Posted by: bmeverett | June 15, 2009

Capitalists against Capitalism


Last week I reluctantly sold my stock in General Electric. Not that I owned much. I bought 700 shares in 1995 at a cost of $10.50 per share. When the share price hit $60 in September of 2000, I will admit to feeling pretty good about my investment prowess. By February of 2003, the price was down to $22 a share – disappointing, but still not bad for my original investment. Over the next four years, GE clawed its way back to over $40 a share before collapsing in the recent financial crisis to a low of $7 in March of 2009. I sold the stock at $13.50 per share, earning with accumulated dividends about 5% annual return – pretty much what I could have earned on a zero risk CD.
Maybe the long decline was due to the retirement of the famous GE Chairman Jack Welch, maybe not. GE’s heavy exposure to banking, insurance and real estate was undoubtedly a critical mistake, but GE’s core businesses in jet engines, industrial machinery and consumer appliances are still pretty strong.
Jack Welch’s successor Jeff Immelt, however, made a strategic decision to turn the company from a market-based industrial giant to what’s known in economics as a “rent seeker.” Rent seeking is a simple concept. Instead of competing actively with other companies for the consumer’s dollar through product quality, innovation, cost control and sound management, “rent seekers” go hat in hand (or more likely dollars in hand) to government and ask for special treatment that allows them to avoid competition.
The best example today is New York City taxi medallions. By law, you may not operate a taxi in New York City unless you are in possession of a special license, known as a medallion. The purpose of this odd system is to limit the availability of taxis. Don’t ask me why in the world that’s a good idea. This process is not the same as safety checks or standards or driver competency testing, and the medallions are owned by individuals, not by the city. In other words, if you want to operate a taxi in New York, you must purchase a medallion not from the city but from some private individual willing to sell you his. The most recent price for a medallion? $600,000! While the previous owner of the medallion heads to the beach with his money, the new owner has to recover its cost from passengers through the fares he charges. The city sets the fares to permit this to happen. It’s easy to understand why taxi owners like this system. It’s much harder to understand why the people of New York tolerate it. In London, by contrast, anyone can own a taxi, but in order to drive a taxi, you must pass a rigorous test known as “the knowledge” covering the streets, landmarks, hospitals, etc. so that the driver actually knows where he is going.
Rent seekers generally don’t admit publicly that they are trying to extract money from the public through monopolistic practices. Instead, they generally talk about the need for regulations promoting safety, fairness, good order, etc. Public school teachers lobby legislatures for strict certification procedures – ostensibly to ensure that our children are taught by competent teachers, but really to limit the supply of teachers in order to support higher salaries. This system explains the higher salaries paid to public teachers compared to teachers in even the best private schools.
The latest twist on rent seeking is environmentalism. GE calls its program “ecomagination,” and describes it as “helping to solve the world’s biggest environmental challenges while driving profitable growth for GE.” Sounds great, and much of what GE is doing makes sense: becoming more efficient, reducing energy use and developing new products.
But GE goes beyond these common sense concepts. GE is, for example, one of the world’s premier manufacturers of wind turbines for the production of electricity. There’s no question that GE’s wind machines are of excellent quality. They should be, since GE has been making turbines for over 100 years. The problem is that wind power is very expensive compared to coal or natural gas, and it’s available when nature gives it to us, not when we need it. In a free market, nobody would buy wind turbines. No problem, simply go to Washington and encourage the government to force people to buy wind power. That eliminates the need to develop and produce products that people actually want. The same is true for GE’s solar energy products – no market without government mandates and subsidies.
Jeff Immelt has become a strong supporter of Barack Obama, the most anti-free market president since FDR, and serves on Obama’s Stimulus Advisory Board, a group which supports the mess known as the “stimulus package.” Perhaps Immelt is really a Keynesian at heart, but it seems to me more likely that he is salivating over the huge pork spending for green energy and infrastructure, some of which will find its way to GE. Immelt is also a strong supporter of carbon “cap and trade” which will further bolster markets for many GE products, like wind turbines. We can expect the same from the health care debate. GE is a major manufacturer of medical equipment and would, I’m sure, be happy to have the government throw money its way as part of the nationalization of our health care system.
GE’s behavior underscores an interesting aspect of American history: capitalists do not always support capitalism. John D. Rockefeller, founder of Standard Oil and the prototypical 19th century robber baron, had disdain for free markets, preferring instead cartels to control production and regulate prices, thereby bringing “order” to markets. Many American corporations support protectionist measures in their industries to reduce foreign competition, although they tend to be free marketers when it comes to their suppliers. One (and probably the primary) cause of our recent financial troubles was the happy acquiescence of major banks in the issuing of sub-prime loans which were then quickly resold to Fannie Mae and Freddie Mac, allowing the bank to keep generous fees while dumping the risks on the American taxpayer.
I have been at many a discussion of climate change over the last several years at which climate change advocates pointed proudly to industry support for cap and trade. The United States Climate Action Partnership, for example, includes, in addition to GE, Alcoa, BP, Ford, Johnson & Johnson, GM, Chrysler, Dupont, Pepsi, Shell and Dow Chemical, all calling on Washington to “quickly enact strong national legislation to require significant reductions of greenhouse gas emissions.” Maybe these companies have a sincere belief in the need to address climate change or perhaps they believe they can improve their public image by associating with green causes. Maybe, just maybe, however, some of these companies see an opportunity to profit from the complex and costly government regulations that will inevitably accompany cap and trade. Hold on to your wallets.
A few weeks ago, President Obama held a press conference to announce his new vehicle efficiency standards. With him on the podium were the US car companies and several environmental groups. This gathering is intended to show what in Washington is called “a consensus.” The only people not present were consumers, who will of course foot the bill for these costly new regulations.
Politicians from the left side of the American political spectrum like to portray free markets as working primarily for the benefit of corporations and investors. In reality, the real beneficiaries of the free market, and the people who ought to defend it most vociferously, are average people who enjoy the benefits of competition through low prices and product innovations geared toward consumer wishes. Corporations don’t always like free markets which require hard work, risk and competition. Easier to get the government on your side.
That’s why I am so disappointed in GE and have divested myself of my tiny shareholding.

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Responses

  1. Professor Everett,

    You’re starting to sound like a proponent of SRI, except your concept of SRI might differ from, say, Domini. 🙂

    I chuckle when it comes to equity because, as I see it, the point of owning shares in a company is to make money. And if GE can make money by tapping the government, more power to them.

    That seems to be the way the American system works…and has always worked, regardless of administration or legislative makeup. Railroads, steel, agribusiness, homebuilders, airlines, military suppliers and virtually every other sector have lined up to take money or subsidies when it has been offered over the years. Further, as with GE, all of those industries have lobbied to give themselves an edge of one description or another.

    I imagine you would argue that shareholder value and consumer options would both be better realized market-wide if the market were unfettered (negative externalities notwithstanding) and allowed to eliminate poor choices and promote better choices. While it might be true, it just seems unlikely, given the history of markets and governments.

    Ultimately, I doubt there is a publicly traded company that wouldn’t behave the same way. Divesting shares accordingly might take you out of the market entirely. Perhaps one should expect firms to wrest taxpayer money away from the government and purchase shares in those firms that are best at it. :))

    On a more serious note, how do you feel about crude at $70 with global inventories near record highs and 6 mbd of spare capacity?

    Hope all is well.

    • You are quite right that rent seeking is a common practice in the US. I am, however, wary of companies whose profitability depends entirely on government subsidies. GE seems to be heading in that direction. What the government giveth, the government can take away.

  2. The former taxi owner, far from heading to the beach, actually uses the money to pay off his medallion loan, on which he has been paying interest all these years. The true rent-seekers in this situation are not the owners, most of whom are individual drivers, but the banks.

    Taxi medallions are essentially artificial real estate, and while it’s possible to make money dealing in real estate, the vast majority of people who actually buy and sell it (as opposed to brokering those sales, or such) are just looking for a place to live.

    • I certainly agree that the value of a taxi medallion is artificial. That was my point. If you bought one of these medallions in 2004, you paid about $300,000. Most recent value (updated since my post) was $766,000. A nice return over 5-years and plenty of money to go to the beach. This gives the tax companies a HUGE incentive to lobby hard for as few taxi medallions as possible – pure rent seeking which makes the life of New York’s citizens less convenient and more expensive.


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