Free Markets and Freedom

My thoughts above emphasize our anchoring loves. Nurturing these loves is a signal imperative, for they give us firm ground on which to stand. But there is also an economic dimension to restoring the American culture of freedom. A person who can earn a decent living, providing for his needs and those of his family while saving a bit of money, enjoys civic autonomy. It’s not just a matter of feeling self-sufficient. A man of means, even modest means, can stand against the powerful forces in society, even against the oligarchs who are ever eager to gather power to themselves. Thomas Jefferson sang the praises of the yeoman farmer. He recognized that a free society requires broad-based prosperity such as can sustain an independent middle class capable of saying “no.”

It was with that thought in mind that I read Erik Peinert’s recent article in American Affairs (Summer 2023), “Intellectual Property and the Fissured Economy.” The notion of fissure concerns a recent development in the American economy.

From the Gilded Age through the postwar years, the wealthiest individuals and most powerful corporations integrated capital, innovation, and large-scale employment. U.S. Steel was exemplary. In early 1901, J. P. Morgan created the company by merging the Carnegie Steel Company (then the largest steel maker) with other steel companies. U.S. Steel employed an army of men, peaking at more than 300,000 during World War II. The Ford Motor Company led automotive innovation, and it employed nearly 200,000 workers on the eve of the Great Depression.

Peinert notes how different are today’s leading corporations. Apple is the world’s most valuable company. In 2019 it had fewer than 100,000 employees, “many of whom were highly compensated design, software, and marketing professionals.” In nearly every instance, the company outsources the production of its products.

The example of Apple is telling. Over the last generation, the market has preferred companies that are expertise-intensive and employee-lean. This separation of corporate success from large ranks of employees is what Peinert means by “fissure.” It’s not simply a consequence of globalization, which allows companies to take advantage of lower-wage workers abroad while avoiding the costly benefits required for American workers, our thick net of labor regulations, and the danger of unionization. Rather, as Peinert shows, the fissure of corporate profitability from large-scale employment has been made possible by our laws protecting intellectual property and by the prevailing interpretation of our antitrust laws.

Peinert walks the reader through a series of court decisions, legislative acts, and international efforts that, beginning in the 1970s, expanded the value of intellectual property. He emphasizes the way in which the current legal regime, unlike earlier antitrust approaches, allows owners of intellectual property to impose very restrictive terms and conditions on those who license their IP. In consequence, a firm like Apple can build out contractor networks for production that are effectively under its control without assuming the liability of hiring employees or deploying capital to build the factories.

All of this can sound technical and abstract, and it is. Peinert’s discussion of the evolution of antitrust law will be best understood by legal experts. But the basic point is not difficult to grasp. Three factors go into economic success: innovation, capital, and labor. Someone must have a valuable idea, one that promises competitive advantage. Someone must build the physical infrastructure necessary to put the idea to use. And someone must hire, manage, and pay the workers to use the physical infrastructure to realize the idea as a product or service. The greater share of the profits will go to the person who does one or another of these functions at the lowest relative cost.

On its face, coming up with the idea seems like the winner, since new ideas are “free,” whereas capital is scarce, and managing and paying people is difficult and expensive. But the reality is otherwise. Ideas are vulnerable. They can be imitated, developed, and exploited by others. The signal purpose of establishing a law of patents was to protect the value of innovations.

Significant enhancements of IP protection have been undertaken in recent decades. These changes have dramatically lowered the costs of possessing valuable new ideas, as compared to the costs that obtained in earlier eras of capitalism. (Costs have fallen because the length of time in which one possesses the right of property and the opportunities to use it in exclusive and profitable ways have increased. Thus the sunk cost of coming up with the idea—paying scientists, for example, or building a laboratory—declines relative to the value of the innovation.) Therefore, Economics 101 tells us that profits will flow toward owners of valuable IP and, along with profits, investor capital. Thus Apple’s status as the world’s most valuable company, with tens of billions of dollars in cash reserves.

Econ 101 likewise tells us that profits will decline for investors in the plants or other physical requirements for putting these valuable ideas into production. Profits will decline also for those tasked with managing and paying employees. With declining profits, it follows that investor capital will dry up for companies that fulfill these essential economic functions. Fewer factories will be built, and fewer ambitious business school graduates will go into the management of productive processes. In short, we get the last forty years: a Silicon Valley gold rush and Middle American rust belts.

Most commentators explain deindustrialization by pointing to trade deals and globalization. Peinert helps us to see that the availability of cheap labor abroad is only part of the story, and perhaps not the most significant part. Judges, regulators, and lawmakers made decisions in the 1980s and 1990s that altered the value of the key factors in our free-market economy, increasing profits for IP and lowering them for capital investments and large-scale employment. These changes inevitably affected our society. Manufacturing and other capital- and employee-intensive activities were as much driven abroad by market fundamentals in the United States—market fundamentals deliberately created by policy makers—as they were lured there by low-cost labor and mercantilist foreign governments willing to direct capital toward manufacturing. In a real sense, our rigorous IP laws and lax antitrust enforcement made China into the world’s factory.

Count me among those exasperated by many “free market” proponents. They cheer market principles while ignoring the ways in which those principles function in reality. Intellectual property, unlike real property, is entirely a creature of government policy. It has no basis in the common law (again, unlike real property). Our maximalist protections of intellectual property and lax interpretations of antitrust are the result of policy judgments. The last generation was persuaded by prudential arguments that our present arrangements are most likely to promote the common goods of technological innovation and material prosperity. Today’s IP laws and antitrust interpretations were not deduced from “market principles,” any more than were our trade deals, tax rates, and many other economic rules of the road.

It’s 2023, not 1980. It’s time to take the full measure of our deindustrialized economy and count the social costs it has imposed on the common man. These costs are not simply a matter of income inequality. They also concern the health of the body politic, which has been damaged by the erosion of middle-class prosperity, a crucial foundation for a free society. After we count the costs, we need to revisit the prudential arguments that brought us to this juncture. Perhaps the wisest way forward is to increase the cost of holding intellectual property by reducing its protection and tightening antitrust limits. This course of action, taken by legislators, judges, and regulators, will not entail “violations” of free-market principles, any more than raising or lowering capital gains taxes is a “violation” of free-market principles. Saying that it would is an ideological mystification.