Aggregate Markup Research Articles

Financial constraints and inflation in Latin America: The impacts of bond financing and depreciations on supply inflation

This paper attempts to provide empirical evidence on whether two variables potentially affecting firms’ liquidity needs have an impact on inflation. Before doing that, since we are interested in the portion of inflation that can be linked to firms’ willingness to produce goods, we identify supply inflation: the part of aggregate GDP-inflation that can be explained by shifts in aggregate supply. Specifically, we test the impacts of corporate bond financing and depreciation on supply inflation and markups for several Latin American countries. Results show that domestic currency depreciation robustly increases supply inflation and aggregate markups, but corporate bond financing does not affect supply inflation. Presumably, when a depreciation occurs, financial constraints for the economy’s supply-side become binding and lead to increasing domestic prices. These results provide an alternative description to the exchange rate pass-through narrative. In several countries, since a sizable part of depreciation can be explained by the global financial cycle, there is also a potential transmission mechanism from advanced countries’ monetary policy actions to supply inflation – through depreciation – in Latin American countries.

Growing by the Masses: Revisiting the Link between Firm Size and Market Power

How are a firm’s size and market power related to one another? Combining micro-data about producers and consumers, we document that while firms mainly grow by selling to more customers, their markups are only associated with their average sales per customer. To study the macroeconomic implications of these facts, we develop a model of firm dynamics with endogenous customer acquisition and variable markups. Relative to a model without customer acquisition, our model generates higher concentration at the top, but a lower aggregate markup. Our quantitative analysis reveals large welfare and efficiency losses due to (mis)allocation of customers across firms. By increasing market concentration among the most productive firms, the efficient allocation achieves 11% higher aggregate productivity and 15% higher output.

Competitive Harm from Vertical Mergers

The 2020 Vertical Merger Guidelines produced by the antitrust enforcement agencies introduce a nontechnical application of bargaining theory into the assessment of competitive effects from vertical acquisitions. The economics of such bargaining is complex and can produce skepticism among judges, who might regard its mathematics as overly technical, its game theory as excessively theoretical or speculative, or its assumptions as unrealistic. However, we have been there before. The introduction of concentration indexes in the Merger Guidelines was initially met with skepticism but gradually they were accepted as judges became more comfortable with them. The same thing very largely happened again when unilateral effects theories of mergers were introduced in the 1990s. The bargaining theory that drives much of vertical merger analysis today has much in common with the theory of unilateral effects. In any event, the value of a particular model depends not on its verisimilitude but rather on its testability. The theory that relates a concentration index to the risk of competitive harm from horizontal mergers involves as much conjecture as does the bargaining theory that the Nash model for vertical mergers contemplates. The concentration thresholds in the Horizontal Merger Guidelines capture a rough generalization about a large number of collusive or oligopolistic strategies, some of which are not consistent with each other. What they share in common is belief in a link between the number of firms in a market, the increase in concentration that results from the merger, and the extent of higher prices. Double marginalization as a vertical merger defense occurs when two bargaining firms each have market power but are unable to coordinate their output. Each takes a markup without considering the other, and aggregate markups are too high. Both firms as well as their purchasers would be better off if they could coordinate better. In the AT&T/Time-Warner case the defendants argued that after the merger TW would not coordinate with AT&T but would set its prices as if the merger had not occurred. In that case the merger would not have eliminated double marginalization either. The debate over the elimination of double marginalization bundles two themes that Ronald Coase developed in his two most well-known articles, The Nature of the Firm and The Problem of Social Cost. The first argued that the boundaries of a firm are determined by the firm’s continuous search to procure inputs in the most cost effective way. The second argued that two traders in a well-functioning market will achieve the joint-maximizing solution. This dual relationship is too often ignored. Anti-interventionists rely heavily on Coasean arguments that unless high transaction costs get in the way firms will bargain to joint maximizing results. If that is true, then double marginalization will rarely provide a defense to a vertical merger. The law of vertical mergers deals largely with firms that transact with one another routinely, in legally enforceable buy-sell relationships. By contrast, the actors who appear in The Problem of Social Cost do not bargain with each other regularly. In a well functioning vertical market durable double marginalization should be rare.

The rise of market power and Ramsey‐optimal policy implications

AbstractDe Loecker, Eeckhout, and Unger document that since 1980 aggregate markups in the U.S. economy have significantly increased from 21% above cost to 61% now. In light of this evidence, this paper revisits optimal fiscal and monetary policy recommendations of standard New Keynesian models and shows that under empirically relevant calibrations of market power they radically change: the optimal inflation rate becomes significantly positive and its optimal volatility sharply rises. Moreover, inflation behaves like a random walk in response to unexpected fiscal shocks. Thus, price stability ceases to be the optimal policy outcome.

Government Subsidies and Firm-Level Markups: Impact and Mechanism

This paper investigates the impact of government subsidies on the firm-level markups and its mechanism of action by measuring the firm-level markups based on a micro dataset of Chinese manufacturing firms from 2000 to 2007. The findings suggest that government subsidies significantly reduce the markups of Chinese firms. Moreover, there is significant heterogeneity in the negative impact of government subsidies among different types of firms. Furthermore, analysis of the impact mechanism based on the mediation effect model shows that the increase in rent-seeking cost is an important way for government subsidies to reduce the firm-level markups. Finally, based on the dynamic decomposition of the aggregate markup of the Chinese manufacturing industry, it is found that government subsidies significantly reduce the industry-level aggregate markup through within-firm and cross-firm effects. This study enriches the literature on government subsidies and markups, and provides a new perspective for understanding the micro-performance of government subsidies.

Increasing market power in Slovenia: Role of diverging trends between exporters and non‐exporters

AbstractThis paper documents the evolution of markups in a small open economy, Slovenia, using a comprehensive data set covering the full population of firms. It makes three novel contributions to the literature. First, in contrast to other work for Europe, we find that markups have increased from 1.05 to 1.19 between 1994 and 2015. Second, while other research so far found exporters typically to have higher markups, we find the opposite in Slovenia. Though the rise in markups occurs both with exporters and non‐exporters, there is a consistent diverging trend in markups in favour of non‐exporters since 1999. This can be attributed to increased competitive pressure faced by exporters following the comprehensive trade liberalisation after 1999 and their increased participation in global value chains. Third, we decompose aggregate markups and show that the increase in markups, for both exporters and non‐exporters, is mainly driven by the within component rather than the reallocation effect. This suggests that all firms were increasing their markups, rather than high‐markup firms increasing their market share over time.

The Rise of Market Power and the Macroeconomic Implications*

Abstract We document the evolution of market power based on firm-level data for the U.S. economy since 1955. We measure both markups and profitability. In 1980, aggregate markups start to rise from 21% above marginal cost to 61% now. The increase is driven mainly by the upper tail of the markup distribution: the upper percentiles have increased sharply. Quite strikingly, the median is unchanged. In addition to the fattening upper tail of the markup distribution, there is reallocation of market share from low- to high-markup firms. This rise occurs mostly within industry. We also find an increase in the average profit rate from 1% to 8%. Although there is also an increase in overhead costs, the markup increase is in excess of overhead. We discuss the macroeconomic implications of an increase in average market power, which can account for a number of secular trends in the past four decades, most notably the declining labor and capital shares as well as the decrease in labor market dynamism.

Growing by the Masses - Revisiting the Link between Firm Size and Market Power

How are a firm’s size and market power related to one another? Combining micro-data about producers and consumers, we document that while firms mainly grow by selling to more customers, their markups are only associated with their average sales per customer. To study the macroeconomic implications of these facts, we develop a model of firm dynamics with endogenous customer acquisition and variable markups. Relative to a model without customer acquisition, our model generates higher concentration at the top, but a lower aggregate markup. Our quantitative analysis reveals large welfare and efficiency losses due to (mis)allocation of customers across firms. By increasing market concentration among the most productive firms, the efficient allocation achieves 11% higher aggregate productivity and 15% higher output.

Input trade liberalisation, institution and markup: Evidence from China's accession to the WTO

AbstractThis paper investigates the effects of input trade liberalisation on firm markups and assesses how institutional environment affects such impacts by using Chinese firm‐level data. To identify the causal effects, we exploit the quasi‐natural experiment of China's WTO accession in 2001 and perform difference‐in‐differences estimation. The results show that input tariff liberalisation leads to a substantial increase in firm markups, and institutional environment significantly strengthens such an impact. We further uncover the underlying mechanisms through which input tariff liberalisation boosts firm markups, and show that both price and cost channels work for the input tariff cut effect on firm markups, of which the latter is much more important. In addition, we also demonstrate that input tariff cut significantly fosters aggregate markup growth, and the reallocation effect is found to be an important channel through which input tariff liberalisation boosts aggregate markup growth.

International Shocks, Variable Markups, and Domestic Prices

Abstract How strong are strategic complementarities in price setting across firms? In this article, we provide a direct empirical estimate of firms’ price responses to changes in competitor prices. We develop a general theoretical framework and an empirical identification strategy, taking advantage of a new micro-level dataset for the Belgian manufacturing sector. We find strong evidence of strategic complementarities, with a typical firm adjusting its price with an elasticity of 0.4 in response to its competitors’ price changes and with an elasticity of 0.6 in response to its own cost shocks. Furthermore, we find evidence of substantial heterogeneity in these elasticities across firms. Small firms exhibit no strategic complementarities in price setting and complete cost pass-through. In contrast, large firms exhibit strong strategic complementarities, responding to both competitor price changes and their own cost shocks with roughly equal elasticities of around 0.5. We show that this pattern of heterogeneity in markup variability across firms is important for explaining the aggregate markup response to international shocks and the observed low exchange rate pass-through into domestic prices.

A Theory of Falling Growth and Rising Rents

Growth has fallen in the U.S., while firm concentration and profits have risen. Meanwhile, labor’s share of national income is down, mostly due to the rising market share of low labor share firms. We propose a theory for these trends in which the driving force is falling firm-level costs of spanning multiple markets, perhaps due to accelerating IT advances. In response, the most efficient firms (with higher markups) spread into new markets, thereby generating a temporary burst of growth. Because their efficiency is difficult to imitate, less efficient firms find markets more difficult to enter profitably and therefore innovate less. Eventually, due to greater competition from efficient firms, within-firm markups actually fall. Despite the increase in the aggregate markup and rents, firm incentives to innovate decline— lowering the long run growth rate.

Is Aggregate Market Power Increasing? Production Trends Using Financial Statements

Recent work in macroeconomics argues that firm market power dramatically increased since the 1980s. Using financial statement data, I find that public firm markups increased only modestly over this time period, and are within historical variation. These estimates improve on earlier work by accounting for marketing and management expenses, which I document are a rising share of costs in firm production. Markups are increasing in firm size and vary by sector. Reasonable calibrations accounting for the representativeness of public firms show a flat or even decreasing aggregate markup.

Uncertainty-Driven Business Cycles: Assessing the Markup Channel

A growing recent literature relies on a precautionary pricing motive embedded in representative agent DSGE models with sticky prices and wages to generate negative output effects of uncertainty shocks. We assess whether this theoretical model channel is consistent with the data. Building a New Keynesian model, we show that indeed with sufficient nominal rigidities markups increase and output falls after uncertainty shocks. The model is also used as a business cycle accounting device to construct aggregate markups from the data. Time-series techniques are employed to study the conditional comovement between markups and output in the data. Consistent with the model's precautionary wage setting, we find that wage markups increase after uncertainty shocks. Price markups in contrast fall. This finding - inconsistent with the model - is corroborated by industry-level data. Overall, these results point to a prominent role for sticky wages in the transmission of uncertainty shocks.

Markups and oil prices in Canada

The markup (the ratio of price to marginal cost) in Canada has risen steadily since the early 1990s suggesting a widening gap between the actual and the efficient level of output and a declining share of labor income in GDP. It exhibits non-stationary movements over the sample period 1982Q1 to 2009Q4, allowing us to identify a permanent markup shock. We provide evidence that oil price movements are important for understanding the behavior of the markup, and separately identify both oil price shocks and permanent non-oil markup shocks. Our key findings are: (1) oil price shocks and non-oil markup shocks account for 50 to 80percent of the variation in the markup, with the former dominating at shorter horizons; (2) the role of oil price shocks is prominent in accounting for the upward trend in the markup since the mid-1990s; (3) the direct effects of oil prices on the markup in the mining sector (which includes the oil-producing sector) have contributed the most to the upward trend in the aggregate markup; and (4) other explanations such as market structure shifts, trend inflation movements and the falling relative price of investment do not appear to account for the behavior of the markup.

Variety matters

Countercyclical markups are a key transmission mechanism in many endogenous business cycle models. Yet, recent findings suggest that aggregate markups in the US are procyclical. The current model addresses this issue. It extends Galí's (1994) composition of aggregate demand model by endogenous entry and exit of firms and by product variety effects. Endogenous business cycles emerge with procyclical markups that are within empirically plausible ranges.

The Cyclicality of Mark-Ups and Profit Margins for the United Kingdom: Some New Evidence

In this paper, we assess the cyclicality of mark-ups and profit margins within the United Kingdom, at both the aggregate and industry level. We find that the private sector labour share moves countercyclically, suggesting that the aggregate mark-up moves procyclically. This result survives when we consider more sophisticated measures of the mark-up. And this result is also supported by industry-level data. We find that the aggregate market sector profit share moves procyclically and that the cyclical behaviour of profit margins is largely homogenous across industries. Nevertheless, there is some evidence that margins moved against the cycle in the late 1990s, starting to fall in 1997, whereas GDP growth did not peak until 2000. In tandem with these cyclical movements, we also find that the market sector profit share has trended upwards since 1970, in contrast to the aggregate mark-up, which fell over the same period.