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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