21 November 2018

How to make American capitalism great again


For many years, the prosperity of the United States offered a resounding argument for the practicality and rectitude of free market capitalism, particularly when ranged against the miserable command economies of the Soviet bloc. At the heart of that success story were all the things that free marketeers wax lyrical about – innovation, creative destruction and competition between companies for their customers’ dollars.

In the last few decades that has begun to change. As Jonathan Tepper and Denise Hearn argue in their new book The Myth of Capitalism, what we now see in America is not so much free markets as “fake capitalism”. Why? Because the key ingredient of true capitalism, competition, has been progressively watered down.

The authors, respectively the founder and head of business development of economic research group Variant Perception, use their own research and a host of academic studies to show how industry after industry is now dominated by just a handful of companies, aided and abetted by politicians and regulators. The upshot is that “the battle for competition is being lost. Industries are becoming highly concentrated in the hands of a very few players, with little real competition.”

The rise of the giants

Monopolies are not a new phenomenon in American history — companies like Standard Oil and US Steel were the Google and Amazon of their day — but The Myth of Capitalism contends that they were not the defining feature of the US economy in the way they are now. Indeed, the explicit strategy of America’s most famous investor, Warren Buffett, has always been to invest in companies with “moats” around them protecting them from real competition.

How did this situation arise? Tepper and Hearn particularly point the finger at both the Department of Justice and the Supreme Court during the Reagan years, which adapted the interpretation of anti-trust law so that for the last few decades pretty much any and every merger has gone through uncontested. The rationale was that bigger firms necessarily meant lower prices, and that therefore mergers were pro-consumer. This, Tepper and Hearn argue, was a purely theoretical justification that has not held up well in reality.

The results of merger-mania are stark: two thirds of US industries are oligopolies and 84 per cent of all profits come from the top 100 companies.  Just five banks control half the country’s banking assets, two firms have cornered 90 per cent of the beer market and three quarters of American households are serviced by just one internet provider. Airlines, mobile phones, online advertising, microprocessors, social media, credit reports, grain, glasses and, perhaps most egregiously, healthcare are all markets cornered by a few players.

To be clear, the authors are not against big companies per se. After all, if a company has significant market share it may be because it is providing a superior service to its rivals and consumers are voting with their feet. What’s more, large firms are able to use their economies of scale to provide goods at lower costs to consumers, which is surely a good thing.

Nor do they accept the Marxist view that big firms gobbling up smaller rivals is an inherent feature of capitalism. Nonetheless, it’s a sign of how bad things have got that the US more resembles Marx’s view of capitalism than a free marketeer’s. Tepper and Hearn point to a study from Credit Suisse that shows that a gobsmacking 50 per cent of all public firms have disappeared in the past 20 years alone. The phenomenon is especially apparent in the tech sector, where the aim for new start-ups now is increasingly not to grow into a player, but simply to be bought by Google, Facebook or Amazon.

Competition or collusion

Nor, as the authors repeatedly demonstrate, is the preponderance of oligopolies proving a boon to the American consumer. In theory, companies ought to battle it out for customers, leading to better service and prices. In reality, dominant firms often prefer to act in either active or tacit cooperation if it means they can all maintain market share and decent profit margins.

This is made worse by the emergence of “horizontal shareholding”, where investors own stock in all the market leaders in a given industry. As the authors note, the “big five” investment companies – Blackrock, Vanguard, State Street, Fidelity and JP Morgan — now own a staggering 80 per cent of stocks of America’s 500 most valuable companies. That only adds to the incentives for firms within a given industry to collude, rather than compete.

As Tepper and Hearn put it: “Today, you can own oligopolies, and those oligopolies are owned by other oligopolies. It’s like an oligopoly layer cake”. This works wonderfully for the likes of Warren Buffett, whose investment strategy has always focused on firms who have “pricing power” in their industries. For him, whether or not monopolies are a corruption of capitalism is beside the point. What matters is that the guarantee of steady returns.

The role of government

How has this state of affairs come about? Contrary to the left-wing view, the massive overconcentration we see in the American economy is not some natural consequence of free market capitalism. Rather, in many cases it is the result of badly drafted and deliberately partial laws and regulations, born of a combination of incompetence, ideological zeal and corruption.

The Myth of Capitalism is a timely reminder that government is often the monopolist’s best friend. By issuing masses of regulations, both the federal and state governments have ensured that only the biggest, most well-resourced firms can get by, while smaller upstarts are strangled by red tape. (The same argument is often made by Eurosceptics, incidentally, about the anti-competitive slew of regulations issuing from Brussels.)

The giants not only don’t mind more regulation, they actively encourage it, as a thicket of red tape is a great way of keeping competitors at bay. The intimate relationship between industry and regulators is clearly a problem too. Indeed, the ease with which corporate operatives enter and exit the “revolving door” with government regulators is startling. Look at the number of former Goldman Sachs employees in both the current and former White Houses, to give just one example.

For all his swamp-draining rhetoric, Donald Trump has actually increased the number of “reverse-revolvers”, who join a federal regulator direct from the industry they are about to start overseeing. That’s before we even touch on the direct payments from companies to politicians in campaign contributions.

Exposing this sort of cosiness should not be the preserve of the left, but of any liberal capitalist worth their salt. After all, enterprise is not free in any meaningful sense if some market participants are effectively buying themselves an unfair advantage. Equally, the incentives for companies to keep innovating and improving the lives of their customers are dampened when their feet are not held to the fire by competitors.

Tepper and Hearn agree that the scourge of uncompetitive capitalism should unite both sides of the political divide. As they put it: “Egalitarians should be appalled by higher inequality. Free market conservatives should be horrified by less competition, economic stagnation, lower productivity and less investment.”

If the book has a weakness, it’s that it probably does not give enough credit to the enhancements in living standards that have been made possible by the newer giants, such as the free Google gizmos we take for granted and the extraordinary range and convenience afforded by Amazon. Although there are lots of eye-popping examples of companies price-gouging their customers, a sense of how the overall cost of living has changed in the last few decades might also have been useful. And on wages, the effects of globalisation and the rise of the Asian economies probably merit more of a mention, as would acknowledging the growth-sapping effects of an ever-expanding welfare state.

The costs of concentration

Nevertheless, the authors make the case against overconcentration with clarity and verve. A lack of real competition is a double-edged sword. It means less choice and higher prices for consumers (or higher than they should be), but it also means less choice and lower wages for workers who have fewer options to shop around. This is a particularly acute problem in rural America, where small towns might only have one or two big employers.

As Tepper and Hearn note, from the 1980s onward “a great divide formed between rural and metropolitan areas in the US. Rural towns were left behind, as gleaming centers of industry increasingly attracted talent by offering high-paying jobs”. Unsurprisingly, the authors point out that there is a strong overlap between areas with high market concentration and votes for Donald Trump.

As well as making it harder for many workers to increase their wages, uncompetitive capitalism means there is little incentive for big firms to innovate, since they can make just as much money by simply buying up other firms and dominating their industries. This is pretty handily demonstrated by the fact that the amount of corporate revenues spent on investment has plummeted – from an average of 20 per cent between 1959 and 2001 to just 10 per cent now.

Worse still, when businesses do innovate, it is taking longer for those changes to filter through to the wider American economy. As Alan Greenspan and Adrian Wooldridge note in their book Capitalism in America: “There is growing evidence that consolidation is slowing the rate of the diffusion of innovations through the economy.” Put simply, that means new things are not happening as quickly as they used to. For a country whose prosperity has always been fuelled by creative destruction, that’s unequivocally bad news.

The sheer cost of bad regulation in some areas is also striking. Note, for instance, that between 1987 and 2014 spending on medicines has increased 1,100%. That’s largely thanks to outmoded patent rules that allow companies to pick their own prices, which in turn feeds through in both higher health insurance premiums for individuals and higher costs for the government in Medicare and Medicaid.

Then there are the drip-drip costs faced by consumers, which mount up – extra charges for airline journeys, for instance, were set to top $80bn last year – and because there are now only a few major carriers, passengers have little choice.

Inequality and competition

The big political conclusion the authors draw from their trawl through the data is that uncompetitive capitalism is what is driving income inequality in the West.  This is a direct challenge to “rock star economist” Thomas Piketty, whose much-feted  book Capital in the 21st Century posited that low growth was the root cause of inequality, with returns on capital outpacing returns on labour to perpetuate the divide between rich and poor.

While leftwingers tend to focus on things like tax avoidance, or low tax rates, Tepper and Hearn argue that what really drives inequality is a combination of low wages and the “everyday toll road of people’s lives”, where a bit of every paycheck is hived off by one monopoly or another. Both of these are exacerbated by over-concentration.

If they are right, and Piketty is wrong about the causes of inequality, it follows that his proposed solutions are also wrong. Although it’s always politically tempting to soak the rich with more taxes, Tepper and Hearn describe this as “like recommending opiates to a cancer patient. It may numb the pain, but it does not attack the cause of the distress”. Instead, they argue that what America needs is “more competition and more capitalism, not less”. If pro-capitalists are not going to shout this from the rooftop, they leave the door open for the simplistic, wrongheaded solutions of the Sanders/Corbyn left – more taxes, more state direction of the economy and, ultimately, less prosperity for everyone.

A way forward?

But how does America get to that promised land of truly free capitalism? Clearly in an economy of 50 states and hundreds of sectors, there is no single, simple answer. That is especially true in the brave new world of the tech giants, where governments are still working out how to even classify their economic activity, let alone regulate it.

Among the solutions Tepper and Hearn propose are clamping down on mergers, breaking up local monopolies, shutting the revolving door between business and regulators, reforming patent rules to bring down drug prices and stopping chief executives pumping up stock prices through share buybacks.

Without wishing to sound too pessimistic, these kind of legal changes could take a very long time indeed, not least as the forces of the mega-companies will be ranged against any politician or regulator trying to make markets more competitive. The hyper-partisanship of American politics also makes consensus-building on matters of common interest more difficult than in previous eras – it’s hard to imagine this Congress coming up with an update of, say, the McCain-Feingold bipartisan campaign finance reform of 2002, even if such a law were on the political agenda.

What may be a simpler, more direct, more capitalist way of proceeding is for Americans to vote with their dollars and their feet — as Tepper and Hearn point out “every day in capitalism is an election”, so if you don’t like monopolies, their advice is: buy stuff from smaller companies, don’t support politicians in thrall to special interests and, perhaps simplest of all, read The Myth of Capitalism (but maybe don’t buy it off Amazon).

John Ashmore is Deputy Editor of CapX.