As the post-pandemic economy emerges, concerns are mounting about the threats to sustained economic growth. Despite a brief bounce induced by stimulus packages, productivity growth remains weak, and the wages share of the economy hovers near record lows in many developed nations.
Economists are now pointing fingers at the growing dominance of a handful of mega-firms, especially within the tech sector, as a key factor in stifling economic progress.
The Era of ‘Superstar’ Firms
Jan Eeckhout, a prominent economist from Pompeu Fabra University in Barcelona, has been at the forefront of this investigation. He and his team have scrutinized detailed US data dating back to the 1960s, focusing on mark-ups and profits of American firms. Their findings reveal a significant shift in the market landscape since the early 1980s. Historically, mark-ups were stable at 20-30% above production costs, but they have now surged to approximately 60%.
This increase in market power is not limited to the United States. Eeckhout’s global data set of around 70,000 firms shows a similar trend worldwide. He labels these companies as “superstar” firms, which rake in substantial profits while the majority of firms struggle to match the performance seen in the 1980s.
Culprits of Market Dominance
To explain this shift, Eeckhout identifies three primary factors: weak competition law enforcement, globalisation, and technological advancements. The rise of tech giants has been particularly alarming due to their ability to establish monopolies and oligopolies, facilitated by high start-up costs and low production costs. These conditions create a winner-take-all dynamic in the digital age, where a few firms dominate entire sectors.
Ross Garnaut, an emeritus professor of economics, adds that the internet era has intensified this phenomenon, especially outside the US, where tech giants predominantly operate. This shift has resulted in a notable increase in the share of the economy occupied by sectors where rents play a significant role, contributing to stagnant economic growth and wages.
Impact on Consumers and Competitors
The growing dominance of superstar firms not only drives up prices for consumers but also suppresses wages growth. It leads to reduced innovation, less business dynamism, and diminished job switching, potentially causing a misallocation of skills and declining productivity.
Additionally, the concentration of market power weakens the effectiveness of interest rates in containing inflation. Large firms with high mark-ups are less likely to respond to interest rate changes, placing the burden on smaller, low mark-up firms and exacerbating economic inequalities.
Breaking the Vicious Circle
To address the issue, economists propose improved competition policy and stricter enforcement of existing laws to break the “vicious circle” of market power. The concern is that powerful firms can influence policies and legislation in their favor, further entrenching their dominant positions.
Professor Eeckhout suggests the implementation of a super profits tax on dominant firms, which could potentially improve competition, lower tax burdens elsewhere, and enhance overall economic welfare. This measure could help redistribute wealth and level the playing field.
Shifting the Tax Burden
Professor Garnaut emphasizes the need to shift the burden of business taxation away from competitive firms and towards those that thrive on economic rent. Specific proposals include immediate expensing of all capital expenditure and denial of interest deductions, to incentivize investment and innovation.
Furthermore, denying tax deductions for imported services not directly linked to provision in Australia could counter income shifting by multinational companies, ensuring a fairer distribution of profits and encouraging domestic investment.
A Balancing Act
While the dominance of superstar firms raises concerns about the economy’s future, striking a balance between fostering innovation and ensuring fair competition remains a challenge. Implementing effective policies to address market concentration and its effects will be crucial for sustaining economic growth and prosperity in the years ahead.
As economists continue to explore solutions and policymakers grapple with the complexities, the fate of the global economy hangs in the balance, waiting for a decisive response to the rise of superstar firms.
