Beneath the Surface

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The “corporate power” referred to in the subtitle of Kochland is not just economic power, but political power. The Koch brothers became poster boys for the role of big money in the political process. They played a leading role in pushing the Republican Party toward more libertarian, pro-market and anti-government policies, and in blocking collective efforts to address national problems like climate change.

David Koch declared his views publicly, running for vice president as a Libertarian in 1980. Kochland author Christopher Leonard characterizes the Libertarian platform as “calling for the abolishment of everything from the US Post Office to the Environmental Protection Agency to public schooling.” Charles preferred to operate behind the scenes, quietly funding a wide range of conservative organizations and campaigns. The Charles Koch Foundation, created in 1974, soon changed its name to the Cato Institute, but its policy positions were also libertarian, with relentless support for tax cuts and privatization of public programs like Social Security.

The “Kochtopus”

Leonard describes Charles Koch’s political influence machine, nicknamed the “Kochtopus,” as a multifaceted operation “including think tanks, university research institutes, industry trade associations, and a parade of philanthropic institutions to support it financially.”

In part, this is a traditional political operation, working to elect candidates and lobby legislators. But it is especially large and well-funded. Leonard compares Americans for Prosperity, the main Koch advocacy group, to a franchise business with “semiautonomous state chapters” all serving “products from the same menu.” Its organization as a tax-exempt “social welfare” entity spares it from having to disclose its donors. It can easily create the appearance of spontaneous, grassroots movements at the local level. Also, today’s corporate lobbyists do not just provide information and persuasive arguments; they organize lavish fundraisers for politicians who vote their way. Another focus of Koch political influence is education, but it is education of an economically and politically motivated kind. The Koch-funded Mercatus Center at George Mason University promotes free-market economics, while the Law & Economics Center at the same university provides a forum for legal scholars who take a dim view of government regulation. It appears to have shaped the views of a generation of judges by inviting thousands of them to its seminars. By blurring the distinction between education and political contributions, Koch has circumvented the restrictions on campaign contributions.

In 1996, Koch Industries created a nonprofit group called the Economic Education Trust. The group did not need to disclose its donors because it was not ostensibly a lobbying or campaign finance organization…. The Economic Education Trust gave $1.79 million to a company in suburban Washington, DC, called Triad Management Services Inc. Triad was supposedly a political consulting firm, but it had a strange business model: it offered its services for free, to Republican candidates. A US Senate report in 1998 concluded that Triad was “a corporate shell funded by a few wealthy conservative Republican activists.”

Instead of just helping elect legislators and influencing their votes, corporations have sought a direct role in writing legislation. Koch has been a major contributor to the American Legislative Exchange Council (ALEC), originally founded by Paul Weyrich of the religious right, which writes model laws to be adopted by state legislatures. Leonard says it has evolved into a “pay-to-play” organization, allowing its largest contributors to write the bills that its member legislators try to get passed.

Energy deregulation

In the 1990s, ALEC developed model legislation for energy deregulation. Koch Industries and other companies that stood to gain from the legislation (notably the notorious Enron corporation) had a large role in writing it. Utility companies, who were more comfortable with the traditional system, opposed deregulation, but Koch and Enron had their way on ALEC’s energy task force. Leonard tells the story of deregulation in California, one state that adopted ALEC’s general approach.

Before deregulation, utility companies were essentially regulated monopolies. Having more than one utility trying to deliver energy to the same house wasn’t practical, but state regulators could protect the public from price-gouging by setting rates to allow a comfortable but not exorbitant profit. When energy prices became more volatile and the need for both conservation and pollution control more pressing, price regulation became more challenging. Setting prices too high would burden consumers, while setting them too low would dampen supply by discouraging producers from bearing the costs of production and pollution control. The free-market solution advocated by ALEC and the libertarians was to let the market set the price. The California deregulation law, passed in 1998, created a competitive market for power, the California Power Exchange:

The law was radical in nature. It instantly broke apart the state’s big utility companies. The utilities became glorified middlemen, buying energy on an open market from traders at Koch and Enron and then selling it to the utility’s customers. The utilities had to sell their power plants to outside companies—many of them in Texas—that operated the plants as independent companies. The utilities also lost their transmission lines, which were taken away and turned into something that resembled a railroad or a pipeline. Anybody could now schedule power to run across the transmission lines, making them the common carrier of power.

In theory, competition among the producers to sell their energy would keep prices under control for consumers. And the competition among utilities to buy energy would keep prices high enough to incentivize production. The price mechanism would balance supply and demand, as in any competitive market.

But what if demand rose faster than supply, pushing up prices? With many other products—let’s use electric cars as an example—some people would just have to wait to buy one until supply caught up and prices went down. But electricity is special, because it has become a necessity. People can conserve energy up to a point, but they need a lot of it all the time. It won’t do to have too many customers seeing their power cut off because they can’t afford it, or to have utility companies going broke trying to buy power on the open market. So, in order to protect the utilities and their customers, California put a cap on the wholesale price charged by producers to utilities, and a floor under the retail price charged by utilities to customers. The retail price was supposedly high enough for utilities to profit, but not so high as to make energy unaffordable for consumers.

What if shortages occurred because the producers would not or could not produce at the capped price? Then another agency—the California Independent System Operator (ISO)—could step in to buy and sell energy for more than the capped price on the exchange. The system was still partly regulated, but with the good intentions of protecting consumers and avoiding blackouts.

Then the energy traders found a way to game the system, in effect creating make-believe shortages so they could sell energy at the uncapped ISO price more often. The game was called energy “parking”, and it worked like this:

Enron traders seem to have invented the parking scheme sometime in the late 1990s. To execute a parking trade, a trader at Koch or Enron sold electricity from a power plant in California to a customer outside the state, like PNM in Arizona. This sale was made in the day-ahead market, where prices were capped. But the sale was bogus. The next day, when power was supposed to be delivered from California to PNM, the utility would suddenly sell the exact same amount of power from Arizona into California, and into the much pricier ISO hourly market.

Such a sale was fraudulent because no actual megawatts were delivered to the out-of-state utility, which simply collected a fee for participating in the deception. Energy prices skyrocketed, and utilities couldn’t pay those prices and remain profitable without being allowed to charge exorbitant rates to customers. The state began to experience both budgetary strains and rolling blackouts.

Enron eventually went bankrupt after this and other fraudulent practices were discovered. The Republican governor who had championed deregulation was out of office, so the political blame fell mainly on his Democratic successor, Gray Davis. Voters recalled him and replaced him with another Republican, Arnold Schwarzenegger. Koch Industries was a lesser offender than Enron, but did settle charges of market manipulation by paying $4.1 million to the state. Only when the Federal Energy Regulatory Commission stepped in was the California energy crisis brought to an end.

Climate-change legislation

In 2008, Congress was considering environmental legislation that took a “cap-and-trade” approach to controlling carbon emissions. “The concept was simple. The government capped the total amount of a certain pollutant that could be released. But then it gave companies a license to release that pollution.” Companies that wanted to exceed their cap had to pay to buy credits to do so, while companies that reduced their emissions below their cap earned credits they could sell. Because it relied on a more-or-less free market in pollution credits, it had the support of many Republicans as well as Democrats. George H. W. Bush had initiated a similar approach to controlling sulfur dioxide and acid rain in 1990, with apparent success.

But even that much regulation was too much for Koch Industries. It conducted its largest lobbying effort yet in order to defeat the proposal, working through a new subsidiary, Koch Companies Public Sector. Not only that, but Koch waged a large-scale (dis)information campaign to convince the public that climate change wasn’t real, and that efforts to curb carbon emissions could only impose unacceptable costs on the economy. Between 2006 and 2009, as the planet warmed, the percentage of Americans believing in climate change dropped from 77 percent to 57 percent. Other oil companies, especially Exxon, also participated in this effort, but Koch outspent Exxon by a wide margin. Koch’s political arm, Americans for Prosperity, got many climate-denying Republicans elected by targeting their more moderate and reasonable opponents with negative advertising. Cap-and-trade lost Republican support and died in 2010. Americans for Prosperity also helped Republicans win the 2010 midterms, and one of the first things the Republican-controlled House did was cut off funding for the Select Committee on Energy Independence and Global Warming, the committee that had originated the cap-and-trade bill.

I have little doubt that the Koch brothers’ enthusiasm for libertarianism was genuine, and that they sincerely believed that what was profitable for Koch Industries was good for the economy and the country. I also have little doubt that in this case and others, they were very, very wrong.

Koch and Trump

Both Charles Koch and Donald Trump held extreme political views, but they did not agree on everything. Trump’s nationalism sometimes conflicted with Koch’s commitment to free trade. Leonard says that “the Koch political machine employed a strategy that could be called ‘block-and-tackle,'” blocking Trump’s proposals where they disagreed, but helping him tackle the problems they agreed on.

The “Kochtopus” supported Trump’s 2017 cuts in corporate and personal income taxes, which by one estimate saved Charles and David Koch personally over $1 billion dollars a year. It also supported Trump’s efforts to withdraw from the Paris Climate Accord and roll back environmental regulations.

Trump claimed that he could repeal Obamacare and replace it with something better but less expensive. Charles Koch just wanted to repeal it without replacing it with any government initiative on health insurance. Neither had his way on that issue, as Obamacare survived by one vote in the Senate.

Koch did not approve when Trump interfered with free trade by abandoning the Trans-Pacific Partnership agreement and imposing tariffs on foreign products. He also opposed the proposed Border Adjustment Tax intended to favor companies that operated in the U.S. rather than in other countries. Under existing law, companies could escape U.S. taxation by producing things abroad—or using accounting gimmicks to shift profits to foreign tax havens. Koch Industries often avoided taxes in that fashion, headquartering many of its operations in the Cayman Islands. The proposed Border Adjustment Tax would have taxed profits based on where products were sold rather than where they were produced. That would be costly for a company like Koch that imported oil and other products for sale here. In this case, Koch’s efforts to kill the bill succeeded.

One conclusion to draw from Leonard’s detailed history of Koch Industries and its political machine is that the radicalization of the Republican Party was well under way before Donald Trump came on the political scene. The ascendant philosophy was libertarian rather than nationalist, but many of the goals were the same—lower taxes for corporations and the wealthy, no action on climate change that would inconvenience the fossil-fuel industry, and a minimal role for government in regulating the economy. The political transformation of the late twentieth and early twenty-first centuries was only partly a grass-roots movement, but heavily a top-down effort directed and financed by wealthy plutocrats.

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After the National Labor Relations Act of 1935 recognized the right of workers to organize and bargain collectively, labor unions became a fixture in corporate life. Author Christopher Leonard says, “It was a losing game to take on unions; their power was too great to challenge. Most companies chose to accommodate organized labor.” But when Charles Koch consolidated his father’s businesses into Koch Industries in 1968, he brought with him a new willingness to take on the unions and subordinate them to his management philosophy and goals.

Pine Bend

The difference became apparent in the early 1970s at the Pine Bend refinery on the Mississippi River in Minnesota. Its workers were organized by the OCAW—the Oil, Chemical and Atomic Workers Union. Leonard acknowledges that by this time, many unions had become “bloated power structures” in their own right. The OCAW at Pine Bend had a lot of say over work rules, and some of their rules created inefficiencies by making extra work or imposing additional costs. For example, if workers were asked to work overtime without two hours notice, they had to receive bonus pay on top of their overtime pay.

When management insisted on rewriting all the work rules without union input, the workers went out on strike. Koch broke the strike with a combination of hardball tactics. The company managed to operate the plant with supervisors and other non-union labor. They bullied other unions like the Teamsters to cross the picket lines by threatening to replace their services (such as delivery services) with non-union suppliers. When violence broke out on the picket line, Koch obtained an injunction limiting the union to four picketers. The OCAW eventually capitulated and accepted the contract offered.

Now the work rules favored the company. My favorite example—even if an employee won a grievance against the company, all he won was the right to work extra hours to earn back the money Koch owed him!

Georgia-Pacific

Leonard devotes three chapters to the long, losing struggle of workers at the Georgia-Pacific warehouse complex in Portland, Oregon. Before it was acquired by Koch Industries, he describes it as an “economic island: one of the last employers in the region to offer solid work and solid pay for people who didn’t have a college degree.” Then “this island began to sink, slowly and steadily, as workers’ pay, benefits, and job security were stripped away further, year after year.” He sees this story as typical of the fate of blue-collar workers in the age of corporate acquisitions and private equity.

Here the union was the IBU—the Inlandboatmen’s Union, originally named after workers on river barges. It was absorbed into the ILWU—the Longshoremen’s union—in the 1990s. When Koch Industries acquired Georgia-Pacific, it started cutting costs by reducing the workforce while trying to get more work out of each remaining worker. In addition to an inventory system called the “Warehouse Management System,” it introduced a “Labor Management System” to exert more control over the workers. The system would issue precise instructions to a forklift driver, maintain a precise record of every movement through the warehouse, rank the workers by performance, and post the rankings on a bulletin board. Drivers had to keep their own written log of every minute they were not “on the grid” carrying out the instructions of the system. From management’s point of view, productivity and profits were rising. From the workers’ point of view, the job had become more demanding and more stressful, while wages failed to keep pace with inflation. The situation in the country as a whole wasn’t much better. Productivity and wages used to go up together, but between 1973 and 2013, productivity rose 74.4 percent, but real wages rose only 9.2 percent.

When the time came to renegotiate the labor contract in 2010, the union was looking for big gains, but Koch brought in tough negotiators who were “trained to beat back unions for a living.” Every request by the union was met by a counterproposal that asked the workers to give back something of equal or greater value. If they wanted a decent raise, they would have to replace their health insurance plan with a less desirable one or replace their traditional guaranteed-benefit retirement plan with a riskier 401(k) plan. When the union voted down what Koch proposed, the Koch negotiators stopped coming to meetings. After over a year without a new contract, and in fear of being replaced by non-union labor, the workers backed down. The Labor Management System would stay. The workers would get minimal pay increases, but have to contribute more to keep their health insurance and pension plan.

The 2015 negotiations did not come out any better. By then the number of unionized workers had been cut almost in half. A new worry was that accidents and deaths at the warehouses had been increasing, and Georgia-Pacific’s safety record ranked relatively low in the industry. Again, management wanted to make wage increases conditional upon replacing the health insurance and pension plans. In the end, workers got only 2% raises for two years and the prospect of $1,000 bonuses for the next two years. (The bonuses were less valuable than raises, since they didn’t become part of base pay and grow by compounding). The workers were disgruntled but resigned. Support for the union itself suffered, no doubt as the Koch brothers intended.

Leonard has provided a ground-level look at what happens when bargaining power shifts from labor to management. While business consolidations made workers in many industries dependent on a smaller number of big employers, the decline in unionized manufacturing jobs intensified the competition among workers for a dwindling supply of good jobs. As profits rose but pay stagnated, the share of the national income going to labor declined accordingly, especially after 2000.

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Christopher Leonard. Kochland: The Secret History of Koch Industries and Corporate Power in America. New York: Simon & Schuster, 2019.

Christopher Leonard has done us all a favor by amassing and organizing a great volume of information about Koch Industries. The company has not usually gotten the attention its wealth and power deserve, because it is the family business of a highly secretive family. But it is a massive company with many subsidiaries producing a wide range of products, and it is the second largest privately held company in the United States. It branched out from its original focus on oil refining and petrochemicals into businesses like agricultural products and building materials.

Koch traders sell everything from fertilizer, to rare metals, to fuel, to abstract derivatives contracts. Koch Industries’ annual revenue is larger than that of Facebook, Goldman Sachs, and US Steel combined.

The profits from Koch’s activities are stunning. Charles Koch and his brother David own roughly 80 percent of Koch Industries. Together the two men are worth $120 billion. Their fortune is larger than that of Amazon CEO Jeff Bezos, or Microsoft founder Bill Gates [as of 2019]. Yet David and Charles Koch did not invent a major new product or revolutionize any industry.

The book is a detailed portrait of one company, but its subtitle reveals how the author sees that company—a prime example of growing corporate power in America over the past half century. Many of the book’s themes are central to recent economic history—the ascendancy of a free-market, antigovernment philosophy, the victories of capital over labor, the reliance on corporate acquisitions and asset speculation for corporate profits, the growing political muscle of big business, and its effective resistance to environmental legislation. The book gives life to these abstractions by showing how one company has accomplished them.

Origins of a corporate powerhouse

Fred Koch founded the company in 1940 in Wichita, Kansas. He had four sons, the oldest of whom, Freddie, was more interested in art than the family business. That made the next son, Charles, the heir apparent, and he took over the management shortly before his father died in 1967. The third son, David, served on the board of directors but devoted himself more to politics, eventually running for vice president as a Libertarian. David’s twin brother William was also on the board, but feuded with his brothers over corporate policy and dividend payments. Charles and David succeeded in getting him fired by the board, and the company bought out both Freddie and William’s ownership shares.

Charles Koch took the lead in consolidating his father’s holdings under the name of Koch Industries. Although it began as mainly a refiner and transporter of oil, the company became more diversified and flexible in order to adapt to increasing economic volatility, such as wild swings in oil prices. Charles created a development group specializing in new acquisitions, which the author compares to a private equity firm, but one within an existing company. “The group would come to embody modern American capitalism in the early twenty-first century, an era when private equity and hedge funds scoured the landscape in search of acquisitions.”

Charles Koch ran his company according to a philosophy he called “Market-Based Management” (MBM) which was formalized and taught to every manager. Although he was well-read in a variety of subjects, his philosophy seemed to rely mostly on what he had learned from his domineering father and from free-market economics in the Austrian tradition of Friedrich Hayek. Fred Koch had been a founding member of the John Birch Society, which was considered the far-right fringe of the Republican Party in the 1950s and 60s. Hayek was a well-known critic of the New Deal, and Leonard says that Hayek “was almost religious when it came to describing what the market could do when left to its own devices. He believed that the market was more important, and more beneficial, than the institution of democracy itself.” Charles Koch saw his company as a kind of internal market that should also reward personal initiative motivated by economic reward. He encouraged the manager of each unit to be on the lookout for new opportunities that could benefit the bottom line. He took his philosophy beyond the company as well, working with Wichita State University to establish the MBM Center there. And on Sunday mornings when many Wichita residents were in church, Charles was in the family library, schooling his own children in “a curriculum that taught them about his systematic view of human behavior and how best to organize human society.”

Growing pains

By the mid-1990s, Koch Industries had developed what Leonard calls a “bias toward acquisitions.” Like private equity firms, the company had discovered that they could make more money by buying existing companies then by developing new products on their own. When it worked best, the acquisition strategy could unlock hidden value in underperforming companies, managing them or reselling them for high enough returns to justify the costs of acquiring them. But Koch Industries wasn’t immediately or consistently successful at this.

In the case of Purina Mills, acquired in 1998, Koch paid much more than Purina appeared to be worth, financing most of the deal with bank loans. Koch tried to characterize the loans as “non-recourse” debt, so that the banks would have no claim on Koch’s assets, only those of the Purina subsidiary. But when a collapse in hog prices threw Purina into bankruptcy, the banks successfully sued, claiming that Koch was not independent enough of Purina to justify non-recourse debt. Koch lost its own $100 million investment in Purina, plus another $60 million.

Koch had many other legal problems. In 1989, a report by the Senate Select Committee on Indian Affairs described the company as “the largest purchaser of Indian oil in the country” but also “the most dramatic example of an oil company stealing by deliberate mismeasurement and fraudulent reporting.” The federal case against Koch was eventually dropped for lack of evidence, but a federal civil suit over the same allegations was more successful.

Violations of environmental regulations were another problem. The company employed environmental engineers, but Koch’s Market-Based Management assigned them only advisory roles, while decision-making authority was reserved for the organization’s profit centers. When too much ammonia showed up in the Pine Bend refinery’s wastewater, Koch maintained production by illegally discharging it into the river anyway or letting it spill onto surrounding land. “Koch industries racked up a shocking number of criminal charges and civil complaints throughout the 1990s, branding the company as a kind of corporate outlaw.”

Leonard attributes such failures to the downsides of Market-Based Management, especially its single-minded emphasis on corporate growth and profits.

The culture inside Koch industries…borrowed some of the worst impulses from Wall Street—a hunger for high-profile deals, a desire for giant paydays, short-term thinking—and combined them with Koch Industries’ mandate for growth.

Reinvention and mastery

In 2000, Koch Industries went back to the drawing board and revised its corporate structure and growth strategy, though without abandoning the MBM philosophy. Koch Industries became basically a holding company, owning many smaller firms. The company took pains to segregate those firms from the parent company, so that the latter could avoid the kind of liability that had arisen in the Purina case. Koch Industries would profit from a strategy similar to that of private equity firms—buy a struggling company using mostly borrowed money, but structure the deal so that the debt was the responsibility of the acquired company; then use the company’s cash flow to make the debt payments. If they came out ahead, Koch got the profits. If they didn’t, they could let the acquired company take the fall. “In a matter of just a few years, Koch Industries would execute some of the largest private equity deals in America, with acquisitions worth nearly $30 billion.”

Another lucrative activity was speculation in futures options. If Koch could acquire more accurate information about future conditions than other traders had, it could profit on the difference. Since the demand for energy depends heavily on weather conditions, Koch hired the best meteorologists it could find. One Koch trader speculating on insurance policies made almost five times as much in a year as Koch’s entire pipeline company.

Surprisingly, for those who thought of Koch Industries as a corporate outlaw, Charles Koch began to insist on what he called “10,000 percent compliance,” which meant that everyone in the company would obey 100% of the laws 100% of the time. Sounds great, but what it may also have meant is that the company learned how to shape the law and use the law to its advantage, rather than risk breaking the law. The Clean Air Act had grandfathered in the pollution standards for refineries, so that old companies like Koch could operate, but newer ones found it too expensive to compete. Deregulation of energy prices opened up new opportunities for profit. Proposed regulations to combat climate change were a threat, but the company could use its considerable lobbying and media campaigns to defeat them.

In the early twenty-first century, Koch Industries was thriving. It seemed to have mastered the financial and political challenges of a complex and volatile economy. The Koch brothers were not simply producing something of obvious value and getting paid for it, like a Henry Ford. As Leonard said, they “did not invent a major new product or revolutionize any industry.” One wonders how much of their vast fortune was earned by making real economic contributions, and how much was a matter of using financial, intellectual and political capital to take advantage of those with less capital. With that in mind, I turn to Koch’s labor practices and political operations in my next posts.

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