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Yes, America Is Rigged. Here Is What I Learned From Reporting on Koch Industries

13 minute read
Leonard is the author of The Lords of Easy Money: How the Federal Reserve Broke the American Economy, forthcoming from Simon & Schuster. His previous book was Kochland: The Secret History of Koch Industries and Corporate Power in America. He is a business reporter whose work has appeared in The Washington Post, The Wall Street Journal, Fortune, and Bloomberg Businessweek.

The election season of 2015 and 2016 was defined by chaos, infighting and a pool of deep resentment that came boiling over when votes were cast. But this election was barely noticed. It happened on February 17, 2016, in a rundown labor union hall in Portland, Oregon. Union members were voting on a new contract with their employer, Koch Industries. The union members felt powerless, cornered, and betrayed by their own leaders. The things that enraged them were probably recognizable to anyone who earns a paycheck in America today. Their jobs making wood and paper products for a division called Georgia Pacific had become downright dangerous, with spikes in injuries and even deaths. They were being paid less, after adjusting for inflation, than they were paid in the 1980s. Maybe most enraging, they had no leverage to bargain for a better deal. Steve Hammond, one of the labor union’s top negotiators, had fought for years to get higher pay and better working conditions. And for years, he was outgunned and beaten down by Koch’s negotiators. So even as the presidential election was dominating public attention in late 2015, Hammond was presenting the union members with a dispiriting contract defined by surrender on virtually everything the union had been fighting for. He knew the union members were furious with his efforts. When he stood on stage to present the contract terms, he lost control and berated them. “This is it guys!” his colleagues recall him yelling. “This is your best offer. You’re not going to strike anyway.”

I thought of the free-floating anger in that union hall often as I travelled the country over the last eight years, reporting for a book about Koch Industries. The anger seemed to infect every corner of American economic life. We are supposedly living in the best economy the United States has seen in modern memory, with a decade of solid growth behind us and the unemployment rate at its lowest level since the 1960s. Why, then, does everything feel so wrong? In April, a Washington-Post/ABC Poll found that 60% of political independents feel that America’s economic system is essentially rigged against them, to the advantage to those already in power. Roughly 33% of Republicans feel that way; 80% of Democrats feel the same.

What reporting the Koch story taught me is that these voters are right— the economy truly is rigged against them. But it isn’t rigged in the way most people seem to think. There isn’t some cabal of conservative or liberal politicians who are controlling the system for the benefit of one side or the other. The economy is rigged because the American political system is dysfunctional and paralyzed—with no consensus on what the government ought to do when it comes to the economy. As a result, we live under a system that’s broken, propelled forward by inertia alone. In this environment, there is only one clear winner: the big, entrenched players who can master the dysfunction and profit from it. In America, that’s the largest of the large corporations. Roughly a century after the biggest ones were broken up or more tightly regulated, they are back, stronger than ever.

I saw this reality clearly when I went to Wichita, Kansas to visit Charles Koch, the CEO of Koch Industries, a company with annual revenue larger than that of Facebook, Goldman Sachs and U.S. Steel combined. Charles Koch isn’t just the CEO of America’s biggest private company. He also inhabits one extreme end of the political debate about our nation’s economy. A close examination of his writing and speeches over the last 40 years reveals the thinking of someone who believes that government programs, no matter how well-intended, almost always do more harm than good. In this view, most government regulations simply distort the market and create big costs down the road. Taxing the wealthy only shifts money from productive uses to mostly wasteful programs. Charles Koch has been on a mission, for at least 40 years, to reshape the American political system into one where government intervention into markets does not exist.

But for all the free-market purity of Charles Koch’s ideology, there is not much of a free market in the corporate reality he inhabits. Koch Industries specializes in the kinds of businesses that underpin modern civilization but that most consumers never see—oil refining, nitrogen fertilizer production, commodities trading, the industrial production of building materials, and almost everything we touch, from paper towels and Lycra to the sensors hidden inside our cellphones. This is the paradox of Charles Koch’s word – he is a high-minded, anti-government free-marketeer whose fortune is made almost exclusively from industries that face virtually no real competition. Koch Industries is built, in fact, on a series of near-monopolies. And it is these kinds of companies that do best in our modern dysfunctional political environment. They know how to manipulate the rules when no one is looking.

Consider the oil refining business, which has been a cash cow for Koch Industries since 1969, just two years after Charles Koch took over the family company following his father’s death. Charles Koch was just in his early 30s at the time, but he made a brilliant and bold move, purchasing an oil refinery outside Saint Paul, Minnesota. The refinery was super-profitable thanks to a bottleneck in the U.S. energy system: the refinery used crude oil from the tar sands of Canada to be refined into gasoline later sold to the upper Midwest. The crude oil was extraordinarily cheap because it contained a lot of sulfur and not many refineries could process it. But Koch sold its refined gas into markets where gasoline supplies were very tight and prices were high.

Why didn’t some competitor open up a refinery next to Koch’s to seize this opportunity? It turns out that no one has built a new oil refinery anywhere in the United States since 1977. The reason is surprising: the Clean Air Act regulations. When the law was drastically expanded in 1970, it imposed pollution standards on new refineries. But it “grandfathered” in the existing refineries with the idea that they would eventually break down and be replaced with new facilities. That never happened. The legacy oil refiners, including Koch, exploited arcane sections of the law that allowed them to expand their old facilities while avoiding the newer clean-air standards. This gave them an insurmountable advantage over any potential new competitor. The absence of new refineries to stoke competition and drive down prices meant that Americans paid higher prices for gasoline. Today the industry is dominated by entrenched players who run aged facilities at near-full capacity, reaping profits that are among the highest in the world. In this industry and others, the big gains go to companies that can hire lawyers and lobbyists to help game the rules, and then hire even more lawyers when the government tries to punish them for breaking the law (as happened to Koch and other refiners in the late 1990s when it became clear they were manipulating Clean Air regulations).

The oil refining business is just one example of how Koch has benefited from complex regulatory dysfunction while public attention was turned elsewhere. In the 1990s, for example, a Koch-funded public policy group called the American Legislative Exchange Council (ALEC) pressured states to deregulate their electricity systems. California was a pioneer in this effort, and the results were disastrous. Lawmakers in Sacramento created a sprawling, hyper-complicated system that surgically grafted a free-market trading exchange onto an aged electricity grid. Virtually no one paid attention to the 1,000-page law as it was being written. Almost immediately after the markets went online in the early 2000s, electricity traders at Koch Industries and Enron began gaming the system. They earned millions of dollars doing so, even as prices skyrocketed and the state’s grid collapsed in rolling blackouts. Lawmakers were blamed when the lights went out, and then Governor Gray Davis was recalled. The role that traders played in the crisis was hard to understand and hidden from view. Federal regulators filed a case against Koch for manipulating markets in California, but the legal proceedings dragged on for more than a decade. Koch ended up settling the charges and paying a fine of $4.1 million, long after the damage was done.

To take another example: In 2017, Koch helped kill part of the Republican tax reform plan to impose a “border adjusted” income tax that almost certainly would have hurt Koch’s oil refining business. The plan was being pushed by none other than Paul Ryan, a onetime Koch ally who was then Speaker of the House. Ryan wanted to include the border adjustment in President Trump’s tax overhaul because it would have benefited domestic manufacturing and would have allowed the government to cut corporate taxes without exploding the deficit. But former Koch oil traders told me that the border adjustment tax would have hurt profits at the Kochs’ Pine Bend refinery in Minnesota. Koch played a vital role in killing the border adjustment tax before a vigorous public debate about it could even begin (A Koch Industries spokesman insisted that the Koch political network opposed the border-adjustment measure only on ideological grounds, because it was basically a tax, and not to protect profits at Koch’s oil refineries) . By the time most people started paying attention, Paul Ryan admitted defeat and jettisoned the border adjustment.

Charles Koch doesn’t talk about issues like this when he talks about free markets. When I met him, Charles Koch was giving interviews for his new book that described his highly detailed business philosophy, called Market-Based Management. I had heard a lot about this philosophy, but what surprised me most when I interviewed the people who worked with him, some for decades, is how much they admire him. They said he was brilliant, but also unpretentious. He was uncompromising, but fair. I felt this way too, the minute I met the billionaire. I remember him telling me something along the lines of: “Hello, Chris! You didn’t need to put on a tie just to see me,” when I walked in the door (my audio recorder wasn’t even running yet, so the quote might be inexact).

Charles Koch’s avuncular, aw-shucks persona masks his true nature. I think of him instead as an uncompromising warrior. He has been fighting since he was a young man. He fought his own brothers, Bill and Freddie, for control of the family company (and won). He fought a militant labor union at the Pine Bend refinery (and won). Most of all, he fought against the idea that the federal government has an important role to play in making the economy function properly—even while taking advantage of government laws to maintain his company’s advantages.

When Charles Koch became CEO in 1967, the U.S. economy operated under a political system that is almost unimaginable today. The government intervened dramatically in almost every corner of the economy, and it did so to the explicit benefit of middle-class workers. This happened under a broad set of laws called the New Deal, which was put in place in the late 1930s. The New Deal broke up monopolies, kept banks on a tight regulatory leash, and even controlled energy prices, down to the penny in some cases. It greatly empowered labor unions and boosted wages and bargaining power for workers. Charles Koch dislikes every element of the New Deal. He has formed think tanks to attack the ideas behind it, donated money to politicians who sought to dismantle it, and built a company that was hostile to it.

As it turned out, the American public joined Charles Koch, to a certain extent, during the 1970s. Vietnam, Watergate, rampant inflation and multiple recessions shattered Americans’ confidence in the government’s ability to solve problems for ordinary people. Passage of the Civil Rights Act shattered the political coalition behind the New Deal, which had relied on Southern segregationists for support. Ronald Reagan rode the tide of antigovernment sentiment to the White House. But even Reagan wasn’t able to repeal the New Deal. He failed miserably when he tried to repeal Social Security, for example. He cut taxes, but never could restrain spending. What emerged during the 1980s and 1990s was an incoherent governing system, one that is deregulated in some key areas, like banking and derivatives trading, but hyper-regulated in others like the small business sector.

If the American political system is confused, Charles Koch is not. He rules over his company with undisputed authority, and he uses that authority to spread his Market-Based Management doctrine. This philosophy inspires the rank-and-file employees at Koch Industries—the company cafeteria is full of young, entrepreneurial workers who thrive in a system that heaps promotions and bonuses on top performers, while unsentimentally weeding out employees considered weak. But the unbending nature of Market-Based Management, and how it applies to the factory floor, played a big role in building the rage that swept through that union hall in Oregon.

When Steve Hammond, the union boss, tried to bargain with Koch, he found himself fighting over ideology, not benefits. In one case, the Koch negotiators wanted to strip down workers’ health care benefits, requiring employees to pay more money out of pocket for their benefits. The Koch team framed their request not as a way to make more money for Koch, but to create a system that better reflected the ideals of Market-Based Management. “It’s a matter of principle,” recalled union negotiator Gary Bucknum. “The principle is that an employee should be paying something toward their healthcare, or otherwise they’ll abuse their health care.” It was hard to bargain against principle. And the unions didn’t have the leverage to fight. The policies that once supported labor unions have been steadily undermined since the 1970s, dragging union participation in the private sector down from about 33% of the workforce to less than 10%. The union took the cut in health care benefits.

The current American political debate is focused on the shiny objects, the high-profile contests between Team Red and Team Blue. But companies like Koch Industries have the capacity to focus on the much deeper system, the highly complicated plumbing that makes the American economy work. This is where Charles Koch’s attention has been patiently trained for decades, as administrations have come and gone in Washington.

Thanks to this focus, Koch wins every time.

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