A number of facts indicate that in recent decades, the leading firms in this industry have taken a more dominant position than in the past. I have noticed that some of this evidence accumulates over time.
For example, Back in 2015, the OECD published the Future of Productivity report. arguing that productivity slowdown problems in many countries arise not because high productivity firms are slowing their productivity growth, but because medium and lower productivity firms are not keeping up. This year, Jae Song, David J. Price, Fatih Güvenen, and Nicholas Bloom have written about how productivity discrepancies between firms have also led to wage discrepancies between firms.. They argued that within a given firm, wage inequality did not change much. But in some high-performing and profitable firms, wages were noticeably higher than in other firms in the same industry, which was the main driver of growing market inequality in labor income. Nicholas Bloom summarized this evidence in a March 2017 magazine cover story. Harvard Business Review.
The McKinsey Global Institute took the lead in 2018 with a report that summarizes past evidence and offers new evidence in Superstars: Dynamics of Firms, Sectors and Cities Leading the Global Economy (October 2018). It looks at some 6,000 of the world’s largest public and private companies: “Over the past 20 years, the gap between superstar firms and mid-sized firms, and between the bottom 10 percent and mid-sized firms, has widened. … Thus, rising economic profits at the top of the distribution are reflected at the bottom by growing and increasingly persistent economic losses … “. In 2019 The US Census Bureau and the Bureau of Labor Statistics have created an experimental database called Productivity Dispersion Statistics that allows researchers to look at how productivity is distributed among firms in a given industry: for example, firms in a particular industry with the 75th percentile of productivity are, on average, about 2.4 times more productive than firms with the 25th percentile. Again, there has been some evidence that this gap is widening and that productivity best practices are not spreading as they used to.
In short, a wealth of evidence suggests that the advantage of dominant firms over their competitors has increased across industries. Jan Eckhout reviews this evidence and also discusses cause and effect in his essay on “Dominant Firms in the Digital Age(UBS Center Public Paper #12, November 2022).
Eckhout argues that the advantage of dominant firms in the digital age can be achieved in several ways. I think the more well-known approach is the idea of network effects. For example, many buyers go to Amazon because many sellers are also on Amazon, and vice versa. When such a network exists, it can be difficult for a new firm to gain a foothold.
A more subtle approach is for firms to make investments that fall under the accounting category Selling, General and Administrative Expenses (SG&A). These include expenditures on research and development (R&D), advertising, salaries of managers, etc. and are often interpreted as fixed costs or intangible assets. The observed growth in SG&A is a source of economies of scale, as the fixed cost of production leads to lower average costs even with moderately reduced returns on variable inputs.” In other words, some firms are investing heavily in technology, brands, and managers who can take advantage of these opportunities. Eckhout says:
The rise of dominant firms that we have seen in the digital age is based on cost-cutting, efficiency-enhancing innovations that deliver increasing returns to scale. This implies a winner-take-all market in which the dominant firm has a strong monopoly position. And although monopoly is often associated with higher prices, most of these firms achieve this position by doing the opposite, that is, lowering prices. They can do this because their innovations and investments lead to even greater cost reductions. And that is why digital technology is so attractive to customers: the protagonist here is technological innovation. But because economies of scale drive down costs more than prices, technological change is also the villain.
(For those who want to dig deeper, Summer issue of Economic Perspectives 2022 includes a three-article symposium on the growing importance of intangible capital in the US economy, including everything from innovation to brand names. Summer Edition 2019 includes a symposium of three papers on the extent to which price premiums change over time, and the implications for labor markets and macroeconomics. As has been the case for over ten years, all JEP articles since the first issue are in the public domain. Full Disclosure: I’m the Managing Editor of the JEP and so I tend to think the articles are of broader interest!).
As Eckhout points out, the potential consequences of the rise of dominant superstar firms include widening wage inequality caused by these persistent differences between firms; a slowdown in the growth of new business start-ups as entrepreneurs face a more challenging environment; shifting the flow of national income into capital rather than labor; and, in general, greater ability of more dominant firms, less concerned with competition, to charge higher prices.
What is the appropriate policy solution? One approach is to tax the profits of dominant firms higher, but without taking a position here as to the extent to which this is desirable, it is worth noting that higher taxes will not change the dominant position of these firms and many of the negative consequences. will persist
An alternative approach would be to recognize the phenomenon but take a tougher stance. After all, if dominant firms succeed by making investments that increase productivity and reduce costs, then this is, in general, a desirable goal, not something to be punished for. Also, today’s dominant firms are not invulnerable, as anyone who monitors the current performance of Meta (Facebook) or Twitter will attest. Not too long ago, companies like America Online and MySpace seemed to dominate.
Also, to what extent are consumers “crippled” by, say, free access to email, word processing, and spreadsheets offered by Google? Preston McAfee said this in an interview a few years ago.:
First, let’s be clear about what Facebook and Google are monopolizing: digital advertising. The correct phrase is “to use market power” and not to monopolize, but life is short. Both companies give away their consumer products; the product they are selling is an advertisement. While digital advertising is likely a market for antitrust purposes, it is not in the top ten social problems we face, and perhaps not in the top thousand. Indeed, since advertising is harmful to consumers, monopolization, by increasing the price of advertising, benefits society.
Amazon operates in several areas. In retail, Walmart’s revenue is still double that of Amazon. In cloud services, Amazon has invented a market and is facing stiff competition from Microsoft and Google, as well as some competition from other companies. In video streaming, they face competition from Netflix, Hulu, and verticals like Disney and CBS. What’s more, a lot of great content is being created; I came to the conclusion that the involvement of Netflix and Amazon in content creation was fantastic for the consumer. …
A more proactive approach would be to seek targeted opportunities to ensure greater competition. For example, McAfee suggests that the Android-Apple duopoly in the smartphone market, as well as very limited competition in the provision of home Internet services, could seriously harm consumers.
Eckhout emphasizes the general issue of “interoperability,” that is, the ability of consumers to switch between companies. He wrote:
Interoperability has many uses. This rule ensures that the hardware manufacturer cannot change the charger plug from product to product, forcing users to buy an expensive new one every time or whenever they need to replace an existing plug. And the concept of interoperability was at the heart of the development of the Internet, where the founding fathers of the World Wide Web ensured the availability of various services. They ensured that an email message, for example, could be sent from one provider (say, Gmail) to another (say, your company’s mail servers). Similarly with access to web pages hosted by different providers. This generates a lot of input and competition from ISPs. But this concept of interoperability is not without regulation. For example, interoperability is not built into messaging services. Unable to send message from WhatsApp to Snapchat as messaging services are closed. Neither service has an incentive to open their messaging platform to their competitors’ messages. As a result, compared to the number of e-mail service providers and the world wide web, the number of messaging services is very small.
If people choose to share their personal information or make that information available from one environment to another, competition can be increased. This goal is not easy. But if people could move their preferences and past shopping lists, even their financial and banking records and their health data, from one supplier to another, competition in a number of areas could become easier. Another suggestion is that antitrust regulators should be skeptical. when a dominant firm seeks to buy up smaller firms that have the potential to become future major competitors.
The most proactive approach would go beyond specific situations of anticompetitive behavior and seek more aggressive use of antitrust regulation, perhaps even to destroy dominant firms. I see no good reason for this kind of action. When strong network effects are the main problem, such effects will not disappear. When the main problem is that firms are making large investments in productivity, that’s a good thing, not a bad thing. Perhaps instead of figuring out how to slow productivity leaders down, we should think more about what market structures and institutions can help spread what they’re already doing to the rest of the economy. Finding ways to level up the laggards is often harder than downgrading the leaders, but in the long run it’s more productive.