Chris Edmond - OECD Global Forum on Productivity June 2019

1. Changing Patterns of
Market Power and Contestability
Discussion
Chris Edmond
University of Melbourne
OECD Global Forum on Productivity
June 2019

2. Market Power and Contestability
• Chiara has given us a very interesting interpretation of some key
facts on productivity dynamics, markups, and concentration
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3. Market Power and Contestability
• Chiara has given us a very interesting interpretation of some key
facts on productivity dynamics, markups, and concentration
• John makes the following important conceptual points
– market power implies markups
but, in the absence of further assumptions,
– markup data (or concentration) does not imply market power
And this provides a challenging environment for competition policy
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4. Market Power and Contestability
• Chiara has given us a very interesting interpretation of some key
facts on productivity dynamics, markups, and concentration
• John makes the following important conceptual points
– market power implies markups
but, in the absence of further assumptions,
– markup data (or concentration) does not imply market power
And this provides a challenging environment for competition policy
• I agree, and will use a structural macro model to help explain why
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5. Structural Model
• Based on my paper “How Costly Are Markups?” with Virgiliu
Midrigan and Daniel Yi Xu
• Dynamic general equilibrium model with heterogeneous firms and
endogenously variable markups
– larger firms face less elastic demand, set higher markups
– new firms choose initial investments to maximize expected
discounted profits, which depend on markups
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6. Structural Model
• Based on my paper “How Costly Are Markups?” with Virgiliu
Midrigan and Daniel Yi Xu
• Dynamic general equilibrium model with heterogeneous firms and
endogenously variable markups
– larger firms face less elastic demand, set higher markups
– new firms choose initial investments to maximize expected
discounted profits, which depend on markups
• Calibrated to replicate recent patterns of sales and employment
concentration observed in US industry
– substantial welfare costs of markups
(e.g., 6% or 7% in consumption-equivalent terms)
– second-best policies to reduce concentration can backfire
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7. “Fixed Point Problem”
• Firm size determines markups
size ⇒ demand elasticity ⇒ markups
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8. “Fixed Point Problem”
• Firm size determines markups
size ⇒ demand elasticity ⇒ markups
• Markups determine firm size
markups ⇒ sunk investments ⇒ size
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9. “Fixed Point Problem”
• Firm size determines markups
size ⇒ demand elasticity ⇒ markups
• Markups determine firm size
markups ⇒ sunk investments ⇒ size
• Concentration, market power etc simultaneously determined
• Determined by underlying technologies, regulatory policies, etc
• Evaluating policies targeting concentration, market power etc
requires taking a stand on this underlying structure
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10. Three Distortions
• Market power distortions operate through three channels
(1) reduction in employment, investment, output
(aggregate markup channel )
(2) reduction in aggregate productivity
(misallocation channel )
(3) reduction in number of firms
(entry channel )
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11. Three Distortions
• Market power distortions operate through three channels
(1) reduction in employment, investment, output
(aggregate markup channel )
(2) reduction in aggregate productivity
(misallocation channel )
(3) reduction in number of firms
(entry channel )
• Bulk of the costs of markups due to the aggregate markup channel
• Smaller role for misallocation. Negligible role for entry.
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12. Welfare Costs of Markups
Total Costs Aggregate Misallocation
percentage deviation from benchmark with no distortions
welfare costs, CEV, % 6.6 4.9 1.3
output 37.0 33.0 3.2
consumption 28.8 28.7 1.2
employment 16.5 15.6 −0.3
number of firms 13.1 6.3 −2.9
physical capital 51.0 47.0 3.2
aggregate efficiency 2.9 1.0 0.3
Large costs of markups. Mostly due to aggregate markup channel.
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13. How Much Concentration Should There Be?
Efficient allocation has more concentration. Large firms expand
log e
-1 0 1 2 3
logl
-10
-5
0
5
10
Employment
equilibrium
planner
Rising concentration may reflect increased allocative efficiency.
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14. Tax on Concentration
Benchmark Tax on Concentration
top 1% sales share 0.30 0.18
aggregate markup 1.15 1.13
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15. Tax on Concentration
Benchmark Tax on Concentration
top 1% sales share 0.30 0.18
aggregate markup 1.15 1.13
misallocation loss, % 0.8 7.3
percentage change from benchmark
number of firms 20.5
aggregate efficiency −4.0
output −5.3
consumption −8.3
employment 4.7
Reduces aggregate markup. But large increase in misallocation.
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16. Negligible Gains from Entry
• Aggregate markup M weighted average of firm markups µi
M =
i
µi ωi
(theoretically correct weights are cost weights)
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17. Negligible Gains from Entry
• Aggregate markup M weighted average of firm markups µi
M =
i
µi ωi
(theoretically correct weights are cost weights)
• Entry has offsetting direct and compositional effects
– direct effect, individual firm markups µi fall
– compositional effect, weight ωi on large firms increases
• Small firms shrink a lot, large firms shrink much less.
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18. Negligible Gains from Entry
Individual markups all fall. But weight on large firms increases.
Tripling number of firms reduces M from 1.150 to 1.149
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19. Sectors with Fewer Firms Have Higher Markups
Simulated relationship between markups and number firms per sector
But this reduced-form correlation is not a good guide to policy.
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20. When is Entry More Effective?
• These results depend on amount of productivity dispersion
• Productivity dispersion chosen to deliver observed concentration
• In this calibration, new firms typically not as productive as large
incumbents, mostly a threat to small incumbents
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21. When is Entry More Effective?
• These results depend on amount of productivity dispersion
• Productivity dispersion chosen to deliver observed concentration
• In this calibration, new firms typically not as productive as large
incumbents, mostly a threat to small incumbents
• But suppose instead entry from large foreign competitors,
comparably productive to large domestic incumbents
Then entry can be much more effective
Key is putting large incumbents under head-to-head competition.
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22. What Explains Rise in Markups?
• Some popular explanations
– technology, e.g., higher returns to scale
(given productivity dispersion leads to more markup dispersion)
– regulation, e.g., less effective antitrust/competition policy, or greater
barriers to entry
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23. What Explains Rise in Markups?
• Some popular explanations
– technology, e.g., higher returns to scale
(given productivity dispersion leads to more markup dispersion)
– regulation, e.g., less effective antitrust/competition policy, or greater
barriers to entry
• But as we have just seen, there are important empirical challenges
to the barriers to entry explanation
– hard to generate the magnitude of the increase in markups
– should see decreasing concentration as increased barriers to entry
disproportionately shield small incumbents
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24. Summary
• So welfare costs of markups may well be substantial
• But not easy to identify simple corrective policies
– if firms differ substantially in productivity, even large changes in the
number of firms may have only small effects on average markup
– size-dependent policies can backfire, reducing average markup but
also reducing aggregate productivity by increasing misallocation
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25. Summary
• So welfare costs of markups may well be substantial
• But not easy to identify simple corrective policies
– if firms differ substantially in productivity, even large changes in the
number of firms may have only small effects on average markup
– size-dependent policies can backfire, reducing average markup but
also reducing aggregate productivity by increasing misallocation
• Observed changes in concentration reflect a complex mix of
underlying technological and regulatory factors
• Policy evaluation requires models that take a stand on the
underlying details that determine markups, market structure
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