It began with a simple question: “Why on earth are US cell phone plans so expensive?” In pursuit of the answer, Thomas Philippon embarked on a detailed empirical analysis of how business actually operates in today’s America and finished up by overturning much of what almost everybody takes as read about the world’s biggest economy.
Over the past two decades, competition and competition policy have atrophied, with dire consequences, Philippon writes in this superbly argued and important book. America is no longer the home of the free-market economy, competition is not more fierce there than in Europe, its regulators are not more proactive and its new crop of superstar companies not radically different from their predecessors.
Philippon, a professor at New York University, is one of a list of brilliant economists of French origin now teaching in the US. Others include the recent Nobel-prize winner Esther Duflo, at the Massachusetts Institute of Technology, Olivier Blanchard, former chief economist of the IMF, and Emmanuel Saez and Gabriel Zucman, both now at Berkeley.
It is not obvious, however, that these people share all that much, apart from their national origin and an inclination not to take free-market platitudes for granted. Sceptics of Philippon’s controversial thesis might assert that a French economist must be ideologically opposed to American capitalism. But Philippon insists that he believes passionately in the value of competition. Indeed, The Great Reversal contains a chapter arguing just that. Moreover, each step in his argument is based on meticulous analysis of the data.
He crisply summarises the results: “First, US markets have become less competitive: concentration is high in many industries, leaders are entrenched, and their profit rates are excessive. Second, this lack of competition has hurt US consumers and workers: it has led to higher prices, lower investment and lower productivity growth. Third, and contrary to common wisdom, the main explanation is political, not technological: I have traced the decrease in competition to increasing barriers to entry and weak antitrust enforcement, sustained by heavy lobbying and campaign contributions.”
All this is backed up by persuasive evidence. Those prices of broadband access in the US are, for example, roughly double what they are in comparable countries. Profits per passenger for airlines are also far higher in the US than in the EU.
The analysis demonstrates, more broadly, that “market shares have become more concentrated and more persistent, and profits have increased.” Moreover, across industries, more concentration leads to higher profits. Overall, the effect is large: the post-tax profit share in US gross domestic product has almost doubled since the 1990s.
There are a number of reasons for the increase in market concentration. In manufacturing, competition from China played a role by driving weaker domestic competitors out of the market. For the rest of the economy, we need other explanations. In the 1990s, superstar companies, including the retail giant Walmart, drove the rate of investment and productivity growth upwards. The reverse happened in the 2000s, however: rising market concentration drove the profits of entrenched companies up and both the investment rate and productivity growth down.
This malignant form of increased concentration reflects significantly diminished entry of new businesses and greater tolerance of merger activity. In other words, the US economy has seen a significant reduction in competition and a corresponding rise in monopoly and oligopoly.
To drive the argument home, the book turns to comparisons with the EU. Many readers will laugh: after all, isn’t the EU an economic disaster? When one compares changes in real gross domestic product per head, the answer, however, is: not really.
From 1999 to 2017 real GDP per head rose by 21 per cent in the US, 25 per cent in the EU and 19 per cent even in the eurozone, despite the damage done by its ineptly handled financial crisis. Levels of inequality and trends in income distribution are also less adverse in the EU, so increases in incomes have been more evenly shared.
In short, comparisons between the EU and the US are justifiable. These show that neither profit margins nor market concentration have exploded upwards in the EU as they have done in the US. The share of wages and salaries in the aggregate incomes — so-called “value-added” — of business has fallen by close to 6 percentage points in the US since 2000, but not at all in the eurozone. This destroys the hypothesis that technology is the main driver of the downward shift in the share of labour incomes. After all, technology (and international trade, as well) affected both sides of the Atlantic roughly equally.
Note that Philippon is making a narrow claim about differences in product market competition. The EU economy is not stronger in all respects, he stresses. On the contrary, “The US has better universities and a stronger ecosystem for innovation, from venture capital to technological expertise.”
Nevertheless, competition in product markets has become far more effective in the EU over the past two or three decades. This reflects purposeful deregulation within the single market — ironically, given the tragedy of Brexit, a UK-driven policy innovation that originated with Margaret Thatcher — and a more aggressive and independent competition policy. The two sides of the Atlantic have switched their focus on the need to preserve and promote competition.
One fascinating proposition is that the EU has established more independent regulators than either its individual members or the US would do (or have done). This is a healthy result of mutual distrust within the EU. Individual states abhor the idea of being vulnerable to the whims of fellow members when it comes to regulation and so prefer fully independent institutions. This is particularly beneficial to countries with weak national regulators. The independence of its regulators also makes returns to lobbying relatively low in the EU.
The evidence is clear. The higher an EU member country’s product market regulation in 1998, the bigger the subsequent decline in such regulation. The effect is also far stronger for members of the EU than for non-EU members.
These developments reflect differences in politics. Lobbying, both against deregulation and for favourable regulation, is much fiercer in the US. Overall, evidence strongly supports the notion that this lobbying, which is inevitably dominated by big companies, works. Why else would people pay for it?
If you’re a lobbyist who never gave us money, I didn’t talk to you. If you’re a lobbyist who gave us money, I might talk to you
The data on the role of money in US politics are even more dramatic. Members of Congress spend about 30 hours a week raising money. The Supreme Court’s perverse 2010 “Citizens United” decision held that companies are persons and money is speech. That has proved a big step on the journey of the US towards becoming a plutocracy.
As former representative Mick Mulvaney (a man gaining a reputation for beguiling honesty) stated in April 2018, “If you’re a lobbyist who never gave us money, I didn’t talk to you. If you’re a lobbyist who gave us money, I might talk to you.” One can indeed get the best congressperson money can buy.
Corporate lobbying is two to three times bigger in the US than the EU. Campaign contributions are 50 times larger in America than in the EU.
The Great Reversal also examines the situation in three crucial industries: finance, healthcare and “Big Tech”.
On finance, the startling finding is that the cost of intermediation — how much bankers and brokers charge for taking in savings and transferring them to end users — has remained around two percentage points for a century. All those computers have made no difference. This then is a rent-extraction machine. That really has to change.
There are two things about America that most outsiders will never understand: its gun laws and its healthcare system. The US spends far more on healthcare (not much below a fifth of GDP) and yet has far worse health outcomes than any other high-income country. How has this happened?
The answer is that the system creates rent-extracting monopolies from top to bottom: doctors, hospitals, insurance companies and pharmaceutical businesses all feed at this overflowing trough.
Finally, Philippon sheds light on what he calls the “GAFAMs” (Google, Amazon, Facebook, Apple and Microsoft). He demonstrates that the economic weight of these titans of tech is no bigger than that of the giants of the past. But their links to the economy as a whole are far smaller. It is no surprise, therefore, that their impact on productivity growth has also been relatively modest.
The author convincingly challenges the view that these businesses’ monopoly positions are the natural product of economies of scale and network effects. So something can and should be done. In rising order of radicalism, these would be: preventing dominant companies from acquisitions or forcing them to divest; limiting their ability to exploit dominant positions by imposing interoperability with other networks and data portability; and breaking them up.
The Great Reversal also notes the rise of monopsony — the monopoly power of buyers — in labour markets, via restrictive contracts, occupational licensing and restrictions on entry. Deregulation needs to focus on such barriers.
As economists have known since Adam Smith, business on its own will pursue restraints on competition, and with great enthusiasm. The outcome is rentier capitalism, which is both inefficient and politically illegitimate. The difficulty, however, is that it can be far too easy for incumbents to buy the political and regulatory protection it desires.
What should the US want? The answers, suggests Philippon, are: free entry; regulators prepared to make mistakes when acting against monopoly; and protection of transparency, privacy and data ownership by customers. The great obstacle to action in the US is the pervasive role of money in politics. The results are the twin evils of oligopoly and oligarchy.
Donald Trump is in so many ways a product of the defective capitalism described in The Great Reversal. What the US needs, instead, is another Teddy Roosevelt and his energetic trust-busting. Is that still imaginable? All believers in the virtues of competitive capitalism must hope so.
Martin Wolf is the FT’s chief economics commentator
The Great Reversal: How America Gave up on Free Markets, by Thomas Philippon, Belknap Press RRP$29.95, 368 pages
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