Superstar Firms Causing Concentration of Market Power
By: Ellen Clardy
Tags: Politics, Business, Economics, Innovation, Technology

For much of the 20th century, economists marveled at the stability of labor’s share of national income.

Labor’s share of national income is the total dollar amount paid out in wages, salaries, and benefits as a percentage of GDP, the market value of an economy’s production in a year.

Even while there has been much turmoil and shifts at the industry level, the bird’s eye view of the economy showed labor held its ground.

Starting in the 1980s and apparently accelerating in the 2000s, we are seeing labor’s share of income decline. Further, it is not just a US phenomenon.

Autor, et al. (2017) are exploring this issue and land on the idea of the “superstar firm” as the cause.

They hypothesize (p. 180)

…that industries are increasingly characterized by a ‘winner-take-most’ feature where one firm (or a small number of firms) can gain a very large share of the market.

What does that have to do with labor share?

If an industry is dominated by a large superstar firm, and if such large firms have lower ratios of labor to income,

then the average share of income going to labor for the industry can drop.

Therefore, if this holds across many industries, we would see the labor share of income drop.

What about those “if’s”?

For the first “if”, the authors compute some concentration ratios for various industry sectors in the country from 1982–2012 and find all sectors have had increasing concentration over that time period. (p. 183)

For the second “if,” the authors note that as a firm grows larger in scale, some labor will increase as output increases, like more factory workers, sales associates, or warehouse workers. This is called variable labor input.

But labor associated with overhead does not necessarily grow as output grows. Bigger firms do have more people working in managerial and accounting roles than small firms, but at a certain scale, they can continue to scale up output without expanding overhead positions at the same rate as a variable labor input.

In addition, these superstar firms tend to be more profitable as they scale up. Put this all together and revenue income is growing faster than the amount spent on labor for our superstar firms.

Or put another way, total income for labor is a shrinking percentage of total revenue for these superstar firms.

Thus, a measure like labor’s share of income tends to be lower for large firms than small firms.

Again, the authors turn to the data and find that employment concentration has grown slower than sales concentration, supporting the idea that there is less labor generating more income. (p. 183)

If more industries are moving in the direction of one or a few superstar firms dominating the market share with many small firms sharing what is left over, then you can explain what the data shows: (p. 180)

Labor share has not declined for the average firm

Labor share has declined in most US industries.

That sounds like a contradiction!

The authors explain that if you compute the average labor share across firms since 1982, and do not weight the average to account for the size of firms, the average has not declined.

That is, the average firm is not using less labor, just the superstar firms of the industry. The smaller firms have not shown a declining labor share of income.

However, the labor share has declined in most US industries because the decline in the labor share of the big firm(s) outweighs the small firms that are not changing when calculating labor’s share of income at the industry level, and thus in the economy level.

I have written about another article exploring some observed macro data for the US that income inequality and the risk of the financial crisis have been rising since the 1980s and trace the primary cause to increasing market concentration.

That article does not attempt to find out why markets have shown increasing concentration, instead of focusing on the consequences of the trend and exploring how to address rising inequality. But in Autor et al. (2017), we are given a theory of why this trend is occurring — the superstar firm.

The Rise of the Superfirms

Why is there a growth in winner-take-most? (p. 180)

The Internet has made price comparisons easier

A shift towards “information-intensive goods” like software and online services means they have high fixed costs in their development but the marginal cost of “producing” the next unit is low or zero.

Network effects — for some products, users prefer to use what everyone else is using. For example, other videos hosting sites have trouble gaining users because all the viewers are on YouTube, keeping contributors posting there.

The idea then is technology has changed our economy so that more industries are winners-take-most and thus our measure of market share is rising.

In the past, more concentrated industries could be combated with antitrust policies, but that may not be appropriate given this seems more driven by changes in technology rather than anti-competitive moves by firms.

This increased market concentration though is accompanied by a falling labor share since the authors have demonstrated why these larger firms have a lower labor share even as the remaining smaller firms in the industries have unchanging labor share.

If the authors are correct about their superstar hypothesis, we should observe sales becoming more concentrated to a small number of firms in many industries.

Consistent with the model, we find that the concentration of sales (and of employment) has indeed risen from 1982 to 2012 in each of the six major sectors covered by the US economic census. (p. 185)

They also refer to earlier work where they found that industries that have the most increase in the concentration of market power also have the largest decreases in labor share.

Further, this drop in labor share is found to be caused by a shift of labor towards these superstar firms that have declining labor share, not by a drop in labor share in other firms in the industries.

Thus, across many industries, we have one or a few growing firms that are more productive with less labor which is enough to make the aggregate labor share of income decline even while it is not changing in the smaller firms in the industries.

Conclusion

Technological changes seem to be behind this increased concentration of firms, so I am struggling with a good conclusion. In the earlier article about market power I referenced above that discussed the increased income inequality and risk of the financial crisis, I concluded:

it seems if we could figure out how to stop the increase in firms’ market power, we would have a better, systematic response to the negative trends.

But now with this article, it seems we have a theory for the increase in firms’ market power which does not sound like something to correct or stop. It seems more like a natural evolution of our economy, thus leaving us searching for other solutions for the trends towards increasing inequality.

I think this is why many are turning to a universal basic income policy for a solution although implementation may prove difficult and further study is needed.

References:

Autor, D., D. Dorn, L. Katz, C. Patterson and J. Van Reenen. (2017). “Concentrating on the Fall of the Labor Share.” AER: Papers and Proceedings, 107(5): 180–185.