Jonathan welcome back to real vision. Thank you so much
I think we last had you on I think it was March April of 2018 when you'd been
Working on you quite a long way through the sort of basic framework of your book
I mean for capitalism that got published I think at the beginning of December and
So we're going to have a discussion and a chat about
Where you think?
Kaplan maybe has gone wrong
but first
I just like to sort of go into
Kind of a thing that's in the front of your book where you say that first of all
Capitalism is the greatest economic system in history. You are a great believer in capitalism
So before we go into where it's gone wrong
Can you maybe just outline how it works or how it should work what capitalism should really be certainly. So one of the
Quotes that I use in the book comes from GK Chesterton, and he said the problem with capitalism is not too many capitalists
But too few and I think the the real problem that we see right now is essentially that we don't have enough capitalism
Meaning there's not enough competition
people have said that capitalism itself is a false of Piketty for example says that
capitalism has within itself an internal contradiction and
when growth is low returns on capital or high and this creates inequality and potentially revolutions if you look at
Capitalism it's by far the best system that we've seen in terms of generating
Wealth and progress and when we have seen open competitive markets
What we've seen is a lot of innovation and the argument that I make in the book is the title myth of capitalism itself
Comes from the idea that this current system that we're seeing is is indeed capitalist
I argue that in many industries there actually is very little competition so you could say that
capitalism has two central elements one is
private property so Marxists
define themselves in opposition to private property so they wanted all property to be owned by the state and that battle broadly was won in
1989 with the fall of the Berlin Wall even China which is supposedly communist, you know
In fact does have large elements of private property and that's one reason why it's been a success
and then if you look at the other element of capitalism is competition and the reason that competition is important is that
You need to have clear price signals that would be able to
induce changes in supply and demand and
that that side in many industries I argue has been deteriorating if not disappearing and
After I finished writing the book
fortunately, it hadn't yet gone to press and I was able to
Get it to my editor
But I found this wonderful quote by a Polish economist and make I collec II and he did some great work on
Essentially national accounts and he was writing about the same time as Keynes. So even though he was a neo-marxist
He was a great mind, but he said while perfect competition he said is maybe useful as a starting point
you know, in fact the capitalist system tends towards monopolies and
competition itself is a myth and I thought this is a great quote to put in there and it's essentially the
Loss of competition that creates the problem in capitalism, so it's not capitalism itself
It's what Stiglitz calls ersatz capitalism it sort of looks like capitalism but isn't isn't quite so I mean what went wrong?
What has it gone wrong with capitalism? Sure. So one of the big
Problems that you see in the United States and many industries. Is that over the last 40 years?
It really started in 1982 with the change of the merger guidelines under the Reagan administration
Companies were allowed to buy each other
and so you ended up with a system that was fairly open and competitive and if you think of the World Cup or you think
Of the sweet 16 in the US you start out with 16 players. Then you go into 8
And then for so many industries now basically have fewer and fewer players. So the and fewer that matter
so for example the beer industry the United States now dominated by two companies if you look at
Airlines for example we've gone down to four, but actually if you look at the what are known as the fortress hubs
There's almost no competition. So
American will have Charlotte United will have Houston and
Delta has Atlanta and so they basically been carving up the US and if you're looking at you know
cable and high-speed Internet
75% of Americans don't have any choice at all. It's oh, it's a local monopoly and then the US healthcare system
Basically, if you're looking at over 20 states, you essentially have a duopoly, you know
There's only real to really two companies that you can buy from and so in many of these
Big decisions about spending. The average American actually has no real competition that they can then choose from and you mentioned their
Competition in the sports analogy and I mean isn't competition
Always going to have a victor and surely if you have competition shouldn't the victor can reap the spoils
And so where does that contradiction in terms of we want competition, but you don't want perfect competition
We want something slightly less. How is that going to sort of build into into this? So the
Question is a very important one
I think it ties into one of the reasons why there's quite a lot of dissatisfaction and
Why a broken economy essentially creates broken politics. So if you have a company and you're doing very very well
I'm going to be attracted to the earnings that you have and I'm going to want to go in and compete with you
and so in theory, you shouldn't necessarily have one victor, you know, most industries don't have
Extraordinarily high barriers to entry you know, most of them are not natural monopolies yet. What we're seeing essentially is monopolies and oligopolies
Even in industries that should have competitors
and the reason is that often you end up with what I call sort of crony capitalism and essentially regulation and legislation that supports
Unnatural monopolies or unnatural oligopolies, you know and agriculture in the u.s
Is a classic one where you know?
There's no reason why for example three companies should control 80% of the potato chip and potato markets
right
The main reason that that's done is one to be able to have market power over the farmers
to be able to have power relative to
Supermarkets, but you could go a can go industry but after industry pointing out, you know
If or if you look at let's say local regulations regarding funeral homes
Right many of them are local monopolies held by service corporation. There are laws
basically that would prevent you and me from going into these industries to compete same things true for
You know a broad variety of industries. I talked about Moody's and S&P in the book, right?
It's easier to raise an armed militia in the US than it is to start a rating agency
You have essentially a Act which created a special category called the NRA SRO the National recognized statistical rating
organization and that if you don't have that you can't then write bonds and those ratings essentially go into sort of
how the Fed and other
These look at risk and so much of these barriers to entry that essentially
you know are created are through regulation and
Lobbying a lot of that is obviously crony capitalism, but I have no problem with a company
Acquiring monopolies by being the best but generally what happens is they merge to get bigger and then to they corrupt the political process essentially
to keep to erect regulatory barriers around the industry
And as an investor, some people say the classic moat system is an investor
Actually, these are fantastic companies and you want to chase the monopolies because if I have no moral compass
All I wanted is good returns, and these companies probably have good returns, but you've done quite a lot of work showing that
Yes, you know these companies are successful
Relative to others, but they are causing
De-stresses elsewhere they are causing a breakdown potential in social fabric
I think you highlight maybe five different areas ranging from income inequality to lack of diversity so you could explain
Maybe before we sort of go on to your whether as an investor
We should care could let you explain what those real issues are when you kind of under life
Go under lying in these in these kind of monopolies oligopoly is and Jia police certainly
So I start the book with Warren Buffett and you know Buffett
Ultimately, you know, he's probably a very decent person based on everyone
I've spoken to who's met him, but he's monopolist at heart and he likes monopolies
and so he looks for these two moats and generally he's buying a monopoly duopoly or you know in the worst case an
Oligopoly he you know, that's that's where he hunts
But he talks about pricing power and that's the ability of a company to raise prices on consumers and he loves those companies
But what's very interesting is if you think if a company really has that kind of power to raise prices on consumers
Why would they not then have that power? Let's say to
not raise wages
Unemployed so they would have power relative to workers. Why would they not have power to squeeze suppliers, right?
So like the the the power on the consumer side is they also have in other areas of the economy
And so what I point out in the book is that there's an increasing body of research
showing that
Wages in highly concentrated commuting areas are much lower than they are in
Concentrated community areas a bit. Therefore there is a squeeze that happens to workers and if you look at for example
monopsony, you know
Which is the opposite of a monopoly so the monopoly is one seller but you could have one buyer and a classic example would be
A coal town in Virginia where one company employs everyone
This is quite rare in the US, but you do have what you could call
Let's say metaphorical monopsony right where the company can fire the worker at will but the companies that impose
Non-competes where the employee can't actually go out and search for another job
So you've effectively narrowed down who they can possibly work for and over one fifth of the US workers are now covered by non-competes
so you've seen a collapse in unionization an
increase in concentration a huge shift in the imbalance of power and so
The ability for companies to impact workers is leading to a squeeze in wages
so that's the first one but the second one essentially comes from a
reduction in productivity and
spending an R&D broadly and the
Endless economic. Dynamism what's quite clear is the argument big versus small I think is a red herring, you know
Big is certainly good and often better. There are economies of scale
so I'm not getting into the argument of big versus small necessarily but the point is that
research shows that companies in highly concentrated industries do spend less on R&D and innovation and you end up with
less economic dynamism and fewer startups
so
I'm not suggesting a mono causal link
It's not like this is the only factor but it is certainly a factor that is damaging to the US economy
When you end up with, you know a few companies and they have an interest in essentially restricting supply
and the
startups at the same time what we've seen is a broadly
Fewer companies are existing in sort of smaller to mid-sized cities moving to the very large cities. So you have a loss of economic
dynamism and
In the book, I'd point out that in the Ireland you had the potato famine
I only had one potato and that was a disastrous. What's happening in the u.s. Is that many industries?
We're now getting down to very few players and in the case of for example
intravenous
Fluids a saline solution
To companies control that for the US market and they put their production facilities in Puerto Rico
So when Hurricane Maria hit the US had shortages of a saline solution, which is just you know
Mind-blowing and so we're basically ending up with a lot less diversity in terms of supply of many key
Drugs or other products and that really is not very efficient
You know, what we need actually is a fair degree of diversity and that comes through competition. So those are some of the
problems in terms of less economic dynamism productivity lower wages, and obviously the inequality angle is that companies are
Essentially very efficient mechanisms for transferring wealth from the middle and lower class to people who own stock and most Americans don't own
almost any stock or don't own it directly and the the very wealthy do and so to the extent that
everyday people are going about their daily lives paying a toll and the term robber baron itself comes from
The Middle Ages where you had barons in Europe who would charge told across their lands, but they wouldn't keep the lands up
You know in terms of maintaining the roads
So it was just a way of passing money from the poor to the Barons and in the u.s
right
Now if you think of sort of the toll roads in people's lives every day
They're transferring a little bit of their wealth to people who are much wealthier than them
and so it's not surprising that inequality is increased in the US and
ultimately, I think that leads to populism and it you know, very poor outcomes for everyone and you
Talk about inequality is not unfair. In fact, we should be clear that inequality is probably the good things that creates dynamism
But you think we probably gone past optimal in ecology to the point where it's become distorted and grotesque
Yeah
so I think that you have to distinguish between
sort of inequality and unjust inequality Sirah Angus Deaton a Nobel Prize winner has done a lot of work on development and inequality and
Inequality itself is essentially an outcome. It's a a symptom. It's not the underlying cause the underlying cause is that the
It's this lack of competition means that people are able to
have pricing power or relative to the consumer or have power over wages and and
This would not be happening if you actually had competition and so it's a sense that this is an unjust
Inequality due to competition that's what creates the problem. I have. Absolutely no problem with people gaining market share through innovation
I have no problem with patents. The problem comes when you erect regulatory and legal barriers to protect those
Businesses, you know and prevent competition and when you know, you see an abuse of the patent system in the United States
You know through reformulations endlessly extending patents and copyrights and things like that. And so I would put those into the unjust
inequality category where people are clearly extracting economic rents, you know without improving production or you know,
Providing any new or better products and it also seems that in this sort of system
you can have I mean one of the great debates is
Disinflation and other people saying no this deflation, but actually what we're saying
What sounds that what you're saying here is actually both camps put could be right
but these people in the middle they potentially take in the
Deflation and they don't pass it on to the end-user they create deflation of wages
But relative inflation of the output of their good and so they take this fat margin
And so this is where you know, everyone could be right about inflation and deflation because it's happening in both ends
Well, so I started looking at this
very question of
competition essentially by looking at variant perceptions leading indicator for US wages, and I thought that
Or saw our indicator was pointing to very high very big increase in wages
We had a relatively tight labor market all the inputs in terms like the quit rate and others reporting higher
But wages weren't going up. And at first I thought you know, just give it time
these are long leading indicators and they'll go up and they didn't overtime and
I thought it was very troubling one because I was they don't like things being broken and our indicator was clearly broken
But two I thought that if I know if I can understand what's going on with this, I'll also understand the profit side. So
The leading indicator for wages if you invert it because the wage bill is the biggest part of corporate spending
Would lead roee and corporate profits
and so when I started looking into this
I realized that actually it's the decline in competition and in a large barriers entry that's creating these abnormally high profit margins and so
from the macro
Standpoint it matters quite a lot because if you what you want to do is to increase wages and you start you know
Trying to shift the aggregate demand curve, which is that the feds trying to do via easy money policy
But actually the microstructure doesn't really permit that you know
Meaning that companies do have power over their workers and wages are going to go up
Then you're not really gonna achieve your goal of, you know, raising wages by shifting
Aggregate demand, you know through sort of looser financial conditions. And so, you know some macro economists have pointed out that
Pursuing a macro strategy that takes doesn't take into account
The micro is not going to solve the problem and sure enough what's happened is?
You've ended up with sort of pricing power on the side of the corporations and they you know, fatten their margins as wages
Stay low. So it's been tremendously good for anyone who's owned asset prices over the last couple years
It's been very good for owners of stocks and bonds, but ultimately hasn't done very much for workers
So obviously this this environment is good for the investor
he's to short-term investor the person who's making the Prophecy's who's kind of gaining from that but in the word you talk about how the
this overall outlook is
Causing a deterioration and kind of not just the social fabric but really in the economic fabric if we think of this longer term
That it's going to cause this decline in productivity. You got evidence that you you cite some data
what are those data points and one of those things you really look at to show that this is actually going to be a
long-term negative
For the economy and therefore the investing outlook certainly
So in in the book we start out looking at for example over the last 20 years
1/2 of all public stocks disappeared now clearly the
Tech bust in 2000 2002 is a factor the financial crisis in o.9 was a factor, but the broad trend though
Has been a decline in public stocks and a lot of that has come from murders and essentially a loss in dynamism
also, if you look at the number of IPOs there been fewer IPOs that have been issued and it's not just a matter of
Regulation like sarbanes-oxley even after the JOBS Act which made it easier for small companies to list
We haven't seen a surge in in listings and at the same time you look at the private companies
We've also seen a fairly steady number of exits
Even as the number of new entrants is collapsed
So this broad economic dynamism is bad
But there is the issue that as these monopolies become much more extractive and sometimes it's through patents
Sometimes it's through regulation
But they end up killing the sort of goose that lays the golden eggs
and if you think of for example the US healthcare system and pharma in
You know
Everyone can raise prices as much as they like
Right, and they have the power to do so due to patents and the lack of competition
but ultimately they're just going to move closer and closer towards a
government-run system essentially where
You know their entire market will probably be taken away
You move towards a British NHS type system, you know or something else
But clearly you can't have private monopolies and duopoly
'he's
endlessly raising prices without having some sort of backlash and you can look at that in sector after sector and I guarantee you that you're
going to see
antitrust reform
in the united states and it may in fact be the big issue of the 2020 election from what people are telling me and
in some ways you have this sort of continuum where if you get extreme capitalism
It's all the same as communism because you have a very very gilded elite
But a potentially quite an inefficient system below that and use of do you draw those sorts of comparisons?
I don't think there's anything inevitable about
Industrial concentration. I think that ultimately markets are a construct of common law and then
legislation what I do think happens is that there there is a pendulum that swings and so you had a
Very high concentration in the late 19th century in the United States in response
You got the Sherman Act and in 1890 in the Clayton Act in 1914
And then we've had this the pendulum has swung back and forth where in the post-war period there were very few
Mergers that were allowed from direct competitors. So you ended up with bizarre
Conglomerates essentially where you would have a Hollywood studio, that would also be part of a
Conglomerate that had an auto parts company and a cigar company and none of these made any sense from a business standpoint
But because they couldn't buy the direct competitors. They ended up doing odd acquisitions. What happened in the
1960s and early 70s was the Robert Bork and the Chicago school economists
Argued that, you know, you needed mergers to create efficiency
And then that efficiency would be transmitted to the consumer and the term in terms of lower prices
And while the pendulum would probably move too far and preventing almost any mergers and now 40 years later
The pendulum has gone to the other end, you know where basically that they're allowing
Drug companies to buy generic competitors. I completely eliminate competition or allowing two companies to control the beer market
you know and to have
Essentially monopolies at the local level and hospitals. So now we've gone so far to the other end
I think the pendulum is going to swing and you know
These things are multi-year in even multi-decade Affairs and I guarantee you that the pendulum is going to swing back the other direction
and when you get these mergers people always talk about merging to talk about
Efficiencies and cost-cutting and we'll pass them on but they rarely do in fact
Isn't it the case that after most mergers prices go up? Yes. So the the consumer welfare argument it reminds me of
once a
Journalist asked Gandhi what he thought about Western civilization, and he said that he thought it would be a good idea
The consumer welfare itself would be a good idea
if genuinely all these mergers actually did create more consumer welfare the problem, is that the
studies that have been done
Overwhelmingly show that mergers lead to higher prices
So it doesn't matter whether you're looking at the cement industry whether you're looking at funeral homes whether you're looking at hospitals
what are you looking at cable and telecoms mergers lead to higher prices, so
That's the the evidence and the book has extensive footnotes on all of this
So on its own terms the the it's failed, you know, meaning that the consumer welfare standard is not broadest lower prices
and then beyond that you throw in all the other problems and it's quite clear that what we need is a
reform of the laws because the there the current
FTC DOJ people running it and the sort of K Street law firms and private sector economists are
involved in this very cozy revolving door, and I'm
Written a piece which will appear in the American Conservative probably be out by the time people watch this video
but basically what you have is
you know Wall Street itself has made 21 billion dollars this year on mergers the
Firm's like compass Lexecon and Charles rivers associates make loads and loads and money arguing in favor of mergers and the
Projections for synergies and mergers is so absurd in 2015
Deloitte looked at all the promised synergies and mergers and they amounted to about two trillion dollars, you know
which is an absurd amount of money on a global basis and
Almost none of these actually happened and generally in fact prices went up and often prices go up
as studies show even before mergers go through so
The the promise of lower prices has not materialized
then what we've ended up with instead has been less competition and if you talk to any people in
US administration was sort of on the lawmaker side in the US and sort of
Engaged them with this and started sort of explaining the framework of the u.s
system and other systems as well and has there been any kind of interest in sort of think people sort of stroking the bids and
Going. Oh, no, this is quite serious
Yes
so there's quite a lot of interest in the House Representatives and in the Senate, so there's
many senators who want reform if you look at the
house representatives, they're people who have gotten in touch and there there's going to be
hearings on the legislative side
So clearly there's a desire for change and a realization that something is very wrong and broken
But if you look at the FTC itself and the part of Justice, they think everything's absolutely fine
of course because you know this they they get paid in that revolving door and they get paid millions of dollars to go work for
Law firms that then push from the mergers since and many of them have done it two and three and even four times
Over the last 30 to 40 years, so they think it's fine
but everyone else in the world recognize that there's a major problem with
that chain mean it's gonna need a catalyst is the catalyst going to be
Slow change slow burning chains people like yourself raising this or is it going to require, you know?
the peasants to revolt with their axes and their pitchforks because
It's something which has been brewing for a long time since 1982 as you say it's coming to an extreme
but the legal side takes a very very long time and unless
Everybody is up in arms and says, you know, hey, this is wrong
But that's kind of often social unrest how did you see the casas when could that happen?
So I don't think that people will be going to the streets and you know
Taken to the barricades and you know burning things. It's not really very American or Early's not recently
But I think the the thing that's driving it much more right now is the realization particularly that Facebook and Google essentially
have a duopoly and online ads and one has a
monopoly in search and the other as monopolies and social networks and so in a way
It's the backlash against tech that these companies are now so big and so powerful
That's leading people to focus on it. And then when you look at Donald Trump and you look at brexit, whatever you might think about
You know the merits of either vote
It's quite clear that technology has played a much bigger part than it did in previous elections
and so people are now waking up to the fact that
Two companies essentially control what we find they control the algorithms in terms of what gets shown to us
Whether it's on the you know on YouTube or whether it's on the Facebook feed and so I think these are essentially the lightning rods
Of attention and because of that people are starting to focus on other things, but it's interesting. I wrote the book
You know, it's wrote it fairly quickly. It's just the way I work, but I didn't know what other books were coming out
you know at around the time the book was coming out and
The Tim we just wrote the curse of bigness
And so there are this really is the zeitgeist where other people are thinking and writing about this
I'm not the only person I'm one of many and
And I think that it tells you that in what you're talking about in terms of their social mood it is changing
And it's not just me
It'll be a danger that the people
Some of these companies it would be kind of useful for them to shine the spotlight on Google on Facebook
Which are it's the social ills it's and it's people say well, you know
You've chosen that we're not sure what we should be really focusing on is the food companies
The people are destroying agriculture to make a massive profit. These guys will hide under the spotlights focused on the text
so it needs to be broad-based you think this will be broad-based or do you think it'll be a tech break but not a
IMF I suspected the monopolies will turn on each other. I
Read an article last week. That was hilarious
It was in a conservative website and it was written by essentially an academic who had been paid by Google
To write positive studies about Google in the past and he was like look, you know
Please leave the innovative tech giants alone
go after these horrible old economy monopolies, you know, and it's sort of those like
You know pick on them not us. And so I suspect that you'll see quite a lot of that
You know, it's just that some people they're monopoly is a good one. It's the other ones that are the bad ones
And you know people will hope that they're they can be a little faster than whoever's the slowest runner and gets eaten by the line
