When the economist, Thomas Phillipon, moved to America in 1999, he found a country where high quality products were available at “dazzlingly cheap” prices. “But over the past two decades, Mr Philippon writes in “The Great Reversal”, this paradise has been lost. Europeans now enjoy cheap cross-continent flights, high-street banking, and phone and internet services; Americans are often at the mercy of indifferent corporate giants.”
Why have American consumers ended up getting a raw deal over the past decade? “Much that has happened to the American economy since the 1990s has not been to the typical worker’s advantage. Growth in output, wages and productivity has slowed. Inequality has risen, as have the market share and profitability of the most dominant firms. Economics journals are packed with papers on these trends, many of which argue that the dominance of big firms bears some blame for other ills. Between 1987 and 2016 the share of employment accounted for by firms with over 5,000 employees rose from 28% to 34%. Between 1997 and 2012, this newspaper reported in 2016, the average share of revenues accounted for by the top four firms in each of 900 economic sectors grew from 26% to 32%.”
Depending on what their political persuasions are, two opposing camps of economists are taking divergent views on the rise of mega corporations in America. In the red corner so to speak – the corner in which Mr Phillipon sits, economists argue that “domestic competition has been weakened by lax antitrust enforcement, anticompetitive practices and regulatory changes friendly to powerful firms.”
In the blue corner, economists say “that concentration is rising because of the success of superstar firms—highly innovative and productive companies that have shoved aside unfit competitors.”
To the extent that these trends being seen in America are to a large extent also being replicated in India, it is essential that we get a grip on the underlying drivers of these trends. Which corner is correct – red or blue?
“If concentration is caused by ultra-productive firms outcompeting weaker rivals, then investment ought to rise as those firms scale up to exploit their competitive edge. Investment, however, has been disappointing across the American economy. In the 1990s a statistic called Tobin’s q (a measure of a firm’s market value relative to the cost of replacing its assets, named after an economist, James Tobin) closely tracked rates of net investment. A high Tobin’s q indicates that future profits are likely to be high relative to the cost of expanding production. That suggests leading firms should scale up or see a flood of investment by competitors seeking to divert part of that profit stream. In this millennium, however, investment has lagged behind what one would expect, given the level of Tobin’s q across the economy. A finer-grained analysis shows that the most concentrated sectors account for nearly all the investment shortfall.” So it would appear that the reds’ argument has a lot going for it.
The red argument seems even stronger when you consider the evidence (or lack thereof) of superstar firms being drivers of productivity: “If concentration is mainly caused by the triumph of superstar firms, it should be rising. Here the data are murkier. The authors of “The fall of the labour share and the rise of superstar firms”, a forthcoming paper in the Quarterly Journal of Economics, find a clear link between size and productivity (bigger firms are more productive) and between industry concentration and patenting (which they use as a proxy for innovation). But the relationship between concentration and measures of productivity is less clear, particularly outside manufacturing. Mr Philippon, on the other hand, finds a positive and statistically significant relationship between concentration and productivity in the 1990s but not more recently. What seems clear is that even as concentration has risen across the economy over the past two decades, the rate of productivity growth has not. If superstar firms are indeed a force for concentration, their unique capabilities have not translated into broader gains for the American economy.”
For those of us living in India, Phillipon’s research points to a pattern of behaviour by large American firms which echoes what we see in India on a daily basis: “America’s tech giants have gobbled up competitors and spent lavishly on political donations and lobbying. There is no guarantee that superstars, having achieved dominance, will defend it through innovation and investment rather than anti-competitive behaviour.”
In India, as in America, there are no easy answers to this political and economic capture. Not only will large, dominant, ambitious firms NOT give way because you and I don’t see the benefit of their dominance, it is not obvious that dismantling these firms will necessarily produce a more efficient economy. This is especially so in a poor country like India where cost of capital is high and, hence, a large company’s reinvestment of internal accruals gives it access to low cost capital.

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Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.

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