In this paper – which can be found here – the authors look at a number of issues that have become a staple of the macro-economic literature of late (i.e. the economy is experiencing a fundamental long term change which manifests itself in a number of trends such as declining labour shares, declining wages, declining labour force participation, slowdown in labour market dynamism, decreased job mobility, lower migration rates, and lower growth).
They argue that while many explanations have been proposed for each of these secular trends, all these developments are consistent with one common cause that hitherto has remained undocumented: the rise in market power since 1980.
After the introduction – where the argument is very clearly outlined – the paper is structured as follows:
- In Section 2, they explain why mark-ups are an important measure to identify market power in this context. They also identify the data sources and develop an empirical framework to identify industry mark-ups.
The main findings on mark-ups are presented in Section 3. This section documents the evolution of mark-ups based on firm-level data for the US economy since 1950 (i.e. all publicly traded firms covering all sectors of the US economy over the period 1950-2014).
Initially, mark-ups are stable, even slightly decreasing. In 1980, average mark-ups start to rise from 18% above marginal cost to 67% nowadays. Over a 35 year period, this is an increase in the price level relative to cost of 1% per year. Moreover, the increase is becoming more pronounced as time goes on, especially after the 2000 and 2008 recessions.
Most of the increase is due to within industry increases in mark-ups. Further, there are marked changes in the distribution of mark-ups over time. Economy-wide mark-ups are higher in small firms across the entire economy, though not within narrowly defined industries where larger firms indeed have higher mark-ups as predicted by most standard models of competition. Furthermore, the increase in the average mark-up comes entirely from the firms with mark-ups in the top half of the mark-up distribution. The median and lower percentiles are largely invariant. These patterns persist in time.
- In order to link mark ups to market power, the authors need to have a measure of profits. They use two sources for this: 1. dividends and 2. the market value (or market capitalization) of firms. The authors find that both fit rather well with the evolution of mark-ups (see below). They conclude that “there is an enormous increase in profits however it is measured, which is consistent with the increase in market power.”
- Section 4 discusses the implications of the rise in market power for debates in the macro/labour literature. In particular, the authors purport to demonstrate that the rise in mark-ups naturally gives rise to a decrease in the labour share, a decrease in the capital share, a decrease in low skilled wages, a decrease in labour market participation and in job flows, and decrease in interstate migration. In particular:
- the labour share tracks the inverse mark-up quite closely, especially since 1980. Since 1980, the capital share (i.e. capital investment) has moved in lockstep with the inverse of the authors’ mark-up measure.
- with a long enough time-horizon, there will be a reduction in capital investment as mark-ups increase.
- The decline in low skill wages is said to be related to market power because total labour demand is lower as firms restrict quantities produced. Furthermore, with constant returns to scale, (nominal and real) wages and labour force participation both decrease with increases in market power.
- Regarding labour force participation, there is a sharp decline since the mid-1990s. This does not fully coincide with the timing of the observed rise in market power. However, the sharp increase in the labour force since the 1960s was driven by increased female participation. This has led to an outward shift of the labour supply. This trend levelled off in the mid-1990s, which is consistent with the fact that we start to see the impact of a decrease in the total labour force participation due to the rise in market power around this time.
- Regarding labour market flows, the authors consider that, in an economy with constant returns to scale, linear demand for output and linear labour supply, higher market power leads to lower responsiveness by labour inputs. This will then lead to a decrease in job flows as market power increases. If firms are based in different local labour markets, and a fixed fraction of all job relocation decisions are between local labour markets, then lower job flow rates will automatically give rise to lower migration rates.
At this point, the authors even purport to demonstrate that, if one properly accounts for the rise in mark-ups, there is no productivity slowdown (as has been commonly argued). Instead, there has been an increase in productivity despite the fact that output growth has slowed down. For a given level of total factor productivity, an increase in market power leads to a reduction in the quantity produced and an increase in prices. Since GDP measure quantities (and price changes are factored out via CPI adjustments), one would expect to see a decline in GDP if productivity stays constant and the labour share diminishes. Looking at the data, the authors find that except for a dip around the great recession, productivity actually increases and hovers around 3 to 4% after 2000. This indicates that, properly accounting for market power, there is no productivity slowdown but instead an increase in productivity.
- Section 5 is devoted to conclusions. There are mainly two that need concern us here, since they relate to policy. One concerns the value of the stock market. Stocks prices reflect the discounted flow of dividends, and thus of profits. A stock market where market power prevails is therefore overvalued relative to a competitive economy. In the presence of market power, the stock market is therefore not a good gauge of an economy’s output. The second conclusion regards inflation. As the authors say: “Relative to a scenario without a rise market power and with the same evolution of technology, prices would have gone up by 1% per year (42% over 35 years, from 1.18 to 1.67). This implies that inflation has been higher than it would have been without the rise in market power. This is surprising given the low inflation rates in the last decades – and particularly low ones since the great recession. Of course, monetary policy is not the appropriate policy tool to remedy that source of inflation. That would be the prerogative of anti-trust policy”.
I am so obviously incapable of commenting on this that I can just be thankful the authors drew many pictures to help me along (and I like pictures anyway). The case seems coherent, even if I’m always suspicious of “we found one cause that explains everything!” in social sciences. There may be multiple causes for the developments identified by the authors: it may well be that increases in market power are just symptoms of a number of underlying causes (e.g. technological developments, globalisation, political capture, etc.), such as the ones reviewed in the paper above.
To my mind, this paper (if its conclusions are accurate) raises a number of very interesting questions for competition law and policy. First, and as I already argued in my comment of the last paper, this is likely to lead to increased demands being placed on antitrust over the coming years. A good example of this is how the authors now see antitrust as one of the main tools to deal with inflation, which would come as a shock to virtually everyone working in competition law nowadays (this is something not seen since the 70’s. The OECD may yet regret abrogating its Recommendation on Competition Law and Inflation…).
Second, these developments raise serious doubts regarding the assumptions underpinning contemporaneous antitrust enforcement. These doubts, in turn, raise serious questions that we will need to grapple with. Such questions include: (i) what are the foundations of market power? Can we still act on the Chicago School basis that companies become dominant because they out-competed other companies? Should this matter, if market power becomes a pervasive feature of markets, with such deleterious effects as the ones identified by the authors? (ii) what is competition law to do about these developments, if anything (Note: this is ultimately the discussion that’s been going on regarding ‘hipster antitrust’ and the digital economy of late)? (iii) what do these developments mean for competition policy (and its potential politicisation) in the long run?
Given the way the debate is moving, and the fact that the evolution of the debate seems to be caused by the identification of structural elements of early 21st century economy of which we were previously unaware, I have a feeling that these questions are going to be with us for many years to come…