The Market Power of Technology (part 3)

March 13, 2024

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The last three chapters of Mordecai Kurz’s The Market Power of Technology contain his public policy recommendations. These are based on his conclusion that a capitalist economy left to its own devices will not produce the optimal, most efficient outcomes—the greatest good for the greatest number imagined by utilitarian philosophers. The accumulation of market power and monopoly wealth ultimately undermines economic growth and mass prosperity.

It also undermines democracy:

[I]n a democracy, the rich can shift society to an equilibrium favorable to them simply by putting together a winning coalition that establishes a free, laissez-faire economic policy. Capitalism then does the rest by enhancing their wealth and preserving their power at the expense of the rest of society. My conclusion is that, in the age of technology, democracy under unregulated free-market capitalism is an unstable economic system; it results in the decline of social cohesion and in a political progression toward plutocracy. For a capitalist market economy, a policy to contain market power is a necessary condition for both democracy and economic growth to succeed.

Reversing these negative trends will require a change of thinking on the part of policymakers and judges. They will need to stop regarding successful companies as so useful to society that their concentrated market power can be overlooked. While new technologies do increase productivity in general, the most profitable firms are not always as productive as they appear, or as they could be. Their high revenues create the appearance of producing great value at low cost, but those revenues also depend on high prices and profit margins.

Technological progress is necessary but not sufficient for strong, broad-based economic progress. Public policy must both restrain the expansion of market power and promote the general good by facilitating upward mobility and expansion of the middle class.

Restraining the expansion of market power

The goal here is to balance the need to reward technological innovation with the need to place reasonable limits on the market power of technology users. Kurz argues for a new principle of antitrust policy, “restraining an entity’s technological market power down to the level granted by patent law.” That is:

If its privately owned technology is entirely innovated by the firm itself (as distinct from having been acquired) and it does not take any actions to erect additional barriers to entry, its market power is then protected by patent laws.

The main way that big firms expand their market power is not by innovating for themselves, but by buying the innovations of smaller companies. Microsoft made 237 acquisitions between 1987 and 2020. Antitrust law should place limits on such acquisitions.

Another target of antitrust law should be large technology “platforms” such as Google, Facebook, and the Apple Store, which are able to extract monopoly profits from advertisers or developers. Kurz would like to see them regulated like public utilities.

Many European countries have gone beyond U.S. antitrust law to develop a concept of “abuse of dominant market position.” That makes it easier for European courts to take action against firms that erect barriers to free competition or raise prices to unreasonable levels. [That was the basis for the European Union’s $1.95 billion fine on Apple last week.]

Kurz has several recommendations for patent reform. He would tighten the requirements for granting patents, allow patents shorter than the standard twenty years, and cut the length of patents in half for those acquired through merger or acquisition.

Since firms with market power use it against workers as well as competitors, Kurz would strengthen protections for workers. He would target practices that restrict a worker’s right to seek the best wages and benefits, such as noncompete clauses for low-wage workers, long-term contracts classifying workers as independent contractors, or “no-poaching” agreements preventing one franchiser from hiring a worker from another. He would raise the federal minimum wage—now a paltry $7.25 an hour—and index it to the cost of living. He would facilitate the formation of unions, not just to increase wages, but “to develop cooperative institutions for addressing the social problems of workers.” That’s because labor’s falling share of the national income is associated with problems like family instability, lower morale, and drug addiction.

Taxation, public investments, and redistribution

The final policy chapter discusses ways to strengthen the economy by promoting the general economic welfare.

The first of these is a return to a more progressive personal income tax. Recent studies in economics support the idea that a higher top bracket rate can provide needed public revenue without reducing taxpayers’ incentive to contribute to society through valued work. (See, for example, my earlier post on this topic.) Higher tax rates did not stop the mid-twentieth-century from being a time of technological innovation and rapid economic growth.

Kurz is also in favor of corporate taxes, if they are carefully designed. Critics of corporate taxes complain that they tax savings and investment. But Kurz would tax only revenue in excess of the cost of materials, labor, and capital, thus taxing only monopoly profits, not investment. He would then use the additional tax revenue “to finance investments that promote long-term efficiency and growth, and for active antitrust policy to remove some of the distortion in factor prices.” Many multinational corporations escape U.S. taxes by moving profits to low-tax countries. Kurz would deal with that by apportioning taxes according to country of sale. If half of sales are in this country, half of revenue should be taxed here.

Kurz would like to see more of the national income going to benefit the lower half of the population. He does not, however, favor direct cash distribution programs, such as the frequently proposed Universal Basic Income. He believes that “the most decisive argument against them is that they do not address the main goal of all long-term egalitarian policies, which is to help individuals improve their skill and motivation to earn, on their own, income above poverty level and perhaps join the middle class.” He prefers health and education programs targeted at the children of low-income families, who he calls “the most wasted human resources in our society.” The evidence shows that such programs are more likely than tax cuts for the wealthy to pay for themselves in future tax revenue and reduced social costs.

Kurz proposes a National Fund for Equity and Democracy that would invest in markets through an index fund, but use the earnings to support a flow of workers into the middle class. For example, it could provide scholarships for low-income students to attend college or technical school, or pay the moving costs for families to move to places with greater economic opportunity.

Several proposals address the continued need for technological innovation. One calls for reversing the decline in public support for basic research, which has dropped dramatically as a percent of GDP over the past forty years. (Recall that publicly-supported basic research is a major source of technological innovation.)

Kurz is also concerned about the impact of technology on jobs. Giving low-income children more skills will be futile if the economy has no jobs for them to do. Machines that are designed to replace workers can create private gain, but they come with a high social cost. However, many smart machines are intended to be used by smart humans! “A policy needs to be crafted that encourages innovations that promote partnership of workers with machines and enhances the productivity of the unskilled rather than replaces them.”

All these proposals are consistent with Kurz’s general argument. The best formula for prosperity is the one that characterized the mid-twentieth century—a technological revolution yes, but also egalitarian policies to curb the power of the few to monopolize the benefits, and to provide avenues of upward mobility for the many.

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The Market Power of Technology (part 2)

March 6, 2024

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To make his case that we are living in a second Gilded Age, Kurz must study variations in market power and public policy over the course of American history. He believes that this comparative approach yields a much greater understanding of the recent era than just studying it in isolation from the past.

Data and methods

Historical research in economics is always challenging, since data for earlier eras are less complete, less reliable, and organized differently from modern data. Kurz needs to integrate two different data series, one from 1889 to 1929 for the private, nonfarm, nonresidential economy, and the other from 1925 to 2017 for the private corporate sector. The second series is more directly relevant, since the corporate sector is where most of the market power lies. Fortunately, the two series overlap for the years 1925 to 1929, and the differences between their estimates of key variables in those years provide a guide to adjusting the first series to make it comparable to the second.

Kurz wants to discern the rises and falls in market power, as influenced by technological developments and shifts in public policy. To do that, he needs to calculate the shares of corporate income going to labor, capital, and profit. Recall from the previous post that he defines capital to include only investments in tangible assets. Income beyond the cost of labor and capital is profit, and profit is an indicator of market power. Kurz’s method is to calculate the labor and capital shares from the data, and then use the residual—what’s left over—as an estimate of the profit share.

The most complicated part of the analysis is the calculation of capital share. The interest rate on corporate bonds is only the starting point for calculating the return on capital. Kurz needs to consider the risk premiums—additional returns—investors get for investing in different classes of capital assets, such as real estate and equipment. The rate he calculates for any given year is a composite rate representing a diversified portfolio of capital investments.

To discern trends, Kurz needs to filter out short-term fluctuations that confuse or distort the data. He makes some adjustments to the numbers and does some mathematical curve-smoothing to tease out the long-term trends.

The first Gilded Age

The first data series includes data for the 1890s, the culminating decade of the Gilded Age. In the first year of the series, 1889, the estimated labor share was 71.3%, and the estimated capital share was 27.5%. Since the residual is only 1.2%, that suggests that almost all corporate income above the cost of labor was going to compensate investors in tangible capital assets. By 1901, the situation had changed. Labor share had fallen dramatically to 50.8%. Did the capital share rise accordingly? No. It also fell, from 27.5% to 15.5%. The large residual, 33.7%, is income that neither wages nor capital costs can account for. Kunz considers it the profit due to market power, especially pricing power.

In 1892, J. P. Morgan financed the merger of the Edison General Electric Company and Thomson-Houston Company to create General Electric. GE’s 1896 patent-sharing agreement with Westinghouse “gave the two firms monopoly power over all U.S. electricity generation and transmission equipment… [T]he relative share of profits in GE’s income rose sharply, to the extraordinary level of 42 percent, in 1901.” Control over what Kunz calls a “General Purpose Technology” (GPT) drove market power and profit.

Since the economy was growing, the declining labor share did not necessarily mean an absolute decline in living standards. But it did mean that someone else was getting rich while the workers lagged behind. According to Kurz’s theory, the rising market power of the owners and managers of capital allowed them to keep prices high and maximize revenue without maximizing output. It also slowed economic growth, weakened the demand for labor and capital, retarded the diffusion of innovations throughout the economy, slowed the improvement in living standards, and allowed the wealthy to dominate politics.

Government policy in those years did not stand in the way. “Market power rose rapidly and was further augmented by a wave of mergers and acquisitions, and, equally important, no active policy or regulatory institutions existed to constrain this rising trend.”

The combination of technology-driven market power and passive public policy is what created the first Gilded Age. It is also what would create a second Gilded Age in the late twentieth century. But first came an era of policy reform.

The age of reform and egalitarianism (1901-1984)

Beginning in 1901, the downward trend in labor’s share of corporate income started to reverse. Labor share rose from 50.8 percent in 1901 to 59.9 percent in 1953, before drifting down to 55.2 percent in 1984. Kurz attributes this change to a more progressive policy regime that put limits on market power and profits, but strengthened the position of workers.

[Theodore] Roosevelt and his reformist allies had a vision of a substantially more active regulatory state. They created long-lasting institutions such as the Food and Drug Administration (1906), the Federal Trade Commission (1914), the Federal Reserve (1913), and the Clayton Antitrust Act (1914) that reinforced the Sherman Antitrust Act by restricting mergers, and settled the constitutionality of the federal income tax (1913). Progressive policy also supported the rising power of labor unions, in contrast with previous administrations that intervened to help in breaking strikes. Although innovations in electricity and combustion engines continued to give rise to new firms with market power, the effect of the stricter regulatory regime was stronger. The share of profits declined, and labor’s share rose.

New Deal legislation in the 1930s added more business regulation, formally recognized the right of labor to organize, and raised taxes on corporations and the wealthy. The top bracket of personal income was taxed at 70% or higher from 1936 to 1986. Union membership reached its peak in the mid-1950s with one third of all workers unionized. “A more egalitarian society emerged from the New Deal era, leading to the 1936-1973 Golden Age of the American experiment.” This was marked by high rates of economic growth and broad participation in the benefits. [But not universal participation—the movement to extend civil and economic rights across racial lines did not come until late in this era.]

The new technologies that dominated the twentieth century—electricity and the combustion engine—made workers more productive without requiring high levels of skill or education. Unionized blue-collar workers now earned enough to join the growing middle class.

What Kurz calls “a sort of miracle” is that the labor share of income held up very well even during a period of rising market power, from 1932 to 1954. Kurz attributes this temporary rise to several factors: further technological advantages arising from the application of electricity and combustion engines, the destruction of smaller firms by the Great Depression, military profits and relaxed antitrust regulation during World War II, and a “massive transfer to private hands of technology that was developed in wartime with public funding.” But this time, labor was better protected by egalitarian public policies.

With labor’s share stabilized at a higher level, fluctuations in the profit share had to be balanced by fluctuations in the capital share in the opposite direction. When the profit share went up, the share of income attributable to capital investment went down. When profit share went down, which it did in the periods 1901-1932 and 1954-1984, the capital share went up. But looking at the entire era from 1901 to 1984, the profit share went down and both the labor and capital shares went up. That was the formula for twentieth-century mass prosperity.

The second Gilded Age

In the most recent period Kurz studied—1984 to 2017, the trends in corporate income reversed the egalitarian trends of the previous period. The labor share declined from 55.2 percent to 52.4 percent. The capital share declined from 29.1 percent to 15.7 percent. The residual, which Kurz takes as an indicator of market power and profit, increased from 15.7 percent to 31.9 percent. What is striking is how much the 2017 shares resemble the shares of 1901, at the culmination of the Gilded Age over a century ago.

How did this happen? Basically, for the same reasons it happened in the 1890s. A new technological revolution provided opportunities for corporations to achieve market power; and passive public policies allowed them to consolidate that power. While the earlier revolution had been based mainly on the General Purpose Technologies of electricity and the combustion engine, the new revolution was based on information technology.

Innovations in computer hardware in the 1960s produced a brief spike in market power and monopoly wealth (think IBM), but that did not last. The longer increase in market power began in the 1980s, with innovations in personal computers and software.

[A]ctual long-term recovery of monopoly wealth began in the early 1980s, when the new software innovation phase of IT went into high gear. IBM adopted Microsoft’s disk-operating system (DOS) as the PC operating system in 1981, and the military communication network (ARPANET) adopted in 1983 the protocol Transmission Control Protocol/Internet Protocol (TCP/IP) which expedited development of what we call today the internet.

Companies that owed their market power to the internet emerged after 1990, such as Amazon (1994), Netflix (1997) and Facebook (2004). Some older firms that were able to adapt to the IT age also gained market power. On the other hand, almost three thousand companies disappeared from the list of publicly traded firms between 1998 and 2016, most of them acquired by the larger firms.

Not only did the labor share of income decline, but the IT revolution had the effect of polarizing the labor force, increasing the income gap between workers of different skill levels. Workers with higher levels of education did relatively well, while less educated workers found their labor in less demand. They often had to settle for jobs in the rapidly growing, low-wage service sector. Workers with the skills to work with the smart machines thrived, while workers without those skills were more vulnerable to being replaced by them.

Just when new technologies were giving rise to greater market power, the “Reagan revolution” weakened the public policies that had limited corporate power and supported organized labor.

The [Reagan] administration…eliminated a wide range of business regulations and reinterpreted antitrust policy to allow a sharp rise in mergers and acquisitions, and hence in business concentration. Government-permitted mergers have led to the consolidation of important sectors such as airlines, banking, communication, chemicals, drugs, and high-tech.

The tax cuts of 1981 and 1986 lowered the tax rate on top-bracket income from 70 percent to 28 percent, just in time to allow the wealthiest stockholders to reap the benefits of the rising profits. One consequence was a sharp increase in the role of big money in politics.

Kurz maintains—and more and more economists agree with him—that the economic consequences of these policies were the opposite of what they were claimed to be:

One of the repeated arguments of those who supported the shift to a laissez-faire policy in the 1970s and 1980s was that the new policy would increase private incentives to work, invest, and innovate. They forecasted a substantial boom in investment and a higher growth rate of the economy. None of that materialized, and the implication of the theory presented here is exactly the opposite: such a change in policy would trigger a long period of adjustment marked by a decline in the rate of investment relative to potential trend and a lower growth rate of the economy relative to trend. This reasoning helps explain the decline of the rate of investment and economic growth from 1986 to 2020.

Our appreciation of the benefits of technology should not blind us to the disadvantages of allowing a small number of people to amass power and profit out of all proportion to their actual contribution to the general good.

Kurz also blames a lot of the social and political polarization of the country on these economic trends. Less educated workers who have been left behind by the IT revolution are among the most disillusioned by democratic government and the most vulnerable to manipulation by anti-democratic demagogues. [For those who argue that our social divisions are more racial than economic, I would stress the intersection of the two. Less educated white workers are most likely to compensate for their losses by clinging to their racial, religious or gender privileges.]

Like many writers before him, Kurz emphasizes the importance of a strong middle class to support democracy and seek compromise between the interests of rich and poor. The greater economic inequality, again reminiscent of the Gilded Age, makes it harder to agree on collective goals. Kurz would like to see a new round of economic democratization comparable to the Progressive/New Deal era, followed by an economic boom comparable to the postwar prosperity. I will turn to his specific proposals in the third and final post.

Continued

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The Market Power of Technology

February 29, 2024

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Mordecai Kurz. The Market Power of Technology: Understanding the Second Gilded Age. New York: Columbia University Press, 2023

I was very impressed by this book. I think that Kurz’s treatment of economic inequality rivals in importance works such as Thomas Piketty’s Capital in the Twenty-First Century.

The book is comprehensive in many respects. It is both contemporary and historical, analyzing variations in inequality since the late nineteenth century. It connects the dots between technological innovations, changes in market power, and shifts in public policy. Kurz does not just theorize, but formalizes his theory in a series of mathematical models, runs computer simulations, and matches the results with actual data from various time periods. That enables him to support his claim that similar developments explain both the inequalities of the earlier Gilded Age and those of today’s economy.

The book is very long and highly technical. Fortunately, Kurz is as good a writer as he is an analyst, presenting his ideas in simple prose as well as mathematical formulas. He also suggests a shorter path through the chapters for those who prefer a “nontechnical reading.”

Here I will lay out the basics of Kurz’s theory. In later posts, I will describe how he applies it to different eras of American history and summarize his policy proposals for dealing with what he calls our “Second Gilded Age.”

Technology and innovation

Kurz makes a sharp distinction between “scientific progress motivated by the desire for pure scientific discovery and technological innovations motivated by profits.” The funding for basic scientific research comes mainly from government, not private industry. That is because basic scientific knowledge is too hard to privatize. Many scientists work on the same basic questions, and their findings are too hard to keep secret. No one owns the science of genetics or quantum mechanics. Government has more incentive to fund basic research because of its potential to contribute to collective goals, such as national security or public health. Government support for basic research is also crucial to the economy, since “in the long run it is the rate of scientific progress that is the long-term speed limit on the rate of economic growth.”

The private sector’s contribution to technology is to take basic knowledge and use it to develop commercial applications. To develop a successful product, a private firm relies heavily on basic research funded by government, and also on inventions by innovators outside the firm. Kurz points out that every key component of the Apple iPhone originated as an innovation financed by government. And Microsoft’s famous disk operating system for PCs (DOS) was invented by smaller developers. Microsoft bought it for a mere $50,000, and then made millions licensing its version of it to IBM.

When scientific breakthroughs create an opportunity for new technological applications, many innovators and firms may start out as equals. At first, no one knows who will succeed in their attempts at commercially profitable innovations. Before long, the distribution of market power becomes very skewed, in that “a small number of very large firms dominate both the technology and the market in each industry, and other firms lag behind them significantly.” Kurz sees this as an example of the “cumulative advantage processes” that scientists have identified in a variety of disciplines. The basic idea is that “success breeds success.” In this case, early success in innovating, even if it occurs by luck, increases the likelihood that later innovation along the same lines will also be successful. In addition, the financial strength of the most successful firms gives them a number of ways to “impede the growth of their competitors, consolidate their position, and expand their market power.”

“Monopoly wealth” and profit

Using data from 2019, Kurz looks at what various companies are worth. A comparison of two firms of very different kinds, General Motors and Microsoft, reveals a lot about the connection between new technologies and market power.

Kurz classifies GM as a firm “in decline or slow growing,” since it is an older company whose glory years were in an earlier era of technological change. Its net worth, based on a comparison of its assets and debts, was $64.9 billion. The market value of its equity was only 51.2 billion, suggesting that its earnings outlook was a little low for a company with its net worth.

Microsoft, on the other hand, represents an “advanced sector transformed by IT where most innovations take place.” Its net worth was $310.7 billion, but its market value was $1,023.9 billion or a little over $1 trillion! (To put that in context, annual GDP for the US economy was about $20 trillion.) That gave it what Kurz calls an “excess market value” of $713.2 billion.

EXCESS MARKET VALUE = MARKET VALUE OF EQUITY – NET WORTH

Sometimes a firm’s stock market valuation is much bigger than its net worth because of what Alan Greenspan called “irrational exuberance.” During the “dot-com” boom of the 1990s, many internet companies with uncertain future earnings saw their stock rise to extravagant heights, only to collapse when the earnings turned out to be wishful thinking. But that’s not the issue here, since Microsoft’s market value is supported by a solid earnings record. Here the excess market value reflects the company’s possession of the technical knowledge it uses to maintain market power.

Excess market value makes up most of what Kurz calls “monopoly wealth.” The use of the word “monopoly” here does not mean that Microsoft is the only firm in its markets; it means that it is the sole owner of certain technical know-how that gives it a large advantage over would-be competitors. Monopoly wealth includes something else besides excess market value. Suppose that Microsoft acquires a smaller tech company—let’s call it Upstart. Suppose Upstart has its own excess market value because its stock valuation of $30 billion exceeds its net worth of $10 billion. When Microsoft makes the acquisition, it transfers Upstart’s assets and liabilities to its own balance sheet. But what does it do with Upstart’s $20 billion excess value? It may put it on its balance sheet as “intangible assets.” Then Microsoft has on its balance sheet something very similar to its own excess market value that (by definition) is not on its balance sheet. Therefore, the two should be added together to calculate Microsoft’s total monopoly wealth.

MONOPOLY WEALTH = EXCESS MARKET VALUE + INTANGIBLE ASSETS

In 2019, Microsoft’s actual intangible assets added another 55.3 billion to its monopoly wealth. For the corporate sector generally, Kurz calculated that about 70 percent of monopoly wealth consisted of excess market value and 30 percent intangible assets included in net worth.

Many economists consider intangible assets a kind of capital asset, along with tangible assets like buildings and equipment. Kurz believes that this confuses the analysis and disguises market power. He says, “Intangibles are not like capital inputs because a firm can replicate them at no cost.” A company that adds a new server bears a cost, but it can install a copy of its proprietary software on that server at practically no cost. Unlike tangible assets, intangibles do not have to be financed by capital. Although firms do spend some money on research and development, “the most successful innovations, those that generate market power, higher stock prices, and monopoly wealth, have a relatively small recorded intangible R&D investment.”

The distinction between capital assets and wealth more broadly defined is essential to Kurz’s argument. Because of this distinction, a firm’s revenue stream cannot be divided into just two parts, labor compensation and capital compensation (return on capital). Successful firms have a third part, the profits left over after paying the providers of labor and the providers of capital, such as buyers of corporate bonds. “Today, capital invested in U.S. corporations is mostly financed by bondholders, while stockholders own and trade mostly monopoly wealth.” Returns on capital go mainly to lenders, while profits go mainly to stockholders. In recent years, those profits have been increasing dramatically, while returns to both labor and capital have been falling. And since rich people own most of the stock, they receive most of the rising profits. “The sharp rise of market power since the 1980s increased both profits and monopoly wealth dramatically, and individuals in the top 10 percent of the wealth distribution gained almost all of it.”

Kurz’s argument is essentially that technological revolutions create market power; market power creates monopoly wealth; and the profits from monopoly wealth make the wealthiest households wealthier.

Technological competition and market power

Kurz maintains that technological competition does not fit the traditional model of capitalist competition. In that model, free competition among many buyers and sellers limits the ability of any one seller to set prices or reap large profits. If a firm is making a lot of money with a hot product, other firms will enter its market and reduce its market share. And if it raises prices too much above costs, it will be undercut by its competitors. Free competition tends to drive down profits until firms are making little if anything above the costs of labor and capital.

In technological competition, firms have various strategies for monopolizing their technical know-how and erecting barriers to entry for competitors. They begin by protecting their newly acquired knowledge in two ways:

First, an innovative firm gains experience and an organizational structure that is adapted to the knowledge it has created. It holds both trade secrets and a superior market position, and these provide initial protection against the use of that knowledge by others. Second, our laws and institutions protect intellectual property rights to incentivize future innovation.

Kurz sees technological acquisitions as “the most important weapon in the expansion of market power.” Microsoft acquired 237 other companies between 1987 and 2020. Companies can then reap the profits from developing the smaller companies’ innovations or keep the innovations off the market to reduce competition.

Dominant companies can also create customer dependencies by creating user networks or linkages among products. I have become pretty dependent on Amazon. not only because it is a convenient site for online shopping, but because I subscribe to Amazon Prime for free shipping and music streaming, and  I download books onto the Amazon Kindle. Other services might be potentially more economical, but they would have trouble getting me to switch.

The various strategies restrict competition and increase pricing power:

Whatever form that advantage takes, the firm obtains the power to set prices higher than its costs and, because it is a technological monopolist, no competitor will force its prices down. The ability to control the price creates excess abnormal profits and wealth.

Although some firms may also engage in illegal practices to maintain their dominant position, Kurz is talking mainly about strategies that are legal under current law, but have some negative consequences for the economy and society.

Economic and political consequences

Many economists and jurists believe that the benefits of technology are great enough to justify giving free rein to big tech companies, allowing them to dominate markets and accumulate profits. But Kurz identifies several disadvantages from the standpoint of economic growth and political democracy.

Companies with market power can increase their profits not just by expanding output, but by raising prices. That reduces demand and output below what it would have been if the company had no pricing power, as in the traditional model of perfect competition. The lower output lowers the demand for labor and capital goods, hurting both workers and lenders. As profits have risen in recent decades:

[R]ising market power has served as a headwind, slowing gains in the living standards of workers, retirees, and other bondholders. Indeed, while automation and globalization are always cast as the villains in explanations of the plight of American workers, rising market power has been the more significant factor.

By pricing some consumers out of the market for hi-tech products, dominant firms slow down the rate at which innovations could have diffused through the population. We can see this in the poor rural areas, where access to high-speed internet remains limited. For an earlier era, Kunz concludes from his case study of General Electric that its pricing power retarded the diffusion of electricity. Sometimes, firms slow down the rate of innovation itself by keeping competing innovations off the market.

Rising market power also “alters the delicate balance of power in society in favor of the rich and, by awarding their voices more weight, weakens the foundations of democratic institutions.” Corporations and their wealthy stockholders can spend some of their new wealth to lobby against policies that would curb corporate power or benefit larger segments of the population.

Public policy and market power

I will describe Kurz’s specific policy recommendations in a later post. For now, I’ll just emphasize his general observation that public policy has played a large role in either facilitating or impeding the accumulation of monopoly power. Indeed, he believes that “aggressive economic policy to restrain the rise of market power is the only force available to prevent the expansion of such market power and to attain a superior economic allocation and a more egalitarian income and wealth distribution.”

Such policies can take many forms, such as:

  • Antitrust legislation to limit market power by curtailing mergers and acquisitions
  • Corporate and progressive income taxes to redistribute monopoly wealth
  • Pro-labor measures like minimum wages and support for unions
  • Public investments for the common good, such as in basic research, infrastructure, health and education, and environmental protection

Kurz argues that the two Gilded Ages of American history, the first in the late 1800s and the second more recently, have had two things in common. Both were periods of spectacular technological innovation, and both were periods of “passive, laissez-faire public policy that allowed the mechanism of growing market power to operate without restraint.” The first Gilded Age ended in a period of social unrest and economic policy reforms. Kurz hopes that the U.S. is about to enter a new era of reform today.

Continued

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The Fraud Factory

February 19, 2024

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Last week, Judge Arthur Engoron issued his ruling in the New York civil fraud case against the Trump organization and its executives. This is his succinct summary of the case:

Donald Trump and entities he controls own many valuable properties, including office buildings, hotels, and golf courses. Acquiring and developing such properties required huge amounts of cash. Accordingly, the entities borrowed from banks and other lenders. The lenders required personal guarantees from Donald Trump, which were based on statements of financial condition compiled by accountants that Donald Trump engaged. The accountants created these “compilations” based on data submitted by the Trump entities. In order to borrow more and at lower rates, defendants submitted blatantly false financial data to the accountants, resulting in fraudulent financial statements.

The complaint by the New York Attorney General accused the defendants of making false statements in a business, intentionally falsifying business records, conspiring to falsify business records, intentionally issuing a false financial statement, conspiring to issue a false financial statement, intentionally engaging in insurance fraud, and conspiring to engage in insurance fraud.

By exaggerating asset values and net worth, the defendants made the organization look like a better risk than it was, helping it to obtain loans and insurance contracts on more favorable terms. Although the loans were repaid, the fraud consisted of not compensating the lenders for the risks they were really taking.

The defendants

The defendants included both the collection of companies branded “the Trump Organization” and the Donald J. Trump Revocable Trust, which holds the assets of the Trump Organization in trust for Donald Trump, the sole beneficiary. They also included the individuals Donald Trump, Donald Trump, Jr., Eric Trump, Allen Weisselberg and Jeffrey McConney.

Donald Trump was both Chairman and President of the Trump Organization until he became President of the United States in 2017. His son, Donald Trump, Jr., served as Executive Vice President from 2011 until 2017, when he and his brother Eric became co-CEOs.

Allen Weisselberg was Chief Financial Officer of the Trump Organization from 2002 to 2022. He was placed on leave “after pleading guilty to 15 criminal counts of tax fraud and falsification of business records at the Trump Organization.”

Jeffrey McConney was Controller of the Trump Organization from the early 2000s until 2023. He maintained the spreadsheets with the itemized property valuations. These were then compiled by the Mazars accounting firm and presented in the annual Statements of Financial Condition (SFCs). The SFCs were then approved by Allen Weisselberg and whoever was in charge at the time, either Donald Trump or co-CEOs Donald, Jr. and Eric.

Michael Cohen was not a defendant because he was now testifying for the state, but he had been an executive V.P. and special counsel to Donald Trump. He testified that Trump asked him to help prepare the SFCs and their supporting valuations beginning in 2012.

Specifically, Cohen affirmed: “I was tasked by Mr. Trump to increase the total assets based upon a number that he arbitrarily selected[,] and my responsibility[,] along with Allen Weisselberg predominantly[,] was to reverse engineer the various different asset classes, increase those assets in order to achieve the number that Mr. Trump had tasked us.”

Cohen said that each reverse engineering process would take several days, and that Weisselberg relied on McConney to assist him in adding value to the numbers on the supporting data for the SFCs… Cohen further made clear that Donald Trump had to approve the final numbers before they went to Mazars to be used in the compilations.

According to Cohen, Trump was motivated not only by a desire to qualify for loans at the most favorable rates, but to boost his net worth to place as high as possible in the Forbes ranking of the richest Americans.

The overvalued properties

Controller McConney understood that the financial statements were required to conform to Generally Accepted Accounting Principles (GAAP). These defined the “estimated current value” of a property as “the amount at which the item could be exchanged between a buyer and a seller, each of whom is well informed and willing, and neither of whom is compelled to buy or sell.” Nevertheless, he and his superiors approved many valuations that violated those standards. For example:

When valuing unsold units in Trump Park Avenue for Donald Trump’s SFCs, McConney used offering plan prices from an internal Trump International Realty spreadsheet, while wholly disregarding “current market values” listed on the exact same spreadsheet. Moreover, McConney “intentionally removed” the current market values column from the spreadsheet before forwarding it to Donald Bender at Mazars, despite McConney’s knowledge and representation that he understood that the SFCs had to reflect the estimated current value.

The defendants used a variety of other methods to inflate the value of the Trump Organization’s assets. The most blatant was simply to overstate the size of the property, which they did for Trump’s Triplex apartment. The valued it as if it were 30,000 square feet instead of its actual 10,996 square feet, which added anywhere from $114 million to $207 million depending on market conditions in a given year. They continued to use the inflated numbers for a time even after journalists from Forbes called attention to the discrepancy.

For some properties, the defendants overstated the number of residential units they had a right to build on the property. For Briarcliff, they claimed 71 instead of the actual 31, more than doubling the appraised value.

Instead of using current market value, some valuations used projections of future value based on dubious assumptions.

From 2011-2014, when valuing a plot of land upon which seven mansions could be built in Bedford [Trump Seven Springs], McConney relied on valuations provided by Eric Trump, who advised McConney to value the seven-mansion development at $161 million on the 2012 SFC. This valuation assumed a host of future events that had not—and as hindsight has shown, would not—occur, including that the Trump Organization had received legal permission to develop the lots, that the mansions were already built and available for sale, and that there would be no construction or development costs associated with building the mansions.

For a piece of land adjacent to the Aberdeen golf course in Scotland, the defendants both exaggerated the number of residences they were permitted to build by a factor of five, and also assumed that the residences had already been built, and at zero cost.

For an income-generating property like 40 Wall Street, where the value was calculated by dividing the net operating income by the capitalization rate, they could inflate the value either by exaggerating the net operating income or understating the capitalization rate. Apparently, they did both.

The value of the Mar-a-Lago club was limited because Trump had signed a “Deed of Conservation and Preservation” in 1995. There he gave up the right to develop the property as a single-family residence and received a tax break in return. That effectively took it off the residential market. No problem—the defendants simply ignored that restriction and based their valuation on the premise that it could be sold as a private residence.

The defense

The overvaluations resulted in large discrepancies between the company’s financial statements and the property appraisals by accounting firms. When confronted with such discrepancies at trial, defendants were generally vague about who had arrived at the higher valuation and with what justification.

When McConney was asked why Mar-a-Lago was valued as a private residence instead the social club it was, he said he couldn’t remember. In other cases, he claimed that he had gotten his numbers from Eric Trump, but Eric testified that he paid little attention to valuations, since “I am a construction guy.”

Although Weissenberg was Chief Financial Officer, he was not a CPA. He had so little knowledge of GAAP that he couldn’t say what the term “estimated current value” meant. Yet, “each year, Weissenberg represented to Mazars that the SFCs were presented in conformity with GAAP and that assets in the SFCs were stated at their estimated current value.” He testified, “I certainly am not one to value a property. I have no idea what properties are worth.”

Donald Trump, Jr. approved financial statements in his roles of co-CEO and trustee of the Donald J. Trump Revocable Trust “despite having no knowledge of the requirements of GAAP, never having been employed in a position that required him to apply GAAP, and never having received any training on applying GAAP.”

What Judge Engoron calls “the crux of the defense” was that:

…defendants relied on their accountants, mainly Mazars, but sometimes Whitley Penn, to make sure that the SFCs were accurate, and that responsibility for any misrepresentations lies with the accountants, not defendants. Donald Trump, Jr. and Eric Trump testified several times that they would have relied on their accountants to find any errors in the SFCs’ supporting data.

Engoron found this claim unreasonable, since these accountants were hired only to be “compilers,” not appraisers, taking the numbers provided by the defendants and organizing them into a single document. The Trump organization was not supposed to rely on them for the valuations; it was the other way around. Trump executives were obligated to represent the financial statements as complete and accurate, and they did so. When the defendants did obtain appraisals on specific properties, such as the $5.5 million appraisal of the Seven Springs property by Cushman & Wakefield, they often ignored or drastically revised them, in that particular case raising the value to $161 million! To say that they “relied on their accountants” is a bit disingenuous.

For his part, Donald Trump mostly claimed that the properties were so great that they were worth even more than the valuations submitted on the SFCs. Overall, the court’s decision gives us an image of defendants playing fast and loose with the numbers because their greed exceeded their competence and their honesty.

The ruling

The organizations and their executives were found liable for using false statements in business, conspiring to falsify business records, and conspiring to engage in insurance fraud. The named individuals Donald Trump, Donald Trump, Jr., Eric Trump, Allen Weisselberg, and Jeffrey McConney were also found liable for intentionally falsifying business records, intentionally issuing a false financial statement, and conspiring to issue a false financial statement. Only Weisselberg and McConney were found liable for intentionally engaging in insurance fraud.

The court ordered the defendants who had personally profited from fraud to disgorge the “ill-gotten gains” they received. Almost all the profits accrued to Donald Trump himself. The state contracted with a highly qualified expert witness, Michiel McCarty, to compare what the organization actually paid in interest with an estimate what it would have had to pay without the inflated assets. In addition, the court ruled that the organization profited from certain real estate deals that could not have been made without the use of false SFCs, so those gains were ill-gotten as well. The court found Donald Trump liable for $354.9 million and his two sons liable for $4 million each. The interest that accrued since the frauds were committed added another $98.6 million.

The court banned the defendants from serving as directors or officers of a New York company for varying lengths of time: Trump, Weisselberg and McConney for three years, and Trump’s sons for two years. In addition, Weisselberg and McConney were banned for life from performing a financial control function in a New York company.

Comment

The ruling in this civil fraud case adds to Donald Trump’s record of fraud, which includes defrauding students of Trump University and defrauding donors to the Trump Foundations by spending some of the donated money for his own benefit. Next month he is scheduled to go on trial for election fraud because of his hush-money payment to conceal an extramarital affair from the voters (which also involved alleged falsification of business records). Trump’s response to all this is almost never to address the specific allegations. He simply claims that every lawsuit and indictment is part of a conspiracy by President Biden and the “radical-left Democrats” to interfere with the 2024 election. That excuse is getting a little stale.

From time to time in US history, we have elected presidents who turned out to be crooked; Warren Harding and Richard Nixon come to mind. This year, the Republican Party has an opportunity to achieve something really special, the nomination of a presidential candidate who is already a certified fraud. How low can we go?

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Posted by Ed Steffes

The Fourth Turning Is Here (part 3)

February 1, 2024

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Neil Howe believes that today’s social turmoil is shaping up to be another once-in-a-lifetime Crisis, similar to the most dramatic turning points in American history. Although the current cultural and political divisions are part of his story, he is cautious about trying to say which side should or will win. He does not expect a total victory of either one. “In a democratic society, one tribe never fully dominates the other without incorporating key elements of the other’s program within its own.”

While I agree with that, I will strike a somewhat more partisan note. One thing that stood out for me as I read the historical parts of the book is that the three last “saecula”—Howe’s term for the long cycles of American history—have all culminated in victories for democracy. The Revolutionary Saeculum ended with the victory of democracy over monarchy and British colonialism. The Civil War Saeculum ended with the victory of democracy over slavery. The Great Power Saeculum ended with the victory of democracy over fascism. Democracy is always a work in progress, and none of these turning points perfected it. But I think we should at least hope that our current Millennial Saeculum leaves democracy stronger than ever before.

Today’s battle for democracy

If that is our hope, then the next question is which side in today’s political struggle better represents our democratic values and institutions. Once we pose the question that way, the answer seems obvious: Surely it is not the party dominated by Donald Trump and the MAGA movement.

Trump’s own autocratic tendencies are obvious to many observers. He places himself above the law, claiming immunity from prosecution for any acts committed as president. He expresses his admiration for dictators like Vladimir Putin and Viktor Orban. He wants to replace thousands of Civil Service employees with people selected less for their expertise than for their personal loyalty to him. Having failed to change the results of the 2020 election by legal means, he led an effort to resort to illegal means, with substantial support from both Republican leaders and the party base. The Mueller Report had already accused him of obstructing its investigation into Russian interference in the 2016 election. Now he continues to obstruct, delay and attack any court that tries to hold him accountable.

In addition to using undemocratic means to gain or maintain domestic power, MAGA Republicans have been impeding US support for democracy in the world. They are currently obstructing military aid to Ukraine as it defends itself against Russian invasion. They are less committed to international cooperation among democratic nations through NATO, the United Nations, and international agreements like the Paris Climate Accord. Their global stance is reminiscent of the isolationism that prevailed before the United States joined the war effort against Nazi Germany. As columnist Max Boot wrote this week:

Every president but one since Franklin D. Roosevelt has believed that the United States should exercise preeminent international influence for its own good and that of the world. Trump is the lone exception. He is committed to an “America First” agenda — the same label embraced by the Nazi sympathizers and isolationists of the pre-Pearl Harbor period. He has nothing but scorn for the twin pillars of postwar U.S. foreign policy: free-trade pacts and security alliances.

MAGA economic policies also seem more appropriate for an earlier, pre-Crisis time. They include propping up the private sector with additional tax cuts, while depriving the public sector of needed tax revenue and opposing public sector investments for the common good. In some cases, these policies are throwbacks to the previous Unraveling era, especially the 1920s. Then too, tariffs and trade wars hampered the global economy, and restrictive immigration laws tried to hold back the ethnic diversification of the population. Howe points out that since the American-born population is reproducing too slowly to replace itself, we depend on immigration to grow the population and boost the economy. Immigration is one area where compromise is needed, with some balance between facilitating legal immigration and blocking illegal immigration. Currently, Trump and his followers prefer chaos to compromise, in the hope that it will benefit them politically. In general, MAGA policies are less likely to leave the nation greater and stronger than poorer and weaker.

Framing the current Crisis as a crisis of democracy highlights the absurdity—but also the critical importance—of this year’s presidential campaign. One of our major parties is preparing to nominate the man who is least likely to uphold democratic institutions at home and abroad.

Where the generations will stand

Donald Trump is a member of the Boom generation, the generation of the Prophet type which is supposed to provide the moral leadership in a time of Crisis. But he is noted for neither his personal morality nor his civic virtue. Writers like Tim Alberta (The Kingdom, the Power and the Glory) have marveled that so many evangelical Christians have hitched their wagon to a leader who flouts so many moral norms. If Trump is a prophet at all, he is a false prophet or Prophet of Doom. His message is that the country is going rapidly to hell, and he alone can save us. Contrast that with FDR’s positive, hopeful message that we have nothing to fear if we all pull together.

Where are the progressive leaders of the Boom generation? Here’s an interesting fact: Both Republican Boomer presidents, George W. Bush and Donald Trump, lost the popular vote to their Democratic Boomer opponents—Al Gore in 2000 and Hillary Clinton in 2016. Both elections were controversial, since five Republican-appointed Supreme Court justices intervened in the 2000 election, and the Russians interfered with the 2016 election. While the presidency has been narrowly out of reach for them lately, Boomer Democrats do hold the position of Senate Majority Leader (Chuck Schumer) and governorships in fifteen states.

I do not know whether any particular Boomer will emerge as a “Gray Champion” like Franklin Roosevelt. I do expect aging Boomers to keep raising questions of values and ideals, trying to formulate broad goals for the nation. They will probably move from asserting individual values like self-expression, personal growth and sexual freedom; to placing more emphasis on civic virtues like voting rights, honest debate and the rule of law. Expect to hear a lot about democratic values being on the ballot in the upcoming election.

As members of Generation X assume their midlife leadership roles, they will bring a lot of practical skills to the collective tasks at hand. As an especially right-leaning generation thus far, they will need to ask serious questions about what values and goals they serve. Hopefully, Trump’s fall from power will soon be complete, either by electoral defeat, criminal conviction, removal from office, or ineligibility to run again. Having been slavishly devoted to its one strongman, the MAGA movement may then disintegrate. Many Generation Xers may then rethink their loyalties, turning from the politics of grievance and resentment to something more constructive. Alienated and lonely young men may then reconnect with their communities and learn how to fight for society instead of against it.

As members of the Millennial Generation complete their transition to adulthood, their first civic obligation will be to vote in large numbers. In later life, they will assume leadership during the High era that hopefully follows the current Crisis, as the G.I. Generation did after World War II. But for now, they will provide masses of followers for whatever leader can set the national agenda. The leader to inspire them will almost certainly be someone less selfish, narcissistic, and belligerent than Donald Trump. This generation craves teamwork, order, security, competence and civility. They are ready and willing to make sacrifices for causes they believe in. Although they are not currently wild about our aging Silent-Generation president, they are ready to join some team, and I don’t think the MAGA team will suit them.

When the national mood changes, it often changes with dizzying speed. Who predicted the emergence of a “counterculture” in the 1960s, the Reagan Revolution of the 1980s, the Global Financial Crisis of 2008, or the MAGA movement of 2016? We live in “interesting times,” in the words of the Chinese curse. Fasten your seatbelts, and prepare to be astonished at how fast the country can turn

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