Welfare gains from technology substantially reduced by tech-driven rise in market power

A well-crafted economic model can illuminate the essential connections among seemingly disparate trends, linking them in a compelling story. In new research, Minneapolis Fed Monetary Advisor Simon Mongey and co-authors connect three striking developments over the past 40 years: rising market power of U.S. firms, declining business dynamism (the creation and destruction of jobs and firms), and rising business overhead costs (see figure).

The economists apply these three facts about the U.S. economy to identify an essential connection between technology-driven productivity growth and market structure (Minneapolis Fed Staff Report 688, “Quantifying Market Power and Business Dynamism in the Macroeconomy,” with Jan De Loecker and Jan Eeckhout). Their web of interlocking causes and effects is complex. But the key, novel insight is this: While leaps in technology brought massive productivity gains to the U.S. over the past 40 years, these gains were increasingly concentrated in fewer firms, creating a self-reinforcing connection between technology and market power. The net effect of these specific interactions was a drag on societal well-being. The economists estimate social welfare was 5 percent lower by 2023 than it would have been had the 1980 market structure persisted.

To be clear, during this 43-year period, productivity increased broadly, and overall U.S. welfare rose. De Loecker, Eeckhout, and Mongey isolate how much more we might have prospered if not for the tendency of technology-driven productivity gains to concentrate. This dispersion of productivity has two opposing effects, which the economists net out using their structural model. First, as the efficiency gains from technology become focused in the most productive firms, this effect boosts economic output. But these firms’ rising market power more than offsets these welfare gains. One mechanism is evident in the dramatic rise in markups—the difference between production costs and prices charged (see Panel A of the figure). While superstar companies boom, they pass a shrinking share of their productivity gains through to lower prices for households and businesses. Rising markups divert a growing share of economic output to profit, rather than expanding production.

In addition, the dramatic advances in technology deployed by leading firms raise the upfront investment required of potential new competitors. These rising fixed overhead costs (Panel B) further absorb resources that might otherwise be used for production, and they reduce competition. The economists find that rising barriers to entry—together with other factors driving market concentration—are behind the decline in business dynamism seen in U.S. data (Panel C).

The net result of these cross-cutting interactions of technology and market power between 1980 and 2023 was to slow overall economic growth, leaving total U.S. output 6 percent lower than otherwise.

As in other foundational macroeconomic growth models, technology is the fundamental force driving economic expansion here. The economists’ innovation is to model how technology also influences market structure, as technology and non-technological forces simultaneously lead to greater concentration. “The broad macroeconomic implications of the rise in market power … are extensive and quantitatively large,” they write. These implications include other long-term, documented trends for U.S. workers, including the declining labor share of U.S. production, falling labor force participation, and stagnant real wages.

The authors also clarify the troubling, dysfunctional connection in recent U.S. history between technological gains and the steep decline in business dynamism. They highlight recent literature that finds a connection between innovation, competition, and churn—the classic value of Schumpeterian “creative destruction,” where we all gain as firms arise and die by the brutal forces of the marketplace. Their model suggests that the effective number of competitors in the average product market plummeted between 1980 and 2023. Such a loss of dynamism in a relatively short period raises the question of whether innovation will be inhibited as technological barriers to entry grow ever higher.

In a general equilibrium model, the economists combine the analytic power of an industrial organization model with prices, wages, and firm entry decisions that adjust in response to market conditions and changing technology. The approach allows steady-state welfare comparisons, year by year, calibrated with micro-level statistics on American firms over four decades.

“We find that jointly understanding changes in market structure and technology is key for understanding mechanisms and welfare implications,” they write. The novel approach allows them to see a fuller picture for American households, revealing how a technological boomtime for some American companies came at a cost to the economy as a whole.

Read the Minneapolis Fed staff report: “Quantifying Market Power and Business Dynamism in the Macroeconomy”