The U.S. economy has grown more concentrated since the early 1990s, with big players taking home a larger share of revenue across industries. That trend has accelerated in recent years. Much of the concern has been around the financial industry, where despite complaints of “too big to fail,” the number of large, international banks has actually fallen since the crisis.
A new paper by economists Jan De Loecker and Jan Eeckhout argues that the problem isn’t confined to finance, or even large international corporations. Instead, using a clever analytical technique, they show that Markups have risen across industries, particularly among smaller firms.
Economists consider markups to be the difference between what a business pays for the inputs it uses and what it charges for the products it produces. In highly competitive markets, firms are forced to lower prices until they just cover their costs. But businesses in less competitive markets — monopolists being the extreme example — are able to raise prices without losing all their customers. Thus, higher markups are a potential indicator that industry consolidation has weakened competition within the U.S. economy, suggesting firms today have much more Market power.
According to De Loecker and Eeckhout, markups have soared from 18% in 1980 to 67% today. If that change is being driven by a rise in market power, then the fundamental nature of the American economy has changed over the last four decades. This is the conclusion the authors draw. They argue that this rise in markups explains some of the most disconcerting and perplexing trends in the U.S. economy: the long-run decline in labor’s share of income; the decline in low skilled wages; the decline in labor force participation; the reduction in labor market mobility both between firms and across regions; and the slowdown in productivity growth since 2008.
This is quite a claim. Do the authors have the goods to back it up? The fact that the authors have put together a single explanation for multiple, contemporaneous puzzles makes me very reluctant to dismiss the work they have done. It is highly likely they have stumbled upon something. The question is, what exactly?
The new paper shows that markups are actually increasing faster for small businesses than for large ones. This is precisely the opposite of what we would expect in an environment dominated by large, powerful firms. In that environment, we would expect smaller firms to face stronger pressure to cut prices. In fact, the story this data tells is less one of declining competition and domination by a handful of large multinational firms than it is a story of ever-increasing market power by relatively small businesses.
And that offers a clue as to what is truly happening. The following is speculative, but so far it is my best guess at how to square the data. In 1980 there were healthy “Main Streets” all over the United States. Small and medium-size businesses were in fairly robust competition with one another. Likewise, local manufacturers participated in a nationwide marketplace in which each of them had little market power.
Over the next several decades, that economy was replaced by one of big-box retailers and global supply chains. Those giant retailers brought even lower prices. The competition was so intense that the typical Main Street business couldn’t keep up. Manufacturers that already faced low profit margins in the national marketplace were driven out of business by suppliers from around the world.
Yet, as intense as this competition was, it didn’t drive all small companies out of business, and it didn’t signal an end to U.S. manufacturing. The smaller businesses that survived were precisely the ones that couldn’t be undercut by big-box retailers and global suppliers. They offered a specialized retail experience, a niche product, or simply served a market that was otherwise hard to reach.
The sweeping away of the small generalized firm made room for the rise of increasingly specialized local businesses, offering what might be thought of as a more artisanal experience. Yes, these firms charge more than the amount needed to cover costs, but those markups don’t represent a lack of competition. Instead, they represent a return to the particular skills or vision necessary to make a specialized product. Economists refer to this market pattern as monopolistic competition, and it provides the variety of products and services that consumers in wealthy, developed economies desire.
If my story is correct, the trend toward higher markups is linked to the major changes sweeping the American economy, as the researchers argue. However, it isn’t the cause of them. Instead, it is another consequence of the radical changes brought about by globalization and the creative destruction that continues to reshape American Main Streets.