Markups, macroeconomics, and the changing U.S. economy

Over the past several decades, the U.S. economy experienced changes in key economic metrics that don’t bode well for the welfare of most people. The labor share of income is down. So, too, is the capital share of income. Wages for less-educated workers also fell, as did the movement of workers between jobs. Could there be one key factor behind all of these trends—one aspect of the economy that policymakers could address to reverse these declines? That’s what a recent working paper argues, singling out the rise of companies’ market power as the root cause of so many economic woes.

But before Jan De Loecker of Princeton University and Jan Eeckhout of University College London can get to that argument, the authors have to document the increase in markups in the U.S. economy. A firm’s markup is simply the amount they can charge over the cost of providing the good or service they sell. A permanent increase in markups leading to a higher level of profits for companies operating in the economy is a good sign of increased market power. Most other studies that focus on calculating markups have focused on specific industries via case studies, but the two authors of this new working paper use a different process to calculate for the entire economy. Their data source is Compustat, a dataset from the financial services company, which covers all publicly traded firms from 1950 to 2014.

The two authors find a large increase in the average markup from 1980 to 2014—specifically an increase by a factor of 3.65. In 1980, the average markup was 18 percent and by 2014, the average was 67 percent. But interestingly, the increase is concentrated at the top of the markup distribution: The firm at the 90th percentile in 2014 had a markup of about 160 percent, compared to a markup of 40 percent for the 90th percentile firm in 1980. The markup at the median didn’t change much at all. In order to tie these increased markups with rising market power, the economists show how increases in markups are associated with higher profit levels, higher dividend payments, and a higher average market value—all of which would correspond to more market power in the economy.

The rest of the paper focuses on how models of the macroeconomy with increasing markups could explain declining inflation-adjusted wages for low-wage workers, declining labor market flows, and several other trends in the U.S. economy. When it comes to the labor market, their model results in higher markups and more market power, resulting in less overall demand for workers. In other words, the increased power that firms have in products and services markets would result in increased power for them in the labor market. And while De Loecker and Eeckhout don’t formally model the implications of market power for trends such as increased income inequality and lower interest rates, the links there are very possible as well.

One caveat with this paper is that the data they use only includes publicly traded firms, so it’s not clear if the rise in markups is also happening for privately held companies. Another is that while the working paper argues for the importance of documenting the rise of market power in the economy, it doesn’t try to explain why market power has increased. Better understanding why this is happening and its seemingly harmful consequences is more important than ever.