Understanding the aggregate implications of market power
From limiting output to stifling innovation and creating inefficiencies, market power can have a negative impact on social welfare. “Market power is a corporate giant’s ability to control the market price of goods or services – it’s essentially how a company maintains prices above marginal costs by either increasing or constraining supply or demand,” explains Jan De Loecker(opens in new window), a researcher at KU Leuven(opens in new window). Economists know that market power can have both microeconomic and macroeconomic implications. For example, there is ample evidence showing how cartels and other anti-competitive behaviour can cause substantial damages to producers and consumers within a given market. What economists don’t fully understand is how market power impacts broad cross-sectional and time-series patterns across sectors, regions and countries. “If market power is present, how does it affect so-called aggregate outcomes in the product and factor markets?” asks De Loecker. Working to answer such questions is the EU-funded M-POWER(opens in new window) project. “Using recently developed techniques, this project set out to systematically document markups across firms and to analyse the implications these markups have on producers and consumers in the economy at large,” adds De Loecker, who serves as the project’s principal investigator.
Market power, social welfare and the allocation of resources
While the macroeconomic literature on misallocation has considered a variety of distortions that affect the allocation of inputs across firms, the M-POWER project is unique in that it introduces an empirical framework to quantify the loss in social welfare that market power causes. The European Research Council(opens in new window) supported project also paid special attention to market power’s impact on productive inefficiency. “Our overall aim is to better understand and quantify how market power affects the allocation of resources within the context of heterogeneous producers while also empirically quantifying the trade-off of price and cost effects,” notes De Loecker.
The impact of market power in the global crude oil market
To facilitate its research, the project compiled a comprehensive database covering both global and American listed companies. They also prepared the variables used in the analysis of markup estimation and developed an innovative methodology for quantifying the total welfare impact of market power in the global crude oil market. “The global market for crude oil is notoriously affected by the OPEC cartel, impacting prices, quantities and mostly profits,” remarks De Loecker. Using data on all oil fields that deliver oil to the market, researchers were able to measure the damages from market power that result in well-known distortions from cartels via higher prices. They were also able to see how the misallocation of resources enabled inefficient producers, such as shale-oil producers, to come online.
The far-reaching effects of monopoly power
With these tools in hand, researchers came to some interesting conclusions. “We demonstrated that monopoly power not only distorts individual markets, but can effect economies at large, affecting prices in product markets, outcomes in labour markets, and ultimately in the distribution of income,” concludes De Loecker. “Our work also underscores how relying on aggregate data alone to analyse secular trends in industries and economies is not sufficient to detect the impact of market power.” Many of the project’s results have been published in various scientific articles(opens in new window).
