Fact of the Week: Rising Market Power Since the 1970s Has Not Resulted in Greater Profit Shares

Source: Thomas Hasenzagl and Luis Pérez, “The Micro-Aggregated Profit Share,” Working Papers, arXiv.org, no. 2309.12945 (October 2023).

Commentary: In a new working paper, Thomas Hasenzagl and Luis Pérez of the University of Minnesota analyzed the effect of increasing market power on firm profits. The authors used firm-level balance sheet data from Compustat and two-digit NAICS industry-level data from the Bureau of Economic Analysis on sales, value added, and GDP. The data covered the period of 1970–2020. The study looked at trends in aggregate markups, along with the trends in monopoly rents, fixed costs, and profit shares as a percent of GDP over that same period. The authors calculated aggregate measures for markups to reconcile the firm-level data with the industry-level data. The aggregation method involved calculating a sales-weighted average of individual firm markups. Their findings have important implications for how to approach antitrust policy.

The study focused mainly on changes in aggregate markups and for aggregate profit shares over the period of 1970–2020. The authors found the aggregate markup, defined by price over marginal cost, went from 10 percent to 23 percent over the period studied. Perhaps the most significant finding, in terms of its implications for antitrust policies, were the findings on profit shares. Over the period studied, monopoly rents increased from 18 percent to 41 percent of GDP. However, profit share remained constant at about 18 percent of GDP. This was due to a rise in fixed costs over the period studied. The authors note that these fixed costs consist of expenditures on R&D, advertising and marketing, information and communication technologies, and costs associated with regulatory compliance. As such, firms would have used the increase in monopoly rents to offset their rising fixed costs. This, in turn, means that profits do not increase.

The authors argue against using market power or market share as the basis for antitrust enforcement. As their empirical analysis suggests, firms with high fixed costs use their monopoly rents to offset those costs. Stricter antitrust enforcement, by curtailing the market power of dominant firms, would very likely have the effect of reducing those monopoly rents. However, fewer firms would be able to cover their fixed costs, thus going out of business and exiting the market. This, in turn, would lead to a further rise in market concentration and further reduction in business dynamism due to fewer remaining firms. Thus, a more aggressive antitrust enforcement would likely have the opposite of its intended effect.