Saving Capitalism: Some Modest Proposals

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Includes: AAPL, AMZN, BAC, BAYZF, BP, C, CVX, DD, FB, GOOGL, GS, JPM, MS, MSFT, MYL, ORCL, OTCRX, RDY, T, TEVA, TLT, VZ, WHOSX, XOM
by: Kevin Wilson
Summary

American socialists have seized the moment because they think that “capitalism” isn't working; President Trump’s success on the right is due to the public's perception that the entire system's broken.

What we see in our economy is not what one might truthfully describe as “capitalism;” indeed, the competitive aspects of "capitalism" are in decline as major players dominate many industries.

Inadequate antitrust laws have not kept up with corporate innovation in the banking, pharmaceutical, and tech sectors; modern business models have somehow out-maneuvered "FTC" and Dept. of Justice antitrust efforts.

Reform legislation is required in order to update antitrust laws so they can deal with the monopolistic powers of big banks, tech firms, drug companies, and many others; also needed is better enforcement against M & A activities, and new legal actions that will challenge the unfair practices of online platforms.

Investors should avoid holding (in the long term) companies like AMZN, AAPL, GOOGL, FB, MSFT, JPM, C, BAC, GS, MS, MYL, TEVA, and RDY.  Smaller companies (IWM) might do relatively better at some point.  In the short run, defensive investors should hold OTCRX, WHOSX, and TLT.

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INTRODUCTION

In recent years there has been a populist rush to embrace socialism by those in the US who’re politically on the hard left. Although this populist theme has gained traction with some Democrats and certainly with the media, it does not appear to be favored by most Americans as the solution to the problems of so-called modern “capitalism,” at least so far. Indeed, although 25-37% of Americans (depending on the poll) appear to favor moving to a (more fully) socialist system, only about 6% of Democrats currently label themselves as “socialist” or “democratic socialist,” in spite of all the media hype on the subject (Karlyn Bowman, 2019). Some 58% of Americans have a negative view of “socialism.” This may explain why a septuagenarian old pol like Joe Biden has jumped to an impressive lead in the 2020 presidential polls in a 22-person Democratic field that is numerically dominated by “socialists” and hard line progressives (Rolling Stone Blog, 2019).

Whether former VP Joe Biden can defeat the younger and more passionate candidates to his left remains to be seen, but one thing is clear: the socialists have seized the moment because in the public mind, there is something not quite right about the current way “capitalism” is working (Kevin Wilson, 2017a; Kevin Wilson, 2018a). President Trump’s success as a populist on the right is at least in part due to this public perception that the system is broken, and this view is not limited to just the way government works, but also includes the belief that globalism and other aspects of the “capitalist” system have caused great harm to the Middle Class in recent decades (Kevin Wilson, 2019a). Trump’s recent hard line stance against Chinese unfair trade practices has met with strong public approval because of this very sentiment (Kevin Wilson, 2019b).

In detail though, it is not at all clear that what we see now in our economy is actually what one might truthfully describe as “capitalism.” Major corporations often successfully seek monopoly power, engage in price fixing, curtail competition, and otherwise engage in the defeat of the competitive aspects of “capitalism” (e.g., Christopher Rowland, 2018; Greg Ip, 2018). Generic drug companies like Mylan NV (MYL), Teva Pharmaceutical Industries (TEVA), Dr. Reddy’s Laboratories (RDY), and some 17 lesser-known firms are the subject of antitrust actions on the pricing of 300 drugs in 47 states (Emma Court, 2018).

There is also much public and scholarly legal debate in the US about whether tech giants like Facebook Inc. (FB), Alphabet Inc., (the parent company of Google [GOOGL]), and Amazon.com, Inc. (AMZN), etc., are monopolies or have otherwise violated antitrust laws. The European Union recently decided that antitrust action was required in the case of Alphabet’s Google platform (GOOGL), so they took them to court and recently won a $4.8 billion judgement against them (Sam Shechner, 2019). The US Federal Trade Commission is in the process of completing a settlement that would fine Facebook (FB) as much as $5.0 billion for breaches of consumer privacy. However, even a $5.0 billion fine is merely a wrist slap against giant firms like Facebook (FB) and Alphabet (GOOGL). Co-founder Chris Hughes believes Facebook (FB) should be broken up because of its monopoly power and the lack of accountability for its CEO, Mark Zuckerberg (Ben Popken, 2019).

Author and hedge fund manager John Mauldin has pointed out recently that what we have now is not real capitalism, but rather a system of “capitalism without competition” (John Mauldin, 2019). For example, five giant banks control about half of the nation’s banking assets. Many states have health insurance markets in which the top two insurers control 80% of the market share. Over 75% of US households only have one local provider of high-speed internet access. Two corporations now control 90% of the beer market in the US. Four companies control nearly the entire US beef industry, together with 66% of the pork and 50% of the chicken sold in the US. Four airlines now control 80% of routes and gates (Michael Collins, 2016). Google (GOOGL) now enjoys a nearly 90% share of internet searches. Facebook (FB) enjoys a nearly 80% share of social network business, and Microsoft (MSFT) absolutely dominates computer operating systems.

Amazon (AMZN) now dominates e-commerce and has crushed other retailers throughout the country. This has happened in part because Amazon has been willing to lose money on many low priced items, and in part because Amazon competes against other firms when they try to sell their goods using Amazon’s network services. The mobile applications market is nearly completely controlled by Apple, Inc. (AAPL) and Google (GOOGL). Three companies (i.e., Visa, Inc. [V]; MasterCard [MA]; and American Express Co. [AXP]) control about 95% of the credit card business. Four companies control 85% of US corn and 75% of US soy bean seed sales, with the largest shares going to Monsanto, a subsidiary of Bayer AG (OTCPK:BAYZF), and DowDuPont Inc. (DWDP). The Fortune 500 companies have grown their revenue share of GDP from 58% in 1980 to 73% now (William A. Galston & Clara Hendrickson, 2018). The share of the even bigger Fortune 100 firms has risen from 33% in 1980 to 46% now. A 2016 study of corporate concentration across 893 industries indicated increasing concentration since 1997 in many of them (Chart 1). How did we get to this point where a just a few companies dominate many of their respective industries, and indeed, only a few dozen dominate almost the entire economy?

Chart 1: Increasing Corporate Concentration Since 1997

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THE DECLINE OF ANTITRUST ENFORCEMENT

There are three major components of US antitrust law: 1) the Sherman Act of 1890; 2) the Clayton Act of 1914, as amended in 1936; and 3) the Federal Trade Commission (“FTC”) Act of 1914 (Chart 2). The Sherman Act applies to restraints of trade via price fixing or territorial allocation, and to various actions that promote monopolization of business sectors. The Clayton Act applies to restraints of trade via tying arrangements, exclusive dealing arrangements, anti-competitive mergers and acquisitions, and price discrimination. The FTC Act applies to deceptive practices and unfair methods of competition. Following passage of the Sherman Act, President Theodore Roosevelt became a prominent trust buster with 45 cases litigated by his administration. President William Howard Taft followed up with another 75 cases litigated under his administration (Wikipedia, 2019a). In recent decades however, antitrust actions have declined on an annual basis. For example, average yearly antitrust filings under the Obama Administration (second term) were not even half the number (Chart 3) filed during the second term of the Clinton Administration (Nitish Jain et al., 2017). In part that is due to changes in the way the antitrust laws are interpreted, and in part it is due to successful lobbying to keep Congress from updating the law (Brian Fung & Hamza Shaban, 2017).

Chart 2: Diagram of Anti-Trust Law Framework

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Chart 3: Antitrust Filings by Year

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Famous historical corporate breakups or other antitrust actions sought by the US government have included: 1) the breakup of John D. Rockefeller’s Standard Oil of New Jersey into 34 separate companies in 1911; 2) the breakup of American Tobacco, also in 1911; 3) the punishment of Socony-Vacuum (the future Mobil) and some of its officers for price fixing in 1940; 4) the breakup of AT&T Corp. (T) into eight separate companies in 1982; and 5) the breakup of Microsoft Corp. (MSFT) into two separate firms in 2000 (Wikipedia, 2019b; Wikipedia, 2019c). It should be noted however, that many of Standard Oil’s 34 daughter companies have recombined to form large companies again (over the years), including Exxon Mobil Corp. (XOM), Chevron Corp. (CVX), and BP Amoco PLC (BP). Four of the eight companies created by the breakup of AT&T have recombined (Wikipedia, 2019d) into the new AT&T (T), while two more recombined as part of Verizon Communications (VZ). Microsoft still completely dominates computer operating systems.

Mergers and acquisitions are two of the primary ways economic power has been consolidated by large corporations (William A. Galston & Clara Hendrickson, 2018; Op. cit.). For example, in the last ten years, Bayer AG (OTCPK:BAYZF) subsidiary Monsanto has acquired 30 companies, Oracle Corp. (ORCL) has acquired over 80 firms, Alphabet (GOOGL) has acquired over 120 firms, and the defense industry has consolidated from some 82 firms down to only five major players (i.e., Lockheed Martin Corp. [LMT]; Boeing Co. [BA]; General Dynamics Corp. [GD]; Northrup Grumman Corp. [NOC]; and Raytheon Company [RTN]). The number of antitrust enforcement actions has shrunk significantly since 2003 for firms with only moderate concentration, as measured by the Herfindahl-Hirschman Index (“HHI”), the standard measure used by the “FTC” (William A. Galston & Clara Hendrickson, 2018; Op. cit.). Enforcement actions have not declined for companies with more severe measured “HHI,” but this may have harmed efforts to control concentration at the margins. And even in some cases where industries have extremely high concentration levels (e.g., food and staples retail, internet software, and wireless communications), little antitrust action has followed.

Compounding the problem, the annual number of business startups has declined by about half since 1978 (Chart 4), and the creative destruction offered by competition is in serious decline as well. As a result, productivity growth has been in decline for many years, although there are other factors affecting productivity as well (Thomas Aubrey, 2017). There are political reasons for this state of affairs, but there are also legal issues with antitrust law as well. Politically, since apparently all federal level politicians can be bought at discount prices (cf. Kevin Wilson, 2017b), little antitrust action has occurred with respect to the largest corporations, which are also amongst the largest political contributors. Legally, a major issue has arisen in the enforcement of antitrust law, and it has impeded investigations and litigation for some years now (David Streitfeld, 2018).

Chart 4: Business Startups Have Declined Sharply

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In 1978 Judge Robert Bork published a book (cf. William A. Galston & Clara Hendrickson, 2018; Op. cit.) on antitrust law that promulgated the notion that, “The only legitimate goal of American antitrust law is the maximization of consumer welfare.” This sounds good in general, but the legal interpretation in cases brought before courts since 1978 has focused on price alone as the determining factor in the evaluation of consumer welfare. This has ultimately meant that other issues like low productivity, declining innovation, low product quality, exclusionary conduct, and exploitation of market power have been ignored or allowed to get out of hand in many cases. There was also a legal doctrine put forth by the Supreme Court called the “Rule of Reason,” which maintains that a trade practice violates the Sherman Act only if there is an unreasonable restraint of trade; the effect of this is that a firm cannot be found in violation merely because of its size alone (Herbert J. Hovenkamp, 2018).

In addition, since the dawn of the internet age about two decades ago, new approaches to data gathering and customer exploitation have allowed some business models (e.g. Amazon [AMZN]) to develop that are written as if the purpose from the start has been to avoid antitrust litigation via loopholes in the law, while accumulating awesome monopoly power (Lina M. Khan, 2017). Under the current interpretation of antitrust law, the “FTC” and antitrust prosecutors have not been able to litigate against obvious cases of abusive monopoly power or other antitrust violations in the tech sector, including giants like Alphabet (GOOGL), Amazon (AMZN), Facebook (FB), and the new Microsoft (MSFT). The current laws do not appear to deal with issues like the use and abuse of personal information (data), or the fact that consumers pay for services with data rather than dollars, or the use of platform power to hold down competition (Kate Patrick, 2018; Sally Hubbard, 2019).

It’s not just the tech sector that’s the problem, either. Just look at what happened after the Great Financial Crisis: instead of breaking up the big investment banks and insurance companies that caused so much harm (e.g. Bank of America [BAC], JPMorgan Chase [JPM], Citigroup [C], and AIG [AIG], etc.), we not only protected them, we helped them to pay massive bonuses during the crisis, and allowed them to grow substantially larger in the last few years than they were even before the crisis began (Kevin Wilson, 2018b). However, under current law it would be very difficult to break up the Too-Big-To-Fail banks, so new legislation may be needed (Mark Thoma, 2009).

TOWARDS A NEW SOLUTION

President Trump has said that he is considering antitrust action against several of the biggest tech sector giants (Brittany De Lea, 2018). There are legal hurdles, as already mentioned, but there may be ways to deal with the tech giants anyway. Lina M. Khan (2017; Op. cit.) has suggested that there are two approaches to the problem: 1) governing online platform markets through competition by restoring traditional antitrust policy; or 2) governing online platform markets through regulation. The first option may require changing the law to replace the consumer welfare (pricing) framework. We could then update safeguards against predatory pricing and create limits to anti-competitive behavior resulting from vertical integration of online platforms. Mergers and acquisitions by major platforms could then be subjected to antitrust scrutiny because of the mass data effects on competition. New “prophylactic” limits on internet platform structures could be put in place to eliminate conflicts of interest. This approach has long been used in banking law via the separation of banking and commerce. The second option for governing online markets is regulation, under which the tech giants would be presumed to be monopolies and would be regulated much like utilities. Conflicts of interest could be outlawed and rates could be set by the regulators, although that would be quite tricky, and may not be very practical. There will be popular support for doing something to increase competition, as long as the internet market is not destroyed in the process.

With regard to the banking sector, it may make sense, instead of relying on regulation regimes that have obviously failed, to simply force all investment banks to go back to the private partnership model that prevailed in the 1960s, when partners could lose everything if they messed up (William D. Cohan, 2017). Alternatively, modern corporate structures could be permitted, but only if bankers who mess up could be forced to forfeit their entire net worth, as Warren Buffett has suggested (Fred Imbert, 2019). Other industries could see breakups of major firms under revised and updated antitrust laws. It is clear that some or all of these measures need to be put in place in order for competition to return to American “capitalism.” Congress will have to act, which is no small order in today’s poisonous political climate. But there may be bipartisan support for reform, and the president would likely sign reform legislation because it would align with his goals and promises.

CONCLUSIONS (AND SOME MODEST PROPOSALS)

Concentration of many industries has reduced competition and is harming the economy and consumers over the long term. Antitrust laws are currently inadequate in meeting the challenges facing us, and must be amended or reformed in order to recover more healthy levels of competition. “Capitalism” can be saved if we do this, because the general public will reap immediate and long-lasting benefits, and will thus see some improvement in their lives. If these benefits are seen to be accruing to the average voter, the current surge towards populism will find a healthy outlet and we will avoid the terrible pitfall of “socialism.” Along the way we could potentially resurrect the formerly good reputation of “capitalism.” The two parties should propose bipartisan legislation to make the necessary changes in due course. The Dept. of Justice, the “FTC,” and the state attorneys general should take a more aggressive look at mergers and acquisitions in the near term, and over the medium term file antitrust actions that will test aspects of the law that are inadequate to the current dilemmas in the tech and banking sectors. This combined approach could result in significantly more competition over time.

It would not shock me to see antitrust reform legislation within a very few years, maybe much sooner than anyone thinks. I base this optimism on the notion that populism is on the rise and such a measure would likely be well-received by voters. For that reason, I would not hold Amazon (AMZN), Apple (AAPL), Alphabet (GOOGL), Facebook (FB), Microsoft (MSFT), JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC), Goldman Sachs (GS), Morgan Stanley (MS), Mylan (MYL), Teva (TEVA), Dr. Reddy’s (RDY), or other large, apparently monopolistic or anti-competitive firms over the long term. It might make sense to consider investing (at the appropriate time) in smaller firms which are unlikely to face antitrust actions and which tend to do be insulated from the effects of a strong dollar regime (e.g., iShares Russell 2000 ETF [IWM]). The market reaction to the ongoing trade war with China has been quite negative so far, and its probable reaction to news of corporate antitrust breakups or new regulations will likely also be negative once antitrust reforms take place. This suggests a defensive stance in the short term, and a wary stance in the medium term.

Also, for those discounting a possible near-term recession and bear market, some liquid alternatives like the Otter Creek Prof. Mngd. Long/Short Portfolio (OTCRX) could be held to protect assets in the event of a much sharper market draw-down associated with deteriorating economic data. Those in a more defensive frame of mind because of the expected eventual market slide should also hold some long Treasuries, in spite of bearish arguments to the contrary, as a stock market crash would be hugely supportive of bond prices: examples include the Wasatch-Hoisington Treasury Fund (WHOSX), and the I-Shares 20+ Yr. Treasury Bond ETF (TLT).

Disclosure: I am/we are long CVX, XOM, OTCRX, WHOSX, TLT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks or other securities mentioned or recommended. This post is illustrative and educational and is not a specific recommendation or an offer of products or services. Past performance is not an indicator of future performance.

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