It’s Still Not the Supply Side

Yes, workers should be able to move and work freely. But economics remains fundamentally about power. A response to the “What’s Holding Us Back” symposium.

By Mike Konczal Marshall Steinbaum

Tagged Free MarketsLaborThe New Deal

In 1934, Henry Simons, one of the founders of the Chicago School of Economics, published A Positive Program of Laissez-Faire—a pamphlet that aimed to carve out a role for the free market amidst the wreckage wrought by the Great Depression on the one hand and what he called the “recklessly collectivist” New Deal on the other. Simons saw what economists call “competitive equilibrium” in markets as a well-functioning machine for the allocation of resources and the creation of wealth, as long as it wasn’t run into the ground by powerful economic actors, either private or public, intent on subverting the pricing system to their own benefit. The spirit of Henry Simons lives on in Steven Teles’s contribution to Democracy’s symposium, “What’s Holding Us Back?” [Issue #42]—the role of government is to protect the free market from the forces of excessive centralization that would do it harm, both in the form of public regulation and private market power that protects profits for incumbents from new entrants and competition. This is the creed Teles calls “Competitive Egalitarianism”:

A commitment to using law to structure markets so that they generate effective competition, and so that they compete in ways that serve the broad public and unleash the vast potential for economic growth that is hampered by current practices and rules.

There are many surprising elements of Simons’s Positive Program, given the legacy of his best-known intellectual descendants at Chicago and elsewhere. Those include his support for the income tax and for government ownership of natural monopolies, as well as an insistence on robust antitrust enforcement. Indeed, one strand of economic thinking in the early twentieth century, both inside and outside the academy, was that antitrust and competition policy constituted the proper exercise of state power: protecting the free market rather than interfering with it, as the more progressive elements that favored social insurance, powerful labor unions, and stricter regulation sought to do. That view of an active, even aggressive, role for competition policy was abandoned by Simons’s intellectual heirs in the Chicago School, who maintained that competition policy more often protected inefficient small producers from the exact competitive pressure that would otherwise drive them out of business and result in efficient corporate consolidation.

In a 1981 reminiscence of the “Law and Economics” movement, Ronald Coase called A Positive Program for Laissez-Faire “a highly interventionist pamphlet,” and the bare defense George Stigler and Milton Friedman could muster was essentially that Simons was forced into his compromising posture by the intellectual currents swirling at the depths of the Depression—namely, the New Deal, and even worse, communism. Judged from the Chicago School’s valedictory vantage point in 1981, after Robert Bork’s systematic intellectual assault on antitrust policy had begun to be incorporated into regulatory policy, Simons’s Positive Program looked like a shameful compromise and historical relic best forgotten.

Teles would disagree, and his bid for “competitive egalitarianism” to revive the intellectual tradition of the small-government, small-business conservative in the aftermath of another financial crisis and long recession most often blamed on the depredations of a financial sector with a stranglehold on the federal government is a constructive contribution to the public debate. In this argument, simply getting competition back in order is enough to revive economic growth and curb the wealth and power captured by those at the top, since its source is found exactly in these anti-competitive barriers to entry.

And yet it misses the point. If there is one thing that both the Depression and the Great Recession taught us about how the economy works, it is that corporate power is a threat to public well-being—that it extracts its own rents. The economy’s only effective protection from that power is to be found in an activist federal government unafraid to deploy countervailing power and provide essential services in the form of public options and regulated utilities.

That proper role of government very much does include antitrust and competition policy, as Lina Khan and Phillip Longman ably demonstrate in their essays. But that powerful tool is only one of many. The other pro-growth policies propounded in the symposium may be worth enacting in and of themselves, but as diagnoses of recent lackluster economic performance or as a coherent pro-growth agenda, they are weak. They depend on the contention that a major cause of poor economic performance and rising inequality is the misallocation of factors of production, primarily labor, thanks to restrictions and regulations whose abolition would unleash a more competitive marketplace and a faster-growing economy. The evidence does not support that prediction.

David Schleicher, for instance, puts great store in the mobility of labor across geography as a source of growth, and argues that over-regulation in both the housing and labor markets impedes that crucial capitalist mechanism. Unfortunately, the evidence suggests otherwise: Geographic mobility has never been all that important as a mechanism for reallocating labor, and recently the effect of mobility across geography has been dwarfed, quantitatively, by mobility out of the labor market—many people of working age, both young and old, and in particular men, are not employed or even actively looking for work. People just don’t move very much and never have, so it’s hard to credit reduced geographic mobility as the deciding factor. Moreover, it is hard to reconcile the proffered cause of recent declines in geographic mobility with the argument that those trends are caused by excessive regulation. In a paper testing the regulatory arguments for declining geographic and job-to-job mobility, we found that the metropolitan areas and industries where the declines in mobility have been worst are also those that saw the largest earnings declines—hardly what you would expect if rising walls and deepening moats were making it impossible for new entrants to breach the castle’s defenses. That should benefit those already inside. Further evidence against the rising barriers argument is found in the weakening distribution of outside job offers for continually employed workers and in the worsening wage gains of those workers who do manage to switch jobs. All the evidence points, rather, to an interpretation of the labor market as suffering from a lack of demand, not constrained supply, and hence earnings and wages move up and down with the employment rate, the size of the active labor force, and job-to-job mobility.

Alex Nowrasteh argues the case for vastly expanding the flow of immigrants to the United States, including skilled migrants qualified to work in those so-called in-demand careers. He gives an overview of the economic literature estimating the impact of migration on earnings for both migrants and incumbents, as well as modeling the great benefits more liberalized global migration would provide for the migrants themselves and for the entire global economy. But those questions are orthogonal to the policy issue of sluggish growth and rising inequality in the United States. As stated before, there is no evidence of a skills or labor shortage in operation now. To the contrary, labor supply outstrips demand and there is downward pressure on wages and earnings. That shouldn’t be used as an affirmative argument to restrict immigration, since as Nowrasteh correctly argues, the evidence suggests immigrants do not adversely affect native workers because they add both demand and supply to the domestic economy. But as a pro-growth policy for the rest of us, immigration reform offers little.

Real free-market economics has little time for a healthy labor market backed by robust aggregate demand.

Phillip Longman gets further with an antitrust and competition agenda for the health sector specifically. Here the evidence is overwhelming, and sadly, recent policy—namely the Affordable Care Act (ACA)—has been less than helpful. The premise behind the “administrative efficiencies” sought under the ACA was that large, integrated hospital systems and physicians’ practices would coordinate their care and reduce the duplication of procedures. That policy paradigm was driven by evidence from a few prominent examples like the Mayo Clinic, and also from documentation of the efficiency of the Medicare system in different metropolitan areas. As interpreted, those areas with a diffused health-care industry proliferated needless treatments for Medicare patients, whereas integrated systems dispensed with that by coordinating providers and offered a higher standard of care.

Unfortunately, that was an over-ambitious reading of the causes of inefficiency in the health-care sector, and it has only further enabled the concentrating tendencies in the industry. To be sure, Medicare is concentrated, and it bargains its position aggressively. But a different dynamic is at play in the private market, where providers are locked in an arms race with health insurers, and where the side that gets the upper hand through consolidation is in a position to dictate terms to its counterparty. The resulting price discrimination drives yet greater concentration: When insurers merge and are able to force one health-care provider to lower prices, it seeks protection in the favorable terms enjoyed by another provider.

The upshot is that as both health insurers and health-care providers consolidate, patients are left with higher prices and insurance premiums, as well as restricted access to physicians’ networks and captive referrals from their doctors. The recent controversy over Aetna’s withdrawal from the ACA’s health insurance exchanges after the Justice Department impeded its merger with Humana shined a bright light on that policy failure, and Longman is correct that the problem runs deep. Evidence suggests that differential consolidation and market structure explain a large chunk of observed variation in health-care prices, and hence a major contributor to reducing the economy’s growing bill for health care may be found in a robust competition policy for the sector.

This imbalance between competition and power becomes clear with Aaron Klein’s advocacy for the potential of “FinTech,” or the potential coming wave of new financial technologies. There may well be a lot of technological innovation in the near future when it comes to financial services, and as Klein notes it is important to evolve our regulations to meet these new challenges. But there is no obvious reason to believe that this wave of technology will harm, rather than help, the largest financial players. The deep pockets and sheer size of the largest finance players may mean they are uniquely suited to take advantage of these possibilities, buying out smaller technology players or developing their own competing startups in-house—or simply sitting on a pile of cash large enough to let the world know that any threat to their dominance will be crushed. The experience in the telecommunications sector—deregulated in 1996 in the expectation that new entrants with Internet-based technologies would emerge to counteract the threat of concentration and excessive profitability—is cautionary in this respect, since the main result of that deregulation has been both vertical and horizontal concentration, segmented markets, and higher access fees.

Klein argues that FinTech can solve the problems of excessive merchant fees and the inability of poorer consumers to access reasonable financial services. Again, it’s not clear whether new technology will strengthen or weaken the power of the largest players, but we can certainly challenge and solve these problems through government action. We already do, partially. The Dodd-Frank Act turns merchant fees associated with debit cards into a public utility, ensuring that they are set reasonably and kept proportional to the costs. Meanwhile government programs such as Direct Express, which provide seniors without bank accounts low-fee debit cards to get Social Security benefits, are overwhelmingly successful and could easily be expanded to all low-income people through the post office. Both of these efforts have the government playing a direct role in provision and network access, rather than simply hoping, against the evidence, that technological advancements will weaken, rather than strengthen, the strongest players.

The bottom line here is this: There are no technological solutions to political problems, and the power of the financial sector is a political one. Even if FinTech shakes up consumer lending, it will do little for the way finance exerts power over the rest of the economy. The power of finance to prioritize payments to shareholders and upper management over long-term investments in both publicly traded companies and through private equity results in weak investment, productivity, and aggregate demand, and no phone app will change that dynamic. Competition itself isn’t a panacea. Opening up competition in the 1990s is what led to the creation of the largest banks that we later feared would tear down the global economy should they ever go bankrupt. That isn’t a call to limiting competition, but it forces us to acknowledge that competition can require more, not less, of a regulatory response. The growth and interconnectedness of finance were abetted as much by the faulty assumption that competition following deregulation would be good for finance and the economy as by any overt public debate about the role finance should play in our economy.

Why is Simons’s idea of a positive program of laissez-faire now returning as Teles’s competitive egalitarianism? The story of how Simons went from free-market icon to embarrassing—or at best misremembered—afterthought among his intellectual descendants tells us something about what’s really going on here. As in the Depression, the prestige of free-market ideas 35 years after the Reagan-Thatcher revolution is lower than it’s been in a long time, and it threatens to fall further as the two dominant political coalitions both move further from it. Teles, like Simons, wants to save them by recasting them as friendly to the little guy, menaced as he is by corporate and government power. That is intended to blunt the enemy’s offensive and peel off an element of its support.

But it’s unlikely to be a viable political program. Real free-market economics has little time for powerful countervailing mechanisms to private power like antitrust or banking regulation, let alone a healthy labor market powered by robust aggregate demand and full employment as government policy. Furthermore, whether the “pro-growth” policies advocated in this symposium would actually deliver growth and genuine security for everyday workers, much less challenge the power the elite have over the economy, is unclear. Luckily, the New Deal that Simons was hoping to keep at bay gave us a better set of tools to build an economy that serves the interests of the many, not the few.

Read more about Free MarketsLaborThe New Deal

Mike Konczal is a Fellow at the Roosevelt Institute and a co-author of Rewriting the Rules of the American Economy (2016).

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Marshall Steinbaum is a Senior Economist and Fellow at the Roosevelt Institute and co-editor of the forthcoming After Piketty: The Agenda for Economics and Inequality (2017).

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