Excessive market power and markups lead to economic problems

A man has been jailed for making numerous dodgy JobKeeper applications during the pandemic.

A man has been jailed for making numerous dodgy JobKeeper applications during the pandemic. Photo: AAP

It’s hard to ignore the growing body of evidence that excessive market concentration can lead to economic problems.

Dominant firms in a market may have less incentive to carry out research and development. They may have less incentive to produce new products. And in some cases, they may have less incentive to pay their employees fairly.

The challenge for economists is to better understand the problems. That means measuring them. Market concentration tells us how much share the biggest players have. But it doesn’t tell us the extent to which they’re throwing their weight around.

By contrast, markups – the gap between firms’ costs and what they charge their consumers – go more directly to the impact on consumers. In that sense, markups are capturing the market power of firms: their ability to influence the price at which they sell their products.

It’s easiest to see this at the extremes. With thousands of companies selling a similar product, there’s a going price, and that’s what sellers charge. The market sets the price. By contrast, when only one company sells the product, they set the market price.

The difference is between market pricing and monopolist pricing.

In one of the original studies on markups, Belgian economist Jan De Loecker and his colleagues found average markups in the US increased from 21 per cent above marginal cost in 1980 to 61 per cent above marginal cost in 2016.

The authors found that markups increased the most for high-markup firms and show that this is due to increased market power.

The authors also showed that high-markup (and highly profitable) firms attracted a greater share of resources, a phenomenon closely linked with the rise of ‘superstar’ firms. As the name suggests, ‘superstar’ firms are large and have come to dominate their industries. MIT economist David Autor and his co-authors showed that those industries with the largest growth in market share going to these ‘superstars’ also saw the steepest decline in the share of income flowing to workers.

Looking further afield, Jan De Loecker and his collaborator Jan Eeckhout estimate markups for 70,000 firms in 134 countries between 1980 and 2016. They found average markups increased globally from around 10 per cent in 1980 to 60 per cent in 2016. This is driven by firms with already high-markups seeing the greatest estimated increase – consistent with previous evidence showing growing dispersion of markups.

Similarly, the International Monetary Fund also analysed approximately 900,000 firms in 27 countries and found an increase in markups between 2000 and 2015.

Global evidence supports the increase in markups being partly linked to the rise of superstar firms (though perhaps not as much as in the US), and suggests that an increase in markups is partly responsible for the decline in the labour share of income.

The decline in labour share worldwide seems to be driven primarily by a reallocation of resources to firms with a relatively low labour share of income.

In Australia, groundbreaking research by economist Jonathan Hambur used firm-level microdata to estimate markups. Hambur’s findings suggest industry average markups increased by around 6 per cent between 2003 and 2016.

This is particularly true for digital firms that have very low marginal costs. Between 2003 and 2016, markups for the most digitally intensive firms increased by 12 per cent, compared with 4 per cent for all other firms. These results suggest that changing technology played a role in increasing markups.

The evidence from markups aligns with other evidence suggesting competitive pressure in the Australian economy have declined over the past two decades. Firm entry and exit rates have declined. There’s a lower share of employees working at young firms. Job mobility has declined. And the largest firms have increased their market share.

Declining dynamism in the product and labour markets have occurred simultaneously.

There is also some evidence of a correlation across sectors. For example, job mobility rates have dropped more in those sectors where the share of young firms has seen the largest declines.

Moreover, between 2003 and 2016 the industries that saw the greater consistent annual increase in concentration saw, on average, greater annual increases in markups.

This finding is consistent with new research from thinktank E61, suggesting that more dynamic markets would benefit most workers. This is partly because higher rates of new firm creation and labour mobility increase the value of workers’ outside options. This aligns with other economic evidence around declining dynamism.

I’m optimistic about the path ahead. It’s not easy, but Australia has an opportunity to boost productivity — the key to increasing living standards. It’s terrific to see a renewed focus on productivity from people across the community from policymakers to researchers to business leaders.

The Jobs and Skills Summit sparked many of these conversations, and productivity and wages will feature in the Employment White Paper to follow. Meanwhile, the Australian Competition and Consumer Commission’s Digital Platform Services Inquiry has made far-reaching recommendations for regulating major tech platforms. The Australian Government is currently consulting on these proposals.

Are markups the malign markers of the Australian macroeconomy? We’re beginning to find out.

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