Saving Capitalism

Neoclassical economics has served us well for nearly two hundred years, a long time for any ideology. The most important assumptions in anything are those which are unstated, and an unstated assumption in neoclassical economics was that technology was static. However, technology is not static, and we are living in a era of ever increasing change driven by technology.

In traditional neoclassical economics, there are two factors, capital and labor, which are combined according to some fixed production function into output. Both capital and labor are treated as a single factor available in any quantity if you are willing to pay enough. The holy grail is market equilibrium where the prices clear: that is at that set of prices firms produce what consumers will buy. It all wraps up with a pretty ribbon, and the real world is a special case.

Unfortunately, the real world is the world in which we live, and these assumptions look increasingly silly. In the long run, capital may all be fungible, but in real life the things which capital controls may be in very scarce supply. Yes, I can build a new factory if I have the time, but I cannot have it tomorrow.

Labor is composed of a large number of skills and abilities, and no amount of education and experience can compensate for some of them. Where it can, it takes time and money. These groups can be very small relative to the size of the world. For example, probably under 1,000 people really understand the technology behind blockchain.

In neoclassical economics labor receives wages, and capital interest and dividends. However, in the world today startups allow highly-skilled labor to receive huge amounts of compensation through equity, so much of what we count as a return on capital is really a return on skills and abilities of a few. The neoclassical lens increasingly blinds us to reality.

Neoclassical economics does recognize that it can fall down when there are increasing returns to scale. That is, if costs fall as you get bigger and fall faster the bigger you get, then much of neoclassical economics no longer applies. IRL increasing returns are ubiquitous because of technology. Witness

Witness the U.S. equity markets: investors are smart. If you can invest in a firm with increasing returns, you invest, and all of the technology darlings have increasing returns. Increasing returns is a recipe for inequality. A recipe for haves and have nots.

Neoclassical economics has a superpower: competition. Indeed, competition is a wonderful thing, and competition among the technology giants continues to generate a flow of goods and services at attractive prices but stagnation or even decline in much of the rest of the economy.

Monopoly has been well studied for decades in neoclassical economics. We have a general public agreement that monopolies are bad, dating back to the days of Standard Oil. The Sherman Act dates back over one hundred years. However, monopolies are traditionally thought of in terms of outputs: being the sole supplier.

Output monopolies may be passé. Modern technology makes them harder and harder to sustain. The monopolies today that matter are not outputs but talent, and talent monopolies are difficult for the public and policy makers to comprehend or understand. They are very real.

Together, Amazon, Google, Facebook, Apple, Netflix and a few others employ most of the most-highly-skilled software talent in the world. They live in a virtuous circle: bright developers like to work with other bright developers, and these companies can pay the most while offering the most exciting work. Everybody else gets second tier players or worse.

Compensating people through equity enables this. The shareholders of Apple voted to let the Board give out up to 10% of the company in stock compensation: $100 billion. Market capitalization has become the ultimate barrier to entry.

It has been this way in this industry for a long time. Forty years ago we had concern over IBM and eventually that translated into antitrust suits. Twenty years ago it was Microsoft, and again we had a flurry of antitrust action. In both cases, new computing models created room for competitors as well, and the new models were attractive to top talent for the challenges they posed. In full disclosure, I was a consultant to the Department of Justice on IBM and three companies where I was a senior official sued Microsoft (and won or settled).

Is it time to take antitrust action against the FAANGs? Doing so will require breaking new ground, because the traditional metrics do not strictly apply. Monopolizing talent (and also data, but that is for another day) would be impossible to prove and difficult to argue no matter how real it is.

An alternative is to target market capitalization. More firms are better for society than fewer firms. More increases robustness and spurs innovation. This tax would be relatively simple and would apply only to firms with an enterprise value over $100 billion, indexed for inflation. Any firm doing business in the United States would owe a tax on enterprise value multiplied by the share of revenues from the United States.

What should this tax be? A strawman would be 1% on enterprise value over $100 billion, 2% on over $200 billion and so forth to 10% on enterprise value over a trillion. The intent is simple: force companies to divide into multiple thriving businesses as they grow and prosper. The intent is not to create a huge government revenue stream. Let capitalism solve its own problems.

I would pair this with an excise ’tax on personal income of 10% on all income over $5 million, 10% more on amounts over $50 million and 10% more on amounts over $500 million. Talent has become the equivalent of land to Ricardo, and incomes at this level are rents not wages. There are 10s of individuals filing W-2 tax forms for earned income over $1 billion (these are confidential, of course, but I assume they are mainly hedge fund managers). This is earned income not capital gains, interest or dividends.

These are not socialism. They are a tribute to capitalism. Unless we address the inequality inherent in today’s world, we will lose capitalism. We should save it.