The deregulation of major U.S. industries like telecom and energy in the 1970s and 80s sparked competition that lowered consumer prices and drove product innovation between competitors. Europe, on the other hand, lagged behind with more expensive internet, phone plans, airline tickets, and more until around 2000 when a major reversal of this trend began. Strikingly, when the EU strengthened deregulation and antitrust efforts to open its markets to more competition, it was the U.S. that reversed course.
According to a new book by French economist Thomas Philippon, Americans’ view of their country as the world’s beacon of free market competition and Europe as an over-regulated region of lethargic corporate giants is out of date, and may be inhibiting our ability to recognize growing corporatism at home. Philippon, a professor of finance at NYU Stern who earned a Ph.D. in Economics from MIT, was named one of the top 25 economists under age 45 by the International Monetary Fund.
“If you have nothing interesting or relevant to say, you can always take a jab at European bureaucrats. It’s the political equivalent of complaining about the weather…”
Based on Organization for Economic Cooperation and Development (OECD) data, the U.S. now has more regulations for opening a new business than every EU country except Greece and Poland — a complete reversal since 1998, when only the UK had fewer rules than the U.S. Per capita GDP growth in the EU outpaced that of the U.S. over 1999-2017. On a purchasing power parity basis, Americans have experienced a 7% increase in prices (relative to EU residents) for the same goods, due specifically to increased profit margins of companies with reduced competition.
The reason for this divergence? According to Philippon, corporate incumbents in the U.S. gained outsized political influence and have used it to a) smother potential antitrust reviews and b) implement regulations that inhibit startups from competing against them. As a result, the U.S. regulatory system prioritizes the interests of incumbents at the expense of free market competition, he says.
Philippon makes his case in "The Great Reversal: How America Gave Up on Free Markets," released this past Tuesday by Harvard University Press. The book builds an argument from extensive data and pre-empts likely critiques by investigating numerous potential confounding variables or differences in research methodology. It is a compelling read for those interested in the dynamics of the overall innovation economy or the political debate over antitrust and Big Tech.
Incumbents over startups
Philippon, who was na states upfront that he isn’t claiming Europe is a bigger startup hub. In fact, he writes that “the U.S. has better universities and a stronger ecosystem for innovation from venture capital to technological expertise.”
What he does do is ring the alarm about a systemic shift in market consolidation in the U.S. that results in a small number of large incumbents charging high prices, an economy-wide prioritization of share buybacks over investments in innovation and government policy that inhibits competition from new entrants.
An important take-away for readers: there's a concerning trend toward more barriers to successful entrepreneurship, higher prices for countless goods and services that startups use, an overall decrease of corporate investment in new technologies and fewer potential startup acquirers.
There are half as many publicly-traded companies in the U.S. as there were in 1997, and turnover within rankings of the top five companies per industry has declined sharply since the late 1990s as well.
Market concentration isn't due to superstars
"The Great Reversal" considers that increased market concentration could be the result of "superstar" firms whose increased productivity is a win-win for shareholders and consumers alike. This has indeed occurred during the 1990s but the correlation between increased concentration and increased productivity ended around 2000 (with the exception of the retail sector).
Corporate after-tax profits as a percent of U.S. GDP were stationary for decades at 6-7% but increased to 10% in the last two decades, highlighting increased "rent-seeking" that shouldn't occur if the leaders in most industries were facing the same amount of domestic competition or increased international competition.
From the 1960s through the 1990s, American companies poured an average of 20 cents from each dollar of operating profit into investments (R&D, capital expenditures, etc.). Since 2000, that's fallen to 10 cents per dollar. With reduced competition, large companies are focusing less on advancing their product offerings and more on extracting profits for shareholders out of existing business operations.
Big tech isn't exempt
Major tech companies — specifically Alphabet (Google), Amazon, Facebook, Apple, and Microsoft — are the focus of multiple chapters of analysis by Philippon, who rejects the notion that these companies are somehow unprecedented relative to the leading companies of prior decades from an antitrust standpoint. They account for a smaller portion of U.S. GDP and stock market value, and they have similar profit margins. Network effects and accelerating economies of scales are not new concepts in economics — existing antitrust regulations are capable of dealing with these companies.
In our interview, Philippon said that leaders of monopolies typically claim they need to maintain their monopoly in order to have the means to invest in innovation. He calls it bogus — companies innovate when competition pushes them to find ways to offer a better product at lower cost. Admittedly, the tech community has perhaps bought in too much to the narrative that the dominance of Alphabet, Apple, and Facebook has provided more long-term R&D into endeavors that will advance humanity.
These companies' "moonshot" projects act as effective marketing for this narrative, distracting from the many billions more dollars that would be poured into innovation investments in the economy if the markets they are in were more competitive.
America’s most important industries are among its least competitive
Philippon acknowledges that the heart of America’s problem isn’t its failure to effectively regulate Silicon Valley; it’s the failure to stop increased concentration in the industries that most shape consumer spending: healthcare, energy, transportation and telecommunications.
During our interview, he estimated that this “great reversal” in the U.S. has cost the median household an additional $300 per month in markups on goods and services — reduced competition has allowed incumbents to increase profit margins at the expense of consumers.
The lack of competition in these industries contributes to America's deteriorating infrastructure. More than 700,000 Californians experienced blackouts in recent weeks due to Pacific Gas & Electric's failure to make capital expenditures that maintained and improved its assets. Most of the 15 million people who live inside the utility's service area have no where else to turn.
What makes Europe different
A critical factor in Europe’s relative improvements over the U.S., Philippon argues, is the greater independence of EU regulatory agencies like the Directorate General for Competition from corporate or political influence. In negotiating over the creation of these agencies, European politicians were more fearful of agencies falling under the control of other member countries than they were fearful of lacking influence over the agencies. Regulators have frequently intervened in mergers even when politicians from the companies' home countries lobbied to permit the deals. In the tech industry, the EU has insisted on consumers retaining ownership of their data and the freedom to take it with them in switching to a competing software service.
Less tied to election cycles and specific political parties, the independence of EU regulators enables them to iterate when new regulations have unintended consequences. Philippon argues that U.S. regulators fail to act in the first place because of concerns that if they don't craft the perfect policy upfront, there will be political repercussions.
Regulatory influence is for sale in the U.S.
Philippon makes the case that politicians' survival is the U.S. has become more heavily tied to fundraising and the overwhelming majority of that fundraising comes directly and indirectly from corporate interests. The top 1% of donors account for about 75% of all political contributions (and the top 0.01% for 40% of all political contributions). Business lobbies are by far the dominant source of money in American political campaigns according to statistics he cites from the Center for Responsive Politics.
Benchmarked against antitrust reviews in the EU, Philippon finds that the decline in the number of antitrust actions in the U.S. (by the DOJ and FCC) has largely corresponded to increased lobbying spending that targets the DOJ and FCC. Each doubling of lobbying expenditures in the U.S. by a given industry corresponds with a 9% decrease in antitrust reviews in that industry, and such lobbying spend tripled overall from 1998 to 2008. He also cites a 2008 book by UVA professor Christine Mahoney finding that the majority of lobbying efforts in the U.S. by corporations and trade associations are successful whereas the majority of lobbying efforts by citizen groups and foundations fail.
What we should take away from "The Great Reversal"
I find "The Great Reversal" to be a timely analysis of the weakening of America's regulatory regime for protecting free market competition. The recent rise of populism as the driving force in American politics has included resounding cries from activists in both parties that capitalism is broken, that free markets have failed us. Tying in the analysis from this book, the more accurate target for this criticism, however, should likely be the country’s embrace of corporatism over free market capitalism.
Citizens' complaints about large companies abusing their power are often blamed on capitalism in general, when the issue is often regulatory capture that protects those companies from being held accountable by competitors. Companies that treat customers poorly don't survive in competitive markets.
Within the circles of politicians and media pundits, policies are referred to as generically “pro-business.” The term brushes over the often conflicting interests of the country’s largest companies and the vast landscape of small and medium size businesses who compete with them. America’s political leadership has been pro-corporate at the expense of entrepreneurs.
It's a case for political reform but also a case for the country's entrepreneurs and venture capitalists to form a more unified voice in Washington separate from industry trade groups that primarily act on behalf of the largest companies in each industry.