Monday, August 27, 2018

The impossible dilemma - business concentration and competition cannot co-exist

John Van Reenen has a paper at the Kansas City Fed's Jackson Hole Symposium analysing the changes in market structure and contributors to business concentration. He writes,
In recent decades the differences between firms in terms of their relative sales, productivity and wages appear to have increased in the US and many other industrialized countries. Higher sales concentration and apparent increases in aggregate markups have led to the concern that product market power has risen substantially which is a potential explanation for the falling labor share of GDP, sluggish productivity growth and other indicators of declining business dynamism. I suggest that this conclusion is premature. Many of the patterns are consistent with a more nuanced view where many industries have become “winner take most/all” due to globalization and new technologies rather than a generalized weakening of competition due to relaxed anti-trust rules or rising regulation.
In simple terms, Reenen appears to be saying that business concentration may be happening due to globalisation and new technologies which have changed the nature of competition, and not weakened it, and that may not be a matter of concern.

He goes on,
There are other explanations of the increasing differences that do not rest on a generalized fall in product market competition. Indeed, an equally strong case could be made that the forces of globalization and new technologies have changed the nature of competition without necessarily diminishing it across the board. For example, if more markets are becoming “winner take all” as with digital platform competition, this will generate the dominance of “superstar firms” such as Amazon, Apple, Facebook, Google and Microsoft. The success of such firms may be as much due to intensified competition “for the market” rather than anti-competitive mergers or collusion “in the market”. Furthermore, even in lower tech markets like retail and wholesale, rapid falls in quality-adjusted ICT prices (information and communication technologies) may give larger firms - who can invest heavily in developing proprietary software - major advantages in logistics and inventory control management...
if firms differ in their productivity and markets are not perfectly competitive more productive firms will have bigger market shares. Furthermore, these large “superstar” firms will tend to have higher profit margins and lower labor shares of value added. If market competition rises (e.g. consumers become more price sensitive) then more output is allocated to the larger, most productive firms – i.e. concentration rises. This can be through the extensive margin (less productive badly managed firms exit) and the intensive margin (amongst the survivors, high productivity firms get even larger market shares). Hence an increase in competition could easily lead to rising concentration. 
In fact, far from being anti-competitive, such business concentration may be due to "intensified competition for the market". He also argues that "the fall in the labor share is due to reallocation towards large, high margin firms rather than a general increase in the markup across all firms". He dwells on the important finding of "rising firm-level productivity dispersion" and "most of the widening earnings inequality being between firms and not within firms". And isn't reallocation towards more dynamic firms in an industry to be welcomed? 

And the underlying premise of the dynamics of modern technologies and other trends favouring "superstar firms" and the fact that these firms dominate the most innovative and vibrant sectors of the economy appears to indicate a merit-based and market-driven selection of these firms. In fact, nothing could be farther from the truth.

It is here that economists would do well to ground their theories of change on priors and not just objective and logical arguments. They need to draw on historical perspectives and on other branches of social sciences to inform their theories. More than anything they need to just watch what is happening in the real world. 

Sample this logically perfect rationalisation, 
Higher competition in general will give firms with a cost or quality advantage a large share of the market. But the growth of platform competition in digital markets has led to dominance by a small number of firms such as internet search (Google), ride sharing (Uber), social media (Facebook, Twitter), operating systems for cellphones (Apple, Android), home sharing (AirBnB), etc. Network effects mean that small quality differences can tip a market to one or two players who earn very high profits. The growth of such industries does not mean that competition has disappeared, rather its nature has changed. There is more competition “for the market” rather than “in the market”.
"Growth of platform competition" driving the trends in digital markets! Really? If nothing else, read the ProMarket Blog please. There are countless articles, including nowadays in the mainstream media, which calls out this argument and describes the anti-competitive practices of these platform companies.

From a historical and inter-disciplinary perspective, intellectuals from Adam Smith to Karl Marx, not to speak of several others subsequently (Pareto, Mosca, Wright Mills, Eisenhower, Galbraith and so on), have all warned of the dangers of political capture by those who exercise economic power. And it cannot be denied that superstar firms or the largest firms, left to their own devices, will not only exercise economic power but also seek political power to entrench their economic power.

In other words business concentration and political capture invariably go together. Alternatively, competition and business concentration cannot co-exist. This is the impossible dilemma of any market structure. 

In simple terms, Reenen's line of reasoning overlooks the central issue. The problem is the reality of business concentration and all its consequences (including the fall in labour share of income). The "superstar firms" are themselves the problem. And not what causes this business concentration or their rise. Not even what is its future. Much less whether this is caused by decreasing or rising competition. 

Economists and researchers schooled in mathematical models gloss over the dynamics of real-world human interaction. Just consider access itself. It was reported that Google for example had 120 lobby meetings with a commissioner, cabinet member or director-general of the EU between 2014-16. Or the extraordinary access of Google to the Obama White House or Goldman Sachs to Hank Paulson when TARP was being formulated or the unprecedented access of corporate executives to President Obama himself. This access, even without malafide intent on any side, itself deeply questionable, marginalises incentives and logical reasoning (and attendant utility preference functions) and primes decision-makers into internalising a particular world-view or line of thinking about an issue. It is just that's the way human beings are. Call it influence, hegemony, socialisation, or whatever. It's a reality that cannot be wished away! This access has to be contrasted with the minimal or no access that the opposing and alternative points of view, which in turn amplifies the influence of business interests.

At a most basic level, if we buy into the inevitability of political capture, it is immaterial what is driving business concentration. The mere fact of business concentration raises the possibility inevitability of the exercise of economic power and political capture.

When Piketty came out, instead of embracing the central message of a world of widening inequality, economists went about detracting attention from it by hair-splitting around the inequality r > g. A similar debate is being reprised amidst the mounting evidence of the harmful effects of business concentration, irrespective of what drives it and what is its future.

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