Way back in 2002, we were visiting the US for Thanksgiving, and it was an extraordinarily depressing time. We couldn’t turn on the television, because all you got there was the non-stop and relentless drumbeat of COUNTDOWN TO IRAQ or some such, and it was really bumming me out. I distinctly remember thinking, “I want to go home,” and that was something of an epiphany.
So Mrs W, in an attempt to cheer me up, said “Hey, Elliott Spitzer is going to be in town at the Kennedy Library.” And, sure enough, he was, as part of a panel discussion on corporations and social responsibility. The line-up looked a lot more impressive than it turned out to be—Spitzer, who had just gone after Wall Street in no uncertain terms, and won; William Donaldson, who had just been appointed to head the SEC the previous week (and therefore had to decline); some muckamuck at Starbucks, and a former Kennedy aide muckamuck at Nike (or maybe the reverse—I can’t remember); and some blowhard named Elizabeth Ross Kanter from Harvard Business School.
It was interesting, in no small part because it was clear that not only was Spitzer the smartest guy in the room, he was really, really smart by any measure. He made some good points about corporate boards taking their legal responsibilities seriously, and there was a lot of blather from the others. But it still left a frustrating aftertaste, and I decided to ask Spitzer a question. So I got up and stood in line until my turn came, and asked Spitzer more or less the following: “Given that what you’re talking about is increased regulatory enforcement, and given that Congress and the regulatory agencies are full of people who are not only hostile to enforcing existing regulation, but are opposed to any kind of regulation whatsoever—what do we do about this?” And Spitzer gave the perfect non-answer:
“Go after the Chicago School.”
It was the perfect non-answer because it provided no immediate comfort, but it indicated what the longer term strategy needed to be. The Chicago School, which refers to a group of economists associated with the University of Chicago whose particular focus over the years, particularly under the influence of the late Milton Friedman and others, has been the economic justification for absolute (or near absolute) opposition to government regulation. This is a vast oversimplification, of course, but it’s true enough. Friedman, who won the Nobel Prize for economics, carved a major career for himself proselytizing for “free markets.” And this sounds good, since everyone is in favor of free markets, right?
Actually, it’s a bit more complicated than this. Because it turns out that most people don’t know what they’re talking about when they talk about “free markets”—or at the very least they fall into a natural confusion. Does this mean markets with open competition? Yes, or it should. Does this mean markets with a complete lack of regulation? No. We’ve just seen what happens to financial markets when they are assumed to regulate themselves. It turns out they don’t, not at all, which came as something of a surprise to the major policy representatives of the Chicago School, such as Alan Greenspan, who still appears confused and bewildered (and very defensive) by the entire sequence of events of the past several years. But there’s a slightly complicated entanglement here between regulation and market function, which has provided endless economic commentary ever since Adam Smith. I’m not about to repeat it all. But the recent financial meltdown, which required extraordinary government measures to prevent an even further financial and economic collapse, has to be understood in the context of a larger and more insidious trend that has been taking place over the past several decades.
Because it’s not just financial markets that have seen a period of intense consolidation, particularly since the repeal of Glass-Steagall in 1999. It’s practically every industry you can think of—technology, manufacturing, pharmaceuticals, retailing, consumer products, metals and mining, you name it. And it all derives from a major change in anti-trust enforcement that went into effect at the beginning of the Reagan administration, when the Chicago-school influenced appointees of the Reagan administration decided to simply not enforce anti-trust laws any more. So for the past 30 years, we’ve been seeing one industry after another consolidate like crazy, driving up the market shares of remaining participants. How many PC manufacturers are there now, as compared with two decades ago, for example? How many packaged food companies? How many retailers? How many broadcast media companies? Health Insurance providers?
The Clinton administration, remember, bought this whole agenda and even furthered it under Robert Rubin and Larry Summers (who now controls economic policy for Obama)—hence we got NAFTA and the repeal of Glass-Steagall, which allowed commercial banks and investment banks to consolidate again, meaning that partners in investment banks could offload risks from themselves to shareholders. And of course the more recent Bush administration gobbled up all this horse exhaust as well. In perhaps the most egregious example of non-regulatory intervention in our lifetime, the Securities and Exchange Commission, under former Republican Congressman Christopher Cox, chose to completely ignore its enforcement role—the Madoff situation is the most public example, but there were plenty of others. And even beyond the SEC, the people put in charge of the nation’s banking system all had very strong anti-regulatory beliefs, encompassing undermining anti-trust provisions that would have served to safeguard consumers over the past decade. And as far as anti-trust oversight, forget it. There was none. It was Bush’s people who were perfectly prepared to let General Electric gobble up Honeywell—it was the European Union regulators who blocked it.
Which gets us to Barry C. Lynn’s new book, Cornered: The New Monopoly Capitalism and the Economics of Destruction, which is an extremely important but simultaneously frustrating book. This is a good successor to Lynn’s End of the Line, which came out several years ago, and which is still one of the best books I can think of for why America’s economic model–not the financial one–is in trouble, and why the globalized economic model we seem to have cheerfully adopted is vulnerable to the kind of shocks we’ve been seeing recently. Lynn’s approach is sort of the reverse of the stupid Tom Friedman books on the glories of globalization. It’s not inevitable, of course, but the trend towards monopoly capitalism in America more or less insures that the American economy will remain in dire straights, and will continue to weaken. You can’t understand the financial crisis of the past three years without understanding how the American economy itself has changed of the past several decades, and Lynn’s books are some of the best in this regard.
To take just one example, the consumer goods industry, Lynn points out that Colgate-Palmolive and Procter & Gamble control over 80% of the market for toothpaste in the United States; nine of the ten top brands of bottled water are sold by Pepsi, Coke, or Nestle; Campbell’s has something like a 70% retail share for canned soups in the supermarket; and Anheuser-Busch In Bev or Miller-Coors produces nearly every beer is manufactured or distributed in the US. Now, what’s wrong with this? Well, a number of things, and Lynn’s book is an explication of what’s wrong. For one thing, this has not necessarily produced any tangible gains for the consumer. In particular, it’s actually contrary to the notion of “free markets” if by free markets we mean two things: (1) the ability of potential market entrants to actually enter the market, and (2) the ability of the market to create efficient prices.
The first of these should give us no problems. There are markets that by their nature are not “free” in this sense. Utilities and telecommunication companies, for example, have infrastructure requirements that can be prodigious. As a result, you generally tend to have only one utility in a particular regions. What keeps this utility from monopolistic pricing? The regulators. And this is still the case, although regulators the past two decades have also allowed these same regulated utilities to build up non-regulated businesses that at times have compromised the financial strength of the regulated portion of the business. On the other hand, you might make a great toothpaste that works really well, and in theory your manufacturing costs might be lower too—you still have to get it to market, and in a market where 80% of the retail shelf space is held by just two companies, and where national distribution trends are dictated by one major retailer, that can be very difficult to do.
These days it’s difficult to say that the state of competitive markets in the modern US economy is actually all that competitive. Rather, most sectors of the economy tend to display all basic characteristics of monopolistic (or at least cartel-like) markets, where a few producers, and those who control distribution, control the pricing. This is partly the Wal-Mart effect that Lynn discusses in both End of the Line and again in Cornered—the fact that Wal-Mart is now in a position to tell manufacturers as large as Colgate and P&G what sort of products it wants to see. And the range of industries where clearly monopolistic tendencies have risen now encompasses many of the basic services that modern Americans have come to expect.
But it’s also the result, as Lynn shows, of a very deliberate policy shift in anti-trust enforcement that was adopted at the beginning of the Reagan administration, when the Chicago School disciples started exercising their own ability to affect policy. Because what became paramount at this point for the regulators was no longer protection of consumers, which had been the guiding economic principle in assessing mergers and acquisitions up to that point, but rather whether any particular M&A transaction could be justified in terms of market efficiency. This was a seminal change, and furthered the creation of what Lynn discusses as both top-down monopolies (creating behemoths like Wal-Mart to compete against smaller retailers) that restricts and controls the supply systems that moves goods to consumers (at whatever level), and of bottom-up monopolies (through supplier concentration—forest products, packaged food, credit). And the costs of this, according to Lynn, have been high—stifling of innovation, an outright reduction in consumer choice, and a general reduction in social welfare.
These are broad claims, and not all of them are completely supportable, as some reviewers have noted. I mentioned that Lynn’s book is important, but also frustrating, at least for me, for several reasons. First, while Lynn does as admirable job of providing the historical context for anti-trust enforcement in American history, going back to the debates among the founding fathers (Jefferson and Madison, as it turns out, wanted two additional rights in the Bill of Rights—no standing armies, and freedom from “monopolies in commerce”). But there’s quite a lot of history and maybe not quite enough economics, and the entire second half of the book could have used many more current economic examples.
Secondly, it’s not clear that all the examples Lynn provides are actually as strong as he thinks—he spends a lot of time on Motorola’s travails over the past two decades, and implies that the problems the company has had over the past decades are solely the result of short-termism by Wall Street analysts. Well, sadly it’s a bit more complicated than that. There were a bunch of bad management decisions during that period that Lynn glosses over. This is not to say that Lynn is wrong—far from it. But there are better examples (from the consumer products and retail industries, for example, where buying businesses simply to close them down and remove them from the market is not unknown) that he could have picked to bolster his case. The world is a complicated place. It’s bad enough to have the maniacal de-regulators ignoring this complexity. It doesn’t help when your friends try to oversimplify as well.
Still, one has the feeling that even though not all the particulars may hold up, that Lynn has the bigger picture right—at least one of the reviewers above concedes this. There has been a transformation in the American business landscape the past three decades, and it’s not one that has necessarily benefited anyone expect Wall Street. Now, that’s fine for Wall Street. But Wall Street continues to believe that this trend has no costs—or, at least, costs that they are concerned with. And the ironies here are manifold. First, in spite of the constant bleating pf people who think they favor “free markets” as opposed to government regulation, it’s clear that thirty years under the regulatory and political control of Chicago School disciples have made markets considerably less “free,” in the sense that people like Smith, Schumpeter and even Hayek meant “free.” Secondly, the monopolistic tendencies that have characterized so many markets during this period is not the natural result of unimpeded economic competition—it’s the direct result of government policies deliberately designed to allow for the reduction of competition to benefit existing (and large) market players.
And the recent financial meltdown and painful (partial, to date) recovery have indicated, what we have created in a number of industries are companies that are indeed Too Big To Fail. But this isn’t an accident. There were plenty of people warning about the consequences of, say, allowing the banking industry to consolidate. They were simply ignored. And there’s there’s little reason to think that anyone has learned these lessons. Phil Gramm, who was John McCain’s principal economic adviser in the 2008 campaign before he had to resign for stating that Americans should stop whining, is principally responsible for, among other things, the law that currently prevents credit default swaps from being regulated. McCain himself still seems to think that it’s perfectly ok to let financial institutions grow humongous, and then fail if they need to, and that this will have no corollary effects in the real economy.
A similar conclusion can be drawn from the consolidation within the auto industry, particularly among the supplier base–the Republican opposition to Obama’s bailout (like that of Bush before him) was entirely along Chicago School lines, ignoring the issues of what unemployment in Ohio would look like right now if there had been no government intervention. Of course, as Lynn points out, the auto industry was allowed to get into this mess in the first place because of anti-trust enforcement failure—the industry allowed itself to “increasingly rely on a single common body of companies that supply the same components to all of them.”
In the financial sphere, the recent Republican response to the Christopher Dodd’s financial regulation bill is not only bereft of sense in its own right, but reflects the kind of anti-regulatory thinking that got us into this mess in the first place. And it’s not as if Dodd’s bill is any great shakes—in fact, it’s pretty weak so far as financial regulation goes, and not nearly as strong, for example, as what Paul Volker has been going around saying the past several years. But Volker is still pretty marginalized in the Obama administration.
Because the Obama people retain this Chicago School mindset as well to a considerable extent, which is not a surprise considering how many of them are associated with this thinking, particularly at the top. Consider these comments from a recent interview with Michael Lewis, whose The Big Short is rapidly reaching the top of my pile of books on th is crisis to read:
Lewis: “The people who were responsible for orchestrating the crisis, because they’re on top and they’re in the middle of it, they’re the only ones who are sort of fluent in the language of it. I mean, who’s to question Tim Geithner, the secretary of the treasury, about this or that, because he’s the only with the information . . . even though he is clearly culpable in what happened.”
Lydon: “Not to mention Larry Summers and Bob Rubin and all the other architects of the deregulation. They’re still calling the shots in a new administration after a change of party management. It’s unreal.”
Lewis: “It is unreal, because basically all of the people you mentioned all swallowed a general view of Wall Street, which was that it was a useful and worthy master class, that these people basically knew what they were doing and should be left to do whatever they wanted to do. And they were totally wrong about that. Not only did they not know what they were doing, but the consequences of not knowing what they were doing were catastrophic for the rest of us. It was not just not useful; it was destructive. We live in a society where the people who have squandered the most wealth have been paying themselves the most, and failure has been rewarded in the most spectacular ways, and instead of saying we really should just wipe out the system and start fresh in some way, there is a sort of instinct to just tinker with what exists and not fiddle with the structure. And I don’t know if that’s going to work. When you look at what Alan Greenspan did, or what Larry Summers did, or what Bob Rubin did, there are individual mistakes they made, like for example not regulating the credit default swap market, preventing that from happening. But the broader problem is just the air they breathe. The broader problem is just the sense they all seem to have that what’s good for Goldman Sachs is good for America.”
All of this while Alan Greenspan continues to try to tell anyone who will l isten that what happened was not his fault.
And what of the Chigcago School itself? Well, we’re already seeing some apostasy. Richard Posner has now dcelared himself a Keynsian. Paul Krugman wrote a lengthy piece for The New York Times last year giving a pretty good history of recent economic theory, the place of the Chicago School in this period, and how it all came apart. And for the more technically oriented, Brad DeLong was written a number of papers laying bare the empty cupboard of the Chicago School’s intellectual failures. And yet, they’re still everywhere.
And while there does seem to be enough alarm about the deregulatory trend of the past thirty years to suggest that changes may be coming, the change of pace here will be slow. How can it not be, when one of the major responses to the collapse of markets and the government response orchestrated by both the Bush and Obama administrations has been a resurgence in the popularity of…Ayn Rand? Spitzer was right. Demonstrating that the underlying philosophy of deregulation has massive flaws that endangered the health of the global financial system should be enough, but it will take time to sink in. What people learn in business schools will need to change. What gets taught in economics will need to change. And it won’t be overnight, either. But it’s the way to go. People who love to throw Hayek around need to start reading Keynes as well. There’s an appropriate balance to be found, and we need to find it soon.
As Keynes once said, “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” This remains as true now as it was when Keynes first said it in 1935. Keynes was also the economist who pointed out that “In the long run, we’re all dead.” So we don’t have time to waste.