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Rent Seeking, Laisser-faire and
State
Capitalism In 1981 the market for personal computers was highly fragmented with dozens of manufactures competing in both in the home and business markets. The IBM PC was released at this time and it proved a huge hit with business. "You can't get fired for buying an IBM" said many. Unable to assess the technical superiority of competing computers directly, customers put their faith in the famous IBM brand. A brand is an asset on which one can earn rent. With a very powerful brand you can release a product which is almost identical to that of your main competitor, but more expensive, and still capture the largest market share. Some customers will not pay for a premium product, so if possible, you leverage your economies of scale by releasing a cheaper unbranded version to pick up the bottom end of the market as well. A huge company such as Nestlé, for example, may have several near identical products competing under a variety of names and brands. Your marketing focuses on creating consumer expectations which maximizes your top end sales and drives upgrades. If you are selling batteries you never advertise how many ampere hours your product actually lasts for, you want your customers to put their faith in your brand, you avoid giving them the capability of making a rational choice. If the government tries to intervene in the market, for example by increasing transparency, you employ lobbyists to argue the libertarian case. A competitive market is your enemy, you do everything you can to subvert it, to monopolise it, to seek rent. Concentration of economic power tends to become self reinforcing, not just because of economies of scale, but also because of the power of branding and the build-up of resources which can be used to stifle competition. This problem was widely recognised in America’s gilded age. The well-founded fear was that the new mega-rich – the Rockefellers, Carnegies, Vanderbilts – would use their wealth to grow their economic power, subverting the market. Today it is Russia that exemplifies this problem. In 1902 Teddy Roosevelt's great "trust-busting" campaign began to reverse the tide of monopoly formation in the US. In the 1920s, however, the reforms unravelled, and by 1929 only 200 corporations controlled over half of all American industry. The New Deal era ushered in another era of antitrust policy, again reducing the percentage of monopolies. However, since the Regan years antitrust enforcement has dramatically declined and there has been a massive increase in consolidation. Consider US corporate earnings over the last several years. They have been regularly exceeding the rate of US GDP growth - a paradox Warren Buffet famously comment on. A transformation is taking place in modern society, competition is shrinking and rents rising, therefore corporate profits are accelerating. We are witnessing a vast transfer of wealth from the average man to the shareholder, and much of it is borrowed money. We also have a new generation of rent seeking Investment Bankers who consequently earn outrageous sums. Wal-Mart is a classic example of unstoppable economies of scale. Its relentless expansion has made the Wal-Mart family richer than the bottom 25% of all Americans. We have Lord Saatchi's point: After 100 years of competition, the record seems to show that Marx was right – the end result of competition is the end of competition. Marx foresaw constant internecine warfare among capitalists, resulting in fewer and fewer controlling vaster and vaster empires. Lenin described capitalism degenerating: Free competition is the basic feature of capitalism, and of commodity production generally; monopoly is the exact opposite of free competition, but we have seen the latter being transformed into monopoly before our eyes, creating large-scale industry and forcing out small industry, replacing large-scale by still larger-scale industry, and carrying concentration of production and capital to the point where out of it has grown and is growing monopoly. Although the IBM brand started the ball rolling, in this particular case the attraction of open standards became a far more important factor. Failing to realise the importance of the operating system, IBM purchased one from Microsoft. As a result other manufacturers were then able to copy the IBM hardware design and ship their 'Clones' with a perfectly compatible operating system purchased directly from Microsoft (in order to produce their own non-infringing functional copies they reverse engineered the IBM BIOS, but reversing engineering the OS would have been too difficult). As a result, even without IBM's approval or participation, their PC became an open standard with virtually unstoppable economies of scale. IBM soon lost control of of the market to clone manufacturers, and later also lost control of the definition of the open standard. However, Microsoft's key role as the operating system supplier to the IBM compatible market gave it a hugely powerful monopoly which it later extended into word-processing, spreadsheets etc. US regulators consequently debated intervening in the market to split Microsoft, as had happened to AT&T in the 1970s. The company, however, eventually escaped intact after making numerous concessions; for example improved interoperability with competing software. Microsoft's dominance clearly allows it to seek rent. For example, Microsoft can, to some extent, set prices for its products simply by maximizing its revenue - whereas in a competitive market prices converge toward the costs of production. The debate in Microsoft's case is to what extend this rent damages the workings of the free market and the economy as a whole. Does Microsoft reinvest the rent raised in the production of economically useful value added innovation? If not it is sucking valuable capital out of the economy, impoverishing the dynamic whole to feed the lazy one. Can we still count on Microsoft continually improving a product which is subject to little competitive pressure? Can we rely on Microsoft not stagnating intellectually, for without competition only its ideas are realised? Is Microsoft powerful enough to manipulate its customer base into wasteful or even damaging activity? For example, forcing customers to spend money upgrading to the frivolous and unproductive Office 2007. Another example of this concept is the food company which encourages its customer to buy and consume unhealthy, but addictive, junk food. The economist Milton Friedman's political philosophy, which he considered classically liberal and libertarian, emphasized the advantages of free market economics and the disadvantages of government intervention and regulation, strongly influencing the opinions of American conservatives and libertarians. Friedman believed that the antitrust case against Microsoft set a dangerous precedent that foreshadowed increasing government regulation of what was formerly an industry that was relatively free of government intrusion, and future technological progress in the industry might be impeded as a result. However, economists today are much more careful about treating the economy as a morality play and, since the credit crisis, much more conscious of the dangers of unregulated markets. How can government intervene to curtail rent seeking? Here are some examples: (1) In the EU Class A Bananas must conform to a certain size and shape. Similarly in the UK all personal loans must advertise a standardised measure of cost called the "APR" - Annualised Percentage Rate. Car manufacturers have to prove their designs conform to certain safety standards. This type of intervention is useful because standards are the lifeblood of competitive markets. Open standards are part of this concept - European governments were right to target Apple's proprietary iTunes format. (2) Many consumers bought the IBM PC because they did not have the skill to make a technical choice, and instead put their faith in the IBM brand, earning IBM rent. To reduce this tendency regulators need to concentrate on educating the consumer. For example, regulators subject consumer products to a battery of tests but the data rarely sees the light of day - they should take a much more proactive stance in publishing pertinent data on the effectiveness of products allowing the consumer to make rational choices. Pursuing vendors for misleading claims, eg in the cosmetics and heath food industry, is not enough. I want to know if there really is any difference between Colgate Total and Wal-Mart's own brand. I want the world to know how bad the sound quality of an iPod really is, because then Apple will be motivated to divert some of their gigantic profits toward fixing it. Today this review function falls to private sector third parties, such as consumer magazines, but these third parties are far to close to the manufactures and therefore corruptible. In most cases their main form of income is advertising from the very manufacturers whose products they review. (3) Consumers are easily duped by small print, regulators need to maximize price transparency by purging contractual complexity. Cross subsidising, for example, endangers transparency and regulators should strive to eradicate it. The foreign exchange fees many companies charge, eg Visa and MasterCard, are at best cross subsidising, at worst profiteering. Contracts with notice periods and also damage transparency and can criminalise the unfortunate, costs should ideally be front loaded. Hire purchase is an obvious example of where this can not happen, yet it is also an example of a shady area that too often delivers low added value to consumers. (4) Regulation of market structure. Duracell and Energiser between them dominate the battery market and sell mostly disposables. Suppose we outlawed the sale of disposables and forced consumers to take rechargeables (which in fact can be made to last just as long). Consumers would gain, as would the environment. What we are saying here is that consumers are irrational for various reasons which include the power of brands and advertising to manipulate their purchasing decisions. This irrationality creates, in a sense, an opportunity for battery manufactures to earn rent. Recognising and legislating against irrational anomalies is for the greater good. Using these examples we can consider how one might go about regulating the Mobile Phone market. For historical reasons we have, in the UK, four major companies competing in the market and each one owns its own infrastructure. As a result we sometimes see four network masts on the same building, yet this setup is deeply inefficient and environmentally harmful. Instead, the government should own the infrastructure and maintain it by inviting bids from private sector companies. Will prices increase if a single company maintains the network infrastructure? No, because we invite bids thus subjecting the provider to competitive pressure, also we maximize economies of scale. Will the network infrastructure quality suffer if consumers have no purchasing power over it? No, because consumers are not network experts, quality is better enforced by a regulator with scientific and engineering expertise. The company the consumer uses to provide him with mobile connectivity must not be allowed to sell/bundle the customers talk time, just internet connectivity. Instead all calls to telephones would be purchased in a stand alone ultra competitive VOIP market. The old fashioned phone disappears and we simply have a computer which connects to wireless TCP/IP networks. Competing within this VOIP market would be easy so prices would be driven to the lowest possible level. The company the consumer purchases his network contract from should also not be allowed to include a phone in the contract, prices will shrink if consumers are forced to buy their phones in a maximally competitive stand alone market. Neither should his carrier be allowed to lock him into yearly network connection contracts, contractual complexity must be minimised in order to expose the providers to maximum price transparency and therefore maximum purchasing pressure. These radical changes would create a viciously competitive market which will drive prices to the lowest possible level and render the maximum level of economic efficiency. Mobile Phone companies would be horrified, it would decimate both their margins and their brand value. This this destruction of brand value also destroys the advertising market, because in a highly competitive transparent market price is far more important than fame. The advertising market is in fact another economic inefficiency, and many argue it also has a deleterious impact on consumers. This example is not unique, applying these principles across the board would totally transform our economic model, our standard of living, and perhaps even our ethical outlook. Vigorous control of rent-seeking is the difference between a competitive market economy and a laisser-faire regime, and it is a vast difference. State Capitalism This much is as far as the FT article goes. Yet there is a further stage of controversy. If concentration of economic power has a hugely beneficial impact on productivity, as a result of economies of scale, we can not necessarily sacrifice it for the sake of a competitive market economy. Monopolies are inevitable and desirable, a properly competitive market is impossible. If competitive pressures can never elevate consumer interests above producer interests, we logically we reach beyond the private sector toward the idea of vastly efficient state capitalism - because the state alone works in the peoples interest, and therefore it alone can be allowed to take a superior position. This, of course, is what the economists in China are thinking, and where China is headed. Using the article SOEs in China today – Not your Grandfather’s State Owned Enterprises any more!, we can examine the model more closely:
Those who have been doing
business in China for awhile are quite familiar with the differences
between the State-Owned Enterprises (SOEs) and the Privately-Owned
Enterprises (POEs). For those of you not familiar with this distinction,
let me break it down for you. The POEs are just that, companies owned
privately with little or no government involvement – traditionally they
are perceived to be run by business-savvy executives with global
business experience. The SOEs, by contrast, are traditionally perceived
as hulking, unprofitable behemoths chocked full of aging assets and run
by 55 year old Party hacks in moth-eaten Mao suits and greasy comb-overs.
Fast forward to today and we are
seeing a surge in SOE. Eg in automotive, the so-called “Big
Four” (First Auto Works, Shanghai Automotive, Dongfeng and Changan) are
on a consolidation tear, encouraged by the government to acquire
smaller, regional automotive companies, much like GM, Chrysler and Ford
did in the early days of the U.S. auto industry. The Chinese oil, gas
and mining giants are actively looking outside of China for investment
and expanding their global footprint. Several of the larger SOE
construction equipment companies are aggressively expanding, both inside
and outside of China. In 2009 state owned airlines have taken advantage
of the credit crisis to gobble up essentially all remaining privately
owned airlines...
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