The new guilded age.

The last post was about the steady and continuous decline in economic growth rate since 1960. This postulated that the decline in growth rate was due to the growing service sector not adding any growth rate. This post tries to explore and explain why many of the service sectors are non productive.

The title is not a spelling error, but a play on “gilded age” a term recently resurrected from the past by the current debate on income inequality. The original gilded age was around the late 1800’s. It was a time of monopoly power accumulated by the new captains of industry during the industrial revolution, particularly in railways, steel and oil. This accumulation of power was a result of natural unconstrained laissez faire market economics. The eventual political response (after much turmoil over decades) was to enforce free markets with government anti-trust regulation to break up the monopolies and outlaw anti-competitive practices. Free markets and democracy are the two bedrocks of our modern society. Contrary to common perception, as this history demonstrates, markets are only free if they are effectively regulated. Normal unconstrained human behavior will tend to monopoly control of markets, not free markets.

Since world war two the US economy has evolved from a largely goods producing economy to a largely service based economy. The rules and regulations established to end the gilded age apply largely to the goods producing part of the economy. Service industries do not fit the model of goods producing industries and have evolved effective methods to evade the anti-competitive constraints imposed on goods producing industries.

During the middle ages, anti-competitive guilds evolved in northern Europe to control and develop merchant traffic and craft based industry. These guilds came to dominate the commerce of the period. The merchant guilds established geographically distributed networks of trust which ultimately led to finance and banking. The benefit of craft guilds was education and quality control through a standard training system. Guilds acted to ensure the benefit of their members by limiting supply and thus increasing the income of their members. This was an effective monopoly of trade and the skilled labor supply that economists now call “rent seeking”.

The growth of income inequality in recent decades has been referred to as a new gilded age. A better moniker would be “a new guilded age”. Many service industries have become effective guilds that benefit their members in much the same “rent seeking” way that medieval guilds benefitted their members.

Guilds enrich their members through “rent seeking”. As such they differ from industrial goods based monopolies that primarily enrich their owners, not their workers. Guilds should also not be confused with unions. Unions are organized labor that grew to defend worker’s rights during the industrial revolution. Some unions particularly craft unions still have attributes of guilds, such as apprenticeship, but most unions lack the power of guilds because they do not control the supply of labor. However, the guild analogy is apt for the case of some service sector unions.

The US economy has some classical guilds. One of the more obvious and powerful is doctors and medical professionals where the AMA through various means controls the supply of doctors. Other guilds are in film and TV, newspapers, real estate and law. These are a relatively small part of the economy and employment. However, the modern economy has evolved other less obvious, much more powerful, guild like groups that control the majority of the service sector. Examples of guild like groups are corporate officers and board members, banking and financial services, education services and public service unions for police and firemen. The new guild like groups all have infiltrated the regulators meant to regulate or pay them. The regulated have become the regulators.

Corporate governance: Boards of directors and company officers make a common distributed guild that mediate their behavior with each other and government through the lawyers and accountants they all employ.  This self serving group have enriched their members at the expense of shareholders and employees by peddling false narratives. In theory, boards of directors are meant to act on behalf of shareholders, but lax government oversight has led to the regulated seizing control of the boards that are meant to be the regulator. The most obvious evidence is the many CEOs that are also chairmen of the board of directors. The governance of public companies seems completely broken with average executive pay over 20 times what it was in 1960 and hundreds of times that of average workers.

Finance:  The financial system as a whole acts as a guild. The key problem is well explained by this paper by Margaret Blair. Banks are incentivized to maximize leverage, which maximizes profit at the cost of increased risk. Regulators should seek to limit leverage which can seriously damage the economy. The false meme that regulation stifles free markets was used by bankers to relax regulations meant to control leverage that were introduced during the great depression. This was aided by the bankers taking control of the government regulators using the argument that banking is so complex, only bankers can understand it. They also corrupted the private ratings agencies that were meant to act as part of the regulatory system. Finance became adept at increasing leverage with new complex financial instruments that expanded debt and hid it from public scrutiny. Income to the guild members was maximized by high-risk, excessive leverage with no personal risk from a “too big to fail” government guarantee.

Unfortunately, as well as enriching bankers, the increased leverage has seriously damaged the economy and still poses a huge danger. It raised debt from 150% of GDP in 1980 to 350% of GDP in 2008. This oversupply of debt was mostly used to buy assets, inflating their value and leading to more lending to finance the higher value. Many of these assets were real estate. As a consequence, rents have also inflated as a rent is mostly a mortgage payment and consumer mortgages are effectively rents. Paying these interest “rents” takes 25% of GDP. This is classic “rent seeking” and the main source of the recent growth in income inequality. Debt at these levels is historically unstable as explained by Ray Dalio. The bubble bursting in 2008 was advertised as deleveraging event that was reducing excessive debt. However, the financial sector has proved adept at defending its privileges. Debt, after a small decline is growing again. Its back to about 340% of GDP in 2015. The great recession has not fixed the economy and more turmoil lies ahead until we actually deleverage.  

Healthcare: US healthcare costs twice as much as European countries but health metrics like infant mortality, and overall mortality are significantly worse. Healthcare in the US has evolved into a complex system that operates for the benefit of providers and not consumers. This is a definition of a guild. Insurance provided by employers separates buyers from sellers, hiding costs. The system is “fee for service” which incentivizes providing excess services and makes no one accountable. Insurance is incentivized by overall rising costs, as their income is a fixed fraction of costs. There is no constraint on cost except the willingness of employers to provide insurance. This has proved a weak and slow acting constraint. Within the system, doctors keep a tight control on the supply of doctors and doctor’s privileges. Hospitals maintain local monopolies on supply without regulatory constraint. Hospitals charge arbitrary amounts based on their costs and extract money from patients based on their ability to pay. This is a clear sign of monopoly. Again the regulators have been captured by the regulated. Health insurance is regulated by the States which fragments and weakens insurance market regulation. Health insurers in contrast are large national entities with far more clout than state regulators.

Education: College education is the clearest education guild. Colleges charge based on the parents ability to pay, not the service they provide. Prices are raised without regard to costs. The benefits accrue to the guild members, not owners. The basis seems to be the exploitation of parent’s basic desire to help their children succeed in life. Recently this has assumed absurd levels where student debt now exceeds consumer debt. Many kids and parents were duped into borrowing excessively for worthless diplomas from corrupt diploma mills. A whole generation is starting out with a millstone around their neck that will damage them and the broader economy. K through 12 education is another guild. This guild operates to expand its membership and protect employment of its members. This is the opposite of skills based guilds like doctors that try to restrict entry and increase compensation

Public servants: Most government spending occurs at the state and local level. Public sector unions have become adept at getting pro-labor local and state public officials elected by appealing to public sentiment. These officials have provided generous benefits to public employees, particularly generous pensions for police and fire. This is a clear case of regulatory capture.
 
To summarize, modern guilds are hard to identify and have great defensive narratives that justify their excess remuneration. They also exploit complexity that misdirects attention. They also exploit natural human biases and weaknesses in their customers. Houses always increase in value. Doctors are altruistic. Only bankers understand banking. A good education is worth great financial sacrifice. Cops and firemen are heroes. Nurses and teachers are saints.
 
By Edmund Kelly