Tuesday, 31 October 2017

Competition improves inequality?

There's a fascinating debate going on about whether market power makes income inequality worse or, putting it the other way round, whether more competition would reduce inequality.

It's been spurred in particular by a piece which appeared recently on the OECD's website, 'Inequality: A hidden cost of market power', where you can find links to the full working paper by three OECD staff economists and to a shorter, more plain English version published by Competition Policy International (CPI) as part of a symposium, 'Antitrust's Inequality Conundrum?'.

The gist of the idea is straightforward. Businesses are disproportionately owned by the rich, which is largely uncontroversial, since we know that there is a heavily skewed distribution of wealth. If businesses manage to exert market power, they can raise prices to above-competitive levels. Consumption is relatively evenly distributed, so everyone feels the pain to much the same degree. But the benefits from above-normal profits flow to the owners of the firms, whose incomes increase even further. Inequality worsens.

The authors have even had a go at measuring the impact, based on sectoral data on firms' mark-ups over cost in eight economies. They've got a model where they can use observed data to back out what pricing in a competitive economy would have looked like, after allowing firms to earn a competitive return. "To illustrate", as they say on pages 17-18 of the full paper, "in the sector of wholesale and retail trade and repairs, the mark-up observed in the UK is 16% and the minimum mark-up (found in
Germany) is 12% [i.e. they're taking this as a benchmark of what a 'normal' mark-up needs to be]. The UK excess mark-up for that sector is then calculated as the difference, i.e. 4.0%". They do the same calculation across all sectors and all economies.

Summing up for all eight countries and sectors, they find the average 'normal' mark-up over cost to be 10.2%, but the actual observed mark-up to be 18.0%, leading to an 'excess' market-power-driven mark-up of 7.8%. And with their model they trace the distributional consequences of this excess mark-up (p23): "Market power may contribute substantially to wealth inequality, augmenting wealth of the richest 10% of the population by 12% to 21% for an average country in the sample...Market power may also depress the income of the poorest 20% of the population by between 14% and 19% for an average country in the sample".

It makes for some pretty dramatic pictures, such as this one from the CPI version of the paper


As you can imagine, this graph has been making the rounds of social media like nobody's business.

But you'll have noticed that the authors carefully said "may" contribute and "may" depress, and that I've included a question mark in the title of this post. We needed to: while it is tempting for pro-competition campaigners to add "substantially lower inequality", like that in the graph, to the list of good things that more competitive markets might achieve, it's a stretch. There's a lot that this model glosses over.

For one thing, it assumes that wages don't rise in response to the higher prices consumers are facing: that's a big ask right there. As the authors concede (p10 of OECD paper), "In fact, if market power increased prices and wages in the same proportion, the redistributive effect of market power would likely be negligible, since workers and business owners would be affected in the same way".

There's also the point that some of the above-normal profits are entirely benign, and not something to be regulated away or deplored: if you've got the hottest software or smartphone or blockbuster movie, good for you. As the authors say (on p6 of the CPI version), "We are by no means suggesting that wealth acquired from market power is in any general sense improper. Much of the profit from market power, and quite possibly the majority, is derived from legitimate sources, such as patents, trademarks and brand differentiation". You should really only be bothered about the inequality (and other) impacts of "bad" market power from, for example, excessively concentrated markets.

And you can pick other holes in it, as for example University of Michigan professor Daniel Crane does in his symposium contribution, "Further Reflections On Antitrust And Wealth Inequality" (there are other critical articles there, too). Pro-competition interventions might themselves be regressive: he has an example of one constraining real estate agents, but benefiting their, wealthier, house-selling clients. The profits from market power don't always accrue to the shareholders, but get siphoned off by key personnel or indeed employees more generally. And the costs mightn't be borne as much by the ordinary guy in the street as you might at first think. It may be, for example, that high market power prices in the health sector might be paid largely by the government, which is actually funded on some progressive tax basis. Richer, higher rate taxpayers end up wearing the bill.

I'm kinda inclined to the view, which Crane says (p5) is the "most salient" response to his critique, that, all qualifications considered,  "Even if many other interests within the firm capture a share of monopoly rents, shareholders capture enough of them to skew this one effect to such a degree that it necessarily outweighs all countervailing effects".

But as Crane puts it, "Maybe. I don’t know. Nor, I suspect, do the people making this assertion. And that’s my point. Before turning to antitrust as a lever to fight income inequality, we need to admit a degree of modesty about what we really know and don’t know. The story is not so simple as it is made to seem".

He's right. We don't know for sure that less market power means lower inequality, even if, to some of us, it looks the way to bet: after all, how likely is is, really, that those with the incentive and ability to raise prices would end up flattening the income distribution?

Fortunately inequality is high on many institutions' and researchers' agendas at the moment, and we'll be seeing a lot more research in this neglected area: there's been surprisingly little until quite recently. Even if they're only along case study lines, like the Mexican mobile phone prices cited in the CPI version of the OECD paper, they'll be a welcome advance in our understanding of something we in the economics and policy trades should have looked at long ago.

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