These are puzzling times. Developments in advanced economies in recent decades have produced a number of conundrums. Productivity has stagnated while new information and communication technologies have boomed. Investment has been persistently weak while interest rates have been at historic lows and corporate profits have been high. The profit rate and real interest rate have increasingly diverged, when both are supposed to be linked to the productivity of capital. Even as investment has been weak, wealth has increased sharply, as highlighted by French economist Thomas Piketty.
At the same time, the share of income going to labor has fallen, overturning Cambridge economist Nicholas Kaldor’s famous stylized fact about the constancy of labor and capital income shares. Related to these outcomes, income inequality has increased, particularly in the United States.
What is going on? There is, of course, no single explanation. Many factors have been at play across product markets and markets for labor and capital, including how markets have been impacted by the forces of technological change and globalization and how public policies have responded or failed to respond.
However, erosion of competition in markets is one factor that has played an important cross-cutting role. Recent research finds growing evidence connecting competition failures to today’s economic puzzles. Paul Krugman, Joseph Stiglitz, and Lawrence Summers, among others, have drawn attention to some of the implications of weakening competition. A recent paper goes further by attempting to develop a unified competition-based explanation of the puzzling outcomes.
For the U.S. economy, there are a variety of indicators that show a trend of declining competition and rising monopoly power since the 1980s. Market concentration has increased in most industries and in finance. New business formation has declined. Markups over costs have increased several-fold, sharply increasing corporate profits. The distribution of profits has become much more skewed toward firms at the top. Overlapping ownership of companies that compete has increased.
How have these developments affected growth and distributional outcomes? Barriers to competition have contributed to widening gaps in productivity and profitability between firms. The benefits of new technologies have been captured in large part by a relatively small number of firms. Research finds that in industries that are less exposed to competition, technological innovation and diffusion are weaker, inter-firm productivity divergence is wider, and aggregate productivity growth is slower.
Weaker competition reduced incentives to make new investments. Firms wielding stronger market power invested less and earned more on existing capital through higher markups. An increasing portion of the high corporate profits reflected rents associated with monopoly power rather than productivity of investment—which helps to explain both the weakness in investment and the increasing separation of the profit rate from the real interest rate.
Wealth increased sharply, rising relative to output, but this was not primarily embodied in new productive capital; much of it reflected increased financial wealth resulting from capital gains as monopoly profits boosted the market value of existing assets. One study estimates that the share of total U.S. stock market value reflecting monopoly power—which the study terms “monopoly wealth”—rose from negligible levels in 1985 to around 80 percent in 2015.
Increased concentration of market power shifted income away from labor. Dominant firms not only acquired more monopoly power in product markets to increase markups and extract higher rents, but they also acquired more monopsony power to dictate wages in the labor market. As the labor income share was squeezed, the share of “pure profits” or rents—profits in excess of competitive market conditions—soared. It is estimated that such profits in the U.S. rose from three percent of national income in 1985 to 17 percent in 2015.
Higher rents and rise in financial wealth increased income inequality as the beneficiaries of these gains belonged disproportionately to upper income groups. These developments reinforced the distributional effects of technological change and globalization favoring capital and higher level skills.
What explains the weakening of competition? Both regulatory acts of omission and commission—deregulation unsupported by competition safeguards, and regulations that restrict competition—are partly to blame. Lax anti-trust enforcement allowed mergers and acquisitions to balloon. Overly broad and stringent patent policies locked in incumbents’ advantages and discouraged follow-on innovation and diffusion. Increased market power stoked rent seeking.
Digital technologies altered the structure of competition through first-mover advantages, scale economies, network effects, and leverage of “big data” that encouraged the rise of dominant, winner-takes-most firms. These effects have been most marked in the high-tech sectors, as reflected in the rise of tech-giants such as Google and Facebook, but are increasingly evident more widely as the new technologies penetrate other sectors. An example is the rise of Amazon in retail trade.
What are the implications for policy? Regulatory reform must be stepped up to revitalize competition. However, this should not be just about deregulation: Both regulatory excesses and regulatory gaps must be addressed. Anti-trust policies should be beefed up. Patent policies should be reformed so that they encourage and protect intellectual property, not intellectual monopoly. Competition challenges of the digital age call for new thinking and innovation in policies. Appropriate regulatory approaches for the digital economy are only now beginning to receive the attention they warrant. Competition policies also need to become more global; today’s corporate giants typically are multinationals that affect competition in markets in many countries.
With high levels of rents in profits, it may be optimal to have relatively high rather than low corporate tax rates. The surge in wealth calls for more effective use of wealth taxes. Tax policies will need to adapt to the new challenges of the digital economy.
A singular focus on competition to explain the seemingly complex growth and distributional dynamics of recent times may come across as a deus ex machina. But competition has been a key part of the story. The erosion of competition has hurt both economic efficiency and equity. As technological change and globalization continue to transform markets, reinvigorating competition will be crucial in harnessing these forces to support more robust, sustainable, and inclusive growth.