21/10/20: Pollution Shifting and Heterogeneity in Local Regulatory Coverage

 

States, like California within the U.S., and some individual member states within the European Union tend to adopt own-level regulations on harmful emissions in an effort to 'pave the way' for other peer states. These regulations, of course, only apply to the economic agents 'captive' in the state. They do not apply to more mobile companies that can shift their emissions across borders to minimize the impact of more stringent regulations. Even Federal-level standards on pollution abatement are often subject to local applicability variations, resulting in pollution shifting across states' borders in line with the above.

A recent study by Feli Soliman, titled "Intrafirm Leakage" published by CESifo as a Working Paper No. 8619 (https://ssrn.com/abstract=3712780) provides some empirical evidence of exactly such pollution shifting. The study finds that "...multiplant firms partially regulated under the ozone regulations of the US Clean Air Act offset regulation-induced reductions among regulated plants with spillovers to unregulated plants and by moving plants out of regulated areas." Crucially, however, the offsetting decisions are  more than sufficient to render overall pollution output un-impacted by the more stringent local regulations:  "Taken together, these leakage effects fully offset emissions reductions at regulated plants."

Another interesting finding in the study is that thee effects of this pollution shifting "are strongest among highly productive firms and those operating in tradable industries." In other words, the companies that hold prospect for future growth (and expansion of their pollution output) and have higher likelihood of survival are the very same firms that gain from pollution arbitrage across borders.

Overall, the author concludes that "By themselves, these results imply that expanded ozone regulation under the [Clean Air Act] has not contributed to the clean-up of US manufacturing"

9/9/2018: Corporate Power, Charity, and Social & Policy Impacts

In an important discussion, titled "Tax-exempt lobbying: Corporate philanthropy as a tool for political influence", Marianne Bertrand, Matilde Bombardini, Raymond Fisman, and Francesco Trebbi (02 September 2018, https://voxeu.org/article/corporate-philanthropy-tool-political-influence) argue that as "special interests use donations to influence the political process", "...philanthropic efforts in the US are targeted, at least in part, to influence legislators. Districts with influential politicians receive more donations, as do non-profits with politicians on their boards. This is problematic because, unlike PAC contributions and lobbying, influence by charity is hard for the public to observe." The resulting conclusion by the authors is that the case of corporate-charity interlinks "amounts to a taxpayer subsidy of corporations expressing their political voice". In other words, concentration of market power causes concentration push in lobbying and, thus, potentially forces policy formation to more closely reflect the interests of the corporate donors at the expense of the taxpayers and ordinary voters.

This is a very important issue in any analysis of the functioning of our democratic processes. But it also raises another 'adjoining' issue, not covered in the paper: American corporations are increasingly relying on other channels to alter social (and related policy) outcomes today. This channel is the companies increasing financial and other commitments to Corporate Social Responsibility and Social Impact (or even broader ESG) targeting. Whilst benign in its core values and ethos, the channel can be open to potential abuse by corporate powers. In addition, like charity status channel, the CSR and SI/ESG channel also avails of public funding link ups to corporate balance sheets (via tax incentives, subsidies, co-financing of projects, etc). The question worth asking, therefore, is the following one: To what extent do modern SI/ESG and CSR strategies of major corporations align with their lobbying objectives? In other words, do corporates use SI/ESG/CSR strategies to promote self-interest beyond purely societal interest?

Surprisingly, very little research in the Social Impact or ESG analysis has been devoted to the potential for corporations to 'game the system' in their favour.

18/8/18: Monopolization trends in Advanced Economies: my column for CFR

My column for the Cayman Financial Review on the topic of structural monopolization of the global economy and the declining competitiveness. https://www.caymanfinancialreview.com/2018/08/14/breaking-the-medici-vicious-circle-monopolization-trends-in-advanced-economies/.

16/7/18: Wither Free Market America

Prior to the 1990's, “U.S. markets were more competitive than European markets”, with the U.S. having a lead-start on the EU of some decades, if not centuries, when it comes to the anti-trust laws and anti-true enforcement. In fact, as noted by Germán Gutiérrez and Thomas Philippon in their new paper “HOW EU MARKETS BECAME MORE COMPETITIVE THAN US MARKETS: A STUDY OF INSTITUTIONAL DRIFT” (NBER Working Paper 24700 http://www.nber.org/papers/w24700 June 2018), it was Europe that largely copied the U.S.  legal and regulatory frameworks for dealing with excessive concentration of the market power. Thus, given the “initial conditions, one would have predicted that U.S. markets would remain more competitive than European (EU) markets.” Except they did not. As Gutiérrez and Philippon show, the U.S. “experienced a continuous rise in concentration and profit margins starting in the late 1990s. And, perhaps more surprisingly, EU markets did not experience these trends so that, today, they appear more competitive than their American counter-parts.”

“Figure 1 illustrates these facts by showing that profit rates and concentration measures have increased in the US yet remained stable in Europe. In addition, note that the U.S the increased integration among EU economies essentially shifts the appropriate measure of concentration from the red dotted line towards the blue line with triangles – which further strengthens the trend."

Figure 1: Profit Rates and Concentration Ratios: US vs. EU

Source:  Gutiérrez and Philippon (2018)

So, in summary, today, “European markets have lower concentration, lower excess profits, and lower regulatory barriers to entry.” even looking at specific industries “with significant increases in concentration in the U.S., such as Telecom and Airlines, and show that these same industries have not experienced similar evolutions in Europe, even though they use the same technology and are exposed to the same foreign competition” (see chart below).

Source:  Gutiérrez and Philippon (2018)

Of course, the point of reduced degree of competition in the U.S. markets is hardly new. I wrote about this on numerous occasions, including covering evidence on the U.S. markets monopolization, oligopolization and markets concentration risks (see links here: http://trueeconomics.blogspot.com/2018/05/24518-america-medici-cycle-and.html) and I wrote about these phenomena in the context of the growing trend toward de-democratization of the U.S. politics (see: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3033949).  Hence, the main issue with this evidence is: “what explains the U.S. trend in contrast to the EU?”

Gutiérrez and Philippon (2018) argue that politicians care about consumer welfare but also enjoy retaining control over industrial policy. We show that politicians from different countries who set up a common regulator will make it more independent and more pro-competition than the national ones it replaces.” In other words, once politicians surrender control to a multinational institution (e.g. the EU or ‘Brussels’ or, in the case of Switzerland, to the umbrella-type Federal Government), they tend to favour such new institutional arrangement to be more independent from national politics.

Hence, as Gutiérrez and Philippon (2018) more, “European institutions are more independent than their American counterparts, and they enforce pro-competition policies more strongly than any individual country ever did. Countries with ex-ante weak institutions benefit more from the delegation of antitrust enforcement to the EU level. “ These dynamics are reflected in the switch from the ’average of the nation states’ red dotted line in the chart above, toward a unified EU-wide measure reflected by the blue line.

This theoretical view produces three treatable hypotheses: if Gutiérrez and Philippon (2018) are correct, then:
1. EU countries agree to set up an anti-trust regulator that is tougher and more independent than their old national regulators (and the US)
2. US firms spend more on lobbying US politicians and regulators than EU firms.
3. Countries with weaker ex-ante institutions benefit more from supra-national regulation.

For Hypothesis 1, the authors look at merger and non-merger reviews and remedies that form “an EU-level competency”. Gutiérrez and Philippon (2018) “show that DG Comp is more independent and more pro-competition than any of the national regulators, including the U.S.” Furthermore, “enforcement has remained stable (or even tightened) in Europe while it has become laxer in the U.S.” More ominously (for the consumption-based economy like the U.S.), product market regulations, usually a shared competency between the member state and the EU, the authors “find that the EU has become relatively more pro-competition than the U.S. over the past 15 years. Product market regulations have decreased in Europe, while they have remained stable or increased in the U.S.”

For Hypothesis 2: Gutiérrez and Philippon (2018) look at political expenditures, and show that “U.S. firms spend substantially more on lobbying and campaign contributions, and are far more likely to succeed than European firms/lobbyists.”

For Hypothesis 3: Gutiérrez and Philippon (2018) show that “EU countries with initially weak institutions have experienced large improvements in antitrust and product market regulation. Moreover, we find that the relative improvement is larger for EU countries than for non-EU countries with similar initial institutions.”

There is, of course, a remaining issue left unaddressed by the three hypotheses above: does more enforcement by more independent regulators inhibit innovation and competition? In other words, is European advantage over the U.S. a de facto Trojan Horse by which inhibiting regulation enters the markets? Gutiérrez and Philippon (2018) “find no evidence of excessive enforcement in Europe: enforcement leads to lower concentration and profits but we find no evidence of a negative impact on innovation. If anything, (relative) enforcement is associated with faster future (relative) productivity growth, although the effects are small.”

So, put simply, part of the increasing market concentration and power in the U.S. can be explained by the tangible politicization of the American regulatory environment. Of course, as noted in my own posts on the subject (see link above), this political channel for monopolization reinforces industry structure channel (ICT ‘disruption’ channel) and other channels that support increased market power for dominant firms. All of this, taken together, means one thing: the U.S. is falling dangerously behind in terms of the degree of its economy openness to challengers to the dominant firms, resulting in barriers to entrepreneurs, innovators and smaller enterprises. The costs of this ‘Google Syndrome’ are mounting, ranging from depressed wages, to jobs insecurity, to lack of investment and productivity growth, to growing voters unease with the status quo.

The premise of the Free Markets America no longer holds. Worse, Social(list) Europe is now beating the U.S. in its own game.

6/6/2018: Monopsony Power in US labour market

I have recently written about rising firm power in labour markets, driven by monopsonisation of the markets thanks to the continued development of the contingent workforce: http://trueeconomics.blogspot.com/2018/05/23518-contingent-workforce-online.html. In this, I reference a new paper "Concentration in US labour markets: Evidence from online vacancy data" by  Azar, J A, I Marinescu, M I Steinbaum and B Taska. The authors have just published a VOX blog post on their research, worth reading: https://voxeu.org/article/concentration-us-labour-markets.

24/5/18: America, the Medici Cycle and the Corporate Powers in Politics

A recent paper by Luigi Zingales of the University of Chicago, titled "Towards a Political Theory of the Firm" (NBER Working Paper No. 23593, July 2017: http://www.nber.org/papers/w23593) deals with the issue of rent-seeking behavior by monopolistic firms through political influence. "Neoclassical theory assumes that firms have no power of fiat any different from ordinary market contracting, thus a fortiori no power to influence the rules of the game," writes Zingales. "In the real world, firms have such power. I argue that the more firms have market power, the more they have both the ability and the need to gain political power. Thus, market concentration can easily lead to a “Medici vicious circle,” where money is used to get political power and political power is used to make money."

In his opening to the paper, Zingales notes 2016 report by Global Justice Now showing that 69 of the world’s largest 100 economic entities are now corporations, not governments. Using "both corporation and government revenues for 2015, ten companies appear in the largest 30 entities in the world: Walmart (#9), State Grid Corporation of China (#15), China National Petroleum (#15), Sinopec Group (#16), Royal Dutch Shell (#18), Exxon Mobil (#21), Volkswagen (#22), Toyota Motor (#23), Apple (#25), and BP (#27). All ten of these companies had annual revenue in higher than the governments of Switzerland, Norway, and Russia in 2015. ...In some cases, these large corporations had private security forces that rivaled the best secret services, public relations offices that dwarfed a US presidential campaign headquarters, more lawyers than the US Justice Department, and enough money to capture (through campaign donations, lobbying, and even explicit bribes) a majority of the elected representatives. The only powers these large corporations missed were the power to wage war and the legal power of detaining people, although their political influence was sufficiently large that many would argue that, at least in certain settings, large corporations can exercise those powers by proxy."

Despite this reality, economic theory largely ignores the issue of political power of the firms despite the fact that throughout modern history, "the largest modern corporations facilitated a massive concentration of economic (and political) power in the hands of a few people, who are hardly accountable to anyone." And despite the well-established fact (including through the precedent of the U.S. sanctions), that "...many of those giants (like State Grid, China National Petroleum, and Sinopec) are overseen by a member of the Chinese Communist party." Worse, as Zinglaes notes, "In the United States, hostile takeovers of large corporations have (unfortunately) all but disappeared, and corporate board members are accountable to none. Rarely are they not reelected, and even when they do not get a plurality of votes, they are coopted back to the very same board (Committee on Capital Market Regulation, 2014). The primary way for board members to lose their jobs is to criticize the incumbent CEO (see the Bob Monks experience in Tyco described in Zingales, 2012). The only pressure on large US corporations from the marketplace is exercised by activist investors, who operate under strong political opposition and not always with the interest all shareholders in mind."

So Zingales argues "that the interaction of concentrated corporate power and politics it a threat to the functioning of the free market economy and to economic prosperity it can generate, and a threat to democracy as well." Which, of course, is simply consistent with existence of the set of market-linked trilemmas, such as The International Relations (Order) Trilemma that implies that in the presence of perfect capital mobility, the nation states can either pursue a democratic sovereign political set up or an objective of international stability/order, as well as. (see more on these here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2786660).

Logically, thus, economics need to be asking the following questions, largely ignored in the neo-classical theory of the firm: "To what extent can the power firms have in the marketplace be transformed into political power? To what extent can the political power achieved by
firms be used to protect but also enhance the market power firms have?"

As Zingales notes correctly, "US economic patterns in the last few decades have seen a rise in the relative size of large companies," as also documented in a number of posts on this blog:
for example, the rise of monopolistic competition here:

• http://trueeconomics.blogspot.com/2018/03/20318-market-power-and-5-macroeconomic.html
• http://trueeconomics.blogspot.com/2018/03/28218-san-francisco-fed-research.html
• http://trueeconomics.blogspot.com/2018/02/7218-american-wages-corporotocracy-why.html 
• http://trueeconomics.blogspot.com/2018/02/9218-angus-deaton-on-monopolization-and.html; 

monopsonistic power here:

• http://trueeconomics.blogspot.com/2018/02/7218-american-wages-corporotocracy-why.html
• http://trueeconomics.blogspot.com/2018/05/23518-contingent-workforce-online.html

effects on regulatory enforcement efficiency here:

• http://trueeconomics.blogspot.com/2017/11/301117-efficiency-of-enforcement-vs.html

effects on democratic institutions here:

• http://trueeconomics.blogspot.com/2017/09/7917-millennials-support-for-liberal.html

As the result, Zinglaes calls "attention to the risk of a “Medici Vicious Circle.” The “signorias” of the Middle Ages—the city-states that were a common form of government in Italy from the 13th through the 16th centuries--were a takeover of a democratic institution (“communes)” by rich and powerful families who ran the city-states with their own commercial interests as main objective. The possibility and extent of this Medici Vicious Circle depend upon several non-market factors. I identify six of them: the main source of political power, the conditions of the media market, the independence of the prosecutorial and judiciary power, the campaign financing laws, and the dominant ideology. I describe when and how these factors play a role and how they should be incorporated in a broader “Political Theory” of the firm."

The driver for this 'Medici Circle' dynamic is market concentration or monopolistic competition. Product differentiation and market regulation can bestow onto a firm a degree of market power that translates into market concentration (rising and significant share of market activity captured by the firm). While in the environment of continued innovation, such competitive advantage generates only temporary abnormal profits, the degree of market power can be significant enough to provide the firm with substantial resources (profits) to engage in lobbying activities, corruption and other rent-seeking activities. There are also symmetric incentives for the firms to engage in rent seeking. As Zinglaes notes: "If the ability to influence the political power increases with economic power, so does the need to do so, because the greater the market power a firm has, the greater the fear of expropriation by the political power". This sounds strange, but it is quite intuitive: as a firm gains market power, it's prices rise above the marginal cost, yielding abnormal economic profits to the firm at the expense of consumers. The Governments can (and do) claim political mandate to limit these profits by taxing the market dominant firms' profits (either through regulation or direct taxation), thus expropriating part of the abnormal profits.

In simple terms, "Most firms are actively engaged in protecting their source of competitive advantage: through a mixture of innovation, lobbying, or both. As long as most of the effort is along the first dimension, there is little to be worried about. ...What is more problematic is when a lot of effort is put into lobbying. In other words, the problem here is not temporary market power. ...The fear is of what I call a “Medici vicious circle,” in which money is used to gain political power and political power is then used to make more money. ...In the case of medieval Italy, it turned Florence from one of the most industrialized and powerful cities in Europe to a marginal province of a foreign empire. At least the Medici period left some examples of great artistic beauty in Florence. I am not sure that market capitalism of the 21st century will be able to do the same."

Zingales relates the Medici circle concept to the modern day U.S. economy. "In the last two decades more than 75 percent of US industries experienced an increase in concentration levels, with the Herfindahl index increasing by more than 50 percent on average. During this time, the size of the average publicly listed company in the United States tripled in market capitalization: from $1.2 billion to $3.7 billion in 2016 dollars... This phenomenon is the result of two trends. On the one hand, the reduction in the rate of birth of new firms, which went from 14 percent in the late 1980s to less than 10 percent in 2014. On the other hand, a very high level of merger activity, which for many years in the last two decades exceeded $2 trillion in value per year... The market power enjoyed by larger firms is also reflected in the increasing difficulty that smaller firms have in competing in the marketplace: in 1980, only 20 percent of small publicly traded firms had negative earnings per share, in 2010, 60 percent did... Barkai (2016) ...finds that the decrease in labor share of value added is not due to an increase in the capital share (that is, the cost of capital times amount of capital divided by value added), but by an increase in the profits share (the residuals), which goes from 2 percent of GDP in 1984 to 16 percent in 2014. ...By separating the return to capital and profits, we can appreciate when profits come from (non-replicable) barriers to entry and competition, not from capital accumulation. Distinguishing between capital and share allows Barkai (2016) also to gain some insights on the cause of the decline in the labor share. If markups (the difference between the cost of a good and its selling price) are fixed, any change in relative prices or in technology that causes a decline in labor share must cause an equal increase in the capital share. If both labor and capital share dropped, then there must be a change in markups—that is, the pricing power firms to charge more than their cost."

And fresh from the presses today: "US IG Chart of the Day: Global M&A deal flow has doubled YTD for a total of $1.5 trillion of announced deals. US-only deals account for about 37% of the global total, for $555 billion of transactions."

While firms require market power to acquire political power, access to political power is required to protect abnormal profits arising from market power. Which, in a highly polarised society (aka, the U.S. system of politics dominated by two mainstream parties) can result in political representation concentrated in the hands of minorities (e.g. Trump Presidency, gained absent major corporate support), and in ineffectiveness of lobbying monitoring (As Zinglaes notes: "Even when it comes to lobbying, the actual amount spent by large U.S corporations is very small, at least as a fraction of their sales. For example, in 2014 Google (now Alphabet) had $80 billion in revenues and spent $16 million in lobbying".) Which is, of course, quite ironic, given that the ongoing Robert Mueller probe of the Trump campaign is focusing almost exclusively on the violations in the legal or declared channels of lobbying, instead of the indirect forms of political influencing.


I will quote Zingales' conclusion almost in full here, for it is a powerful reminder to us all that we live in a world where corporatism (integration of State and corporate powers) and monopolisation / concentration of the markets are two key features of our environment, not only in the economic sense, but in the political / democratic domains as well.

"In a famous speech in 1911, Nicholas Murray Butler, President of Columbia University, considered the practical advances made by large corporations in the late 19th and early 20th century and stated: 'I weigh my words, when I say that in my judgment the limited liability corporation is the greatest single discovery of modern times, whether you judge it by its social, by its ethical, by its industrial or, in the long run, ...by its political, effects.' Butler was right, but this discovery of the modern corporate form – like all discoveries – can be used to both to foster progress or to oppress. The size of many corporations exceeds the modern state. As such, they run the risk of transforming small- and even medium-sized states into modern versions of banana republics, while posing economic and political risks even for the large high-income economies. To fight these risks, several political tools might be put into use: increases in transparency of corporate activities; improvements in corporate democracy; better rules against revolving doors and more attention to the risk of capture of scientists and economists by corporate interests; more aggressive use of the antitrust authority; and attention to the functioning and the independence of the media market. Yet the single most important remedy may be broader public awareness."

The latter bit is still woefully lacking in the Fourth Rome of Washington DC, where the usual, tired, unrealistic narrative of American Exceptionalism reigns supreme, and where the U.S. flags at the 4th of July picnics are still confused for meaningful symbols of the U.S. meritocracy and the American Dream, the native entrepreneurialism and the social mobility. Wake up, folks, and smell the roses.

23/5/18: Contingent Workforce, Online Labour Markets and Monopsony Power

The promise of the contingent workforce and technological enablement of ‘shared economy’ is that today’s contingent workers and workers using own capital to supply services are free agents, at liberty to demand their own pay, work time, working conditions and employment terms in an open marketplace that creates no asymmetries between their employers and themselves. In economics terms, thus, the future of technologically-enabled contingent workforce is that of reduced monopsonisation.

Reminding the reader: monopsony, as defined in labour economics, is the market power of the employer over the employees. In the past, monopsonies primarily were associated with 'company towns' - highly concentrated labour markets dominated by a single employer. This notion seems to have gone away as transportation links between towns improved. In this context, increasing technological platforms penetration into the contingent / shared economies (e.g. creation of shared platforms like Uber and Lyft) should contribute to a reduction in monopsony power and the increase in the employee power.

Two recent papers: Azar, J A, I Marinescu, M I Steinbaum and B Taska (2018), “Concentration in US labor markets: Evidence from online vacancy data”, NBER Working paper w24395, and Dube, A, J Jacobs, S Naidu and S Suri (2018), “Monopsony in online labor markets”, NBER, Working paper 24416, dispute this proposition by finding empirical evidence to support the thesis that monopsony powers are actually increasing thanks to the technologically enabled contingent employment platforms.

Online labour markets are a natural testing ground for the proposition that technological transformation is capable of reducing monopsony power of employers, because they, in theory, offer a nearly-frictionless information and jobs flows between contractors and contractees, transparent information about pay and employment terms, and low cost of switching from one job to another.

The latter study mentioned above attempts to "rigorously estimate the degree of requester market power in a widely used online labour market – Amazon Mechanical Turk, or MTurk... the most popular online micro-task platform, allowing requesters (employers) to post jobs which workers can complete for."

The authors "provide evidence on labour market power by measuring how sensitive workers’ willingness to work is to the reward offered", by using the labour supply elasticity facing a firm (a standard measure of wage-setting (monopsony) power). "For example, if lowering wages by 10% leads to a 1% reduction in the workforce, this represents an elasticity of 0.1." To make their findings more robust, the authors use two methodologies for estimating labour supply elasticities:
1) Observational approach, which involves "data from a near-universe of tasks scraped from MTurk" to establish "how the offered reward affected the time it took to fill a particular task", and
2) Randomised experiments approach, uses "experimental variation, and analyse data from five previous experiments that randomised the wages of MTurk subjects. This randomised reward-setting provides ‘gold-standard’ evidence on market power, as we can see how MTurk workers responded to different wages."

The authors "empirically estimate both a ‘recruitment’ elasticity (comparable to what is recovered from the observational data) where workers see a reward and associated task as part of their normal browsing for jobs, and a ‘retention’ elasticity where workers, having already accepted a task, are given an opportunity to perform additional work for a randomised bonus payment."

The findings from both approaches are strikingly similar. Both "provide a remarkably consistent estimate of the labour supply elasticity facing MTurk requesters. As shown in Figure 2, the precision-weighted average experimental requester’s labour supply elasticity is 0.13 – this means that if a requester paid a 10% lower reward, they’d only lose around 1% of workers willing to perform the task. This suggests a very high degree of market power. The experimental estimates are quite close to those produced using the machine-learning based approach using observational data, which also suggest around 1% reduction in the willing workforce from a 10% lower wage."

To put these findings into perspective, "if requesters are fully exploiting their market power, our evidence implies that they are paying workers less than 20% of the value added. This suggests that much of the surplus created by this online labour market platform is captured by employers... [the authors] find a highly robust and surprisingly high degree of market power even in this large and diverse spot labour market."

In evolutionary terms, "MTurk workers and their advocates have long noted the asymmetry in market structure among themselves. Both efficiency and equality concerns have led to the rise of competing, ‘worker-friendly’ platforms..., and mechanisms for sharing information about good and bad requesters... Scientific funders such as Russell Sage have instituted minimum wages for crowd-sourced work. Our results suggest that these sentiments and policies may have an economic justification. ...Moreover, the hope that information technology will necessarily reduce search frictions and monopsony power in the labour market may be misplaced."

My take: the evidence on monopsony power in web-based contingent workforce platforms dovetails naturally into the evidence of monopolisation of the modern economies. Technological progress, that held the promise of freeing human capital from strict contractual limits on its returns, while delivering greater scope for technology-aided entrepreneurship and innovation, as well as the promise of the contingent workforce environment empowering greater returns to skills and labour are proving to be the exact opposites of what is being delivered by the new technologies which appear to be aiding greater transfer of power to technological, financial and even physical capital.

The 'free to work' nirvana ain't coming folks.

8/4/18: U.S. economy: entrepreneurship is not 'the new thing' outside Academia

These days, every business school on every university campus is sporting a burgeoning post-graduate program in Entrepreneurship. And this trend is driven by the perceived - and often hyped up by the media and by business futurists - rise in entrepreneurship in the modern society. Apparently, allegedly, an increasing proportion of today's business students want to start their own businesses (despite the fact the vast majority have never worked in a start-up and have no expertise to run one). The new dynamism of the economy, the college-to-start up model of business education, the 'can do' attitude (or aspirations) are all part and parcel of the mythological creature that is the New Economy.

In reality, of course, brutally put, there is no evidence of rising demand for entrepreneurship. And, worse, in fact, there has been a dramatic decline in entrepreneurial rates in the U.S. economy:

Source: http://rooseveltinstitute.org/wp-content/uploads/2018/03/Powerless.pdf.

Now, consider the two data series above, together: firm entry (new firms creation) and firm exist rates. As the blue line trended down, rapidly, without a pause, the green line remained relatively flat. Which means that the ratio of entries to exits has fallen over the time, pretty dramatically. In the 1970s and 1980s, firms entries had, on average been more frequent and less likely to be associated with higher firm exits. In the 1990s,  both relationship deteriorated. In the 2000s, both literally went down the drain.

So as the rate of new businesses additions went down, the rate of old businesses exiting did not change that much. So much for dynamism and for 'entrepreneurial spirits' of the young. The start ups mythology is strong. But the reality of the U.S. economy is that of concentration, market power, monopolization and decline of entrepreneurship. Funny thing, how Silicon Valley propaganda works, right?

How do we know the bit about monopolization? Why, look at profit share of output:

Still want to build up that 'entrepreneurship program' in the University? Because students want to learn about starting their own businesses? Should you really think twice?

20/3/18: Market Power and 5 Macroeconomic Puzzles: Rotten State of the ‘Competitive Markets’

Washington Centre for Equitable Growth has recently published a new modified version of the neoclassical model attempting to explain a number of empirical facts. A paper by Gauti Eggertsson, Jacob A. Robbins, Ella Getz Wold, titled “Kaldor and Piketty’s Facts: The Rise of Monopoly Power in the United States” (February 2018: http://equitablegrowth.org/working-papers/kaldor-piketty-monopoly-power/) departs from the empirical observation that the empirical facts of the real economy can be reconciled with in contrast to the traditional neoclassical models. Specifically, per authors:

• “(P1) An increase in the financial wealth-to-income ratio despite low savings rates, with a stagnating capital-to-income ratio.”
• “(P2) An increase in Tobin’s Q to a level permanently above 1.” So that stock market value of assets exceeds productive value of assets.
• “(P3) A decrease in the real rate of interest, while the measured average return on capital is relatively constant.” So profit margins on investment rise.
• “(P4) An increase in the pure profit share, with a decrease in the capital and labor share.” So shareholders get to carry away more in returns, while capital suppliers and workers get less.
• “(P5) A decrease in investment-to-output, even given historically low borrowing costs and a high value of empirical Tobin’s Q.” In  other words, low investment, even as the interest rates (cost of investment) fall.

Table 1: Factor shares. 5-year moving averages

The paper then modifies the standard neoclassical model. The authors introduce a market concentration distortion: “an increase in monopoly profits, [coupled] with a decrease in the natural rate of interest”.

To justify this, they, first, “depart from perfect competition, and posit that market power allows firms to make pure profits”. Second, authors assert that “there are barriers to entry, which prevent competition from driving these profits to zero.” This is consistent with the proposition that we are witnessing increased pressure of monopolistic and oligopolistic competition in the U.S. economy, as covered by me in a range of previous posts and articles.

“Third, claims to the (nonzero) pure profits of firms are traded and priced, and the ratio of the market
value of firms (which includes the rights to pure profits) to the replacement value of the productive capital stock is permanently above one; this ratio is commonly known as “empirical Tobin’s Q”.” Note that the tradability of pure profits of the firm (as opposed to rents on capital) is a distinct part of the model. Traditionally, we think of stock markets valuations as reflective of economic rents, not pure profits. That is so, because we assume that over the longer run, pure profits are driven down to zero. However, if/when pure profits are non-zero, stock market valuations are reflective of both: capital rents (low, due to extremely low cost of credit), plus pure profit (high, due to the transfers from interest rate subsidy from labor and technology logical capital to financial capital via pure profit monetisation, plus, dare I say it, the monetary policies excesses of the recent past).

CHART 1

Now, the authors confine their explanation for market power perpetuation to the following: “Because of the barriers to entry, the assets which hold the rights to the pure profits are non-reproducible: unlike productive capital, individuals cannot recreate these assets through investment, they must instead purchase them from others.” Personally, I would agree that barriers to entry - formal ones, e.g. via licensing and regulation - are one part of the problem. But there is a more direct problem arising in the American economy as well: concentration driven by pure monopolistic differentiation (see buy post on this here: http://trueeconomics.blogspot.com/2018/03/28218-san-francisco-fed-research.html, and here: http://trueeconomics.blogspot.com/2018/02/7218-american-wages-corporotocracy-why.html, and here: http://trueeconomics.blogspot.com/2018/02/9218-angus-deaton-on-monopolization-and.html.

The authors simply ignore this consideration as if it represents an uncomfortable truth about the state of the modern American society and economy. Instead, they create a marginal wrap-around argument to explain these dynamics: “This produces an interesting result: returns to assets that receive the rights to pure profits are significantly riskier than the returns to productive capital.” Why would returns to pure profit assets be riskier? Because the authors want to explain the differential between the returns to pure profit (higher) and the returns to productive capital (lower) by something ‘organic’, related to traditional financial theory. In other words, they need to show that pure profits returns bear additional risk and are paid additional risk premium over and above the returns to productive capital.

Here’s the authors’ argument: “The reason for this result is closely connected to the non-reproducibility of the assets which hold the rights to pure profits. When the economy is shocked, the price of these assets show large fluctuations, because their supply is fixed. In comparison, there is less fluctuation in the price of productive capital, since the supply is not fixed and it can be produced through new investment; the variance of the price of productive capital is determined in our model by the level of capital adjustment costs. As the economy transforms from one in which the majority of assets by market value are productive capital into one dominated by pure economic rents, this generates an endogenous increase in risk premium.”

CHART 2: Average return on capital

I do not buy this argument AT ALL. Let me explain. Non-reproducibility of these assets is a pure, unadulterated nonsense. We used to have Microsoft (a monopoly) and then we got Google (another monopoly), then we got FAANGS (more monopolies), and so on. If anything, rising concentration of the S&P 500 at the hands of larger, monopolistic issuers strongly suggests not only that the monopolistic assets ARE reproducible, but the our financial markets are solely preoccupied with reproducing them. Behold the ‘unicorns’.

The real driver for the abnormal (pure profit-linked) returns is the very existence of that pure profit, driven by: (a) regulatory barriers to entry (think banks), (b) state subsidies (think Tesla), (c) market macrostructure (think Google and Facebook), (d) rampant rent-seeking (think all), (e) outdated anti-trust regulations (think the U.S. system dominated by only one consideration, that of the material harm to consumers, that ignores the fact that modern ICT services are NOT your typical transactions, and involve a barter-type set of transactions between consumers and, say, Google). Majority of these drivers are reinforced by the selectively ultra-low cost of funding for the monopolistic competitors, available courtesy of the rounds and rounds of global risk-mispricing, aka, QE.

Despite the above shortcomings, the paper is an important one. Its conclusions are succinct and far-reaching. “There are a number of reasons why we argue for this hypothesis (i) there is a wide variety of confirmatory evidence that concentration, profits, and markups have increased over the time period, while the natural rate of interest has decreased (ii) it is parsimonious, in the sense that we use two data series (markups and interest rates) to explain the movements of 5 separate trends (iii) our model does not generate counterfactual implications.”

“In this paper, we argue that these trends can be explained by an increase in market power and pure profits in the US economy, i.e., the emergence of a non-zero-rent economy, along with forces that have led to a persistent long term decline in real interest rates.” Whatever your views on the causal factors might be, the dangers inherent in this systemic dismantling of the competitive, open, entrepreneurial model of the American economy of the past is a major source of future risks, uncertainties and social risks.

9/2/18: Angus Deaton on Monopolization and Inequality

For anyone interested in the topics of wealth inequality, structure of the modern (anti-market) economy and secular stagnation, here is an interview with economist Angus Deaton on the subject of market concentration, rent seeking and rising inequality: https://promarket.org/angus-deaton-discussed-driver-inequality-america-easier-rent-seekers-affect-policy-much-europe/.

I cover this in our economics courses, both in TCD and MIIS, as well as on this blog (see here: http://trueeconomics.blogspot.com/2018/02/7218-american-wages-corporotocracy-why.html).

In simple terms, rising degree of oligopolization or monopolization of the U.S. (and global) economy is, in my opinion, responsible for simultaneous loss of dynamism (diminished entrepreneurship, weakened innovation) in the markets, the dynamics of the secular stagnation and, as noted in our working paper here (http://trueeconomics.blogspot.com/2017/09/7917-millennials-support-for-liberal.html), for the structural decline in our preferences for liberal, Western, values.

As Deaton notes, "Monopoly, I think, is a big part of the story. Both monopoly and monopsony contribute to lower real wages (including higher prices, fewer jobs, and slower productivity growth)—just a textbook case! But there are things like contracting out, which are making it much harder at the bottom, or local licensing requirements—mechanisms for making rich people richer at the expense of stopping poor people starting businesses and stifling entrepreneurship. There are also more traditional mechanisms other than rent-seeking, like the tax system. All these affect the distribution of income very directly. One of the things that seem to be going on more than it used to be is rent-seeking that’s redistributing upwards."

While I agree with his top level analysis on the evils of monopolization, I find the arguments in favour of unions-led 'redistribution downward' to be extremely selective. Unions co-created the current rent-seeking system through (1) collusion with capital owners, and (2) selective redistribution based on membership, as opposed to merit. In other words, unions were the very same rent seekers as corporations. And, just as capital owners, unions restricted redistribution downstream to select few workers at the expense of all others. Which means returning unions to a monopoly power of representation of labor is a fallacious approach to solving the current problem. Instead, we need to make people shareholders in capital via direct provision of carefully structured equity.

Disagreements aside, a very good interview with Deaton, worth reading.

7/2/18: American Wages, Corporotocracy & Why the Millennials Should be Worried

Pooling together a range of indicators for wages, Goldman Sachs' Wage Tracker attempts to capture more accurate representation of wages dynamics in the U.S. Here is the latest chart, courtesy of the Zero Hedge (https://www.zerohedge.com/news/2018-02-05/goldman-exposes-americas-corporatocracy-wage-growth-slowing-not-rising)

According to GS, wage growth is not only anaemic, at 2.1% y/y in 4Q 2017, and contrary to the mainstream media reports and official stats far from blistering, but it has been anaemic since the Global Financial Crisis. The latter consideration is non-trivial, because it implies two things:

1. Structural change, consistent with the secular stagnation thesis, that is also identified in the GS research that attributes wages stagnation to increasing degree of concentration of market power in the hands of larger multinational enterprises (or, put more succinctly, oligopolization or monopolization of the U.S. economy); and
2. A decade long (and counting) period in the U.S. economic development when growth has been consistent with continued leveraging, not sustained by underlying income growth.

The first point falls squarely within the secular stagnation thesis on the supply side: as the U.S. economy becomes more monopolistic, the engines for technological innovation switch to differentiation through less significant, but more frequent incremental innovation. This means that more technology is not enabling more investment, reducing the forces of creative destruction and lowering entrepreneurship and labor productivity growth.

The second point supports secular stagnation on the demand side: as households' leverage is rising (slower growth in income, faster growth of debt loads), the growth capacity of the economy is becoming exhausted. Longer term growth rates contract and future income growth flattens out as well. The end game here is destabilization of the social order: leverage risk carries the risk of significant underfunding of the future pensions, it also reduces households' capacity to acquire homes that can be used for cheaper housing during pensionable years. Leveraging of parents leads to reduced capacity to fund education for children, lowering quantity and quality of education that can be attained by the future generation. Alternatively, for those who can attain credit for schooling, this shifts more debt into the earlier years of the household formation for the younger adults, depressing the rates of their future investment and savings.

Goldman's research attempts to put a number on the costs of these dynamics, saying that in the longer run, rising concentration in the American private sector economy implies a 0.25% annual drop in wages growth since 2001. While the number appears to be small, it is significant. From economic perspective this implies 3.95% lower cumulative life cycle earnings for a person starting their career. And that is without accounting for the effects of the Great Recession. A person with a life cycle average earnings of USD50,000 would earn USD940,000 less over a 30-year long career under GS estimated impact scenario, than a person working in the economy with lower degree of corporate concentration. 

The 0.25% effect GS estimate is ambiguous. So take a different view: prior to the Global Financial Crisis, longer term wages growth was averaging above 3% pa. Today, in the 'Best Recovery, Ever' we have an average of around 2.2-2.4%. The gap is greater than 0.6-0.8 percentage points and is persistent. So take it at 0.6% over the longer term, forward, the lower envelope of the gap. Under that scenario, life cycle earnings of the same individual with USD 50,000 average life cycle income will be lower, cumulatively, by USD 1.53 million (or -6.4%). 

That is a lot of cash that is not going to be earned by people who need to buy homes, healthcare, education, raise kids and save for pensions.

Remember the "Don't be evil" motto of one of these concentration behemoths that we celebrate as the champion of the American Dream? Well, their growing market power is doing no good for that very same Dream.

Meanwhile, on academic side of things, the supply side secular stagnation thesis must be, from here on, augmented by yet another cause for a long term structural slowdown: the rising market concentration in the hands of the American Corporatocracy.