By Lachlan Carey and Amn Nasir
The following paper studies three main questions: First, What is the association between increasing concentration and labor and profit shares? Second, is this effect different across sectors? Third, is this effect uniform across advanced economies? The paper finds that while there is a negative relationship between concentration and labor share and a positive relationship between concentration and profit share, the result is more pronounced in the United States than in similar advanced European economies. Moreover, the results are stronger for the manufacturing sector than for the services sector. The paper concludes that this evidence suggests that deviations from perfect competition are likely explained by declining competition in the U.S., whereas these secular trends, such as heterogeneous technology adoption and the declining price of capital, are more likely at play in Europe. Consequently, the paper prioritizes pre-distribution over redistribution.
The replication in this analysis is in the appendix. You can access it here.
According to The Economist (2016), the share of America’s nominal GDP generated by the Fortune 100 largest companies has increased from 33% in 1994 to 46% in 2013, and the number of listed companies roughly halved over the same timeframe. Simultaneously, markups and profit shares of companies are rising steadily (Weche and Wambach 2018) even as business investment has been falling. Furthermore, labor’s share of earnings has been in decline for decades, and both income and wealth inequality have increased proportionately.
The examination of such trends has been at the core of economic policy since the time of classical economists like David Ricardo. Ricardo wrote in 1817 that “the produce of the earth...is divided among three classes of the community [labor, capital and profits]...To determine the laws which regulate this distribution is the principal problem in Political Economy”. Nearly 150 years later, Nicolas Kaldor (1957) published his famous ‘stylized fact’ that these factor shares of income remain constant over time. By 2014, Piketty had achieved global fame for proposing a return to Ricardo’s emphasis on factor share distribution, and dismissing Kaldor’s ‘facts’ as a mere historical aberration. In his book Capital in the 21st Century (2013), he writes that “there is no natural, spontaneous process to prevent destabilizing, inegalitarian forces from prevailing permanently.” The implication of this finding is that “the history of the distribution of wealth has always been deeply political, and it cannot be reduced to purely economic mechanisms.”
This renewed focus on political mechanisms and the falling labor share has spawned a range of literature arguing over how and why the “produce of the earth” has been divided between classes over time. Two important contributions to this literature in the last several years are those by Barkai (2017) and Gutiérrez (2017), who use the so-called ex-ante methodology for calculating factor shares to return to a Ricardian division amongst the three classes; empirically dismantle Kaldor’s view of stable income shares; and propose that declining competition is a key component for why we have seen such changes between countries, within industries, and across time.
This methodological contribution is far from trivial. It abandons the assumption of perfect competition and allows for the possibility of the sort of economic and political rent-seeking usually ignored by neo-classical economics. In simpler terms, if Barkai (2017) and Gutiérrez (2017) are correct, then there is in fact ample evidence for more government intervention, not less, as economists have been proposing for forty years. A 2017 paper by De Loecker and Eeckhout (2017) also found links between rising concentration, falling competition, and declining productivity. Their methodology provided evidence for rising markups—the price charged above marginal cost and broadly synonymous with falling competition or a rising profit share—whereas this paper uses the ”profit share” approach due to both its intuitive appeal and direct links to previous work on factor shares.
The “profit share” is implicitly the opportunity cost of rent-seeking on society; it is income neither distributed to labor for work, nor to the future productive potential of the economy, but captured by the most wealthy and powerful segments of society for the purposes of furthering their wealth and power. The inherently political implications of this concept are therefore clear, whereas rising mark-ups are a more difficult phenomenon to approach.
The “profit share” is implicitly the opportunity cost of rent-seeking on society; it is income neither distributed to labor for work, nor to the future productive potential of the economy, but captured by the most wealthy and powerful segments of society for the purposes of furthering their wealth and power.
Though not the focus of this paper, a rising profit share has very real economic consequences. It is therefore not merely a refutation of long-standing theory, but possibly a key factor behind a range of real-world problems. According to recent literature, declining competition can explain:
- low rates of capital investment over the post-recession period (Gutiérrez and Philippon 2017);
- declining business dynamism (Davis and Haltiwanger 2014);
- a slowdown in aggregate productivity ((Baqaee and Farhi 2017));
- declining labor share (Barkai 2017);
- rising inequality (Atkinson 2009);
- falling long-term interest rates (Summers 2015); and
- a low investment-to-output ratio (Eggertsson et al. 2018)
Our paper seeks to empirically replicate these important results and expand the scope of analysis to include additional political and institutional considerations and assess their policy implications. In this paper, we analyze the association between increasing concentration and labor and profit shares, aggregated and disaggregated across sectors and across a sample of advanced economies. We seek to answer whether there is a relationship between concentration and labor and profit shares, and how they vary across countries, over time and across sector.
Section 2 reviews key literature related to this topic. Section 3 derives capital and profit shares using Barkai’s ex-ante approach, whereas Section 4 replicates German Gutiérrez’s regression analysis. Section 5 presents our extension and key results. Section 6 briefly outlines five areas of future research and considers policy options that could address the core issue of declining competition and the rising profit share.
2. Literature Review
There have been multiple attempts to describe and evaluate changes in factor shares across countries (Rodriguez and Jayadev 2010, OECD 2015) . Karabarbounis and Neiman (2014) documented a 5 percentage point decline in the global labor share over the past 35 years. The IMF (2017) extended this analysis and concluded that the majority of countries experienced a downward trend in their labor share, and that roughly 90 per cent of this was due to within-industry changes. However, all these works assumed perfect competition, where economic profit is zero and therefore the only two factors are capital and labor.
Relaxing the assumption of perfect competition allows the all-important third factor of economic profits to factor into the analysis.
Methodologically, the so-called ex-ante approach—which specifies an ex-ante required rate of return on capital from a standard model of production theory, and derives a separate series for capital and economic profits—was pioneered by Hall and Jorgenson (1967) and further developed by Barkai (2017). Intuitively, this methodology assumes that businesses only wish to invest until they have covered the interest payments on their debt obligations. Corporations will therefore seek to minimize their compensation to employees and capital investment, so long as they can maintain high or rising profits.
As far as we are aware, the Gutiérrez (2017) paper has been the only subsequent attempt to extend the ex-ante approach across countries. While Christopoulou and Vermeulen (2012) use a similar approach to derive the change in markups across Europe and the United States, they do not consider income shares per se. This is also true of De Loecker and Eeckhout (2017).
2.2 Reasons for the Decline in the Labor Share
Until quite recently, the literature has largely focused on secular trends that could explain changes in the labor share across countries. These trends are unrelated, time varying patterns, that are not subject to seasonal or cyclical effects.
First, are the effects of capital-augmenting technological change and production automation (Acemoglu 2003, Summers 2013, Acemoglu and Restrepo 2017). That is, as technology has improved its ability to replace labor, a larger share of economic gains has gone to capital owners. While the literature claims that the decline in the relative price of capital has been a contributing factor, it can’t explain the majority of the decline, nor can it explain heterogeneity across industries and countries.
Second, Piketty (2014), and Zucman (2014) have argued that the falling price of capital masks how falling productivity and economic growth are responsible for labor’s declining share of income and the rise in income and wealth inequality. Piketty proposes that an economy will inevitably move towards a higher capital-to-income ratio over the long run as economic growth slows. Falling productivity across OECD countries (OECD 2015) is also a contributing factor to slower growth, though there remains little consensus on whether this is endogenous to the falling labor share (Summers 2015, Stansbury and Summers 2017, Zingales 2017).
Third is the dramatic increase in both trade and financial integration (Harrison 2005, Rodriguez and Jayadev 2010, Elsby et al. 2013), which causes a shift of resources away from labor in countries that have a comparative advantage in capital-abundant industries towards those with relatively cheap labor resources, as demonstrated by studies on the ‘China Shock’ in the United States (Autor et al. 2016) and on how the labor share is affected by capital mobility (see Rodrik 1997, Hung and Hammett 2016, Jayadev 2007).
Recent literature has begun to consider the impact of heterogeneous institutional environments on income shares. One popular strand contends that the real source of declining labor shares has been changes to the returns on housing. Matthew Rognlie argues that “the net capital share has increased since 1948, but once disaggregated this increase turns out to come entirely from the housing sector.“ It is uncertain how much of this effect is due to secular factors or institutional variation and regulatory differences. Some authors (Maclennan and Miao 2017) show that the strong demand for land in metropolitan areas is due largely to zoning restrictions (Cava 2016), while Gonzalez and Trivin (2017) argue that a global rise in asset prices (as measured by Tobin’s Q, which is the ratio of the value of all the shares of stocks outstanding divided by the book value of everything publicly traded companies own) explains roughly 60 percent of the decline in the labor share.
2.3 Declining Competition and the Rising Profit Share
The literature cited above demonstrates how both secular trends and changes in wealth across countries have affected the labor share over time. However, due to their implicit assumption of perfect competition in these markets, they each potentially miss the relationship between economic profits and the declining labor share. Importantly, though structural factors are of course likely at play, imperfect competition is the likely explanation for a declining labor share and the product of political decisions (Erbach 2014).
Barkai and Gutiérrez, by including profit share in this analysis, illustrate how imperfect competition has been rising for at least 30 years (Peltzman 2014, Grullon et al. 2015), and is having significant consequences on the growth and distribution of economic output.
Christopoulou and Vermeulen (2012) use a similar ex ante approach to our own, to describe changes in markups in Europe and the US over the period 1981 to 2004. They find that the assumption of perfect competition can be rejected; that there is considerable heterogeneity across countries and industries; and that markups are higher in services than in manufacturing. The findings of Weche and Wambach mirror those of our study, even as they focus on markups rather than the profit share. They show a drop in markups immediately following the 2008 to 2009 crisis, followed by a slow but steady rise towards pre-crisis levels in subsequent years.
3. Empirical Replication: Labor and Profit Shares
We replicate and confirm the results of Barkai and Gutiérrez, by applying Hall & Jorgensen’s (1967) ex-ante approach to the labor and profit shares of the non-financial corporate sectors over the period 1980-2015. Replication is important in this instance due to both the importance of the findings and the desire to interrogate these authors conclusions with new hypotheses. Therefore, we limit our data to the same range as Barkai and Gutiérrez but add additional explanatory variables in our regression analysis below. This detailed analysis is carried out in the appendix.
As expected, our results illustrate consistent falls in labor shares across countries over time. The labor share peaked in approximately the mid-1970s before declining precipitously until roughly the mid-1990s. While for the United States and Germany this decline has continued relatively unabated, for most other countries in our sample, there has been a reversal over the last 20 years or so. These results are shown in Figure 1 below.
Figure 1: Labor Share by Country: with and without Real Estate
Four stylized facts emerge from our cross-country industry-level analysis of labor shares:
- At the aggregate level, labor shares have fallen for the majority of countries in our sample. Unlike Gutiérrez, this result appears to hold whether real estate is included or not.
- While labor shares have rebounded for most European countries in our sample since 2000, this is not true of the USA and Germany, for whom there have been the largest falls in labor share within the manufacturing sector.
- The labor share has fallen across the majority of industries since 1990, with some heterogeneity across countries.
- In general, the fall in labor share has been more pronounced in manufacturing industries than services, where the labor share largely rebounded since 2000 or has remained flat.
As expected, profit shares have exhibited an upward trend in most countries for which there are available data. However, the differences pre- and post-crisis are more stark for profit share results and figure 2 shows that profit shares differ distinctly between manufacturing and services for most countries. Appendix 1 looks at the industry-level changes in more detail and notes that there are few cross-country similarities. There are, however, some similarities between the so-called “core” European nations, as there is for the “peripheral,” suggesting that in Europe a large factor has been the effects of the monetary union since 1999.
This suggests to us that a variety in policy responses and institutional environments are more likely to be responsible for these differences than secular trends, as has been the convention in the literature thus far. In the United States, the broad trends are more consistent with a variety of “superstar firm” theories, whereas in Europe, the development of a pan-European institutional environment seems more likely to be at play. We test this conclusion in our regression analysis section.
We have therefore established, in line with Gutiérrez (2017), that there is sufficient heterogeneity in changes in both labor and profit shares across industries and countries to discount simplistic one-size-fits-all explanations. These results also suggest four further stylized facts:
- Perfect competition—that is, zero economic profits—is the exception, rather than the rule for all countries in our sample.
- At the aggregate level, the profit share was rising in all countries in our sample prior to the 2008 to 2009 financial crisis.
Figure 2: Profit Share: Manufacturing and Services
- The profit share fell in all countries during the crisis and in those in which it has been increasing again, has generally since exceeded pre-crisis levels.
- Every country in our sample has seen some increase in the economic profits of the services sector (when excluding real estate) since the financial crisis, while the results for manufacturing are more mixed.
4. Empirical Replication: Regression Analysis
In his paper, (Gutiérrez, 2017) uses the following specification to determine the association between various explanatory variables and labor share:
where ηj denotes industries, tdenotes year, Xjt denotes empirical proxies for each explanation, and ηjdenotes industry fixed effects. Standard errors are robust and clustered at the industry level.
denotes the main outcome variable of interest-labor share in industry j in year t.
In this paper, we replicate results for labor share in the USfor 4 different empirical proxies that Gutiérrez uses: 1) Industry-level markup 2) Intangibles’ share of total capital stock 3) Price of capital and 4) Total Factor Productivity. The key implication of this analysis is that we are determining the extent to which these four secular trends—which are often posited in the ex-post literature examining just two factor shares—apply when the assumption of zero economic profits is relaxed and a rising profit share is included.
4.1 Industry-Level markup
First, we follow the approach of Grullon et al. (2015) and define the Lerner index (L) as operating income before depreciation minus depreciation divided by sales. We obtain data on all three variables from Compustat. We then use the L to construct the markup, . This markup is an empirical measure of a firm’s ability to extract rents from the market—that is, income neither invested in productive capital or paid to its workers.
Empirically, the markup can be seen to be increasing in the US between 1980 and 2016, from 11.5 percent to 16.1 percent. This increase is most pronounced in industries in the 90th percentile, where markup goes from 1.196 to 1.228, compared to industries in the 10th percentile, where markup increases from 1.044 to 1.054. There has also been variation in the evolution of markup across sectors-the sharpest increase has happened in manufacturing, from 9.8 percent in 1980 to 19.9 percent in 2016, followed by services, where markup has increased from 18.1 percent in 1980 to 24.4 percent (see Figure 3).
The univariate regression of labor and profit shares on markup produces results identical to Gutiérrez’s. A one percentage point increase in markup leads to a 0.69 percentage point decline in labor share and a 2.29 percentage point increase in profit share, both of which are highly statistically significant, at the 1 percent and 5 percent significance levels respectively. Since increasing markup indicates declining competition, this implies that decreasing competition is strongly correlated with both labor and profit shares.
Figure 3: Evolution of Markup in the United States
4.2 Price of Capital
A strand of literature argues that the decline in labor share can be attributed to the decline in the price of capital, which has led to substitution of capital for labor (Karabarbounis and Neiman 2014). While there has indeed been a large decline in the price of capital in the US since the 1980s, the price of capital has remained relatively stable since 2000, as can be seen in Figure 4. Thus, this indicator cannot explain the decline in labor share since 2000.
A strand of literature argues that the decline in labor share can be attributed to the decline in the price of capital, which has led to substitution of capital for labor.
The univariate regression of labor and profit shares on one-year lagged price of capital shows that a one percent point decrease in price of capital is associated with an 0.45 percentage point decline in labor share and 3 percentage point increase in profit share, neither of which are statistically significant. This is consistent with Gutiérrez’s results, and results from other literature such as Elsby et al. (2013).
Figure 4: Evolution of Price of Capital in the United States
4.3 Intangibles’ share of total capital stock
Gutiérrez hypothesizes that the rising share of intangibles (items that aren’t physical goods yet carry value, such as research and development, software etc.) as a proportion of total capital stock may explain some decline in labor share since ”higher depreciation of intangibles translates to a higher capital share”(Gutiérrez 2017). Empirically, the average share of intangibles in 1980 for the US was approximately 12.7%, compared to 18.1% in 2014. This evolution can be seen in Figure 5.
The univariate regression of labor and profit shares on two-year lagged intangibles’ share shows that a one percentage point decrease in intangibles’ share is associated with a 0.089 percent point decline in labor share, although this is insignificant. In Gutiérrez’s paper, this coefficient is statistically significant at the 10 percent significance level. The differences in our result could be attributed to differences in how the variable is constructed, since Gutiérrez is ambiguous about his methodology in the paper. Despite our divergence with Gutiérrez’s results, he argues that this explanation is inadequate to explain the post-2000 decline in the US labor share. This is consistent with our Figure 5, which shows that post-2000, there has been very little increase in intangibles’ share, with the share being 17.9 percent in 2000 and only increasing by 0.2 percentage points between 2000 and 2014, while labor share drastically decreased in the same time period.
Figure 5: Intangibles’ Share of Assets in the United States
4.4 Total Factor Productivity
Lastly, the literature also makes references to the compositional effect of increasing productivity on labor share. However, it is often difficult to extricate this effect from that of increasing concentration as high-productivity and low labor share firms capture a larger share of the market (Autor et al. 2017). According to Zingales (2017) “Large firms may attain their leadership position legitimately based on their innovations or efficiency; but may then use their market power to erect barriers to entry and protect their position.”
Despite these methodological concerns, we replicated Gutiérrez’s univariate regression of labor and profit shares on TFP (the portion of output not explained by traditionally measured inputs of labor and capital used in production). However, we do not have access to firm-level TFP data for all countries in our sample, and so, we use industry-level TFP measures as a proxy, since we expect there to be more heterogeneity in TFP between industries rather than within an industry. While Gutiérrez uses industry-level TFP dispersion, measured by the interquartile range of TFP in each industry, we use the mean industry-TFP, as shown in Appendix Figure 30. While Gutiérrez’s TFP dispersion measure does not have a statistically significant association with labor or profit share, in our specification TFP is associated with a decline in labor share and is statistically significant at the 5 percent level. As TFP increase by 1 percentage point relative to its 1995 value, labor share declines by 0.245 percentage points. The full replicated results are shown in the following table:
Figure 6: Replicated Regression Results
Our extension has two main sections. First, we delve into deeper analysis of the trends in labor share in the US, specifying a multivariate regression that attempts to deal with omitted variable bias in the univariate regressions of the previous section. We also investigate effects of markup on labor share in various sectors, to determine whether markup has uniform effects on all sectors. In the second section, we extend the same analysis to a sample of advanced European economies. Gutiérrez does not conduct regression analysis for European countries. This is because he claims that the fall in labor share in non-real estate industries is unique to the US and not Europe, and that most of the decline was limited to pre-2007. However, even in his data, Germany appears to be an outlier, with declining labor shares and rising profit shares even in the post 2007 period. We further investigate this trend and find that that results are mostly insignificant for European countries. However, when disaggregating by sector, significant results can be seen in several European countries.
5.1 Multivariate and Sub-sector Analysis for the US
We suspect that there may be omitted variable bias in the univariate regressions, whereby exclusion of an unobserved variable that is correlated to both markup and labor share may lead to inaccurate results. For instance, TFP and concentration are likely to be positively correlated with each other and negatively correlated with labor share. Yet in a univariate regression of labor share on markup the coefficient for markup is likely to have a downward bias due to the omission of TFP, thereby underestimating the impact of markup on labor share. However, we are also concerned that a post-treatment effect may be at play, whereby rising TFP amongst a set of dominant firms may partially explain industry concentration, which in turn suppresses productivity amongst the more competitive fringe (Barkai 2017). Unfortunately, data limitations prevent us from accurately testing this hypothesis, since cross-country firm-level TFP data is not readily available.
Regardless, it is likely that once we control for concentration we are partially controlling for this productivity channel and, therefore, the coefficient on TFP is likely underestimating the effect of TFP on wages. Thus, we specify two different multivariate regression models: One that contains all four proxies at the same time and a second that controls for price of capital and intangibles’ share but not TFP.
Figure 7: Regression Results for United States
Even when controlling for other industry-level variables, markup has a statistically significant association with both labor and profit shares. As expected, the coefficient on markup is smaller in absolute terms when controlling for TFP. The coefficient for the price of capital is also significant for our labor share regression, suggesting that the substitution of capital for labor also has a persistent effect. Meanwhile, only the coefficients on markup are significant for the rise in profit share.
Next, we disaggregate the results for manufacturing and services to see if the effect of increasing concentration varies across sectors. Results for this can be seen in Figures 8 and 9.
Figure 8: Regression on U.S. Labor Share by Sector
These results show that the effect of increasing concentration isn’t uniform across sectors in America. Increasing markup is associated with a sharper decline in labor share and a larger increase in profit share for manufacturing than for services. We hypothesize explanations for this in the discussion section. Interestingly, changes in the price of capital only have a significant effect within manufacturing, which is consistent with the hypothesis that labor is more easily substituted for capital in manufacturing than in service-based industries. In other words, as capital has become cheaper the manufacturing sector has increasingly replaced its workers with advanced machinery.
Figure 9: Regression on U.S. Profit Share by Sector
5.2 Multivariate and Sub-sector Analysis for Europe
Next, we replicate these results for the European economies in our sample to see if our results align with Gutiérrez’s claim that these results are unique to the US. By aggregating European advanced economies, Gutiérrez misses important variations across countries. While it is true that markup does not generally appear to be statistically significantly associated with labor share in each of these countries (Figure 10), results are different if we disaggregate by sector.
Appendix Figures 19 and 20 show that if we look only at the manufacturing sector, three countries have statistically significant coefficients for markup: France, Germany and Austria. For the services sector, the results are only significant and have the right sign for Austria. This is consistent with results from the US, where increasing concentration is associated with a larger decline in labor share in the manufacturing sector.
Similarly, Figure 11 shows that overall, markup does not appear to have a statistically significant effect on profit share in Europe, in contrast to the US, where there was a substantial increase in the profit share associated with an increase in markup. However, unlike labor shares in Europe, sub-sector analysis does not yield significantly different results, as can be seen in Appendix Figures 22 and 21.
Figure 10: Regression on Labor Shares across Europe
Figure 11: Regression on Profit Shares Across Europe
One key result throughout this paper has been that the effect of concentration on labor share is far more pronounced for the United States than for other advanced economies. This result persists when we aggregate results by sector. This indicates that there may be underlying political and institutional factors in the United States that distinguish it from other countries that may be experiencing the same general macroeconomic trends.
The latest literature suggests five potential reasons why we might see a greater degree of declining competition, increasing markups, and a rising profit share in the United States than Europe: 1) increased returns to scale and the rise of so-called ’superstar firms’; 2) the proliferation of ways in which companies can evade anti-trust legislation; 3) the relative increase in firms’ bargaining power within labor markets; and finally, 4) the rise of ’shareholder capitalism’; and 5) heightened political rent-seeking and regulatory capture.
It is beyond the scope of this paper to compare and contrast each countries’ experience with regards to these five phenomena. Furthermore, none of the five explanations have industry-level data to test these theories. While each hypothesis has firm underlying empirical evidence, further research is still needed to determine the relative contribution of each of these to a rising profit and falling labor share across countries and between industries. The following discussion will therefore focus on the American experience, based on the empirical result that the labor share has fallen further and profit share risen higher in America than can be explained by secular factors alone. There may also be political and institutional changes in Europe—particularly surrounding the formation of the Eurozone—that explain the divergence in Europe, which should be the focus of future research. We will also provide possible policy solutions to each issue, though once again, these are focused on the U.S. context.
6.1 Frontier/Superstar Firms.
According to Barkai (2017), these results are “consistent with a model of a dominant firm and a competitive fringe.” Similarly, Autor et al. (2017) describe a model in which “superstar firms” emerge in response to changes in the competitive environment, allowing them to gain a very large share of the market. Consistent with our results, they show that in industries where such concentration rises the most the declines are also the steepest. Importantly, the authors also find cross-country evidence to suggest that this model applies across advanced economies (including those countries within our sample). Recent work by the OECD (Andrews et al., 2015) suggests this is due to slower technological diffusion between “frontier firms” and the rest of an industry, providing a competitive advantage that allows for “winner take most” scenarios to arise. Bessen (2017) similarly argues that information technology systems have raised the productivity of top firms relative to others, increasing industry concentration. More recently Liu et al. (2019) argue that “low interest rates encourage market concentration by giving industry leaders a strategic advantage over followers, and this effect strengthens as the interest rate approaches zero.”
The rise of labor augmenting technology that increases output per worker is more likely to be prevalent in manufacturing than in services.
This “superstar” theory is especially appealing as it is the most likely to explain the divergence in manufacturing and service industries seen in our results. The rise of labor augmenting technology that increases output per worker is more likely to be prevalent in manufacturing than in services. Similarly, innovation such as increased patenting intensity is also more likely to exist in manufacturing. Relatedly, more concentrated firms may also increasingly use domestic outsourcing ”to contracting firms, temporary help agencies, and independent contractors and freelancers for a wider range of activities previously done inhouse” (Autor et al. 2017). Manufacturing firms are more likely to be concentrated, since they are more capital-intensive and more vulnerable to activities such as mergers and acquisitions, thereby causing further erosion in labor share. The especially large increase in the profit share of the IT industry in the US found in our data is also consistent with this theory and popular concerns around the market power of firms like Google and Amazon.
Therefore, a set of policy solutions would focus on promoting innovation, diffusing productivity benefits, and facilitating the catch-up of laggard firms. Andrews et al. (2015) at the OECD argue this would require patent protection reform, R&D incentives for small and medium enterprises (SMEs), as well as pro-competition reforms such as deregulating factor markets. While these must certainly form part of the solution, the economist Mariana Mazzucato (2017) argues that the government needs to adopt a more ambitious approach to innovation policy by returning to the “connected science” model that underpinned much of the technological innovation of the post-WWII period, becoming the sort of “entrepreneurial state” that creates new markets and doesn’t simply resolve market failures. She argues that the state should be a key partner with the private sector at every stage of innovation, from basic research to product development to guiding the economy towards new “techno-economic paradigms,” such as clean energy and biotech. Such an approach could erode the advantage large global firms have in being able to innovate and adapt new technologies well ahead of their SME counterparts, reaching the rising profit share problem at its source.
6.2 Circumventing Anti-Trust Legislation.
Several authors have suggested that anti-trust legislation has not kept pace with the ways in which companies have been able to concentrate market power—although once again, this literature is largely limited to the United States. Research from Kulick (2016) and Blonigen and Pierce (2016), for example, show how mergers and acquisitions (M&As) are positively associated with increased markups and declining competition. Grullon and Larkin (2017), meanwhile, show how the consolidation of publicly traded firms into larger entities has driven large increases in industry concentration. Azar et al. (2014) shows how the concentration of firm ownership has been increasing, while Fichtner et al. (2017) look specifically at the “Big Three”—BlackRock, Vanguard and State Street—who they find to be the largest shareholder in 88 percent of S&P 500 firms, giving them the ability to exert “hidden power” through private engagements with management of invested companies, and because company executives could be prone to internalizing their objectives.
Qualitative analysis and cross-country comparisons of M&A activity suggestthat the different institutional environments of countries and changes in anti-trust legislation in our sample may help explain variation in profit shares—and, in particular, the far higher markups in the US vis-a-vis Europe.
In terms of M&A activity, Rossi and Volpin (2004) describe significant heterogeneity and how changes over time depend on variation in institutional characteristics, such as the presence of a Common Law tradition, financial regulations, shareholder protections and accounting standards. M&A activity in our sample ranges from 15 percent of total traded firms targeted for mergers in Spain to 65 percent in the United States in 2002, with the US easily having the highest share of hostile takeovers (see Figure 23). Interestingly, there may also be a link between M&A activity and labor market institutions (discussed below), with evidence from Dessaint et al. (2017) showing that major increases in employment protection reduce takeover activity by 14to 27 percent.
Anti-trust concerns are in many ways a simpler issue from a policy perspective, as modern governments already have many of the necessary tools at their disposal. Yet these tools are too often being applied to yesterday’s problems. The Roosevelt Institute (2018), a progressive think-tank, has suggesting a range of ways existing anti-trust legislation could be implemented more effectively, including: revising merger guidelines such that anti-competitive behavior is scrutinized throughout the supply chain; examining the negative effects of vertical integration; using powers such as the Sherman Act in the United States to break up existing monopolies in new sectors, such as ”Big Tech”; targeting management and ownership consolidation, such as the common ownership of multiple firms by major shareholders; and implementing intellectual property reform to weaken protection for incumbents.
6.3 Monopsony Power
In addition to the imperfect competition in product markets, there is a growing set of research arguing that imperfect competition is persistent in factor markets—so-called “monopsony power”—as well (Booth, 2014). That is, firms with more market power are able to drive down the price of inputs, such as wages. Former President Obama’s Council on Economic Advisers (2016) issued a report on labor market monopsony, showing how greater employer use of non-compete agreements, employer-sponsored health insurance, and the proliferation of occupational licensing laws, facilitates firms’ abilities to capture an increasing share of overall income, echoing the work of Kleiner and Krueger (2011). A new paper from Benmelech et al. (2018) finds that average local-level employer concentration across the United States increased between 1977to 1981 and 2002to 2009 and is negatively correlated with wages. Perhaps unsurprisingly, they find that the only employees who did not experience wage stagnation in markets with high plant concentration were those who belonged to unions. Similarly, Azar et al. (2018) find that 54% of local labor markets in America are highly concentrated.
The literature is complicated by the array of competing labor market explanations for wage disparities and the falling labor share. Salverda and Checchi (2015) describe how such literature has shifted from a focus on labor market institutions, such as declining unionization, in the 1970s, to skill-biased technological change by the 1990s, to the presence of monopsonistic conditions today. Of course, each of these factors are likely to interact in ways that are well beyond the scope of this paper. For example, Stigler (1946) famously showed that a higher minimum wage can increase employment in monopsonistic conditions. What’s more, Hirsch et al. (2018) find evidence using German data that firms have more monopsonistic power during economic downturns, which adds difficulties in parsing out the cyclical effects from those of imperfect competition.
Addressing labor market monopsony can also be tackled by expanding the scope of existing tools, including providing new resources for antitrust authorities and expanding the scope of existing antitrust statutes to explicitly include monopsony (Steinbaum 2018). Authorities could go a step further and ban the sort of non-compete and no-poaching agreements that put unnecessary restraints on labor market competition. More generally, increasing labor dynamism and mobility would go a long way towards reducing the effects of market concentration. For example, providing appropriate mobility subsidies, safety net options and training programs would make it easier to not only switch jobs, but move to an area with a more competitive labor market.
More generally, increasing labor dynamism and mobility would go a long way towards reducing the effects of market concentration. For example, providing appropriate mobility subsidies, safety net options and training programs would make it easier to not only switch jobs, but move to an area with a more competitive labor market.
6.4 Shareholder Capitalism
Since Milton Friedman’s famous New York Times Magazine article, ‘The Social Responsibility of Business is to Increase its Profits” (1970), American (and to a lesser extent, European) law and finance has shifted towards a view of shareholder supremacy. Such supremacy takes the form of redesigning CEO pay to incentivize shareholder gains, greater focus on share buybacks, and other changes to corporate governance that prioritize shareholder value at the expense of business investment and labor earnings. As pointed out by Piketty and Zucman (2014) and others, one value of shareholder capitalism, the Tobin’s Qhas been steadily rising since 1980. This has been particularly true in the UK and US where shareholder capitalism has been adopted most fervently (Lee 2016). The economist William Lazonick (2014) describes this phenomenon as a shift from a “retain-and-reinvest” approach, which prevailed at major corporations until the late 1970s, to a “downsize-and-distribute” regime since the Reagan-Thatcher era. More recent evidence of this trend has been the response of business to the Trump administration’s $ 1.5 billion corporate tax cut. While business investment seems to be up slightly, the far greater effect of the tax cut has been to increase stock buybacks. Goldman Sachs estimates payouts to shareholders (both buybacks and dividends) reached $ 1.3 trillion in 2018, up 28 per cent from 2017 (Tankersley 2018).
Excessive focus on shareholder value by corporations is ultimately an issue of corporate governance. Appropriate reforms should lower the incentives for a shareholder value-first approach (and in so doing, increase the incentives for investing in greater productivity and labor compensation) and encourage less focus on short-term goals more generally. The first priority should be for the Securities and Exchange Commission (SEC) to crack down on the ties between executive pay and stock-market valuations. For example, the SEC has allowed share repurchases on the open market with virtually no regulatory limits since 1982, which provides a strong incentive for executives to make short-term decisions based on valuations rather than their contribution to the real economy. Furthermore, since 1991 the SEC has allowed executives to gain from “short-swing” changes in valuations through selling stock options, further reducing their motivation to concentrate on long-term goals (Lazonick 2014). Other options for reform include an overhaul of corporate boards to give less voice to executives interested in stock valuations, and more to employees and owners who have a stake in the long-term success of the corporation (Barton 2011). Mandating fewer short-term earnings reports or introducing measures to reduce the volume of high-frequency trading would also shift incentives in the right direction.
6.5 Regulatory Capture
Political rent-seeking and regulatory capture is an issue that cuts across each of these explanations. Bessen (2016), for example, argues that political rent seeking has led to regulations that favor incumbents, reduce barriers to entry, and lead to increases in market valuations, estimating that such rent-seeking transfers approximately $200 billion a year from consumers towards firms. Lindsey and Teles (2017) in their recent book, The Captured Economy, describe the extent to which such favorable regulations permeate industries throughout the economy. Similarly, Joseph Stiglitz (2012) writes in his book The Price of Inequality that “some of the most important innovations in business in the last three decades have been centered not on making the economy more efficient but on how better to ensure monopoly power or how better to circumvent government regulation.” Unfortunately, there are no cross-country comparisons that we could find, but an interesting avenue for future research would be to examine the extent to which regulatory capture interacts with technology diffusion, anti-trust legislation, and labor market institutions.
Eroding the extent of regulatory capture in the system begins at the level of election reform, extends to how politicians and regulators interact with lobbyists, but is ultimately a question of market power more generally. A competitive marketplace has more incentive to undercut oligopolistic practices in pursuit of market share, including collusion with policy makers. Other reforms include greater public funding of election campaigns to ensure politicians are less beholden to corporate interests. What’s more, one could provide greater funding to political offices to increase available resources, and reduce the dependence on advocacy groups for information, regulatory text, and policy ideas. Greater restrictions could also be placed on the movement of personnel between politics, lobbyists and corporations where potential conflicts of interest arise. While some of these options are clearly restricted by court decisions, such as Citizens United, there are still options available for amplifying the voice of everyday citizens and reducing the options available to politicians for enriching themselves, such as by serving on for-profit boards.
The results of this paper suggest two possible policy approaches going forward. On the one hand, one might recommend greater income and wealth redistribution to compensate for these trends. However, we would argue that this is akin to treating the symptom and neglecting the disease. Instead, as recommended by the political scientist Jacob Hacker (2011), the policy agenda needs to be one of “predistribution,” not redistribution. Predistribution is not a single policy item but a focus on “the way in which the market distributes its rewards in the first place.” This requires smarter regulation and government intervention in every market rather than an acceptance of market outcomes as they are followed by a belated attempt to create fair outcomes through a progressive tax system or social security benefits.
The persistent and growing profit share across a range of advanced economies and within industries fundamentally challenges the assumption of perfect competition and suggests that growing market power is at the heart of many of the economic challenges in America today. Imperfect competition implies a misallocation of resources, which would explain a range of macroeconomic phenomena—from stagnant growth and low productivity, to low investment and the financialization of modern economies. Meanwhile, the fall in the labor share potentially illustrates the human costs of these developments, due to its strong correlation with inequality.
This paper has shown that by replicating the results of Barkai (2017) and Gutiérrez (2017), these findings are robust to a range of econometric analyses. Further, by extending these results across a range of advanced European economies we can begin to think further about how institutional differences and policy changes interact with secular economic trends to influence how the labor and profit share evolves over time. Our evidence suggests that deviations from perfect competition are likely explained by declining competition in the United States, whereas secular trends such as heterogeneous technology adoption and the declining price of capital, are more likely at play in the European context.
Finally, a rising profit share calls for predistribution over redistribution as the dominant policy response. If the market, left to its current devices is increasingly distributing income in the form of rents, both the capital investment needed to increase productivity and growth, as well as the labor earnings that underpin a fair and just society, will continue to decline.
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Gutiérrez does not show regression results for other countries in the paper. Our extension section below applies the replicated methodology to the remaining countries in our sample
EU KLEMS reports TFP values as growth rates relative to the base year of 1995
Unfortunately, data on M&As and corporate ownership is not easily accessible, which means we were unable to test this hypothesis in our regressions. Such data generally requires paid subscriptions to financial services, such as Thomson Reuter’s SC Platinum