America Has an Oligopoly Problem

There’s a growing bipartisan push on Capitol Hill to strengthen antitrust agencies and weaken the dominance a few big companies have over entire industries in the United States, namely the big tech companies. In June, House lawmakers took their first votes on a series of bills that would, for one thing, make it harder for companies to acquire potential rivals. And that’s a big deal, says Maryland Smith’s Bruno Pellegrino. His research proves that America has an oligopoly problem.

Pellegrino’s research, which just won a best-paper award from the Western Finance Association, looks at the rise of oligopolies in the United States with a groundbreaking new model for economists to more accurately measure competition in U.S. markets and the consequences for consumers.

For many products, Americans are limited to choosing among a few dominant suppliers – think airlines, credit cards, health care – while consumers would benefit from having more options. It’s part of the argument by those lobbying for tighter antitrust regulations: “When there are fewer firms competing in the marketplace consumers find it less easy to switch away from any particular product,” says Pellegrino. “This allows firms to charge higher prices, to the detriment of consumer welfare – that is oligopoly power.”

But some economists have been skeptical of these arguments, because putting a price tag on oligopoly power is extremely difficult.

“This story seems plausible, but one can’t say for sure – unless you have an objective method to define who competes with whom,” he says. “The only way to tell whether competition has become more or less intense, is to have a model capable of capturing product market competition across many different industries.”

His research makes that possible for the first time.

In studying competition, economists have traditionally looked at individual industries (cars, ready-to-eat cereals) for which they could obtain detailed data on product characteristics. But these industries are completely different from those that we suspect to harbor the new oligopolists (tech, for example). For these reasons, Pellegrino set out to develop a macroeconomic model that is capable of capturing oligopoly power across not one, but many different industries.

Pellegrino takes advantage of a dataset (developed by two former Maryland Smith professors) that is based on a textual analysis of product descriptions contained in Securities and Exchange Commission filings. Pellegrino created an innovative macroeconomic model that uses this data as a better map of the U.S. competitive landscape. His approach looks at competition like a network that can shift and change over time, rather than a static classification. This is particularly helpful as companies introduce new product offerings or sell off business sectors.

Economists measure in dollars the value produced by companies to society at large as “total surplus.” This gets split into profits (the share that goes to producers) and consumer surplus (the share that goes to consumers). These two measures capture how the value that companies create is split between producers and consumers. Additionally, the gap between the value that is created and the value that could be created (in the absence of market power) is called the deadweight loss.

Pellegrino’s model is the first to give economists a picture of these three measures across multiple industries, allowing them to measure the cost of oligopoly to consumers.

Pellegrino computes the toll on the U.S. economy. He estimates that this deadweight loss increased to 11% in 2017, up from 8.5% in 1997. The seminal paper from economist Arnold Harberger, which inspired Pellegrino, put that price tag at 0.1% in 1956. That’s two orders of magnitude difference.

The increasing deadweight loss shows the United States is not as prosperous as it could be, says Pellegrino. The higher the oligopoly power of firms, the bigger the share of surplus that goes to the producers as opposed to the consumer.

“Oligopoly also affects the distribution of income” he says. “When oligopoly power increases, a larger share of GDP goes to capital owners, and a smaller one goes to workers. Hence, oligopoly has major implications for inequality.”

“In a nutshell, the analysis suggests that American consumers are capturing a smaller slice of a shrinking pie,” Pellegrino says.

A different way to put it is that the economy is moving closer to a monopoly, and further away from an ideal competition, he says. His research also traces the causes and finds that a potential explanation can be offered by the secular decline of initial public offerings (IPOs).

“The last few decades have seen tremendous growth in the number of venture capital-backed startups,” he says. “The problem is that most of them end up being acquired – as opposed to going public – and do not end up competing with incumbent firms.”

According to Pellegrino’s model, the startups’ secular shift from IPOs to acquisition – particularly by big tech firms – can account for a large fraction of the observed decline in consumer surplus.

“This paper contributes to an ongoing debate in antitrust circles on whether we need to start worrying about acquisitions of startups,” Pellegrino says. “Most startup acquisitions fall under the reporting threshold for merger review, and are not scrutinized by antitrust authorities.”

So what’s the right balance?

“It appears, not only from my research, but from other colleagues’ research as well that startup acquisitions have gone under the radar of antitrust policy makers for too long,” Pellegrino says. “I am not arguing that all startup acquisitions are harmful for the consumer, but right now antitrust policy is conducted, in my estimation, as if none of them are.”

Read more: “ Product Differentiation and Oligopoly: a Network Approach,” is a working paper.