Daily Comment (April 24, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It was an unusually quiet night.  After a barrage of tweets recently, the president appears occupied with his French visitor for now, which might account for the current “tweet silence.”  Earnings are coming in stronger than expected (see above), while Treasury yields remain elevated.  Here is what we are watching today:

Early look at the ECB: The ECB meets on Thursday.  We don’t expect too much new information.  Recent economic data out of Europe has been soft, in part due to the strength of the EUR over the past year.  We expect Draghi to have little new to say on forward guidance or tapering.  Reports that the ECB may delay the decision on the timetable for ending QE until July are probably responsible for recent EUR weakness.  Overall, we don’t expect much from this meeting and the drop in the Eurozone currency has probably already discounted that outcome.

Regulation and privacy: The NYT[1] opines that new EU privacy regulations may end up strengthening the market power of the incumbents.  To some extent, this is public policy 101.  Regulation drives up the cost of doing business which acts as a barrier to entry for potential new firms coming into the business.  This article suggests another twist to the idea—regulation may enhance the existing brands because the new regulations will put the idea of privacy into the minds of consumers and make them prone to stay with the familiar, the current dominant firms.

In public policy, there are generally two broad theories of managing excessive market power.  The first is to use anti-trust laws to break up large firms into parts.  This method has drawbacks; some firms are difficult to unwind.  In a vertically integrated firm, some parts may not be able to function as standalone entities.  The classic example of anti-trust is the breakup of Standard Oil in 1911 that created 34 firms.  Several did exceedingly well in the aftermath, suggesting the breakup was good public policy.  The other theory is to allow the monopolist to exist but regulate it heavily.  The original AT&T (not the current one) is the most obvious example.  The key decision input that should decide which policy to deploy is if the industry is a “natural monopoly” or not.  A natural monopoly is an industry with increasing returns to scale; the bigger one gets, the faster the profits.  Industries where redundant infrastructure is inefficient is a good example.  So, for telephones, having competing firms all hanging wires to phones and being unable to send voice “across” different firms’ wires meant that the first mover could gain scale by crowding out new entrants.  It is unclear if the social media firms are natural monopolies.  There is evidence to suggest that due to learning curve costs or grouping (all my friends use a certain social media platform precluding the use of others) they have the characteristics of natural monopolies.  On the other hand, there is a bit of Yogi Berra’s famous line, “Nobody goes there anymore; it’s too crowded.”  We notice that social media platforms rise and fall in popularity, suggesting these markets are not natural monopolies after all.  If they are not natural monopolies then anti-trust would be a better solution.  We suspect the firms would prefer to be regulated on the assumption that they can continue to run their businesses as they see fit and, via regulatory capture, manage the regulatory environment to their advantage.  Anti-trust takes years to implement, whereas regulation can come quickly.  Therefore, the most likely short-term outcome is more regulation on social media which may not necessarily be bad for these firms.

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[1] https://www.nytimes.com/2018/04/23/technology/privacy-regulation-facebook-google.html?emc=edit_mbe_20180424&nl=morning-briefing-europe&nlid=567726720180424&te=1