It has been long understood by economists that market power can negatively affect welfare by limiting output, stifling innovation, and introducing inefficiencies in the overall allocation of production. On the one hand, there is ample evidence from case-studies, that the presence of market power, in the form of explicit or implicit cartels and other practices of anti-competitive behavior, can lead to substantial damages to producers and consumers in a given market. On the other hand, very little is known about the broad cross- sectional and time-series patterns of market power across sectors, regions and countries. In addition, and perhaps more importantly, if market power is at all present, does it affect so-called aggregate outcomes in the product and factor markets? For example should the analysis of productivity growth and investment take into account the presence of market power, and does market power play a role in labor market outcomes, such as e.g. in the recently reported decline in the labor share across a variety of countries? This project aims to fill the gap in the literature by applying recently developed techniques to, first of all, systematically document markups, across firms in the entire economy, and secondly, to analyze the implications for producers and consumers in the economy at large, including both product and input markets. While the macroeconomic literature on misallocation has considered a variety of distortions that affect the allocation of inputs across plants, the project introduces an empirical framework to quantify the welfare loss from market power. Special attention is given to the impact on productive inefficiency. The overall aim is to better understand, and quantify, how market power affects the allocation of resources in the context of heterogeneous producers, and empirically quantify the trade-off of price and cost effects.
The project finds that the rise of aggregate markups is due to reallocation of market shares, and most notably due to the rise of the inverse expenditure share on what are arguably variable inputs. We then analyze the macroeconomic causes and consequences of this process, and use a model to evaluate the potential underlying mechanisms. Key in the transmission mechanism is the underlying heterogeneity in the distribution of parameters. This passes through to heterogeneity in the distribution of outcomes such as output, the labor share, profits and welfare. We illustrate that focussing on aggregate measures of market power is misleading as the same aggregate markups are associated with different output and welfare, depending on how the markups and underlying parameters are distributed. We conclude with a discussion of the role of policy, in particular, how competition policy can be a tool not only for restoring economic efficiency, but also for redistribution.
