Saving Capitalism

by Robert B. Reich

  Similarly, those who view the global economy as presenting a choice between “free trade” and “protectionism” overlook the centrality of power in determining what is to be traded and how. Since all nations’ markets depend on political decisions about how their markets are organized, as a practical matter “free trade” agreements entail complex negotiations about how different market systems will be integrated. “Free trade” with China, for example, doesn’t simply mean more trade, because China’s market is organized quite differently from that of the United States. The real issues involve such things as the degree of protection China will give the intellectual property of American-based corporations, how China will treat the assets of U.S.-based investment banks, and the access of China’s state-run enterprises to the American market. In such negotiations the interests of big American-based corporations and Wall Street banks have consistently trumped the interests of average working Americans, whose wages are considered less worthy of protection than, say, an American company’s intellectual capital or a Wall Street bank’s financial assets. The United States has never sought to require, for example, that trading partners establish minimum wages equal to half their median wages.

  In all these respects, freedom has little meaning without reference to power. Those who claim to be on the side of freedom while ignoring the growing imbalance of economic and political power in America and other advanced economies are not in fact on the side of freedom. They are on the side of those with the power.

  A close examination of each building block of the market will make this apparent.

  4

  The New Property

  Private property is the most basic building block of free-market capitalism. In the conventional debate it’s contrasted with government ownership, or socialism. What is left out of that debate are the myriad ways government organizes and enforces property rights and who has the most influence over those decisions.

  Private property has obvious advantages over common ownership. A half century ago the American environmentalist Garrett Hardin warned of the “tragedy of the commons,” by which individuals, acting rationally but selfishly, deplete a common resource—allowing their cattle to overgraze the town common, for example. When property is privately held, on the other hand, rational owners take care to avoid depletion, investing in fertilizer and irrigation. There are many other examples. To my knowledge, no customer has ever washed a rental car.

  But the debate over private versus public ownership obscures basic decisions about the rules governing private property: What can be owned, on what condition, and for how long? Some of these are profoundly moral issues. They are also, inevitably, political, because their answer depends on the distribution of power in society.

  Three centuries ago, it was common for people to own other people. As historian Adam Hochschild has noted, by the end of the eighteenth century well over three-quarters of all people alive in the world were in bondage of one kind or another, as slaves or serfs. In parts of the Americas and Africa, slaves far outnumbered free persons.

  Slavery rested on the political power of slave owners and traders to maintain slavery as a form of property. The Republican Party in the United States was founded in the 1850s in direct opposition to wealthy slaveholders and those Democrats who asserted that ownership of slaves was a property right protected by the Constitution. Yet within fifteen years, politics and power shifted. Slavery was banned in America in 1865 with the passage of the Thirteenth Amendment to the Constitution. By the end of the nineteenth century slavery was outlawed almost everywhere in the world. But not entirely. It was not officially banned in Mauritania until 1981. And it still continues, illegally, in many places around the world. Even in twenty-first-century America, an estimated 100,000 children are enslaved in the sex trade.

  Other than slaves, the most valuable form of property in the nineteenth century was land. Yet even landownership was based on social norms as well as political power. In England, vast tracts were locked away in an aristocracy that handed them down from generation to generation, allowing tenants to farm them. In America, by contrast, a series of laws, beginning with the Land Ordinance of 1785 through the Homestead Act of 1862, made frontier land available to potential settlers rather than to political elites. (In most Latin American countries, frontier lands went to the politically powerful.) But America’s white settlers had political power behind them, too. The United States gave them right to the land, and the U.S. military fought native Americans to secure it.

  As land prices escalated through the nineteenth century, those who owned large tracts saw their wealth increase dramatically even if they did nothing but rent the land. Land values were increasing simply because land was becoming scarce. Henry George, in his book Progress and Poverty (1879), described progress that pushed up land prices as “an immense wedge being forced, not underneath society, but through society. Those who are above the point of separation are elevated, but those who are below are crushed down.” The book sold two million copies, but George’s proposal for a steep tax on land that would recapture for society most of a landowner’s capital gains went nowhere.

  Then came another economic and political shift, as factories and machines transformed America and other advanced economies from agriculture to industry. Within a few decades, most Americans no longer owned or even rented the property that supplied their livelihoods. They were employees. And the critical question about property then moved to the freedom of workers to organize in order to gain a larger share of the income resulting from the combination of their labors with the factories and machines, versus the owners’ “liberty of contract.”

  Even the modern corporation, and its ownership, is part of the property mechanism—a consequence of particular decisions by legislatures, agencies, and courts that people who invest in the corporation are entitled to a share of its profits and that their personal property beyond those investments is protected if the corporation can’t pay its debts. The “free market” doesn’t dictate this. Property and contract rules do. Yet the idea that shareholders are a corporation’s only owners, and therefore that the sole purpose of the corporation is to maximize the value of their investments, appears nowhere in the law. In fact, in the first three decades following World War II, corporate managers saw their job as balancing the claims of investors, employees, consumers, and the public at large. The large corporation was in effect “owned” by everyone with a stake in how it performed. The notion that only shareholders count emerged from a period in the 1980s when corporate raiders demanded managers sell off “underperforming” assets, close factories, take on more debt, and fire employees in order to maximize shareholder returns.

  The rules governing private property are constantly being contested and adapted, sometimes in big ways (banning slavery) but often in small ways barely noticeable to anyone not directly involved. What looks like government regulation is sometimes better understood as the creation of a property right. For example, before 1978, airlines with overbooked flights simply bumped their excess passengers arbitrarily. After many complaints, the Civil Aeronautics Board (which then regulated airlines) began requiring airlines to treat each seat as the property of the passenger who booked it. That way, airlines with overbooked flights would have to “buy” the excess seats back by offering whatever inducement was necessary to get the right number of passengers to give up their “property” voluntarily.

  Scarce resources often depend on property rights to encourage conservation and investment in technologies that could reduce future scarcity and help ensure that those who need them can get them. By 2015, several water districts in California, facing acute shortages because of drought conditions, turned water into a form of property whose cost depended on usage—starting low for a basic allocation covering families’ essential needs and rising rapidly with volume so that people do not mindlessly refill their swimming pools. The same approach could be taken with the environment as a whole—a scarce resource on a global sc
ale. Ideally, the right to emit carbon dioxide into the atmosphere would be treated as a form of property whose price continued to rise over time. Polluters could buy and trade it, so it would be used where most needed. This would also give them a strong incentive to minimize their emissions immediately and devise innovative ways of reducing them further. Such property rights require that government determines how they are to be allocated initially, by what criteria, and how they are to be traded. If necessities such as clean air and water simply go to the highest bidders, income and wealth disparities can result in wildly unfair outcomes. Government must also monitor and enforce any such system.

  The underlying mechanisms that define property become even more complicated when property takes the form of strands of genetic material, or combinations of molecules, or gigabits of software code, or, more generally, information and ideas. This sort of property doesn’t exist in one unique place and time. It can’t be weighed or measured concretely. And most of the cost of producing it goes into discovering it or making the first copy. After that, the additional production cost is often zero. Yet such intellectual property is the key building block of the new economy, and without government decisions over who can own what aspects of it, and on what terms, the new economy could not exist.

  Here, the tragedy of the commons poses a particularly vexing dilemma. Unless discoverers and inventors can own what they discover and invent, and make money by selling or licensing it, many won’t put in the effort in the first place. Some might do it for free because of the thrill of discovery, or fame, or simply having others use these new items—creators of all sorts post on the Internet free of charge. But free labor won’t pay the rent, and an economy cannot be based entirely on it, so some property rights are necessary. Yet once the discovery or invention has been made, the public will benefit most by having full access to it at no more than the cost of replicating it—which is often near zero. Why should a company that creates a blockbuster drug that can be reproduced for pennies earn billions while many who would benefit from it cannot afford it?

  What’s the proper balance between giving would-be inventors enough ownership that they’re motivated to invent and giving the public affordable access to their discoveries? Here again, it’s not a matter of the “free market” versus the government. Legislatures, courts, and administrative agencies must decide.

  One way of dealing with the dilemma is to give inventors a temporary monopoly—a property right that disappears after a certain length of time. The framers of the Constitution contemplated this, authorizing Congress to grant patents and copyrights “to promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.” But they did not decide precisely what could be patented or for how long because they had no way of knowing what would be invented. The first patent law in America, enacted in 1790, simply said patents could be obtained for “any useful art, manufacture, engine, machine, or device, or any improvement thereon not before known or used,” and its duration would be fourteen years. Since then, Congress has extended patent protection to twenty years (for applications filed after 1995), but the real battles have been over what is “new and useful.” The Patent and Trademark Office makes these determinations on a case-by-case basis; another office handles copyrights on literary works.

  Those who disagree with Patent Office decisions can appeal them to a special court set up for the purpose and take their cases all the way to the Supreme Court if the court is willing to hear them. As inventions have become ever more complex, patent litigation—typically legal fights between those who are granted patents and competitors who believe the patents unjustifiably infringe on patents they already own, or who believe no patent should have been awarded—has increased in volume and duration. By the second decade of the twenty-first century, the U.S. Patent and Trademark Office had almost ten thousand employees, most of them based in a five-building headquarters in Alexandria, Virginia, and the federal courts included a special court of appeals to hear patent cases. Most patents are for software and deal with highly technical issues regarding what is new or has already been discovered. Some applications merely describe ideas or concepts that will be turned into software. Amazon, for example, received a patent for the concept of “one-click checkout.” In 2014, Apple received a patent based on the idea of offering author autographs on e-books.

  Strong and enduring property rights provide incentives to invest and innovate, but they also raise consumer prices. Importantly, the economic power of those who possess these rights often translates into political and legal power to make them even stronger and more enduring.

  An entire legal industry has developed around defending patents or suing for patent infringement. Big high-tech companies often dedicate small armies of lawyers to the task. In 2013, Congress rejected a proposal that would have allowed the Patent Office to expedite its review of questionable software patents, often filed by big companies to lay claim to vast areas of possible invention. Among the corporations whose lobbyists successfully blocked the proposal: IBM and Microsoft.

  The biggest technology companies are spending billions accumulating patent portfolios and then suing and countersuing one another. By purchasing Motorola Mobility for $12.5 billion in 2012, for example, Google gained ownership of seventeen thousand patents, many of which would serve as valuable ammunition in the smartphone patent wars that Google, Samsung, and Apple were waging against one another. As White House intellectual property advisor Colleen Chien noted in 2012, Google and Apple have been spending more money acquiring and litigating over patents than on doing research and development.

  Again, the underlying issue here has nothing to do with whether one prefers the “free market” or government. The question is how government defines property rights, what that process entails, and who has the most power to determine its outcomes.

  America spends far more on medications per person than does any other developed country, even though the typical American takes fewer prescription drugs than the typical citizen of other advanced nations. Of the $3.1 trillion America spent on health in 2014, drugs accounted for 10 percent of the total. Government pays some of this tab through Medicare, Medicaid, and subsidies under the Affordable Care Act. We pick up the tab indirectly through our taxes. We pay the rest directly, through copayments, deductibles, and premiums.

  Drug prices are high in America partly because, while other governments set wholesale drug prices in their countries, the law bars the U.S. government from using its considerable bargaining power to negotiate lower costs. But the bigger reason drug prices are so high in America is that drugs are patented—and those temporary monopolies often last beyond when the patents are supposed to run out (now twenty years); I will explain why in a moment.

  The Patent Office and the courts initially decided that products from nature couldn’t be patented. That’s why early vaccines, using viruses to build up the human body’s immunity, couldn’t become the private property of drug companies. It also explains why drug manufacturers were slow to invest in research necessary to come up with new vaccines.

  But in the 1990s, the rules changed. Pharmaceutical companies were allowed to patent the processes they used to manufacture vaccines and other products from nature. As a result, the number of applications for patents on vaccines soared tenfold to more than ten thousand. Not surprisingly, vaccine prices also took off. In 2013, Pfizer raked in nearly $4 billion on sales of the Prevnar 13 vaccine, which prevents diseases caused by pneumococcal bacteria, from ear infections to pneumonia—for which Pfizer was the only manufacturer.

  Many lifesaving drugs continue to be made by only one company long after the original patent expires. In part, that’s because the Patent Office often renews patents on the basis of small and insignificant changes to the original drugs that technically make them new and therefore patentable. The office is not required to weigh the financial burdens its decisions imp
ose on customers. And pharmacies cannot substitute generic versions of a brand-name drug when it has changed in even the most minor of ways. For example, Forest Laboratories announced in February 2014 it would stop selling the existing tablet form of Namenda, its widely used drug to treat Alzheimer’s, in favor of new, extended-release capsules called Namenda XR. The capsules were simply a reformulated version of the tablet, but even that minor change prevented pharmacists from substituting generic versions of the tablet, whose patent was about to run out. “Product hopping” like this keeps profits flowing to the pharmaceutical companies but costs consumers and health insurers a bundle.

  Many drugs that are available over the counter in other countries can be bought only by prescription in the United States, and the drug companies aggressively market these brands long after the patents have expired so that patients ask doctors to prescribe them. America is one of the few advanced nations that allow direct advertising of prescription drugs to consumers.

  It is illegal for Americans to shop at foreign pharmacies for cheaper versions of the same drugs sold in the United States, either branded or generic. In 2012, Congress authorized U.S. Customs to destroy any such medications. The ostensible reason is to protect the public from dangerous counterfeit drugs. But for at least a decade before then, during which time tens of millions of prescriptions were filled over the Internet, no case was reported of Americans having been harmed by medications bought online from a foreign pharmacy. The real reason for the ban is to protect the profits of U.S. pharmaceutical companies, which lobbied intensely for it. Yet the real threat to the public’s health is drugs priced so high that an estimated fifty million Americans—more than a quarter of them with chronic health conditions—did not fill their prescriptions in 2012, according to the National Consumers League.