was waxed and waned for and against the free-and-neutral market for virtually its whole existence. Such is life in political capitalism where special government favor is sought and received by business.

John T. Flynn’s 1928 essay, “Business and the Government”   (Harper’s Monthly Magazine), criticized the Chamber motto More Business in Government and Less Government in Business as ”sloganeering.”

Flynn noted that new laws were coming far less from the imaginations of legislators as from “the legislative program committees of trade associations or from the special counsel of trade groups … backed often by resolutions from trade conventions and chambers of commerce.”

The Chamber, complained Flynn, was falsely selling a view of business “as a huge giant, gagged and shackled like a moving-picture galley slave to his oar,” to which Flynn forwarded his own ideal for the Chamber: Less business interference in government and more statesmanship in business. (Quoted in Bradley, Capitalism at Work, chapter 6, pp. 172–74.)

Flynn, early on, captured the essence of free-market capitalism and Principled Entrepreneurship™.

The September 5th Letter

The September 5^th letter from the Chamber of Commerce to the U.S. Congress and President Obama, reprinted below, is noteworthy for its free market flavor. With government running on empty, and the public mood against Big Government in most areas, the Chamber has come a long way from its disappointing cap-and-trade position on carbon dioxide (CO2) emissions and its watered down energy White Paper.

The six point jobs plan was singed by Thomas Donohue, president and CEO of the Chamber.

———————————————-

The most immediate priority facing our nation is to create jobs for the 25 million Americans who are unemployed, underemployed, or have simply given up looking for work.

To create jobs, we must enact policies that promote and sustain stronger economic growth. We must also address extraordinary fiscal and competitive challenges that are smothering growth and driving away jobs. At the same time, there are specific steps Congress and the administration can take right now to spur faster job growth in America’s private sector without adding to the deficit.

We are seeking your action in the following areas:

1. EXPAND TRADE AND GLOBAL COMMERCE

You have the tools in your hands to quickly open new markets for American businesses and create new jobs for American workers. Please use them!

• Pass the three pending free trade agreements (FTAs).

Implementing FTAs with Colombia, South Korea, and Panama would prevent the loss of 380,000 jobs to our foreign competitors and create hundreds of thousands of new jobs in the United States. The U.S.-South Korea FTA alone has the potential to create as many as 280,000 new jobs.

• Complete export control reforms. The administration can enact nearly all of its proposed export control changes without legislation. Complete this task now, and U.S. businesses can expand exports and create good-paying jobs without jeopardizing national security. One study found that modernizing U.S. export controls could create as many as 340,000 new jobs.
• Spur American exports to Asia and Europe. Swiftly complete a Trans-Pacific Partnership agreement to expand U.S. exports to rapidly growing Asian economies. Initiate talks with the European Union to eliminate all tariffs on goods trade as a first step toward a broader free trade pact with our largest commercial partner.
• Protect intellectual property. IP-intensive industries support 19 million American jobs. Congress can take immediate steps to safeguard these jobs and create new ones by passing a patent reform bill as well as legislation to shut down foreign rogue websites. These websites are stealing sales from American companies by violating trademarks and copyrights.

2. PRODUCE MORE AMERICAN ENERGY

Let American energy workers and businesses responsibly develop all sources of domestic energy immediately. This will not only create jobs but will generate new government revenues, protect our energy security, and release us from the grip of some unfriendly governments.

• Open offshore resources. Almost 190,000 new jobs could be created by 2013 if permitting in the Gulf of Mexico for offshore development returned to pre-moratorium levels. In Alaska, opening up energy production off the coast would create 54,700 jobs.
• Expand access on federal lands. By expanding oil and gas exploration on federal lands, we could create 530,000 jobs, reduce imports by 44% by 2025, and increase government revenues by $206 billion.
• Promote development of natural gas. Expanding the development of the nation’s massive shale gas deposits would create hundreds of thousands of jobs and help bring manufacturing back to the United States, especially in the chemicals and steel industries.

By 2020, natural gas production in Western Pennsylvania alone could create 116,000 new jobs, generate more than $2 billion in government revenues, and add $20 billion to the region’s economy.

• Approve the Keystone XL pipeline. Construction of the Keystone XL oil pipeline connecting Canada to U.S. refineries in Texas would support 250,000 jobs, boost investment in the United States by $20 billion, and generate government revenues totaling $585 million.

3. SPEED UP INFRASTRUCTURE PROJECTS

Government at all levels is standing in the way of badly needed improvements in the nation’s infrastructure. Hundreds of clean and traditional energy projects have been held up by Not In My Backyard (NIMBY) delays. We can strengthen our economy, clean the air, and save lives while putting hundreds of thousands of Americans to work.

• Pass core transportation bills. Reauthorizing the surface transportation, aviation, and water resources programs—using, in part, revenues already coming in from user fees—would enable states and communities to plan projects, hire employees, and prevent devastating layoffs of existing workers. Reauthorizing the FAA alone would help keep 70,000 workers on the job.

• Remove documented obstacles to 351 green and traditional energy projects. The U.S. Chamber has identified 351 energy projects, including many renewable projects, which have been sidetracked by government regulations, zoning restrictions, antigrowth advocates, and lawsuits. (For a complete list, visit www.ProjectNoProject.com.) Completing all of these projects could create 1.9 million jobs annually over seven years of construction and boost our national economy over time by $1.1 trillion. Working with state and local governments, Congress and the administration should lead a nationwide effort to remove the obstacles that are blocking these needed projects.

• Remove impediments to private capital. By removing regulatory roadblocks and embracing innovative financing approaches, we can unlock an estimated $250 billion in global capital which, if welcomed and invested here in the United States and leveraged with government investment, could create up to 1.9 million jobs over 10 years.

• Fully implement the Energy Savings Performance Contracts (ESPC) Program. Under ESPC, the private sector finances projects that make federal buildings more energy efficient. Participating firms are paid back out of the energy savings over the life of the contract—at no net cost to the government. The president should issue an executive order requiring the Department of Energy to make this program a priority. Full and faster implementation could create 35,000 jobs a year, save energy, and reduce government costs.

4. WELCOME TOURISTS AND BUSINESS VISITORS TO THE

UNITED STATES

Travel and tourism is a small business-centered sector that already accounts for $700 billion in revenues and 7.4 million American jobs. Spending by foreign tourists counts as U.S. exports and helps our balance of trade. When business visitors come here for conferences, training, and trade shows and to buy our products, they strengthen America’s role as the center of innovation and global commerce. We have an opportunity to create new jobs, spur consumer spending, and generate more revenues for government at all levels.

• Remove the hassle factor. Now is the time to make travel to the United States more convenient and welcoming. We must expand the visa waiver program and reform and streamline the visa application process to ensure a consistent, predictable, fair, and timely process without compromising security. We should implement trusted travelers programs that speed through low-risk travelers who submit to a comprehensive screening and pay a fee. Wait times at customs should not exceed 30 minutes.
• Promote American destinations. Congress and the administration should work aggressively to achieve the full potential of the Travel Promotion Act—a private-public partnership requiring no U.S. taxpayer funds—to promote America as a travel destination abroad.

We can create 1.3 million American jobs by 2020 just by restoring the U.S. share of the travel market to its 2000 level. The United States is the greatest destination in the world, but the world needs to know that.

5. SPEED UP PERMITS AND PROVIDE REGULATORY CERTAINTY AND RELIEF

Small and large businesses alike have cited regulatory burdens, the excessive litigation that regulations spawn, and fears about what government regulators will do to them next as among the most significant obstacles to new hiring. Immediate regulatory relief is required in order to begin moving $1 trillion–$2 trillion in accumulated private capital off of the sidelines and into business expansion.

• Streamline and expedite the permitting process. The administration should limit environmental reviews to 6 months; forgo reviews when no significant environmental impact is expected; prevent duplicative reviews by the state and federal governments;
• and, when multiple agencies are involved, appoint a lead agency to coordinate actions and move things along. Accelerating the permitting process would quickly mobilize economic activity, construction, and hiring from one end of our country to the other.
• Provide regulatory relief and reform. The president should issue an executive order directing agencies not to issue any discretionary regulations that would have a substantial economic impact—until our rates of GDP and employment growth have substantially improved.
• This would not impact regulations mandated by Congress or delay permits. It would, instead, provide more certainty to a business community that is hesitant to invest and hire. Furthermore, the White House should insist that agencies fully and faithfully implement existing requirements, such as cost-benefit analyses, sound science, and quality data.

Congress has responsibilities as well—to invoke the Congressional Review Act when necessary; pass legislation requiring an up-or-down vote before new major rules can take effect; and mandate a higher standard of proof to justify regulations with a major impact on economic growth and jobs.

6. PASS TAX INCENTIVES THAT CREATE JOBS WHILE

INCREASING REVENUES

Comprehensive pro-growth tax reform must be a key deliverable of the Joint Select Committee on Deficit Reduction. Lawmakers and the administration can begin delivering now by swiftly enacting tax measures that stimulate business expansion and jobs without adding to the deficit.

• Implement a repatriation holiday. By reducing the tax rate for a specified period of time on profits earned and accumulated overseas, U.S. multinationals could be encouraged to bring as much as $1.2 trillion back to the American economy. A new study suggests that such a move could help create 2.9 million jobs over the course of eight quarters of implementation.
• Create a corporate capital gains tax window. Congress should temporarily reduce the tax rate that companies pay on the sale of capital assets, such as property and stock. A reduced rate would increase economic efficiency, free up capital for investment and jobs, and generate revenue for the government that it might not otherwise collect.

* * *

Your timely action on these and other ideas would significantly ease uncertainty, get existing capital off the sidelines, spur business and consumer activity, and create American jobs.

These proposals do not diminish the need to act on an array of other critical challenges to our economy. For example, we must restore the health of our housing market by allowing the foreclosure process to proceed. The sooner we allow the market to take its corrective course, the faster this key sector will recover and start building and hiring once again.

We must address, without further delay, the need to substantially reform our education, immigration, health care, capital markets, and legal systems. And as the Chamber wrote in our recent letter to members of the Joint Select Committee on Deficit Reduction, it is imperative that Congress and the administration agree on a bold plan to rein in government deficits and debt by reforming entitlement programs, overhauling the tax code, and controlling runaway federal spending.

Time and time again, Americans have heard Congress and the administration declare that creating jobs must be the nation’s highest priority. If you are serious, then we ask you to enact policies aimed at growing the private sector, not at growing the government. Millions of American entrepreneurs and businesses large and small are ready to act if you act. Give them the freedom to do what they do best and the certainty that their hard work and responsible efforts will be rewarded and not punished. Then, you will see the American business community achieve extraordinary things for this great country.

To spur action, the Chamber is strongly promoting our job creation ideas to state and local chambers, industry associations, the 3 million businesses that comprise the Chamber federation, and to the American people. We are urging them to tell you directly about economic conditions in their communities and how these proposals and others could help create jobs for the citizens you represent.

We stand ready to work with both parties in Congress, with the administration, and with all economic stakeholders to revitalize the American Dream by putting Americans back to work.

Sincerely, THOMAS DONOHUE

[Ed. note: This post is taken from Robert Bradley's conclusion in chapter 18 of Oil, Gas and Government: The U.S. Experience. In this series, Part I summarized the manifold contributions of John D. Rockefeller to a fledgling, powerhouse industry; Part II critically interpreted rebates and other 'unfair' practices of Rockefeller's Trust; and Part III critically reviewed other complaints about unfair practices against Standard Oil.]

The Standard Oil Trust of John D. Rockefeller qualifies as a free market company, not a political one. The major mistake of Standard Oil in its distinguished history was not a failing of economic performance. It was underestimating the need to present information to explain to the public and critics the virtues of integration and scale economies, particularly in petroleum. (This was an intellectual problem of critics too–see the Appendix below.)

By following an explicit policy of secrecy until the late 1880s, Standard allowed opponents to get the upper hand in a public debate that for Standard would worsen at almost every turn, culminating in the 1911 Supreme Court dissolution decree.

Successful consumer service was considered by the company as its best strategy; it was not understood that competitors would be dissatisfied by the very fact that the public was so well served by Standard Oil. Given the precedent of intervention at all government levels, offense would have been the best defense.

Prior to the onslaught of state antitrust activity, political action by Standard was occasional and defensive. Eminent-domain rights, tailored to the needs of Standard’s pipeline competitors, and rate regulation of company pipeline and storage facilities, prompted Standard’s entrance into state politics in the 1880s in Pennsylvania, Ohio, Maryland, and elsewhere to financially support friendly politicians. In the late 1890s, federal politics became important to Standard, and company pesident John Archbold made large contributions to favored candidates until a 1907 law prohibited corporate political contributions.

By this time, Standard regularly spoke for the public record, but it was too late. Numerically powerful producer interests, who blamed their cyclical difficulties on Standard, joined by hard-pressed independent refiners and marketers, inspired muckraking journalism that nudged the public to the “little man’s” side.

Ida Tarbell’s standard of goodness was not superior consumer service but “the right to do an independent business” and “free and equal transportation” for all. The idea that consumers decide the structure and form of business and that in a free market less efficient firms – which she realized existed in the independent sector – must conform or perish had no part in her ethics, understanding or sympathy.

State and federal politicians, many with personal motives, data points all for what later would become public-choice economics, readily capitalized on anti-Standard themes to seal the fate of the trust. Standard, meanwhile, had to wastefully redirect resources to the political fight when it found itself persecuted by regulation it neither sought nor benefited from. Standard’s distaste of the political means to success, as opposed to the economic means of consumer service, was noticed and criticized by Ida Tarbell.

The notion that the business man must not appear in politics… save as a “stand-patter” – not even as a thinking, aggressive force – is demoralizing, intellectually and morally. Ever since 1872 the organization has appeared in politics only to oppose legislation obviously for the public good.

But Tarbell was off the mark to idolize political activity. State and federal regulation of the day was the work product of special interests and unjustified from the consumers’ point of view (although some consumers may have supported it). It is an enduring monument to Standard and Rockefeller that special privileges such as subsidies or tariffs were not sought. The company placed its fate in the hands of the consumer. It passed every test except the political one.

Appendix: Intellectual Error and the ‘Muckrakers’

There were personal motives that skewed a fair evaluation of Rockefeller and Standard Oil–witness the prejudice of Ida Tarbell who put family first. But there was intellectual error too given the infant state of business economics that explained why big firms did so well in the marketplace. As explained in chapter 6 of Bradley’s Capitalism at Work: Business, Government, and Energy:

What explains the muckrakers’ preconceived notion that business titans were predatory promoters injuring the natural competitive order and public weal? Why did these writers—at least prior to 1929—give so little weight to the results of industrial change—improved affordability, better products, and mass production for mass consumption? As Harvard business historian Thomas McCraw would later explain, these writers did not have an adequate theoretical foundation to understand the whys and wherefores of commerce:

“Without the benefit of a vocabulary that distinguished conceptually between center and peripheral firms, productive and allocative efficiency, vertical and horizontal integration, economies of scale and transaction cost, these observers had only their personal sensibilities and political ideologies to guide them. And both their personal and political values concerning the nature of liberty, the meaning of opportunity, and the promise of America were directly threatened by the trusts.”

The despair of boom-gone-bust made for an angry decade, one in which intellectuals rushed forth with ideas and proposals that precluded key free-market reforms. The intelligentsia, in fact, had much to do with Hoover-FDR interventionism.

It did not have to be this way. Eighteenth century’s Adam Smith, and a long line of capitalist thinkers after him, would have asked and determined why their products and firms were so successful. They would have differentiated between the market and political means to success and praised or criticized accordingly. Smith would have seen John D. Rockefeller, Andrew Carnegie, and Cornelius Vanderbilt as classic market entrepreneurs— capitalists practicing capitalism. Smith would have applauded Vanderbilt’s victories against Robert Fulton and Edward Collins, two business rivals wed to political means. The Scottish professor would have been disappointed in, but hardly surprised by, the likes of railroad titans Henry Villard, Leland Stanford, and Jay Gould, who feasted off government subsidies and/or legislatively blocked new entrants.

[Editor note: This article first appeared in the October 2010 issue of Discovery, the quarterly newsletter of Koch Companies, Inc. This company's values include an adherence to free-market capitalism, in opposition to political capitalism or rent-seeking, currently the fashion at a number of major U.S. corporations. (Also see "The Future of  Economic Freedom"). ]

We live in an era when many people–including policymakers and media celebrities–view businesses and corporations with disdain or intense suspicion. Their way of thinking begs a simple question: What is the primary role of business?

Is it to create jobs and provide benefits?  Help advance a social agenda?  Or just to make as much money as possible, by exploiting customers and employees?

As a matter of principle, Koch companies believe there is only one reason for any business to exist: creating value.

“Value creation,” says Charles Koch, “involves making people’s lives better.

“It means contributing to prosperity in society.  If a company’s not doing that – enhancing the well-being of society – then it needs to go out of business.

“We all tend to pursue our own interests, but in a true market economy we can only prosper long-term by providing others with what they value.”

History and sound theory have both shown that the only way to consistently create value for society is to faithfully follow a set of reality-based principles.

For Koch companies, those are the 10 MBM® Guiding Principles, which include integrity, compliance, value creation, humility and respect.

Principled Approach

Koch employees are among the world’s most efficient at making products and providing services that customers value more highly than their alternatives.

Those products build and heat homes, protect the environment, help grow food, fuel cars and planes, purify water, help prevent disease, improve clothing and make vehicles safer.

In producing all these and many other products and services, Koch companies also strive to use less resources.

Those resources (economists call them inputs) can include labor, raw materials, energy and capital.

For example, Georgia-Pacific operates a pulp mill that has greatly reduced the amount of water needed to make the pulp that goes into disposable diapers and other products. In doing so, GP Cellulose has freed up more groundwater – a very important resource – for other uses. What’s more, efficient use of groundwater has helped prevent expansion of a saltwater plume in the aquifer that could foul public drinking water supplies.

Without profits, it wouldn’t have been possible to invest the $400 million needed to improve efficiency – thereby creating more value – at that pulp mill.

Similar stories can be told across many other Koch companies.

At Flint Hills Resources, more than $100 million in investments (made possible by profits) allowed the Pine Bend Refinery to produce ultra-low sulfur gasoline years before it was mandated by the federal government. That product – called Blue Planet – was highly valued by Minnesotans concerned about air quality.

Biting the Hand

In a system of economic freedom, a company will generate long-term profits only if it uses resources in a way that consumers value more than alternative uses.

Large or small, a company will not stay in business for long if it is not truly creating value. Unfortunately, the same cannot be said for governments. Most governments consume massive amounts of resources – primarily labor and capital – much of which doesn’t create value.

Was it worth more than $200 million of U.S. taxpayers’ money to build an airport in Johnstown, Pa., that services just three commercial flights per day?

Although it was never built, would the federal government have created real, long-term value by spending nearly twice that much for the infamous “bridge to nowhere” in Alaska?

“It is essential that use of resources is directed by consumers, rather than politically,” says Charles Koch. “When resources are directed for political ends, the result is misallocation.”

What About Jobs?

Job creation is one of today’s hottest topics.  Governments of many nations – liberal, conservative and even Communist – are under enormous pressure to “do something” about high unemployment and lagging job growth.

In reality, it is businesses of all sizes in the private sector, not the government, that tend to produce the sorts of jobs that create real, long-term value. Government interventions – particularly controls, subsidies, barriers to entry, tariffs and bailouts – misapply resources, thwarting the efficient production of what people value.

An economist would say such actions replace activities that convert resources to higher-value products with activities that convert them to lower-value products. Think about that for a moment.  If a business activity is really creating value, should it need to be subsidized?

Similarly, if a business is destroying rather than creating value, shouldn’t it be allowed to go out of business, rather than be subsidized or protected?

Productivity

Productivity is more than a business buzzword.  It is a key driver of success for all of society. The more productive we are in enhancing the value of resources, the better off virtually everyone is going to be.

By contrast, anything that interferes with productivity is going to make people less well off, especially the poor, who are least capable of weathering economic shocks.

It’s important to realize what makes us better off.  It’s not just how much money we have, but the availability of the goods and services we value. In the old Soviet Union, lots of people had rubles to spend, but there was very little of value to buy. Government policies resulted in chronic shortages of food, clothing and shelter.

Similarly, in any nation where government policies systematically destroy value, shortages of valued goods and services should be expected.

Good Idea?

Government-mandated transfers from one group to another don’t solve the problems of lower productivity and higher unemployment.

In fact, they make those problems worse.

If the government insists that someone should be paid $50 per hour in wages and benefits, but that person only creates $30 worth of value, no one will prosper for long. In a scenario such as this, as businesses lose money because of the government’s policy, employees will end up losing their jobs and fewer (if any) new employees will be hired.

Consequently, the result of what sounded good – making a guaranteed $50 per hour – will not be prosperity, it will be higher unemployment.

Anything that undermines the mobility of labor, such as policies that make it more expensive and difficult to change where people are employed, also increases unemployment.

In Europe, where stringent labor laws make it difficult and expensive to terminate someone – even for cause – this has become especially troublesome.

Similar policies that distort the labor market – such as minimum wage laws and mandated benefits – contribute to unemployment. Policies that make it difficult to get permits to build plants and equipment that are more efficient lower productivity and reduce wages.

All these obstacles interfere with the ability to create valued products and services, adversely affecting consumers, employees and employers.

Alternatives

In The Science of Success, Charles Koch wrote: “Societies that value freedom and prosperity protect their citizens’ rights to free speech, which greatly facilitates the discovery and the dissemination of knowledge.”  What we see in many nations today is just the opposite.

Citizens who are openly critical of the European Union bureaucracy in Brussels or the out-of-control government of the United States are being shouted down by politicians, government officials and their media and other allies.

Too many government elites think they know what’s best for citizens and ignore the wishes of the citizens themselves. Those in power tend to want to control more and more, all in the name of making things “fair.”  To do so, they pile on more rules, more regulations, more restrictions, more programs and more costs.

As Charles Koch has noted, this kind of thinking is a recipe for disaster – both for a company and for a government. “Over-specifying and enforcing particulars undermines prosperity,” wrote Koch. “It also facilitates corruption and abuse of power, subservience and stagnation.”

[Editor note: Robert L. Bradley Jr.'s book review of Charles Koch's The Science of Success (New York: John Wiley & Sons, 2007) appeared in the August/September 2008 issue of The New Individualist (Atlas Society). It is reprinted below to better publicize the worldview of the individual who has been behind a number of free-society initiatives across the country for several decades--and is now a target of Al Gore and the anti-free-market Left).

In 1859, the first treatise on “best practices” appeared: Self-Help, With Illustrations of Character, Conduct, and Perseverance, by Samuel Smiles. Motivational self-improvement books were not new, but Smiles’s 400-page opus was persuasive. Profusely illustrated with stories of men-made-good in industry, engineering, the arts, and music, Self-Help combined age-tested wisdom with knowledge of the industrial present.

From Self-Help to Organizational Success

Nearly 150 years later, the most recent addition to the self-help literature is The Science of Success by Charles G. Koch: businessman, philanthropist, and applied intellectual. Koch’s book has all the earmarks of a classic, but not because it is a tome (the 166-page main text is quite brief for the material covered) or because it is the last word on the subject (it is really just the beginning, despite two monographs published by Koch disciples a decade or more ago). The book’s seminal potential is that it presents what could be the most logical, systematic framework for organizational success articulated to date.

Applying primarily to business but also to nonprofits and government, the book offers the outlines of a tested framework for organizational success. Koch draws upon his forty years of experience in building what Forbes calls America’s largest privately held business (80,000 employees, $90 billion in annual revenue), studying and applying what is called “The Science of Liberty,” and founding and nurturing dozens of libertarian-related nonprofits.

Charles Koch deserves an audience. The family company he took over in the 1960s that had an enterprise value of perhaps tens of millions of dollars (inflation-adjusted) is worth, again according to Forbes, tens of billions. Koch Industries has never suffered a yearly loss. And in relative terms, a dollar invested in Koch in 1967 (the year Charles took over from his father) would be worth $2,000 today, outdistancing the same investment in the S&P 500 index ($500 today) or Warren Buffett’s Berkshire Hathaway ($1,400).

Koch, like Smiles, stresses the timeless personal attributes required for success. The Victorian moralist had carefully made a case for self-respect, cleanliness, chastity, reverence, honesty, thrift, sobriety, politeness, courtesy, generosity, forethought, economy, and (his favorite) perseverance. Koch pays homage to “principled behavior” and “a culture of virtue,” consisting of integrity, humility, and respect, as well as “the sense of urgency, discipline, accountability, judgment, initiative, economic and critical thinking skills, and risk-taking mentality necessary to generate the greatest contribution to the company.”

But for Koch these personal traits are only the beginning. For it is one thing to tell an employee what is good, to instruct him to be good, and to urge him to do well—but quite another to have employees creating real wealth for an organization and thus for society. The challenge of “the science of success” is to get from the commonsensical micro to the complex macro, or to achieve what Charles Koch has termed Principled Entrepreneurship™, defined as “maximizing long-term profitability for the business by creating real value in society while always acting lawfully and with integrity.”

Market-Based Management®

Enter Market-Based Management®, defined as “a philosophy that enables organizations to succeed long-term by applying the principles that allow free societies to prosper.” MBM, Koch’s framework for the science of success, has five dimensions (reproduced here verbatim):

• Vision—Determining where and how the organization can create the greatest long-term value

• Virtue and Talents—Helping ensure that people with the right values, skills and capabilities are hired, retained and developed

• Knowledge Processes—Creating, acquiring, sharing and applying relevant knowledge, and efficiently measuring and tracking profitability

• Decision Rights—Ensuring the right people are in the right roles with the right authorities to make decisions and holding them accountable

• Incentives—Rewarding people according to the value they create for the organization

Five of the book’s eight chapters explain these dimensions, one chapter per principle. What is left is an opening chapter on the history of Koch Industries, a second chapter introducing the science of human action (of which MBM is a part), and a final chapter on lessons.

MBM entails asking the right questions and getting to the right answers about how to continually create economic value while staying within the rules. MBM is about creating a free market in communication and feedback (“free speech”) and a meritocracy where property rights (“decision rights”) flow to the value creators. Such economic concepts as opportunity cost, sunk cost, transaction cost, comparative advantage, and time preference come alive in the framework, as do the more abstract notions of tacit knowledge and spontaneous order. MBM is a way to learn and apply Austrian-school economics, which is just real-world economics under another name.

Koch repeatedly (eight times by my count) emphasizes that MBM is a holistic system, with all five dimensions being interdependent and mutually reinforcing. Just as one can neuter a diet by breaking the regimen for just minutes of a 24-hour day, one cannot expect to obtain the benefits of MBM by following only some of the dimensions or by following all the dimensions for only part of the time. And not only the organization, but MBM itself, must be subject to continuous improvement and creative destruction for inter-temporal success.

The underlying assumption of MBM is that there is an objective means for identifying success and for becoming successful (thus the science of success). The terms “reality” and “truth” (see the sidebar) are taken as self-evident, although there is a warning that correctly interpreting reality takes work and having the right values. For example, profit/loss measurement should not be profit-maximizing for its own sake (“let’s show as much profit as we can to please the bosses and get more reward”) but for the sake of value-creation (“let’s realistically match period costs and revenues for learning”). Koch explains:

A business can best determine where and how to create value when it is organized into profit centers . . . . [But profit/loss] financial statements must reflect economic reality. Remember, anywhere profit and loss is measured, analysis is also needed to understand what drives those results.

Koch does not mention companies other than his own in the book. But, to use a riveting example, Enron was “profitable” during almost the entire time it was destroying enterprise value on a grand scale. By gaming the accounting rulebook, Enron reported paper profits instead of creating real wealth. And so there was little midcourse correction, almost everyone was surprised, and many were victimized.

Enemies of Success

The Science of Success also takes aim at the enemies of wealth creation (and thus of applied MBM): “cynicism, form over substance, bureaucracy, command-and-control, or destructive, self-serving behavior.” Other attitudes and behaviors that come in for criticism are “emotion and gut feeling,” “impulsive action,” “entitlement and unaccountability,” and “inaction, abdication or finger-pointing.”

Koch takes particular pains to warn against arrogance and to extol the virtue of humility, which might surprise some who are supremely confident about interpreting objective reality. But if business and life are about learning and making mid-course corrections for improvement, then humility—understood contextually—is important indeed.

For the business person, humility means being open to changing course, if necessary. Consumers can start and stop valuing something altogether. What works today might fail tomorrow, and, given competition, each business success will inevitably peter out unless changes are made (cost reductions, product improvement or differentiation).

Thus the challenge for any organization is not only to become successful but to stay successful. “It is often more difficult to overcome success than adversity,” Koch notes—the implication being that, ironically, it can be easier for an unsuccessful company to become successful than for a successful company to remain that way.

Politics and Principled Entrepreneurship™

Thus Principled Entrepreneurship™ is a framework for how to deal with the “creative destruction” of the marketplace, how to stay successful in the sense of avoiding losses and making real wealth. Such success has to get beyond personalities and products—the stuff of the moment—to an organizational methodology where success can be replicated amid change, where the good drives out the bad and the better drives out the good.

A section of Koch’s book deals with “Practicing MBM in a Political World.” Here, Koch distinguishes between the economic means and the political means to success. The first involves voluntary transactions in the marketplace; the latter, the use of government coercion to achieve business ends.

Koch advocates the economic means as part of Principled Entrepreneurship™ by which value and wealth are created rather than forcibly obtained (redistributed from others). But given existing regulations and laws—even those that the company opposes on business or intellectual grounds—full compliance is rule number one. Only in that context can reform be effectuated, Koch explains:

Striving to comply with every law does not mean agreeing with every law. But, even when faced with laws we think are counter-productive, we must first comply. Only then, from a credible position, can we enter into a dialogue with regulatory agencies to demonstrate alternatives that are more beneficial. If these efforts fail, we can then join with others in using education and/or political efforts to change the law.

Conclusion

This is a profound, even radical, book. For historians, including the present writer, it explains organizational success in a way that also helps us to understand organizational failure, such as the bankruptcy of notable companies. But, to repeat, this book is but an introduction. One can hope for a good deal of follow-up study, analysis, and testing, to see just how far a “science of success” can go—and whether such a science can overcome its own success. Stay tuned.

Thoughts on Success from Charles Koch

“We must constantly remind ourselves that just because we believe or want a thing to be true does not make it so.” (Page 30)

“[We] pioneered internal markets and greatly expanded the use of scorecards. This helped us more fully appreciate the value of having measures based on economic reality.” (Page 43)

“A company’s reputation is critical to how it will be treated by others and to its long-term success. We must build a positive reputation based on reality, or others will create one for us based on speculation or animus. . . .” (Page 47)

“Our losses . . . were costly examples of the failure to develop a reality-based vision . . . .” (Page 70)

“As . . . Richard Whately observed: ‘It is one thing to wish to have truth on our side, and another thing to wish sincerely to be on the side of truth.’” (Page 115)

“Decisions should be made using economic and critical thinking, logic and evidence, rather than emotion or gut feeling . . . . [Moreover], style should never take precedence over substance.” (Page 117)

Here is the essence of this man. An engineer. More than 40 years with a major energy company in a variety of advancing positions at home and abroad. Successful. Private sector philanthropist with his time and money.

And through it all, a ”heroic capitalist” in the Smith-Smiles-Rand tradition (see Part I of my Capitalism at Work). A practitioner of Principled Entrepreneurship ™.

Think of what Julian Simon would have said about Stephen Simon (no relation): He created more than he consumed to leave us resource richer. And he used that wealth to create still more wealth and advance civil society.

Finally, think of Mr. Simon and his company when you think about the names that made the news at the once rival of ExxonMobil, the late Enron. (Enron’s Ken Lay, in fact, joined Exxon two years before Simon as a corporate economist before going to Washington for various assignments and never really getting politics out of his blood.)

The obituary follows:

J. Stephen Simon

J. STEPHEN SIMON, 1943 – 2009 J. Stephen Simon, a former director and senior vice president of Exxon Mobil Corporation, passed away unexpectedly at his home in Dallas, Texas, on Wednesday, July 8, 2009, at age 66.

Mr. Simon had a long and distinguished career of over 40 years with the corporation. During this time he held a series of increasingly senior roles, culminating in his election to the board of directors in 2006. He retired from the company on May 31, 2008.

Mr. Simon joined Exxon Company, U.S.A. in June 1967 and shortly thereafter began a two-year assignment in the United States Army. He returned to Exxon U.S.A. in July 1969 as a business analyst in the Baton Rouge Refinery.

After holding a variety of supervisory and managerial positions throughout the Baton Rouge and Baytown refineries, and Exxon U.S.A.’s Refining and Controller’s departments, Mr. Simon became executive assistant to Exxon U.S.A.’s executive vice president, located in Houston.

In 1980, he returned to the Baton Rouge Refinery as Operations Division manager, following which he became refinery manager. In 1983, Mr. Simon moved to New York where he was executive assistant to the president of Exxon Corporation. In 1984, he moved to London, England, as supply manager in the Petroleum Products Department of Esso Europe Inc. and then supply and transportation manager. Mr. Simon returned to Houston in 1986 as general manager of Exxon U.S.A.’s Supply Department, and in 1988, he became chief executive and general manager, Esso Caribbean and Central America located in Coral Gables, Florida.

Mr. Simon moved to Italy in 1992, to become executive vice president and then president of Esso Italiana. He returned to the United States in 1997 and was named an executive vice president of Exxon Company, International, headquartered in Florham Park, New Jersey. In December 1999, he was appointed president of ExxonMobil Refining & Supply Company and vice president of Exxon Mobil Corporation. In December 2004, he became senior vice president of Exxon Mobil Corporation and in January 2006 was elected to the board of the corporation.

Beyond his leadership roles at ExxonMobil, Mr. Simon also served on the boards of many voluntary organizations over the course of his career, including the United Way, the Boy Scouts, and the Salvation Army. He was also a member of the Governance Committee of the National Action Council for Minorities in Engineering and had served on the board of the US-China Business Council, the American Petroleum Institute and the National Association of Manufacturers. Following his retirement from ExxonMobil, he became Chair of the Board of Visitors for Duke University’s School of Engineering and had also been active in support of the Children’s Advocacy Center in Dallas.

Mr. Simon is survived by his loving wife of 43 years, Susie; daughter Marnie and her husband Nicolas Medina, of Houston, Texas; daughter Angela and her husband Steve Reynolds of Nashville, Tennessee; daughter Candice and her husband Rick Murillo of Frisco, Texas and grandchildren Alexandra, Nicolas Jr. and Isabel. Also surviving are his brother Dan of Columbia, Missouri; sister Sheryl of Mt. Lebanon, Pennsylvania; brother Mike of Winterhaven, Florida and father B.D. Simon of Columbia, Missouri. He was preceded in death by mother Joan Francis Simon, who passed away in 2008.

In his memory, the Pratt School of Engineering at Duke University has established the J. Stephen Simon Scholarship Endowment Fund. Memorial contributions to the J. Stephen Simon Scholarship Endowment Fund may be made to Duke University in care of Judge Carr, 305 Teer Engineering Building, Box 90271, Duke University, Durham, NC 27708.

Steve was an amazing person — a loving husband, father and grandfather. We will miss him dearly.