Power shifts, or not?

by
Peter Radford
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from Peter Radford

“Even someone as smart as Larry Summers.”  

Power can flummox even the best economist.  A typical explanation of events in an economy makes scant reference to the way in which power distorts the wondrous smooth motions that so obsess the discipline.  It’s almost as if human relationships don’t exist in those wonderful models they are all so proud of.  For the rest of us, power is central.  It takes little time to realize that establishing an imbalance can have all sorts of advantages.  They most notable being that it defeats or undermines the consequences of the classic impersonal marketplace.  Fair is out.  Asymmetry is in.

Not that the existence of asymmetry ought surprise anyone.  The real world is an awfully lumpy place.  Resources, information, people, and everything else exist in clumps.  Without those clumps there would be no exchange.  There would be no trade.  There would be no markets.  But the world is lumpy, hence all of the above.  This paradox, that economists study idealized worlds whose features eliminate the very phenomena that are the supposed object of study, is one of the more endearing aspects of economics.  Building theories about made up worlds is a whole lot more fun and easier than inventing them to explain the real world.  But, hey, let’s be fair: as long as we all know that we are theorizing about our fantasies in order to extract useful nuggets about the real world, we should go for it.  Unfortunately, and I think this is fair criticism, the way in which economics is taught often elides this.

One of the odd things about our emergence from the pandemic and the sudden prospect before us of a robust economy is that the more conventional analysts are all bleating about inflation.  Something terrible is about to happen, they argue, unless we correct for all that money sloshing about as a consequence of governments trying to bail out their respective economies.  The ghosts of the 1970s are everywhere.  Strange things are afoot.  Are massive purchases of government debts by central banks properly called monetary policy?  Or are they a sort of fiscal policy?  Are we in an era of well-anchored inflation expectations?  Or are we adrift about to take on water?  And the difference between forecast and outcome based policy setting is keeping some analysts awake at night.

It’s enough to confuse even the most adroit of us.

There are so many puzzle pieces on the table it’s difficult to send the outline of the picture we need to paint.  So let’s look for a straight edge.

That’s where power comes in.

It might be passing, but at the moment workers here in the U.S. have the upper hand.  For the first time in decades they are able to extract higher wages from prospective employers.  And the employers aren’t liking it.  Nor are the financial media types and analysts brought up in an era of shareholder value dominated business strategies.  All those consultants whose existence is to give intellectual cover to the suppression of the workforce despite all their screeds on employee “engagement” and “human capital” are perplexed.  What is a cost-cutter to do when the source of the largest single cost in most businesses gets less supine?  Heck management might even have to pay the workforce more.  Hell is freezing over.

Power is shifting.  At least temporarily.

How temporarily will be affected by the ability of business to re-assert its oligopolistic hold on the economy.  This is why a new book by Jan Eeckhout is so timely.  It is called “The Profit Paradox”, although the subtitle “How Thriving Firms Threaten the Future of Work” is far more telling.  It is somewhat disappointing to find a book in 2021 whose main thesis is the shift in the balance of power away from labor to capital.  Surely we all knew about this a long time ago.  Has it really taken this long for someone to take a good look at why?  Of course not.  Others have ventured here before.  What I find interesting about Eeckhout’s ideas though is that he ties the individual firm’s pursuit of self-interest — via the infamous shareholder value proposition — to the general decline of economic performance.  It’s an inversion of the famous Smithian view that the result of self-interest is to produce a socially beneficial result.  Clearly when we examine firms rather than individuals that is no longer true.

Rather than belabor the point let me quote from page 75 of his book:

“This is the central thesis of the book.  We tend to accept that when firms do well, the economy does well.  Competing firms that make profits create jobs and work benefits.  Alas, currently dominant firms exert market power and do the opposite.  They generate excess profits because they face too few competitors and make consumers pay too high a price for a bottle of beer or for their grandmother’s prosthetic hip.  Therefore they sell fewer units, as fewer people can afford to buy.  Market power is now so widespread, from tech to textiles, that it lowers production and the demand for labor.  Instead of creating jobs, profitability due to market power lowers wages and destroys work.  That is the profit paradox.  Only a competitive marketplace where firms sell at low prices brings benefits for workers and restores a healthy economy.”

The entire book is an explanation of how market power is created and protected.  The consequences are lower economic growth, lower wages, and fewer jobs.  It is an interesting thesis and well worth getting to know.

Okay: I cheated a little.  Eeckhout doesn’t actually mention shareholder value.  I assume that’s because it has become such an institutional piece of management technology that it is subsumed into the reality we deal with.  No one appears to question it much.  So I thought I would add it into my narrative to remind us that the rise in market power Eeckhout describes so well is a consequence of the strategic decision-making of firms driven by the perceived need to maximize shareholder value.  That “need” is, of course, not a need at all.  It is a choice.  It is ideological.  It has deep roots in neoclassical economic thought.  But let me give Eeckhout credit.  He touches briefly on the issue when he talks about cost-cutting in his chapter on technological change.  One of the great technological innovations in management is the development of supply chains that stretch around the globe.  The objective is to cut costs.  They could not exist without the enablement of the digital information flows and the development of super-sized carriers to make transport cheap.  The words “supply-chain” and “logistics” were hardly used a few decades back.  Now they are talked about obsessively in management circles.  In this context, Eeckhout even hints at what he seems too think of a business school education:

“That is possibly the success of a business school education.  MBAs have learned finance, how to act strategically, and how to minimize expenses.  This cost-cutting cult achieves lower costs for the firm, higher profits for the shareholders, and lower prices for the customer … [but] Cost cutting that results in such market power is not entirely beneficial to the customer because the dominant firm does not pass the entire cost reduction to the customer, and keeps part of those savings in their own accounts as profit.”

Business school education is exactly about how to create excess profits.  It is about how to undermine all the standard economic arguments for a free market.  Firms seek power to undermine the market.  That us what Eeckhout points to as a major, if not the main, cause of our recent stagnation both in the economy at large and in wages in particular.  Reducing his entire thesis to one short sentence: business strategy [and therefore all MBA education] is an attempt to suppress the workforce in favor of shareholders.  It is about power.

And here we are.  It has taken a pandemic to create the space within which workers can challenge that power.  Given that our economy is now so riddled through with oligopoly it seems hard to see how workers can maintain this space for themselves.  As an aside: Eeckhout reminds us to use the word oligopsony rather than monopsony when we discuss the wage suppression big business espouses.

Perhaps all the inflation hawks out there haven’t been paying too much attention.  They appear to have missed the role of power in wage rate setting.  Instead they all seem hell-bent on providing intellectual cover for the continuation of wage stagnation.  After all we can’t have those pesky workers getting too much of a pay raise.  Even after decades of near flat wages a significant pay raise would rock the establishment boat too much.  Look at the inflation it all would cause!   We can’t have that.  Who ever heard of workers having power?

Oh, as an an addendum: let me say I was surprised to learn, via Larry Summers, that savings could be a cause of inflation.  I had no idea.  None.  I thought the detrimental effect of excess savings was through its reduction of demand.  Larry, though, added the existence of the “excess” savings created by all those government support payments as one of his potential causes of inflation.  Anyway, I assume he means that once those savings are no longer savings but turn up as demand they then become pernicious.  That would imply he thinks we would have demand in excess of supply.  Which, kind of, gets us back to market power and Eeckhout’s argument: one of the major effects of oligopolistic market power is in the under-supply of product.  It pays dominant firms to reduce supply in order to build excess profits.

As I said: power can flummox any economist.  Even someone as smart as Larry Summers.  Maybe he needs to go to business school to get an understanding of how the economy is actually run?  No!  That’s not our answer.  We need to re-think the MBA, not advocate it!