Tuesday, July 26, 2011

Conservatives and Monopoly

I'm trying to synthesize a couple strands of thought into one post here, so bear with me.

The main reason that I don't think the U.S. will ever go back to an 1800's "laissez-faire" version of government that Tea Party conservatives might wish for is because economic conservatives (the political right, I mean) can't seem to nail down a consistent position on monopoly. Government and business have become too intertwined in the U.S., and you basically have to go further back than 1776 to resolve that.

Anyone who has read Gordon Wood knows the only Founding Father that would recognize the U.S. today is Alexander Hamilton. Hamilton foresaw Manifest Destiny, American empire with a large standing army, and a federal government promoting the interests of American industry through a central bank coordinating loans and a system of trade protection. Hamilton's way arguably helped America achieve its economic superpower status, and we've been wrestling with Hamiltonian vs. Jeffersonian ideas of democracy and government ever since. One symptom of this is recent polling data that show Tea Party Republicans are more protectionist and skeptical of free trade than even Democrats. (Protectionism is contrary to Classical Liberal/Libertarian principles.) Rupert Murdoch, a monopolist, and the Koch brothers, part of a cartel, have helped give the Tea Party a larger platform to speak from. Hamilton was willing to have monopolies, so long as they were American.

But the monopolist has always been seen as the enemy of free markets. Adam Smith:
"People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices."

Competition is the solution to monopoly, of course, the government should maintain freedom of entry and exit. But classical liberals have always found some regulation necessary-- particularly regulation of monopolies located in the financial sector. There is skepticism about the ability of competition to regulate bank behavior. In Wealth of Nations, Smith recommends a legally mandated cap on interest rates in order to curb what he saw as excesses by lenders.

F.A. Hayek also took a dim view of financial self-regulation. Lawrence White points out in this paper that Hayek didn't support "laissez-faire banking." Hayek believed that competitive commercial banks necessarily engage in a pro-cyclical process of expanding credit due to increased demand, rather than allowing interest rates to rise. He basically argued that as banks compete for customers, there will be an expansion of credit creating a harmful monetary disturbance and a boom/bust cycle. He therefore argued that some central control of monetary policy may be necessary. (White spends much of the paper showing how this contradicts Hayek's other philosophical views.)

Hayek's words remind me of self-professed "lifelong libertarian" Alan Greenspan's recent recantation before Congress in regards to his previous views on financial self-regulation. During the housing boom, Greenspan had repeatedly expressed the view (along with Rubin and Summers) that firms' risk-taking would be curbed by their own self-interest not to go bust, and that assets were priced properly and needed no regulation because the trades were taking place among "professionals."

“All of the sophisticated mathematics and computer wizardry essentially rested on one central premise: that enlightened self interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring and managing their firms’ capital and risk positions,” the Fed chairman said. The premise failed in the summer of 2007, he said, leaving him “deeply dismayed.”

Self-regulation is still a first-line of defense, Mr. Greenspan said. But after the financial collapse of 2007 and 2008, “I see no alternative to a set of heightened federal regulatory rules of behavior for banks and other financial institutions.” He said hoped hoped it would come in the form of tougher capital requirements for banks.


If you read any of the leading Money, Banking, and Financial Markets textbooks you'll find a history of U.S. financial markets as one of increasing consolidation. We have fewer, bigger banks that also now own insurance companies, hedge funds, and other large players in the capital markets. I'm currently reading a book that begins with a historical perspective on U.S. financial markets (not a textbook, emphases mine):
According to historian Thomas McCraw, “in the period 1897–1904 … 4,227 American firms merged into 257 combinations. By 1904, some 318 trusts … were alleged to control two-fifths of the nation’s manufacturing assets.”50 The rise of the trusts depended heavily on investment bankers, who provided the money needed to buy shares and rearrange shareholdings and also offered the social glue necessary to bring disparate industrial interests together. A handful of bankers led by J. P. Morgan played a central role in this rapid transformation...Morgan’s empire handled an extraordinary share of the money flowing into American industry—as high as 40 percent of total capital raised at the beginning of the twentieth century.

After Depression-era regulations on banking activity and consolidation are removed in the 1980s and 1990s, this process continues:

Between 1990 and 1999, the ten largest bank holding companies’ share of all bank assets grew from 26 percent to 45 percent, and their share of all deposits doubled from 17 percent to 34 percent. The largest financial services conglomerate of all (at the time) was put together by Sandy Weill, who began with Commercial Credit, bought Primerica (which owned Smith Barney) in 1988, added Travelers Insurance in 1993, bought Salomon Brothers in 1997, and finally merged his empire with Citicorp in 1998. (this merger was illegal until the Glass-Steagall Act was effectively repealed in 1999.) ...at the end of 2007, Citigroup had $2.2 trillion in assets, not counting $1.1 trillion in off-balance-sheet assets.

Every textbook lays out the premise that the increasing consolidation is inevitable and necessary due to advances in technology. Our economy is better off because the industry exhibits economies of scale and scope. It's interesting that in Road to Serfdom Hayek directly confronts this idea, and sees nothing "inevitable" (his word) about the development of natural monopolies (pgs. 91-94). He sees such arguments as backdoor arguments of monopolists for protection, eventually resulting in state control and socialism. Hayek's recommendation for regulating natural monopoly is simple price controls-- taking away the monopolist's profit and therefore reducing incentive for other monopolies to form:

(W)herever monopoly is really inevitable the plan... of a strong state control over private monopolies, if consistently pursued, offers a better chance of satisfactory results than state management. This would at least seem to be so where the state enforces a stringent price control which leaves no room for extraordinary profits in which others than the monopolists can participate...Only make the position of the monopolist once more that of the whipping boy of economic policy, and you will be surprised how quickly most of the abler entrepreneurs will rediscover their taste for the bracing air of competition!

Hayek goes on to say that he'd rather put up with "a little inefficiency" as a result of government restrictions on monopoly than to have his fate dictated by the monopolists. I can't help but think of Bank of America, the U.S.'s largest bank and wealth manager, active in all 50 states and providing financial services in some way to the majority of Americans. It tried to foreclose on a house that it didn't own, and was even willing to battle in court for it. Is this not the tyranny of monopolists Hayek was talking about?

But there's a knee-jerk reaction on the political right to the word "regulation," it is always and everywhere seen as a bad thing. A stated GOP goal is to repeal Dodd-Frank, or at least not fund regulation for certain aspects. But as Hayek and classical liberals before him have argued, the financial sector is unlike other sectors in its need for regulation.

From the late 1930s to the late 1970s, banking and financial services were heavily regulated. Competition was limited and profits were higher to the banks in business. But the industry was also stable, there were very few bank failures or scandals. The argument for deregulation of the financial sector was essentially that it would increase productivity in the U.S. by better allocating capital. Lower prices and interest rates for the consumers would help foster home ownership and other forms of investment. But the highly regulated banking sector of the 1950s and 60s oversaw 4% annual RGDP growth and one of the greatest booms in productivity in U.S. history. The deregulated banking sector of the 1980s and 1990s oversaw The Great Stagnation-- there were no productivity gains from financial deregulation.

Classical economic theory says that the wages someone earns should be equal to the marginal product of their labor. So, if traders at AIG are earning $165 million bonuses in 2007 and "(Citigroup CEO Jamie) Dimon earned $34 million,( Goldman Sachs') Blankfein $54 million, John Thain of Merrill Lynch $84 million, and John Mack of Morgan Stanley $41 million,"
they must have boosted productivity by that much. But there's no evidence of this, as their firms all took large hits and lost billions in wealth. So, there is a strong case that these CEOs are earning monopoly rents.

And instability has increased, the 1980s S&L crisis, the 1990s failure of LTCM, and the larger debacle of 2007 to today, where banks are still failing every week. The direct result has been the creation of new monopolies.

So, I'm skeptical of Tea Party conservatism because I don't see it attacking the monopoly problem and I see it attacking any government efforts to impose any Classical Liberal regulation on banking monopolies and financial sector activities (regulations now being called for by Randians like Greenspan). I hear anger over government proposing tax increases rather than skepticism over whether the pay of financial sector CEOs and professional athletes match up with their marginal productivity or if it's just monopoly rents that the government might do well to tax. I hear the angry denunciation of "bail-outs," for the financial sector but I don't hear very many (other than Ron Paul) on the political Right calling for the large banks to be broken up to foster competition-- I mainly hear that argument from people on the Left.

(I should note that left-ish economist and sometimes Obama adviser Jeffrey Sachs claims that "It's more accurate to say that the Republicans are for Big Oil while the Democrats are for Big Banks. That has been the case since the modern Democratic Party was re-created by Bill Clinton and Robert Rubin.")

No comments: