Thomas Philippon’s misdiagnosis of rising profits justifies economic policy that would discourage risk-taking, impede growth, and gradually reduce competition.
The Great Reversal: How America Gave Up on Free Markets, by Thomas Philippon (Harvard, 344 pp., $29.95)
With profits rising, productivity growth slowing, investment middling despite near-zero interest rates, and large competitors gaining market share, proponents of income redistribution insist that an increase in monopoly rents — profits earned by cooperating with competitors to raise prices and restrict output rather than competing honestly with them — has misallocated resources, increased income inequality, and slowed middle- and working-class wage growth. If cronyism increasingly misallocates resources, theoretically policymakers can redistribute income without significantly slowing growth and diminishing prosperity — the proverbial free lunch. Politicians such as Elizabeth Warren insist that, without slowing growth and gradually reducing middle-class prosperity, America can tax the rewards of success and redistribute income that would otherwise be invested. Unbiased economists must scrutinize such claims. Unfortunately, in his newly published book, The Great Reversal, Thomas Philippon offers one-sided support for them.
Many scholars dispute Philippon’s claim that rising monopoly rents are diminishing America’s competitiveness. To refute his argument, they point to America’s market-share leaders, which have invested more, produced more innovation, achieved greater productivity, and gained market share relative to their competitors — the opposite of rising cronyism. Philippon answers his critics with evidence that investment has been lower than expected since 2000, given the high market value of America’s leading companies relative to the replacement cost of their assets. He points to Europe for comparison. His arguments are fraught with complications that he leaves out of his book.
Unmentioned is the importance of earning returns in excess of the cost of capital to incentivize risk-taking necessary to produce innovation and increase prosperity. If competitors can easily copy innovation and compete away excess returns, everyone will wait for others to innovate, and the pace of innovation and investment will slow. Fortunately, that hasn’t happened.
Aside from the slow-growing automotive sector, America’s 200 largest companies are investing twice as much in research and development as their European counterparts. The U.S. economy is investing nearly 25 percent more in intangible assets, such as software and training, than Europe. America is investing about eight times more venture capital per dollar of gross domestic product. And America has produced about six times as many billion-dollar startups as Europe — an indicator of innovativeness more broadly. Rising cronyism isn’t evident in any of these revealing comparisons. Instead of confronting this evidence, Philippon diverts the reader’s attention to the consolidation of capital-intensive cellphone networks and airlines, where marginal competitors have struggled to survive, and to other industries where consolidation has increased but is still below antitrust standards of concern.
Low risk-adjusted returns, rather than rising cronyism, temper greater investment, even by companies with high market values relative to the apparent replacement cost of their assets. Innovative expertise-intensive companies such as Apple have bubbled up improbably from large pools of costly failure, which, in the case of Apple, includes Palm Pilot, Motorola, Blackberry, Nokia, Erickson, and other middling and failed cellphone manufacturers. By focusing exclusively on survivors, Philippon ignores the high cost and likelihood of failure.
Similarly, America’s largest companies require less capital than they used to require. Instead, they increasingly earn profits from differential insights that investment can’t often replicate in economically justifiable ways. Experts and expertise-intensive companies profit by learning from their experience without much need for capital. They gain experience by serving customers, not by increasing investment. Some companies learn more from their experience than others do, and information technology magnifies these differences. Today, most earners in the top 0.1 percent are undiversified working-age owners of closely held, midmarket, skill-intensive businesses, with three times more sales per employee than comparable companies. These top-performing companies lose most all of their profits when the owner retires or dies. Despite high valuations relative to the apparent replacement cost of their assets, investment alone won’t necessarily duplicate their success.
To say that America’s competitiveness has declined relative to Europe’s because America’s success has produced more highly valued and unusually productive “superstar” competitors than Europe has produced (whose number of superstar competitors is half what it was in 2000) misses the forest for the trees. While innovation-driven productivity growth has slowed from its torrid pace during the commercialization of the Internet, IT-related market leaders are racing to increase their share of cloud-based computing capacity, expand their collection of metadata, and commercialize artificial intelligence and quantum computing as Europe falls further behind. The same is true of synthetic biology and innovation more broadly.
America is fortunate to have these rare market-leading competitors and is growing more competitive because of them. Even if superstars earn profits in excess of the cost of capital, they invest more, innovate more, and provide America’s work force with valuable exposure to the technological frontier that spills over to the rest of the economy. Although Europe has nearly twice as many academic high scorers per capita as America, the digitization of its economy lags behind that of the U.S. As measured by GDP per hour worked, productivity in the U.S. since 2000 has grown 50 percent faster than in northern Europe, and three times faster than in southern Europe that has demographics similar to America’s. Europe’s productivity growth would be slower still without the outsized contribution of American-made innovation. By using GDP per capita as a measure of productivity without mentioning GDP per hour worked — when hours worked per capita have risen in Europe from a base that is low relative to the U.S. — Philippon selects evidence that matches his conclusions. When he claims that Google doesn’t significantly increase productivity because its search engine doesn’t employ many workers, he is pointing at the tail instead of the dog.
Even if billionaires such as Bill Gates innovated only out of love for computer programing and they never expected to earn billions of dollars, the army of talented risk-takers hoping to get rich who have followed in their wake has powered America’s innovation-driven growth. Unlike Europe, these armies of risk-takers have produced trillions of dollars of innovation since 2000. Their success has increased the demand for American workers and put upward pressure on wages at all skill levels as globalization has increased the supply of low-skilled labor and put downward pressure on their wages. Don’t let the implications of The Great Reversal’s one-sided arguments fool you; redistributing high profits earned by successful innovators would discourage risk-taking, impede growth, and gradually reduce competition.