It's true, the Amazon's and Google's are ruining the benefits of capitalism
As Amazon continues to grow at a seemingly unstoppable pace, the company appears poised to take over the world any day now.
Just kidding. Kinda. Although Amazon may not be angling for actual world domination, concerns about the increasing corporate influence of big-shot companies continue to mount. Ahead of the 2020 presidential race, politicians have called for stricter regulations on large corporations. Elizabeth Warren and Bernie Sanders, two of the democratic nominees, have repeatedly criticized Amazon, claiming the company is underpaying workers and failing to pay their fair share of taxes.
The International Monetary Fund (IMF), founded in 1945 to ensure that global capitalism wouldn’t screw itself over, has heard these concerns and responded with a comprehensive analysis of the situation. When the organization, which basically acts as the main advisor to free market economies around the world, warns that the rising power of mega-corporations like Amazon and Google could spell trouble for the global economy, you know shit has hit the fan.
At the IMF’s Spring Meetings in Washington D.C., Wenjie Chen, an economist in the research department, presented the findings of a study aimed at determining the effect of burgeoning corporate power on the global economy. The study, found in chapter two of the April World Economic Outlook, looked at data for almost one million companies from 27 advanced and emerging market economies since the early 2000s. The authors found that rising corporate market power has had a fairly limited negative economic impact so far, but if left unchecked, could adversely impact the economy and contribute to income inequality in the future.
How Do We Measure Market Power?
One of the primary ways is by looking at price markup. This is measured by comparing how much a company charges for an item with the cost of producing that item; this number is expressed as a ratio. The idea being that, as a company becomes more successful, it can increase prices while the amount it costs to make their products remains unchanged, allowing them to make bank.
The study revealed that firms’ average markup has increased by almost eight percent in advanced economies since 2000, and by less than two percent in emerging economies included in the data. Those companies with a rise in price markup have also increased in terms of their market share, i.e. how much influence and power they have in the stock market.
Gian Luca Clementi, PhD, an associate professor of economics at NYU’s Stern School of Business, pointed out that the IMF’s study is not novel. Actually, it is an expansion of a study published in November 2018. This earlier study, conducted by professors at Belgium’s KU Leuven, Barcelona’s Pompeu Fabre and Harvard, focused solely on the United States and looked at economic data starting in 1955. Clementi says the IMF’s work confirms the findings of this study, which shows that price markup in the US has been trending upwards since the 1980s, and reveals that this phenomenon is, in fact, taking place on a global scale.
Rooster spoke with Professor Clementi about these studies, their implications and how worried we should actually be.
Why Do Some Companies Have More Market Power Than Others?
This is dependent on two factors. The first has to do with how technology evolves. When a company comes up with a breakthrough innovation and develops a product that is better than anything available, they can completely grab the market (think of Apple’s iPhone). This is called the “winner-takes-most,” or, “winner-takes-all” dynamic. The two terms are often used interchangeably; the study uses the former, while Clementi uses the latter. Their technology is difficult to imitate, allowing the company to enjoy a great deal of market power for a prolonged period of time. “In reality,” says Clementi, “this inability to imitate, in most circumstances, is short lived.” Soon enough, other companies figure out how to replicate the product, maybe even more efficiently (here, think of the Samsung Android).
This is where the second factor comes into play: policy roadblocks. Even if a company is able to replicate a piece of technology, they may not be able to actually use it. In the US, the patent system is strictly enforced, and oftentimes, prevents competitors from imitating a product and effectively competing with the initial innovator. Work patents are, of course, essential in ensuring that there are enough incentives in place for companies to engage in very expensive research and development. If a company manages to successfully execute their idea, patenting their technology guarantees that they will enjoy a degree of monopoly power in a certain industry, allowing them to make up enough profits to offset the costs they incurred during the research and development process.
The trade-off, Clementi argues, is that while innovators are rewarded, consumers are negatively impacted. If a firm has no competitors offering a version of their product for a cheaper price, that firm can continue to markup prices, forcing consumers to pay hefty fees for access to their product.
Eager investors, limited regulations and a low capital gains tax rate make the US somewhat of a haven for startup companies. But, patent policies often prevent entrepreneurs from making the leap from startup to successful company. For example, an innovator may have figured out how to replicate a particular product, but a small aspect of the technology required to make this product is already patented. The innovator must pay a licensing fee to use that patent.
What’s more, there are several well-established companies who maintain patent portfolios filled with several thousands of patents on detailed aspects of various products. Oftentimes however, these firms don’t actually use the aspect of the product that is patented. They patent certain innovations to avoid potential competitors, explains Clementi. “Their business is that they own patents and use these patents to sue other companies,” he says. This is called patent-trolling. “The attitude of US courts has been, and this is not only my point of view, to award very comprehensive protection to these patents, even in circumstances where it's clear that it is used for trolling purposes only.”
Clementi argues that this system should be reformed, allowing for more market competition and product diversity. “Congress can become proactive in promoting legislation that pushes the enforcement of patent laws in a different direction,” he notes. “[It] can introduce guidelines for the courts to abide by when ruling on patent infringement cases with the idea that, when patents are used for the sole purpose of trolling, they become a barrier to entry.”
Another issue is the lack of nuance in patent law. “In particular, the length of the patents are very rigid,” says Clementi. “They are pretty much the same for all products.” This one-size fits all approach also impacts entry fees. Some industries, such as pharmaceuticals, have incredibly large initial costs, while others face more limited financial barriers to entry, he notes.
How Does This Affect the Average Person?
The study revealed that this increase in market power has accounted for, at least, 10 percent of the overall decline in the share of national income paid to workers in advanced economies. This means that though the US economy has grown a lot since the early 2000s, the portion of total income that is going to workers, and particularly to low-skilled workers, has declined. To be clear, these employees aren’t making less than they used to. Rather, they are making the same amount. “Wages for low-skilled workers have been fairly constant over the last three decades,” notes Clementi.
If companies are making more money, why aren’t they paying workers more? Part of the reason is that as startup-culture has grown, more businesses are born from the disruptive ideas of a few select innovators. Now, a larger fraction of profits are going to those entrepreneurs and to the shareholders who own bits of the company.
The other explanation has to do with supply-and-demand. As technology advances, the demand for highly-skilled workers, like engineers and computer programmers, has gone up. The number of new graduates entering the technical field, though, is lagging behind. Meanwhile, demand for rank-and-file employees has gone down; at the same time, the supply of workers who want these jobs is at a surplus. Thus, there is no logical reason for corporations to pay higher wages. “This is a major problem, not only in the US economy, but pretty much in all advanced economies in the world,” Celementi adds.
On top of that, many of these jobs are being outsourced to countries where the US dollar is stronger and employees will work more for less. Apple, for example, partners with Foxconn, a Taiwanese electronics company, to manufacture its products in Shenzhen, China at a discounted cost. Social-justice warriors have long pushed for higher wages and better working conditions in factories where these, and other, products are made. But, there could be unwanted consequences if governments imposed stricter labor regulations on these firms. In the case of Foxconn, Apple could simply opt to move their operations to Vietnam, or another country without such standards, leaving over one million workers unemployed. If that isn’t enough to bum you out, the negative trend in wages is especially pronounced in occupations that are easy to routinize and substitute with machines, says Clementi. In China, Apple competitors have streamlined their operations by integrating robots into the manufacturing process.
Despite the fact that wages and benefits haven’t improved for Apple workers in China, the company is actually one of the few mega-corporations to increase wages for its blue collar employees in the US. Clementi thinks this policy may have more to do with the nation’s current social climate than Apple’s desire to be altruistic. “I think the company is afraid of people boycotting the products unless they show that they are good citizens, and giving higher salaries is part of being a good citizen.” But, this doesn’t mean we should expect the wages of low-skilled workers to increase anywhere close to the pace that wages for high-skilled employees are increasing. Once again, this is because of supply-and-demand.
More Examples Please
Once upon a time, this ride-share app was a unicorn among a sea of old-school taxi cabs. Now, Uber is kept on its toes by a number of competitors such as Lyft and Via. This competition has helped to keep prices down and has forced Uber to continue to innovate and develop new techniques to entice riders and drivers. In addition to rolling out new features, the company is investing a great deal of resources to weed out competition. One of their strategies is to aggressively try to gain exclusive access to their drivers, discouraging them from driving for any other providers, explains Clementi. The problem, he says, is that if Uber succeeds in eliminating these threats and captures the market, it will become almost impossible for new competitors to emerge. In turn, Uber will be free to charge users much higher prices.
Unlike Uber, Amazon isn’t struggling to fight off competitors. The global marketplace is an industry-leader that has arguably improved the shopping experience by minimizing consumer costs. It has simplified the search process by consolidating products into one place and allowing shoppers to customize their experience by selecting products based on characteristics such as cost and rating. It has also kept prices relatively low. “I think something everybody agrees upon is that the advent of Amazon has brought down prices,” says Clementi. “But, people are concerned that may not last into the future. By becoming so large, it implies that it becomes particularly costly for potential firms to challenge them.”
Something potentially even more concerning than price increases is Amazon’s huge cache of information. Not only is Amazon a global marketplace, but it is also a seller on that marketplace. “In a sense, that is big time cheating because they are able to gather all the possible data about consumers-- what they look for, what they want-- and also gather prices about every other company that sells on Amazon,” explains Clementi. This gives it a huge informational advantage over other sellers because Amazon can use this data to target certain products in particular markets, creating a major barrier to entry for competitors. It makes sense that this advantage accounts for a sizeable chunk of Amazon’s market valuation (how much investors think a company is worth). Several candidates for the democratic nomination have said they want to regulate the company precisely because of this significant leverage. Clementi says he won’t be surprised if, in the future, the US and European governments try to break up Amazon in a similar fashion to AT&T in the 1980s, separating the seller from the marketplace
How Fucked Are We?
“Economists have been, perhaps more than any other category of intellectuals, very concerned historically about the impact that market power may have not only on the distribution of income, but also potentially on economic growth,” Clementi notes. The main concern is that without a check on their power, these companies could charge higher and higher prices. From a macroeconomic standpoint, rising prices mean a lower level of business for the economy and thus, decreased demand for workers. It also means that investment and therefore, economic growth, could stall.
Monopolies are, by nature, bad for technological growth because without competitors, they may become complacent and invest less in improving their products. “Determining how ‘in trouble’ we are depends on the assessment of how large the barriers to entry are,” says Clementi. For instance, human transportation, the industry that Uber falls into, has relatively low barriers to entry. On the other hand, it would be almost impossible for a new startup to compete with Facebook and Instagram to establish a solid presence in the social media space right now.
How soon could we see these negative effects? “It's hard to tell because, in a sense, these industries are very novel,” says Clementi. “Yet, you can essentially make a call based on the market valuation of these companies.” Based on those valuations, investors think these companies will see profits relatively soon. Definitely in the next decade or so. Of course, these investors could all be wrong, he points out.
So, things sound pretty bad. Before you freak out, though, Clementi assures readers that our current situation isn’t anywhere near Armageddon-level. These studies validate a very real concern about the growing market power of large corporations, but do not mean that we should expect to see incredible changes to the way we live. These findings point to the need for more research and could possibly help build the case for more regulations that may limit this phenomenon. Amazon, in particular, is under severe scrutiny, with many economists studying the company’s marketplace impact.
There is a case for meaningful, but limited impact to the economy relatively soon, Clementi concludes. The first step is to gather further information. “Once we study more, we can actually come up with reasonable guidelines, if needed, for a policy intervention that, in part, reduces the adverse impact of this increased market power.”