January 06, 2022
Okay, I’m a bit slow for a New Year’s piece, but what the hell, we can always use a bit of optimism. Anyhow, I thought I would spout a few things about what the world might look like if we didn’t rig the market to give all the money to rich people. Not much new here for regular readers, I just thought I would spell it on paper, since it is a nice backdrop for many of our battles.
Before I go through my favorite unriggings, let me start by making a general point, which some people may miss. I focus much of my writing on ways that we rig the market to give money to the Bill Gates and Moderna billionaires of the world.
The idea of restructuring the market, so that these people do not get so rich, is not just a question of punishing the wealthy. When we give these people more money, in excess of what they contribute to the economy (we have to pay people something to develop mRNA vaccines, just not as much as we did), then we are generating more demand in the economy. This has the same effect on the economy as an increase in government spending.
To take my favorite example, if because of patent and related monopolies, we pay drug companies $400 billion a year more than is needed to have the drugs manufactured and distributed, this has the same effect on the economy as if we wrote $400 billion in checks ($3,300 per household) and sent them around to everyone. This policy (the writing of large checks) would run the risk of creating inflation if the economy is near its capacity.
The same is true of sending all this money to drug companies. While many people in the pharmaceutical industry earn normal salaries, higher-up employees can earn millions of dollars, or even tens of millions of dollars, a year. And those lucky enough to be at the top of the big winners, like Moderna, can score billions.
When these people spend this money on their second, third, or fourth homes, on their yachts, or their space trips, it pulls resources away from other areas. We, therefore, have fewer people to build homes for ordinary families (and less land), and fewer people to provide medical care or child care because the pharmaceutical industry folks have hired them.
Restructuring the market so that less income flows upward has the same impact as taxing the income away. Of course, it has the huge benefit over taxation in that it is done through the market. This is enormously more efficient than handing rich people money and then trying to take it away with taxes. It also is likely to be far more feasible politically.
With that backdrop, it’s time for a bit of fun, thinking about what the world might look like if we unrigged the economy.
Free Market Drugs and Vaccines
There is probably no sector where the impact of government-granted patents and copyrights is more pernicious than in healthcare. Drugs are almost invariably cheap to produce and distribute. The reason that some can cost thousands, or even tens of thousands of dollars for a year’s treatment is because the government grants drug companies patent monopolies. When they are producing a drug that is essential for people’s health, or possibly even their lives, the patent monopoly allows companies to charge prices completely out of line with costs.[1]
This is a case where every good progressive should be a huge proponent of the free market. If we didn’t have any patent or related protections for vaccines, we could have had manufacturers all around the world producing and stockpiling vaccines even before they were approved. (It costs around $2 to manufacture a vaccine dose, if we had stockpiled 400 million vaccines that proved ineffective and then had to throw them out, so what? The wasted $800 million is a bit more than 0.01 percent of what the U.S. government has spent on pandemic-related measures.) This would likely have meant that we could have had most of the world vaccinated by the spring, likely preventing the omicron variant and possibly even stopping the delta variant.
Also, to cut off a standard line from our friends in the pharmaceutical industry, it’s true that much of the technology of the industry is protected by industrial secrets rather than government-granted patent monopolies. This one is easily dealt with; we just make their non-disclosure agreements unenforceable. That would allow the top engineers at Pfizer, Moderna, and elsewhere to freely share their expertise with everyone in the world.
We do have to pay for research, but the patent monopoly system is a very inefficient mechanism. In addition to making drugs and vaccines very expensive, it also gives companies an incentive to carry on their research in secret, rather than sharing important findings with potential competitors.
Science advances most rapidly when it is open. If we pay for the research upfront as we did with Operation Warp Speed, we can make openness a condition of the research, with all results posted on the web as quickly as practical. This would allow researchers everywhere to build on each other’s successes and learn from their failures, preventing much needless duplication. Also, all patentable results would be placed in the public domain so that generic manufacturers anywhere in the world could produce them. (In chapter 5 of Rigged [it’s free], I describe a mechanism involving long-term contracts that the government could use to dish out the money.)
We would need some system of international sharing of research costs, which would have to be negotiated. But, this sort of open research system offers enormous potential gains for the whole world. And, it’s worth noting that our current system, requiring patent enforcement internationally, has hardly been problem-free in both negotiation and implementation. In a positive turn of events, the European Union is actively considering expanding public investment in biomedical research, including an open research option.
Open research would also eliminate the incentives for misrepresenting research findings or outright fraud, like the Elizabeth Holmes-Theranos case. If research is fully open for the community of researchers to evaluate, it would be almost impossible for someone to perpetuate a Theranos-type fraud. Also, there would be very little incentive, since no one would stand to make millions or billions by pushing false claims.
In this context, it is worth noting that, while Theranos is an extreme case, the problem of companies hyping their drugs to maximize the profits from their patent monopolies, is pervasive. This is a huge part of the story of the opioid crisis. More recently the question of biased research has come up with reference to the high-priced Alzheimer’s drug Aduhelm. Without patent monopolies, not only would we get cheap drugs, but we would get honest assessments of their benefits and risks.
The idea that for some reason we can’t have successful innovation without patent monopolies is frankly bizarre. The pathbreaking research in developing mRNA technology was done almost entirely on the government’s dime, as was the work by Moderna to develop a Covid-specific vaccine. We also have the example of a Covid vaccine developed on a shoe-string by Texas Children’s Hospital and Baylor University. We need to pay researchers for their work, but the idea that we can’t have successful innovation without the lure of earning hundreds of millions or even billions from a patent monopoly is absurd on its face.
Imagine a world where most drugs, including the latest breakthrough drugs, were selling for $10 or $20 a prescription. That would be the case without patent monopolies or related protections. The same would be true of medical equipment. The latest blood tests and scans would also almost all be cheap.
In this world, doctors could without hesitation prescribe the course of treatment that they considered to be best for their patient. We would not have moral dilemmas, like whether an otherwise healthy 80-year-old should be prescribed a cancer drug that costs $150,000 a year. Since the drug would likely only cost a few hundred dollars, or at most a few thousand, this would be a no-brainer. Of course you would prescribe the drug that might save their life.
The savings would be enormous. By my calculations, we would save around $400 billion a year ($3,000 per household) on prescription drugs if they all were sold in a free market without patent monopolies. We would need roughly $100 billion in additional spending to replace the research now supported by patent monopolies, but that would still leave us with savings of around $300 billion a year. That is more than one and half times the cost of the latest version of Build Back Better. If we are also covering the cost of developing medical equipment and tests, that would likely save us an additional $100 billion a year or so. In short, this is real money.
With these sorts of savings, we would be much of the way towards being able to pay for a universal Medicare system, like the one in Canada. Cutting out the insurance industry as a middleman would save us more than $300 billion a year. Also, getting doctors’ pay more in line with their pay in other wealthy countries could net us another $100 billion annually.[2]
Downsizing Patents and Copyrights More Generally
In addition to raising the price of everything from computers and software to video games and movies, patent and copyrights create a morass of legal issues that both raises costs for everyone and impedes the development of technology. It seems reasonable to minimize the role of these government-granted monopolies everywhere, as I describe in chapter 5 of Rigged. This means more public funding of research, with the cost of access for companies being that they have to accept much shorter patents (e.g. four to five years rather than twenty), with their patents being added to the public pool for the rest of the duration of the patent.
One major exception is innovations related to slowing climate change. Here it makes sense to have the same approach as with biomedical research, where we attempt to pool technology worldwide and have it available at no cost to whoever wants it. If China invests a huge amount to further increase its lead in clean energy and electric cars, that is not a threat to the United States, it is doing us and the world a favor.
The same story holds with every other country in the world. We want them to use the technology to lower their emissions. We shouldn’t be trying to keep it away from them with patent monopolies or related protections. This is just simple economics. If solar panels or batteries cost 20 to 30 percent less, because there is no charge for using patents, then businesses, governments, and households will be quicker to switch to clean energy.
The other area where it would be desirable to largely replace the patent/copyright system is with the funding of journalism and creative work more generally. The amount of money going to support newspapers under the current system has plummeted due to both the Internet and the growth of Facebook and Google. The same is true for recorded music, where current spending is a small fraction of what we saw two decades ago.
I have argued for a system of individual tax credits, modeled on the charitable contribution tax deduction, to support creative work. Under this system, every adult would get a modest sum (e.g. $150 a year) to support the creative worker(s) or creative organization (newspaper, blues music promoter etc.) of their choice. Any work produced through this system would be in the public domain and therefore not subject to copyright protection. A neat aspect of this proposal, in my view, is that enterprising politicians could experiment with it at the state and local levels.
Anyhow, if fully implemented, it could produce a vast amount of creative work that would be available at no cost to anyone with Internet access. It could also revitalize news organizations at the state and local level, which have been hugely downsized in the last quarter-century, or put out of business altogether.[3]
Applying Market Forces to CEO Pay: Getting Corporate Boards that Do Their Job
There has been considerable research in the last two decades showing that CEO pay bears little relationship to their performance in terms of producing returns for shareholders. A recent study surveyed corporate directors and found that the vast majority did not even see it as their job to contain CEO pay. Instead, they saw their role as supporting top management.
In that context, it’s not surprising that even mediocre CEOs can get paychecks in the tens of millions of dollars. After all, if you’re a director sitting on a huge pot of money in the form of the company’s annual revenue, why wouldn’t you dish out tens of millions to your friend, the CEO? This attitude might explain how boards can give out lavish pay packages even when it’s against the explicit wishes of shareholders.
It is important to recognize that the issue with bloated CEO pay is not just one person getting $20 or $30 million (and sometimes considerably more), it is a whole pay structure that follows from the outsized pay for the CEO. If the CEO is earning $20 million, then it’s likely the chief financial officer and other top-tier executives are earning in the range of $8 to $12 million. The third-tier executives can easily be making $2 or $3 million.
This sort of pay structure also has an impact outside of the corporate sector. It is common for presidents of large foundations and charities or major universities to get paid well over $1 million a year. And, the next echelon at these institutions often get paid in the high six figures.
If we go back to the sixties and seventies, the CEO of a major company would typically get paid twenty or thirty times as much as an ordinary worker. That would translate into $2 million to $3 million a year today. If CEOs were currently getting pay in this neighborhood, we would see correspondingly lower pay for other top management in the corporate sector and elsewhere.
Instead of getting well over $1 million a year, maybe the president of a major university would draw pay in the high hundreds of thousands. And the provost and deans would be in the middle six figures. That would mean a radically different pattern of income distribution with a lot more money available to those lower down the pay ladder.
It is common for policy types to accept the outlandish pay of CEOs and other top-level executives as simply market outcomes. But this view is hard to justify when we recognize that there is no one placing downward pressure on the pay of these people in the same way that these top-level people put downward pressure on the pay of ordinary workers.
It is a standard for economists to put lots of faith in the “invisible hand” of the market, but in the case of restraining the pay of CEOs and others at the top of the pay ladder, that hand really is invisible.
Pay for Performance in the Financial Industry?
The list of the country’s top earners is heavily populated with hedge fund and private equity partners, who typically pocket millions of dollars a year, and can sometimes earn tens of millions or even hundreds of millions. The rationale for these huge paychecks is that they are providing outsized returns for investors, which both makes money for investors and steers capital to its best uses.
There are lots of bad stories about what hedge funds and especially private equity funds do with their money. They are notorious for downsizing and often bankrupting firms, laying off workers, stealing pensions, and leaving creditors empty-handed. In this story, creditors include not only knowing lenders like banks and bondholders, but also unintentional creditors like suppliers and landlords. They also are notorious for gaming the tax code.
But even apart from their dubious business practices, there is an even more basic issue with hedge funds and private equity funds: they don’t produce returns for shareholders. In prior decades, investors in these funds could count on beating a stock index fund, often by a large margin. The margin is appropriate since these are highly illiquid investments (money is typically locked in for a decade) and there is considerably more risk than with a stock index fund.
However, this is no longer true. In recent years, returns to investors on the typical hedge fund and private equity fund trailed a stock market index. This means that pension funds actually lost money by investing a portion of their assets with private equity funds rather than a stock market index. Similarly, many universities lost money by having a large portion of their endowment managed by hedge funds.
It shouldn’t be a radical demand to the presidents of Harvard and other schools with huge endowments that they not pay big bucks to investment managers to lose them money. For some reason, it doesn’t seem like anyone has taken up that cause.
It is possible to structure contracts so that these managers only do get big payouts if they actually produce above-normal returns to pensions or universities. Contracts differ across institutions, but a standard pattern in years past was to pay fund managers 2 percent of the money being managed each year, and then 20 percent of returns over some target, such as the S&P 500. In this story, if a hedge fund was managing $1 billion of Harvard’s endowment, they would get paid $20 million a year, even if their investments trailed the S&P 500. That is a lot of money to pay to lose money.
Pension funds and universities can structure their contracts so that the entire payment is dependent on beating a threshold. In that case, if a fund trailed the S&P 500, they would get nothing. (There can be a clause that ensures everyone who worked for the fund gets the minimum wage for the time they put in. We wouldn’t want to undermine labor laws.) Some private equity and hedge funds would balk at this sort of arrangement, but if these fund managers don’t have confidence in their own ability to beat the market, why should institutions risk money with them?
There are many other areas where we have large amounts of economic waste in finance, which persists because rich people are pocketing this waste. For example, we could have the Fed give every person and business a digital account from which they could conduct normal business transactions, such as getting their paycheck and paying their bills. This would save us tens of billions of dollars annually in banking fees. But, that would mean less money for people in the financial industry.
There is a similar story with retirement accounts. It is common for the financial industry to charge people with 401(k)s or IRAs 1-2 percent of the money in their accounts each year as an administration fee. This means that if you have $100,000 in a 401(k), the bank, brokerage house, or insurance company that manages it could be charging you $1,000 to $2,000 a year. This can be in addition to the fees charged by specific funds, which also can be as high as 1 percent.
These fees can be radically reduced if the government offered a public option similar to the Federal Employees Thrift Saving Plan. The fee for that fund is around 0.1 percent annually. Many states have already taken the initiative to begin to allow workers in the private sector to have money invested by their public worker pension fund managers.
We can also do a lot to downsize the financial industry with a modest financial transactions tax. A fee of 0.1 percent would eliminate a huge amount of wasteful transactions while having virtually no impact on productive investment. It would also radically reduce the money going to high-frequency traders and others engaged in speculative trading.
Making the World Safe and Good for Ordinary Workers
The sort of restructuring of the market described here would mean much less money going to the rich and very rich. That means they will be pulling away fewer resources for lavish lifestyles since their lifestyles would have to be somewhat less lavish. That leaves more money for everyone else.
I wrote a piece last year pointing out that in the three decades from 1938 to 1968, the minimum wage not only kept pace with prices, it also rose in step with productivity. This means that as the country got richer, so did the workers at the bottom rungs of the wage ladder.
In the years since 1968, the minimum wage has not even kept pace with prices, so that a worker getting $7.25 an hour in 2022 can buy far less than a worker earning the minimum wage in 1968. However, if the minimum wage had continued to keep pace with productivity growth, it would have been more than $23 an hour in 2021.
Imagine a country where the lowest-paid full-time worker was pocketing more than $46,000 a year and a two-earner couple would have more than $92,000 a year, even if both were just getting the minimum wage. This is not possible in our world, where the economy has been deliberately structured to send so much income to those at the top, but we should never forget that this is a policy choice.
We have implemented a set of policies that give large amounts of money to people in a position to benefit from patent and copyright monopolies, to CEOs and other top management, and to a favored few in the financial industry. These groups will fight like crazy to prevent these policies from being reversed.
But, the first step in the battle is recognizing they rigged the deck. Don’t let them ever get away with saying that it was just the natural workings of the market.
[1] It also helps that it is typically a deep-pocketed third-party payer, like an insurance company or the government, so drug companies don’t have to convince patients of the value of their drugs.
[2] I calculate the savings and costs involved in getting to a universal Medicare program here.
[3] I have also proposed radically restructuring Section 230 protection, taking it away from sites that sell personal information or accept advertising. This should have the effect of downsizing Facebook and other sites that operate along similar lines.
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