National Champs or National Chumps: US Big Business vs China
How important are 'economies of scale' in production and innovation?
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Today I’m going to invite you into a debate within Congress in which I was a part.
First, some house-keeping.
I wrote a piece for American Affairs on exploding conflict within corporate America over concentrations of power.
I also did a book talk with the former Chairman of the Federal Communications Commission, Reed Hundt, on the rise of populist politics. In this one I went over the massive rebellion called the Bonus Army, which was the Occupy Wall Street of the Great Depression.
Please keep sending me info on what you’re seeing in terms of supply chain disruptions. I think that is one of the biggest stories in the world right now.
Finally, Substack has implemented a comment feature, so if you want to talk about this issue with other readers, just click on the headline and there’s a comment box at the bottom of the page.
National Champions or National Chumps?
There’s a debate these days in the national security world over how to address the rising power of Chinese industrial might. Many of our domestic monopolies - particularly Google, Facebook, Amazon, and Microsoft - argue that we have to protect our big business scale to face off against Chinese scale, particularly in high technology markets. In Europe, you see this same notion, the idea that Europe must have a European Mark Zuckerberg to face off against Mark Zuckerberg and Chinese big tech. Doing so is called the ‘national champion’ argument, which is to say, we should promote and protect our biggest to match up with their biggest.
This question is given added importance because of the supply chain disruptions we’re beginning to see across the economy due to the coronavirus. I was invited to debate this problem in Congress by Senator Marco Rubio’s staff. Rob Atkinson of the Information Technology and Innovation Foundation, who wrote a book called Big is Beautiful, took the other side.
That’s me, in the center of the photo. Here’s what I had to say.
What Is Our Goal Versus China?
Thanks for inviting me.
China’s goal is to concentrate power, both within China and over the American and European industrial commons. In responding, the question we have to wrestle with is not just how to beat China, but what is our goal? What is competitiveness? And what is our actual problem?
The actual problem is twofold. Roughly forty years ago, we stopped seeing the relationship between democracy and private economic power domestically, which enabled the roll-up of power into domestic monopolies. And then in the Clinton, Bush, and Obama administrations, we stopped seeing the relationship between security and economic power globally. All of this goes under the philosophy of neoliberalism, and it manifested itself through trade, antitrust, and regulatory policy.
In 1998, Bill Clinton allowed Exxon to buy Mobil, helping to recreate a good chunk of the Standard Oil empire. In 2006, someone asked Exxon Lee Raymond why he wouldn’t build more refining plants in the U.S. for security purposes. He said, “I’m not a U.S. company and I don’t make decisions based on what’s good for the U.S.”
In other words, today we have an open and largely ungoverned American political economy dominated by financiers and monopolists with no loyalty to United States interests. And now we are encountering aggressive authoritarian state capitalists who will not hesitate in exploiting our own corporate giants. Disney, for instance, not only makes most of our billion-dollar movies but does so according to the whims of Chinese censors.
Let’s start with domestic concentration. Over the last two decades, 75% of U.S. industries have experienced an increase in concentration levels. You can see it in everything from syringes to cheerleading to missiles and munitions. Such concentration results in a host of problems, like low productivity growth, less firm formation, and regional inequality. Hidden risk is a classic feature of monopoly, because a monopoly means putting all your eggs in one basket.
The increase in concentration is obvious if you pay any attention to business, but there is a sort of ‘believe me not your lying eyes’ quality to the debate. There are an endless army of economists who explain how concentration doesn’t exist or isn’t a problem, but these arguments are often parlor tricks of only measuring the benefits of scale.
For instance, in Rob’s book Big is Beautiful, one of the key examples of the importance of scale is Boeing. Boeing is a roll-up of aerospace companies, and it first crossed $100 billion in revenue in 2018 as America’s leading exporter, as Rob was writing his book. Like large banks on Wall Street, Boeing’s size and market power, which mistook for innovation and health, was masking an underlying deterioration of the corporation’s ability to make airplanes. Much of the strength of monopoly is often a mirage, based on refusing to look at hidden risk.
Hidden risk is now everywhere. According to the Pentagon, we now have sole sources of domestic supply for large numbers of military inputs, from flares to high voltage cable, fittings for ships, valves, key inputs for satellites and missiles, and even material for tents. Drug shortages tripled between 2005 and 2010 and continue to grow. More than 100 drugs were in shortage as of January 2020.
And this hidden risk has enabled China to acquire power. Now all the CCP has to do is gain control over a sole source producer. China makes a host of key inputs for DoD missiles, satellites, and other defense manufacturing programs. Our ability to fight a war with China in some ways hinges on whether Chinese companies are willing to keep selling us ammunition. The same is true in medicine. Our hospitals are critically under-sourced for things like respirators and masks, as well as chemical inputs for drugs, most of which are made in China.
We have also learned helplessness among our policymaking elite.
Here’s Assistant Air Force Secretary for Acquisition, Technology and Logistics Will Roper’s plan for dealing with the F-35 disaster, and a lack of competition in military aerospace. “I don’t think we’ll have a new prime come in, but maybe a company that’s founded by a bored billionaire that wants to build cool airplanes just because.”
In other words, not only do our top military officials have no control over what China does, but they have little ability to source domestically. I can assure you, that is not how we won World War Two.
One solution to this situation is to have us mimic China’s authoritarianism. Atkinson, for instance, wants concentrated corporate power, but he wants the hand of the state to fuse with it. You don’t have to take my word for it. His book is full of effusive praise of Marxists, as when he noted “Surprisingly, it’s the neo-Marxist scholars who present a more accurate picture of competition.”
One of his icons is socialist John Kenneth Galbraith, and Galbraith was a fan of what was called the convergence school of thinking in the 1960s, a view that in terms of political economy, there really were no differences between the Soviet Union and the United States. American business and Soviet enterprises were, in his view, the same.
The Chinese present a challenge of state capitalism that is fascist in nature, a fusion of the state and the corporate state. We can mimic them, but at great risk. As Woodrow Wilson put it, “Once the government regulates the monopoly, then monopoly will see to it that it regulates the government.”
Antitrust and Innovation
There is a better alternative. We can meet state capitalism with liberal democracy. That means that government will have a strong role in the market, but by focusing on protecting us from concentrations of power abroad and domestically. This is in fact the strategy the U.S. used to become the world’s technological leader in the first place.
From the late 1930s until the 1970s, the U.S. did two basic things to encourage innovation. First, we decentralized innovation through an aggressive antitrust and procurement regime. In the late 1930s, Antitrust Division head Thurman Arnold systemically restructure American industry with 1,375 complaints in 40 different industries. During World War II, for most of the major war industries, including airframes, ships, tanks, trucks, ordinance, and electronics, there were at least a dozen major prime contractors. We fought Nazis abroad, and robber barons at home.
There were break-ups, merger prohibitions, and policymakers focused on dispersing know-how. I got a list of antitrust cases in 1952, and here are some of the industries where the DOJ antitrust division forced an end to anti-competitive uses of patents:
Electric lamps, glass bulbs, tubing, argon gas, machinery, electrical equipment, fluorescent lamps, soap and synthetic detergents, variable condensers (the tubing devices used on radios to select broadcasting stations), chlorinating equipment, braking systems, electrical equipment, powder, and paste for the detection of defects in metal parts, wrinkle finishes for paint, enamel, and varnish, latex, prismatic glassware and illuminating appliances, peach pitting machinery, fluorescent materials, metal abrasives industry, machine tools, dental impression powder, telescope grocery carts, sheet chargers used to feed sheets of metal materials to rolling mills, etc.
Second, we spent a lot of government money on R&D. During World War II, the government basically paid to replace all our machine tools. In the first half of the 1960s, as Silicon Valley historian Margaret O’Mara points out, research and development made up more than 10% of the Federal budget, largely because of space programs. The U.S. government was the biggest and most important venture capitalist, and the biggest and most important customer of technology.
One consequence was Silicon Valley.
For instance, AT&T’s Bell Labs invented the transistor, but it had problems manufacturing them because its leaders focused on maintaining its regulated monopoly. An antitrust suit forced AT&T to share its patents. Fairchild semiconductor, a small company that birthed Silicon Valley, took the market lead. By 1963, the price of silicon chips fell from $1,000 to $25, entirely because of demand created by the Apollo and Minuteman programs. Other industries could now afford them. And in fields with compulsory licensed patents the number of follow-on patents exploded in subsequent years, mostly from small companies. There was also direct spending; the government, for instance, created the first micro-processor.
During the Clinton administration, we threw all of this away as libertarians finally conquered our institutions. They made arguments how big was good, about how markets are natural institutions, and about Schumpeterian creative destruction, arguments we hear today. And they won.
As Lucas Kunce and I detailed in the American Conservative, Clinton encouraged a roll-up of prime contractors, and dozens of primes combined into the few we have today. Lockheed became Lockheed Martin, buying up 17 other defense divisions. Subcontractor mergers quadrupled from 1990 to 1998, driven by private equity.
This radical consolidation mirrored the shift that was happening in the commercial world. Corporate raiders had been layering corporations with debt since the 1980s. In the 1990s and 2000s, the “LBO” boys, as one manufacturer told me, went around industrial states and shipped off factories to China. Tens of thousands of them from 2000-2014.
And that’s the story. Now how did we get so confused about what was happening?
Economies of Scale
Well one way to tell the story is that we got confused about economies of scale. There is technical scale, which means massing men and capital in a way that produces more operational efficiency or innovation. There is legal scale. And too often we hear ‘economies of scale’ and confuse the two. Having a big factory can be operationally efficient. But holding company which owns a bunch of such factories and exploits market power can be slothful.
Take General Motors. In the early 1990s, its average plant produced 206,000 vehicles a year. Honda was about a third GM’s overall size, but its average Japanese plant time made 650,000 vehicles a year. GM was the least efficient producer, with its plants about 40% less productive than Honda’s. GM made arguments about scale, premised on the idea that policymakers wouldn’t see the difference between legal and technical scale.
In the 1980s, during his tenure on GM's board of directors, Ross Perot talked about the problem of size and management: "At GM, if you see a snake, the first thing you do is to hire a consultant on snakes. Then you get a committee on snakes, and then you discuss it for a couple of years. The most likely course of action is-nothing. You figure, the snake hasn't bitten anybody yet, so you just let him crawl around on the factory floor."
Technical economies of scale are not necessarily related to the corporate structure for example, the TCP/IP protocol scaled by a factor of 10 million since it was created in the early 1970s by the government. Corporations preferred walled gardens (DECNet, WangNET, HPNet, Xerox OIS, etc) but highest scale network - the internet itself - happened outside of the legal form of the corporation.
It’s not just operational scale. Bigness often cuts against innovation, or the question of whether Hamlet could be written by committee. Capital and skilled people combined often do interesting things. The question is whether pairing capital, skilled people, and manufacturing capacity into one giant corporate legal arrangement with market power is optimal. That’s unclear.
When the first investor in Alexander Graham Bell’s new venture tried to sell the telephone to telegraph giant Western Union, the head of Western Union replied, ‘What use could this company make of an electrical toy?” It was only when Bell’s company began taking market share from Western Union’s other products that the giant entered the telephone market. A certain type of political economy based on competition in communications network services in the 1870s “birthed four “blockbuster” innovations—namely, the quadruplex (or broadband) telegraph, the telephone, the phonograph, and the electric power system.” Such innovation did not happen in Europe, which had more monopolistic network systems.
From the other side, Alfred Sloan, the head of General Motors, told his sales committee in 1925. “You have no idea how many things come up for consideration that are discussed and agreed upon, but too frequently we fail to put the ideas into effect until competition forces us. Sometimes I am almost forced to the conclusion that General Motors is so large and its inertia so great that it is impossible for us to be leaders.”
A consultant told me about a '90s with someone at Microsoft. “I parroted the line that Microsoft was using its monopoly to stifle innovation in the market, which it was, of course. My conversation partner observed that the stifling of innovation within Microsoft to protect cash cows was even greater.”
This is a common story; Xerox didn’t commercialize its graphical user interface innovations, Apple did. IBM and Microsoft, like General Motors, followed innovators in the computer industry rather than being leaders.
Finally, in over-emphasizing legal scale, we didn’t just sacrifice innovation and operational efficiency. We increasingly allowed private power to decide key social questions. Mark Zuckerberg may innovate in ways that enable censorship or concentrate wealth or speech patterns. Chinese censors control what our corporations say.
The American political project, up until the 1970s, was based on attempting to decentralize both public and private power. The reason America developed technological prowess in the first place is because of this. Innovation is, at its heart, the liberty to tinker, an educated populace free from domination by either private or public masters.
Today, we are waking up to terrible problems. The only way to address them is how our forebears did. And they did not run into arms of Marxist scholars or mimic Chinese autocrats. Instead, they fought for their republic. That is how we defeat China. More importantly, it is how we keep ourselves free.
Thanks for reading. And if you liked this essay, you can sign up here for more issues of BIG, a newsletter on how to restore fair commerce, innovation and democracy. If you want to really understand the secret history of monopoly power, read my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.
P.S. I started collecting a list of products that are likely to be impacted by the China supply chain problem. Send me more. Here are a few.
Pet food. Garden hoses. Antibiotics. Printed circuit boards. Flat panel TVs. Electric motors. Roku streaming devices. Pump/valve parts for oil/mining machines. Air conditioning parts. Certain snow removal tools. Germanium for semiconductor wafers. Ball caps, sports bags, backpacks, baseballs, softball, hockey sticks, lacrosse gloves, batting gloves, golf bags. Certain semiconductor machine tools. Bicycle helmets and safety equipment. Tires.