More on business concentration in the US

As I have blogged on several occasions, there are too many signatures of modern capitalism that point to an innate dynamics of business concentration and inefficiencies. A new paper by US Federal Reserve economists Isabel Cairo and Jae Sim reiterate the points.

They point to six secular trends from the US economy from the last four decades.

First, real wage growth has stagnated behind productivity growth over the last four decades and, as a result, the labor income share has steadily declined. If the real wage growth is the best measure of improvement in living standards, the decline of labor share can be considered an undesirable trend for the welfare of the majority of households. Second, the before-tax profit share of U.S. corporations has shown a dramatic increase in the last few decades. If the rise of the profit share is due to a growing concentration of U.S. industries and the rise of prices over production costs, it can also be considered detrimental to the welfare of consumers. The profit share is negatively correlated with labor share, and the degree of correlation is strong: -0.91 over the 1980–2018 period. This correlation suggests that the rise of the profit share and the fall of the labor share may have been driven by a common cause. 

Third, income inequality has been exacerbated over the last four decades. In particular, the income share of the top 5 percent households has been steadily rising from 21 percent in early 1980s to more than 34 percent on the eve of the Global Financial Crisis (GFC) in 2008. The rise in income inequality over the last decades may be closely related with the first two trends. To the extent that the major income source of wealthy households is the profits of the firms and the major income source of the working class is labor income, the first two trends explain the trend in income inequality. This suggests that income inequality, too, may have been driven by the same factor behind the decline of the labor share and the rise of the profit share.

Fourth, wealth inequality has also been exacerbated during the last four decades. According to the Survey of Consumer Finances, the net worth of the top 5 percent households has increased about 186 percent between 1983 and 2016. The rise in wealth inequality is not simply the result of rising income inequality–though related, since a bulk of the rise is due to capital gains. If most of capital gains are related to increased stock market value, the surge in wealth inequality may have been driven by the same cause that explains the aforementioned three secular trends.

Fifth, the rise of income inequality has happened concurrently with the rise of household sector leverage ratio. The household sector credit-to-GDP ratio was 45 percent at the beginning of 1980s. Since then, the ratio steadily increased and reached almost 100 percent on the eve of GFC. This suggests that a growing share of national income has been allocated to income groups with low marginal propensities to consume (MPC). If there is a negative correlation between income level and MPC... even this secular trend may have the same cause that generates the rising income inequality. Finally, the rising household sector leverage has been coupled with rising financial instability... The probability of financial crisis in the United States, computed using the estimates of the multi-country logit model of financial crisis by Schularick and Taylor (2012), has steadily risen from 2.1 percent in 1980 to a level close to 3.5 percent on the eve of GFC. The secular rise of financial instability is clearly linked to credit expansion over the last few decades.

Their findings from their economic model bears striking similarities with the actual trends,

We develop a real business cycle model and show that the rise of market power of the firms in both product and labor markets over the last four decades can generate all of these secular trends.

Their recommendation,

Since the GFC, most of the focus of macroprudential policies has been on building the resilience of financial intermediaries by bolstering their capital positions, restricting their risk exposures, and restraining excessive interconnectedness among them. These policies are useful in maintaining financial stability. How- ever, these policies might not address a much more fundamental issue: Why is there so much income “to be intermediated” to begin with? In our framework, the root cause of financial instability is the income inequality driven by changes in market structure and institutional changes that reward the groups at the top of the income distribution. Our experiment suggests that if an important goal for public policy is to limit the probability of a tail event, such as a financial crisis, a powerful macroprudential policy may be a redistribution policy that moderates the rise in income inequality.