Monday, May 16, 2016

"Rising monopoly power may partly explain US inequality and productivity slowdown"

This is not the Stiglitz piece on Monopoly from the Guardian or Project Syndicate that was making the rounds this weekend.
Rather, it is a post from Simon Taylor's Behind Blue Eyes* blog:
A new theme in explaining slow growth and productivity and rising inequality: greater monopoly power in the US.
I’ve been thinking about my forthcoming teaching for the Cambridge Advanced Leadership Programme in June, which is always an interesting session, with a lively and challenging group of delegates from across the world. I try to combine three things in my module: i) an overview of where the world economy is at present; ii) a deeper structural view of the world financial system; and iii) one or two specific themes which are being discussed in the world of finance and economics research which are not yet in the wider public debate but which may contribute to understanding why the world economy is not performing as well as hoped.

The latest theme is monopoly power, or equivalently the concentration of supplier power in markets in advanced economies. This may be part of the explanation for three intertwined but poorly understood aspects of the advanced economies, especially in the US: i) slow productivity growth; ii) rising inequality; and iii) weak GDP growth that some call secular stagnation.

Textbook economics usually starts with perfect competition, a world in which nobody has any market power on the demand or supply side. The logical consequence of this is that resources are efficiently used. Firms are price-takers, meaning they just have to sell at the prevailing market price, which will be exactly the price that just incentivises the marginally efficient firm to keep producing.

Perfect competition is what in social sciences is known as an ideal type, a stylised model that helps us understand the world but is not necessarily realistic. There are some markets that are close to perfectly competitive, for example farmers often have absolutely no pricing power, though it’s often the case that there is market power on the demand side (supermarkets, agricultural purchasing boards in developing economies).

But most goods and services are traded in markets where there is some market power. This arises from the product or service being differentiated – it’s not identical to others so there is not perfect substitutability. Even location matters – a corner shop may compete in terms of being more convenient than a cheaper supermarket some distance away. Branding is a way of discouraging consumers from simply comparing the prices of similar products (even if they are in fact practically identical).

All this is fine within limits. You could even define the primary goal of any business to build some market power by making its product different. It can then potentially earn a slightly higher return and perhaps invest in product innovation which would be unaffordable in perfect competition. There is a virtuous circle in which companies innovate, differentiate, invest in further innovation and thereby produce better products for their customers, at the same time building some degree of market power.

The dark side of monopoly power
The problem comes if this market power is either unearned through successful innovation or service or even if it was, it allows a company to build barriers to entry which prevent other firms from competing. To an economist, the danger of monopoly power comes in two forms: i) the monopolist can and will price above marginal cost, so the price no longer reflects the true resource cost of production; and ii) the monopolist may stop being innovative and dynamic and instead become lazy and inefficient, secure in the knowledge that competitors offer no threat.

A related consequence of monopoly power is that firms are not under the same pressure to pay workers their marginal revenue product (the value of what they produce). If there is concentration on the employer side but lots of workers for hire then firms can get away with paying less than before. (Cambridge economist Joan Robinson suggested that this might be the source of what Karl Marx, using a very different and ultimately unsuccessful economic framework, called labour “exploitation”. Marxists generally disagreed with her approach but the long term predictions of Marxist economics have mostly failed to happen). So rising monopoly power might be part of the explanation for stagnating middle class incomes in the US and the trend of rising inequality in the last forty years or so....MUCH MORE
*We last visited Professor Taylor in "The Political Economy of Cows: Udder Peoples Money".
His bloggy bio says:
Simon is the Director of the University of Cambridge Master of Finance (MFin) degree and a member of the finance and accounting faculty group at Cambridge Judge Business School. An economist and former equities analyst at JPMorgan and Citigroup, he teaches on financial markets and institutions, infrastructure finance and the world financial system. His new book on nuclear power in the UK was published in March 2016.
He also has a faculty profile at Cambridge Judge Business School >