The Great Reversal: How America Gave Up on Free Markets

by Thomas Philippon

In the end, the big debates in economics are about growth and inequality: How did they come about, and what should be done about them?

One: Competition has declined in most sectors of the US economy.

Two: The lack of competition is explained largely by policy choices, influenced by lobbying and campaign finance contributions.

Three: The consequences of a lack of competition are lower wages, lower investment, lower productivity, lower growth, and more inequality.

If we apply this idea to workers within a firm, we see that it justifies performance-based compensation. And as long as performance varies across workers, this will lead to inequality. But it does not necessarily justify high degrees of inequality.

In general, if we compare two economies, the one with more competition will have lower prices, higher production, higher employment, and higher investment. Competition therefore increases our standards of living.

Hence, in a competitive economy, payouts (dividends, shares buybacks) are small relative to labor income. Since financial capital (ownership of financial claims, mostly stocks and bonds) tends to be more unequally distributed than human capital (your labor and your education), it follows that a more competitive economy is also likely to be less unequal.

When economists talk about “rent-seeking,” they refer to the attempt by individuals or by groups to tilt public policy in a way that establishes or increases those artificial advantages in their favor.

Overall, however, it is difficult to come up with convincing examples of domestic competition that hurts the poor and the middle class, and it is easy to come up with many examples (low-cost retail and airlines, competition in telecoms, among others) where competition is clearly beneficial.

hurts the rich...

Foreign competition benefits domestic consumers, but it can hurt domestic producers and their employees.

Foreign competition might benefit domestic consumers more than it disrupts local businesses and employees, but there is no natural way to redistribute these gains and losses. Countries have experimented with all kinds of trade adjustment programs, but most have been rather ineffective.

We know that exposure to trade creates winners and losers. Lyon and Waugh study how society can mitigate the losses while preserving the gains from trade. They find that a progressive tax system is very helpful and that the optimal level of progressivity increases with the exposure to trade.

Competition destroys rents and is therefore the enemy of rent seekers.

concentrated special interests are likely to organize and fight to protect their rents, while diffuse majority interests are trumped.

International trade also creates diffuse winners and concentrated losers.

I would argue that the case for free competition within a country is as strong as any case one can make in economics. Unfortunately, the virtue of competition—that its positive effects are widespread—is also its downfall: the winners are dispersed, and the losers are concentrated. This is why we see a lot of lobbying aimed at restricting competition and little advocacy to protect it.

We have seen some of the standard tools that economists use to study competition: market shares, concentration, profits, and prices. We have seen that none of them is perfect. Concentration raises legitimate concerns of market dominance, but it can also reflect the increasing efficiency of market leaders. Efficient firms are profitable, but sustained abnormal profits are a bad sign. Low prices are almost always a good sign, unless they involve predatory pricing.