How America gave up on free markets: Q&A with Thomas Philippon


How concentrated is corporate power in America today? How big of a problem is this? According to Thomas Philippon, the answers are “more concentrated than in Europe, and more concentrated than any other time in recent American history,” and, more simply, “yes, it’s a big problem.” Last week on Political Economy, Thomas and I delved into this argument, outlined in his recently released book, The Great Reversal: How America Gave Up on Free Markets. We explored how industry concentration has affected various American markets — from air travel to health care. We also explored the difference between good and bad concentration, and discuss which label better applies to big technology companies.

Thomas is a professor of finance at New York University’s Leonard N. Stern School of Business. He is also an associate editor of the American Economic Journal and a research associate at the National Bureau of Economic Research.

What follows is a lightly edited transcript of our conversation, including brief portions that were cut from the original podcast. You can download the episode here, and don’t forget to subscribe to my podcast on iTunes or Stitcher. Tell your friends, leave a review.

Pethokoukis: Now, when you say competition has been declining and America is “giving up on free markets,” I take what you mean is that over the past few decades, the US has seen increased levels of industry concentration, leading to declining competition. So how do we know this is true?

Philippon: Yeah, that’s a good question. That’s why I took a long book to try and convince people that something like this was happening. I think the ways you can look at this are to compare the US with how it was 20 years ago or to compare it with other countries. And in these cases, the data suggest that, indeed, there is a decline in competition. If you look at the US 20 years ago, many industries that today are dominated by one or two firms had many more players. And so that suggests that maybe there was more competition in the US at that time.

Are you looking at like one or two statistics? Do you look at what share of revenue the top four firms take? I’m sure you obviously are doing a much more sophisticated job, but what are one or two statistics that you can look at?

Well, so take an example: air transport. 20 years ago, you had eight major airlines in the US. By that, I mean they were national airlines and they were serving more or less the entire country. And today, this number is down from eight to four. You have four airlines who control more than 80 percent of all the flights in the US. That’s a very large increase in concentration in that specific industry. So that’s one example.

What we try to do is to look at all the industries to the extent that we can, and compute these kind of numbers. How many big players are out there in the market? What is the market share of the top four players? And in the case of airlines, you see that the market share of the top four is maybe 90 percent today. If you look at 20 years ago, that number would have been much lower, less than half.

We’ll get to the tech industry in a bit — that’s the sector that seems to be the one most frequently mentioned when we’re talking about competition issues these days. But in the meantime, what are some other industries that have just become markedly more concentrated?

Well, another one that I find striking is the telecom industry. Of course, it’s very much in the news today because of the proposed merger between Sprint and T-Mobile, but that’s also one where — I told you at the beginning there’s two ways to think about it — you can compare the US today to how the US was 20 years ago, or over time to other countries over time. That’s why a long section of the book is devoted to comparing the US with Europe, which is very interesting because Europe, to some extent, has been inspired by the US, and even to a large extent, has imitated what the US was doing in the 1990s on antitrust or competition policy, regulation, etc.

T-Mobile CEO John Legere (L) and Sprint CEO Marcelo Claure at the New York Stock Exchange in New York, NY, April 30, 2018 – via REUTERS

But then what you see is that in the telecom industry, for instance, 20 years ago the US had lower prices than Europe in key markets. Let’s take two markets that people are going to very quickly understand. One is internet at home. How much do you pay to have a broadband access cable at your house? And the second one is, how much do you pay each month for your cell phone? So take these two markets: broadband at home and cell phone plans.

These used to be cheaper in the US than in Europe 20 years ago, and now they are much cheaper in Europe. And by much cheaper, I mean half of the price. So whatever your plan is today, there is a very high chance that if you lived in London, Berlin, or Paris, you would pay half of what you pay today for exactly the same service.

So it’s the same service, not that American broadband is a lot faster than Europe. It’s basically the same kind of service, same level of quality.

Yeah. Well, in every country you have a range — so you can buy high-speed or low-speed service depending on your needs. But the comparisons that we are making are for the same exact service.

And so what’s striking is that the US went from being cheaper to being much more expensive. On the flip side, of course, Europe went from being more expensive, to being cheaper than the US. That’s telling because it’s the same technology — it’s not that it’s the same market or the same household, but it is the same technology. And yet, prices have moved widely over time. So it’s not technology that explains that. It’s not the taste of consumers because they are basically the same here and in Europe. At the end of the day, the difference is mostly competition.

And you kind of alluded to this — we look at the results of the increased concentration, the climbing competition — because increased competition doesn’t necessarily mean something bad is happening, right? It does matter, though, what’s driving the concentration.

Yeah. In fact, you brought up tech at the beginning. That’s one market where it’s obviously very ambiguous.

Now, what’s not ambiguous is that, today, they have a lot of market power. But what is ambiguous is whether many of them got there by being better than their competitors. In the book I try to be very pedagogical about that. I have a very simple way to think about it. Make two camps — the good concentration camp and the bad concentration camp — and think about what it means.

So good concentration would be when the market leader becomes better and better and better. The market leaders would be more than one. Then what happens is that because they’re becoming more efficient, they are taking market share away from their competitors. They are sometimes even wiping out some of competitors. And so over time, you see that the efficiency of the leader explains why they are taking market share away from their competitors and why concentration is going up. But it’s a good type of concentration. At the very least, initially, it’s a good type of concentration, because it comes together with high productivity growth and lower prices.

This is exactly what happened if you follow the growth of Walmart from roughly the mid-80s to the mid-2000s. Walmart became ginormous, as we all know. But if you look at retail prices, they were declining throughout the period. The profit margins of Walmart were very flat. What it was doing was investing a lot in IT. It was big and extremely efficient, and getting market share by lowering prices. It’s still disruptive, of course. It puts out of business many other competitors. But at the very least, you can say that productivity is going up and prices are going down. Consumers are getting a good deal. So we think of this as efficient concentration.

People talk outside a Wal-Mart Pickup-Grocery test store in Bentonville, Arkansas, June 4, 2015. Via REUTERS/Rick Wilking

The inefficient concentration is when we see the big players managing to protect themselves — to insulate themselves from competition — by raising barriers to entry. In that case, you would still see concentration because there will be no entry to challenge the leaders, but prices would go up and productivity would be mediocre at best.

So that’s the two parallel cases. And you see both in the US, obviously. In retail, even today still, retail is very competitive. So you see productivity growth and low prices. Then you have at the other extreme air transport, telecom, healthcare, and, to some extent, also the energy sector, where we don’t see productivity growth and we definitely see higher prices for households. And the rest of the economy’s somewhere in between.

So how did this happen in the United States? How is it that the EU has better competition policy than the US? Is that what we said we were doing just didn’t work, or did we stop doing what we said we were going to do 30 years ago?

The second one. US competition policy was working very well. In fact, it was working so well that the rest of the world was inspired by it. So it turns out that — you asked two questions. How did the EU become better at having free and competitive markets, and how did the US become worse?

It sounds like it’s much easier to answer the first one. It’s actually very easy to know how the EU got there, because it’s a very simple story. It got there by essentially copying what the US was doing 20 years ago. Exactly how that happened and why the Europeans decided to do it  is a more complicated story. But once they decided, the way it was done was very straightforward. It’s exactly the same playbook as the US 20 years ago: You remove barriers to entry, you make entry easier into various industries, and you have strong antitrust enforcement. That’s what’s happening in Europe.

Just to give you an example: In France, in the telecom industry, we used to have very high prices, because we had an oligopoly of three legacy carriers. And they were all charging very high prices for the basic cell phone plans, like unlimited text and data. Of course, the people knew that. So there was potential for competition. But to enter the market, you needed a license. And there was a force who was asking for a license but under heavy lobbying by the oligopoly was denied a license for a long time until 2011.

In 2011, finally, the regulator gave a license to the new entrant, together with the means to enter and the new player entered. And the new player was named Free Mobile. So Free Mobile entered the market at exactly half the price of the incumbent. The incumbent used to charge maybe 20, 40-plus euros for the basic plan and Free Mobile entered at 20 euros in the market. Huge disruption. They started to gain market share. Six months later, the incumbent had to match the price of the entrant and everybody was at 20 euros. And so literally in two years — the data is in the book — France went from being 20 or 30 percent more expensive than the US to being 30 percent cheaper.

When I hear — I guess you would call them the antitrust activists — in this country talk, it seems to me that what they’re saying is that the American approach to antitrust is not so much that we stopped doing it, but the approach that began maybe around 1980, the approach that didn’t look at how many companies there were, or what share the market they had, but looked at the impact on consumers. Did consumers have a lot of choices? Were they getting good quality products? That kind of consumer welfare standard was a bad idea. That’s what it seems to be what activists in this country are saying. That was a bad idea.

Is that a bad idea? Does Europe follow that, or do they do something completely different?

No, I disagree with the statement that the consumer welfare standard is the problem. It’s not the standard that’s the problem.

In this country, the activists seem to think it is the problem. Especially when they’re dealing with tech companies, maybe specifically dealing with them.

Yeah. Well, so for the tech one, it’s slightly more complicated. Even then, I would argue it’s not a question of standards. It’s a question of application of the standards. So I disagree with the activists. I don’t think you need to change the standards. In fact, in Europe we didn’t change them. We do have consumer welfare standards, but essentially we think that there are some cases where in the medium-to-long run, the only way to make sure the consumers are better off is to avoid excessive concentration. It’s not that we’re suspicious of concentration in and of itself. It’s just we think that it always leads to bad outcome for consumers.

Do regulators in Europe look more to the long term? They could say, “Well, everything seems fine right now, but the lack of competition down the road could lead to a bad situation. So we’re going to act now.” Are they more preemptive?

They try to be, but honestly I think that debate is missing the boat. It’s not as if the Europeans are doing something very different. The Europeans are doing what the US was doing 20 or 30 years ago. We use relatively similar outcomes, which is free and competitive markets. So the question, from the US perspective, is really: Why is it that the US stopped having sensible antitrust and competition policy at home? I think that’s the question. Although we are going to talk about Amazon, Facebook, and Google — and I’m very happy to talk about them, they’re very important — you shouldn’t confuse the forest for the trees. Right? There are many, many problems in basic markets that have nothing to do with the new tech firms.

Why don’t you tell me a bit about healthcare? Because that obviously is an issue. It’s a big chunk of the economy. So what’s going on in the American healthcare industry from a competitive standpoint?

Well, the problem is that healthcare is a very difficult industry to regulate. And there is no free market for healthcare anywhere in the world. So every country has to choose one way of regulating the system. The problem of the US is that you have a very strong lack of regulation together with very strong anti-competitive forces at all levels in the system — in terms of the providers or hospitals, the care providers or insurance companies, and the pharmaceutical companies.

Senate Minority Leader Chuck Schumer (D-NY) and Speaker of the House Nancy Pelosi (D-CA), take part in an event calling for healthcare protection ahead of the State of the Union address in Washington, U.S., February 4, 2020. Via REUTERS/Joshua Roberts

All of these three big players are very much in oligopolistic settings, where they can maintain very high margins with non-competitive behavior. So that makes the whole system extremely costly for everybody.

Well, let’s just focus on one of those: hospitals. Have there been too many hospital mergers in this country?

Oh yeah. So there’ve been lots of research on that over the past five years, and now it’s one of the most well-documented facts. It’s just a complete disaster in terms of quality and prices. Essentially, quality goes down and prices go up when we have these mergers between hospitals.

Now, we wouldn’t care as much about the mergers if we were getting much better results. Even if prices went up a bit, if there were much better outcomes, it wouldn’t be so concerning. But that’s not what we’re seeing.

No, that’s definitely not what we see. Absolutely not. What’s tricky for the healthcare system is that the alternative is not a simple free market. Even the countries that are successful in having a fairly efficient and relatively cheap system regulate a lot.

But healthcare is interesting in another respect, in that it exemplifies the deep issue in the US system today. The way these companies get away with high prices — and essentially lots of market power — is by lobbying their local regulators, their industry regulators, and their federal regulators. And the healthcare industry is very much in line with that practice. So that’s the common thread across all of these industries: very heavy lobbying to make sure that their rents or their profits are not threatened by competition.

So would the solution be to then to break them up, in some fashion?

Well, so you want to be more rigorous when you look at mergers, but again, in the case of healthcare, I think the thing is you starting from a system which is so inefficient. In some industries, the inefficiencies are not that large, and the obvious solutions are not there yet. You need to think, “Okay, should I break up these pharmacies or that firm or remove the merger between Sprint and T-Mobile?” You need to argue the case. But for healthcare, the level of inefficiency is so large that there are some obvious things you want to do, like having price transparency — just knowing how much things are going to cost — that’s obvious. You would think it’s obvious, but even that is not the case in the US today, right? They don’t post prices. In fact, they work very hard to hide the prices from patients. So all of this, that would be my first action on that market.

Once you do the obvious, then you have the less obvious, which is: What’s the right level of concentration in among hospital providers?

As far as the big technology companies go… again, activists in this country think it’s obvious. They think the case has been proven: These companies are too big, too concentrated, and too powerful. The harms are obvious, they don’t do a good job of governing themselves, they are hurting innovation, and therefore we should just go down one by one, split them up. Split Facebook up into Instagram and WhatsApp and Facebook, cut YouTube off of Google. Company by company, that’s what we do.

So again, among these activists, they see something clear — a clear problem, clear harm, and they have a clear solution. Is it that clear?

I think it’s a bit tricky. On the one hand, I think without the energy of activists, we go nowhere. So I think we shouldn’t use the analogy of “finally do something.” So I think that’s useful. But anybody who thinks this solution is obvious needs to go back to the drawing board. I mean, I’m very much in favor of having antitrust actions against Big Tech companies. But the one thing that I know for sure is that this is not obvious.

What is perhaps clear today is that many people wish they had blocked the acquisition of Instagram by Facebook, knowing what we know today. Now, far fewer people actually said this in real time, when it mattered. That is, when the acquisition took place, many people who say today it was obvious that they should have been blocked didn’t say anything in real time.

Demonstrators hold signs at a protest on the campus of Google during its shareholders meeting in Mountain View, California May 14, 2014. Via REUTERS/Robert Galbraith

But I think that Big Tech, to me, fits very well into the good and bad concentration framework. Most of them actually got to where they are today by being better than their competitors. So in that sense, it’s the good concentration.

I mean, Google didn’t get to its market share because it had an effective lobbying team in Washington, right?

Well, no. First, they had the better search engine, and then they made very smart acquisitions on the auction business. So that’s one technological improvement and one smart business move. After that, of course, they started lobbying to protect their rights, but there is no question that at some point, they were very innovative. I mean, I remember vividly — I was at MIT when Google launched their search — the first time I opened the Google search page, which was so clean. Just a blank, totally white, with just a clean search bar. I thought it was brilliant. So you give them credit for that. There is no question.

The problem today is that they’ve become very dominant and we don’t see entry in this market, and we don’t see new firms challenging them. I think that’s the problem. And the question is what to do about it. I think that’s where, at the very least, we need to try antitrust actions because even if it does not succeed, it would be useful for A) learning the facts and B) putting the brake on — putting some sand in the wheel to create some space for new entrants. I think that would be useful.

The second thing that I think is important is that the solutions are not going to be the same when you look at Facebook, Apple, Amazon, or Google, because they are going to play out very differently.

Take Apple, for instance. I think most of the issues with Apple are really about the App Store, because that’s where there’s a conflict of interest. It’s a market that is really run by Apple and where they take a very high cut on the price that people pay for their apps. So that issue is located in one particular part of the Apple ecosystem, and I think we want some specific action there.

On the other extreme, you have Facebook and Google, where the issue is much more at the core of their business model, which is the dominance they have in online advertising. And also that’s why it ties up to issues of privacy. Now to deal with privacy, it’s not clear whether you want to do antitrust or regulation. My hunch is we need to do both, actually. Because I think that position would also be good for privacy. But it’s not obvious.

If we do nothing in the United States, if we just let these big companies get bigger — even granting that they’re spending a lot of money on cutting-edge research and development, and these companies seem to be acting like their competitive positions aren’t guaranteed forever —but if we keep doing what we’ve been doing for the past 25 years or more, then what? What does the US economy look like a generation from now?

Well, two things are going to happen. One of these is that you’re going to miss on some and new ideas and new innovations, which are going to be stifled, which won’t take place because of the dominance of these big players. Even though they do spend a fair amount on research and development, it doesn’t mean that they are very efficient. Firms tend to be very strongly incentivized only when their life is on the line. That’s when the innovation’s the best.

I mean, think about when Google was the most innovative: early on, when they really wanted to establish that they were the best in search. That’s when they really did the best innovations. Think about Apple. When did Apple really innovate over the past 20 years? When they had their backs against the wall, everybody thought Microsoft would totally dominate, and Apple would be just gone in the next five years. That’s when they invented the sequence from the iPad to the iPhone. It’s not when they became very rich and established that they did these innovations. It’s before.

Hans-Henrik Duessel from Svendborg, Denmark, displays his old Apple Macintosh Classic computer from 1990 beside his newly purchased Apple iPad after being among the first to purchase the new device during an iPad launch event at the Apple retail store in Hamburg May 28, 2010. Via REUTERS/Christian Charisius

So what we are missing today are these new firms that are very hungry for innovation because they haven’t made a name for themselves yet. But they don’t have the space to grow because of these very large players who just dominate the ecosystem too much. So if we keep going like this, we’ll miss these young firms. That’s the first effect.

And the second effect — and that applies much in a broader context than just the tech — is just that people are going to keep paying too much.

I feel like I don’t pay much for my Google search.

That’s exactly right. So that’s one place where you don’t need to change the consumer welfare standard. You just need to interpret it in a broader context. That’s exactly the reason I think that it would be a mistake to focus on antitrust only on the Big Tech firms. Because even if you’re successful with the big tech firms, these are not the markets where you’re going to have a bigger impact on the standards of living of the median household. The typical household living in the US makes $50,000 a year. You don’t really spend that much on the services from Google and Facebook because the ones you face are free. The one you don’t see are expensive, but you don’t pay directly for them.

But if you look at your cell phone bill, your internet provider bill, or all the bills that fly around, that’s a lot of money. And these markets are the ones where the regulators should also do something. My estimation is if you’re the typical household in the US and you earn, again, something around $50,000 a year for your household, you are missing about $5,000 of extra income each year because of these monopolies.

So that’s the thing that you’d be missing if you keep going in this route toward less free markets and less competition.

My guest today has been Thomas Philippon. Thomas, thanks for coming on the podcast.

Thank you.

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