Superstar Firms Are in Spotlight at Jackson Hole

(Bloomberg) -- As economic policy luminaries gather in Wyoming for the Federal Reserve Bank of Kansas City’s annual symposium this week, their minds will be on superstars.

This year’s meeting is focused on shifting market structure and how tech giants like Amazon.com Inc. -- productive behemoths that have small wage bills relative to their sales -- are coming to define American and global industry.

To get you ready for the shindig, which kicks off at 8 p.m. Thursday, this week’s research roundup summarizes some of the top work on market concentration, changing firm dynamics, profit margins and the fall in labor share in our Amazonian economic future.

Check this column each Tuesday for new economic research from around the world.

Pumped-up Profits

Profit Margins: Rising Wages Vs. Superstar Firms
Published Aug. 18
Available to Goldman Sachs subscribers

Profit margins at S&P 500 companies are at an all-time high at 11.2 percent, but Goldman Sachs Group Inc. analysts find that total corporate profits have been softer recently as a share of gross national product, as reported in the national income and product accounts (NIPA). That’s heralded a downturn in S&P 500 margins in the past, but this time may be different.

Softening national accounts margins may have offered a good signal in cycles past because the data more heavily weighed small companies, and smaller employers are especially sensitive to interest rate changes and wage growth.

But the fact that highly productive “superstar firms” with bargaining power over workers and consumers make up a bigger share of the S&P 500 these days means NIPA profits may be a more muted predictor. First, as they make up a bigger share of the S&P basket, there’ll be a boost through simple composition. Second, their high sales-to-compensation ratio and wage-setting power could limit how much the tight labor market drags on margins.

In the end, the economists expect profits to climb a little higher before trending sideways starting next year. “Further significant gains likely require both continued moderate wage growth along with rapid productivity growth, for instance driven by the continued outperformance of superstar firms,” Daan Struyven writes for his team.

Birth of a Superstar

The Fall of the Labor Share and the Rise of Superstar Firms
Published May 2017
Available on MIT website

The Goldman note builds on the work of many economists, including MIT’s David Autor, who wrote in a 2017 paper that globalization and new technology were driving the emergence of superstar firms. “Industries are increasingly characterized by a ‘winner-take-most’ feature where a small number of firms gain a very large share of the market,” he wrote.

The paper also pins the well documented decline in the proportion of income going to workers on superstar firms. Labor share, Autor argues, is not falling at the average company. Rather, those companies with higher profit levels and lower fixed labor costs -- and thus lower labor share -- are capturing more and more of total output. In other words, it’s a case of reallocation and not general decline. But it’s expected to get worse.

“As the importance of superstar firms increases, the aggregate labor share will tend to fall,” he wrote.

Profits Up, Competition Down

The Rise of Market Power and the Macroeconomic Implications
Published August 2017
Available at author’s website

One thing that’s not suffering in the U.S. is profitability. Jan De Loeker of Princeton University and Jan Eeckhout at Pompeu Fabra University in Barcelona show why that’s not necessarily a good thing, as it reflects a rise in “market power.”

From 1950 to 1980, average markups in the U.S. remained steady at an estimated 18 percent above cost. Since then, they’ve risen to about 67 percent, suggesting firms have much more power. That, they say, helps explain some huge secular trends in recent decades, including declining labor share, falling real wages for low-skilled labor and lower labor participation rates.

The change also augers poorly for investment and productivity, as successful companies insulated from true competition will feel less compelled to invest in the innovation that would otherwise be required to stay on top.

“With a long enough horizon, also capital investment adjusts to reflect the same first order condition as labor, and hence there will be a reduction in capital investment as markups increase,” the authors wrote.

The Amazon Paradox

Amazon’s Antitrust Paradox
Published January 2017
Available at the Yale Law Journal

It’s not only common sense that assumes that outsized market power goes hand in hand with high prices. U.S. antitrust enforcement law has narrowed over the years to focus on cases where companies exploit their position to harm consumers.

But what if a company forsook higher profits to build ever more market share, crushing would-be competitors along the way? And what if it used market power in one sector to grab share in others? Say hello to Amazon, argues Lina Khan of the Open Market Institute in Washington.
The online retailing behemoth has a dizzying record of revenue growth, but a spotty history of making a profit. We shouldn’t be seduced by the latter to assume Amazon isn’t causing harm, Khan argues in a paper published in the Yale Law Review.

Khan painstakingly (there are 464 footnotes and citations) built a case that Amazon employs practices that should provoke a rethink of antitrust enforcement in the U.S. “Current law under-appreciates the risk of predatory pricing and how integration across distinct business lines may prove anticompetitive,” she wrote.

To help drive home her point, Khan points to Amazon’s market valuation, which is linked more closely to its revenue growth than profit. In other words, investors are convinced that, given time, Amazon will exploit its market share with higher prices and higher profits.

Superstar Firms Are in Spotlight at Jackson Hole

It also may be worth reading a relatively recent paper on productivity growth and income inequality by Jason Furman and Peter Orszag.

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