Monday, August 10, 2015

Best tool against inequality: antitrust enforcement? (of two kinds?)

[Update, 10/28: An updated version of Einer Elhauge's article is available here.]

The Wall Street Journal reports today that activist shareholders, who force management and operational changes in public companies to boost "shareholder value," are increasingly enlisting large mutual fund companies as allies and thus winning more battles. Their aims generally: "share buybacks, cost-cutting and asset sales."

That boost to shareholder activism, taking place over the last decade, recalls a theory of what's driving growing economic inequality recently advanced by Harvard law professor Einer Elhauge. According to Elhauge, increased consolidation of public company ownership by institutional investors like BlackRock, Vanguard, Fidelity, and State Street leads to a phenomenon called "horizontal shareholding," in which these mega-investors own major stakes in all the major players in a given industry and thus provide incentives to those companies to collude rather than compete -- or more exactly, to act in ways that boost share prices across the industry rather than relative to their competitors.

Elhauge's analysis is prompted by the fact that "the increasing share of stock held by institutional investors...has grown from 34% of all stock in 1980 to 67% of all stock in 2010." He links that rise to the often-cited drop in the percentage of corporate revenue going to wages and capital investment:

Recently corporate profits have risen to record levels, nearly $2 trillion dollars per year, four times the corporate profits in the late 1990s and higher as a percentage of GDP than any time in the last sixty years. But despite that spending, U.S. corporate investments in expansion and capital projects have fallen; indeed, as a percentage of GDP, corporate investments were nearly 50% higher in the late 1990s than now. Instead of spending to expand output, corporations have retained between $3.5 trillion and $5 trillion dollars in cash and spent other profits on stock buybacks, dividend payments, and high executive compensation.
Noting that while the massive fiscal and monetary stimulus of the post-financial crisis years  "has produced high corporate profits, it has not produced the expected level of business expansion that would seriously increase employment levels and wages," Elhauge proposes:
Perhaps the explanation is that we now have pervasive horizontal shareholdings because more and more stock is in the hands of institutional investors but we have, so far, had virtually no antitrust enforcement against it because the anticompetitive problem was until recently unappreciated. With such horizontal shareholdings, firms acting in the interests of their shareholders have incentives to constrain output rather than expand. The high profits they reap are not a signal to competitively expand individual firm output. The high profits are, rather, a symptom of the fact that they have successfully constrained overall market output. This could help explain why high corporate profits have not led to expansion and higher economic growth and employment levels. 
While he acknowledges that horizontal shareholding may not be the primary driver, his secondary candidate is the industry consolidation that shareholder consolidation arguably supports:
To the extent the recent rise in economic inequality does reflect a rise in anticompetitive practices, the recent increase in horizontal shareholdings may not be the sole or main cause of that rise. As the graph above shows, economic inequality starts to rise around 1980. This coincides with the post-1980 increase in horizontal shareholdings caused by the growth of institutional investor stockholdings, which in turn is related to ERISA and tax rule changes that spawned 401(k)s in 1980 and greatly expanded IRAs in 1981. But the rise of economic inequality also coincides with President Reagan’s 1980 appointment of Bill Baxter to head the Antitrust Division, which ushered in the modern era of more conservative antitrust enforcement influenced by Chicago School critiques of prior activist antitrust enforcement. Although those critiques have never been fully accepted, they have been persuasive enough with agencies and courts to continue to narrow antitrust enforcement in subsequent administrations, including Democratic ones. To the extent one thinks that at least some of that narrowing has incorrectly allowed more anticompetitive mergers and conduct, the variations in economic inequality may reflect variations in general antitrust enforcement.
Elhauge does not argue that mega-investor alliance with shareholder activists per se -- the phenomenon fingered in today's Journal -- drives anticompetitive behavior. In fact, it's often shareholder passivity, for example in acceding to corporate pay that rewards industrywide stock price appreciation, that works against competition. But the frequent agenda of shareholder activists -- buybacks and cost-cutting -- also works against capital investment. If mega-investors are more inclined to join such campaigns, that change in behavior, it seems to me, supports Elhauge's thesis.

Elhauge argues more broadly that corporate consolidation is a major driver of inequality and that FDR's turn to vigorous antitrust enforcement in 1938 was the main factor in pulling the U.S. out of the depression. In brief, strong growth began in 1938 even as defense spending dropped in the years prior to entry in WWII and prices dropped as a result of swift multi-industry antitrust action.

Vigorous antitrust enforcement was a volte-face for Roosevelt, kicked off
in March 1938, when President Roosevelt appointed Yale Law Professor Thurman Arnold to head the Antitrust Division. Arnold explicitly rejected the notion that antitrust enforcement should be relaxed during an economic downturn. He vastly increased antitrust enforcement, expanding the antitrust division to 583 lawyers by 1942. In his five years in office, he brought 44% of all the antitrust cases that had been brought in the first 53 years of the antitrust laws.

Arnold also made antitrust enforcement far more systematic and focused. Prior enforcement (even before the New Deal) had been not only isolated but also mercurial in a way that often seemed to challenge big businesses just for being big. The combination meant little deterrence of anticompetitive conduct not only because enforcement was unlikely, but also because it was unclear just what firms were supposed to do to avoid enforcement. Arnold brought intellectual clarity to the task, making clear that (unlike his predecessors) he had no problem with businesses being big as long as their conduct was efficient and lowered consumer prices. This gave firms a far clearer and more desirable signal about how to modify their behavior. Further, Arnold deliberately used antitrust enforcement as a form of economic policy, targeting industries that he thought were inefficient in a way that hampering economic growth and using multiple simultaneous lawsuits in each selected industry to thoroughly restore free competition at each stage of the industrial process. His strategy was to "hit hard, hit everyone and hit them all at once.” He multiplied the effect of his expansion of prosecutorial resources by using prosecutions to obtain extensive consent decrees designed to go beyond the alleged antitrust violations to make markets as competitive as possible, as quickly as possible, in as many industries as possible.

Arnold himself stated that his goal was to lower prices that were elevated by anticompetitive conduct so that consumers could buy more, which would cause firms to increase production and thus employment, which in turn would increase consumer purchasing power, further increasing production and employment. His antitrust enforcement successfully lowered prices in the targeted industries. This antitrust enforcement can thus explain, unlike fiscal and monetary policy, why prices declined during the economic expansion of 1938-41. It also provides the missing factor that explains the remarkable strength of that recovery.
Elhauge correlates the period of vigorous antitrust enforcement with the period of reduced income inequality identified by Piketty, roughly 1940 to 1980. The reverse swing of the pendulum since then corresponds with shareholder consolidation as well as reduced antitrust enforcement.

In the final section of his paper, Elhauge argues that federal agencies have the authority to take action against horizontal consolidation under the  Clayton Act § 7, which bans any stock acquisition "where in any line of commerce or in any section of the country, the effect of such acquisition may be substantially to lessen competition.” The first part of his paper presents economic evidence of such effects, using the airline industry for the primary demonstration. Secondarily, he suggests that action against such consolidation could be taken under the Sherman Act § 1, which enables action against "an agreement whose anticompetitive effects would constitute an unreasonable restraint of trade."

To the extent that Elhauge's economic argument is convincing, it has obvious implications for progressive policymakers, e.g., Hillary Clinton's massive economic team. Vigorous antitrust enforcement, whether directed at companies or shareholders, does not require legislation.  If Elhauge is right, it might do more to reduce inequality and boost consumption-driven growth and wage growth than any legislation.

Oh, and the current administration might take a wee look at the consolidation wave hitting health insurers, not to say healthcare providers.

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