Tuesday, September 1, 2009

The Road to Smurfdom

One of the first things you notice about American capitalism is that there are a bunch of really large firms.  How many?  Well, to make serious progress on this question, I can think of a couple of numbers that I'm too lazy to go try and find right now:
  1. A history of S&P 500 profits as a percentage of GDP
  2. An analogous history of large company profits as a share of GDP for other countries, an for the Euro area as a unit
  3. A history of the concentration of profits broken down by individual industry.
The history of the concentration of capital may not be at our fingertips, but one thing we know for sure is that right now, bigger is better.  In fact, the impetus for this note comes from two stories to that effect that I came across this morning.  The WSJ says that bigger firms are finding the current environment easier because their competitors are struggling for access to credit:

Panera Bread, a St. Louis-based national chain of more than 1,400 cafes, is a rare winner in its industry. With more than $100 million in cash and no debt, it is demanding, and getting, cut-rate leases from landlords. Panera's occupancy costs have come down 10% to 20% since last year. It is hiring and expanding into spaces formerly occupied by Blockbusters and Bennigan's.

"For us, this is the best of times," says Ron Shaich, its chief executive. "Cash is king and this is a buyer's market."

Business is tougher for Panera franchisees. They can still borrow -- but at a price. Mike Hamra, who owns 47 Panera restaurants in the Boston and Chicago areas, says he is paying a full percentage point more on his loans than he paid last fall. "Banks are not throwing money at us," Mr. Hamra says.

while bigger banks are trouncing their smaller rivals because of cheap government money:

Big lenders are currently enjoying an advantage in their "cost of funds" -- the raw material of a bank, which is in the business of borrowing cheaply and lending at a higher rate. The handful of banks with more than $10 billion in assets were paying 1.18% to borrow money in the second quarter, the FDIC said in data issued Thursday. By contrast, banks with $100 million and $1 billion in assets were paying 1.97%, a big difference in a business where tenths of a percentage point translates into millions of dollars in profits.

Meanwhile, the Economist does it's best to miss the point (and I'm openly dubious of this GDP share figure -- of course the production of big industrial companies fell as a percentage of GDP since 1974, the US ceased to be an industrial country):

Great names such as Pan Am had disappeared. Others had survived only by dint of huge bloodletting: IBM sacked 122,000 people, a quarter of its workforce, between 1990 and 1995. Everyone agreed that the future lay with entrepreneurial start-ups such as Yahoo!—which in late 1998 had the same market capitalisation with 637 employees as Boeing with 230,000. The share of GDP produced by big industrial companies fell by half between 1974 and 1998, from 36% to 17%.

Today the balance of advantage may be shifting again. To a degree, the financial crisis is responsible. It has devastated the venture-capital market, the lifeblood of many young firms. Governments have been rescuing companies they consider too big to fail, such as Citigroup and General Motors. Recession is squeezing out smaller and less well-connected firms. But there are other reasons too, which are giving big companies a self-confidence they have not displayed for decades.

In any case, as a result of the financial crisis, we are currently seeing a fairly dramatic increase in the concentration of economic power.  Suggestive ¿no?  So, you're telling me that one driving force behind the concentration of economic power is entirely financial, and has nothing to do with economies of scale of efficiencies of production?  I would argue that this is not a special case, but a moment where we can see a dramatic illustration of a glacial everyday force in our supposedly free markets; our financial system, broadly construed has always been the primary driver behind economic concentration.  The ability to leverage, together with privileged access to markets and bank credit, are constant small advantages that accrue to size in normal times, but that pay huge dividends in extraordinary circumstances.  But of course, there's no way to separate these two times because crises are an inherent part of capitalism.  Extraordinary times are utterly commonplace, and capitalism (as opposed to markets) only works by breaking down.

Looking over the history of the last year, it's clear that a number of financial firms looked at this dynamic and quite sensibly adopted the idea of too-big-to-fail as a business model.  Sometimes you hear people complain that our supersized financial firms are the product of regulatory failure, or excess Chinese savings or whatever.  In my mind this is no different than the argument that corporate influence in politics is the product of corruption or corporate greed or, again, whatever.  Both diagnoses mistake symptoms for causes.  Both lack a systematic perspective on the forces at work. 

Corporations, be they financial firms or car manufacturers or Wal-Mart, seek profits.  You make profits, over a long period of time, by sustaining some sort of advantage over the competition.  You make profits, that is, by staying out of the free market.  This is the dirty open secret of capitalism that somehow got erased from our macroeconomic theory and policy debate -- corporations abhor the free market, and the opposite of a market economy is less socialism than capitalism.  So the natural working of a capitalist economy moves it further and further away from the free market equilibrium ideal as businesses develop and refine models that protect them from the competition by any means necessary.  In the case of financial firms, the only sustainable way to stay ahead of the competition was to capture the government and its unique ability to extend credit.  So that's what the successful firms did.  It was systematic and inevitable.  A simple evolutionary process.

I think that idea is less controversial now that we've seen a collapse of the financially less well connected.  What I hear less about is the way this adaptation amongst the highest level of the food chain had a trickle down effect on everyone beneath.  Concentration spreads like a virus, as Galbraith aptly pointed out in his Countervailing Power essay.  If suppliers concentrate, it prompts a concentration in buyers.  If retailers concentrate, manufacturers will do the same to maintain their profit margins.  And if your competitors with better access to leverage start buying up the industry, you too better get yourself a pet banker and get your deal on before you're done for. 

The implicit government guarantee of excessive leverage forces a concentration of economic power across the spectrum.  And it also forces a concentration of power in the biggest business in the country.  You know the one I mean.  The 'protection' business.  The goodfellas with the greenbacks get their game on, and you start to see what competitive advantage really means.  In the end, the capitalist axiomatic is just a way of backing slowly into totalitarian socialism.  Fascism has real economies of scale.

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