Quoting from a Washington Post article describing the Harvard University poll results, “For those who grew up recently, capitalism has meant a financial crisis from which the global economy still hasn’t completely recovered (emphasis added). By using the word meant, the Post article author is saying that the financial crisis was a direct result of capitalism. And since the author of that article uses it without any evidence to support it, I infer that the author believes this is common knowledge, and a pervasive view held by Americans, that doesn’t require further evidence to support it. But is such an attitude correct? Was it capitalism that failed? Was it crony capitalism? Was it government-controlled or socialism, or some combination of these? It is simplistic to say that the U.S. economy is capitalistic, government-directed or socialist, since different areas of the economy include aspects of all of these.
Below is a graph from the Wall Street Journal showing the output of the U.S. economy by sector. Some of these economic sectors operate most in the free market and some mostly not.
Let’s start with the biggest contributor to the economy, the financial sector. (The category of Finance in the graph above includes insurance and real estate.) According to the Federal Reserve Bank, currently the total assets of commercial banks is currently around $17 trillion. Below is a graph from the St. Louis Federal Reserve showing the growth in commercial banking assets, riding the heels of U.S. money supply growth.
The Federal Reserve has increased the U.S. money supply by more than 8% per year over the last 35 years, far in excess of economic growth. This alone disqualifies the banking industry from pretending to operate in the free market. It was not the free market that ended real gold-backed money (i.e., free money) and allowed fiat currency in its place, allowing artificial money-printing and inflation. The banking giants are the direct beneficiaries of governments going off the gold standard and allowing nearly infinite money to wash through their income statements. The U.S. banking sector saw record profits last year, $171 billion. Given the incredible increases in money supply washing through the economy it would be a surprise if yearly record profits weren’t the norm.
The government railing against the financial industry by some on Capitol Hill is a smokescreen. The financial industry is a government-connected one, directly benefitting from money printing. When money is “created” by the Federal Reserve, the banking industry is the first recipient of nearly free money, with inflation later hitting the citizens after working its way through the financial industry. The inflation hurts everyday Americans, but is a boon to the banking industry. Since the end of the gold standard in 1980, the financial industry in America has seen a sharp increase in its share of the U.S. economy, more than doubling (the percentage share of finance has increased further since the time of this graph in 2008, now exceeding 9%).
Another indicator showing the low and declining free market in the industry is the near-monopolistic concentration among the financial powerhouses. According to S&P Global Market Intelligence, as of early 2017, just six U.S. banking giants – JP Morgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs and Morgan Stanley – control nearly $10 trillion of banking assets, or about 60% of total financial assets. Rare is the individual who doesn’t have one or more loans or investment accounts from one of these giants or their many subsidiaries. Below is a graph from SNL Financial (data ending in 2014) showing the steady increase of assets (the blue bars) among the megabanks, along with the percentage of the industry controlled by just five banks (the red line).
Is this the free market at work where small banks die and large ones thrive? Well, there are many reasons for the decline of small banks, but a significant one is that they can’t absorb the high government regulation costs added after the banking crisis of the late 1980s and after the 2008 financial meltdown. The Dodd-Frank act of 2010 added an additional 22,000 pages to the financial sector’s Federal Regulations (see chart below). Without the heft and resources (and political connections) of larger banks, these regulations put further strain on smaller banks. Just from 2010’s Dodd-Frank bill until 2014, the number of community banks in the U.S. fell an additional 14%.
And of course, that’s how the heads of big finance like it. At the end of last year, when Congress discussed the possible repeal of the Dodd-Frank law, the CEOs of Bank of America and Goldman Sachs openly argued against it. In his desire to keep existing regulations in place, Lloyd Blankfein of Goldman Sachs said that regulatory costs helped raise the barriers to entry in his business “higher than at any other time in modern history.” So more regulatory costs mean higher barriers to entry. Higher barriers to entry mean less competition. Less competition means fatter profits and increased concentration among the leaders in the financial industry.
When we see an industry with a declining number of firms, increasing regulatory restrictions and increasing industry concentration we are seeing an industry that is becoming less competitive, and less free market. For decades, the U.S. financial industry has been becoming steadily less free market. It was not a free market on the eve of the financial collapse in 2008, and it is less so today.
Is the second largest contributor to the U.S. economy, the government, a free market? Of course the answer is no. Government, by definition, is not the free market, although aspects of the free market can exist within some government departments, and when hiring, and when purchasing outside services and products. But the jobs themselves and the taxes taken from citizens to pay from them are not in the free market. And without a market to determine whether or not the functions of government employees would be voluntarily paid by the beneficiaries of their services, it is not possible to know how many, if any, would be similarly compensated doing the same function (possibly an economic activity) in a free market. Ironically too, since, although disputed by some, government employees, are on average compensated more highly than those in the free market (see chart below). One thing we can be sure of is that the government’s “contributions” to the economy are not based on the free market. In fact, we don’t know what that missing pie piece of our economy would look like as long as government is taking the place of real economic activity.
It is not clear how the government’s 13% contribution to GDP is calculated, but such an estimate should be taken with a grain of salt. Technically, a government employee can dig a hole and fill it and the cost of his or her labor will be added to GDP, but there will likely be no economic value added for that time, despite government-calculated “contributions” toward GDP. The government essentially admits as much, because its government sector contributions toward GDP are a much smaller fraction than the percentage of total government spending. In 2017, federal, state and local government spending is expected to be around $7.0 trillion, which is about 36% of estimated GDP. In other words, government spending is calculated at almost three times its contributions to the U.S. economy. And even that economic activity may be overstated.
The next two largest sectors of the U.S. economy, manufacturing and business services, would seem likely to operate in the free market, but they too operate in a land of regulations and restrictions. Below is a graph showing the growth in the U.S. Code of Federal Regulations affecting every U.S. business. Not even including state and local regulations, manufacturers, and business in general, has been fighting an uphill battle in the U.S. over the last several decades. As with the financial industry, the regulations help to reduce industry competition. The larger and more politically-connected companies will have an easier time dealing with the increased regulations, while entrepreneurs and small-business will have a difficult time competing. The result is that the big get bigger, as well as more politically connected, and small companies struggle to survive. This is the ironic aspect of the government’s role in reducing the state of monopolies and oligopolies. Regulations are actually making it easier for the big to get bigger and keep many potential business from surviving or even starting at all.
Of course, there are many reasons for this decline, not least the globalization boom of the 1990s, but increasing and heavy regulations in the U.S. has played a part. Shifting workers and production to lower-cost countries has been corporate strategy since 2000. It’s often noted that low-cost countries pay lower wages to their employees, but it should also be noted that most of those countries have significantly lower regulations, compared to the U.S. This further reduces costs for foreign manufacturing and decreases U.S. competitiveness. The manufactures that remain in the U.S. operate in an environment of taxes, fees and regulations. The manufacturing industry is still fairly competitive, especially on a global scale, but increasing regulations, lobbying, government “trade deals” in the U.S., is leading to a less free one.
There’s much more to say on the state of free markets, and how they’re being replaced. I’ll add more on it next time.