Why Soaring Stocks Could Be Bad News For The Economy
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While it's had some ups and downs, the stock market has soared to historic heights in recent years. For many, that's great news: It's a sign the economy and their retirement accounts are doing really well. For Jan Eeckhout, however, the booming stock market is a sign there's something deeply wrong with the economy.
Sure, the economist says, he has a retirement account with stocks, and he personally benefits from the ongoing bonanza on stock exchanges. But the rocket ride of the stock market is powered by the exploding profits of increasingly powerful corporations. Their increasingly ridiculous profits, he says, are eating the income of the vast bulk of workers and hurting the overall economy. That notion is the central thesis of his forthcoming book, The Profit Paradox: How Thriving Firms Threaten the Future of Work.
Lurking behind the soaring profits and stock prices of corporate America is a powerful force. Eeckhout argues that force is one of the biggest reasons why the wages of the typical American worker have flatlined, why there's been a significant decline in the percentage of people participating in the workforce, why the share of national income going to workers has been falling and why startup growth has slowed in recent decades. That force, he says, is the startling growth of market power since 1980.
The astonishing rise of market power
Market power — aka monopoly power — is the ability of companies to make hefty profits, by pricing their products and services higher than it costs to make and provide them. It costs Apple less than $500to make a high-end iPhone, but it charges more than double that amount to consumers. The ability of Apple to do this is a sign the company has a lot of market power.
Investors love market power. Warren Buffett, for example, famously advises that people invest in companies that will have lots of it. Companies with market power are moneymaking machines, protected by machine guns and bazookas that keep potential competitors at bay.
Market power often comes from genuine innovations, efficient business models and the creation of stuff that consumers like, but it also has costs for society. Those costs are outlined in the classic theory of monopoly. Without competition, companies can increase their prices to maximize profits. As prices for products rise, many consumers can't afford them, and so the monopolistic company reduces what it produces and sells. And that means they need fewer workers.
If it were just one company, it wouldn't be such a big deal for the overall economy. But Eeckhout documents an astonishing rise of market power across all sorts of industries since 1980. We're not just talking about the usual suspects here: Amazon, Google, Facebook and so on. We're talking about everything from the makers of cat food to the sellers of caskets. More than half of all the dry cat food in the United States is sold by one company. Almost 90% of mayonnaise in the U.S. is sold by two companies. Airlines, social media, pacemakers, pharmaceuticals, energy, cars, home improvement — there are so many industries that are increasingly dominated by only a few companies.
The International Monetary Fund rang alarm bells about the issue of growing market power back in 2019 (read our newsletter about it). It studied almost 1 million companies, focusing on one measure of market power: markups, which is the ratio of the price of stuff a company sells to the cost of producing it. The IMF found markups grew by 8% between 2000 and 2015 in advanced countries.
In his own study, published in a top, peer-reviewed journal, Eeckhout and his colleagues found that the markups of companies publicly traded in the United States have tripled since 1980, and that dominant companies are much more profitable than they used to be. In 1980, the average profit rate of a publicly traded company was 1% to 2% percent of sales. Now, they have profit rates of between 7% and 8% of sales. It's a mind-boggling increase.
Eeckhout says he has nothing against profits per se. But he says the excessive profits of so many companies are coming at the cost of the economic livelihoods of ordinary workers. In the world of omnipresent market power, workers not only have to pay higher prices for goods and services, but they also, Eeckhout says, find it harder to get good-paying work. That's because higher prices of stuff means lower demand for that stuff, which also means lower demand for workers to make or provide that stuff.
"Market power now is so widespread, from tech to textiles, that it lowers production and the demand for labor," he writes. "Instead of creating jobs, profitability due to market power lowers wages and destroys work. That is the profit paradox."
Why has there been growth in market power?
Eeckhout blames two big factors for the rise of market power. The first is lax enforcement of competition by the government. This includes allowing companies to merge with and gobble up their competitors as well as an overly generous patent system that hands lengthy monopoly rights to sell all sorts of gadgets and pills. Most of the corporate lobbying done in Washington is all about protecting and expanding market power.
But Eeckhout says the main story is about rapid technological change creating winner-take-all markets and making it harder for Davids to challenge Goliaths. Over the last four decades, we've seen huge technological progress in computing, transportation and communication. That has fed the rise of global supply chains, big-box retailers, search algorithms and platforms with "network effects," which give companies such as Google, Amazon and Facebook more value the more people use them. Smaller companies now struggle to amass the resources, know-how and brand reputations to cross the formidable entry barriers needed to compete with the big guys.
What should we do about it?
The simple answer is for the government to break up companies. But Eeckhout stresses that the reason many companies remain dominant is that they often offer greater efficiency and better products, because of their technologically advanced and well-managed businesses. Sure, you can break up Google, but its search algorithm, which is the main source of profits, actually works better the more people use it. Breaking the company up could make consumers worse off.
Some companies do need to be broken up, Eeckhout says. Others, however, just need to be better regulated. One idea: a "reverse patent" system, where companies such as Google only get a limited amount of time to keep the data they collect private. After that, the data becomes freely available for competitors to use.
Another idea: a new Federal Competition Agency, modeled on the Federal Reserve. The main job of the Fed is to prevent inflation, and, Eeckhout says, the costs of market power are way bigger than the costs of inflation have ever been. Like the Fed, this new agency would be well-staffed and have enhanced powers that it can exercise independently from Congress and the president. Its main job would be to regulate monopolies and limit market power.
Eeckhout acknowledges that taking this issue seriously won't make stock traders happy. Limiting market power and increasing competition would reduce profits for companies. That, in turn, would mean companies would have lower stock prices. If we return to the levels of competition we saw in the early 1980s, he writes, "[B]e prepared for a Dow Jones below 10,000 instead of at 30,000."
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