On November 26, 2018, Jonathan Tepper writes on Bloomberg Business:

America is supposed to be a land of economic dynamism filled with disruptive companies, but the reality is very different.

Everyone knows the inspiring stories of companies starting in garages in Silicon Valley from Hewlett Packard to Google. The popular press focuses on big success stories we all know: Dropbox, Airbnb, Tinder, Nest, Fitbit and so on.

However, the overall numbers tell a different story. Recent research shows that the rate of new business formation in the U.S. has slowed dramatically since the late 1970s. In fact, we have seen more firm exits than entries in the past few years.

In a growing economy, new businesses start every day, and older businesses fail and die. Restaurants like Chipotle open, while older ones like Chevys Fresh Mex go bankrupt. Startups like Netflix launch new media offerings, and businesses like Blockbuster go bust.

This is the second of two excerpts from ‘The Myth of Capitalism.’ Read the first:

• Competition Is Dying, and Taking Capitalism With It

Much like children are born and grandparents die, this is a vital part of economic life. Unfortunately, the process of creative destruction has been slowing steadily over the past 30 years.

What is most troubling is that the decline in economic health is not confined to one sector but is widespread and has been nearly universal geographically.

The collapse of startups should be no surprise. Ever since antitrust enforcement was changed under President Ronald Reagan in the early 1980s, small was bad and big was considered beautiful. Murray Weidenbaum, the first chair of Reagan’s Council of Economic Advisers, said, “It is not the small businesses that created the jobs, but the economic growth.” Small businesses were sacrificed for the sake of bigger businesses.

In a comprehensive study, Professor Gustavo Grullon showed that the disappearance of small firms is directly related to increasing industrial concentration. In real terms, the average firm in the economy has become three times larger over the past 20 years. Grullon concluded that the evidence points “to a structural change in the U.S. labor market, where most jobs are being created by large and established firms, rather than by entrepreneurial activity.”

The employment data of small firms supports Grullon’s conclusions; from 1978 to 2011, the number of jobs created by new firms fell from 3.4 percent of total business employment to 2 percent.

Large companies argue that big is beautiful, due to economies of scale, where being a gorilla is better than being a chimpanzee. Some industries simply can’t be small.

The airplane industry’s scale is such that only Boeing and Airbus can compete globally. For example, the latest Boeing 787 costs over $200 million a plane and has parts from 45 separate companies.

For other industries, the scale of research and development is now so great that no startup could ever compete. For example, given the complexity of microchips few companies can spend what Intel does. And finally, for some businesses network effects create winner-takes-all outcomes that favor vast size.

Yet most industries don’t fall into these categories. When it comes to productivity, small is often good. Sometimes scale does not necessarily help.

Economists in the area of growth theory have found that new companies are like ants, carrying far more than their weight. They are responsible for innovations, opening new markets and creating economic growth.

The work of John Haltiwanger is critical to understanding the causes of job creation and economic performance. His landmark book “Job Creation and Destruction” showed that it was “young, high-growth startups — the ones that are experimenting, innovating new products and services and trying to figure out new business models that are disproportionately responsible for the great majority of new job creation.”

Ever since the time of Thomas Jefferson, Americans have idealized the yeoman farmer and the small business. While family neighborhood stores are a critical part of the economy, it is important to distinguish between small businesses and the high-growth startups that Haltiwanger describes.

Small businesses like restaurants and dry cleaners create most jobs, but they also destroy most jobs. They create most new businesses, but they have the highest rate of failures. They are important, but they don’t drive productivity.

It is the small companies that become big, like the next Costco, Southwest Airlines or Celgene. All of these started small.

Geoffrey West, in his masterful book “Scale,” showed that companies are like living organisms. Just like in the animal world, many startups die when they are very young, but those that survive and grow quickly tend to grow exponentially, which leads to higher profitability and productivity.

As firms get older, their growth slows and they become less innovative. The funding for innovation lags the spending on bureaucratic expenses. In a vicious circle, they employ more people to manage the increasing number of people as they grow.

Much like human beings, the limited energy of companies is used for the internal repair of cells rather than for growth. When West examined the data for large companies, he found that they appear to settle down toward a slow rate of growth, but reality is slightly trickier. When you adjust for inflation “and the overall growth of the market has been factored out, all large mature companies have stopped growing.”

Unlike humans, large companies don’t simply die; they resort to buying smaller, fast-growing rivals.

In an influential paper, Titan Alon and his colleagues found that the age of a company plays a key role in shaping the dynamics of labor productivity growth. If new companies can survive their startup phase, they show productivity growth of roughly 20 percent in the first five years of operation.

When monopolists stamp out startups, they kill productivity in the economy. In fact, if you look at the decline in high-growth entrepreneurship in high tech, it coincides with the decline in aggregate productivity growth in the sector.

The battle lines are drawn in the debate over productivity as big companies face off against the small. The truth is far more interesting.

In their book “Big is Beautiful,” Robert Atkinson and Michael Lind show that large companies spend the most on research and development. Historically, giants like AT&T or IBM could pay for large research centers like Bell Labs or Yorktown. Today, large companies are still the biggest spenders; DuPont and Google can dedicate a lot of money to R&D. But this is only half the story.

In a study, Zoltan Acs and David Audretsch discovered that companies in highly concentrated industries spent less on R&D. They found that “the total number of innovations is inversely correlated with concentration” and that monopoly power deters innovation. They concluded, “Innovation falls as industrial concentration increases.”

Not only are we getting fewer startups, big companies are also gobbling up small ones and killing them off. Today, many of the new tech startups never get the chance to compete.

Google, Amazon, Apple, Facebook and Microsoft have bought more than 500 companies in the past decade. These giants are looking for the younger fast growers.

You can see how big companies kill productivity by looking at Google and the field of robotics. In 2013 Google acquired Boston Dynamics, as well as eight other companies, to create a new robotics division called Replicant. The robotics industry was excited that the 800-pound gorilla in technology was throwing money around. However, it turned into a disaster.

Over time, Google shut many of the companies down and the top researchers left. Jeremy Conrad, a partner at hardware incubator Lemnos Labs, said, “These were some of the most exciting robotics companies, and they’re just gone.” Google was really in the business of selling internet ads.

In June 8, 2017, Google announced the sale of the company to Japan’s SoftBank Group.

We’ve seen giant monopolies throw away innovation before. During the 1960s and early 1970s, Xerox had a monopoly on its copying technology. Xerox’s Palo Alto Research Center basically invented the modern computer and internet, yet failed to profit from it. Anything besides copying was simply not of interest.

The list of Xerox’s inventions is extraordinary: the graphical user interface, computer-generated bitmap images, object-oriented programming, Ethernet cables and more.

Yet the company did little with these innovations. It took Steve Jobs and Apple to license them and bring products to the public.

Creativity can stagnate when businesses become monopolies. Frederic Scherer of Harvard University has examined the patents of monopolists and shown that as firms become dominant, the number of important patents declines.

Monopolists often fail to commercialize their own inventions. Before Standard Oil was broken up, it invented “thermal cracking” to improve gasoline for cars, but did nothing with it. When the monopolist was broken up, the Indiana unit that discovered the technology commercialized it to enormous success.

Escaping large companies is often crucial to growth. Companies frequently get rid of units via spinoffs. They hand shares in their subsidiaries to shareholders and allow the smaller company to go its own way.

McDonald’s spun out Chipotle, eBay spun out PayPal, and Sara Lee spun out Coach. These turned into phenomenal investments. The research on spinoffs tells us that these companies vastly outperform the parent company and the market.

As companies get bigger and more like King Kongs, we’ll never know how much productivity and how many innovations are lost.

Another great mystery for economists and central bankers is why businesses are not investing more. They’re returning almost all cash to shareholders rather than doing more research and development or spending it on new equipment.

Larry Summers, the former Treasury, argues we’re experiencing a “secular stagnation.” Supposedly, the economies of the industrialized world suffer structurally from too much saving and too little investment. He blames inequality and technology. “Greater saving has been driven by increases in inequality and in the share of income going to the wealthy.”

Fellow stagnation proponents do not tie the problem to monopolies and oligopolies, but the connection should be obvious. Under competitive market conditions investment will be greater than under monopolies, where the monopolist reduces supply to keep prices high.

Research by Germán Gutiérrez, Thomas Philippon and Robin Doettling helps explain the lack of investment. In a paper they analyzed investment in the U.S. over the past 20 years. They found that investment was lower than predicted by fundamentals starting around 2000, and the gap is driven by industries where competition has decreased over time.

They found that investment relative to returns had fallen most sharply in concentrated industries. If leading firms had maintained their share of overall investment since 2000, the American economy would have 4 percent more capital today, an amount roughly equivalent to two years’ investment by nonfinancial companies.

Today firms find it is more profitable to restrict production than to invest in growing. Think of airlines that don’t want more capacity, beer companies that don’t expand plants, and cable companies that don’t upgrade infrastructure.

Instead, firms take their high profits and plow them into share buybacks. The money goes to wealthy shareholders who spend less relative to their income than poor people. And so low investment and low consumption are tied together.

Monopoly is the last stage of capitalism, according to Lenin. Yet it was the Soviet Union that achieved a total monopoly in industries. When the Cold War ended, Moscow residents rioted because cigarettes were unavailable; the filter tips that were only produced in war-plagued Armenia had run out.

We are approaching the Soviet stage in some industries. Americans are not rioting over cigarette filters. They are meekly accepting far worse shortages.

In 2017, when Hurricane Maria hit Puerto Rico, the U.S. faced a severe shortage of intravenous solution bags. Baxter and Hospira have an effective duopoly, and their production facilities were in Puerto Rico. Even before the hurricane, price hikes were a problem. Prices in the U.S. have more than doubled in the past few years.

It is appalling that such a simple, vital medical supply could be in such short supply in the hands of two companies. Yet that is the story of America: high profits due to offshored production, and artificial scarcity at the hands of private monopolists.

The U.S. needs growth, productivity and diversity in business. A Harvard Business School study that analyzed the community involvement of 180 companies in Boston, Cleveland and Miami found that locally headquartered companies had the “most active involvement by their leaders in prominent local civic and cultural organizations.” Locally owned businesses hire more local workers, they buy from local suppliers, and the revenue they receive is recycled locally. Today, though, even large local champions have been acquired, and their headquarters moved to even bigger U.S. metropolises.

The owners and top managers have moved on. Like parasites sapping energy and nutrients, they soak up local earnings, turning them into share buybacks and dividends.

Small towns across America have been discovering how deadly it is to become monocultural when it comes to business.

In early 2016, Walmart announced that it was closing 154 stores in the U.S. In the grand scheme of things, this matters little to the nation, but for the tiny coastal town of Oriental, North Carolina, it was devastating news. Renee Ireland-Smith’s family grocery store was forced to close in October 2016 after 45 years because it could not compete with Walmart. Walmart was finally the only game in town.

But two weeks later, Walmart announced it was closing in Oriental. At the same time, Walmart announced a $20 billion share buyback to send money to shareholders.

“This town was fine before,” Ireland-Smith said. “Now it’s broken.”

(This is the second of two excerpts from “ The Myth of Capitalism: Monopolies and the Death of Competition.” Read part one here.)

https://www.bloomberg.com/opinion/articles/2018-11-26/tech-monopolies-strangle-economic-growth