Today's less-competitive markets would anger Teddy Roosevelt
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In 1776, the father of modern economics, Adam SmithDavid (Adam) Adam SmithOvernight Defense: Pentagon watchdog to probe extremism in US military | FBI chief warns of 'online chatter' ahead of inauguration | House conservative bloc opposes Austin waiver Conservative caucus opposes waiver for Biden's Pentagon pick 'I saw my life flash before my eyes': An oral history of the Capitol attack MORE, famously compared the forces of competition to an invisible hand that regulates free markets and safeguards fair prices and growth.

Indeed, the idea that competitive markets increase efficiency and result in better allocation of resources is central in economics and motivated governments around the world to initiate policy reforms that enhance competition. For most of recent history, the United States has been the leader in supporting competitive markets.


For example, in the second half of the 20th century the U.S. implemented a number of policies aimed at promoting competition, such as tariff reductions, deregulations of several key industries, and effective antitrust enforcement. There is empirical evidence that shows that during the second part of the 20th century, the U.S. economy became more competitive by any measure.


Surprisingly, in the past two decades, our research shows that this trend has undergone a significant reversal. Over 75 percent of U.S. industries have now become less competitive and more concentrated.

Economists and regulatory agencies, such as the Department of Justice and the Federal Trade Commission, use a measure called the Herfindahl index to measure the level of concentration in different markets. Our empirical analysis indicates that this measure has significantly increased for the majority of industries.  

Similarly, the market share of the largest firms has increased in most industries, and U.S. public markets have lost almost 50 percent of their publicly-traded firms.  

Is the current state of U.S. product markets alarming? It depends. If markets are contestable, that is, if there are few barriers to entry, then even firms operating in highly-concentrated industries should behave as if they had many competitors.  

Alternatively, if there are significant barriers to entry (technological barriers, for example), then firms operating in increasingly concentrated industries could generate larger profits by exercising market power, reducing overall competition in the process. Our evidence points to the latter.

We show that firms in industries that became more concentrated have enjoyed significantly higher profitability and profit margins, greater gains from mergers, and significantly higher stock returns. We also find that the increased presence of foreign and private firms have not mitigated either the increased concentration or the higher profit margins. 

Still, an important question remains — what are the underlying forces behind this secular trend? We explore several possible explanations.  First, we find evidence of a significant decline in antitrust enforcement during the administrations of Presidents George W. Bush and Barack ObamaBarack Hussein ObamaBiden faces monumental task healing divided country Garth Brooks to play at Biden swearing-in ceremony Obama honors MLK Day: 'He never gave in to violence, never waved a traitorous flag' MORE.

For example, the use of antitrust rules, allowing government agencies to prevent increases in market power of existing dominant firms, has declined substantially. We also find evidence that completion rates for merger and acquisition transactions in the U.S. have been increasing over time, consistent with the idea that antitrust regulators are now less likely to block proposed mergers.    

Second, we examine whether markets are becoming more concentrated due to greater barriers to entry. Given the critical role of computer-related technology and innovation in the growth in output in the past two decades, firms can create significant barriers to entry by capturing the lion’s share of technological advances through internal research and development and/or acquisition of innovative firms.

For example, think of how difficult it would be to compete against Amazon, with its vast and efficient technological infrastructure. In support of this argument, we show that over the last two decades, firms in industries that became more concentrated possess, not only a larger number of patents, but also the most valuable ones.

In general, this evidence suggests that technological barriers to entry may have prevented new firms from entering profitable markets.    

Taken together, the economic findings paint a potentially gruesome picture. The U.S. product markets are currently dominated by a small number of large and very profitable corporations that continue growing by swallowing smaller incumbents. These firms are able to generate higher profit margins, possibly at the expense of their customers.  

Although it is possible that the trend of more-concentrated product markets improves the quality or variety of products offered, it is unclear whether those changes are sufficient to compensate customers for the higher profit margins that firms enjoy.  

So what should be done about it? As an investor, tilt your portfolio toward firms in industries that have become more concentrated. These firms earn abnormal returns. But more importantly, to enhance competition and protect consumers, regulatory agencies should guard and protect competition more vigilantly.  

In a 1910 speech, President Theodore Roosevelt cautioned that a country founded on the principle of equality of opportunity was in danger of becoming a land of corporate privilege. He pledged to do whatever he could to bring the new giants under control. Since history often repeats itself, current policymakers should re-read Roosevelt's speech.


Gustavo Grullon is a professor of finance at the Jesse H. Jones Graduate School of Business at Rice University. Yelena Larkin is an assistant professor of finance at the Schulich School of Business at York University. Roni Michaely is the Rudd Family professor of finance at SCJohnson College of Business at Cornell University. 

The views expressed by contributors are their own and not the views of The Hill.