Sunday, November 8, 2015

Will Breaking Up Monopolists Help Low Income Consumers?

Might Condemn Facebook

A recent article in the Wall Street Journal examines evidence that a new phenomenon is responsible for apparent income inequality, namely, inequality between firms.  To be precise, some evidence suggests that the gap between profits (measured by return on capital) earned by median firms and those earned by the most profitable firms has widened considerably over the past few decades.  As a result, it is said, some firms are able to pay their lowest paid employees far more than other, less profitable, firms pay individuals in the same occupation.  The article summarizes the findings of a study by Peter Orszag and Jason Furman as follows:

"A company at the 90th percentile—that is, more profitable than 90% of all other companies—saw its return on invested capital jump from 22% in 1982 to 99% in 2014. For the median company, the return climbed from 9% to just 16%, and for the company at the 25th percentile it stayed the same, at 6%."

The article attributes such high profits to excessive market power, gained by firms, particularly those in the technology industry, that dominate their respective markets.  Thus, the article reports that Apple recently announced a 25 raise for its shuttle bus drivers, Google's parent Alpha made its security guards full time employees with benefits, and Facebook has raised wages for its cafeteria staff and custodians to $15.00 per hour. 

If accurate (and there is no reason to believe that it is not), this evidence could have significant implications for public policy.  The article itself advocates more intrusive "competition policy," in the form of aggressive anti-merger policy and less robust patent protection for inventions.  The article concludes with the following claim: "[m]ore competition isn’t just good for customers; it’s good for workers, too."

The article and the academic it invokes are important contributions to the debate over the causes and possible cures for income inequality.  Too often policy makers assume that the source of income inequality is "occupational," e.g., that all fast food workers earn low wages compared to individuals in most occupations, with the result that society can fight inequality by increasing the wages of such such workers.  The data highlighted by this article suggest that the issue is far more complicated.

At the same time, policymakers should not embrace the article's conclusions without further inquiry and reflection. For instance, the article seems to mis-describe the harm that supposedly results from the conduct it documents.   To be sure, an exercise of market power, other things being equal, injures consumers in the market served by firms exercising such power.  Such an exercise of market power will to that extent alter the distribution of income compared to that which would obtain in a competitive market, as consumers pay higher prices and thus see real wages fall.  Eliminating such market power (again, other things being equal) would thus reduce prices and increase the welfare of consumers (including some workers) previously injured by exercises of such power.  However, the elimination of such power, while reducing the wages of individuals working for once-dominant firms, would not increase the wages of those working for firms in competitive markets.  Thus, such increased competition would only be "good for workers" qua worker if such workers feel better off because their fellow workers in other industries are now worse off.

More fundamentally, it seems unlikely that more intrusive competition policy would in fact increase the welfare of consumers apparently harmed by the exercise of market power by dominant firms.  Firms like Google, Facebook and Apple apparently did not obtain their dominant positions via horizontal mergers but instead through internal expansion that took advantage of so-called network effects.   Thus, more aggressive anti-merger policy likely will not prevent the next Apple or Facebook from dominating its market.  Only active deconcentration, that is, breaking up such firms into several rivals, could render such markets more competitive and thus reduce market power.  However, such a policy would not be without its costs.  Social media and other high technology markets are often characterized by network effects, whereby the value of the product to any given user increases as the number of users rises.  Such markets tend toward monopoly because a dominant firm can, other things being equal, provide a more valuable product to consumers than would, say, a firm with a ten percent share of the market.  (Imagine if there were ten different social media platforms like Facebook, none of which dominated the industry.  An individual who wished to reach "friends" on each such platform would have to post ten different times.)  Thus, while breaking such firms into constituent parts could appear to reduce consumer prices, quality, too, would suffer.  The new and smaller firms might also have to incur higher costs to replicate the quality once provided by the dominant firm.  As a result, society's given stock of resources would produce less value than before the break up.

There was a time, of course, when antitrust law appeared to condemn firms that achieved and/or maintained their dominant positions by producing a better product at a lower price.  Most famously, in United States v. Aluminum Company of America, 148 F.2d 416 (2d Cir. 1945), the Second Circuit Court of Appeals, in an opinion by judge Learned Hand (pictured above), found that ALCOA had violated Section 2 of the Sherman Act because it repeatedly expanded production to meet rising demand, thereby preempting possible entry by rivals.  The court did not assert that ALCOA had priced below cost or engaged in other predatory tactics.  It was enough that ALCOA was what antitrust scholars now call an "efficient monopolist," that is, a firm that acquired or maintained its market dominance by realizing efficiencies that actual or potential rivals could not replicate. Fortunately courts (including the Second Circuit itself) have since rejected Judge Hand's hostility toward efficient monopolies, holding that a firm may acquire and/or maintain a monopoly by realizing efficiencies that exclude or disadvantage rivals, even if such dominance results in higher prices.    In so doing, courts have implicitly recognized that such efficiencies likely outweigh the negative impact of dominance on the allocation of resources (the so-called "dead weight loss" effect), with the result that efficient monopolists likely improve society's welfare, including the welfare of poor consumers.  (See here, for a discussion of the development of Section 2 standards governing efficient monopolists and here for an analysis of the welfare implications of different standards governing conduct that creates both market power and efficiencies).

Similar logic likely compels rejection of any proposal to employ an anti-concentration program as a means of enhancing income equality.  There are, however, other mechanisms, such as the earned income tax credit previously discussed on this blog (see here and here), for reducing income inequality more directly. Hopefully the data surveyed in this article will advance public discussion about these and other possible remedies for income inequality.