Writings of a techie wizard
Tag: economics
Sun, 14 Sep 2014

Peter Thiel, in a recent article, says that (as the article's subhead puts it)

If you want to create and capture lasting value, look to build a monopoly

Of course this works out well for the monopolist; but how about the rest of us?

I'll go ahead and get the obvious criticism out of the way first: Thiel's actual examples don't justify the "create" part, only the "capture" part. Actually, "examples" is an overstatement, because he only gives one (at least, only one that directly addresses the point made in the subhead): he compares U.S. airline companies to Google. His numbers do show that Google, the monopoly, captures much more value than the highly competitive airlines do. But they also show that the airlines create much more value than Google does.

I'll also go ahead and clear up the obvious objection that the word "monopoly" raises: Thiel does make it clear that he isn't talking about monopolies that only got that way because of special favors from the government or a willingness to bend the rules in a way that other companies are not. He is talking about

the kind of company that is so good at what it does that no other firm can offer a close substitute.

Of course, that definition makes a monopoly sound like a good thing, even though, as we saw above, they don't actually create more value. But that isn't really why Thiel thinks monopolies, in his sense, are good (which is why I got that criticism out of the way quickly, so we could focus on his real points--never mind that they aren't the same as the point the subhead makes). His real argument is twofold. First, he says, monopolies are better for workers:

Imagine you're running one of those restaurants in Mountain View. You're not that different from dozens of your competitors, so you've got to fight hard to survive. If you offer affordable food with low margins, you can probably pay employees only minimum wage. And you'll need to squeeze out every efficiency: That is why small restaurants put Grandma to work at the register and make the kids wash dishes in the back.

A monopoly like Google is different. Since it doesn't have to worry about competing with anyone, it has wider latitude to care about its workers, its products and its impact on the wider world.

This is wrong in at least two ways. First, the problems Thiel attributes to the restaurants in Mountain View are really problems of small businesses, not low-margin businesses. They can only afford to pay minimum wage (assuming they actually do; Thiel only says they "probably" do) because they have a small customer base, so wages, like everything else, have to come out of a small pool of resources. There are plenty of competitive businesses that can afford to pay high wages for people with the skills to justify them. Intel, for example, is certainly facing stiff competition, but they don't skimp when it comes to paying chip designers; they can afford to pay them well, because they have a much larger customer base and therefore a much larger pool of resources to draw on.

Second, even if it's true in theory that Google, as a monopoly, has more leeway to care about things, it's not at all obvious that this actually translates to better outcomes in practice. Plenty of ex-Googlers have described various downsides of working there. And the "impact on the wider world" that Google is having is by no means an unmixed blessing. Along with the undeniable value of the search engine and of some apps like Google Maps, there is the ad-supported business model, the increasing amount of personal data on Google's servers, the repeated pattern of apps being launched, getting wide usage, and then being shut down because they aren't gaining Google enough revenue, and so on.

Looking at the actual impact of Google, instead of the theoretical impact, based on the "don't be evil" motto, that appears to be all Thiel has bothered to consider, also brings up another problem with his analysis. Monopolies are supposed to be better because they capture more of the value they create: but Google actually captures no value directly from any of its applications. Anyone can use any Google app for free. All of the value Google captures is indirect, from measuring how many eyeballs land in the various places that it tracks. The major direct effect of this is on Google's users, not on its workers (and we'll talk about that further below); but the fact that users have no way of directly communicating to Google how much value they are getting from its services is a huge elephant in the room that Thiel never even mentions, even though capturing value is central to his analysis.

So it's by no means clear that monopolies are better, either for workers or for users, if we go by the example of Google. But Thiel gives another argument for why monopolies are better for customers, despite the claims of economists to the contrary:

Profits come out of customers' wallets, and monopolies deserve their bad reputation—but only in a world where nothing changes.

In a static world, a monopolist is just a rent collector. If you corner the market for something, you can jack up the price; others will have no choice but to buy from you. Think of the famous board game: Deeds are shuffled around from player to player, but the board never changes. There is no way to win by inventing a better kind of real-estate development. The relative values of the properties are fixed for all time, so all you can do is try to buy them up.

But the world we live in is dynamic: We can invent new and better things. Creative monopolists give customers more choices by adding entirely new categories of abundance to the world. Creative monopolies aren't just good for the rest of society; they're powerful engines for making it better.

On the face of it, this seems backwards. The usual view in economics is that competition is what forces companies to innovate. But Thiel claims that competition actually prevents companies from innovating; in fact, it prevents companies from doing anything beyond day-to-day operations:

Monopolists can afford to think about things other than making money; non-monopolists can't. In perfect competition, a business is so focused on today's margins that it can't possibly plan for a long-term future. Only one thing can allow a business to transcend the daily brute struggle for survival: monopoly profits.

In part, the error here is the same as the one we saw above with the restaurants in Mountain View: having no resources to spare for anything beyond day-to-day operations is a problem of small businesses, not low margin businesses. It also doesn't help that Thiel fails to take into account that the profit margins companies report in their financials are what's left after all expenses are subtracted, and those expenses include things like spending to plan for a long-term future. (They also include employee wages and salaries, which is why a low-margin business is not forced to pay low wages, as we saw above, provided it has enough of a customer base to justify hiring highly skilled people.) Airlines, for example, spend plenty on things like new aircraft, and that spending is subtracted before they quote their profits.

But the real problem here is that, while monopoly profits do provide an extra pool of resources for the company to spend as it wishes, they do not guarantee that this extra spending will actually translate into extra value. We saw an aspect of that above, when we looked at the effect of Google's business model on its users: the fact that Google captures no value directly from its users means that Google has no way of knowing the value of its various services to users. Of course, figuring out a way for users to be able to, for example, directly pay for Google search is a very hard problem. But solving it certainly seems like it would be of great value, and surely, if any company in the world is in a position to solve that kind of a problem, it's Google. So why, if monopolies really work the way Thiel claims they do, hasn't Google solved it?

The standard economist's answer to this question is that Google has no incentive to solve the problem. The only way to create such an incentive would be for some competitor to put Google in a situation where the problem had to be solved in order to keep its user base. In the absence of such competition, Google is free to do, not what its users actually want (since it has no way of knowing that), but what it thinks its users might want, at least enough to increase its ad revenues. In other words, Google is using its monopoly profits, not to create wonderful new benefits for users, but to run expensive experiments on what users will click on; any new benefit for users is a lucky side effect (and is likely to go away once Google realizes that it isn't going to increase their revenues). Google is doing this simply because it can--because nothing is forcing it to do what seems obvious from the user's viewpoint and simply let users tell it directly how valuable its services are, by paying for them.

Of course there's an obvious objection to this: if Google started charging for search, say, people would simply stop using it. But if that is really true, then that just sharpens the argument I made earlier: monopolies like Google may capture more value, but they create less. If Google search isn't worth paying for, let alone its other services, then Google is creating even less value than we thought. And that just makes Thiel's claims even harder to swallow.

The other examples Thiel gives don't make his case any better. For example, the change from AT&T's monopoly of phone service to the current state was a classic example of increasing competition benefiting users by reducing prices and increasing the availability of services; it was certainly not a case of a new and improved monopoly displacing the old one, which is Thiel's stated reason for mentioning it. One can perhaps justify viewing Microsoft and Apple as monopolies in Thiel's sense, depending on how narrowly you want to draw the line around what would count as a "close substitute". But, as with the case of Google, the benefits of Windows and iPhones have brought with them significant downsides for users: for example, the litany of security flaws in Windows, and a greatly increased cost of switching systems and applications. What has kept these problems from being worse than they are is competition: from Macs and Linux for Windows, and from Android for iOS.

Thiel may be confused about competition because he is confused about how economists model it. He says:

Economists copied their mathematics from the work of 19th-century physicists: They see individuals and businesses as interchangeable atoms, not as unique creators. Their theories describe an equilibrium state of perfect competition because that is what's easy to model, not because it represents the best of business... But every new creation takes place far from equilibrium.

It's true that, in order for new creation to take place, the economy has to be out of equilibrium. But new creation is not what disturbs the equilibrium; the equilibrium is always being disturbed anyway, simply because people's needs and wants are always changing. Economists know perfectly well that the "equilibrium state of perfect competition" exists only in theory, not in reality, just as physicists know that no real system is ever in perfect thermodynamic equilibrium, because the system is always interacting with its environment, and the environment is always changing. But a physical system's drive towards equilibrium is what enables useful work to be done; and similarly, an economy's drive towards equilibrium--competition--is what enables useful creation to be done. Without that driving incentive, monopoly profits will simply get frittered away on things that may look good to the company, but don't actually benefit the rest of us.

Posted at 23:38   |   Category: opinions   |   Tags: economics   |   Permalink
Wed, 27 Nov 2013

A few weeks ago the Federal Reserve announced that it would continue "quantitative easing" at its current level. The reason, as explained in the press release just linked to (though in rather oblique language, as is the usual practice with such things), was basically that, while the economy appears to be recovering, the Fed isn't sure that it's recovering strongly enough. Which leads to the obvious next question: how much longer will this have to go on?


Posted at 23:31   |   Category: rants   |   Tags: economics, politics   |   Permalink
Mon, 31 Dec 2012

This is my obligatory blog post about the "fiscal cliff". One can't expect to maintain one's blogging credentials without making some comment on an issue like this, but I have been hesitant even so because there didn't seem to be anything worth saying that hadn't already been said many, many times. Then I came across this op-ed from yesterday's New York Times:

As the nation teeters at the edge of fiscal chaos, observers are reaching the conclusion that the American system of government is broken. But almost no one blames the culprit: our insistence on obedience to the Constitution, with all its archaic, idiosyncratic and downright evil provisions.

My take is exactly the opposite: our government is broken because we don't obey the Constitution, or indeed any coherent system of rules, if we think we can get our way by breaking them. And the fiscal cliff gives a perfect illustration of how this works and why it's a problem.


Posted at 18:55   |   Category: opinions   |   Tags: economics, politics   |   Permalink
Wed, 17 Oct 2012

I recently came across a blog post proposing a rather novel solution to what it calls "the shortage of technology talent in the United States".


Posted at 22:16   |   Category: opinions   |   Tags: computers, economics, education, politics   |   Permalink
Thu, 19 Apr 2012

Along with a lot of other people, I watched Discovery fly over Washington, DC on its way to Dulles Airport. A good sequence of pictures is here. I lamented a while back that today's NASA seems to have fallen far from the NASA of the Apollo missions, but obviously there's not much to be done about that except to move on (see below for more on that), and anyway, that's not Discovery's fault. The Shuttle deserves a good retirement, and will get one; I plan to go see it in its new home.


Posted at 23:07   |   Category: opinions   |   Tags: economics, politics, science   |   Permalink
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