Rethinking Market Regulation
Helping Labor by Overcoming Economic Myths
JOHN N. DROBAK
3
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Names: Drobak, John N., author.
Title: Rethinking market regulation : helping labor by overcoming economic myths / John N. Drobak.
Description: New York : Oxford University Press, [2021] | Includes bibliographical references and index.
Identifiers: LCCN 2020055607 (print) | LCCN 2020055608 (ebook) | ISBN 9780197578957 (hardback) | ISBN 9780197578971 (epub) | ISBN 9780197578964 (updf) | ISBN 9780197578988 (online)
Subjects: LCSH: Trade regulation—United States. | Antitrust law—United States. | Labor policy—United States.
Classification: LCC KF1609 .D76 2021 (print) | LCC KF1609 (ebook) | DDC 331.120973—dc23
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DOI: 10.1093/oso/9780197578957.001.0001 1 3 5 7 9 8 6 4 2
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For Mary
Preface
This book would not have been possible without the advice and help I received from so many people over the years I was writing the book. My deceased friend and colleague, Doug North, had a tremendous influence on my ideas. In the over twenty-five years we taught and worked together, I grew to understand the core principles that influenced so much of his scholarship. Some of those principles are reflected in this book. Doug always encouraged people to think critically, to question what people say and evaluate the conclusions for yourself. He also emphasized the mismatch between the economic theory taught in universities and written in journals with the way economics is used in the real world. He was part of the new institutional economics movement because he hoped that academic theory could be modified in a way that made it more useful for policy analysis and governance. Those principles led me to ask whether the U.S. economy is a competitive one, the basis for Chapter 3. Doug’s emphasis on belief systems, the filters through which people understand the world, is the basis for Chapter 8. Finally, much of Doug’s scholarship was devoted to the importance of constraints on human conduct, the “institutional framework” for economic behavior. He emphasized over and over again that there was never a true laissez-faire economy, that the real question was the degree of government involvement in the economy. That question is at the heart of this book.
My work with Doug and my involvement with the International Society for New Institutional Economics (now the Society for Institutional and Organizational Economics) led me to think about where there was a clear mismatch between economic theories and how the theories were used to craft the law. As a longtime teacher of antitrust law, I have focused on the need for competition to make an economy work, while, at the same time, watching the U.S. economy becoming more concentrated and, as I argue in this book, less competitive. I was also aware of the limited scope of merger review, with its disregard of issues that do not directly reflect on the competitive aspects of the merger. I was touched by the loss of jobs that followed many mergers. Even though that causes serious harm to the workers who lose their jobs, that byproduct of a merger is never considered in merger review. Thinking
about the loss of jobs through mergers prompted me to examine the massive movement of manufacturing jobs to other countries in the first decades of this century. As with mergers, there was no regulation to limit this kind of corporate action. That brought me back to economic theory and the belief by some economists and law professors that corporations existed solely for the benefit of shareholders.
I grew up in a vibrant region in Upstate New York, the Triple Cities of Binghamton, Johnson City, and Endicott, where abundant manufacturing jobs made it possible for workers to live a good middle-class life. These cities were the home of the Endicott Johnson Shoe Company, one of the largest shoe manufacturers in the country, and the birthplace of IBM, with its large manufacturing facilities. The region had an energy and optimism that came with the ability of so many to achieve upward mobility—until the factories closed and the jobs went away. The same thing happened to many other manufacturing towns throughout the country. Even though these kinds of business decisions changed hundreds of communities for the worse, the government left the business firms unregulated. Part of the justification for this inaction is the acceptance of the shareholder primacy of corporations and the belief that the government need not intervene because the constraints of a competitive market are sufficient. As a result, I tried to tie together my concern for the problems of using economic principles as a justification for the lack of government intervention with the harm that has been caused to workers. A book that started out as a refutation of the utility of some economic principles turned into a book that ties together unworkable economic principles and harm to labor.
In addition to the influence of Doug North and my colleagues in the new institutional economics, there are a few people I want to single out. I am deeply indebted to Claude Menard, who read at least three versions of the text, listened to my ideas, and gave me copious suggestions for improvement. I also appreciate the comments of Tom Ulen and an anonymous referee who carefully reviewed my manuscript. Thráinn Eggertsson’s advice not to stray from my main ideas helped me focus on what is important. In addition, his scholarship and ideas are part of the foundation of Chapter 8. Bertrand du Marais gave me helpful comments. I also benefited from the advice of many of my colleagues in the law school and other departments at Washington University. Bob Pollak’s comments on an early draft helped me understand the different perspectives among academic economists and realize that many would agree with my conclusions. Ron King introduced me to the concept
of residual income, which I use in Chapter 3, while the scholarship of Steve Fazzari and Mark Rank had a strong influence on my ideas. I also benefited from workshops at St. Mary’s law school and at the Mercatus Center at George Mason University.
Throughout the years I worked on this book, I received invaluable help from a good number of research assistants at Washington University, as well as from the librarians and administrative staff members at the law school. I want to thank all of them for their assistance. The law students researched many issues, gave me feedback on my ideas, and provided substantial help with citation style. The librarians helped with my research, while members of the administrative staff were invaluable in helping me with word processing, formatting, and organization of the many iterations of the book. I also want to thank my editors at the Oxford University Press, Alex Flach and David Lipp, and their staff who helped bring this book to fruition.
Finally, I want to thank my wife, Mary, for the support she has given me. Not only did she tirelessly listen to my ideas, provide the initial design of the book cover, and tolerate the piles of my research notes (which sure made a mess at times), she was my biggest booster throughout the process, encouraging me to keep working on the book as the topic seemed to expand unceasingly. I cannot thank her enough for all that she did.
1 Introduction
Millions of American workers lost their jobs this century as a result of outsourcing jobs to other countries and layoffs after mergers. Many were in manufacturing. This did not just result in a loss of income; it caused terrible disruptions in the lives of the workers, with loss of self-esteem, depression, and drug use for many laid-off workers. The massive unemployment also had social effects extending through families and communities. It also played a major role in the election of Donald Trump as president in 2016, with his election turning on victories in the manufacturing states of Pennsylvania, Ohio, Michigan, and Wisconsin, and led to the strong support for Bernie Sanders in the Democratic primary. The problem of displaced workers helped fuel the rise of a new populism that will continue to have political consequences in the United States.
Globalization of the U.S. economy has caused the outsourcing of jobs. With worldwide transportation by sea and air, fast communication between countries by the phone and internet, and English becoming the common language of the world, it has become easy to manufacture products for the U.S. markets in other countries. In addition, the strength of the U.S. dollar when compared to other currencies, especially the Chinese yuan, has exacerbated the problem. Jobs are lost after mergers through the elimination of redundant jobs and by the trimming of a workforce in order to reduce costs. Merger regulation makes this possible because the regulatory agencies do not consider the effect on labor in their merger review. To the contrary, mergers are more likely to be approved if they result in efficiencies, which often mean the elimination of jobs.
I am far from the first to refer to these initial decades of the twenty-first century as a new Gilded Age, with vastly increasing wealth at the top, a greater disparity between the wealthiest and the rest of society, and huge impediments to the American Dream of achieving prosperity through hard work. In 1890, when the Sherman Antitrust Act was being debated on the Senate floor, Senator John Sherman said:
Rethinking Market Regulation. John N. Drobak, Oxford University Press. © Oxford University Press 2021. DOI: 10.1093/oso/9780197578957.003.0001
The popular mind is agitated with problems that may disturb social order, and among them all none is more threatening than the inequity of condition, of wealth, and opportunity that has grown within a single generation out of the concentration of capital into vast combinations to control production and trade and to break down competition.1
Senator Sherman could have been referring to our times. Just as economic conditions in the late nineteenth century led to the passage of the first antitrust laws in the United States, today’s economic conditions demand new regulation to soften the impact of market forces on the losers and to undo the inequality of wealth and opportunity.
It is impossible to stop market forces, but government can soften the effects. However, the government has done virtually nothing to slow the elimination of jobs or to help the workers who lost their jobs, in spite of many proposals for action. Unlike our inaction, Canada and countries in the European Union have taken steps to protect the jobs of workers. Although there are many reasons for the lack of concern in our country for displaced labor, I want to focus primarily on the role economic theory has played.
Over the decades I have spent with economists, I have grown skeptical about how descriptive some economic ideas are of the actual economy. There are elegant economic theories based on such unrealistic assumptions that they have little to do with how businesses actually operate. This is not just a lawyer’s skepticism; it is something I have learned from economists themselves. Many academic economists openly recognize the limitations of their discipline. However, people use economic ideas to shape public policy without a word about limitations.
I want to examine two economic “principles” that have shaped our world today: (1) the U.S. economy is competitive, making government regulation less necessary, and (2) corporations exist for the financial benefit of their shareholders and not for other stakeholders. Perhaps the word “beliefs” is a better description than “principles” because neither statement is part of the core of economic theory. There is a core theory of economics that explains competitive markets, but whether a particular market is competitive is an empirical question. A lack of competitive markets does not alter the theory of competition itself, although it makes the theory less helpful in understanding the actual economy. Similarly, economists take corporations to be
1 21 Cong. Rec. 2460 (1890) (statement of Sen. Sherman).
actors in a market. They are assumed to act as the theory posits: a corporation, as any business firm, is a producer of goods and services that is assumed to maximize profits. Whether corporations actually take actions solely for shareholders is irrelevant to the theory. Nonetheless, much of the original— and the continued—impetus for the application of these principles as a way to run the U.S. economy comes from economists. Not surprisingly, there is a substantial difference among economists in their belief in these principles. It is the conservative ones, who have an unshakable faith in the market, who espouse these views. Sometimes they are labeled as members of the Chicago School of economics or, pejoratively, free-market zealots. With a patina of academic legitimacy from these economists, these two beliefs have captured government leaders, policymakers, and media commentators. This intellectual capture has had a strong influence on how the U.S. economy is run.
The application of these two economic principles has justified this loss of millions of jobs in the United States in the first two decades of the twentyfirst century. Rarely have so many people been harmed in such a short period of time by the workings of an economic system. Although this harm is justified as the normal consequences of a market economy, the economic principles used to support this result are not inviolate laws, like the law of gravity, even though conservative economists state them to be certainties. When the claim that markets are competitive is not true, consumers are hurt by higher prices, poorer quality products, and fewer products to choose. Semi- and unskilled workers are hurt when firms act as monopsonist buyers of labor. Just as troublesome, the lack of competition undermines the common argument that government regulation is unnecessary because the competitive market already provides sufficient constraints. Uncompetitive markets lack the constraints that come from competition, making regulation necessary.
An erroneous belief in the existence of competitive constraints was a major cause of the economic problems stemming from the Great Recession of 2008 and its aftermath. Many argued that the existence of competitive financial markets made it unnecessary to enact regulations that would have prevented or at least softened the effects of the Great Recession. Two examples of this occurred during the Clinton administration. The economists Alan Greenspan, the Chair of the Federal Reserve, Robert Rubin, the Treasury Secretary, and Larry Summers, the Deputy Treasury Secretary, advised President Bill Clinton not to regulate financial derivatives, when the Commodities Futures Trading Commission was considering whether to regulate them. Later, Summers, then Treasury Secretary, also advocated
the repeal of the Glass-Steagall Act, which had separated investment and commercial banking in the aftermath of the Great Depression. President Clinton accepted both of those recommendations. The decisions not to regulate derivatives and to deregulate banks turned out to be major causes of the Great Recession of 2008.
There has never been a purely laissez-faire economy. The libertarian longing for a purely laissez-faire economy, free of government intrusion, is fascination with a fantasy.2 A functioning economy requires, at a bare minimum, laws that protect property rights and exchange. This was just as true in the days of Adam Smith as it is today. A modern market system—with impersonal nonsimultaneous exchange, complex multiparty transactions, and esoteric financing methods, to name just a few attributes—requires significant government involvement. The underlying question is not government versus the market but the extent to which government should regulate—or, we could say, interfere in—the market. There must be some regulation, so the debate is really over the extent of government regulation. That is a debate that depends upon how competitive a market truly is.
Many people have strong beliefs that affect how much government interference in the market they view as appropriate. In making the comparison between government and market, it is important to recognize the truth in what the Spanish economist Benito Arruñada has written: liberal “idealism errs by comparing imperfect markets with perfect politics. Libertarian idealism makes the opposite mistake, by comparing perfect markets with imperfect politics. In so doing, it makes it impossible to understand the role that the state plays in making real markets less imperfect.”3 We all bring biases to our comparison of the market and regulation. The data that we have to show the existence of competition are imprecise, so it is impossible to prove definitively whether some markets are competitive. That makes our preconceived notion of the relative benefits of one over the other even more important. It skews how we see the available facts and creates a presumption of the desirability of one over the other.
Some people consider government regulation to be a four-letter word. With an intuitive sense that any expansion of the government is horrible, they often label it as socialism. These people express a preference for the market over the government as part of an overarching fear of big government. They
2 Douglass C. North, Understanding the Process of Economic Change 122 (2005).
3 Benito Arruñada, Coase and the Departure from Property, in The Elgar Companion to Ronald H. Coase 305, 307 (Claude Menard & Elodie Bertrand eds., 2016).
have a libertarian philosophy that, all things being equal, people are better off being left alone by the government, whether it concerns economic issues or social matters. They fear the “nanny state,” in which the government runs every little aspect of our life, from telling us the kind of light bulb or toilet we need to use, to limiting when we can use an outdoor grill. The Affordable Care Act was so controversial because it required people to have health insurance, a mandate that many opposed. Some people dislike regulation because they believe that the government is inefficient and wasteful. There are also people who oppose government action out of a genuine belief that the market itself provides sufficient regulation, making regulation unnecessary. Others are disingenuous in their opposition to regulation because their reasoned arguments mask their desire to become richer free of government interference.4 Regardless of the source of this opposition to government regulation, this belief makes it much harder to marshal the government to improve economic conditions.
An ideology that arose in the aftermath of World War II, when the Cold War raised the fear of the spread of communism and when countries in Europe were embracing socialism, is still persuasive today. Influential European economists, like Ronald Coase and Fredrick Hayek, lamented Europe’s move toward socialism.5 Their preference for limited regulation of the market, as a counterweight to socialism, influenced economists in the United States, who then in turn had a compelling effect on the public’s view of the ideal relationship between government regulation and the market, as well as an influence on the law.6 It is unrealistic today to fear that the United States will become a socialist country. Nonetheless, an ideology forged during the Cold War persists today and makes it much harder to use the
4 It is impossible to know whether people really act on the beliefs they express as justifications or whether their statements are just a pretext. For example, in discussing whether law and economics really influenced the development of antitrust law, Richard Posner wrote: “To begin with, it is generally believed that law and economics has transformed antitrust law. It can, to be sure, be argued that all law and economics really did, so far as its impact on the practice of antitrust law was concerned, was to provide conservative judges with a vocabulary and conceptual apparatus that enabled then to reach the results to which they were drawn on political grounds. Even if this is all law and economics has done for (or to) antitrust, or for that matter to any other field of law, it would be far from negligible; to enable is to do much.” Richard A. Posner, The Deprofessionalization of Legal Teaching and Scholarship, 91 Mich. L. Rev. 1921, 1925 (1993).
5 Hayek was among the economists of the Austrian school who had a strong influence on the importance of a free market with minimal government intervention in the United States. Mark Blyth, Austerity: The History of a Dangerous Idea 143–45 (2013).
6 For a summary of the history of economic thought and its influence on neoliberalism in the United States, see id
government to correct the market imperfections that have caused tremendous harm throughout society. As John Maynard Keynes wrote:
[t]he ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.7
Over fifty years ago, the conservative economist George Stigler noted that economists had a strong preference for a market free of government regulation because they were drilled in the methods by which a price system solves problems without the aid of the government.8 Not only do they teach their students and the public about the desirability of relying on the market, they also influence and make government policy.9 To further compound this issue, some economists may advance theories solely because the theories support the policy outcomes they prefer. Ronald Coase noted this problem when he considered how economists choose which theory to advance:
In public discussion, in the press, and in politics, theories and findings are adopted not to facilitate the search for truth but because they lead to certain policy conclusions. Theories and findings become weapons in a propaganda battle. In economics, whose subject matter has such a close
7 John Maynard Keynes, The General Theory of Employment, Interest, and Money 383 (1964), quoted in Blyth, supra note 5, at 118.
8 George J. Stigler, Essays in the History of Economics 52–54, 59 (1965).
9 There are many economists who are skeptical about the prevalence of competition. However, from my acquaintance with economists in the United States, I believe that the majority of economists are true believers in a competitive market. It is impossible to know what most economists teach in their classes, but university textbooks emphasize the prevalence of markets. In the 1960s and early 1970s, economic textbooks described the U.S. economy as a “mixed economy,” meaning a mixture of capitalism and socialism. Sometime in the 1980s, the texts began to describe the U.S. economy as a “market economy.” David R. Henderson, Burying Good Ideas, Reg., Spring. 2011, at 56, 58 (book review). Gregory Mankiw’s textbook, which is the most popular, explains at the beginning of the section on markets: “The market for ice cream [an example he just gave], like most markets in the economy, is highly competitive.” N. Gregory Mankiw & Mark P. Taylor, Economics 64 (1st ed. 2006). Mankiw does soften this statement over the next few paragraphs as he introduces monopoly and oligopoly. He ends the section with this:
Despite the diversity of market types we find in the world, we begin by studying perfect competition. Perfectly competitive markets are the easiest to analyze. Moreover, because some degree of competition is present in most markets, many of the lessons that we learn by studying supply and demand under perfect competition apply in more complicated markets as well.
Id. at 65.
connection with public policy, it would be surprising if some academic economists did not adopt the criteria of public discussion in selecting theories, that is, choose because it lends support to a particular policy. . . . At the same time, they may belittle the work of other economists because it seems to have the wrong policy conclusions.10
The second principle, or belief—that a corporation exists solely for the financial benefit of shareholders—justifies harm to the other corporate stakeholders. Workers can be laid off, labor can be outsourced, plants can be closed, and communities can be destroyed all in the name of improved profits for shareholders. Acceptance of this principle is a relatively recent phenomenon; yet many people accept the principle as a natural result of incorporation. People overlook the fact that the corporate form came about as a way to aggregate capital and to minimize risks, not as a vehicle for maximizing shareholder wealth. They overlook the fact that many corporations served their workers and communities, as well as their investors, for a good part of the twentieth century. Mistreatment of labor is not a prerequisite for a robust economy, as shown by the success of the economies in the E.U. countries that have limited outsourcing and protected labor.
Starting at least from the junk bond crisis in the 1980s, it has become acceptable to many people that getting richer by any means was something to strive for. In effect, greed was legitimatized and applauded. One example of this has been the meteoric rise in the compensation to senior management. The media reinforces the legitimacy of this quest for wealth by constantly publicizing the stock market. It is true that many middle-class people gain wealth in their pension plans when the stock market rises, but more workers have little or no investments. No one reports that the cause of a rise in the value of a stock was the layoff of workers or the closure of plants. The emphasis on increasing the value of capital has been a major cause in the growing disparity in wealth in the United States. Once a society accepts the legitimacy of the all-out quest for wealth, it becomes very hard to change that notion.
Part of the analysis in this book depends on data. However, much of the data is far from certain. Information about corporate profits from the sale of particular goods and services is nearly impossible to obtain because
10 Ronald H. Coase, How Should Economists Choose? G. Warren Nutter Lecture in Political Economy at the American Enterprise Institute for Public Policy Research (Nov. 18, 1981), in Essays on Economics and Economists 15, 30 (1995).
corporate financial reports give aggregate results for a corporation’s overall business, not for individual goods and services. Although the degree of the concentration of an industry is relevant to the competitiveness of the industry, the Federal Trade Commission suspended a program that collected data on industry concentration in 1981.11 As a result, we need to rely on studies by academics who gather their own data from other government and private sources. Data about the number of workers who lost their jobs as a result of mergers or outsourcing is also difficult to obtain. To my surprise, the federal government does not keep this kind of data. In fact, Congress has rejected proposed bills that would have required gathering this kind information. It seems as if some people prefer that the magnitude of job losses remain uncertain as a way to limit public pressure for regulation.12 As a result, what we know of job losses comes from academics who study these problems, press releases and statements from corporations, and reports from the financial press. This is less precise than systematic data gathered by the government, but it is the best that we have. Another problem stems from the lack of a consensus among economists about how to interpret and explain data. Conservative economists will reject the conclusions of liberal economists out of distrust in their objectivity, and vice versa. The analysis in this book would be more convincing if the data were more certain, but I believe that we have enough information about corporate earnings and job losses to justify my conclusions.
Although I recognize that my conclusions are debatable, I would not have written this book if I did not believe that they are correct. Even if I am completely correct, some readers will still not believe my analysis and conclusions. This stems from their perspective on the world, which makes them blind to contrary views. My late friend and colleague, the economic historian and Nobel laureate Douglass C. North, culminated his sixty years’ of economic research by focusing on the importance of belief systems. North believed that we need to understand that people do not perceive the world directly, but through their own mental filters, resulting in different people
11 David Leonhardt, Opinion, The Monopolization of America, N.Y. Times (Nov. 25, 2018), https://www.nytimes.com/2018/11/25/opinion/monopolies-in-the-us.html [https://perma.cc/ 5LJ6-H97G].
12 Congress did precisely this for gun control in 1996 when it enacted the “Dickey amendment” to a spending bill. The amendment prohibited the Centers for Disease Control and Prevention from using any funds to promote gun control. As a result, the CDC stopped all research on gun violence, including the compiling of statistics for the public. In 2018, Congress allowed the use of funds to study gun violence, but not to advocate gun control. Allen Rostron, The Dickey Amendment for Federal Funding for Research on Gun Violence, 108 Am. J. Pub. Health 865 (2018).
seeing the world through different lenses. That people see the world through their own filters is not a novel idea, going back at least to Plato’s cave. Once people form their beliefs, confirmation bias reinforces them. This aspect of human decision-making makes it that much harder for people to agree on the ways to resolve social problems.13
This book does not explain the benefits of globalization on consumers, shareholders, and business people in the United States. That is a well-known story. I am aware that lower wage rates and regulatory costs have enabled firms in other countries to produce products for the U.S. market at costs significantly lower than the costs of U.S. firms. The strength of the dollar relative to other currencies makes moving jobs overseas even more attractive. In addition, some countries, like China, were known for stealing U.S. intellectual property and erecting import barriers to give their firms an advantage in global competition. This has forced U.S. firms to adapt to foreign competition, with tactics that included layoffs of workers and outsourcing of jobs. There is a real question as to whether the federal government and the firms themselves could have taken other paths this century to minimize the impact of globalization on U.S. workers, as was done in some European countries and Canada. Rather than tackling all the issues of international trade, this book is about only part of a much larger problem, but it is a part that is less known than the benefits of globalization.
This book is organized as follows. Chapter 2 explains the theory of competitive markets, something that will be familiar to readers with just a basic understanding of economics. It also analyzes the assumptions that underlie the theory, emphasizing the problems that stem from the assumption of consumer sovereignty and the ability of producers to manipulate consumer preferences. It also explains how the assumption that markets are competitive became the paradigm of economic education rather than recognizing the prevalence of monopolies and oligopolies.
Chapter 3 analyzes the competitiveness of U.S. markets in four different ways. First, it examines the profitability of business firms to determine if their profits are so high that we can conclude that they operate in markets lacking competition. Second, it looks at the increasing consensus
13 Although North developed his ideas from cognitive science and not from philosophy, what he referred to as a belief system has been a basic tenet of a number of schools of philosophy, including realism, idealism, and pluralism. Even Leo Tolstoy noted this proposition in War and Peace in 1869: “For the first time in his life, Pierre was struck by the endless variety of men’s minds, which guarantees that no truth is ever seen the same way by any two persons.” Leo Tolstoy, War and Peace 474 (E. Zaydenshnur trans., Penguin, 2009).
by economists that markets are becoming less competitive, including an issue brief by President Barack Obama’s Council of Economic Advisers. Third, it shows how an examination of the conduct of the firms in an industry can help us assess the competitiveness of that industry. Finally, it analyzes the concentration of the firms in a market as a way to determine competitiveness, examining the many studies over the past few years that show greatly increased concentration in many markets. Based on these four perspectives, I argue that there is strong evidence of a lack of competition in many markets, which shifts the burden to those who oppose government regulation to demonstrate that there actually is viable competition that sufficiently constraints the firms.
Chapter 4 shows that part of the decrease in competition has resulted from the recent wave of large mergers. Mergers are thought to be desirable economically because they benefit consumers with lower prices and better products. However, many mergers are justified by a claim of increased efficiencies in the combined firm, which is often the result of layoffs and plant closures. Not only does this change the lives of the workers who lose their jobs, it also hurts their families and communities. When a plant closes, it harms the businesses that had supplied goods and services to the plant. Many studies have shown that the closure or transfer of a corporate headquarters also results in a significant decrease in charitable giving and support for local educational and cultural activities. In economic terms, these spillover effects are externalities. Even though merger regulation does not take these kinds of externalities into account, they are nonetheless harmful consequences of mergers. When I first considered this problem, I wondered about the ways to compare the benefits to consumers with the resulting harms to labor and communities, a comparison I find hard to make. Then I discovered that numerous studies have shown that many mergers do not result in lower prices, while some mergers have even led to price increases. In these mergers, workers suffered not for the sake of consumers but for the financial benefits reaped by the shareholders and managers of the merging firms and by the professionals who put the deals together. It also appears that investment advisors encourage mergers just so that they can profit from the transactions, regardless of the degree of benefit provided to consumers (or even shareholders). With little or no benefit to consumers from some mergers and significant harm to labor, I argue that we need to reassess how the government should review mergers. The current form of merger regulation does not take into account the harm caused by mergers because it solely
examines a merger’s effect on competition between the firms in the relevant market.
Chapter 5 examines shareholder primacy, the notion that corporations exist to increase shareholder wealth. It traces the origins of this idea and explains how it has come to be accepted as a truism by many scholars, judges, and commentators. When Milton Friedman originally popularized this idea in 1962, he wrote that corporations should serve shareholder interest “within the rules of the game.” These days the rules of the game are influenced tremendously by business lobbying. The chapter explains how the political influence of labor waned and was replaced by business influence in the 1970s. Since that time, Congress has done very little to protect labor because business interests have become extremely powerful lobbyists and substantial donors to political campaigns. The chapter ends with a discussion of the growing sentiment that corporations should take into account the interests of their other stakeholders in addition to shareholders.
Chapter 6 analyzes one of the consequences of shareholder primacy: the outsourcing of millions of jobs to other countries. It details the failed attempts in Congress to regulate outsourcing, partly due to lobbying by business but also as a result of the belief that these kinds of activities should be left to the market. The chapter then compares the situation in the United States with the protection of labor and the limits on outsourcing in some countries in the European Union, particularly in Germany. Not only do many European countries have laws protecting labor, they also have a culture respecting the rights of workers. The chapter explains that the prevalent cultural views in the United States toward labor, unions, and government regulation make it impossible to do that. Nonetheless, I argue that we should not only learn from the E.U. experience, but we should also adopt some of the European protections of labor.
Chapter 7 discusses the changes in norms that have made it acceptable to make as much money as possible in any legal way, even at great harm to labor and communities. The chapter also considers the role of the media in glorifying the wealthy, along with its constant reporting of stock prices— which reinforces the belief that corporations exist only for shareholders. The chapter shows how the quest for wealth this century has led to a huge and still-growing disparity in both income and wealth. Then the chapter examines the imprecision of unemployment statistics, showing how the statistics overlook people who are not seeking work and disregard the change in pay and benefits when displaced workers take new jobs. In trying to
assess the permanence of the harm caused displaced workers, the chapter examines retaining programs under the Trade Adjustment Assistance program, which was designed to help workers who lost their jobs as a result of outsourcing. In what may be a surprising result, a number of studies have shown that retraining generally does not improve the employment prospects of displaced workers. Finally, the chapter looks at the tragic effects on two communities from the closing of an automobile manufacturing plant in Janesville, Wisconsin, and the shrinkage of a glass manufacturing company in Lancaster, Ohio.
Chapter 8 then examines why so many people are locked into their views about the market and the government. It begins by describing the development of belief systems, the filter through which people see the world. The world is too complex for people to rationally analyze every question that faces them. As a result, we create mental models of the world that simplify decisions for us, and we use heuristics and rules of thumb to help us derive answers to problems. Once we develop our views of how the world works, confirmation bias makes it difficult to change them. We pay attention to the information that reinforces our prior beliefs and disregard information that challenges them. The vast majority of people have much more to think about than the relationship between the market and the government, so they do not pay much attention to details and to what many perceive as boring data. The chapter uses studies about the rigidity of political views as an example to show the difficulty in changing the public’s acceptance of the harm done to workers by mergers and outsourcing.
Chapter 9 lays out proposals for change. They range from simple and uncontroversial ones, like requiring the government to collect reliable statistics about the number of jobs lost through mergers and outsourcing, to controversial proposals, like adding labor representation to the corporate boards of directors. Although some antitrust scholars have recently proposed changing merger review to include consideration of the effects on labor, I do not think that changing the current process is feasible. Instead, I propose the creation of a new government panel to review proposed mergers and outsourcing. The board would assess the expected displacement of labor in comparison with a realistic appraisal of the expected gains to consumers. This chapter also deals with political effects, by pointing out that the harm to workers has aggregated over the years, culminating in popular support for both Donald Trump and Bernie Sanders in the 2016 presidential election. There is a dark side to this growing populist movement, however, because disgruntled labor
has played a role in nationalistic and fascistic movements during the twentieth century. It would be a tragedy if the problems facing workers worsened so badly that they fueled a violent movement.
The postscript in the last chapter shows the commonality between other economic propositions and the two economic beliefs that are at the heart of this book, that U.S. markets are competitive and that the primary responsibility of a corporation is to make money for its shareholders. Many people believe assertions just because economists make them. Some people take these statements to be absolute truths, even though they are only opinions. Besides the two propositions I discuss, there are other economic narratives that are disputed by many economists. Yet, despite this rejection, policymakers, members of the media, and laypeople still believe that they are true. John Quiggin labels these as “zombie economics” because they “still walk among us.”14 The chapter considers three of these: trickle-down tax policy, austerity, and privatization. No serious economist supports trickle-down tax policy, while the benefits of the other two propositions are disputed by a good number of economists. One of the lessons of this book is the need to question whether economic propositions put forth by policymakers are the absolute truth.
14
John Quiggin, Zombie Economics: How Dead Ideas Still Walk Among Us (2012).
The Theory of Competitive Markets
The ideal market postulated by economic theory performs two important social functions. First, it provides a way to allocate goods and services without the need for government direction. Supply and demand respond to each other through the pricing system. Part of this allocative function is to direct investments into activities where they are needed. The result is to maximize resource allocation and to achieve the largest possible breadbasket of goods and services. Second, the ideal market provides constraints on producers through competition. This second function is the one relevant to the ideas in this book.
Perfect competition is the engine that makes the market system work without government intervention. It creates constraints that prevent undesirable conduct by business firms. It prevents high prices because the firm that charges above the market price will be underpriced by its competitors and theoretically lose all business because consumers will buy from the firms with lower prices. The constraints of competition force business firms to act in the interests of their customers, rather than in their own interests. Perfect competition also creates incentives for efficient production techniques, better products, and research and development. Although the model assumes perfect competition, these benefits will arise from vigorous, although less than perfect, competition. But there must be competition for these benefits to arise. If the firms in a market collude or if the firms refuse to compete as in an oligopolistic market, these benefits of competition are lost. To the contrary, if the market does not provide constraints, something else must do that. The only other realistic sources of constraints are self-restraint by firms or government regulation.
The discipline of economics provides an elegant model about how a market economy works. It is an intuitive model that can be described with narratives, as Adam Smith did, so it is understandable to most people. It has been mathematized, beginning with Antoine Augustin Cournot in the nineteenth century and popularized by Alfred Marshall in the early twentieth century, so it can be manipulated and studied in what seems to be a
Rethinking Market Regulation. John N. Drobak, Oxford University Press. © Oxford University Press 2021. DOI: 10.1093/oso/9780197578957.003.0002
scientific way. In addition, economists write with a certitude that makes their conclusions seem unshakable.1 These characteristics make people forget that it is only a model, a theory that only works perfectly on a blackboard. In the messy real world, the model works well at some times and poorly at others. Plus, the rapid pace of technological change and globalization has been altering the real economic world, raising the question of whether a theory that worked in the past works today.
The theory of perfect competition is based on a number of assumptions: (1) a large number of buyers and sellers, each so small relative to the market that no purchase or sale will affect the market price;2 (2) a homogeneous product, so that products are perfect substitutes for each other; (3) no barriers to entry to or exit from the market; (4) perfect information to buyers and sellers, particularly information about price; (5) producers live by the simple decision rule of maximizing profits; and (6) consumers are sovereign, meaning that each buyer has perfect knowledge of the differences between the various choices in the marketplace and perfect knowledge of what product will bring them the best satisfaction (or utility).3
It is obvious that these assumptions are not met in the real world. The mismatches most relevant to my concerns are those that allow firms to take advantage of consumers and workers. In welfare economic terms, consumer surplus is the benefit consumers get above the price they pay for a product. Theoretically, we could measure each consumer’s surplus by the difference between the highest price a consumer would pay for a product and the actual price paid. For example, if a consumer would pay $35,000 for a particular car but can buy it for $30,000, that person has a surplus of $5,000. We could view labor surplus to be the difference between the actual wage paid and the lowest wage at which a person would work. In attempting to maximize profits, a producer is trying to decrease consumer surplus by raising price, thus converting consumer surplus into producer surplus, and trying to reduce labor surplus by paying low wages. Competition has the benefit of limiting the amount of producer surplus, while a monopolist can achieve much greater producer surplus than possible in a competitive market. If our economic objective is to increase the breadbasket of goods and services by maximizing resource allocation, we might be agnostic about the transfer
1 Donald N. McCloskey, The Rhetoric of Economics, 21 J. Econ. Lit. 481, 493–94 (1983).
2 Hence the well-known saying that firms in perfect competition are “price takers,” unlike monopolists that are “price makers.”
3 E.g., Robert Cooter & Thomas Ulen, Law and Economics 22–41 (1988).
of consumer surplus into producer surplus because we do not know which type of surplus will lead to greater economic productivity. It might be that increased producer surplus will be reinvested in research and development and thus lead to better products, or it might just be passed on to shareholders and managers. Increased consumer surplus may be spent on additional goods and services, thus fueling the economy, or it might be put under a mattress at home for safekeeping. Since the second-order effects of surplus are so uncertain, it is understandable why economists may not take any position of the transfer of surplus.4
Supposedly the increase in the breadbasket of goods and services is good for everyone. As the economic pie grows, all of us have a bigger piece, even if our proportional share remains the same. However, the past few decades have shown that not to be true. Inequality in the United States has grown astronomically, with the rich getting an ever-growing share of the country’s wealth. Part of the reason for this result is the stagnation of real wages since the late 1970s.5 That is one of the reasons some economists have recently emphasized that wealth comes from capital accumulation these days, not from labor.6 The increasing inequality in wealth leads to my concern about the transfer of surplus from consumers to producers.
Economic theory deals with wealth maximization and resource allocation, not with wealth distribution. The discipline assumes that people vote with their dollars to make the system work. The result is that people with less wealth have less power in the market. Many economists care about relative wealth, but they view that as an issue beyond economic theory. They view government programs designed to alleviate adverse wealth effects, like taxation, welfare, and healthcare, as matters of social, not economic, policy, making it acceptable to use a process that depends on people voting with their dollars. However, if progressive social policies are not followed, wealth disparities will increase and decisions based on economic reasoning will lead to the kinds of problems described earlier.7
4 This is why the primary economic objection to monopoly is the deadweight loss that results from consumers who are priced out of the market and forced to buy their second-choice product, rather than a transfer of surplus.
5 Barry Z. Cynamon & Steven M. Fazzari, Rising Inequality and Stagnation in the US Economy, 12 Eur. J. Econ. & Econ. Policies: Intervention 170 (2015).
6 See, e.g., Thomas Piketty, Capital in the Twenty-First Century (Arthur Goldhammer trans., 2014).
7 Joseph Stiglitz has noted that large “behemoths” use their size to avoid taxation, depriving the public of “essential revenues to invest in infrastructure, people, and technology—contributing again to our economy’s stagnation and distorting our economy by giving those firms an unfair competitive advantage.” Joseph E. Stiglitz, America Has a Monopoly Problem—And It’s Huge, The Nation (Oct.
