Monopoly Is Not a Game

A lack of competition may be holding back the U.S. economy.

Well, that might be overdoing it.

Photographer: Ron Antonelli/Bloomberg

One of the basic lessons of economics is that monopolies are bad news. When there’s only one company in a market, it can jack up prices to above their efficient level. That gives a big boost to profits, but results in too few people being able to afford to buy what the company is selling. Most markets are not monopolies, but a similar principle holds for situations where there are only a few companies, called oligopolies. A lack of players stifles competition, raising profits but lowering overall economic output.

It’s therefore natural to ask whether the U.S.’s subpar economic  growth is caused by a decrease in competition, and in fact, a bunch of people have been suggesting this explanation lately. In an article entitled “Too much of a good thing?," the Economist cites high rates of profit, record levels of merger activity and increasing industrial concentration as evidence of reduced competition.

I’m not sure it’s a bulletproof case. It’s true that after-tax profits are historically high as a percent of gross domestic product. But pretax profits might be a better measure of market power, since they represent companies’ ability to wring value out of the economy (some of which then goes to the government as taxes). The following chart shows that pretax profits are high relative to the 1980s and ’90s, but are only back up to the level that prevailed from the ’50s through the ’70s:

Pretax profit graph

Nor is merger and acquisition activity unusually high. Although last year was a record, the number and total value of merger deals has been pretty stable since the turn of the century.

How about those big banks? The U.S.’s megabanks may still be too big to fail, but the sector still is much less concentrated than in countries such as Canada, Germany, Japan and the U.K.

The airline sector is the poster child for high concentration in U.S. industry. But this might have merely been what the industry needed to survive. Profit margins have traditionally been so razor-thin that U.S. airline bankruptcies for decades were  regular headlines in the news. The recent consolidation might serve only to raise airline profits to normal, sustainable levels.

Has federal antitrust enforcement become more lax? Not according to the law firm Gibson & Dunn, which reports that fines for anticompetititive behavior have been increasing for a decade:

Antitrust fines chart

So the evidence that the U.S. has become less hostile to oligopolies is mixed. Larry Summers, however, raises an interesting point when he contrasts the recent rise in profit with the decline in corporate investment:

If monopoly power increased one would expect to see higher profits, lower investment as firms restricted output, and lower interest rates as the demand for capital was reduced.  This is exactly what we have seen in recent years!...[O]nly the monopoly power story can convincingly account for the divergence between the profit rate and the behavior of real interest rates and investment.

Summers also brings up the possibility that information technology is making it much easier for companies to be monopolies, by creating strong network effects or by extending their reach across larger geographical areas. I too have suggested this idea recently. Another force pushing us toward increased industrial concentration might be globalization -- promonent theories predict that international trade leads to a larger number of companies around the world, but fewer within each country.

There is also some academic work suggesting that financial innovation may be reducing competition much more than would be implied by the modest rise in industrial concentration. The University of Michigan’s Martin Schmalz, along with private-sector co-authors Isabel Tecu and Jose Azar, recently found that when mutual funds own pieces of a number of different companies in an industry, competition in that sector falls. Passive investing -- index funds, exchange-traded funds and the like -- has led to an increase in this sort of distributed ownership. Those new funds have allowed investors to diversify their risk, but that may be coming at the expense of healthy industry competition.

So we should definitely be keeping a wary eye on the level of competition in the economy.

More importantly, the problem of competition requires a broad shift in our thinking about the proper roles of government and private industry. Free-market orthodoxy has taught generations of Americans to think that the private sector runs best when left to its own devices, but monopoly power throws a big wrench into the equation. If the level of competition fluctuates naturally as technology, finance and globalization change, then the appropriate level of government intervention changes too. It may be that an efficient economy needs government to constantly fine-tune a nation’s industrial structure, enforcing antitrust more stringently when natural forces diminish competition, but backing off when competition increases on its own.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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