Tuesday, June 17, 2014

Competition policy and income inequality

The op-ed piece in last Sunday's Washington Post ("How American became uncompetitive and unequal," by Lina Khan and Sandeep Vaheesan)  suggests that a main contributor to income inequality, depressed wages, and lack of job opportunities is increasing concentration in U.S. industry, fostered in part by competition policy that focuses on economic efficiency over "fairness." Unfortunately, the authors have only a fuzzy grasp of the facts.

As a starting point, it's hard to tell what the authors mean by economic inequality. The piece starts by referencing the 1980s, but the next paragraph cites Piketty's Capital in the Twenty-First Century which, I've read, argues that income inequality today has increased relative to the early 20th century. (Others have critiqued Piketty's book, in particular the very premise that income inequality has increased.) However, it's an inescapable fact that merger policy fundamentally changed in the 1980s - part of the "Reagan Revolution"  - by focusing more on the economic effects of mergers, placing greater weight than before on cost-reducing efficiencies of mergers, rethinking the relationship between price and market concentration, and, as a consequence, challenging fewer mergers than before. Even as political winds shifted toward the Democratic Party, with its greater tendency to view mergers suspiciously, the fundamental approach to analyzing mergers hasn't changed since the 1980s.

What this means is that many industries have become more concentrated. This doesn't necessarily imply that these industries have become less competitive for reasons that include:
* Greater competition from foreign companies, so that U.S. concentration is not necessarily the relevant measure of concentration;
* A growing economic literature that reduced the myth of a strong price-concentration relationship; instead, studies showed that markets remained reasonably competitive until the number of firms was relatively small - markets of one or two firms certainly performed worse than they would have performed with more competition, but three or four vigorous competitors was generally enough to keep one another honest;
* Recognition that mergers could lead to significant cost reductions, a portion of which would be passed on to consumers in the form of lower costs.

At the same time, firms were rethinking their businesses. Cheap computing power and, later, the ubiquity of the Internet allowed firms such as Wal-Mart to revolutionize bricks-and-mortar retailing and Amazon to do the same with on-line retailing. Manufacturing firms could use just-in-time inventory to reduce costs and cheaper transportation allowed firms to conduct business over longer distances. Instead of many small-scale retailers serving local markets, a small number of large retailers served markets across the country. Instead of the "big three" U.S. car companies dominating the domestic market, foreign competitors made substantial inroads, resulting in cheaper and more reliable models (and forcing the U.S. firms to step up their game).

Of course, this transformation of the economy had losers as well as winners. Greater overseas competition in manufacturing meant that labor unions were under pressure to agree to wage reductions, and (not coincidentally) higher U.S. manufacturing costs, including labor costs, have meant job losses to overseas competition. Wal-Mart's growth has meant a reduction in "mom and pop" retail operations; even if the net result in employment was about a wash, as some studies have shown, the average wage at Wal-Mart is lower than the jobs it replaced. Bear in mind, however, that a small number of workers have lower wages while a large number of consumers - mainly lower-income consumers - have access to goods at lower prices. 

Khan and Vaheesan have a number of examples of anticompetitive behavior in particular industries, some of which are better than others. They mention the tech industry agreements to not poach workers. It's hard to quantify how much this affected wages, but it's certainly an example of an anticompetitive agreement that harmed workers (and, arguably, consumers as well). On the other hand, they claim that consolidation in the health-care industry has led to huge markups in the price of services. While it's true that some hospital mergers have been found to have led to higher prices - indeed, the FTC has challenged a number of hospital mergers (back in the 1990s, the agency lost those cases routinely; now the agency has a good track record of winning such cases) - much of the wacky pricing of hospital services is the result of efforts to cross-subsidize various parts of the business. For example, the requirement that hospitals take all comers for emergency services means that the cost of indigent patients be borne by patients of means - and their insurers.

In cable markets, another area mentioned in the article, operators such as Comcast and Time Warner Cable have certainly made out well, largely because of lack of competition. However, this lack of competition has not arisen through mergers - most cable mergers involved non-overlapping service areas, and where there have been substantial "overbuilds" (areas served by two cable operators) the FTC has ordered divestitures of the overlap areas - but because historical franchise agreements with local governments and the natural monopoly nature of utilities (including cable) have limited competition. Some parts of the country are lucky to have Verizon's FIOS service, or Google fiber-optic service, to compete with the local cable monopoly, and DirecTV has been a somewhat more distant competitor for much of the country, but there's no denying that cable prices are out of control. (Consumers get more for their higher prices - remember the days of just a handful of cable channels and no DVRs? - but still, this is an area that begs for more competition.)

Corporations certainly have an incentive to reduce competition, and mergers are one potential way to do so, but big companies have a much easier way to limit competition: enlist the government. Large firms are often in favor of  costly regulations because such regulations impose disproportionately high costs on small firms. A firm with a national footprint can afford a big legal department, to hire people full-time to handle regulatory compliance issues. Smaller firms are at a disadvantage. Furthermore, firms that induce the government to impose barriers to entry (regulatory or otherwise - a patent system that awards patents willy-nilly serves as an effective entry deterrent) can enjoy higher returns.

The sad truth is that the golden years of the U.S. economy are behind us. There are a lot of reasons for this. Much of the post-World War II boom was driven by the unique confluence of pent-up consumer demand (because of wartime shortages) and a decades-long increase in women's labor force participation: people wanted stuff and more people became available to make and sell stuff. We value thing such as cleaner air, workplace safety, consumer product safety, and social safety net programs (including a minimum wage), all of which have value but come at the expense of productivity. Government has gotten big and highly regulatory. Whether the pendulum has swung too far in the direction of regulation is a topic for another time, perhaps, but it's clear that there is no going back to the competitive conditions of the 1950s - including the dominance of U.S. manufacturing.

I don't want to leave the impression that regulation is necessarily bad - indeed, cable providers and the like probably should be regulated more than they are - nor that competition policy is unimportant. We want to be on the lookout for mergers to monopoly or near-monopoly. We want to look for widespread non-poaching agreements such as the one the technology companies had in place, just as we want to maintain our lookout for price-fixing agreements. And I agree with Khan and Vaheesan that the competition agencies should block mergers rather than okay complex settlements to deals. For the most part, however, what government should do to foster a healthy business - and hence healthy jobs - climate is to create conditions for entrepreneurs to take advantage of profit opportunities (including government's crucial role in protecting property rights) and then, to the extent possible, get out of the way. 

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