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Margin rates and monopolies

The margin of listed companies in the United States has increased by one third since 1980, whereas it had been stable before. Does this trend mean that competition is running out of steam?

April 2018
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Executive Summary

The margin of listed companies in the United States has increased by one third since 1980, whereas it had been stable before. Does this trend mean that competition is running out of steam?

Everyone knows what margin is: the price minus the cost. The same applies to the margin rate, i.e. the ratio of price to cost. In 1980, this ratio was 1.18, 18% higher than cost, and by 2014 it had risen to 1.67, 67% higher than cost. Margin is a simple concept but estimating it is a different matter. What cost are we talking about? And how do we know it? Unlike price, costs are not displayed on labels or reported by companies to statistical institutes. And what does this have to do with monopoly power and competition?

The cost that economists are interested in is the marginal cost, which in practice they equate with variable cost, i.e. the cost that varies with the quantity produced. The long trend highlighted in the United States (PDF) is thus one of price growth relative to variable cost. It has been estimated for a sample of more than 100,000 companies, all types of industry combined. It therefore does not only concern Amazon, Google and others, nor the digital sector alone.

To measure market power (also called monopoly power), economists use the Lerner index. It is equal to the margin divided by the price - and of course equal to zero when competition is perfect, since in this theoretical model the price is precisely equal to the marginal cost. And it grows when the market moves away from this situation and approaches that of the monopoly. In short, the higher the margin, the higher the margin rate or the Lerner index (each combining price and cost in different ways), the less competition there is.

It's intuitive, but it's also tricky since it works as if fixed costs didn't exist. The updated trend could thus simply reflect, at unchanged competition intensity, a historical shift in production techniques towards increasing fixed costs (e.g., building construction, software design, R&D investment) and decreasing variable costs (e.g., less raw material, less energy and fewer intermediate products per unit produced).

Moreover, the estimate of the variable cost leading to the increase in market power mentioned above is based on disputable assumptions. In particular, it is assumed that companies perfectly minimize costs and that selling and administrative costs are fixed. If they were included in the estimate, the calculated growth would be much less dramatic.

An effect on inequality

Having said that, we observe that a strong growth in the market power of American companies since the 1980s is consistent with other long trends: increase in profits, growth in concentration, decrease in the share of labor in value added, rise of powerful, superstar companies...

The increase in the market power of firms is itself leading to growing inequality between households. Higher margins penalize consumers and favor shareholders. Low-income households spending all or almost the whole of their budget on consumption are therefore the most affected. In contrast, high-income households hold shares directly or indirectly and then receive dividends.

Globalization and technology can rightly be seen as the cause of the trend towards increasing monopoly power. On the other hand, as Angus Deaton, winner of the Nobel Prize in Economics in 2015, points out, causes on which it is easier to act are undoubtedly also at work. Deaton mentions the mergers and acquisitions too easily authorized or the weak resistance of the elected representatives and the American government against the lobbying and the political power of the companies driving out the rents and the protections. It does not seem that the Trump administration is willing to take on these causes.

François Lévêque
Professor of Economics, Mines ParisTech - PSL