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Economy

Where Is the Free Market Utopia?

Reprinted from EconLib

The Great Reversal defends a provocative and surprising thesis: the United States has given up on free markets while Europe has embraced them. As a result, Europeans pay less and get more in a lot of industries, like telecommunications and air travel. Throughout the book, New York University economist Thomas Philippon explains why the United States is no longer the seat of dynamic, innovative capitalism that it once was.

It resonated with some of my recent experiences. In August, I visited the Center for Political Studies in Copenhagen, Denmark for a week and gave a few lectures. One of my lectures applied some of the insights Deirdre McCloskey and I explored in our 2020 book to the Danish retail sector. I was surprised when I was doing some research for the talk and learned that according to OECD data, Danish retail shoulders a smaller regulatory burden than American retail even though Danish land use laws make it so that grocery stores there are inefficiently small and Danish consumers pay higher prices.

In fifteen clearly written, easy-to-read chapters plus an introduction, a conclusion, and a technical appendix, Philippon shows why some of my Danish audiences should have stifled their laughter when I described their country as a free-market paradise compared to the United States. He defends his thesis by exploring numerous data sources, including the Mercatus Center’s database working to quantify the intensity of regulation in the United States (pp. 94-96). They tell the same story: European markets have gotten freer while American markets have gotten less free. As he explains with respect to occupational licensing, the United States and Europe are moving in opposite directions, with the United States moving toward more tightly controlled labor markets and Europe moving toward freer labor markets (p. 283). Philippon makes a convincing case that we would do well to revise our belief that the American economy is a free market while European economies are not. He goes industry-by-industry to explain where and how European markets have become freer than American markets. He also looks at the data to see how “new” and “unprecedented” firms like Google, Apple, Facebook, Amazon, and Microsoft are, and he finds that while they definitely represent important new technologies, they aren’t really that different from other superstar firms of the past, relative to the rest of the economy.

Philippon is a self-described “free market liberal” who approaches his subject with a set of arguments and tools that are straight out of the neoclassical mainstream. Philippon writes explicitly that by “free markets,” he means “markets are free when they are not subject to arbitrary political interference and when incumbents are not artificially protected from competitive new entrants” (p. viii). From what I can gather, he believes with most economists that free markets work wonderfully in most instances, fail miserably in some instances, and can be fixed with appropriate regulations, taxes, and subsidies.

I’m less sanguine about “our” ability to fix markets by relying on experts, no matter how much data they are able to assemble. In 2009, I asked, “is the definition of the market too important to be left to the market?” in response to the Federal Trade Commission’s effort to block the Whole Foods-Wild Oats merger. I think Philippon, like many economists, does not take the implications of F.A. Hayek’s argument about the use of knowledge in society as seriously as he should. Hayek isn’t arguing that markets calculate more efficiently than central planners. He argues that the knowledge problem is of a wholly different kind than the problems experts can solve with enough data and powerful enough computers. There is a great deal of often tacit, rarely articulated knowledge of “the particular circumstances of time and place” that cannot confront an expert or regulator as meaningful data. Forsaking the market necessarily substitutes the regulator’s imagination for the combined but unarticulated wisdom embodied in prices and evolved rules.

Political economy gets about fifty of the book’s roughly three hundred pages, and Philippon concludes that American markets are not as competitive as they would have been without lobbying and rent-seeking. I’m reminded of my late friend Steven Horwitz’s first law of political economy: “no one hates capitalism more than capitalists,” and a point Donald J. Boudreaux made once: “if rents can be created, they will be sought.” It would be useful, I think, for future work building on Philippon to focus more on the supply side of the market for economic rents a la Randall Holcombe in Political Capitalism and Fred McChesney in Money for Nothing: The Political Economy of Rent Extraction.

It warmed my heart to see Philippon bring Mancur Olson’s analysis into the conversation, but I would have preferred that he carry the public choice analysis further and more clearly highlighted the difference between how coercion and cooperation work as crucibles in which social knowledge is tried and authenticated. He argues that “(t)olerating well-intentioned mistakes is therefore part of good regulation, provided that there is due process and that there is a mechanism to learn from these mistakes” (p. 4), but there is nothing analogous to profits and losses in the regulatory world, and few of those making the rules have much skin in the game. Since they don’t enjoy large rewards for being right or suffer large losses for being wrong, they are likely biased toward errors.

Consider antitrust policy, which is in theory about protecting gains from trade, but which is in practice often about protecting incumbents’ rents. Judge Learned Hand’s decision in United States v. Alcoa (1945) is instructive. Without irony, he excoriated Alcoa for hustling to innovate, lower prices, and produce more whenever and wherever the company’s executives saw opportunities. In short, he denounced Alcoa as a monopolist for doing the exact opposite of what monopolists do.

I think Philippon and I would both agree that organizations like the Food and Drug Administration and various licensing boards should lose their power to block entry and thwart competition. I for one would love to see a reciprocal approval agreement where (say) any drug approved in any OECD country is automatically approved for sale in the United States. It falls short of the free market utopia I would like to live in, but it’s a definite improvement over the status quo.

Similarly, Philippon points out that foreign airlines are not allowed to fly U.S. domestic routes. There is no compelling economic or even security reason for this, and we would see lower prices and better service if airlines like Etihad and RyanAir could carry passengers from New York to Los Angeles and back. I would also like to see more reciprocal licensing agreements among licensed professions in the United States along with permission for people trained in foreign medical schools to practice in the United States. I’m not going to hold my breath, though, given what I know about the dynamics of the rent-seeking society.

While I have various disagreements with what is otherwise a fine book, it is important not to lose sight of the fact that we fundamentally agree that markets work and that if a government is going to do anything, it should work around the margins to make markets work better. It’s easy to forget that this widely-shared consensus among professional economists is most definitely not shared by the general public or by many intellectuals and scholars who are not economists. Philippon explains why we should embrace competition, and if more people do so after reading The Great Reversal, he will have done an important job.

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