The Great Reversal Read online

  THE GREAT REVERSAL

  How America Gave Up on Free Markets

  THOMAS PHILIPPON

  The Belknap Press of Harvard University Press

  CAMBRIDGE, MASSACHUSETTS

  LONDON, ENGLAND

  2019

  Copyright © 2019 by the President and Fellows of Harvard College

  All rights reserved

  Cover design: Tim Jones

  978-0-674-23754-4

  978-0-674-24310-1 (EPUB)

  978-0-674-24311-8 (MOBI)

  978-0-674-24309-5 (PDF)

  Many of the designations used by manufacturers and sellers to distinguish their products are claimed as trademarks. Where those designations appear in this book and Harvard University Press was aware of a trademark claim, then the designations have been printed in initial capital letters.

  The Library of Congress has cataloged the printed edition as follows:

  Names: Philippon, Thomas, author.

  Title: The great reversal : how America gave up on free markets / Thomas Philippon.

  Description: Cambridge, Massachusetts : The Belknap Press of Harvard University Press, 2019. | Includes bibliographical references and index.

  Identifiers: LCCN 2019018624

  Subjects: LCSH: Free enterprise—United States. | Free enterprise—Europe. | Free enterprise—Political aspects—United States. | Markets—United States. | Markets—Europe. | Competition—United States. | Competition—Europe. | Lobbying—United States.

  Classification: LCC HB95 .P53 2019 | DDC 330.973—dc23

  LC record available at https://lccn.loc.gov/2019018624

  CONTENTS

  Preface

  Introduction

  PART ONE. THE RISE OF MARKET POWER IN THE UNITED STATES

    1.   Why Economists Like Competition … and Why You Should Too

    2.   Bad Concentration, Good Concentration

    3.   The Rise in Market Power

    4.   The Decline of Investment and Productivity

    5.   The Failure of Free Entry

  PART TWO. THE EUROPEAN EXPERIENCE

    6.   Meanwhile, in Europe

    7.   Are US Prices Too High?

    8.   How European Markets Became Free

  PART THREE. POLITICAL ECONOMY

    9.   Lobbying

  10.   Money and Politics

  PART FOUR. AN IN-DEPTH LOOK AT SOME INDUSTRIES

  11.   Why Are Bankers Paid So Much?

  12.   American Health Care: A Self-Made Disaster

  13.   Looking at the Stars: Are the Top Firms Really Different?

  14.   To Regulate or Not to Regulate, That Is the Question

  15.   Monopsony Power and Inequality

  Conclusion

  Appendix

  Glossary

  References

  Acknowledgments

  Index

  PREFACE

  THE QUESTION that spurred me to write this book is surprisingly mundane. It’s something that virtually everyone in the United States has probably asked themselves at one point or another: Why on earth are US cell phone plans so expensive? Or, to broaden it a little further, why do consumers in Europe or in Asia pay less for cellular service and, on average, get much more?

  Asking this seemingly simple question was my first step on a journey through some of the most hotly debated issues in modern economics. Looking for the answer led me to investigate wage stagnation, corporate lobbying, special interests, governance of large financial funds, money in politics, free trade, technology, and innovation.

  It also led to some surprising revelations about the relative prices of goods and services in the US and Europe, overturning common assumptions—including my own—about the status of consumers in the two largest economic markets on the planet.

  How did I wind up here? Believe or not, this was not my intention. It’s the data’s fault. I started with a precise, well-defined question, and then I followed the facts. All the facts. Nothing more, but nothing less. And I’ll admit freely that I was as surprised as anyone by the outcome.

  My aim is to retrace some of these steps, taking you along with me. If you follow, you’ll find out why you’re paying an arm and a leg for your cell phone every month, but you’ll also learn a lot about economics. In fact, the book could serve as an introduction to modern economics, though in an unconventional format.

  A quick note about my approach. Unlike some who write about controversial topics in economics or in other fields, I readily admit that I don’t have all the answers. In much of the writing on economics and society today, the tone is certain and prescriptive. The problems are “obvious” and, predictably, so are the solutions.

  I would suggest, however, that such prescriptions be taken with a (large) grain of salt. When you read an author or commentator who tells you something is obvious, take your time and do the math. Almost every time, you’ll discover that it wasn’t really obvious at all.

  I have found that people who tell you that the answers to the big questions in economics are obvious are telling you only half of the story. More often than not, they think the answers are obvious either because they have an agenda or because they don’t really know what they are talking about.

  So be skeptical—always. Most people simply repeat what they have heard without checking the data. In fact, there is often a negative correlation between outward certainty and factual information. The first thing anyone should discover when they research an interesting question is always the limits of their knowledge. Mancur Olson put it eloquently in The Rise and Decline of Nations: “The reader should accordingly not accept the argument in this book simply because he or she finds it plausible and consistent with known facts. Many plausible stories have been told before and often also widely believed, yet they failed to stand up.”

  This brings me to another important note about this book. I plan to enable your skepticism by showing you how the work is done. That research informs much of this book, and where I rely on it to reach conclusions, I provide enough background on the data to allow you to make your own judgment about my findings. I will present all the facts as simply and transparently as possible, refraining from making any claim that is not backed by at least some data. In doing so, I hope to reduce the risk of imposing my own subjective views.

  But I am certainly going to fail, at least to some extent, so it is probably useful for you to know a bit about my beliefs, which in economic jargon we call our priors to emphasize our willingness to change them if new facts emerge. As John Maynard Keynes is often credited with saying to a critic, “When the facts change, I change my mind. What do you do, sir?”

  The best summary of my priors is probably that I am a free market liberal. I believe that free markets work best, provided that we agree on what we mean by “free” markets. I believe that markets are free when they are not subject to arbitrary political interference and when incumbents are not artificially protected from competitive new entrants. Keeping the markets free sometimes requires government interventions, but markets are certainly not free when governments expropriate private property, when incumbents are allowed to suppress competition, or when they successfully lobby to protect their rents.

  I am also liberal in the sense that I believe that reducing inequality is a worthwhile goal. I don’t believe that inequality is evil. Inequality is necessary to reward success and punish failure, and it would be pointless to argue against that. But I believe that, on balance, there are more forces in our economic system pushing toward excessive, unjust, or inefficient inequality than there are forces pushing toward excessive equality. These are my pri
or beliefs as I write this book. They should be debated, and they can certainly be challenged. I will try not to let them interfere with my thinking, but I will not ignore the potential value in the belt-and-suspenders approach.

  On Data, Anecdotes, and Intuition

  “Data! data! data!” he cried impatiently. “I can’t make bricks without clay.”

  ARTHUR CONAN DOYLE, THE ADVENTURE OF THE COPPER BEECHES

  I should like to close by citing a well-recognized cliché in scientific circles: “In God we trust, others must provide data.”

  EDWIN R. FISHER, PROFESSOR OF PATHOLOGY, ADDRESSING A SUBCOMMITTEE OF THE US HOUSE OF REPRESENTATIVES IN 1978

  If economists are to be of any use to society—a big “if,” some critics might add—then at the very least they should be able to challenge common wisdom, to take a contrarian perspective, and to avoid repeating what everyone else is saying. This is what I find so remarkably refreshing in Robert Gordon’s The Rise and Fall of American Growth. Contrary to the techno-optimists arguing that innovation has never been faster, Bob argues that our current wave of innovation is not nearly as transformative as previous waves have been. Bob may or may not be right, but he is willing to think coherently about a topic and base his conclusions on data and logic instead of anecdotes and preconceived ideas.

  It is also important to emphasize that smart people often disagree, and that is mostly a good thing. In fact, I would argue that we are more likely to learn something interesting precisely when smart people disagree. In a 2014 conversation with James Bennet in the Atlantic, Microsoft founder Bill Gates said: “I think the idea that innovation is slowing down is one of the stupidest things anybody ever said.” To illustrate his point, he added, “Take the potential of how we generate energy, the potential of how we design materials, the potential of how we create medicines, the potential of how we educate people.” Entrepreneurs are “birds-in-the-bush” people, while economists are more “birds-in-the-hand” people. We are certainly interested in the “potential” applications of an idea, but we need to see its impact in the data to be convinced. And so far, we are not convinced by Gates’s emphasis on potential. Until the data suggest otherwise, we tend to follow Stefan Zweig and think that “Brazil is the country of the future—and always will be.”

  It is never easy to change the common wisdom. The idea that US markets are the most competitive in the world has been widely accepted in economics for several decades. Businessmen argue that it’s never been easier to start a business, that competition is everywhere, and that the internet allows people to search for the cheapest goods. We certainly live in the most competitive, most breathtakingly innovative society ever. Right? To some extent, these arguments reflect a universal bias in human psyche, namely the idea that we are smarter and more sophisticated than our ancestors, and that everything we do is “unprecedented.” This is, in my mind, one of the most bogus claims ever made. In fact, little of what we do is unprecedented.

  For example, in the 1990s, the booming stock market was widely believed to be performing at levels never seen previously. Firms were moving from the start-up phase to an initial public offering of stock at record speed. Or so we thought. In fact, Boyan Jovanovic and Peter L. Rousseau (2001) show that the initial public offering market of the 1920s was remarkably similar to the one of the 1990s: IPO proceeds (as share of gross domestic product) were comparable, and firms moved quickly from incorporation to listing. Whatever we were doing in the 1990s with our screens and computers was neither fundamentally different nor fundamentally better than what they were doing in the 1920s without screens and computers.

  We should always look at the data first. This is particularly true if we are interested in changes that take place over decades. We cannot trust our intuition, and we certainly should not repeat the conventional wisdom, especially when it happens to coincide with our preconceptions or economic interests. Hence, when you hear a manager arguing that competition has never been tougher, you should put as much faith in that statement as one from a barber who says you really need a haircut. Or, I might add, from a banker who argues that leverage is really, really safe.

  There is another example I find striking, and that hits close to home. You have probably heard that the time when a person could expect to enjoy a long career at a single company is long past. Nowadays, we’re told, people need to be ready to change careers often. Millennials really just want to hop from one job to the next. Turnover in the labor market, the story goes, is higher than ever. And while that story may feel true, it’s not. Data from the Bureau of Labor Statistics show that employees stay a bit longer with a company today than they did thirty years ago. During the 1980s and 1990s, the average employee tenure was around 3.5 years. It started to rise around 2000 to about 4.5 years today. In fact, in almost all developed economies, we observe a decrease in job turnover, which is driven by a steep decline in voluntary separations. Worker flows have declined since the 1990s.a In other words, people are less likely to quit their jobs now than in the past.

  When I first saw these numbers, I was reminded of a discussion I had with my own grandfather about being a worker in France in the 1950s and 1960s. Employment protections—in the form of minimum wages, unemployment insurance, severance pay, long-term contracts, and the ability to sue one’s employer for wrongful termination—were much lower than today. Overall, it certainly looked like firms held more sway over their workers then. I asked him if he felt the pressure as a worker, and he looked at me as if he was surprised by the question. “I guess not,” he said: “if the boss or the firm did not treat you well, you simply did not show up the next morning and went to work across the street.” That was a Frenchman in the 1950s, not an American millennial in 2019. Let us keep these examples in mind when we review the evidence on the evolution of competition in US markets.

  * * *

  aThe best measure—the Job Openings and Labor Turnover Survey—shows a continuous decline since 2000. The Current Population Survey (Hyatt and Spletzer, 2013) and the Longitudinal Employer–Household Dynamics data show a decline as well. Longer series from Davis and Haltiwanger (2014) show a decline since 1990.

  Introduction

  I LANDED AT Logan Airport, Boston, in late August 1999. I was coming to the United States from my native France to pursue a doctorate in economics at the Massachusetts Institute of Technology. This was an incredibly exciting time. I was eager to meet my new classmates and learn as much as I could as quickly as possible.

  I was fortunate to be supported by a graduate scholarship. Still, life as a student forced me to pay attention to my personal finances. I studied prices and shopped around for the best deals. As an economist, I would now say that I was “price-elastic.”

  Figuring out what to do with the scholarship was easy enough. The first thing I needed was a laptop. The second was an internet connection. The third was a place to sleep (priorities!), preferably not in the graduate computer lab because I don’t enjoy waking up with a QWERTY keyboard imprinted on my forehead.

  I had already agreed to share an apartment with two classmates, so that took care of the detail of putting a roof over my head. I could thus focus on the serious business of studying, buying books, and purchasing a computer. The US was a great place to get a laptop. Computers were so much cheaper that people from other countries would often ask their friends in the US to buy laptops for them, even if it meant dealing with a different keyboard layout. From my own experience, I would say that laptops were at least 30 percent less expensive than in France. Indeed, looking at official statistics (something we will do a lot in this book), Paul Schreyer (2002, fig. 1) shows that the US experienced a steeper decline in its price indexes for computers and office equipment between 1995 and 1999 than France, the United Kingdom, or Germany.

  My next task was to get online. When I called around looking for an internet connection to the house, I discovered that access was also a lot cheaper than in Europe. A typical dialup connection via a 56K mode
m was so slow that you often needed to stay connected for several hours to download a file. In the US, local calls were free, which meant that if your internet service provider (ISP) had a server near your house, you could make a call and stay connected for as long as necessary without paying extra. In France, you were charged by the minute, and it would have cost a fortune. These differences had a large impact on the economy. Nicholas Economides (1999) explained that “one of the key reasons for Europe’s lag in internet adoption is the fact [that] in most countries, unlike the US, consumers are charged per minute for local calls.”

  Having secured a roof, a computer, and an internet connection, my next goals were to attend conferences and to explore this amazing country. I quickly realized that air travel was also easier and cheaper in the US than in Europe. Back in Europe, I would fly maybe once a year, usually in the summer. In America, plane tickets were cheap enough that I could afford them fairly often, even as a student.

  Durable goods, transport, and most services were surprisingly cheap in the US. Wages, on the other hand, were rather high, which meant that workers had solid purchasing power. None of this happened by chance, although I was blissfully unaware of it at the time.

  The Land of Free Markets

  Let us consider air transport first. Before 1978, the Civil Aeronautics Board regulated airlines in the US, controlling the fares they could charge and the routes they could fly. The Carter Administration argued that customers would benefit from deregulation because it would encourage competition among existing carriers as well as entry of new airlines. And it did. The Airline Deregulation Act of 1978 phased out the government’s control over prices and routes. Over the following fifteen years, from 1979 to 1994, the average fare per passenger mile decreased by about 9 percent at airports in small communities, 11 percent at airports in medium-sized communities, and 8 percent at airports in large communities, as documented by the Government Accountability Office in its 1996 report. Lower prices led to a sustained increase in the number of passenger-miles flown each year. In recent years, however, most people have had frustrating experiences with differentiated fares, hidden fees, and crowded planes. It seems that the gains achieved in the 1980s and 1990s were not sustained. I will explain how that happened.