Spreading the thriving

Jan Eeckhout’s The Profit Paradox: how thriving firms threaten the future of work is a very good read. It’s a game of two halves (yes, someone in my household is permanently watching the football at the moment).

The first half (in fact parts 1 and 2) is a nice synopsis of the reasons the economy (mainly the US but others are covered) tend towards a) concentration across many markets and hence b) diverging fortunes of companies and their employees, and the places where people live. This covers the features of digital technology, superstar phenomena, agglomeration economies – these are familiar to anyone who has been keeping up with the literature, but I applaud how well the book is written. Hooray for an economist who can write so engagingly. This section documents the evidence on concentration and mark-ups, the growing divergence between companies in terms of productivity and profits, and the corresponding decline in the labour share as outsourcing of routine occupations (call centres, cleaners, admin) has progressed. Eeckhout argues that there is assortative matching such that pay and conditions are polarising between people with high value jobs in frontier firms and people with low value added jobs in their contractors.

The book’s focus is on the implications of market power for people as workers, rather than as consumers – although it also notes the excess pricing power too. In sum, it reduces wages, both directly through monopsony power in individual labour markets and also because of the the macroeconomic consequences: with so many people in contingent work with low pay, aggregate demand is inadequate. (Some) firms are doing well but the economy isn’t. And this is the heart of Eeckhout’s argument: “The effect of the tide of market power is lowering wages across the economy.” I find this link persuasive. While there are many economists looking at the elements of this story, the way they are combined here is enlightening.

The second half turns to the much harder question of what to do, starting with an affirmation that for all the disruption the new technologies are a good thing (this chunk reminded me a bit of my own Paradoxes of Prosperity, which first came out in September 2001 and not surprisingly was hardly noticed).

The recommendations boil down to: enforce labour standards; mandate more data openness; and beef up anti-trust policies. In particular (under the last heading) stop big tech making more acquisitions, regulate them rather than break them up (so as not to lose beneficial network economies), and assess market impacts in the round rather than firm by firm. (Tricky to implement but I do remember that in my days on the Competition Commission, as it then was, we often had to include a section of the report on ‘Features of the market’ – problems in concentrated markets do often spread beyond an individual transaction).

I’d agree with all these suggestions in the book but they add up to a meta-suggestion: find the political will to change the institutional architecture so that it delivers fairer outcomes. The technological tides won’t retreat but the effects depend on what institutions confront them. Is Lina Khan’s appointment in the US a sign of lasting change?

 

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Banks versus business

The latest in my catch-up reading has been British Business Banking: The Failure of Finance Provision for SMEs by Michael Lloyd. This is obviously a bit niche but of great interest as the vacuum in finance for growing businesses has often been identified as one of the reasons for the UK’s weakness in translating an excellent research base into lasting commercial success and eventually productivity gains. The stock of bank lending to SMEs in the UK was £166bn at the end of 2018, according to an OECD survey. (It will perforce have increased signigicantly in 2020.) If this sounds a lot, it was only about one tenth the stock of their residential mortgages. The UK banking sector just doesn’t do much business lending.

I’ve long thought lack of competition is a key part of the story. The commercial banking sector has consolidated steadily over the decades – I’m old enough to remember some of those swallowed up, like Williams and Glyns and National Provincial. In this book Michael Lloyd argues that while the development of an oligopoly might have been part of the cause of the SME finance gap, introducing more competition won’t be part of the cure now. There has been some new entry such as Santander, but the newcomers are not interested in the SME sector either.

He anyway sees the gap as a quasi-cultural one, linked to the “free market” philosophy embraced more eagerly in the UK even than in the US, and in the centralisation of banking decisions. He advocates a restoration of relationship banking spearheaded by a state Investment Bank. What we are getting instead is a National Infrastructure Bank – needed, but unlikely to do a lot for SMEs around the country. However, I find the relationship argument persuasive: I’d see it in terms of a vast loss of information that has come about through bank mergers and centralisation. Automated decisions are based on too little information, whereas old-fashioned bankers in boots would have a wealth of information about local SMEs.

It’s a hard problem to solve even with a government willing to have a go. Still, this is an interesting book for those worrying at the issue, well worth a read.

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Big Tech – the contrarian view

There’s a torrent of material to read about competition (lack of) in digital markets, which of course goes much wider than economics and law. Indeed, I’ve contributed to the many pages written, including in the form of being a member of the Furman Review team. The general theme is that Big Tech does indeed pose a challenge for competition policy, with the individual conclusions running from ‘some adjustment within current framework is needed’, all the way to ‘destroy them’.

What makes Big Tech and the Digital Economy by legal scholar Nicolas Petit so refreshing is its absolutely contrarian perspective. He has coined the phrase ‘moligopoly’ to describe Big Tech, and argues that while there has certainly been increasing competition in digital markets, there is also vigorous competition unremarked by all the commentators. I’d describe what he calls competition as oligopolistic rivalry, but the book does document the ways in which the GAFA and others compete with each other.

Some of the emprical evidence is rather interesting. For example, the book looks at what the big companies describe as the major risks facing them in their SEC filings and all but Facebook claim competition is their 1st or 2nd biggest threat – they would say that of course, but it intrigues me that Facebook doesn’t bother (number 4 or 5 in its ranking). The others do all see each other as their main rivals. Among the book’s other evidence is their high rate of spending on R&D – but I’d like to know about what it is they’re researching, though.

The ultimate question is not about current competitors, however, but about potential competitors. If you believe digital markets tend to winner-takes-all because of network effects, and you can live with concentration because of the large consumer benefits, then what matters is whether new rivals with great technology and products can take the current Big Tech markets. In that case, moligopolistic rivalry along various dimensions is not only fine but anyway inevitable.

The book didn’t win me over in the sense that I concluded there is no reason to be concerned about digital competition. Without intervention, it’s hard to see anybody rivalling Google in search, or Apple and Android in mobile operating systems. To be fair, the author doesn’t argue that there’s no cause for concern, quite. He is issuing a useful warning that we should think carefully and in detail about what harms we believe Big Tech is causing. This book is a distinctive corrective against the current tendency toward groupthink on this subject. As we said right at the start of the Furman Review, Big Tech has brought many benefits, and there is growing evidence about how much people value its products. Anyone certain they know Big Tech needs fixing should read this more nuanced argument with an open mind.

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Why competition is good

I would be an even bigger fan of Michelle Meagher’s provocative book if she had stuck with the subtitle – How Big Business is Harming Our Society and What to Do About It – and not gone for the title ‘Competition is Killing Us’. Because it’s the absence of competition that’s killing us – as indeed this very accessible and well-argued book goes on to explain. There is a footnote on page 2 referring to a glossary explaining that ‘competition’ as used here doesn’t mean, well, competition, or rivalry between firms contesting with each other for customers. Here it is used to mean big businesses eating up more and more market share, lobbying to get the rules of the market economy shaped to their own advantage, and generally subtracting value from society rather than adding it.

This is a shame. It means the book adds to the general confusion on this point, as I think quite a lot of people hear ‘business’ when they see ‘competition’. When economists talk about competition, though, this does not mean arranging things in the interests of business. Far from it. Economists love competition (on my definition) while businesses hate it. I particularly love competition, having spend 8 years as a member of the Competition Commission and recently having been a member of the Furman Review panel.

Other than this – quite a major point, and one which I failed to persuade Michelle about before the book was published – this is a great book and well worth  a read. It’s of the moment too. Our own Competition and Markets Authority is gearing up to tackle the market power of the digital giants, as is the European Commission with its greater impact, and even – perhaps – the US with the publication of a pretty fierce House Judiciary committee report this week. It does feel like we are seeing the tide turning away from big companies and in favour of fewer mergers, tighter corporate governance rules, and a far, far greater emphasis on the need for business to serve society rather than profiting at society’s expense.

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Not-so-free markets

Thomas Philippon’s The Great Reversal: How America Gave Up On Free Markets, my pre-Xmas Day reading, deserves the positive reviews it’s been getting. It’s a highly accessible synthesis of Prof Philippon’s always-illuminating research into the empirics of US finance and competition. The argument is neatly summed up in the final part of the book: the US economy has become meaningfully less competitive, leading to higher prices, lower wages and lower productivity, and the main explanation is regulatory capture – the extraordinary (in scale and effectiveness) corporate lobbying in the US. The method of argument is set up near the beginning: all the possible explanations for the rise in concentration are listed:

  • there isn’t really an increase in concentration, it’s a data issue
  • competition has declined in lots of US industries
  • superstar firms are so successful they are organically gaining market share
  • technology is driving winner-take-all market structures
  • foreign competition means there has been domestic globalisation so it’s the overseas-adjusted concentration that matters
  • the growing importance of intangible assets explains concentration

The first part of the book explores these different hypotheses in the US data. The two left standing are decreased domestic competition with some – incomplete – mitigation from overseas competition. For my taste the book takes the available data on intangible assets far too seriously – they are highly incomplete and have limitations – but on the other hand part of the value of intangible assets is politically created (eg over-long copyright, scope for patent trolling). There is a ton of interesting evidence along the way – my favourite table is 13.2, the star companies over the decades; it shows that today’s tech stars are actually smaller in most ways (market cap, profitability and especially employment share) than star companies even of the 50s, 60s and 70s. There’s a very interesting section on how unintegrated they are with the rest of the US economy compared with the past.

Part 2 of the book is a compare and contrast between the US and EU, observing that the EU’s Single Market and enforcement by independent EU-level bodies means European markets are now notably more competitive than their US counterparts (not that Philippon sounds particularly impressed with other aspects of the EU economy). There is a neat political economy explanation for the independence of regulators: no individual country wants another country to dominate so independence is a Nash equilibrium.

The third part of the book covers campaign finance and lobbying in the US – no surprises – while the fourth part looks more closely at some individual sectors. The eye-opener is finance: despite extraordinary technological advances and innovation (after all, finance is one of the most ICT-intensive industries), the sector is no more efficient now than at the time of  the original JP Morgan. “Why is the non-financial sector transferring so much income to the financial sector?” Philippon asks. Lack of entry, and heavy-handed regulation (often a barrier to entry) are the culprits. I do constantly find it extraordinary that finance, having almost brought down the global economy and cost gazillions in lost output, is back to exactly where it was in the mid-2000s. We could go round the goldfish bowl again. This more than anything signals the political power of the finance lobby: the sector paid a negligible price for its actions.

So all in all, The Great Reversal is an important read. I also welcome one of the concluding points: Philippon writes, “I was surprised by the gap between economic research and policy,” in researching the book. I couldn’t agree more. Too few academics have any incentive to produce timely and policy-relevant research, as opposed to their strong incentive to produce narrow papers that will (slowly) get published in a small number of journals. Thank goodness for engaged academics like Prof Philippon.

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