In an earlier article, we provided some stylized facts on the economy in need of explanation:
- A decline in new business formation and economic dynamism
- A slow decline in productivity growth
- A slow decline in investment
- Record profits and cash holdings
- Record low interest rates
- Very low inflation
- Tepid economic growth (although still very good compared to basically all other advanced nations)
We're in search of a framework that best explains these issues. In earlier articles we looked at:
- Deleveraging in the wake of the financial crisis
- Taxes and regulation
- Secular stagnation, whether low growth is structural
There is another way which can explain the high corporate profitability with sluggish business investment, decreasing productivity growth and economic dynamism and tepid economic growth.
What if market concentration is increasing, limiting competition and innovation, increasing profitability and making it more difficult for new firms to enter?
What if companies expanded more effort into so-called rent-seeking behavior, that is, efforts to appropriate the regulatory process in order to protect or even increase their rising market power and limit competition? That would explain at least part of these stylized facts.
A main proponent of this thesis is former Labor Secretary Robert Reich. He (in a new book called Saving Capitalism) argues that corporations have been able to increase economic power, which is their ability to affect the prices they charge and/or pay.
The obvious suspect here is the healthcare sector, where numerous companies have been engaging in jacking up prices which bear no relation to cost (price gouging).
Or what to think of VanishPoint, which invented a retractable syringe which was not only cheaper, but prevents hospital workers against accidents (of which there are quite a lot). But it came up against Becton, Dickinson and Company (NYSE:BDX), which sells 80 percent of all syringes in America (David Dayen, Prospect):
After 18 years in operation, after a federal law mandating that hospitals work to prevent needle-stick, and after two successful lawsuits resulting in BD paying more than $400 million for violating anti-monopoly statutes, Retractable Technologies made only $34 million in global sales last year. BD, with an inferior, more expensive product, sold $8.4 billion, the payouts to its competitor serving only as the cost of doing business. In 2000, the Centers for Disease Control estimated 380,000 needle-sticks at hospitals every year. Today, they estimate 385,000.
And this is only half of that story (one should really read the article). Although not as blatant as in healthcare, abusing market power is certainly not limited to that sector alone. Here is Reich in an article (RCP):
Americans now pay more for pharmaceuticals than the citizens of any other advanced nation because Big Pharma is setting the rules - extending the life of drug patents, prohibiting Medicare from using its bargaining power to get lower drug prices, and blocking consumers from buying cheaper drugs from Canada. We pay more for Internet service, health insurance, airline tickets, and banking services because the increasing market power of key players in these industries lets them raise prices. Antitrust enforcement has been systematically weakened. The biggest Wall Street banks continue to reap the financial benefits of being too big to fail. Hedge-fund partners make bundles from confidential information, trading on which used to be illegal. CEOs cash in their stock options and grants just when they pump up the value of their company's stocks with buybacks. It's allowed because laws and regulations have been loosened.
Reich's book, as well the above quoted American Prospect article, is rife with other examples. Economic concentration is far more widespread than many people might think (David Dayen, Prospect):
The unaware consumer walks into a supermarket and sees aisles brimming with a daunting array of choices. But the majority of products come from just ten manufacturers. You're made dizzy by the sheer variety of toothpastes, for example, but 70 percent of sales go to just two companies: Proctor & Gamble and Colgate-Palmolive. One company, Luxottica, makes virtually every different brand of sunglasses in the world. They also own nearly all the eyeglass retail outlets, from LensCrafters to Pearle Vision to Sunglass Hut. Several years ago, Tyco bought up all its competitors and now makes practically every plastic hanger in America. You'd be excused for thinking you have many options for booking airline tickets and hotels online, but when the Expedia-Orbitz merger clears, there will only be two (Priceline is the other).
It also summarizes the damage:
This accelerated consolidation can be self-perpetuating, with incumbents discouraging competitors from getting a foothold, or buying them up as soon as they gain some market share. Market concentration has a powerful impact on the day-to-day lives of every American, not just because monopolists have pricing power. Monopolies can also stunt innovation, degrade quality of service, increase inequality, and concentrate political power. This trend operates against a background of weakening antitrust enforcement.
There exists a wealth of evidence that economic concentration has increased, a study by Jason Furman provides a nice overview of evidence:
These include the finding that "in 42 percent of the roughly 900 industries examined, the top four firms controlled more than a third of the market in 2012, up from 28 percent of industries in 1997" and that in financial services, "the loan market share of the top ten banks increased from about 30 percent in 1980 to about 50 percent in 2010."
Competition policies have been more relaxed as a response to University of Chicago economists like Robert Bork, who argued in 'The Antitrust Paradox' that antitrust enforcement made consumers worse off. In the Chicago tradition, there is little place for concepts like market power.
However, a study by economists Bruce A. Blonigen of the University of Oregon and Justin R. Pierce of the Federal Reserve Board about the effects of mergers and acquisitions on productivity and market power found the following results (Equitable Growth):
What the two economists find is that the efficiency gains that were supposed to appear didn't in fact happen. This study found that increased consolidation doesn't have any significant effect on plant-level productivity. What it does have an effect on is prices (and profits): markups increased due to the consolidation of manufacturing firms. The increase in markups appears quite significant: 15 percent to 50 percent of the average markup in the data. In other words, the price of manufactured goods increased while there were no productivity gains. The increasing amount of rents in the manufacturing sector could very well have contributed to higher income inequality, either intrafirm or interfirm, depending on how the gains were shared within the company.
And, from David Dayen:
John Kwoka, an economics professor at Northeastern University, collected retrospective data on 46 closely studied mergers, and found that 38 of them resulted in higher prices, with an overall average increase of 7.29 percent. In cases where the Justice Department imposed some sort of condition for accepting a merger, like divestiture of some product lines or bans on retaliation against rivals, the price increases were even higher, ranging from 7.68 percent to 16.01 percent.
There are all kinds of regulations that benefit entrenched powers and limit competition. Take for instance non-competition clauses (Vox):
This week the White House proposed a new plan to increase labor market competition and wage growth in the United States - one that prominently featured a call to state governments to rein in "noncompete agreements." These arrangements - far more widespread than most people think - prohibit employees from leaving to join or start firms within the same industry as their existing employer.
While essentially private, these provisions turn out to be way more widespread than previously assumed.
While the emergence of the internet might have increased price transparency, it also gave rise to enormous electronic platforms which are virtually unassailable, imbued with huge market power, the likes of:
- Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) in digital advertising, creaming off huge margins on the back of content creators
- Amazon (NASDAQ:AMZN) exerting huge buyer power, flattening prices in a whole host of supplier markets
These create monopsonies with huge buying power, according to Dayen:
Monopsony creates many spillover effects. Suppliers can cut corners on labor and environmental standards to keep their profit margins up amid the squeeze. Wages can drop. So even if inflation stays low, the public can suffer.
One of the biggest mysteries this approach can enlighten is why higher profits (and the availability of ultra-low interest rates and record levels of corporate cash) hasn't increased investment.
The rising monopsony power as a result of increased corporate concentration and market power doesn't just affect the digital economy, wages could be another victim (NYT):
Furman argues that "both market concentration and frictions that reduce worker mobility can lead to greater monopsony power for employers" (monopsony is a buyer's monopoly). "With fewer firms competing for a given type of worker," Furman contends, each firm is more likely to exercise local monopsony, and their smaller numbers may also facilitate tacit or explicit collusion.
There was a 21-page briefing by the Obama administration published last month just on this topic of labor market monopsony, arguing additional stuff like when an industry includes only a few big companies, they don't have to compete with one another as hard to attract employees.
It's notable how labor's share in GDP has fallen markedly after 2000.
While, if anything, the return on capital has risen mildly even when the safe rate of return kept on falling.
While power has been concentrated at buyers of labor, the reverse has happened on the other side. Unions have declined, minimum wages have lagged far behind inflation and labor mobility has decreased.
It's difficult to say to what extent these combined forces have been responsible for the wage stagnation in the U.S., but it is certain wage stagnation has been considerably more marked in the U.S. compared to most other advanced nations.
Monopsony power is a well-known problem in agriculture as well, and one which, after a promising start, the Obama administration has ultimately disappointed:
Obama sent Attorney General Eric Holder and Agriculture Secretary Tom Vilsack to rural communities to hear how large agriculture processors squeeze small suppliers. Family farmers feared retaliation from speaking out, but did so in the hopes that the administration would revamp the industry. And then it did nothing. Markets for meat, poultry, dairy, and seeds have concentrated further (see the impending Monsanto-Bayer merger). Family farmers still must submit to the predatory terms of Big Agriculture, competing with their fellow suppliers in a race to the bottom. A Republican backlash against proposed rules to protect small farmers, and the expectation that the courts would not sanction radical reform, contributed to the failure... Big Ag lobbies led the charge against the aborted Obama effort.
What can be done?
This isn't the place to discuss remedies extensively, we'll just list a few items so the reader has an idea. One can find a more extensive discussion in Furman (pdf).
- A more vigorous antitrust policy and practice
- Limits on lobbying
- Intellectual property and patent reform
- Increasing the bargaining power of workers
- Reform of state laws requiring occupational licensing
- Reform of land use regulation
Good for investors?
- Rising economic concentration and market power tends to be good for profits, and hence good for shareholders, and this is certainly something which the data supports.
- However, insofar as it leads to higher prices, dampens competition, investment, wages and the entry of new firms, it dampens economic dynamism and growth.
- It can be detrimental to the economy insofar as it reduces economic dynamism and growth. It can do that by limiting competition, reducing business investment and diverting company activity towards rent-seeking behavior (most notably capturing the regulatory process in order to limit competition and new entries).
So we're saying that in the short term, it's good for profits (at least of the existing firms enjoying significant or even increasing market power), in the longer term it is likely to be a drag on the economy.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.