Over-powered corporations have grown too used to dictating terms to consumers, workers and suppliers. Merryn Somerset Webb talks to Jonathan Tepper about how to fix it.
• Listen to Merryn talk to Jonathan Tepper about this on the MoneyWeek podcast.
There is something wrong with the way capitalism is working in the West at the moment. On that I think pretty much everyone is agreed. But what is wrong? Jonathan Tepper, author of The Myth of Capitalism: Monopolies and the Death of Competition might have the answer. It came, he says, from trying to figure out something all economists have been trying to figure out over the last few years – why wages just won’t rise. Tepper’s day job is as an economist at Variant Perception, the global macroeconomic trading and research group he founded. There, “year after year,” he monitored all the leading indicators that usually tell us where wages are headed. They told him that the US labour market was tightening, and that wages should be rising. After all, as the supply of labour falls, so the price of that labour should rise as companies started to compete and bid up wages. But that never happened, something that had the puzzling consequence of preventing corporate profits from reverting to the mean (the wage bill is the average company’s biggest bill).
That mattered hugely to Tepper in his day job. Company profit margins have always reverted to the mean – ie returned to their long-term average – in the past (market guru Jeremy Grantham of US asset manager GMO calls them “the most mean-reverting series in finance”). But if they aren’t going to any more (and profits will be elevated forever) two questions arise. First, is there a new argument for paying higher earnings multiples for stocks than in the past? And second, can the death of mean reversion explain what’s wrong with capitalism?
Too few companies with too much power
It was in looking into the first question that Tepper found the answer to the second. “I realised that… particularly in the US… which is probably the most advanced in this trend, you’re seeing more and more industrial concentration.” There are fewer players in each industry than there used to be. That gives companies pricing power over the consumer (which investors such as Warren Buffett love to see). But “less discussed and understood is that they often have power over the worker”: they don’t have to bid against rivals for labour. They also gain huge power over the suppliers. The result is obvious: a small number of huge companies capturing very high profit margins.
The key, says Tepper, is that “capitalism has two elements”. The first, absolutely vital to it, is private property. This is no longer really disputed. China – which still declares itself communist – now offers most people the ability to own property. Even in North Korea, the leaders have their own private property. “So that battle’s won.” The second part, however, is competition – and that battle, once won, is now being lost to the extent that we are back to the problem G. K. Chesterton once identified: the problem of capitalism not being “too many capitalists, but too few capitalists.”
How, I ask, did we get here? In the post-war period, says Tepper, anti-trust laws in the US and western Europe were strict and “broadly enforced.” So firms were in the main not allowed to buy their direct competitors (they bought firms that did other things instead – this was the age of the diverse conglomerate). Then in 1982 work by Robert Bork and Milton Friedman’s disciples at the University of Chicago led to a change in the rules, the idea being that if you allowed companies to merge, they would become more efficient and “magically pass on those savings to the consumer.” And so it began – and four decades and four mega-merger waves later, the make-up of the corporate world has been transformed.
The illusion of choice
Take the US beer industry. Go into a liquor store and you will see hundreds of brands of beer. It looks like you have endless choice. But in truth, two players control 90% of the market between them. Tepper’s book is full of similar examples (go and buy it!). Cereals are another obvious place of concentration. Three firms control the entire market – to the extent that they decide between themselves what shelf space they take at the supermarkets (this is called “category management” and “not prosecuted as being in any way collusive”). Cable companies are another example; airlines another. There are four main airlines but even that doesn’t tell you quite how much control they have. Look more closely and you see that they operate local monopolies: for example, 80% of the flights in and out of Atlanta are Delta flights (something that explains how they get away with treating their passengers as badly as they do). And “if you live in Charlotte, good luck getting out of Charlotte not flying American.”
It isn’t, however, just mergers that have created monopolies. It is also the rise of regulation. Take credit ratings agency Moody’s (a huge favourite with Buffett, thanks to its monopolistic characteristics). It is, says Tepper, a classic example “that only exists due to regulation. You and I spend our lives looking at markets. There’s no reason why you and I today could not start a rating agency. But we can’t do that… because of the NRSRO (Nationally Recognised Statistical Rating Organisation) credential you need.” Moody’s has one. They are hard to get – so much so that “it’s easier to raise an armed militia in the US than it is to start a rating agency.” These are the kind of regulations that serve to create “crony capitalism” and which are doing so in industry after industry (in the last 22 years, federal agencies have published more than 88,000 final rules) with the depressing result we see all around us: “less competition, less innovation, less capitalism.”
Look to the European Union (EU) and you can see a similar dynamic. Take asset management and the sharp rises in compliance costs there, as a result of new regulation (those in the business will get an instant non-holiday feeling from acronyms such as AIFMD, MiFID and MiFIR). The result is a few big asset managers and banks who are the only ones who have the wherewithal to have the required internal systems to deal with “compliance, legal, tax and all that” – and very few start ups. Look at hedge funds, for example: the top 100 have about 90% of the assets.
The way to think about the effect of regulation on competition (and to understand why the more oppressive-seeming it is, the more big companies love it) is to think about it in terms an organisation’s capacity to deal with it. A big bank that is no longer growing has hordes of energy for compliance. A start- up using all its energy to innovate does not. A huge dose of new regulation can kill it fast – by distracting it, but also by adding hugely to its costs before it has the critical mass to absorb them. Note that the number of start ups and newly-listed companies has been falling for years – and not just in the US, in Germany too: it’s like a dystopian movie, says Tepper, “where we all get old and no-one has any children.”
We go back to what this means for inequality. In a nutshell, I say, what’s happening here is that the merger and regulation-driven concentration of industry is holding back both wages and entrepreneurial activity, and this is giving us higher levels of both income and wealth inequality than we should have. That’s it, says Tepper. Think of it as a type of “aggressive taxation” in that it transfers money from the poor or middle class to those who own shares in these companies.
Back to Buffett (who I get the impression is not Tepper’s favourite person): “it’s no surprise that almost all of Buffett’s holdings have been monopolies and duopolies and that’s made him, up until Jeff Bezos, the richest man in America.” This takes us to the really tricky bit. If Tepper is right (and it’s hard to think he isn’t) and it is the rise of powerful oligopolies that are in large part responsible for the rise of inequality (and its political consequences), what do we do about it?
First, ensure markets are open for competition. Second, break up the huge merged groups that destroyed it in the first place. And third, recognise the role of regulation, says Tepper. Obviously we need it (“I’m not in favour of people being poisoned by the water”) but perhaps it needs to be “principles-based regulation rather than extreme rules-based.” Think more the 35 pages that made up the very effective Glass-Steagall Act, rather than the thousands that make up new ones. Ask firms to observe principles and the spirit of principles, rather than endless complicated rules, and you’ll get more competition. Do it with banks in particular and, given small banks tend to lend to small businesses, “we will end up with a much better and more equitable social outcome.”
This all really matters. We have been saying at MoneyWeek for years that capitalism has to reform itself before it is reformed. Tepper is saying something very similar: “if capitalists and people who love competition don’t reform markets, people who don’t like capitalism are going to do it.” The good news is that the response to his book has been hugely enthusiastic (all events are packed) and, like us, he feels that change is coming – politicians are grasping the problem and would now “prefer to get ahead of the crowd and pretend they’re leading the parade.” Witness, for example, the talk of a breakup of Facebook given its dominant market position as a result of its acquisition of Instagram and WhatsApp.
None of this will happen fast (“history moves slowly”); wealth taxes may appear in the interim. But there is a message for long-term investors: some people are paying very high multiples for companies with “moats” (high barriers to entry). If those moats are vulnerable to government action and hence to competition, those people “may be disappointed.”
The Myth of Capitalism: Monopolies and the Death of Competition by Jonathan Tepper with Denise Hearn is out now (published by John Wiley & Sons).
• The Myth of Capitalism: Monopolies and the Death of Competition by Jonathan Tepper with Denise Hearn is out now (published by John Wiley & Sons). Buy it on Amazon.