When Adam Smith Spoke of the Free Market, He Meant “Free of Rents”
or “How the Panamanian Economy Works, Part 2”
Versión original aquí.
The original version of this essay was published January 28, 2024 under the title “Cuando Adam Smith habló del mercado libre, se refería a ‘libre de rentas’”
As we discussed last week, Cable & Wireless Panama (CWP) — a public-private corporation that for many years had a national telecommunications monopoly — has generated millions of dollars annually for its shareholders, including the Panamanian State, since its establishment in 1997.
On one hand, this money represented, for many years, economic rents extracted by the State from its own citizens through inflated phone rates and/or crappy services in a legally monopolized market.
At the same time, Panama’s ownership stake in CWP ensured that nearly half of the rents extracted from consumers were, to some extent, recaptured by the State. This has translated into enormous benefits for all Panamanians, even to this day.
This type of rent (re)capture — or, more precisely, the lack thereof — has had a massive influence on our socioeconomic landscape. If we could adjust our “model” slightly, particularly to recapture the value extracted from Panama by well-positioned companies, we could create a less unequal, more prosperous, and, most importantly, united country.
What the hell are “economic rents”?
When Adam Smith, “father” of the social science we know today as economics, spoke of “the free market”, he meant free of rents. In other words, free from any type of income, for the sellers of a product or service, beyond the value they had, themselves, added to it. Members of the Scottish Enlightenment, like Smith, envisioned the role of markets as tools for social (or national) good, not as ends in themselves.
Now, I’m not assuming I know exactly what Adam Smith meant with every word he published during his career (some incredibly simplistic without the proper context) in the second half of the 18th century. Just like Jesus, the many versions of Smith are all filtered through the context and, well, “meatsuit” of the storyteller.
In case of CWP, the rents extracted were reflected in the high prices it charged for phone services (first landline, then mobile phone), with Panamanian consumers having no alternative providers — prices far above the real value of the services, and significantly higher than they would have been in a market present competition. This way, CWP extracted much more value from users, through charges, than it provided in services.
It’s worth emphasizing that these rents — even though they are a literal deadweight on consumers, especially entrepreneurs — still count toward the final value of a country’s Gross Domestic Product (GDP). That is, today we add them to GDP rather than subtract them from it.
Although we’ll discuss this in future articles, this is one of the biggest problems with the economic theories that “justify” the phenomenal profits of some companies, both in Panama and worldwide. The numbers say one thing but actually reflect a very distorted reality.
For example, if in Year 1, CWP generated $100 million in total net profits, then the following year, without changing anything but its rates, it generates $150 million, Panama’s GDP for Year 2 — like CWP’s revenue — would increase by $50 million. Even if, in real terms, this money was nothing more than a direct and substantial increase in the cost of living for Panamanians (including the cost of doing business) without adding value in return, Panama’s GDP still grows by $50 million.
Think about it. It’s messed up.
Correspondingly, after the telecoms market opened up, while CWP’s revenues decreased, the value it created increased significantly.
How does that work?
Although Panama’s annual income from its CWP stake dropped considerably after the market opened — once a monopoly ends, extracting value isn’t as easy — the nature of the money the State received also changed. While CWP’s big-ass checks to the Panamanian State had come from money the company simply took from its users ‘cause it could — rather than money users willingly paid, after comparing competitors’ prices, in exchange for quality products/services — once new providers entered the market, the source CWP’s earnings shifted to value created or added by the company.
In other words, CWP’s rents are said to have been “competed away”. After market “liberalization”, the income CWP contributed to Panama’s GDP, beyond its inherent value (i.e., what could be purchased with it), resulted from a more dynamic and competitive economy, with innovative, better-quality products and services, available at affordable prices, for the vast majority of Panamanians.
I distinctly remember, in the late ’90s and early 2000s, when mobile rates (both prepaid and postpaid) began to drop sharply, and cell phones became so cheap that suddenly it seemed like everyone had one. The market was composed of just four players, technically an oligopoly, but at least you saw them competing with one another — if only on price.
This kind of not just sustainable but pro-social development is exactly what Panama could have with a well-designed capitalist economy. Instead, our “best and brightest” focus on activities that extract value, placing great socio-economic burdens on consumers, not to mention the societal stress that rising prices always produce.
For Smith and many of his European contemporaries, rent extraction was the main obstacle to “The Wealth of Nations”. Just as in his time with the British East India Company — the OG multinational, practically a private empire controlling more global trade, and extracting more local value, than any corporation since — our markets today are also easily captured by well-positioned companies, most often politically.
Nowadays, however, extraction tends to be subtler, and comes with enormous marketing and PR budgets (sometimes called “stakeholder outreach”), so we need to pay much more attention, especially in the never-ending whirlwind that are our nonstop, hyper-accelerated lives.
The love you make is equal to…?
There are several ways private enterprise can extract value from the State. Market power concentration — the monopolies, duopolies, and oligopolies you’ve surely heard of (Boeing, for instance) — is just one of them. Next, we’ll look at the example of a “Panamanian” company that extracts its rents in a more idiosyncratic way.
Before we dive in, though, let me emphasize that although figures like GDP fail to distinguish economic rents from other productive transactions in the national economy, rents represent money that, while not stemming from what a company does — or does better than its competitors — almost always ends up directly in their owners’ pockets.
Instead of being reinvested productively as “classical” economists envisioned, to allow it to multiply, this money usually fuels the runaway competitive consumption of those extracting it. While in my day you only saw this occasionally — debutante balls and a few quinceañera trips — today we experience it in the 24/7 doom loop of endless comparison and impossible expectations fueled by social media.
Unfortunately, all those trips to #Breck during #BreckSeason — though they make those who spend the money feel #blessed— are funds generated in Panama not directed toward:
Investment in local technology — unnecessary without competition and thus nonexistent in Panama, except maybe for one or two companies in niche industries;
Local savings — which have been in negative territory for decades, making us a debtor nation generation after generation (though hopefully we might someday invest them in seed capital for Panamanian entrepreneurs)
Local consumption — in every market, which would increase aggregate demand for local small and medium enterprises (SMEs) or, better yet, encourage the creation of new businesses to meet that demand.
Because of the unprecedented value extracted from the State, Panama lacks not only the public goods generated by well-designed capitalist economies but also, as if that weren’t enough, opportunities for enterprising Panamanians — those striving to get a good education, start a business, or simply keep up. The middle class is stuck, conversely, under a Mt. Everest of debt: a time bomb we’ve so far ignored, both as households and as a nation, but one we’ll have to face sooner or later, whether we want to or not.
Just in case I wasn’t clear, the value extracted from Panama by British multinational Cable & Wireless (C&W) was biblical, what many would call neocolonialism. First, through a monopoly on landline telephony and, later, a duopoly (alongside the U.S. firm BellSouth) in the early days of mobile phones in Panama.
Just as privatization of Panama’s national phone company (eventually) provided the country with a relatively modern (at the time) telecoms system, Panamanians paid for every last cent of that investment, make no mistake, and the truth is we’ll never know if what we got in return was of equivalent value.
The major difference between CWP, however, and the rest of the “Panamanian” companies extracting value from the State — and this is the key point — is that nearly half the rents extracted by CWP came back to Panama, thanks to its ownership stake stipulated in the original contract.
Technically speaking, of course, because surely a lot of that money went to yet another group extracting enormous value from the State: local politicians. But they didn’t steal all of it and, additionally, the company’s employees, most of whom are highly skilled Panamanians, got 2% of the company’s stock — honestly, great for them!
So while avoiding economic rents entirely is almost impossible, there are ways — as the mixed, public-private structure of CWP clearly shows — for the State to recover at least part of this extraction through, among other things, direct ownership in companies that enjoy special rights or “benefits.”
Remember: all economies are political economies, legislated into existence by government officials, like when the Perez Balladares administration legally structured Panama’s phone market. Unfortunately, it’s precisely this type of legal structure we choose not to use, but absolutely should, when the country’s most profitable companies are those directly exploiting state resources.
The Value of Everything
The most commonly cited example of a monopoly in Panama is, of course, Copa Airlines. Yet it’s worth re-examining it through the lens of value creation vs. extraction, because our “national” airline isn’t a monopoly in the same way CWP was.
Popularized by economist and author Mariana Mazzucato in her book “The Value of Everything: Who Makes and Who Takes in the Global Economy”, this perspective distinguishes between two fundamental ways companies can generate wealth: value creation and value extraction.
Value creation involves producing goods or services that are valuable to society and contribute to overall economic well-being. Companies focused on value creation aim to innovate, improve productivity, and ultimately offer something that wasn’t previously available, or that significantly improves on what was. This approach includes investment in research and development (R&D), process improvements, workforce training, and infrastructure building. These activities not only benefit the company but also the economy as a whole, leading to a more skilled workforce, a stronger industrial base, and a healthier society.
Value extraction, on the other hand, occurs when companies generate profits through means that don’t contribute proportionally to overall (national) economic well-being. This includes market manipulation, leveraging monopolies to set high prices, lobbying for government subsidies or favorable regulations that limit competition, and exploiting natural or social resources without adequate compensation to the State. Instead of adding new or improved value to the market, value extraction typically redistributes wealth (emphasis mine) from society to the company’s owners or shareholders, often at the expense of the common good and without reinvesting adequately in the country’s future.
What’s a “Panamanian company”?
Panamanian companies don’t really exist. The only truly Panamanian company is the Panama Canal Authority (ACP), which provides all net profits to the State. This income reflects the value that shipping companies derive from using the Canal, that is, they pay Panama for the use of its resources — in this case, its infrastructure and territorial waters.
All other corporations, including Copa Airlines, belong to their shareholders: private persons, both natural and legal. For instance, Copa’s CEO has a fiduciary duty to maximize the company’s stock value. My interest as a (nominal) Copa shareholder is for company management to spare no effort in increasing the stock price, including minimizing expenses such as taxes and airport fees paid to the Panamanian State.
The less Copa pays Panama out of its revenue — or to its employees, who are actual Panamanians — the more my shares are worth. My interest as a Panamanian citizen and my interest as a shareholder of Copa, therefore, are in direct conflict.
Clear for take-off
Let’s take a look at how Copa Holdings, S.A., a company listed on the New York Stock Exchange [NYSE: CPA], exploits Panamanian resources — in this case, its infrastructure and airspace — to compete in the international air travel market, while paying the State comparatively nothing for the benefit.
As everyone knows, Copa uses the Tocumen International Airport (PTY), a state-owned asset, to connect passengers between various destinations in the Americas. This right, although technically exclusive to “national airlines,” is, in practice, what enables Copa to carry out its core business activity, which generates hundreds of millions in revenue each year — for its shareholders.
Unfortunately for the country, this activity has very little to do with bringing tourists to Panama or taking Panamanians abroad. It’s almost entirely about flying passengers, via Panama, from Point A to Point B. For this purpose, Copa enjoys the exclusive use of our main airport as its “Hub of the Americas.”
The term “hub” comes from the hub-and-spoke transportation model widely used in industries like aviation and logistics. A hub is a central airport, or node, used to concentrate passenger traffic, with flights departing from this point to various destinations, the spokes. This way, airlines with their own hub can operate more efficiently, concentrating operations in one place and offering passengers an extensive route network.
PTY serves as Copa’s hub (and only Copa’s), connecting multiple destinations across the Americas. Its strategic geographic location makes it an ideal point for passengers traveling across North, Central and South America, and the Caribbean.
Consequently, the service Copa provides (what it sells) — specifically, the value it provides customers by connecting them from Point A to Point B by way of PTY — wouldn’t be possible without the use of Panama’s infrastructure and airspace. This is precisely what allows Copa to compete with other private airlines, like LAN Chile or Aeromexico, on direct flights between, say, Santiago, Chile and Cancún, Mexico.
For every ticket it sells on the Santiago-PTY-Cancún route (or vice versa), Copa keeps 100% of the ticket’s value, while the airport receives practically nothing. Copa can offer value to customers on this route, one of the company’s many highly lucrative ones, because, thanks to the connection in Panama, Copa can also take them from Santiago to Cancún, and back.
Copa’s value proposition: a cheaper (or somehow more convenient) flight via PTY, compared to either Aeromexico’s or LAN’s direct flight, exists due to national infrastructure and regulations. If the State isn’t compensated fairly for this, it’s value extraction, plain and simple. Essentially, what Copa provides its customers — although, surely, partly derived from its fleet and world-class service — comes mainly from its routes, made possible by way of its monopolistic use of Panama’s main airport.
Unlike CWP, which since 1997 has injected tens of millions annually into state coffers from the value it’s extracted, Copa Airlines doesn’t pay Panama a single dime beyond the standard airport fees and taxes paid by all airlines. This, despite the significant value it derives from the exclusive use of our airport as an air bridge. Other airlines, private companies not privy to such an extraordinary benefit, may only take passengers to Panama or fly them out of the country.
This is probably the reason Aeromexico didn’t renew its Mexico City-PTY route after the pandemic, leaving Copa as the sole airline serving it. Most Mexicans fly to Panama to connect, making the destination more expensive for those who actually want to leave the airport and spend money in Panama. This is yet another cost of Copa’s monopoly in PTY, but it’s different from the direct rent extraction detailed above.
Don’t believe the hype
In this sense, Copa’s business model is much more like that of Maersk and other international shipping companies, which use Panama to transport goods, also, from Point A to Point B — for example, from Shanghai to Rotterdam — with the difference being Maersk actually pays the Panamanian State a good chunk o’ change for said use, and the country keeps 100% of the net gain.
This doesn’t mean Copa, through PTY, doesn’t compete with other private airlines with their own hub in the region — for instance, Avianca in the Bogotá (Colombia) airport, El Dorado. However, this only means that the value Copa extracts from PTY isn’t as significant as the value Maersk gets from using the Canal. Why? Because, at least for now, the Canal has no direct competition, while PTY does.
Nonetheless, Copa still extracts significant value from our airport. And it’s actually through our laws — Panama’s rules of the game, written by the same corrupt politicians who “do nothing but steal” — that we have allowed a private corporation to reap the benefits of our country’s unique geographical position, quite literally, in the middle of the Americas.
All you have to do is look at Copa’s operating margins to understand how phenomenally lucrative this particular arrangement is. According to Reportur, a Latin American tourism news outlet for professionals, Copa boasts operating margins of 20%, while the industry average is only 3%.
There’s no doubt Copa is an exceptional airline that offers world-class service, probably among the best in the industry. But it’s also clear that a considerable portion of its tear-inducing margins are due to its legal monopoly in PTY.
All the while, the story Copa and its advocates have fed us for years, and that as Panamanians we’ve swallowed — hook, line, and sinker — is that the airline is no monopoly; the use of international airports, they say, is governed by the so-called Freedoms of the Air, which determine who can fly, land, and operate in each country. These rights are negotiated by governments through multilateral and bilateral treaties. In other words, it’s no business of theirs or any other private corporation.
In theory, this is true: any “Panamanian” airline can technically use PTY or other Panamanian airports to connect passengers. So why don’t we see other airlines competing with Copa? According to Reportur, “the lack of competition in [Panama] has frequently been criticized by [Copa’s competitors], who have also highlighted political issues (emphasis mine) whenever they try to operate in an airport where, they claim, the authorities favor the main airline, even though greater competition would also have positive effects.”
Once again, don’t let anyone tell you the economy isn’t political. It absolutely is.
As Mazzucato explains, huge corporations — not just Copa and not just in Panama — use their considerable financial resources, including influence over all kinds of powerful media outlets (not to mention their “contributions” to political campaigns), to align the interests of the Panamanian State, that is, the interests of Panamanians, with their own, usually business objectives.
This narrative is further reinforced by relentless marketing campaigns, including those promoting the company’s Corporate Social Responsibility (CSR) activities. At the end of the day, though, it doesn’t matter how many times Copa takes the national soccer team to the World Cup or how many scholarships it awards to local children.
As a country, and especially as a broad middle class, we must be crystal clear: the respective interests of the Panamanian State, on one hand, and Copa Airlines, on the other, are not the same — often, in fact, they are completely at odds.