Big Isn’t Beautiful
Michael Lind’s “The Case for Goliath” [Issue #13] offers a new view on some old ideas, including a role for the U.S. government in the post-crisis economy that rejects much of what we know about how modern economies work. Lind is correct to think that the financial system’s collapse reveals fundamental weaknesses in the economy. His prescription, however–that we should address these weaknesses by promoting or creating regulated cartels and monopolies across the economy’s central sectors, in the service of what he calls “utility capitalism”–is simply wrongheaded.
Utility capitalism would treat the economy’s core sectors as privately owned public utilities protected from competition and antitrust, and obliged to guarantee generous wages, benefits, and job security for workers. Lind would like to associate this view with the early Franklin Roosevelt. Yet the last advocates of such cartels were the nineteenth century railroad, banking, and energy barons, while the regulatory guarantees Lind seeks were then the province of the progressives who tore down those baronies. In short, he uses the progressive tool of regulation in the service of the decidedly non-progressive goal of cartelization.
Lind goes further, however, by holding that regulated cartels and monopolies will produce stronger growth and more innovation than America’s relatively deregulated brand of capitalism. If these claims were right, the results would constitute a revolution in modern economics. Instead, they bring to mind a famous remark by Daniel Patrick Moynihan: “Everyone is entitled to his own opinion, but not his own facts.”
We all can agree that stricter and farther-reaching financial regulation is in order, to protect against yet another economic meltdown. Here’s a start that doesn’t require reorganizing the U.S. economy: Those who create or purchase financial instruments should have to do so through publicly regulated markets, so basic disclosure and transparency requirements apply to everyone and everything. And those who create or purchase these instruments should have to hold funds equivalent to at least 10 to 20 percent of their value, depending on their risk. Most economists today would support some version of these rules (although, unhappily, they go beyond the Treasury Department’s current proposals).
But that’s not the regulation imagined under utility capitalism. Financial institutions would be reorganized along cartel lines–the cheering you hear is coming from the Goldman Sachs executive suites–and regulators would determine the instruments they could issue, the interest rates they could charge or pay, and presumably their employees’ wages and benefits. It should be obvious that many of our current problems followed from too much concentration in finance, so it’s difficult to see why intensifying and formalizing it in a cartel would constitute an advance. Anyway, no cartel regulator can insulate our economy from global capital markets–they would continue to generate new instruments, and collectively they would still determine global interest rates.
The central issue, however, is whether utility capitalism could provide a reasonable model for the real economy–everything outside finance–that would produce stronger growth, income gains, and innovation than one organized around competition. Lind cites a statement by Nobel Laureate Edmund Phelps that productivity grew in the 1920s and 1930s at an unusually fast rate, which we are told was the result of “the New Deal’s system of regulated, managerial utility capitalism.” But the cited period covers the 1920s as well as the 1930s; and the ‘20s were as close to laissez faire as any time in the last century. FDR’s NRA plan represented a brief foray into something that might approximate utility capitalism, albeit with limited reach. But that program died a quick, court-ordered death, as Lind notes; while the key regulatory steps that followed in the later 1930s–federal deposit insurance, the Glass-Steagall Act, the Securities and Exchange Commission, Social Security, and so on–looked nothing like utility capitalism.
Lind also attributes the country’s strong productivity gains in very recent years to the “quasi-monopolies” of Microsoft and Google. Yet economists trace those productivity gains not to innovative software, but to the market-driven reorganizations undertaken by hundreds of thousands of businesses so they could put to good and efficient use the software and other information technologies developed by hundreds of competing companies. And by the way, Microsoft and Google achieved their own breakthrough innovations as start-ups, not industry titans.
Even in industries that require large resources to develop new products–biotech and other pharmaceuticals, for example–much of the initial innovation comes from small startups, which the big players then purchase to complete the development. This process isn’t mysterious: Large, incumbent firms try to enhance the efficiency and reduce the costs of what they already do well. Younger firms have to establish a new place in the market, and since their size precludes competing on price, they have to compete in some area of quality, which often means innovation. Don’t take my word for it: Kenneth Arrow, another Nobel laureate, established these dynamics theoretically and empirically some time ago.
But it’s the deregulation that started in the 1970s that really riles Lind. Here, he makes his central argument that “monopolistic and oligopolistic corporations are more likely to invest in breakthrough innovation than firms struggling to break even in highly competitive markets.” He misreads Joseph Schumpeter to lend credibility to this claim, conflating the role of large companies in generally competitive industries with cartels and monopolies. Then he misstates the views of William Baumol, writing that the “most important innovations originate from large, oligopolistic firms” (Lind’s words, not Baumol’s). Yet, in the introduction to Baumol’s most recent book, (Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity, with Robert Litan and Carl Schramm), he and his coauthors note that “it takes a mix of innovative firms and established larger enterprises to make an economy really tick.” Nowhere in Baumol or Schumpeter are there suggestions that cartels and monopolies are the way to drive innovation and growth.
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