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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Ages of American Capitalism (part 2)

June 29, 2021

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Jonathan Levy divides American economic history into four ages:

  1. The Age of Commerce (1660-1860)
  2. The Age of Capital (1860-1932)
  3. The Age of Control (1932-1980)
  4. The Age of Chaos (1980- )

Here I discuss the Age of Control, which is the era of the New Deal, World War II, and the postwar prosperity.

The Great Depression

“Rarely if ever before had an industrial economy been so poised on the brink of a great leap forward in wealth-generating enterprise. But it had stalled in mid-leap.” The run-up to the economic crash of 1929 is a prime example of one of Levy’s general observations, that major investment booms involve both long-term fixed investment that drives real economic growth and speculative bubbles that end badly. In this case, much of the new investment was in “Fordist” mass production of consumer goods like cars and home appliances. The electric assembly line represented the “largest surge in labor productivity ever recorded.” Unfortunately, high productivity does not translate directly into sustained economic expansion and lasting prosperity. The story of economic history must include the cyclical fluctuations in confidence and credit as well as the linear trend in technological innovation and rising productivity.

At the beginning of the 1920s, investor confidence was high. But one reason for the high confidence also contained the potential for a boom-and-bust cycle. During World War I, European governments had gone off the gold standard and expanded the money supply in order to finance the war effort. Now they returned to the gold standard and restricted the money supply to fight inflation. The U.S. Federal Reserve went along by raising interest rates. These policies contributed to a temporary situation of price stability, confidence in the currency, and a willingness of investors to lend, but at relatively high rates. The high rates set a high bar for business investments, which only made sense as long as the returns exceeded the costs of borrowing.

All was well as long as confidence in future profits remained high but also realistic. But once the boom got going, speculators could easily borrow too much in order to pay too much for assets whose real prospects couldn’t justify their cost. When these unrealistic expectations went unfulfilled and profits didn’t materialize, confidence was shaken, credit dried up, and investment collapsed. In 1931, the Federal Reserve made things worse by further tightening the money supply. By the time Franklin Roosevelt was elected in 1932, the economy had entered a “liquidity trap.” Precautionary liquidity had taken over, and businesses were afraid to invest in production even when they could borrow at lower rates. The Fed brought interest rates down, but it was too late. The economy hit bottom in 1933, with economic output only half of what it had been in 1929 and unemployment over 20%. The most productive factories the world had ever seen couldn’t sustain prosperity if they were idle.

New Deal capitalism

One of the first things the new administration had to do was counter the collapse of confidence that kept the economy in the liquidity trap. Much economic activity had simply come to a halt, as lenders were afraid to lend money they might not get back, businesses were afraid to produce goods that wouldn’t sell, and consumers were afraid to spend what little money they had as incomes fell. Roosevelt’s famous declaration that “we have nothing to fear but fear itself” was more than just rhetoric. The crisis of confidence went beyond the economy to challenge government as well. As some European countries turned to authoritarian leaders to address the crisis, many Americans questioned whether liberal democracy was up to the task.

Roosevelt believed that it was, and he welcomed the characterization of his policies as “liberal”. In its early days around the time of the Civil War, the Republican Party had been the liberal party, but now Democrats earned that label, leaving many Republicans to play the part of conservative doubters of the New Deal.

Democratic efforts to get the economic crisis under control initiated the “Age of Control.” One of the first things Roosevelt did was adopt a policy he called “definitely controlled inflation” by taking the country off the gold standard. Rather than be inhibited by the supply of gold, the money supply could expand along with economic activity. In fact, monetary expansion could encourage economic activity—at least in the short run—by putting more dollars in the hands of spenders, including the government itself.

Levy distinguishes two different kinds of economic liberalism, regulatory and developmental. While the New Deal was strong on economic regulation, it was weaker on directing the nation’s investment, a weakness that Levy sees as a problem to this day.

The two main objects of New Deal regulation were business practices and income security. The Security Exchange Act created the SEC to regulate publicly traded corporations and curb the worst abuses associated with financial speculation. It banned insider trading, required regular financial reports, and contained many provisions to prevent fraud. The Social Security Act created not only social insurance for retirees, but unemployment compensation and aid to poor women and children. The National Labor Relations Act guaranteed the right of workers to organize and collectively bargain. The Fair Labor Standards Act set maximum hours and minimum wages. New agricultural programs supported commodity prices to provide more stable farm incomes. If Americans were more secure in their incomes, they would feel more comfortable buying the goods that the emerging mass-production economy was capable of producing.

Developmental liberalism tried to stimulate investment in two ways. It lent capital to private investors, especially in banking, real estate and agriculture. It also made massive public investments in infrastructure through projects like the Tennessee Valley Authority.

These programs were liberal but not radical. They did not overturn the fundamental assumptions or power structures of capitalism; nor did they bring the Depression to an end, although the economy did improve from 1933 to 1936. Levy’s assessment:

New Deal capitalism was a variety of capitalism because the discretionary power of when and where to invest remained in the hands of the owners of capital. During the 1930s, whether the investment was private (incentivized or not) or public, its combined magnitude was simply insufficient to draw out sufficient economic activity to end the Great Depression. A general lack of initiative and spending remained.

In 1937, the government contributed to a “recession within the Depression” by prematurely trying to balance the budget and tighten monetary policy. Levy also suggests that a new kind of liquidity preference played a role, one that he calls “political liquidity.” Industrial capitalists who opposed the New Deal “threatened not to invest unless their political demands were met, especially for lower taxation on their incomes.”

In 1938, Roosevelt accepted deficit spending as a way to stimulate the economy. John Maynard Keynes had presented the rationale for this in The General Theory of Employment, Interest, and Money (1936). But he also warned, in 1940, “It is, it seems, politically impossible for a capitalistic democracy to organize expenditure on the scale necessary to make the grand experiment which would prove my case—except in war conditions.”

World War II

As Keynes expected, the massive government spending required by World War II was what brought the economy back to full production. It also provided a powerful psychological stimulus, generating popular support for an all-out political and economic effort to win the war. Economic preferences shifted dramatically toward fixed investment and away from any kind of liquidity—precautionary, speculative, or political. Why be shy about investing, when the government provided a willing buyer for all the armaments a factory could turn out? By 1942, the U.S. was winning the “war of the factories,” surpassing both Germany and Japan in the production of munitions.

Big Government liberalism thrived in both its regulatory and developmental aspects. On the regulatory side, government raised taxes, rationed consumer goods like gasoline, and implemented wage and price controls to curb inflation. On the development side, military planners told industry what to invest in.

World War II also encouraged a spirit of shared sacrifice and shared rewards. In addition to winning the war itself, Americans could expect a more equal distribution of economic benefits, through measures such as a more progressive income tax, support for organized labor, and the GI Bill of Rights.

The American military-industrial machine not only won the war, but unlike the economies of other combatants, remained undamaged by the war. Now that we had a fully-functional mass-production system up and running, we just had to convert it to peacetime uses.

Postwar prosperity

Levy uses the term “postwar hinge” to refer to the unique connection between domestic politics and international politics at the end of World War II. “At the war’s close, Americans owned three-quarters of all invested capital in the world, and the U.S. economy accounted for nearly 35 percent of world GDP….” Big Government combined with capitalist industry to make the U.S. the most powerful country in the world, the biggest exporter of products, capital, democratic ideas and consumer culture. The U.S. was the newest hegemonic power, although its hegemony was challenged by its next-strongest rival, the Soviet Union.

As a result of the Bretton Woods conference of 1944, the American dollar became the anchor of the global financial system. The dollar was agreed to have a fixed value in relation to gold. Other currencies would have a value in dollars, but could be revalued under certain circumstances. This arrangement institutionalized the dollar as the world’s strongest currency and helped secure the value of investments denominated in dollars.

Although wartime military spending declined, government contributed in a number of ways to the continuation of the private investment boom—not only maintaining the strength of dollar, but continuing support for income security, maintaining a military establishment during the Cold War, and engaging in Keynesian deficit spending to counter recessions.

At the same time, postwar politics placed definite limitations on government’s role in the economy, especially with respect to developmental liberalism. The owners of capital reassumed control over investment decisions, choosing, for example, to direct investments toward single-family homes and shopping malls in all-white suburbs, while inner cities were allowed to decay. Government cooperated by providing highway construction and racially discriminatory housing loans. Once the Cold War began, conservatives could exploit the fear of communism to defeat liberal proposals for greater government influence. Among the casualties were Harry Truman’s call for national health insurance in his “Fair Deal,” the Taft-Ellender-Wagner public housing bill, and a provision within the Full Employment Act of 1946 that called for supplementing private investment with public investment in order to maintain full employment.

The federal government might tax and redistribute incomes, and it might regulate specific industries, but it remained incapable of acting autonomously and creatively in furtherance of a recognized public interest beyond “national security.” Cold War military spending was the most legitimate form of government expenditure to sustain economic growth…. That the government enjoyed an autonomous arena of action only when targeting benefits toward white male breadwinners, or invoking national security, warped state action at home and abroad…. Surely government planning for long-term economic development on behalf of the public interest was off the table.

The political economy of the postwar era was strong enough to produce a postwar economic boom and raise incomes for millions of white working families. The era became known as a “golden age” of capitalism. Yet it was not sustainable enough to last more than a few decades before things started to go seriously wrong again.

Continued

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