A dearth of competition among firms helps explain wage inequality and a host of other ills
Oct 1st 2016 Economist
In “The Fugitive”, a 1960s television drama, David Janssen plays Richard Kimble, a doctor wrongly convicted of murdering his wife who escapes on the way to his execution. He claims, but cannot prove, that he encountered a one-armed man minutes before he discovered his wife’s dead body. After his escape he drifts from town to town trying to find the ghostly figure and to elude the man obsessed with recapturing him.
The damage that globalisation has done to America’s economy is as obvious to some as Dr Kimble’s guilt was to his pursuers. Careful academic studies have linked competition by Chinese manufacturers to the growing propensity of prime-aged men to drop out of the labour force. A pillar of trade theory says that increased commerce with labour-rich countries will depress the pay of the low-skilled; and some reckonings of wage inequality in America pin part of the blame on trade and migration. GDP growth has been sluggish during the long hangover from the financial crisis. The globalisation of finance provided the kindling for America’s subprime crisis and spread its effects around the world. Globalisation is on the run. But might there be another brigand who bears responsibility for its alleged crimes?
An intriguing line of research identifies an increase in the incidence of economic “rents” (profits over and above the levels needed to justify investment or input of work) as a possible villain. The top 10% of firms by profit have pulled away sharply from the rest. Their return on capital invested rose from more than three times that of the median firm in the 1990s to eight times. This is way above any plausible cost of capital and likely to be pure rent. Those high returns are persistent. More than four-fifths of the firms that made a return of 25% or more in 2003 were still doing so ten years later.
Other research suggests that this increasingly skewed distribution of profits goes a long way to explaining the rise in wage inequality. Most of the growing dispersion in individual pay since the 1970s is associated with variations in pay between companies, not within them. In other words, the most profitable companies pay handsomely and people who work for them earn more than the rest. Virtually all of the rise in income inequality is explained by a growing dispersion in average wages paid by firms. This finding holds across all industries, regions and firm sizes. One of the most striking implications is that inequality within firms has not changed much: the relationship between managers’ and shop-floor workers’ pay in each firm is still roughly the same. But the gap between what the average and the best firms pay their workers at all levels has widened. Where managers are well paid, so are janitors.
More power, more profit
This wider range of profits is likely to be related to increases in market power. Some of this is due to the rise of internet giants, which dominate their respective markets thanks to network effects. But many of America’s industries have also become more concentrated by a slow creep of acquisitions. A study by The Economist earlier this year divided the economy into 900-odd sectors covered by the five-yearly economic census and found that two-thirds of them were more concentrated in 2012 than they had been in 1997. The weighted average share of the total held by the leading four firms in each sector rose from 26% to 32%.
America used to be famous for its workers’ willingness to follow the jobs, but they have become far less mobile. Over the past three decades migration rates between states have fallen by at least a third for most age groups. For those aged between 20 and 24, the most mobile group, the annual rate of internal migration fell from 5.7% in 1981-89 to 3.3% in 2002-12.
Many of the reasons put forward for this are not wholly convincing. It cannot be the rise of the two-income family, because the trend to less mobility holds for workers of all ages. Nor is it the housing boom and bust: the decline in mobility started long before that, in the early 1990s, and has continued since. It is certainly not trade unions (membership of which has declined), labour-market regulation or unemployment benefits, claims for which have dropped sharply.
A few researchers have made an intriguing link between the decline in labour mobility and wider profit dispersion. The argument has several steps. The average age of established businesses has risen steadily because fewer new firms are formed. Startups have a high labour turnover, but in mature firms fewer people join and leave in any given year. The lower the churn rate of jobs, the fewer the opportunities for job-changers to find new work. So it is possible that less dynamism in American business, characterised by industry concentration and lower job turnover, has reduced the incentive for jobseekers to go and look for work in another state.
Another reason may be rent-seeking within the labour force itself. The share of America’s workforce covered by state-licensing laws has risen to 25%, from less than 5% in the 1950s. Much of this red tape is unnecessary. On the most recent estimates, over 1,000 occupations are regulated in at least one state but only 60 are regulated in all states. The scope of the rules vary from state to state. A licensed security guard requires three years of training in Michigan but only around two weeks in most other states, for instance. Licensed workers can command higher pay than the unlicensed kind because entry to the occupation is restricted, so consumers have to pay more.
For much of the past 40 years economic liberals have argued for the dismantling of barriers to the free flow of commerce, such as state monopolies, trade unions and restrictive practices. Such policies have produced some clear successes. In Britain the privatisation of monopoly utilities, such as British Telecom, and the opening up of other sectors to competition was a spur to productivity and innovation, leading to better and cheaper services for customers. In America the deregulation of airlines brought lower fares and an increase in the number of trips. Labour markets in America and Britain became more flexible, and unemployment has generally been lower than in continental Europe.
Deregulation is almost always a difficult task. Those whose interests are hurt by such reforms protest noisily. The political costs quickly become apparent, whereas the gains may not become clear before the next polling day. It is even harder to make changes when so many people feel that the cost of liberalising markets in the past was unfairly distributed. Critics of such liberalisation point to a decline in labour income as a share of GDP as evidence that wage earners have the odds stacked against them. They argue that blue-collar workers provide the flexibility, having to accept lower pay and less job security, whereas white-collar workers and bosses are protected. Increased openness to trade and the growing mobility of capital have made it harder for workers to push for pay rises, so they cling to the jobs they have. In an age of insecurity, it is hard to persuade anyone that they should give up such protections for the greater good.
Market power is supposed to be policed by competition agencies, but they have lost some of their vim, particularly in America, where competition cases are fought out in the courts. A landmark Supreme Court judgment in 2004 said monopoly profits were the just reward for innovation. That has made it harder for trustbusters to root out rent-seeking or block mergers. Most big firms got where they are by being good at what they do, not because of coddling by regulators. But if firms can hold onto their market share for years, they create distortions in the rest of the economy. Incumbent firms are powerful lobbyists.
Big tech firms also have a penchant for so-called “shoot-out” acquisitions, whereby a startup is bought to eliminate a budding rival. For many tech startups and their financiers, a buy-out by one of the big platform companies is a badge of success. But if small firms cannot become independently big, the market power of incumbents is not sufficiently challenged.
Competition policy faces difficult questions in an age of superstar firms that dominate global markets. But the trickiest political problem for reformers is how to inject some dynamism into the economy without getting people even more worried about their livelihoods. Raising import tariffs or closing borders to people and capital is not the answer. Instead, policymakers should encourage more competition while putting in place adequate protections for those who lose out from it.