The start-up economy is fundamentally broken. The virus will make it worse.
Imagine this: The year is 2013. You've got 25 billion dollars you'd like to flush down the toilet, but your personal commode simply can't handle an entire cargo plane full of 100-dollar bills. Luckily for you, Uber is there — because $25 billion is about what the company has lost since that date. From 2013-2018 they lost $14 billion; in 2019 a further $8.5 billion; and in the first quarter of 2020 another $2.9 billion.
This kind of money-torching start-up has taken root all over the economy. Uber competitor Lyft, the mattress company Casper, and dozens of other companies are following the same strategy. Some have hit a rough patch — the WeWork property-leasing money pit has lost most of its value, and Uber's taxi business is struggling thanks to the coronavirus. But Uber also recently proposed an acquisition of delivery service Grubhub, which would make it the largest player in the restaurant delivery middleman market (ahead of Doordash, which also loses gobs of money). Delivery for both restaurants and grocery stores are surging due to the pandemic, though unsurprisingly most such deliveries are still unprofitable.
These companies generally treat both their suppliers and their workers like crap, but what is less noticed is that their "business model" is undermining one of the basic premises of capitalism — the price system. The process may only accelerate thanks to the pandemic.
The libertarian economist Friedrich von Hayek once wrote a soaring paean to market prices as the best possible way of allocating resources. The details of economic production are continually changing, and every person has differing preferences as to what they want. So, he argued, prices were the only way that all that widely-dispersed information could be processed in an efficient and accurate way. Through the "marvel" of the price system, news about the scarcity of some raw material could be known "without an order being issued, without more than perhaps a handful of people knowing the cause," he wrote. That leads to "tens of thousands of people whose identity could not be ascertained by months of investigation [using] the material or its products more sparingly[.]" That in turn alters people's behavior regarding other goods that become relatively cheaper.
Now, Hayek was an evidence-proof zealot and his essay is a political tract attempting to rule out any sort of government economic planning by definition. But the interesting thing for today's circumstances is how the plague of loss-making start-ups destroys all that he likes about the price system. If a company sells below cost, then the entire system of preference aggregation is turned on its head, because customers have inaccurate information about the relative costs of different goods and services. In 2015 an Uber passenger paid only 41 percent of the cost of the real resources (mainly labor of the driver, plus use of his or her car) required to make the ride happen, while competitors or other businesses who do not have investor cash to set on fire appear expensive by comparison.
The price system thus becomes a disinformation machine — millions of people being misled into wasteful overuse of taxis as if by magic. Indeed, in addition to driving many normal taxi companies out of business, Uber-style companies have sharply increased congestion. One study found that they added 5.7 billion vehicle miles traveled annually in the nine largest American cities. A big reason for this is that somewhere in the range of 30-60 percent of Uber rides end up with the driver deadheading back with no fare. Normal taxi companies that have to make their accounting pencil out can't tolerate that kind of waste, but Uber does. The reason is that like most of their loss-making brethren, Uber is attempting to create a monopoly so they can then raise prices to their heart's content (though it probably won't work in their case).
Libertarians would no doubt protest that the market will punish businesses that can't turn a profit. And it may well turn out that Uber and all its cash-annihilating compatriots will eventually go bankrupt. But Uber has already existed for over a decade, and it shows no sign of losing investor support yet. That's an entire economic expansion spent burning billions upon billions of dollars and seeding the price system with wildly inaccurate information. Not exactly encouraging for market self-regulation.
In turn, the major reason for that situation is for years there has been far more investor capital than there have been high-quality investments for that capital. "We find ourselves in a liquidity surplus," as one investor told the Wall Street Journal about money-losing companies going public. Thanks to inequality, global plutocrats are sitting on vast hoards of wealth, but there are few places to invest it precisely because they have left nothing but scraps for the broad population who would serve as customers for new businesses. As former Federal Reserve Chairman Marriner Eccles wrote about the 1920s, "by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants." Thus all these start-ups selling below cost — it's the only way to get a big chunk of market share.
That situation has been dramatically escalated by the pandemic. Stock markets are back to near-record highs despite the fact that unemployment is near Great Depression heights, and sales in most economic sectors are collapsing. The Federal Reserve is blasting the plutocrat class with cheap credit, and private capital apparently sees little better return than stocks. The combination of dimwitted investors (especially the Saudi royal family, which has poured billions into the venture capital toilet) and fast-talking founders promising a quick return on impossible business models will surely persist so long as the plutocrats are swimming in money with nowhere to go.
Consumer adaptations and small business competitors going out of business will likely mean in the short term that many of these companies can succeed in their goal of grabbing greater and greater market share. But that won't do anything to fix the fact that their customers, most of whom are struggling even more than they were before, love and use the services because their prices don't reflect what it actually costs to provide them. The investor Ranjan Roy amusingly suggests a "pizza arbitrage" start-up that would make money by buying pizzas from yourself, thanks to Doordash subsidies.
That brings me back to Hayek. His error is to portray the price system as some naturally-occurring phenomenon mankind "stumbled upon … without understanding it." In reality, it takes an elaborate state apparatus to make markets function at all, because otherwise you instantly get cheating or other problems. This has been understood for centuries — indeed, every one of today's money-losers are straightforwardly violating a 1936 law against predatory pricing that is still on the books but has been rendered inoperative through business-friendly judicial rule-by-decree. We see that without state channeling and rules, capitalist institutions readily devour themselves.
At bottom, markets are just another form of state economic planning that are useful in some contexts and not in others, depending on background conditions and the details of implementation. So nations may want to provide certain services without any market, or below cost, if doing so makes sense or achieves a worthy goal (like free education or public transportation). But insofar as we want businesses to compete on price and quality, the money-burning business model needs to be regulated out of existence.
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