The Great Reversal

by Thomas Philippon

  A similar process of deregulation took place within the telecommunications industry. As the economists Steven Olley and Ariel Pakes write in their influential 1996 paper, “For most of the twentieth century, American Telephone and Telegraph (AT&T) maintained an exclusive monopoly in the provision of telecommunication services and, through their procurement practices, extended that dominant position into the equipment industry.” The landmark antitrust lawsuit United States v. AT&T was filed in 1974. The Department of Justice (DoJ) claimed that AT&T had monopolized the long-distance market. In January 1982, Charles Brown, CEO of AT&T, and Assistant Attorney General William Baxter agreed to settle the government’s decade-long antitrust suit against the Bell System, and the “Baby Bells” were carved out in 1984. They owned local infrastructures and remained regulated monopolies within their regions. The new AT&T competed with other phone companies, and prices of long-distance phone calls fell dramatically. Much of the initial decrease came from lower access charges, but competition in long distance was also a success. The average revenue per minute of AT&T’s switched services declined by 62 percent between 1984 and 1996, and as more competitors entered the market, its market share fell from above 80 percent in 1984 to about 50 percent in 1996, to the clear benefit of US households.

  As in the case of airlines, however, later policies have been less successful. The Telecommunications Act of 1996 was intended to foster competition but also led to a merger wave. We will discuss mergers in Chapter 5, the lobbying activities of telecommunications firms in Chapter 9, and the revolving door issues at the Federal Communications Commission in Chapter 10.

  These two examples of air travel and telecommunication illustrate three important characteristics of competition policy at that time, all of which we will revisit often in this book. The first feature is that antitrust was largely a bipartisan affair. Airline deregulation happened under a Democratic president, Jimmy Carter, and the breakup of AT&T under a Republican president, Ronald Reagan.

  Second, regulation and technology are deeply intertwined. Technological change creates a permanent, and often beneficial, challenge to existing regulations. In the telecom industry, the cost of transmission and information processing declined thanks to integrated circuits and computers. The open architecture of the network and its digitization encouraged entry and competition while improvement in software allowed the sharing of information at a scale that was previously unimaginable. Microwave transmission was a major breakthrough that allowed competition in long distance. Transmission through satellite and through optical fiber followed suit.

  As we will see, this interaction of technology and regulation is both a blessing and a curse. It is a blessing because it forces regulation to evolve and regulators to pay attention. It is a curse because it makes it harder to disentangle the consequences of policy choices, and therefore harder to agree on what is a good regulation and what is a bad regulation. Lobbyists know how to use this to their advantage by creating smoke-and-mirrors arguments to push for regulations that hurt consumers but are often difficult to disprove.

  A third lesson that I take away from these historical cases is that regulators make policy decisions under a great deal of uncertainty. It is rarely obvious at the time a decision needs to be made whether antitrust actions are a good idea or a bad idea. Journalist Steven Coll wrote about AT&T: “Whether the break of American Telephone & Telegraph Company will be remembered decades from now as one of the more spectacular fiascoes of American industrial history, or whether it will be recalled as a seminal event in the emergence of a great global information age, or whether it will be forgotten altogether, is a matter that was impossible to predict intelligently in 1985.” This has an important implication. We must be able to let the government make some mistakes. Sometimes it will be too lenient. Sometimes too tough. It should be right on average, but it is unlikely to be right in every single case. Tolerating well-intentioned mistakes is therefore part of good regulation, provided that there is due process and that there is a mechanism to learn from these mistakes. Unfortunately, this kind of tolerance has become a rare commodity in recent years.

  The Reversal

  When I landed in Boston in 1999, the US was a great place to be a student or, as far as I could tell, a middle-class consumer. Over the next twenty years, however, something utterly unexpected happened. Each one of the factors I have mentioned has reversed. Access to internet, monthly cell phone plans, and plane tickets have become much cheaper in Europe and in Asia than in the US. Computers and electronic equipment sell for about the same price in Europe as in the US, although comparisons are complicated by differing tax regimes.a

  Consider home internet access first. In 2015, the Center for Public Integrity compared internet prices in five medium-sized US cities and five comparable French cities. It found that prices in the US were as much as three and a half times higher than those in France for similar service. The analysis also showed that consumers in France have a choice between a far greater number of providers—seven on average—than those in the US, where most residents can get service from no more than two companies.b

  The US used to be a leader in ensuring broad access to the World Wide Web for its citizens, but this leadership has slipped over the past two decades. According to data on broadband penetration among households gathered by the Organisation for Economic Co-operation and Development (OECD), the US ranked fourth in 2000 but dropped below fifteenth place in 2017.

  In 2017, market research company BDRC Continental together with Cable.co.uk compared the prices of over 3,351 broadband packages around the world. Table I.1 provides a snapshot of their results. In most advanced economies, consumers pay around $35 per month for broadband internet connections. In the US, they pay almost double. How on earth did that happen? How did the US, where the internet was “invented,” and where access was cheap in the 1990s, become such a laggard, overcharging households for a rather basic service?

  TABLE I.1

  Broadband Prices, Selected Countries, 2017

  Rank

  Country

  Average monthly cost ($US)

  37

  South Korea

  $29.90

  47

  Germany

  $35.71

  54

  France

  $38.10

  …

  113

  United States

  $66.17

  Data source: Cable.co.uk; https://www.cable.co.uk/broadband/deals/worldwide-price-comparison/

  As Susan Crawford at Harvard Law School argues, “New York was supposed to be a model for big-city high-speed internet.” Instead, it has become yet another example of expensive and unequal access to services. “When the Bloomberg mayoral administration re-signed an agreement with Verizon in 2008, it required that the company wire all residential buildings with its fiber service, FiOS … the presence of Verizon’s fiber product would end the local monopoly of Time Warner Cable.” Unfortunately, “a 2015 city audit showed that at least a quarter of the city’s residential blocks had no FiOS service. About a third of Bronx residents and more than 60 percent of New Yorkers without a high school education don’t have a wire at home.”c

  Returning to the question that launched this book, we see the same pattern with cell phone plans. Economists Maria Faccio and Luigi Zingales (2017) have studied the global mobile telecommunication industry. They argue that procompetition policies can reduce prices without hurting the quality of services or investments. In fact, they estimate that US consumers would gain $65 billion a year if American mobile service prices were in line with German ones.

  And finally, airlines are probably among the worst offenders. The Economist noted in 2017, “Airlines in North America posted a profit of $22.40 per passenger last year; in Europe the figure was $7.84.”d Around 2010, the net profit per passenger was similar in both regions, but since then, prices have increased more in the US than in Europe.

  You might reasonably wonder, where’s the o
utrage? If prices are indeed so different, why don’t we know about it? First, it is actually quite difficult to compare prices across countries, even for supposedly similar goods and services. We will discuss this issue in Chapter 7, and in the process learn about the price of haircuts and Ferraris around the world. Second, the increase has been gradual, and so it has attracted little attention.

  How to Boil a Frog

  Price hikes are rarely so clear that consumers notice them. Sometimes headline prices remain unchanged but hidden fees increase. Sometimes prices drift so slowly that it takes several years to notice any significant difference. Stealth, however, can allow harm to go unnoticed.

  According to the fable, if a frog is thrown into hot water, it will jump out, but if the frog is put in tepid water, and the temperature is slowly raised, the frog will not perceive the danger until it is too late. In a way, that’s what happened to me in my experience with the changing US economy. (And yes, as a Frenchman, I get the irony.)

  In the twenty years following my arrival in the US in 1999, most domestic US markets lost their competitive edge. I did not notice any of these changes as they were happening. I was not aware of the trends until I stumbled upon the facts in my own research. Why? Because the changes were very gradual, and because a lot of things are always happening at the same time: the internet bubble, 9 / 11, the war in Iraq, the housing bubble, the financial crisis of 2008–2009, the eurozone crisis of 2010–2012, oil price volatility, the rise of populism, the risk of trade wars, and so on. Throughout this tumultuous history, oligopolistic concentration and markups have increased slowly but steadily. And it’s only now, looking back, that a clear picture emerges.

  Notice that I am talking about US markets, not US firms. US firms do very well in global markets. In that sense, they are competitive. But US domestic markets have become dominated by oligopolies, and US consumers pay higher prices than they should. How did it happen, why did it happen, and what does it mean for US households, consumers, and workers? In answering these questions we will visit many of the important debates in economics and political science.

  Here are some of the specific questions we will address:

  Do these higher prices affect all industries, or are airline and telecommunications industries special?

  How did Europe, of all places, become more of a “free market” than the US?

  Isn’t it better if firms make profits rather than teeter on the verge of bankruptcy?

  Is big beautiful? Can concentration be a good thing? What, if anything, sets Google, Apple, Facebook, and Amazon apart?

  Should we worry more about privacy or about competition? Or are they perhaps two sides of the same coin?

  What are the implications of market power for inequality and for growth, wages, and jobs?

  Why are free markets so fragile? How did lobbyists end up wielding so much power?

  This list may seem like an implausibly wide array of topics to cover. It’s important to understand, however, that while the questions we’re considering are varied and complex, the underlying forces are few. I hope to convince you that economic analysis can shed light on all of them. After all, science aims at reducing complex problems to a few fundamental issues.

  An Economic Approach

  Economics is the science that studies the allocation of limited resources among individuals or among groups of individuals. The unit of analysis may be a firm, a family, a city, a country, or many countries. The manner in which allocations are determined also varies a great deal. There could be one centralized market, such as a stock exchange, many markets, such as for local services like barbers or dry cleaners, or no market at all, as in the case of internal promotion within a firm.

  The goal of the allocation might be efficiency (maximizing the productive use of resources to increase growth) or justice (limiting unfair inequality, redistributing income toward the poorest members of the group). The important point in all of this is that the resources are limited. Hence the economic system, no matter how it is organized, must make choices. Tough choices.

  In the end, the big debates in economics are about growth and inequality: How did they come about, and what should be done about them?

  Where We Go from Here

  The book makes three main arguments.

  One: Competition has declined in most sectors of the US economy. Measuring competition is easier said than done, for we can find only imperfect proxies. We will look at prices, profit rates, and market shares. None is perfect, but together they can form a convincing picture.

  Two: The lack of competition is explained largely by policy choices, influenced by lobbying and campaign finance contributions. We will look at the dollars spent by every US corporation over the past twenty years to lobby their regulators, their senators, their congressmen, and members of key committees, as well as to finance federal and state elections. We will show how these efforts distort free markets: across time, states, and industries, corporate lobbying and campaign finance contributions lead to barriers to entry and regulations that protect large incumbents, weaker antitrust enforcement, and weaker growth of small and medium-sized firms.

  Three: The consequences of a lack of competition are lower wages, lower investment, lower productivity, lower growth, and more inequality. We will examine how the decline in competition across industries has effects that reach into the wallets and bank accounts of everyday Americans. We will also demonstrate why lower competition leads to less of the sort of thing that we traditionally associate with growing economies: investment, technological advancement, and rising wages.

  Are you ready? Let’s begin.

  * * *

  a  US prices are quoted before taxes, whereas prices in France always include VAT. There are also specific taxes. For instance, France levies a tax on iPhones and iPods to pay artists and composers. The extra cost is around 10 euros for iPhones with 16GB of memory, and up to 18 euros for 64GB iPhones.

  b  Center for Public Integrity, “US internet users pay more and have fewer choices than Europeans,” April 1, 2015, updated May 28, 2015.

  c  Susan Crawford, “Bad internet in the big city,” Wired, February 28, 2018.

  d  “Air fares are higher per seat mile in America than in Europe. When costs fall, consumers in America fail to enjoy the benefits. The global price of jet fuel—one of the biggest costs for airlines—has fallen by half since 2014. That triggered a fare war between European carriers, but in America ticket prices have hardly budged.” “A lack of competition explains the flaws in American aviation,” Economist, April 22, 2017.

  [  ONE  ]

  THE RISE OF MARKET POWER IN THE UNITED STATES

  Let us start by exploring the evolution of the US economy over the past twenty years. In doing so, we’ll investigate how economists think about competition, concentration, and antitrust. You will learn about the impact of China’s entry into the World Trade Organization, about initial public offerings and mergers, and about the growth of young firms. We will introduce the fundamental law of investment, the concept of intangible assets, and the evolution of productivity.

  CHAPTER 1

  Why Economists Like Competition … and Why You Should Too

  THE BIG DEBATES in economics are about growth and inequality. As economists, we seek to understand how and why countries grow and how they divide income among their citizens. In other words, we are concerned with two fundamental issues. The first issue is how to make the pie as large as possible. The second issue is how to divide the pie.

  Economists study those choices because they want to understand the factors that foster growth and the factors that influence the distribution of income among individuals. At least since Adam Smith, we have understood that one of these factors is competition.

  Growth

  An economy can grow in exactly two ways: its labor force can expand, or its output per worker can increase. From the Roman Empire to the Industrial Revolution, population growth was slow and
productivity growth was nil. The Industrial Revolution earned its name by unleashing unprecedented productivity growth. The First Industrial Revolution began in Britain in the eighteenth century and moved the economy from agriculture toward manufacturing. It involved new machines (the spinning jenny), new energy sources (coal, steam), and a new division of labor in large plants. As countries became richer and agriculture became more productive, populations also grew. Thus, after 1700, population growth and productivity growth both contributed to overall economic growth.

  Which rate of growth should we consider: overall, or per capita? There is no simple answer; it depends on the issue at hand. If we are interested in measuring the global clout of a country—its gross domestic product (GDP), for example—then overall growth is what matters. For instance, when comparing the relative worldwide influence of the US and China, we would want to use total Chinese GDP versus total US GDP. But if we want to understand how the average Chinese consumer feels, we would want to use per-capita GDP estimated at purchasing power parity (PPP). Chapter 7 explains how PPP exchange rates are computed and how to use them. And sometimes GDP itself is not the right measure. In the case of Russia, for instance, there is a large discrepancy between its semiglobal influence and its relatively small economy because of the hypertrophy of its armed forces.