The Death of Free Markets as a Game of Clue
A Review of The Great Reversal by Thomas Philippon
I am sometimes nervous to buy books with academic publishers, because I know that I should expect pages of charts littered with obscure statistics. If you purchased the French economist Thomas Philippon’s masterful defense of domestic competition as a prerequisite for flourishing markets hoping for plenty of takes on endogeneity bias and getting deep in the weeds on how market concentration statistics are measured and analyzed as well as regulatory differences between the U.S. and Europe, you will not be disappointed. But, for economists, The Great Reversal, actually makes for some nice beach reading this summer.
There are plenty of little details and anecdotes that are usually left out in books like this one. I did not know that Truman’s well-known remark on two-handed economists was preceded by Churchill who said of economists, “If you put two economists in a room, you get two different opinions, unless one of them is Lord Keynes, in which case you get three opinions.” I can’t believe that wonderful little quote missed the cut in Zachary Carter’s biography of Keynes. I had forgotten how then-Freshman congressman turned Never Trumper, David Jolly, demonstrated in a 60 minutes segment just how distorted incentives had become in Washington with all Congressmen expected to spend more than 30 hours per week cold calling potential donors to hit fundraising targets. Surely, even Jimmy Stewart could not have foreseen just how far we have drifted from the project of establishing self-government envisioned by the Founders. I was also unaware of how Newt Gingrich’s pioneering brand of culture war politics, attacking the line items funding Sesame St. on the grounds of progressive indoctrination, did not work so well pre-Twitter, backfiring spectacularly following a grassroots mailing campaign in support of Sesame St.
All of these details made the book more engaging than I typically expect from economists. But maybe I shouldn’t be so surprised. As Paul Krugman has noted on Twitter, the economist that sits down for a sustained period of time to write a book that implicates himself in the messy world of politics belongs to a noble, but dying breed. That is simply not how economists behave in their natural habitat at universities.
The gift that Philippon possesses that compels him to drift from other members of his tribe is that he sees the world so clearly though an honest interpretation of data, eschewing the abstract models the profession is mostly inclined to uncritically accept. The whole point of a theory of how the economy is supposed to work is to know when the data is telling you that it is in fact going off the rails. Along these lines, I would argue that the central detective story of the book is why the labor share of national income has deviated so far from the 2/3 proportion that is as close to an Iron Law as exists in economics. Philippon appears to argue that it is this statistic, which is observed only in the U.S. and not in Europe, that is the clue to the larger phenomenon of why American markets lost their distinctive allure at the precise moment in 1999 when the younger Phillipon arrived at Logan International Airport in Boston motivated to study their features based on their sterling reputation. In a strange twist of history, Philippon’s contingent of European economists and policymakers were largely successful in adopting the insights to be learned from American markets, making their countries more competitive and easing the burden of regulatory restrictions. As a consequence, there has been a great reversal, which Philippon succinctly characterizes in the conclusion:
European countries have not generally been at the forefront of good and innovative economic policies over the past 30 years….[and] that’s the irony. The reason EU consumers are better off than American consumers today is because the EU has adopted the U.S. playbook , which the U.S. itself has abandoned.
As modest as a decline of 6 percentage points over two decades may appear to the untrained eye, the distributional repercussions in terms of loss of consumer welfare in the U.S. relative to Europe are enormous.
However, just because we can prove reasonably well that there has been massive upward redistribution to capital (with the important caveat that some of the upward redistribution has gone to segments within labor) does not necessarily imply that the causes of that distribution are unnatural. After all, according to some industry proponents, maybe capital really has become more important in the production of goods and services due to exogenous shocks that have occurred over the last 20 years. Philippon isn’t convinced for reasons that relate to the nature of the clue—the decline has only been observed in America. If the shocks were truly exogenous, we would expect similar effects to be observed in all developed countries. On these grounds, Philippon rejects the lower search cost hypothesis, intangible asset hypothesis, the globalization hypothesis, and the trivial much ado about nothing hypothesis. The final hypothesis posits rather ridiculously that patterns of market concentration and capital’s dominance in the economy are mere statistical anomalies in spite of their recurrence. Fundamentally, all these explanations suppose that the distributional balance could be upset when either technological and patent advances or foreign competition occur, as was certainly true in the first 15 years of the 21st century. But there is little evidence to suggest that either of those factors should be experienced disparately on each side of the Atlantic.
The superstar firm hypothesis may be a satisfying explanation for declining labor share of national income due to the resurgence of monopsony power in labor markets, previously only studied by heterodox economists like Joan Robinson, but does not account for the explosive combination of lower wages, lower investment, and lower productivity, some economists have characterized as secular stagnation. It rationalizes the clue, but does not explain the death of the old Fordist model of American capitalism, where wages fueled investment, profits were retained then reinvested so as to sustain increases in productivity. Instead, an environment of declining domestic competition has made it so incumbent firms, especially the superstar firms of the Information Age’s commanding heights which Philippon refers to by the acronym GAFAM, feel entirely comfortable rejecting that model of the economy, favoring the divest and distribute mode of corporate governance signified by skyrocketing corporate buybacks.
Although Philippon does not say so explicitly, he appears to argue that many of the misgivings progressives have about contemporary political economy would be waved away if only they were to grant enlightened bureaucrats at autonomous regulatory organizations the authority to revive domestic competition so incumbent firms feel less secure in their ability to extract rents. My skepticism notwithstanding, declining domestic competition is undoubtedly the syndrome of secular stagnation for the reason stated by Philippon’s review of historic turnover of dominant firms, “Market shares have become more persistent. You can easily predict who will be on top 5 years from now—the same firms as today.” This is the essence of what it is implied by the term stagnation; capitalism deprived of its essential quality of creative destruction. And unlike Philippon’s European colleagues who had the sense that European markets did not adequately deliver the goods and there was much to learn from 20th century America, 21st century America is entirely satisfied with the market dominance of its superstar firms, blinding us to the reality that markets have ceased to function as they once did.
The details of how markets ceased to function are illuminating as Philippon has an astute eye for contextualizing economic data with news coming from the business world, especially relating to mergers and acquisitions and the entry of innovative firms in European markets. In perhaps the most salient evidence for his Great Reversal thesis, in a timeline of just 3 years, the French telecommunications industry charged more for mobile phone plans than in the U.S., which became 25 percent cheaper by the end of the period. Likewise, for the airline industry, a wave of controversial mergers beginning in 2008 was a Rubicon moment for competitiveness over American skies with stark and growing disparities relative to Europe.
The trouble with these recent events, which Philippon places squarely within the 21st century and not further back in the Reagan administration, is that they create a path dependence where increasing markups among dominant firms fortifies their dominance vis-à-vis the real economy. When the political system has few constraints on the tendency for economic affluence to breed political influence, welfare-reducing concentration could become locked-in. Rent-seeking, protected by the full force of lobbyist mercenaries and even more perniciously campaign contributions flowing through anonymous dark money groups, will simply become a permanent feature of American markets for goods and services and for labor in key industries.
The threat is in fact real. Lobbying is more concentrated among dominant firms in the U.S. than Europe, suggesting these firms view lobbying as a protective device to preemptively anticipate threats to their business models. Even gloomier, campaign contributions dwarf those of Europe, on the order of 50 to 1 in most European countries normalized for country GDP.
Yet I think it would be a mistake to portray a deterministic tendency of institutional decay where the norms and policies that once worked lose their distinctive ability to adapt giving way to broader civilizational decline. Philippon approvingly cites the Italian-American economist, Luigi Zingales. His book, A Capitalism for the People, a manifesto that hopes to stop American capitalism’s slide into another variant of the nepotism rampant in the Italy of his youth, is a complementary treatise on free markets. Zingales is correct to explore the civilizational overtones of the institutional decay of market societies, or more broadly, open access orders. Another more recent book wonders whether civilizational collapse can always be explained by out of control rent-seeking.
Even as it is increasingly difficult to deny that America is on that course, I am left thinking about an Obama speech that I regard as symbolizing the lost promise of his 2008 campaign. In that speech, delivered as the economy was imploding, he used Christian imagery to argue that the Great Financial Crisis presented a new opportunity to rebuild the economy on a New Foundation, not one of sand, but of stone. Though the original intent was sabotaged by the poverty of ambition of mere crisis management, Obama was the first mainstream politician to articulate explicitly that ridding these industries of rent-seeking is the only reliable strategy to reverse America’s unwinding. The reason why I happened to recall that Obama speech, which increasingly feels like ancient history, is that Philippon singles out precisely finance and health care as particularly odious departures from free market principles. He shows that releasing finance out of the constraints of Bretton Woods restored the premium financial professionals garnered in the labor market out of step with the priorities of the real economy, noting that clever strategies to execute trades a fraction of a second faster than competitors is unmoored from the original mission of finance as intermediaries and unlikely to generate welfare gains. In a similar vein, he illustrates that American health care expenditures are truly off the map and diverged sharply from the EU after 1990.
In identifying the worst offenders, Philippon clearly outlines the scope of the problem as well as a political sensibility to institute the kinds of government regulation demanded of economic liberals to foster domestic competition, while removing interventions that are purely distortionary, such as housing GSE’s. There is also a deep understanding of the forces of institutional decay. If Americans intend to restrain their superstars from perversely jeopardizing everything they hold dear by charging markups that erode their wages and ensure rent claims are delivered in perpetuity, aggressive actions must be taken to build a New Foundation on stone, a marvelous foundation where American free markets are properly situated. Or, to quote the Italian novel, “For everything to remain the same, everything must change.” When it comes to free markets, a nation in repose is a nation in decline.