Is Lord Voldemort right about Superstar firms?
“There is no good and evil, only power and those too weak to seek it.”
After concluding my Ph.D. thesis chapter on Superstar firms, I just wanted to write my conclusions about the issue. Here I share my thoughts. Do you agree?
As JK Rowling implied with this Lord Voldemort's line in Harry Potter and the Sorcerer's Stone, I think there is no good or evil, or at least a very distinguishable line dividing them. Instead, there is hidden power between the two waiting to be untapped. However, what could be ingenious thinking is not applying to the heated global debate dividing big companies and regulators about the implications of high "markups." Economists mean by markups the difference between what a business charges for the products it produces and what it pays for the inputs it uses.
The advent of the massive market values and profit margins of big tech companies such as the MATANAs (or the FAANGs, depending on whom you ask), a group of firms composed of firms such as Microsoft, Amazon, Alphabet, Apple, Nvidia, and Tesla, triggered the debate about whether getting that profitable was good not only for them but also for everybody else. The MATANA stocks comprise nearly 50% of the widely followed Nasdaq-100 index. Together they could be the fifth largest economy in the world in GDP after the U.S., China, Japan, and Germany, with a combined value of more than USD 3 trillion in market capitalization.
In 2018, economists De Loecker, Eeckhout, and Unger found astonishing increases in average markups in the U.S. from 18% in 1980 to over 67% over costs in 2016. They found similar rises in other countries in Europe but with less prevalence in Latin America and Asia. The alarms went on since some schools of thought in economics and regulators consider rising markups are on the dark side of the force; they signal market power (the ability to set up higher prices), which brings negative implications for aggregate welfare.
Higher prices disincentive consumer demand and disincentive firms to demand factors of production because of the reduced demand. Less demand for factors such as labor triggers workers' income share in revenues to decline. Subsequently, production decreases as it does the incentives to further investment to innovate, eventually leading to a decrease in the share of capital in revenues. After a domino effect, owners are the most significant winners taking a bigger share of the revenues pie.
These scholars have found supporting evidence for this. In the past two decades, profits have been increasing besides increasing markups, whereas labor and capital shares in revenues have been declining. In addition, excess profits have shown not to be dedicated to covering increasing fixed costs, and despite lower-than-ever interest rates, investment has also declined. More importantly, despite recent decades' technical progress, productivity growth remains sluggish at best. These authors argue that big companies exercise anti-competitive practices due to weak antitrust enforcement. According to them, these corporations have been buying up small, innovative (mostly tech) companies in a heavy-handed play to clear the field of potential competitors.
Nonetheless, many studies have controverted this by finding rising markups in Europe, where antitrust has been more restrictive. So, what is the catch? Another stream of scholars showed that rising markups, on the contrary, may arise from increased competition triggered by cost-reducing and heterogenous productivity-enhancing technological progress. The revolution of intangible investments, such as increased software, research and development, business models, and intellectual property, has triggered structural changes in economies worldwide. Estimates vary, but the share of the intangibles from total investments grew from 4% to almost 40% in the last fifty years in major developed economies.
The economic property of scalability is one of the main reasons for rising markups. For example, unlike a machine, an artificial intelligence algorithm can be sold and used without wearing out or extra reproduction costs. Thus, a winner-takes-most approach emerges; companies who can afford and adequately exploit such intangibles will skyrocket productivity and will be able to keep prices low, but those who do not will have a more challenging time competing. Although technological progress brought a productivity revolution, which is positive, just some firms with enough cash flow will be able to get it. Start-ups will have a more challenging time competing with such low prices at the start. Even worse, since banks have yet to take intangible assets as collaterals in mass, young innovators still need to take the money of more prominent firms to scale up.
Given the current discussions, I see the phenomenon's good and evil and propose discovering the hidden power between the two. For example, since the evidence of market power per se is not strong, why do we not look further at how to address the challenges brought up by the evolution of human technology with updated regulation? Perhaps there is no need to chastise big companies immediately for being tremendously productive. Instead, redirecting policy efforts towards technology transfers and knowledge diffusion in exchange for allowing acquisitions or mergers could be a better proposition. Furthermore, the implications of the intangible revolution should encourage governments to focus more on alleviating financial restrictions and the lack of technical capabilities of start-ups; perhaps it is more constructive to enable them to exploit the properties of intangibles so they can compete more successfully. I suggest taking advantage of the good and evil of this story rather than adopting a wholly pro or against approach.
Lord Voldemort was totally on point.
Lord Voldemort, photo by Unknown Author, is licensed under CC BY-SA
