It’s always good to be ahead of the power curve. I see that the eminent Paul Krugman had an editorial in the New York Times about the very issues that I’ve dealt with in this blog, his example in this case being Amazon. This is just one of many articles that have been raised about the monopsony power as a result of the Hatchette controversy. In The New Republic Franklin Foer also addresses this issue at length in the article “Amazon Must Be Stopped.” In my last post on this topic I discussed public monopsony, an area in which I have a great deal of expertise. But those of us in the information world that are not Microsoft, Oracle, Google, or one of the other giants also live in the world of private monopsony.
For those or you late to these musings (or skipped the last ones), this line of inquiry when my colleague Mark Phillips made the statement at a recent conference that, while economic prospects for the average citizen are bad, that the best system that can be devised is one based on free market competition, misquoting Churchill. The underlying premise of the statement, of course, is that this is the system that we currently inhabit, and that it is the most efficient way to distribute resources. There also is usually an ideological component involved regarding some variation of free market fundamentalism and the concept that the free market is somehow separate from and superior to the government issuing the currency under which the system operates.
My counter to the assertions found in that compound statement is to prove that the economic system that we inhabit is not a perfectly competitive one, that there are large swaths of the market that are dysfunctional and that have given rise to monopoly, oligopoly, and monopsony power. In addition, the ideological belief–which is very recent–that the roots of private economic activity is one that had arisen almost spontaneously with government being a separate component that can only be an imposition, is also false, given that nation-states and unions of nation states (as in the case of the European Union) are the issuers of sovereign currency, and so choose through their institutions the amount of freedom, regulation, and competition that their economies foster. Thus, the economic system that we inhabit is the result of political action and public policy.
The effects of the distortions of monopoly and oligopoly power in the so-called private sector is all around us. But when one peels back the onion we can see clearly the interrelationships between the private and public sectors.
For example, patent monopolies in the pharmaceutical industry allow for prices to be set, not based on the marginal value of the drug that would be set by a competitive market, but based on the impulse for profit maximization. A recent example in the press lately–and critiqued by economist Dean Baker–has concerned the hepatitis-C drug Sovaldi, which goes for $84,000 a treatment, compared to markets in which the drug has not been granted a patent monopoly, where the price is about $900 a treatment. Monopoly power, in the words of Baker, impose 10,000 percent tariff on those who must live under that system. This was one of the defects in a system that I wrote about in my blog posts regarding tournaments and games of failure, though in pharmaceuticals the comparison seems to be more in line with gambling and lotteries. The financial risks of investors, who often provide funds based on the slimmest thread of a good idea and talent, are willing to put great sums of money at risk in order to strike it rich and realize many times their initial investment. The distorting incentives on this system are well documented: companies tend to focus on those medications and drugs with the greatest potential financial rate of return guaranteed by the patent monopoly system*, drug trials that downplay the risks and side-effects of the medications, and the price of medications is placed at so high a level as to eliminate them from all but the richest members of society since few private drug insurance plans will authorize such treatments given the cost–at least not without a Herculean effort on the part of individual patients.
We can also see the monopoly power at work first hand with the present lawsuits between Apple and Samsung regarding the smartphone market. For many years (until very recently) the U.S. patent office took a permissive stand in allowing technology firms to essentially patent the look and feel of a technology, as well as features that could be developed and delivered by any number of means. The legal system, probably more technologically challenged than other areas of society, has been inconsistent in determining how to deal with these claims. The fact finder in many cases has been juries, who are not familiar with the nuances of the technology. One need not make a stretch to pick out practical analogies of these decisions. If applied to automobiles, for example, the many cases that have enforced these patent monopolies would have restricted windshield wipers to the first company that delivered the feature. Oil filters, fuel filters, fuel injection, etc. would all have been restricted to one maker.
The stakes are high not only for these two giant technology companies but also for consumers. They have already used their respective monopoly power established by their sovereign governments to pretty effectively ensure that the barriers to entry in the smartphone market are quite high. Now they are unleashing these same forces on one another. In the end, the manufacturing costs of the iPhone 6–which is produced by slave labor under the capitalist variant of Leninist China–are certainly much lower than the $500 and more that they demand (along with the anti-competitive practice of requiring a cellular agreement with one of their approved partners). The tariff that consumers pay for the actual cost of production and maintenance on smartphones is significant. This is not remedied by the oft-heard response to “simply not buy a smartphone,” since it shifts responsibility for the establishment of the public policy that allows this practice to flourish, to individuals who are comparatively powerless against the organized power of lobbyists who influenced public representatives to make these laws and institute the policy.
The fight over IP and patent (as well as net neutrality) are important for the future of technological innovation. Given the monopsony power of companies that also exert monopoly power in particular industries, manufacturers are at risk of being squeezed in cases where prices are artificially reduced through the asymmetrical relationship between large buyers and relatively small sellers. Central planning, regardless of whether it is exerted by a government or a large corporation, is dysfunctional. When those same corporations seek to not only exert monopoly and monopsony power, but also to control information and technology, they seek to control all aspects of an economic activity not unlike the trusts of the time of the Robber Barons. Amazon and Walmart are but two of the poster children of this situation.
The saving grace of late has been technological “disruption,” but this term has been misused to also apply to rent-seeking behavior. I am not referring only to the kind of public policy rent-seeking that Amazon achieves when it avoids paying local taxes that apply to its competitors, or that Walmart achieves when it shifts its substandard pay and abusive employee policies to local, state, and federal public assistance agencies. I am also referring to the latest controversies regarding AirBnB, Lyft, and Uber, which use loopholes in dealing with technology to sidestep health and safety laws in order to gain entry into a market.
Technological disruption, instead, is a specific phenomenon, based on the principle that the organic barriers to entry in a market are significantly reduced due to the introduction of technology. The issue over the control of and access to information and innovation is specifically targeted at this phenomenon. Large companies aggressively work to keep out new entries and to hinder innovations except those that they can control, conspiring against the public good.
The reason for why these battles are lining up resides in the modern phenomena known as disaccumulation of capital, which was first identified by social scientist Martin J. Sklar. What this means is that the accumulation of capital, which is the time it takes to reproduce the existing material conditions of civilization, began declining in the 1920s. As James Livingston points out in the same linked article in The Nation, “economic growth no longer required net additions either to the capital stock or the labor force….for the first time in history, human beings could increase the output of goods without increasing the essential inputs of capital and labor—they were released from the iron grip of economic necessity.”
For most of the history of civilization, the initial struggle of economics has been the ability for social organization to provide sufficient food, clothing, shelter, and medical care to people. The conflicts between competing systems has been centered on their ability to most efficiently achieve these purposes without sacrificing individual liberty, autonomy, and dignity. The technical solution for these goals has largely been achieved, but the efficient distribution of these essential elements of human existence has not been solved. With the introduction of more efficient methods of information processing as well as production (digital printing is just the start), we are at the point where the process of less capital in the aggregate being required to produce the necessities and other artifacts of civilization is accelerating exponentially.
Concepts like full employment will increasingly become meaningless, because the same relationship of labor input to production that we came to expect in the recent past has changed within our own lifetimes. Very small companies, particularly in technology, can have and have had a large impact. In more than one market, even technology companies are re-learning the lesson of the “mythical man-month.” Thus, the challenge in our time is to rethink the choices we have made and are making in terms of incentives and distribution that maximizes human flourishing. But I will leave that larger question to another blog post.
For the purposes of this post focused on technology and project management, these developments call for a new microeconomics. The seminal paper that identified this need early on was by Brad DeLong and Michael Froomkin in 1997 entitled “The Next Economy.” While some of the real life examples they give from our perspective today provides a stroll down the digital memory-lane, their main conclusions are relevant in how information differs from physical goods. These are:
a. Information is non-rivalrous. That is, one person consuming information does not preclude someone else from consuming that information. That is, information that is produced can be economically reproduced to operate in other environments at little to no marginal cost. What they are talking about here is application software and the labor involved in producing a version of it.
b. Information without exterior barriers is non-exclusive. That is, if information is known it is almost impossible for others to know it. For example, Einstein was the first to observe the mathematics of relativity but now every undergraduate physics student is expected to fully understand the theory.
c. Information is not transparent. That is, oftentimes in order to determine whether a piece of software will achieve its intended purpose, effort and resources must be invested to learn it and, oftentimes, apply it if initially only in a pilot program.
The attack coming from monopsony power is directed at the first characteristic of information. The attack coming from monopoly power is currently directed at the second. Doing so undermines both competition and innovation. The first by denying the ability of small technology companies to capitalize sufficiently to develop the infrastructure necessary to become sustainable. Oftentimes this reduces a market to one dominant supplier. The second by restricting the application of new technologies and lessons learned based on the past. The nature of information asymmetry is a problem for the third aspect of information, since oftentimes bad actors are economically rewarded at the expense of high quality performers as first identified in the automobile industry in George Akerlof’s paper “The Market for Lemons” (paywall).
The strategy of some entrepreneurs in small companies in reaction to these pressures has been to either sell out and be absorbed by the giants, or to sell out to private equity firms that “add value” by combining companies in lieu of organic growth, loading them down with debt from non-sustainable structuring, and selling off the new entity or its parts. The track record for the sustainability of the applications involved in these transactions (and the satisfaction of customers) is a poor one.
One of the few places where competition still survives is among small to medium sized technology companies. In order for these companies (and the project managers in them) to survive independently requires not only an understanding of the principles elucidated by DeLong and Froomkin. Information also shares several tendencies with other technological innovation, but in ways that are unique to it, in improving efficiency and productivity; and in reducing the input of labor and capital.
The key is in understanding how to articulate value, how to identify opportunities for disruption, and to understand the nature of the markets in which one operates. One’s behavior will be different if the market is diverse and vibrant, with many prospective buyers and diverse needs, as opposed to one dominated by one or a few buyers. In the end it comes down to understanding the pain of the customer and having the agility and flexibility to solve that pain in areas where larger companies are weak or complacent.
*Where is that Ebola vaccine–which mainly would have benefited the citizens of poor African countries and our own members of the health services and armed forces–that would have averted public panic today?