Social Capital: 2019 Annual Letter
“Imagine a time of incredible economic expansion and wealth creation punctuated by periods of class warfare, strife and political upheaval. During the Gilded Age of the 1870s-1900 we saw all of these: rapid economic growth, wage growth, immigration and expansion of social programs like education with the standardization of primary schools and the emergence of high schools. At the time, the major industry of growth was the railroads which in turn led to technological expansions in factories, mining and farming. As is the case today, Wall Street played an important role during the Gilded Age as a financial intermediary and financed everything including a bubble in railroads which eventually burst. While this economic expansion was happening, immigrants fled to America in droves and a class division started to emerge with the 1% owning more than 25% of all property and the bottom 50% owning less than 4%.
If you replace ‘railroads’ with ‘technology’ and re-read these last few sentences, does any of this sound familiar?
….. The Gilded Age seems to have many similarities with today – both economic and societal. That said, it’s most important to ask not what was right or wrong with the Gilded Age, but what came of it? How did Americans internalize the dynamics of the period and respond? What can we learn from this and how similar may our reactions be today? The answer is that the excesses and lopsided nature of the Gilded Age ushered in the Progressive Era, which is elegantly summarized in Wikipedia as follows:
“The Progressive Era was a period of widespread social activism and political reform across the United States that spanned the 1890s to the 1920s. The main objectives of the Progressive movement were addressing problems caused by industrialization, urbanization, immigration, and political corruption. The movement primarily targeted political machines and their bosses. By taking down these corrupt representatives in office, a further means of direct democracy would be established. They also sought regulation of monopolies (trust busting) and corporations through antitrust laws, which were seen as a way to promote equal competition for the advantage of legitimate competitors. They also advocated for new government rules and regulations, and new agencies to carry out those roles, such as the Food and Drug Administration.”
Over the past thirty years, we’ve seen our own version of the Railroads and have created our own Gilded Age. A few companies have done wonderful things with technology, creating a massive downdraft of costs and an attendant upswing in value – a consumer surplus like we could have never imagined. But it came with a cost.
For a few companies, entrepreneurs and their employees, massive gains in wealth, status and influence were realized. Meanwhile, for the rest, wages stagnated, insecurity grew and the cost of this lopsided economic allocation became increasingly obvious. Most people are now left to internalize why they won’t live better than their parents, and even more concerningly, that they won’t be able to give the chance of a better life to their children. In turn, populism is on the rise. Whether its via surrogates on the right who want stricter borders and nationalistic economies or their equivalents on the left that demand universal social programs, increasingly loud refrains are being made for change – any change.
The first signal that the modern Gilded Age is ending will be symbolized by reigning in Big Tech (MSFT, AAPL, AMZN, GOOG, FB) and the only way to do this effectively is with trust busting. Across the world, governments are realizing a growing responsibility to act by stepping in and attempting to break up these behemoths, forcing divestitures, demanding transparency, and in the specific case of ad-based businesses, modifying auctions to limit artificial bidding wars and disabling broad scale data gathering and surveillance of people. While some may argue that this is, in some ways, anti-capitalist, this is the most realistic way of making capitalism work for everyone versus the few.
As governments and regulators take this first step, they will have to be careful to make sure Big Tech doesn’t find a way of helping write the regulations to promote and cement their monopoly. In order to do this effectively, regulators will need to convene broad groups of disinterested experts who can cogently explain how each of Big Tech’s business models work, what the positive and negative effects of them are and how to ring-fence their impact, protect and promote small businesses and guarantee individual civil liberties and privacy.
If the regulator’s efforts are successful, Big Tech will be broken up within the decade.
This means that some of iPhone, Azure, AWS, Amazon Retail, Google Search, Youtube, Gmail, GCP, Facebook, WhatsApp and Instagram may all be distinct companies who are explicitly not allowed to share data amongst each other. Further, any of these companies with a 3rd party ad-network capability will have to divest it. This initial phase will allow the “demand” side of the internet economy to more effectively compete with the “supply” side.
The second step in ending the modern Gilded Age will be taxation.
Governments will eventually demand that any revenues and profits generated by Big Tech inside of their borders from their citizens should be subject to local taxes. While, initially, this will be a sticky issue with respect to tax treaties, tariff wars and the like, the reality is that the increasing nationalism in various countries is a trend that is at its beginning versus its end and makes this outcome more and more likely. Further, exogenous events like the coronavirus pandemic will make stronger cases for more resilient national economies, less globalization and more restrictive borders and trade agreements.
If these first two phases come to pass, it will dramatically slow down how Big Tech compounds their monopolies by making them smaller and less profitable. By slowing down their profitability and ability to use money as a weapon, governments and regulators will help prevent lock-in and incentivize more competition.
The last step in ending the modern Gilded Age is changing market incentives specifically around stock based compensation, M&A and taxation of options.
Governments can do a lot to make it more expensive for Big Tech to hoard human capital and allow this talent to flow more naturally to small businesses and startups so that they can more effectively compete and create vibrant ecosystems. They can do this by making stock based restricted stock unit (RSU) compensation extremely expensive to companies above a certain size or profitability by taxing them more onerously and forcing GAAP reporting of stock based compensation. At the same time, they can favor a more simple, remunerative tax treatment for employees who choose to receive stock options or income from small companies. Lastly, governments should prevent any further M&A from Big Tech including the deceptive practice of acqui-hiring.
Essentially, by making the incremental engineer more costly for Big Tech while making that same engineer less expensive for startups, we can stimulate an entirely new wave of entrepreneurship we weren’t expecting.
If these steps are undertaken, Big Tech will be crippled. If one reads the tea leaves, it seems like it is the time and many governments are sounding the drum to action. While Big Tech initially created a lot of value, the incremental value they deliver now comes at too high of a cost if these companies are left intact as they are. The value created is an increasingly decaying function (it’s difficult to name something truly innovative that Big Tech has invented in the last decade) while the need for true progress is increasing.”