Keep McKinsey Away from Biden's Infrastructure Push
McKinsey is overpriced and corrupt. It is also gunning for government cash.
|Matt Stoller||Apr 5||60||21|
Welcome to BIG, a newsletter about the politics of monopoly and finance. If you’d like to sign up, you can do so here. Or just read on…
Today’s issue is about why Biden needs to keep McKinsey away from infrastructure money, and more broadly how America needs to take on government contractors and consultants if we ever want to have nice things again. Plus a follow-up on the Suez mess, and a nugget on how stopping a merger in the safety razor market helped bust a half century old monopoly.
The New Deal or McKinsey. Pick One.
If there’s one striking feature of the Biden administration so far, it’s the rejection of Barack Obama’s policy framework by his own party. It is now the consensus that Obama’s lack of ambition led to Trump’s election. For instance, party leader Senator Chuck Schumer recently called the Obama stimulus a “mistake” and “a small measly proposal” on CNN, as a way of selling Biden’s much larger proposals.
Biden’s goal, and that of the Democratic Party that controls both houses, is to break from recent politics, and be “more like Franklin Delano Roosevelt (FDR) and the Congress of 1933, and less like Barack Obama and the Congress of 2009.” Biden wants to spend a lot, to go big, instead of the go small vision of Obama.
Last week, the Biden administration laid out a $2 trillion vision on infrastructure called the American Jobs Plan. The theory behind the American Jobs Plan is that the U.S. has a few key challenges, all related to the physical design of the country. We have to wean ourselves off of Chinese imports, deal with climate change, and create a more equal economy. The American Jobs Plan is the proposed solution. It will do everything from expand broadband to repair roads and bridges using “cleaner cement and steel,” upgrade ports and electric grids, subsidize semiconductor factory investment, and on and on, all with inputs “made in America and shipped on U.S.-flagged, U.S.-crewed vessels.”
It’s a bold vision. One important question is whether it’s actually possible to spend that amount of money on so many things without immense amounts of corruption or waste. The difference between FDR and Obama, after all, was not just spending amounts. Obama didn’t spend enough, but he did spend a lot. FDR, however, actually built things, whereas Obama’s stimulus money for, say, California’s high-speed rail, evaporated into a cloud of consultants. (A particularly mean joke was that FDR won WWII in less time than it took Obama to build Obamacare web sites that didn’t work.)
Biden isn’t inheriting a well-functioning government, so pushing $2 trillion through a battered public sector is going to lead to problems. To understand Biden’s challenge, we should go to the last time America had to build a bunch of infrastructure. In 2017, in Puerto Rico, hurricane Maria wiped out the island’s electric grid. If you want to know the nightmare scenario for Biden’s infrastructure plan, start there.
McKinsey: The Government’s Brain
When I was a Senate staffer, one of the worst pieces of legislation I worked on was called PROMESA. It was June of 2016, and Puerto Rico was having trouble paying back $70B+ of its state debt. There are no bankruptcy provisions for U.S. territories, so Congress stepped in and appointed a control board of bankers and technocrats to govern the island, the idea being that the democratically elected government had been fiscally reckless, and the Federal government should step in.
The control board hired McKinsey, the management consulting firm, as the island’s ‘strategic consultant,’ with the goal of getting Puerto Rico back to fiscal solvency. A little over a year after Congress passed PROMESA, hurricane Maria hit. Puerto Rico’s water, health and electric systems were weak, which the hurricane exposed by ripping through the island’s physical plant.
For the last five years, McKinsey has detailed highly paid consultants to help the control board both renegotiate debt and oversee infrastructure spending. Has the rebuild gone well? In short, no. The unelected control board has allowed the awarding of electric grid contracts to corrupt insiders, so power outages are still common. Mass protests forced the governor’s resignation in 2019. And schools are closing even as the government continues to pay government salaries to people who don’t work for the government.
So what has McKinsey been doing, if it hasn’t been running Puerto Rico? The answer is, McKinsey has been looking out for McKinsey. It has ensured that Puerto Rico will spend the mind-bogglingly large sum of $1.5 billion on professional services, meaning lawyers, bankers, and consultants (including McKinsey), which is five times what Detroit paid in services for its bankruptcy. I don’t know how much the firm will make, but according to the GSA schedule, just one recent college graduate working at McKinsey costs around $3 million a year. Beyond the straight fee extraction, the conflicts of interest are comical; McKinsey’s internal hedge fund actually owns Puerto Rican bonds.
Far from an anomaly, such a situation for McKinsey is common. McKinsey helped ruin the U.S. spying apparatus with a bloated, failed contract. They helped run Trump’s U.S. Immigration and Customs Enforcement; ICE even hired McKinsey to write its own contract. McKinsey structured France’s terrible coronavirus response, and that of New York state. McKinsey is so brazen that it was caught by the GSA Inspector General for cheating the government out of $65 million. It didn’t seem to matter. In 2019, McKinsey worked for more than 15 federal agencies and departments, and 25 states.
This broad range of clients gives McKinsey a cartel-like relationships with the circle of law firms, investment banks, and fellow professional services firms involved in bankruptcies, infrastructure spending, and other specialized institutional work.
Joe Biden’s infrastructure plan is a good plan, in theory. We need to do a lot of what Biden wants to do. The problem is that every overpriced government contractor out there is gearing up to steal as much of the $2 trillion as they can. And they will try to steal it the way McKinsey has, by taking advantage of bad policy choices that turned the government into a sucker.
If Biden wants to make his plan functional, he should follow FDR’s model.
Stop the Real Steal
Roosevelt’s first major infrastructure battle was over Muscle Shoals in Alabama, the great hydroelectric resource. The Morgan interests and the electric utility magnates wanted that resource privatized for their use. Roosevelt said no, and had the government directly build the Tennessee Valley Authority, a publicly owned and operated electric utility for much of Appalachia. TVA was part of a package of reforms to constrain and control Wall Street, to end what FDR called the ‘informal economic government of the United States.’
Over the rest of the New Deal, FDR transformed the physical plant of the country, and spent a lot of money on infrastructure. But Roosevelt first made sure Wall Street had little say over how public money or public resources were spent. Public institutions got bigger and more competent, and the financiers and monopolists lost power. One key result is that the government could do big things. During World War II, military procurement officers had immense capacity and power, imposing tight control over contractors, and ensuring that there were at least a dozen competitors for each major weapon system. They could peer into the books of contractors, and even claw back excessive profits.
America used this governing capacity for decades, constructing the national highway system, winning the space race, deploying the polio vaccine, landing on the moon and building the internet, and running the project Sematech in the 1980s to address foreign threats to semiconductors.
In the 1990s, however, Bill Clinton’s “Reinventing Government” initiative killed the public capacity Roosevelt had constructed. Clinton encouraged the big prime defense contractors to merge, shrinking them from over 100 to just 5 firms. Clinton’s procurement initiative, led by Steve Kelman, invented a whole new vocabulary for ways to let contractors steal. The details get complex, but the gist was a ‘light touch’ approach to negotiating by the government. Procurement officers stopped making hard-nosed demands for better prices, and were stripped of the ability to look at the books of the contractors to make sure there weren’t excess profits.
Government began using a new set of contracts to get rid of competition and negotiating in contracting; today, agencies can just order stuff from pre-approved contractors without doing much negotiating. Procurement officers don’t have to write a full-blown solicitation with clear specifications, and contractors no longer have to put together a real proposal. There’s very little competition in any of it. And contractors are eager to make the system even worse, with some asking for Biden to stop requiring them to list any prices at all when selling to the government.
This kind of buying system - no prices, no transparency, no competition - is precisely the opposite of what firms like Amazon, Walmart, and other ‘power buyers’ do to wring efficiency from their suppliers. Walmart, for instance, goes into excruciating detail to learn everything about its suppliers, making detailed demands about every facet of every product, including price. Unlike the government, Walmart acts like a monopoly buyer, and demands value for its money.
The problem isn’t just that Uncle Sam gets ripped off. The net effect of encouraging laziness and monopoly throughout the government procurement process is poorly thought out initial requirements, which of course results in bloated costs and failed projects later on. If you half-ass an initial proposal, the cost will explode when you’ve built half of it, and find out you’ve built it wrong. This problem is pervasive throughout America; New York City, for instance, is on the verge of collapse, and infrastructure costs in the U.S. are laughably expensive. (I did a bunch of interviews with people in construction to find out why, and the best explanation I got was because American public officials tend to change requirements a lot more in the middle of projects.)
All of this boils down to hiring capable people as procurement officers, demanding they be aggressive in negotiating with contractors, and breaking up large firms so there is competition over the government’s business. It also means no longer using firms like McKinsey, because such firms don’t actually offer any value.
There is hope. Operation Warp Speed, which super-charged vaccine development and roll-out, was probably the most effective government project since the moon landings. And ideologically, there’s a lot more interest in the public sector these days. Nevertheless, the financial power spread out among bankers, government contractors, Silicon Valley monopolists, private equity shops, and management consultants is going to be a real problem, since each will try to grab as much of that infrastructure money as possible and do as little work to get it as possible. That will become clear over time, as infrastructure spending scandals inevitably emerge. Hopefully, Biden will take the right lesson, and begin reconstructing capacity in the public sector.
If he doesn’t, his legacy won’t be the New Deal. It’ll be a failed Presidency, and a lot of new Teslas for government contractors.
Ending the Safety Razor Cartel: Why Blocking Mergers Is Good for Business: Stopping mergers is good for business. Take a very simple consumer product - razors and razor blades for shaving, or disposable wet shave safety razors.
Razor blades are an overpriced product with known excess profits, so much so that selling low-margin razors so you can sell high-margin razor blades in the aftermarket is now a business strategy cliche. The razor business is, like most consumer packaged products, all about distribution. Prior to the internet, that meant getting into stores. "Shelf space is diamond-encrusted gold. It's exposure to the consumer and everyone wants exposure to the consumer," said one retail analyst in 2005.
Gillette, now a part of P&G, had so much power that it still controlled 70% of the market in 2010, even though razors as a disposable wet shave razor product are more than 50 years old (with Schick controlling the rest). And the incumbents exploited their power, with yearly annual price increases and nice margins for a commodity product. (This market power insulated P&G from having to compete, so the consumer conglomerate now is a giant sleepy company whose workers don’t really do much work.)
In 2013, Harry’s launched, challenging the duopoly of P&G and Schick by going direct to consumer online. A similar firm, Dollar Shave Club, also entered the space. Both firms sold razors cheaper than the giants, but did so only online, which meant that the incumbents maintained much of their power by controlling retail shelf space. However, in 2016, Harry’s got shelf placement in Walmart, Target, and other big box stores. The result is Schick and P&G had to cut prices.
Enter the buyouts. In 2016, Unilever bought Dollar Shave Club, in a transaction that should have been challenged by the Obama DOJ, but was not. Still, Harry’s continued putting pressure on the giants. Three years later, Schick tried to take out the remaining challenger by buying Harry’s. The FTC, however, filed a case against the merger, and Schick walked away from the deal.
Opponents of stronger antitrust laws say that blocking mergers will harm the economy. Is that true? Dan Primack in Axios Pro Rata published a story on what happened next. The CEO of Harry’s, Jeff Raider, raised $155 million from Bain Capital Ventures and Macquarie Capital at a higher valuation than Schick had offered, with the goal of using this money to expand its product line. As Raider put it: "We had expanded into other standalone brands on our own and were super excited about taking over their portfolio, but when the deal didn't go through we still thought we had come up with compelling ideas."
Today Harry’s product line “includes men's and women's shaving products, shampoos, deodorants, lotions and even fresh cat food.” And Raider wants to expand more. In other words, blocking this merger helped everyone in the market - consumers got cheaper razors, Harry’s owners got more value, and now there’s going to be more competition in consumer packaged goods more generally. The only entities who lost out were P&G and Schick.
The Big Dumb Ship Problem Is Much Worse Than We Think: I got a bunch of fascinating responses to my last issue of BIG, What Can We Learn from a Big Boat Stuck in a Canal? I found this one particularly insightful.
You said in your note below… “...frankly, we should have seen this coming, because a lot of people have been noticing supply chain fragility, even if Thomas Friedman didn’t."
Well some of us in the industry have been aware of this for a very long time and have been writing about it. Tom Friedman is a nice guy, along with all of the other observers of how the world should be working. But logistics and supply chain management is usually considered boring and get almost no airtime… until this!
The concentration of risk in these E+ Class ships is huge. Actually though, a bigger risk to global commerce is if one of these monsters falls over in the entrance channel to a regional hub, such as Rotterdam or Long Beach. Blocking Suez is one thing as there is an alternative (sail round the horn of Africa) albeit taking more time. But blocking access to Rotterdam hits traffic in an out. Diversion are possible, but this impacts road and rail links into and out of the alternatives (e.g Hamburg, Le Havre). These cannot be replicated at scale fast enough for the present velocity of global trade. Example when China shutdown due to the pandemic, the problems were caused globally when they restarted, due to boxes and ships being in the wrong place.
The chaos can best be described as analogous to that of a hub airport having a baggage handling system failure. It’s not so much the bags in the system that are a problem, it’s the bags arriving on inbound flights and the bags arriving with passengers for outbound flights. Now scale this up to billions of dollars of containers with general cargo, bulk carriers with commodities such as grain or ore, Ro Ro vessels, etc. etc. etc.
I have done several studies including one for the US Government (related to the potential of terrorist exploitation) awhile ago about the likely impact of events such as this. Back then the biggest ships were around 10K TEU per vessel, but even they were too big for many ports to handle. In the US, Halifax on the East coast and Long Beach on the west coast, can reliably handle the 24K TEU ships. The scale of cranes needed to offload them is also a challenge, as are the bayplan systems to operate the loading/offloading process. Get that wrong and the balance goes and the ship flips. This is not uncommon in some parts of the world.
Finally, the dirty little secret of global shipping is the number of mis-declarations on the manifests. This is why when some vessels catch fire, even though the containers are identified in the firefighting systems, a full on emergency is declared as the master and ship owners cannot trust what the manifest says. Shippers are supposed to declare hazmat goods and follow IMCO regulations, but the often don’t declare the hazmat and plan the game that there will not be a problem… Until there is.
The point I wish to make in writing to you, is that you are correct to highlight the problem this has caused, but it’s only one piece of a very complex puzzle. Ask Lloyds about this and they know it’s a problem in waiting… Well it has turned up - in a fortunately brief example, according to the reports in todays List and the mainstream media.
The truth is out there… as a TV show used to claim… You just need to look a bit harder. ;-)
Economies of scale are great, until they aren’t.
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