Equitable Growth in Conversation: an interview with William A. Darity Jr. (“Sandy”) of Duke University

Posted on by Emilie Openchowski

“Equitable Growth in Conversation” is a recurring series where we talk with economists and other social scientists to help us better understand whether and how economic inequality affects economic growth and stability.

In this installment, Equitable Growth’s Research Director John Schmitt talks with economist William A. Darity Jr. (“Sandy”), the Samuel DuBois Cook Professor of Public Policy at Duke University’s Sanford School of Public Policy, about the importance of stratification economics in understanding U.S. economic growth and inequality. Read their conversation below.

John Schmitt: I have not too many questions, but hopefully we’ll have a good conversation. You are the founder of stratification economics, which you pioneered with a group that includes Darrick Hamilton, James Stewart, Gregory Price, and others. How would you describe the main features of stratification economics? And how would you differentiate them from the kind of standard, neoclassical economics that most of us were taught in graduate school or in undergraduate economics classes?

Sandy Darity: So, I think the core of stratification economics offers a structural rather than a behavioral explanation for economic inequality between socially identified groups—whether they’re racial groups, ethnic groups, gender groups, or groups that are differentiated on some other basis such as religious affiliation, for that matter. Stratification economics goes against the grain of trying to argue that the kinds of differences that we observe and economic outcomes are attributable to cultural practices or some forms of dysfunctional behavior on the part of the group that’s in the relatively inferior position.

We argue instead that economists and other social scientists have to look at social structures and policies to really explain why those differences exist. What might be unique about stratification economics is the particular way in which it offers the structural analysis of these kinds of inequalities, and that particular way is by focusing on the importance of relative group position from the standpoint of participants in our social world.

That persons compare themselves against others is based on research on happiness, which suggests that the major factor in determining whether a person reports feeling happy is actually their perception of their position in comparison with others—not their absolute position, but their relative position. What stratification economics brings on the scene is a specific view of exactly with whom individuals are comparing themselves.

Not only are folks making comparisons with individuals who they perceive as being part of their own social group, but they also are making comparisons about their group’s position.

The cross-group comparisons are made against the social groups that are “the other” for them. It’s those two sets of comparisons that drive behavior and drive people to actually act in ways that are supportive of the status of their relevant social group. I think traditional economics doesn’t pay much attention to the comparative dimension, and it certainly doesn’t pay much attention to the comparative dimension in terms of an individual’s sense of group identity or group affiliation.

I do want to add that a lot of this work is deeply collaborative. And I think it’s important that my collaborators be recognized, particularly [associate professor of economics and urban policy] Darrick Hamilton at the New School, Mark Paul, who is a postdoctoral fellow here at the Cook Center at Duke, and Khai Zaw, who is a statistical researcher at the Cook Center, who all have worked very closely with me.

And there’s a string of folks who have been involved in various dimensions of the development of stratification economics as a field, among them economists Greg Price [Morehouse College], James Stewart [Pennsylvania State University], Patrick Mason [Florida State University], Marie Mora [University of Texas at Rio Grande Valley], Alberto Dávila [University of Texas at Rio Grande Valley], Sue Stockly [Eastern New Mexico University], and Stephanie Seguino [University of Vermont].

So even though I don’t think stratification economics is sweeping the economics profession, there’s actually a significant core of folks who are embracing the approach, and, hopefully, the numbers will grow.

Schmitt: So, you make the comment about where conventional economics falls short. Can you give an example or two of a social or economic problem where you think that the tools developed in stratification economics give a better explanation for an economic or social phenomenon than the standard economics view?

Darity: One example would be the persistence of discrimination under competitive conditions. In standard economics, there’s very little room or terrain for trying to explain why we might observe sustained discriminatory practices by one group toward the other, particularly discriminatory practices that have economic content.

In stratification economics, it’s fairly straightforward to try to come up with an explanation that makes some sense. Because of the emphasis in stratification economics on what we might call tribal affiliation—or team affiliation or group affiliation—to the extent that people value those kinds of affiliations and the position of their team, group, or tribe, then they will engage in collaborative ways, whether those collaborative ways are fully conscious or whether they are implicit.

They’ll engage in collaborative ways to preserve the position of their group. And so discrimination can be something that’s sustained. And even more strongly than that, stratification economics would suggest that if the difference between the two groups narrows, the group on top will intensify its discriminatory practices. If it becomes harder to exclude the out-group because the out-group is becoming better educated or has other kinds of indicators that suggest that it is comparably productive to members of the in-group, then the in-group will intensify the degree of discrimination that it practices toward the out-group. I think that conventional economics would never actually see that phenomenon.

Schmitt: You’ve described stratification economics as combining influences from economics, sociology, and social psychology, and it’s obvious in a lot of what you just described about the persistence of discrimination. What led you to blend those things together? What are the influences or the ways that brought you to piece the various parts of this together?

Darity: You said at the outset that I was the founder of stratification economics—I think it’s maybe more accurate to say that I’m the person who gave this set of ideas a label. But I don’t think that these ideas originated with me, and I think that to a large extent, I’ve synthesized ideas from others. But I do think that these ideas from others are extremely powerful and influenced the way in which I began to think about this. I’ve long been wanting to bypass arguments for intergroup inequality that are predicated on the notion that there’s something fundamentally inferior about one of the two groups.

So from economics, for example, you could draw upon the work of the idiosyncratic early 20th century economist Thorstein Veblen, who, for example, in The Theory of the Leisure Class, talks about the significance of comparisons within your group versus comparisons vis-a-vis the group that is supposed to be outside of yours. And that translated into the forgotten theory of consumption—aggregate consumption in economics—that the late economist James Duesenberry developed, called the relative income hypothesis. People frequently discard that one when they think about theories of aggregate consumption, but that’s a body of work that influenced my way of thinking about some of these issues.

From sociology, I think that the most important contribution probably is Herbert Blumer’s 1958 essay on prejudice as a function of relative group position. He challenged the view that prejudice is something that we can identify as some sort of individual defect, arguing instead that prejudice is really something that’s functional for preserving or extending the relative position of an advantaged social group. That, to me, is very much stratification economics, without the label.

Then there’s a whole body of work about notions of individual productivity being influenced by the context in which people are performing tasks. This might include employment in a hostile workplace environment for an individual from a group that is subjected to stigma, which will affect the individual’s capacity to perform. And it’s not just the question of what educational credentials they have, or what kind of training they have, or what kind of motivation they have. It’s also a question of the atmosphere in which they are functioning. And so from social psychology, I took the phenomenon that has been developed by researchers such as Claude Steele [emeritus professor at Stanford and former vice chancellor and provost at the University of California, Berkeley] of stereotype threat as another dimension, or angle, for thinking about how individual productivity can be distorted or reduced as a consequence of the social climate that they face. In short, in the jargon we frequently use in economics, individual productivity is endogenous.

Schmitt: In a lot of your recent work, you’ve turned your attention to the issue of wealth inequality. What led you to make that a focus? And what do you think are the most important findings from that research?

Darity: My turn to the focus on wealth inequality came about for two reasons. One is because of an increasing recognition that these types of disparities are the most important indicator of differences in economic well-being. The second reason is because the work that I have begun to do on reparations kept pointing me back to the racial wealth gap as the most important manifestation of the effects of racism and discrimination over time in the United States.

Those two considerations kept directing me toward an emphasis on wealth inequality. But it is also my sense that all economic inequalities—particularly group-based economic inequalities unfortunately—have been assigned to be the purview of labor economists.

Of course, the work that labor economists do can point us toward some explanations for disparities that are associated with earnings and occupational status, but their perspective doesn’t take us very far in explaining wealth inequalities.

Stratification economics offered a relatively simple but, I think, much more powerful explanation for why we observe wealth inequality in general but also wealth inequality by race. One of the big findings that has emerged from our work, which is now being replicated in other people’s research, is a very simple but important conclusion that education in and of itself does not eliminate racial economic disparity.

There are tons of people who focus on education as the answer. I certainly think improving education for everyone is a great idea, but it’s not going to close the racial wealth gap. Thus far, it has not eliminated discriminatory differences in wages or in unemployment rates. Simply put, education is far from enough to solve the kinds of disparities that we are concerned about.

Schmitt: You did your Ph.D. at the Massachusetts Institute of Technology in the late 1970s, so you’ve been in the business for a little while. What’s your take on how the economics profession has developed, say over the past 30 years or so? Do you think that it is moving in a good direction, bad direction, indifferent? Do you think it is more or less open to some of the ideas that we’ve been talking about right now?

Darity: That’s a tough one. I don’t know that in my experience it’s been particularly open to any of these ideas. I think that there’s been a greater receptiveness or interest in these ideas from scholars in other disciplines. To be frank, I think that the economics profession has a certain anti-intellectualism. That’s a pretty strong statement, but I mean that in the sense that if you think about intellectual activity as involving wide-ranging curiosity and also wide-ranging interests in research unbounded by disciplinary lines, I think the economists are very, very inclined to be somewhat incurious and to treat every problem from the standpoint of a fixed package of ideas.

In that sense, I think there’s a certain anti-intellectualism, and therefore, very little receptiveness to ideas that go outside of the standard box. I’m not sure the conditions are a lot different now in the economics profession; I mean, there’s a sense in which I think it’s long been that way, particularly ever since the quantification revolution in economics that largely was spearheaded by one of my mentors, [the late Nobel Laureate] Paul Samuelson. The process of making economics appear to be more of a mathematical science was accompanied by driving out some of the more interesting ideas and approaches, rather than incorporating them into the process of making it a mathematical science.

Schmitt: Do you take any comfort from the rise of informational economics, or search models, or the rise of the importance of behavioral economics?

Darity: If you are talking about search models that are associated with search and employment, I’m not a real enthusiast for imperfectionism. Because the implication is that if we did not have those frictions, if we did not have those imperfections, then everything would be glorious. But it is my view that a smoothly functioning market economy would still generate high degrees of inequality, and certain kinds of inequities, because those processes pay very little attention to inherited advantages and disadvantages. I don’t necessarily see imperfectionist approaches as providing a solution. I particularly don’t like search theories of unemployment because I think what they say is people are out of work because they are looking for work, rather than people are looking for work because they are out of work.

Stratification economics actually attempts to be somewhat of a departure from behavioral economics. Behavioral economics, to my way of understanding it, suggests that people actually behave irrationally, and so it’s trying to explore and understand irrational behavior, whereas the whole historical thrust of much of economics has been oriented toward suggesting that there is rationality to people’s behavior. Stratification economics accepts the premise that there’s a rationality to behavior, but it also presumes that there is rationality to the behavior of social groups, as well as individuals. It’s a rationality that’s predicated on the notion that these groups frequently, or typically, act as if they view themselves as being in competition with one another.

Schmitt: One of the things that’s important for us at the Washington Center for Equitable Growth is to look at the rise of inequality from a high level, beginning at the end of the 1970s to an extremely high level now, based on almost any metric you want to use. Do you have a working model in your mind for what explains that big increase in inequality over this period? And do you have any guidance as to what policymakers could do to turn things around?

Darity: One of the things that I mentioned at the start of our conversation was the importance of social structures and policies. And I think that the run-up in inequality that we’ve observed in recent years is closely tied to a set of social policies that have produced virtually unlimited capacity to generate extraordinary levels of wealth. One is a form of profit sharing, which is what we call super salaries for high-level executives at the nation’s most highly resourced corporations. Another is the deregulation of the financial markets, while maintaining a moral hazard problem, in the sense that the investment bankers can anticipate that they’ll be bailed out in the event of a crisis. And a third is the reform of the tax system, where we’ve moved from having marginal tax rates for folks at the upper end of the income distribution, in the vicinity of 90 percent to less than 30 percent today. The Great Recession also contributed to a greater explosion or extension of inequality, both in wealth and in income.

In short, I think we can look directly at a set of policies and, more recently, at the advent of the Great Recession to understand the rise in economic inequality.

Schmitt: So my last question: Do you have any advice for a young person who wants to get a Ph.D. in economics? Or a Ph.D. in a social science? In particular, do you recommend studying economics?

Darity: I definitely don’t want to forsake the economics profession. I still have hope that there will be other, younger economists who will try to bring very fresh perspectives to the way in which we conduct economic research. I would encourage folks to go into the field, but I’d want them to have their eyes open. I think that they need to be very selective about which institutions they choose to attend to try to do their work.

If graduate students have ideas that are not conventional or are unorthodox, then they need to have their eyes set on trying to identify departments that have the flexibility and open-mindedness to allow them to pursue the kind of approaches that they want to undertake. There are some, and it’s not just departments that we view as being explicitly heterodox. I think that there are some departments that are more conventional, where there are faculty members who are extremely open-minded, in comparison with other places.

A new graduate student really has to make a very careful choice about which department to go to, and once there, who they should work with in that department. I would say that’s the research that needs to be done carefully, rather than telling people they shouldn’t go into economics.

Schmitt: Thank you so much, Sandy, for your time.

Darity: Thanks for inviting me to do this. Take care.

Does Supplemental Security Income inhibit success?

Posted on by Emilie Openchowski
Terry Work stands outside a store that accepts food stamps in Tennessee. Work’s 27-year-old deaf son recently was denied disability payments.

It’s been nearly 21 years since the federal Personal Responsibility and Work Opportunity Reconciliation Act—commonly known as welfare reform—was passed. Most of the debate about the legacy of the bill centers on the elimination of the Aid to Families with Dependent Children program and its replacement with Temporary Assistance to Needy Families. But the legislation also created new reforms to another cash assistance program, the Supplemental Security Income program. The reforms to SSI made it less likely that disabled children would continue to receive cash assistance in adulthood. One might think that reducing cash payments would help spur some workers into fully engaging with the labor market and replace lost SSI income with labor earnings. But new research casts doubt on this line of thinking.

Among the cash welfare assistance programs in place after the enactment of the 1996 welfare reform law, Supplemental Security Income is the largest, with expenditures more than double the level of the Temporary Assistance to Needy Families program as of 2013, according to the Congressional Budget Office. About $50 billion through SSI is allocated to 8 million recipients annually, including 1.3 million children.

In her paper, “Does Welfare Inhibit Success? The Long-Term Effects of Removing Low-Income Youth from the Disability Rolls,” University of Chicago economist Manasi Deshpande evaluates the effects of removing low-income youth with disabilities from Supplemental Security Income on their earnings and income earned in adulthood. Many children receiving this stipend through the Social Security Administration are diagnosed with such conditions as Attention Deficit Hyperactivity Disorder, speech delay, and autism spectrum disorder—any one of which can greatly affect their integration into the labor market later in life.

Yet for young adults to continue receiving these SSI benefits, they must requalify for the program when they reach the age of 18 by undergoing a medical examination to determine their ability to participate in the workforce. While almost no young adults nearing the age of 18 immediately before the cut off received a medical review, nearly 90 percent of them did receive one after their 18th birthday. Because people who turned 18 right before the deadline and those who did right after are very similar, this sudden change can tell us about the causal impact of the policy change.

Deshpande’s results show that previously eligible SSI recipients do increase their earnings after their 18th birthdays, yet their earnings do not make up for the loss of stable SSI income. Removing youth from this income-assistance program reduces their observed lifetime income and results in an increase in income volatility. Over the span of 16 years after their 18th birthdays, individuals removed from SSI lose $21,000 in “present discounted total observed” income—or a $21,000 decline in the value today of all future income. This represents a 20 percent decrease relative to those who are not removed from the program at age 18. Deshpande also finds that individuals move from a stable income to a much more volatile income stream.

Policymakers should take two key points away from this paper. First, the fact that increased labor-market earnings didn’t nearly make up for the loss of SSI cash support means that these workers face significant labor-market challenges. It seems very unlikely that the cash payments from SSI are a compelling reason these young adults lack significant labor earnings. Second, the increased volatility in overall income for young adults who lose SSI support means that the program was effectively providing economic security to disabled young adults.

Reducing young adults’ access to Supplemental Security Income might have succeeded in pushing some workers into the labor force and increasing their labor earnings. Yet Deshpande’s findings show that the tradeoff maybe be a reduction in lifetime overall income and more volatile income. Whether that tradeoff is worth it is something policymakers and the general public should decide.

Market power in the U.S. economy today

Posted on by David Evans

Overview

The U.S. economy has a “market power” problem, notwithstanding our strong and extensive antitrust institutions. The surprising conjunction of the exercise of market power with well-established antitrust norms, precedents, and enforcement institutions is the central paradox of U.S. competition policy today.

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Market power in the U.S. economy today

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As this policy brief explains, the harms from the exercise of firms’ market power may extend beyond individual markets affected to include slower overall economic growth and increased economic inequality. The implications for future economic productivity and welfare are troubling, but before detailing these consequences, it is necessary to understand why market power is a major issue despite well-established antitrust enforcement institutions and legal precedents.

Market power in an era of antitrust

We live in an era of antitrust. The United States has well-established norms against anticompetitive conduct, experienced enforcement institutions, a rich body of judicial precedents, and an active and knowledgeable community of antitrust lawyers and economists. These norms, precedents, and institutions are remarkable in their scope and depth. They have undoubtedly discouraged a great deal of anticompetitive conduct by businesses.1

Most antitrust cases are noticed by the affected industry and the antitrust community only, but some achieve wider public attention. In recent years, for example, antitrust enforcers famously stepped in to prosecute Archer Daniels Midland Co. for agreeing with its major global competitors to boost the price of lysine;2 to stop Microsoft Corp. from monopolizing the operating systems for Intel-compatible personal computers by limiting, among other things, the growth of Netscape Communications’ Internet browser;3 and to prevent AT&T Inc. from acquiring Deutsche Telekom AG’s T-Mobile USA Inc. affiliate, one of AT&T’s rivals in providing retail mobile wireless communications.4

Yet there are a number of reasons for concern about the exercise of what economists refer to as market power. Firms exercise market power in their output markets as sellers either by raising prices relative to what they would charge in a competitive market or by reducing quality or convenience or otherwise altering terms of trade adversely with their customers. Firms can also exercise market power as buyers by lowering prices or altering terms of trade adversely to sellers.
While seller market power has been more extensively studied, many of the reasons for concern about its exercise in the U.S. economy today are also reasons for concern about the exercise of market power by buyers. Some of those reasons suggest that sellers exercise substantial market power, and others suggest that the exercise of market power has been widening for decades—extending to more markets, increasing in importance within markets, or both. None is decisive individually, but collectively they make a compelling case that market power has become a serious problem in the U.S. economy.
Among those reasons are:

  • Insufficient deterrence of anticompetitive coordinated conduct
  • Insufficient deterrence of anticompetitive mergers between rivals
  • Insufficient deterrence of anticompetitive exclusion
  • Market power is durable
  • Increased equity ownership of rival firms by diversified financial investors
  • The rise of dominant information technology platforms
  • Oligopolies are common and concentration is increasing in many industries
  • Increased governmental restraints on competition
  • The decline in economic dynamism

Let’s examine each in turn.

Insufficient deterrence of anticompetitive coordinated conduct

The steady rate at which the U.S. Department of Justice uncovers criminal price-fixing and market-division cartels, year after year,5 combined with evidence that that penalties for collusion and treble damage awards to victims are systematically too low6—along with the absence of evidence that criminal enforcement systematically chills procompetitive conduct or induces excessive expenditures on antitrust compliance—indicates that the antitrust laws do not sufficiently deter collusive conduct. Some cartels are purely domestic, and others are global, with harm to buyers in the United States and elsewhere. This form of anticompetitive business behavior has little or no procompetitive justification. It likely allows sellers to overcharge U.S. buyers by billions of dollars annually.7

Even more troubling, cartel prosecutions by the Justice Department are probably only the tip of a large market-power iceberg arising from coordinated conduct among oligopolists. It is probably substantially easier to deter express price-fixing and market division, which is what is usually involved in criminal cases, than it is to deter tacit collusion that leads to higher prices.

That’s why it is reasonable to infer from the cartel statistics that the exercise of market power arising from anticompetitive coordinated conduct is common in oligopoly markets. One case in point: A recent study found that coordination between brewing behemoths—the MillerCoors joint venture (now owned by Molson Coors Brewing Co.) and Anheuser-Busch InBev SA/NV (owner of the Budweiser brand)—raised beer prices by at least 6 percent after the joint venture was consummated in 2008.8

Insufficient deterrence of anticompetitive mergers between rivals

Nor are anticompetitive mergers adequately deterred. A recent study of mergers between rival manufacturing firms between 1998 and 2006 finds that those deals systematically increased profit margins at acquired plants without reducing costs, suggesting that the lost competition from mergers generally resulted in higher prices.9

On average, moreover, so-called horizontal mergers (between two firms in the same market) that were close calls at the two federal antitrust enforcement agencies—the Justice Department and the Federal Trade Commission—turned out to harm competition.10 Systematic over-optimism among acquiring firms about the efficiencies they can achieve through acquisitions may help explain why too many harmful mergers between rivals are proposed.11 A book-length business strategy analysis points to bad acquisitions as “the single most important reason for underperformance by media companies,” for example.12

Insufficient deterrence of anticompetitive exclusion

The antitrust rules today insufficiently deter harmful exclusionary practices that raise rivals’ costs or limit rivals’ access to customers,13 including those implemented through so-called vertical agreements (also termed vertical restraints), which are between a firm and its suppliers, distributors, or customers.14 That conclusion is consistent with the evidence that more than one-quarter of international cartels used vertical restraints to support collusion,15 and with the evidence that prices were higher and output lower in U.S. states in which one vertical practice—resale price maintenance—was subject to rule-of-reason review (which evaluates its actual or likely competitive effects) than in states that kept the per se ban (which looks only to its nature).16

While some interpret the economic evidence on the competitive consequences of vertical agreements as counseling against enforcement, that interpretation is based heavily on studies of markets other than the oligopoly settings in which antitrust enforcement is concentrated and on studies that do not account for the possibility that the anticompetitive uses of vertical agreements were deterred by past antitrust rules.17 It is not surprising that anticompetitive exclusionary conduct is insufficiently deterred, given that the U.S. Supreme Court’s antitrust decisions from the late 1970s through early 1990s (which are largely still followed) targeted for relaxation rules governing exclusionary conduct.18

Market power is durable

Market power is a concern not only because it is common, but also because it is durable. Among cartels cut short by antitrust enforcement, the average cartel has been found to last more than eight years and a number have survived for at least 40 years.19 To similar effect, even when monopolies or near-monopolies have eroded over time, they have often persisted for decades. Think General Motors Co. (automobiles), International Business Machines Corp. (computers), Eastman Kodak Co. (photographic film), RCA Corp. (television sets), United States Steel Corp. (steel), and Xerox Corp. (copiers) over much of the 20th century.

In many cases, moreover, dominant firms and colluding firms have erected entry barriers to exclude new rivals. This evidence shows that anticompetitive conduct can often be sustained for long periods of time, overcoming the incentive of firms to cheat on cartels and the incentive of fringe rivals and entrants to expand and compete away monopoly profits.

Increased equity ownership of rival firms by diversified financial investors

Large institutional investors such as BlackRock Inc., FMR LLC’s Fidelity Investments, State Street Corp., and The Vanguard Group Inc. now collectively own roughly two-thirds of the shares of publicly traded U.S. firms overall, up from about one-third in 1980.20 As a result, it has become common for rival firms to have common financial investor ownership.21

Recent studies of the airline and banking industries suggest that when competing firms have the same large shareholders, they may refrain from competing aggressively against each other, leading to higher prices.22 This evidence, combined with the growth and widespread nature of the practice, raises the possibility that financial investor ownership of rival firms has become a pervasive and increasing source of market power throughout U.S. industry.

The rise of dominant information technology platforms

Many information technology firms that have become large during the recent past—such as Apple Inc., Bloomberg L.P., Facebook Inc., Alphabet Inc.’s Google Inc. subsidiary, Microsoft Corp., and Oracle Corp.—have likely achieved those positions, at least in part, through varying combinations of network effects, intellectual property protections, endogenous sunk costs, and the absence of divided technical leadership.23 As a result, their platforms are probably insulated from competition in some of their major markets.

These platforms have delivered substantial consumer benefits, and their conduct does not necessarily violate antitrust laws. Yet consumers and the U.S. economy as a whole would likely benefit even more if they faced greater competition.24

Oligopolies are common and concentration is increasing in many industries

Many markets are oligopolies, in which a small number of firms account for most sales. A number of major industries, including airlines, brewing, and hospitals, have become substantially more concentrated over recent decades.25 The number of major U.S. airlines, for example, including regional and low-cost carriers, has declined after multiple mergers, from nine in 2005 to four today. Similarly, in brewing, Anheuser-Busch InBev SA/NV and Molson Coors Brewing Co. account for nearly three-fourths of the beer sold in the United States and likely exercise market power notwithstanding competition from the many craft brewers that have entered in recent years.26 Likewise, a number of studies show that hospital industry consolidation has led to higher prices.27

Some evidence suggests that concentration has risen generally in U.S. manufacturing,28 and perhaps also in other sectors.29 Other evidence involving broad national aggregates also is consistent with rising concentration,30 but it may instead reflect that large firms increasingly compete with the same large rivals across multiple product lines or regions.31

Coordinated conduct is a serious threat in oligopolies for several reasons. First, oligopolists, acting in their individual interest, may have an incentive not to compete aggressively.32 Second, businesses are taught to exploit gaps in antitrust rules to engage in coordinated conduct without running afoul of those rules.33 Third, the empirical economics literature finds that greater market concentration is associated with an increased risk of anticompetitive conduct.34n cross-section comparisons involving markets in the same industry, seller concentration is positively related to the level of price”). See Timothy F. Bresnahan & Valerie Y. Suslow, Oligopoly Pricing with Capacity Constraints, 15/16 Annales D’Economie et de Statistique 267 (1989) (relating price to concentration in the aluminum industry); see also William N. Evans, Luke M. Froeb & Gregory J. Werden, Endogeneity in the Concentration Price Relationship: Causes, Consequences, and Cures, 41 J. Indus. Econ. 431 (1993) (relating price to concentration in the airline industry); see also Vishal Singh & Ting Zhu, Pricing and Market Concentration in Oligopoly Markets, 27 Marketing Sci. 1020 (2008) (relating price to concentration in the auto-rental industry). Cf. Sam Peltzman, The Gains and Losses from Industrial Concentration, 20 J. L. & Econ. 229 (1977) (finding that greater concentration in an industry is associated with lower average industry costs and higher average industry price-cost margins, and that higher margins are associated with reduced competition rather than derived from the incomplete pass through of lower costs in markets in which small firms are becoming more efficient and only slowly taking share from less efficient larger firms).]

Increased governmental restraints on competition

Governmental restraints on competition appear to have grown in past decades. These include more extensive occupational licensing.35 They also include growth in the scope of what may be patented, along with an excessive number of patents improperly granted as a result of inadequate review of patent applications.36 To similar effect, competitive harm from “pay-for-delay” settlements—high drug prices that arise when the settlement of patent disputes under an industry-specific regulatory framework delays the entry of generic pharmaceuticals—has increased over time,37 though it is possible that the trend changed in 2013, when the Supreme Court made antitrust challenges easier.38

Lobbying and other political rent-seeking activity by firms to limit competition and boost supra-competitive profits—a precursor to governmental restraints—may also be increasing.39 For instance, one form of lobbying that may lead to competitive harm—citizen petitions from drug companies before the U.S. Food and Drug Administration seeking to delay entry by rivals—has “essentially doubled” since 2003.40

The decline in economic dynamism

The troubling decline in dynamism of the U.S. economy over the past few decades is consistent with a concern about widening market power, though the jury is still out about the contribution of market power relative to other plausible causal factors. The most productive firms and plants in the economy are expanding less rapidly now than they did before 2000,41 and the rate of startups has been declining for nearly four decades.42

Moreover, economic growth increasingly comes from improvements to existing products by incumbent firms rather than the displacement of existing products by better ones or the creation of new product varieties. Incumbent firms are increasingly accounting for productivity improvements relative to entrants and other rivals.43

Widening market power of productive firms offers one plausible interpretation for these macroeconomic trends: If productive firms are often insulated from competition, that insulation would limit their incentive to expand and innovate and would discourage expansion, entry, and innovation by rivals. Widening market power also plausibly contributes to the growing gap in accounting profitability between the most and least profitable firms,44 the rising profit share of U.S. gross domestic product,45 and a secular slowdown in business investment.46

Harms from market power

Firms exercise market power in their output markets (as sellers) when they raise prices relative to what they would charge in a competitive market or when they alter analogous terms of trade adversely to buyers (their customers).47 As the reference to analogous terms of trade indicates, firms exercising market power may do so on a range of competitive dimensions—most obviously by raising prices, but also by reducing quality or convenience, modifying product features, reducing discounts to customers, or altering the geographic locations or product niches they serve.

The definition of buyer market power is analogous: Firms exercise market power in their input markets (as buyers) when they lower prices or alter terms of trade adversely to sellers. When seller market power is exercised by a dominant firm, it is termed monopoly power; when buyer market power is exercised by a dominant firm, it is termed monopsony power.

As market power has widened in the U.S. economy, its adverse effects have grown. Some of those adverse effects appear primarily in the specific markets affected by the exercise of market power, while others may be experienced economy-wide.

Harms within the affected markets

For the most part, antitrust analysis adopts what economists refer to as a partial equilibrium framework, looking at competitive harms within the markets potentially affected by the exercise of market power. From that perspective, the exercise of market power by sellers (in output markets) is harmful in several ways, among them:

  • Wealth transfer and allocative efficiency loss
  • Wasteful rent-seeking
  • Slowed productivity improvements and innovation in affected markets

Each of these harmful outcomes in affected markets is complex and, for that reason, important to understand.

Wealth transfer and allocative efficiency loss

The exercise of market power in output markets leads to a wealth transfer from buyers to sellers—buyers are overcharged, conferring monopoly profits on sellers. Market power also creates what’s known as an allocative efficiency loss, or deadweight loss, which arises because some transactions that would occur in a competitive market are not made—even though buyers value the product or service more than it costs sellers to make or provide it. Hence the economy sacrifices wealth (gains from trade) potentially available to be shared between buyers and sellers.

The wealth transfer (lost surplus to buyers) and the allocative efficiency loss (lost aggregate surplus) are both considered harms from the exercise of market power.48 These harms are most easily described in a market for a homogenous product sold at a single price—perhaps grains, crude oil, raw metals, or industrial gases—though similar harms arise when products or services are differentiated or not always sold at identical prices, or when competition is primarily in quality, convenience, or features rather than price, as with branded consumer products, professional services, or transportation.

Wasteful rent-seeking

An efficiency loss from wasteful rent-seeking arises when firms compete for the opportunity to profit from exercising market power.49 That may happen when sellers spend resources lobbying to secure or protect a government-granted privilege to sell to buyers free from competition, as might be conferred, for example, through certificate-of-need laws for hospitals—which can enable hospitals to serve a community free of competition—or patents, which are awarded by the U.S. Patent and Trademark Office. Moreover, when sellers spend resources to erect barriers to entry and exclude rivals through means not involving the government, those expenditures also may be wasteful.

Slowed productivity improvements and innovation in affected markets

The exercise of market power also may have adverse dynamic consequences for productivity and innovation.50 First, the exercise of market power slows the rate at which firms improve products and production processes, and lower costs.51 The loss of competition reduces firms’ incentives to expand markets and take business from their rivals, which they might do by cutting costs and prices, improving quality and features, developing new and better products and production processes, or enhancing the value they offer customers by providing increased variety and better services.

The loss of competition also inhibits productivity-enhancing selection—the tendency of the best products and most-efficient producers to win out, as products, technologies,52 business models, plants, and firms that are unable to price competitively or attract sufficient customers to remain profitable are forced from the marketplace. Not surprisingly, modern economic and business literatures consistently and convincingly demonstrate that enhanced competition in an industry leads to greater productivity and that the exercise of market power reduces it.53

Second, firms may seek to innovate in order to escape competitive pressures, which means they tend to innovate less when they have durable market power protecting them from the entry of other firms into their markets. There is a theoretical qualification: The exercise of market power could instead enhance innovation incentives if a firm’s pre-existing market power reduces the likelihood that its rivals will quickly copy its new products or processes, then compete so aggressively as to prevent the firm from earning a profit sufficient to justify its investments in research and development.54 That qualification is unlikely to be important in most markets where antitrust issues arise, however, because firms making major R&D investments usually have many reasons other than pre-existing market power for expecting to appropriate sufficient returns, even with some imitation.55

Moreover, even if the prospect of greater post-innovation competition means a dominant firm would expect to earn less by innovating, the firm may still be led to keep investing in R&D for fear of losing out to its rivals—many of which may themselves have a strong incentive to pursue new products and production processes in order to steal business from the dominant firm.56 For all these reasons, greater competition—not greater market power—generally enhances the prospects for innovation,57 and the exercise of market power tends to slow innovation and productivity improvements in the affected markets.58

The exercise of market power by buyers (in input markets, including labor markets) leads to static and dynamic harms within affected markets analogous to the three types of harms arising from seller market power.59 When buyers exercise market power, suppliers (the sellers) are paid too little, so wealth is transferred to buyers. In addition, allocative efficiency losses can arise because resources (the inputs) may not be employed in the markets where they are most valued. If the hospitals in a city collude to depress the wages paid to nurses below competitive levels—as hospitals in cities across the nation have allegedly done60—then they will pay nurses too little, hire fewer nurses than they would otherwise, and lead some nurses to take non-nursing jobs.

Moreover, if lessened input purchases restrict downstream production, then the reduction in downstream output could generate additional allocative efficiency losses. If hospitals exercising market power as buyers hire fewer nurses, patient care may suffer.

The exercise of market power by buyers also can also lead to insufficient supplier investment in improving production processes and developing product and service improvements, creating dynamic harms analogous to the way innovation and productivity are discouraged by the exercise of market power by sellers. If cable providers are able to depress the prices they pay for video programming through the exercise of market power in purchasing content, for example, content providers may invest less in developing new programs.

Competition can be wasteful at times. Competing firms typically make duplicative fixed expenditures,61 and competition can lead to excessive entry into existing or new markets.62 Notwithstanding these qualifications, the economics literature taken as a whole strongly supports the view that market competition is beneficial and market power is harmful within the affected markets, accounting for both static and dynamic effects.

Economy-wide harms

Looking beyond the individual markets affected by market power, the exercise of market power is harmful to the U.S. economy as a whole. Although competition operates market-by-market and industry-by-industry, the scope of market power can affect the overall economy. The resulting harms are not limited to the participants in the particular markets in which competition has declined. Instead, the exercise of market power may result in slowed economic growth and increasing economic inequality.

Slowed economic growth

The cross-national and cross-industry studies undertaken by the McKinsey Global Institute, summarized by William W. Lewis in 2004 for a popular business audience in “The Power of Productivity: Wealth, Poverty, and the Threat to Global Stability,” demonstrate that differences in competition in product markets across nations are likely as important as cross-national differences in macroeconomic policies and more important than cross-national differences in labor and capital markets in explaining variation in productivity and economic performance.63 National economies do better, Lewis concluded, when competition is both “intense” and “fair” (not distorted by governmental subsidies to less productive firms).64 Another leading expert on business strategy, Harvard Business School’s Michael Porter, reached a similar conclusion from a large cross-national study. Porter found that “vigorous domestic rivalry” in an industry helps make that national industry successful.65

To similar effect, economists seeking to understand why some nations have grown wealthy consistently find that impediments to competition—which are frequently imposed at the behest of private interests with a stake in protecting existing economic and social arrangements—impede innovation, growth, and prosperity.66 These studies reinforce the plausibility of the connection between the systematic widening of market power by firms and the decline in dynamism in the U.S. economy over the past few decades.

When firms and industries can secure long-lasting political power through their size and lobbying influence,67 their economic and political power can reinforce each other in a vicious circle. Market power may give firms the resources to create and exploit political power, which they may use to protect or extend their economic advantages—and then invest some of the resulting rents to extend their political power.68

Increased inequality

The exercise of market power also probably contributes to economy-wide inequality because the returns from market power go disproportionately to the wealthy. Increases in producer surplus from the exercise of market power (the wealth transfer) accrue primarily to a firm’s shareholders and its top executives, who are wealthier on average than the median consumer. In a recent year, the top 1 percent of the wealth distribution held half of stock and mutual fund assets, and the top 10 percent held more than 90 percent of those assets.69 Unionized workers in the past may have been able to appropriate some of the profits from the exercise of market power, but with the decline of private-sector unionization, this possibility now has limited practical importance.

Whether economy-wide harms arise from slowed economic growth or increased inequality, the extent to which markets are competitive is far from the only determinant of economy-wide productivity, growth, and inequality. While the economic literature has yet to measure successfully the magnitude with which increasing market power has contributed to the post-1970s slowdown in the rate of U.S. productivity growth or the rise in inequality,70 it is nonetheless evident that market power retards growth and enhances inequality—making it plausible that widening market power over the same period has contributed to these adverse economy-wide trends.

Conclusion

Our well-established antitrust norms, precedents, and institutions undoubtedly do much to deter the exercise of market power by firms. But that is not a reason for complacency: Market power is a substantial and widening problem for the U.S. economy today.71 The resulting harms may extend beyond the individual markets affected to the economy as a whole—in the form of slowed productivity and economic growth, and increased inequality. The surprising conjunction of widening market power with well-developed judicial norms against anticompetitive conduct and well-established antitrust enforcement institutions presents a challenge for academic researchers and policymakers alike: to determine where competition has been harmed, establish whether and how anticompetitive conduct undermines broad-based and equitable U.S. economic growth, and identify ways that courts, antitrust enforcers, and policymakers can do better to deter anticompetitive conduct.

—Jonathan B. Baker is professor of law at American University Washington College of Law. He has served as the director of the Bureau of Economics at the Federal Trade Commission and as the chief economist of the Federal Communications Commission.

Must-Read: Bob Christie: 380,000 Arizonans May Lose Medicaid

Posted on by Brad DeLong

Must-Read: Bob Christie: 380,000 Arizonans May Lose Medicaid: “The report looks at the patients who gained coverage under a Medicaid expansion pushed through in 2013 by former Gov. Jan Brewer…

…Brewer said in an interview earlier this week that “it weighs heavy on my heart” when she thinks of the current Republican plan to repeal and replace Obama’s law. “It just really affects our most vulnerable, our elderly, our disabled, our childless adults, our chronically mentally ill, our drug addicted,” she said of the potential elimination of coverage for the expansion population. “It will simply devastate their lives and the lives that surround them. Because they’re dealing with an issue which is very expensive to take care of as a family with no money.”…

Gov. Doug Ducey said earlier this week that he isn’t pleased with the current proposal. “I’ve said that I don’t want to see anybody have the rug pulled out from underneath them, and that’s what I’m going to be advocating,” he told reporters Tuesday. “I have concerns with the bill as its written today.” Ducey said he has the ear of the state’s congressional delegation and the new Secretary of Health and Human Services, Tom Price, and expects to see changes. He was on a call with White House officials talking about the health law on Tuesday. “I think you’re going to see a different bill if it does get out of the House, if it does get out of the Senate, than the bill you see today,” he said….

“I just want to let the world know I am 100 percent in favor” of the measure, Trump said at the White House…

Should-Read: Andrew Neather: Foragers, Farmers and Fossil Fuels: How Human Values Evolve by Ian Morris

Posted on by Brad DeLong

Should-Read: Andrew Neather: Foragers, Farmers and Fossil Fuels: How Human Values Evolve by Ian Morris: “Ian Morris… argues that key societal values…

…are directly related to the way we answer our most basic practical need: energy. Foraging societies captured… energy… through hunting and gathering… semi-nomadic… little opportunity to accumulate wealth…. a daily average of 4,000-8,000 kilocalories per person. They tended to be egalitarian, since hunting and gathering required a high degree of co-operation. And while there was a sexual division of labour, attitudes to female sexuality were relatively relaxed. But they were also violent — Morris thinks 10 per cent or more of adults died violently.

Then around 10,000 years ago… farming…. With their high levels of energy capture — up to 30,000 kcal/day per person — came new values… the accumulation of wealth… [by the] industrious or lucky, inequalities… sustained labour…. Women’s sexuality became tightly controlled: these were societies in which inheritance — and therefore fidelity and bloodlines — mattered a lot. But they were also less violent, with rulers imposing legal structures. With the dawn of fossil fuels in the 18th century, energy capture increased exponentially… broke the Malthusian link… generated vast wealth… more egalitarian over gender, and much less violent….

What is less sure is whether certain values are really such direct products of a particular mode of energy capture — he shuns any language as Marxist as a mode of production — or more fundamental to the human condition. One place where this becomes clearer is in his brief discussion of post-fossil-fuel societies. Part of the problem is, of course, that he doesn’t know what will come next…

Should-Read: Nancy LeTorneau: There Is No Grand Strategy to Repeal Obamacare

Posted on by Brad DeLong

Should-Read: Nancy LeTorneau: There Is No Grand Strategy to Repeal Obamacare: “The Congressional Budget Office… released their report…. What we’ve seen from conservatives/Republicans/the White House since then…

…If anyone can see a grand strategy here, I’d like to hear about it:

  1. HHS Sec. Tom Price and OMB Director Mulvaney said you can’t believe what the CBO says.
  2. Speaker Paul Ryan praised the CBO report.
  3. The White House produced a report that was even worse than CBO’s – suggesting that 26 million people would lose coverage.
  4. Someone leaked the WH report to Politico.
  5. Breitbart validated the CBO report by broadcasting the news that Paul Ryan’s plan would result in 24 million people losing their health insurance.
  6. Almost simultaneously, Breibart released a tape from last October in which Ryan said he was abandoning Trump forever and wouldn’t support him.
  7. Trump is telling conservative Republicans that he’ll work with them to make the bill even worse by speeding up the changes to Medicaid and basically saying, “who cares if that makes it less likely to pass the Senate, we’ll deal with that later.”

Let’s note one thing right away. The plan to rally right-wing media around the idea that the CBO report cannot be trusted has completely gone off the rails. When everyone from Ryan to Breitbart to the released White House report are validating it, that simply isn’t going to fly…. The theory that… Bannon is working… to discredit Speaker Ryan… Breitbart has consistently referred to this bill as “Ryan’s plan,” even though the president embraced it as “our wonderful new health care bill” the day it was released…. But then why is Trump working with conservative Republicans behind the scenes to get the bill passed, apparently with an assist from Bannon in dealing with the head of the Freedom Caucus, Rep. Mark Meadows (per Politico)?… I’m going to assume that the error in my thinking is assuming that there is either some grand strategy for passing Obamacare repeal or fighting the factional war…. The easier position to defend is that this is a party that doesn’t know how to govern and it’s being exposed for its inadequacies. The silver lining is that it could be good news for the 24 million people who want to keep their health insurance.

Should-Read: Anton Howes: Inducing Ideas for Industrialisation

Posted on by Brad DeLong

Should-Read: Anton Howes: Inducing Ideas for Industrialisation: “Perhaps the most popular modern theory of the causes of the Industrial Revolution is Robert C. Allen’s “Induced Innovation”…

…as outlined in his 2009 book The British Industrial Revolution in Global Perspective. The argument is straightforward, but compelling: Britain had uniquely high wages from about as far back as the Black Death, along with relatively low capital and energy costs.* At the same time, places like China had low wages and relatively higher capital and energy costs. Britain’s relative factor price structure therefore induced a lot of labour-saving inventions, whereas China was stuck with a bunch of labour-intensive innovations.

The benefit of this theory is that it even goes some way towards explaining why Britain might have been earlier than most other European countries: it had relatively higher wages…. But… imagine yourself a creative potter in the 18th Century-do high wages cause you to sit down and focus on a labour-saving invention? Or are you more likely to simply grumble and make do? There seem to be a few extra steps required here. One key facet of the IR is not so much the type of inventions that Britain witnessed, but their sheer volume: in every industry, and all around the same time. Indeed, many of these were saving labour, energy and capital indiscriminately. One thing that Allen’s theory does not explain is the source of this generalised and accelerated outburst of inventive activity….

[With] the out-of-the-blue, game-changing inventions like the steam engine, coke smelting, or the spinning machine… becomes even more stark than if we’re only talking about incremental improvements to a pre-existing technology (so-called ‘micro-inventions’)…. Allen’s theory is strongest when it comes to the success of an invention in the market… explaining why particular major inventions were successful in high-wage Britain. This rings true: look at the extraordinary successes in Britain of foreign-invented contraptions such as the Lombe silk loom (stolen from Piedmont), or of the Jacquard Loom (a French-invented attachment to looms enabling patterns to be programmed-the inspiration for Babbage’s proto-computer, the analytical engine). By focusing on market viability, this aspect of the theory also goes some way to explaining the rate and pattern of industrialisation’s spread….

Thus, while Allen’s theory might explain why some inventions were adopted for further development, many other inventions appear to have been developed further despite the bias of relative factor prices…. It’s only after research and development that Allen’s theory really kicks in…. For a fuller explanation of the Industrial Revolution, though, we need to go right to the inventive source-why was there so much more invention in Britain to be adopted in the first place? 

Must-Read: Nicholas Bagley: The GOP Obamacare replacement would help the rich, hurt the poor and unleash chaos

Posted on by Brad DeLong

Must-Read: Time for every state to neutralize all policies of the Trump administration. States that do not are being really stupid:

Nicholas Bagley: The GOP Obamacare replacement would help the rich, hurt the poor and unleash chaos: “Republicans have finally released their long-awaited alternative to the Affordable Care Act…

..a huge tax cut to the wealthy and gut the federal spending that the poor and the middle class depend on for their health insurance…. The Republican bill would undo most of Obamacare’s gains. Bad as that will be for the entire country, it will be especially bad for states like California, where the Affordable Care Act is working well…. The Republican bill would set chaos in motion because it would immediately eliminate the individual mandate… Obamacare wasn’t collapsing — but it could if the Republicans get their way.

California has a shot at preventing that collapse…. The Legislature would have to act…. The California exchange is healthy and, with a substitute mandate in place, the economic picture for the next two years shouldn’t look all that different than it does today…. California and other blue states should take the GOP, and Ryan, at their word — and take matters into their own hands, not in the future, but now.

Must- and Should-Reads: March 19, 2017

Posted on by Brad DeLong

Interesting Reads:

Should-Read: Kevin Drum: Here’s Why CBO Projects 10% Lower Premiums Under the Republican Health Care Bill

Posted on by Brad DeLong

Should-Read: Kevin Drum: Here’s Why CBO Projects 10% Lower Premiums Under the Republican Health Care Bill: “One of the surprising things about the CBO score of… the Republican health care bill…

is… that premiums will fall starting in 2020. By 2026… 10 percent lower than they would be under Obamacare. But why…. CBO didn’t do anything wrong here. They simply did their projections based on a (correct) assumption that AHCA would be too expensive for many old people and would produce crappier policies that had higher deductibles and paid far less of your medical bills. The “average” premium is lower, but obviously not in a way that helps anybody in real life.