The House Judiciary Committee just released its antitrust report which states that Amazon, Apple, Facebook and Google have become gatekeepers sitting on supra-competitive profits and unchecked, significant and durable market power. The simple question of how much do technology firms actually earn is non-trivially difficult at this point. Partly because U.S. accounting rules treat research and development (R&D) and Selling, General and Administrative (SGA) outlays as expenses that depress the reported accounting return on assets (ROA). This is despite the fact that R&D and SGA increasingly contain substantial investments in intangible assets.
In a recently completed paper, my co-authors, Anup Srivastava and Rong Zhao, and I carefully correct these distortions and compute the internal rate of return (IRR) earned by industries that invest in R&D. Consistent with the House Judiciary Committee’s assertions, Apple, Microsoft, Amazon, Alphabet and Facebook (public since 2013), have indeed earned an average annual IRR of 41%, 38%, 41%, 26% and 36% respectively over the years 2013-2019. An IRR of 41% means that the payback to an investment is aa mere 2.5 years (100/41). The accounting ROAs based on expensed R&D, in contrast, were much smaller at 18%, 13%, 4%, 13% and 18% respectively.
The House Judiciary is no doubt justified in many of its assertions. I support some sort of data portability across platforms, a scheme to pay customers for their data and a closer scrutiny of acquisitions of competitors such as Facebook’s purchase of Instagram. But is this the most pressing problem facing Congress and America? I would focus on health care instead.
In our research, we find that the health care industry has earned higher IRRs relative to technology in every decade beginning in 1980 except for the latest one. In particular, the IRRs earned by health care were 14.2%, 18%, 18.4% and 16.4% over the decades of 1980-89, 1990-99, 2000-09 and 2010-19 respectively. Even in the last decade, healthcare underperforms technology only by a tiny bit (IRR of 16.4% relative 17.4% for technology).
Why has Congress averted its gaze from an industry that has outperformed technology over four decades? They are perhaps dazzled by the $5 trillion stock market valuation of these tech giants. But stock market valuations are highly influenced by sentiment and could prove to be ephemeral. Operating returns, in terms of earnings and cash flows, are the equivalent of “show me the money” and are not as influenced by market sentiment.
IRRs and accounting ROAs are abstract and hard to internalize, so it is useful to dig deeper and place more context on the health care numbers. Let us compare average life expectancy, a proxy for health care quality, with the proportion of GDP claimed by health care, a proxy for the cost burden borne by the economy. The U.S. spends 17.7% of its GDP on health care. In the developed world, the next best competitor for that unenviable distinction is Switzerland which spends 12.2% of its GDP on healthcare. The average life expectancy in the U.S. is around 78 years relative to 82 years in Switzerland.
Imagine a world where you would get Swiss healthcare at Swiss prices in the United States. In that world, we would save 5.5% of GDP. Further, imagine a world where we return 5.5% of GDP per capita back to every U.S. household of 2.5 members as a pay hike. The average American household’s income would go up around 14% from $61,000 to around $69,000. And go on to imagine such a 14% health care dividend to U.S. household income over the last 30 years!
It is natural to ask where does all this extra spending on health care go? Consider this estimated breakdown of per capita spending of health care costs in the U.S. compared with other advanced countries compiled by Dr. Ezekiel J. Emanuel. In 2015, for which this data was compiled, the per capita health care spending in the U.S was $9,403 relative to $5,202 in the Netherlands. Why do we pay almost twice as much as the Netherlands?
The average U.S. doctor is paid 30% more than in the Netherlands. Pharmaceuticals cost us three times as much as a Dutch citizen. Imaging, most notably, magnetic resonance and computed tomography, cost us between six to ten times of what it costs a Dutch patient. A knee replacement here is three times as expensive while a hip replacement is two and half times more costly here. A coronary artery bypass graft surgery costs six times more, an angioplasty five times more and a Cesarean delivery eight times more in the U.S. than in the Netherlands. Of the $9,403 in per capita U.S. health care spending, $752 goes into administration relative to $208 in the Netherlands.
Before you tell me that U.S. private sector firms are happy to pay this much for the healthcare of their employees, note that half of the 17.8% of GDP attributable to healthcare in the U.S. is borne by the U.S. federal or state governments.
Yet, Congress thinks the tech industry is a big problem!