Posts Tagged ‘mergers’

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Kevin Hassett and the other members of the president’s Council of Economic Advisers are just like the long-haired preachers Joe Hill sang about more than a century ago. They come out every night to tell us what’s wrong and what’s right. But when asked about something to eat, they answer in voices so sweet:

You will eat, bye and bye
In that glorious land above the sky
Work and pray, live on hay
You’ll get pie in the sky when you die.
That’s a lie

With one notable exception: according to the Council (pdf), that “glorious land above the sky” lies just on the other side of the Trump administration’s proposed tax reform. And workers, whose real wages have stagnated for decades now, won’t have to die to receive their pie in the sky.

Reducing the statutory federal corporate tax rate from 35 to 20 percent would. . .increase average household income in the United States by, very conservatively, $4,000 annually. The increases recur each year, and the estimated total value of corporate tax reform for the average U.S. household is therefore substantially higher than $4,000. Moreover, the broad range of results in the literature suggest that over a decade, this effect could be much larger.

There’s no other way to put it. That’s a lie.

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As is clear from this chart, both corporate profits (the red line) and investment (the blue line) have soared in recent decades. There’s simply been no shortage of investment or investment funds, either from retained earnings or in terms of money borrowed from financial institutions. At the same time, the wage share of national income (the green line in the chart) has fallen precipitously.

So, even if cutting corporate tax rates (and thus permitting higher retained earnings) did lead to more investment, there’s no guarantee workers’ wages would increase as a result. They haven’t for decades now. Why should that change in the future?

Moreover, there’s no guarantee higher retained earnings would lead to more investment. Just as likely (perhaps even more so), corporations would be able to use their profits for other purposes—including higher CEO salaries, increased dividends to stockholders, more stock buybacks, and a higher rate of mergers and acquisitions—which have nothing to do with raising workers’ wages.

The only result would be more corporate power and more obscene levels of inequality in the United States.

And that’s no lie.

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The capitalist machine is broken—and no one seems to know how to fix it.

The machine I’m referring to is the one whereby the “capitalist” (i.e., the boards of directors of large corporations) converts the “surplus” (i.e., corporate profits) into additional “capital” (i.e., nonresidential fixed investment)—thereby preserving the pact with the devil: the capitalists are the ones who get and decide on the distribution of the surplus, and then they’re supposed to use the surplus for investment, thereby creating economic growth and well-paying jobs.

The presumption of mainstream economists and business journalists (as well as political and economic elites) is that the capitalist machine is the only possible one, and that it will work.

Except it’s not: corporate profits have been growing (the red line in the chart above) but investment has been falling (the blue line in the chart), both in the short run and in the long run. Between 2008 and 2015, corporate profits have soared (as a share of gross domestic income, from 3.9 to 6.3 percent) but investment has decreased (as a share of gross domestic product, from 13.5 to 12.4 percent). Starting from 1980, the differences are even more stark: corporate profits were lower (3.6 percent) and investment was much higher (14.5 percent).

The fact that the machine is not working—and, as a result, growth is slowing down and job-creation is not creating the much-promised rise in workers’ wages—has created a bit of a panic among mainstream economists and business journalists.

Larry Summers, for example, finds himself reaching back to Alvin Hansen and announcing we’re in a period of “secular stagnation”:

Most observers expected the unusually deep recession to be followed by an unusually rapid recovery, with output and employment returning to trend levels relatively quickly. Yet even with the U.S. Federal Reserve’s aggressive monetary policies, the recovery (both in the United States and around the globe) has fallen significantly short of predictions and has been far weaker than its predecessors. Had the American economy performed as the Congressional Budget Office fore­cast in August 2009—after the stimulus had been passed and the recovery had started—U.S. GDP today would be about $1.3 trillion higher than it is.

Clearly, the current recovery has fallen far short of expectations. But then Summers seeks to calm fears—”secular stagnation does not reveal a profound or inherent flaw in capitalism”—and suggests an easy fix: all that has to happen is an increase in government-financed infrastructure spending to raise aggregate demand and induce more private investment spending.

As if rising profitability is not enough of an incentive for capitalists.

Noah Smith, for his part, is also worried the machine isn’t working, especially since, with low interest-rates, credit for investment projects is cheap and abundant—and yet corporate investment remains low by historical standards. Contra Summers, Smith suggests the real problem is “credit rationing,” that is, small companies have been shut out of the necessary funding for their investment projects. So, he would like to see policies that promote access to capital:

That would mean encouraging venture capital, small-business lending and more effort on the part of banks to seek out promising borrowers — basically, an effort to get more businesses inside the gated community of capital abundance.

Except, of course, banks have an abundance of money to lend—and venture capital has certainly not been sitting on the sidelines.

Profitability, in other words, is not the problem. What neither Summers nor Smith is willing to ask is what corporations are actually doing with their growing profits (not to mention cheap credit and equity funding via the stock market) if not investing them.

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We know that corporations are not paying higher taxes to the government. As a share of gross domestic income, they’re lower than they were in 2006, and much lower than they were in the 1950s and 1960s. So, the corporate tax-cuts proposed by the incoming administration are not likely to induce more investment. Corporations will just be able to retain more of the profits they get from their workers.

But corporations are distributing their profits to other uses. Dividends to shareholders have increased dramatically (as a share of gross domestic income, the green line in the chart at the top of the post): from 1.7 percent in 1980 to 4.6 percent in 2015.

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Corporations are also using their profits to repurchase their own shares (thereby boosting stock indices to record levels), to finance mergers and acquisitions (which increase concentration, but not investment, and often involve cutting jobs), to raise the income and wealth of CEOs (thus further raising incomes of the top 1 percent and increasing conspicuous consumption), and to hold cash (at home and, especially, in overseas tax havens).

And that’s the current dilemma: the machine is working but only for a tiny group at the top. For everyone else, it’s not—not by a long shot.

We can expect, then, a long line of mainstream economists and business journalists who, like Summers and Smith, will suggest one or another tool to tinker with the broken machine. What they won’t do is state plainly the current machine is beyond repair—and that we need a radically different one to get things going again.

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Back in 2010, Charles Ferguson, the director of Inside Job, exposed the failure of prominent mainstream economists who wrote about and spoke on matters of economic policy to disclose their conflicts of interest in the lead-up to the crash of 2007-08. Reuters followed up by publishing a special report on the lack of a clear standard of disclosure for economists and other academics who testified before the Senate Banking Committee and the House Financial Services Committee between late 2008 and early 2010, as lawmakers debated the biggest overhaul of financial regulation since the 1930s.

Well, economists are still at it, leveraging their academic prestige with secret reports justifying corporate concentration.

That’s according to a new report from ProPublica:

If the government ends up approving the $85 billion AT&T-Time Warner merger, credit won’t necessarily belong to the executives, bankers, lawyers, and lobbyists pushing for the deal. More likely, it will be due to the professors.

A serial acquirer, AT&T must persuade the government to allow every major deal. Again and again, the company has relied on economists from America’s top universities to make its case before the Justice Department or the Federal Trade Commission. Moonlighting for a consulting firm named Compass Lexecon, they represented AT&T when it bought Centennial, DirecTV, and Leap Wireless; and when it tried unsuccessfully to absorb T-Mobile. And now AT&T and Time Warner have hired three top Compass Lexecon economists to counter criticism that the giant deal would harm consumers and concentrate too much media power in one company.

Today, “in front of the government, in many cases the most important advocate is the economist and lawyers come second,” said James Denvir, an antitrust lawyer at Boies, Schiller.

Economists who specialize in antitrust — affiliated with Chicago, Harvard, Princeton, the University of California, Berkeley, and other prestigious universities — reshaped their field through scholarly work showing that mergers create efficiencies of scale that benefit consumers. But they reap their most lucrative paydays by lending their academic authority to mergers their corporate clients propose. Corporate lawyers hire them from Compass Lexecon and half a dozen other firms to sway the government by documenting that a merger won’t be “anti-competitive”: in other words, that it won’t raise retail prices, stifle innovation, or restrict product offerings. Their optimistic forecasts, though, often turn out to be wrong, and the mergers they champion may be hurting the economy.

Right now, the United States is experiencing a wave of corporate mergers and acquisitions, leading to increasing levels of concentration, reminiscent of the first Gilded Age. And, according to ProPublica, a small number of hired guns from economics—who routinely move through the revolving door between government and corporate consulting—have written reports for and testified in favor of dozens of takeovers involving AT&T and many of the country’s other major corporations.

Looking forward, the appointment of Republican former U.S. Federal Trade Commission member Joshua Wright to lead Donald Trump’s transition team that is focused on the Federal Trade Commission may signal even more mergers in the years ahead. Earlier this month Wright expressed his view that

Economists have long rejected the “antitrust by the numbers” approach. Indeed, the quiet consensus among antitrust economists in academia and within the two antitrust agencies is that mergers between competitors do not often lead to market power but do often generate significant benefits for consumers — lower prices and higher quality. Sometimes mergers harm consumers, but those instances are relatively rare.

Because the economic case for a drastic change in merger policy is so weak, the new critics argue more antitrust enforcement is good for political reasons. Big companies have more political power, they say, so more antitrust can reduce this power disparity. Big companies can pay lower wages, so we should allow fewer big firms to merge to protect the working man. And big firms make more money, so using antitrust to prevent firms from becoming big will reduce income inequality too. Whatever the merits of these various policy goals, antitrust is an exceptionally poor tool to use to achieve them. Instead of allowing consumers to decide companies’ fates, courts and regulators decided them based on squishy assessments of impossible things to measure, like accumulated political power. The result was that antitrust became a tool to prevent firms from engaging in behavior that benefited consumers in the marketplace.

And, no doubt, there will be plenty of mainstream economists who will be willing, for large payouts, to present the models that justify a new wave of corporate mergers and acquisitions in the years ahead.

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Much of the debate about the U.S. healthcare system is focused on the role of public financing (in terms of subsidies and, for some, the possibility of a public option or even a single-payer program). But no one seems to want to look at the other key part, the actual delivery of healthcare to American workers and others. And that, regardless of the system of financing, remains mostly in profit-oriented private hands (which, as I argued earlier this year, undermines patient-centered healthcare).

There are a few exceptions, such as the Veterans Health Administration and Indian Health Service, whereby the government directly employs nurses, physicians, and others to provide health services to targeted populations. But the rest of healthcare is provided by private  (profit and nominally nonprofit) individuals, groups, and corporations.

As I discussed on Friday, a significant sector of private healthcare is the increasingly concentrated and enormously profitable pharmaceutical industry. Hospitals (which I’ve commented on many times over the years) are, of course, another key sector (at close to $1 trillion in 2014). That’s where Americans receive most of their in-patient care, critical care (including many without health insurance in emergency rooms), and an increasing number of out-patient treatments. And while hospitals appear to be independent from and non-overlapping with physicians (whose services accounted for roughly $600 billion in 2014), that’s an optical illusion. Not only do they compete with one another (in surgery, imaging, and other ambulatory services), each is forced to work closely with the other: hospitals rely on physicians to admit patients to their facilities, refer to their specialists, and to use their lucrative diagnostic services (with, as it turns out, illegal kickbacks), while physicians tend to their own patients within hospitals and are contracted for “in-house” supervision. And, increasingly, hospitals are directly employing physicians (and other healthcare workers) as salaried and piece-rate workers.

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U.S. hospitals are, as it turns out, remarkably profitable. And, according to a recent analysis by Ge Bai and Gerard F. Anderson (unfortunately gated), 7 of the 10 of the most profitable hospitals (each exceeding more than $163 million in total profits from patient care services) are officially non-profit institutions.

According to Anderson,

The system is broken when nonprofit hospitals are raking in such high profits. The most profitable hospitals should either lower their prices or put those profits into other services within the community. We need to develop incentives that allow all hospitals to make a fair profit while at the same time keeping prices reasonable.

It’s true, many other hospitals (56 percent in their sample of acute-care facilities) are not profitable strictly in terms of patient services (the median hospital lost $82 per adjusted patient discharge). However, as the authors explain,

the median overall net income from all activities per adjusted discharge was a profit of $353, because many hospitals earned substantial profits from nonoperating activities—primarily from investments, charitable contributions (in the case of nonprofit hospitals), tuition (in the case of teaching hospitals), parking fees, and space rental. It appears that nonoperating activities allowed many hospitals that were unprofitable on the basis of operating activities to become profitable overall.

The most important factors boosting hospital profitability were markups (especially for uninsured and out-of-network patients and casualty and workers’ compensation insurers who often pay the hospital’s full charge) and the combination of system affiliation and regional power.

In fact, 50 hospitals in the United States are charging uninsured consumers more than 10 times the actual cost of patient care. All but one of the facilities are owned by for-profit entities. Topping the list is North Okaloosa Medical Center, a 110-bed facility in the Florida Panhandle about an hour outside of Pensacola, where uninsured patients are charged 12.6 times the actual cost of patient care. Community Health Systems operates 25 of the hospitals on the list. Hospital Corporation of America operates 14 others.

Again according to Anderson:

They are price-gouging because they can. They are marking up the prices because no one is telling them they can’t. These are the hospitals that have the highest markup of all 5,000 hospitals in the United States. This means when it costs the hospital $100, they are going to charge you, on average, $1,000.

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It should come as no surprise, then, that, while the total number of hospitals has remained relatively constant over time, the number of those hospitals in health systems has continued to increase, thereby increasing regional power, markups, and profitability.

In another recent study, by Richard M. Scheffler et al., the authors found that the hospital markets in two states (California and New York) “were moderately to highly concentrated,” with mean Herfindahl-Hirschman indices of 2,259 and 3,708, respectively.* They also found that more concentrated hospital markets were associated with higher premium growth.

As expected, then, there is a continuing strong movement of hospital mergers and acquisitions—with at least 100 deals covering 178 hospitals, involving the takeover of profit and especially non-profit organizations, in 2014—leading to increased concentration in the hospital sector of the U.S. healthcare industry.

As Martin Gaynor explains,

There has been so much consolidation that most urban areas in the US are now dominated by one to three large hospital systems — examples include Boston (Partners), the Bay Area (Sutter), Pittsburgh (UPMC), and Cleveland (Cleveland Clinic, University Hospital). It is also now more likely that further consolidation will combine close competitors, given how many mergers have already occurred.

Clearly, the provision of healthcare through U.S. hospitals—both profit and, at least officially, non-profit—is generating enormous profits for their owners and top executives. But it’s Americans workers, who are both hospital employees and consumers of hospital services, who are paying the price.

 

*To remind readers, the Herfindahl-Hirschman Index is often used to evaluate the potential antitrust implications of acquisitions and mergers across many industries, including health care. It is calculated by summing the squares of the market shares of individual firms. Markets are then classified in one of three categories: (1) nonconcentrated, with an index below 1,500; (2) moderately concentrated, with an index between 1,500 and 2,500; and (3) highly concentrated, with an index above 2,500.

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One thing is clear in the current conjuncture: corporate investment in capital equipment is declining, and it’s dragging overall economic growth and labor productivity down with it.

In the second quarter of 2016, the U.S. economy grew at an annual rate of only 1.2 percent, which caught business commentators and Wall Street analysts by surprise. They expected something closer to 2.6 percent. And while consumer spending continued to increase (at at rate of 4.2 percent in the second quarter), business investment fell (at a 2.2 percent pace), and companies ran down inventories for the fifth consecutive quarter.

So,  what’s going on?

Given the centrality of business investment to capitalist growth, you’d think the business press would have a cogent, carefully elaborated analysis of why it’s declining during the current recovery.

Well, they don’t. All they can do is invoke their usual hand-waving gesture, “political uncertainty,” as the underlying cause. Political uncertainty is blamed for the slowdown in mergers and acquisitions and for sputtering business investment.

Most CEOs will be risk-averse and conservative with their balance sheets until they see signs of a growth rebound, even though they’re sitting atop piles of cash and the cost of capital is at all-time lows. They will also hold off investing until they have a better sense of the future tax and regulatory burdens they are likely to face next year.

Yes, there is a high degree of political uncertainty (in the United States, the United Kingdom, and elsewhere). But that doesn’t explain corporate behavior, especially their investment decisions.

One can just as easily reverse the argument: Political realities have to respond to corporate decisions (especially when growth is slowing). And the slowing of economic growth itself is a consequence of the corporate decisions to curtail private nonresidential fixed investment.

The alternative explanation is that corporations are responding quite certainly to their own market signals. First, they’re choosing to substitute labor for capital, given depressed wage growth around the globe.

“Instead of buying an expensive piece of machinery, businesses are hiring really cheap workers they can fire whenever they want,” said Megan Greene, chief economist at Manulife Asset Management.

And they’re reacting to the decline in their own index of success and failure, the corporate profit rate (which, as one can see in the chart of the top of the post, has been falling during the last two years).

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It’s not that corporations are doing nothing: they are engaged in massive mergers and acquisitions (just not at the same pace of 2015) and they’re using the profits they’ve accumulated since the recovery began to increase dividends, buy back stock, and reward their top managers.

So, is capital on strike? The Wall Street Journal suggests it is: “The investment plunge is a signal that business is on strike.”

And, given the way the economy is currently organized, the rest of us are forced to endure the consequences of capital’s decision to do whatever is necessary to restore its profitability.

David Simonds cartoon showing oil firms preparing for mergers

Special mention

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According to the Wall Street Journal,

Takeovers are booming as companies gain more confidence about the economy, use stockpiles of cash to reach for future growth and get boosts from low interest rates and the surging stock market.

At the current pace, mergers-and-acquisitions volume for the full year would exceed $3.7 trillion, making it the second-biggest year in history after 2007. Among the deals proposed or announced so far this year, 15 are valued at more than $10 billion, the highest such number on record, says Dealogic.

As we know, these deals may boost corporate profits but will do nothing to create new jobs, much less stem the rise in inequality in the United States. They’re likely, in fact, to have the exact opposite effect.