How Does Market Concentration Affect Societal Well-Being?

Competition is the cornerstone of a capitalist economy. Economic theory argues that free and open contestation between firms compels businesses to remain efficient and cost-effective while providing a high quality product, leading to a more positive outcome for consumers.^[1] However, a number of factors can create uncompetitive markets, in which industry activity is concentrated in a small number of dominant firms. The Roosevelt Institute notes that between 1985 to 2017 the number of mergers completed annually in the United States rose from 2,308 to a staggering 15,361, suggesting a marked uptick in market concentration in recent decades.^[2] Many economists argue that increased market concentration exacerbates economic inequality, dampens labor mobility, and drives prices higher for consumers.^[3] These serious claims beg the question: do highly concentrated markets harm society?

Market concentration measures the structure and firms operating in a specific market. In a highly concentrated market, a small number of firms dominate the activity and value within that specific industry. This can be used as a proxy for market competitiveness, since newer and smaller firms would find it difficult to break into an industry dominated by a few well-established players. For example, search engines are a highly concentrated industry. As of March 2023, Google had a 91.4% market share, with its second place competitor, Bing, accounting for just 3.1% of market activity. Google’s status in this market insulates it from effective competition, and, since users cannot turn to an alternative engine if they disapprove of Google’s policies, reduces its incentive to remain accountable to its already captive customers.

A related concept to market concentration is market power. Market power is “a company’s relative ability to manipulate the price of an item in the marketplace by manipulating the level of supply, demand or both.”^[4] In an open competitive market, various firms vying for higher profits will undercut each other’s prices to attract new customers. No one firm can unilaterally raise prices without losing a substantial amount of market share. In this scenario, individual firms have low market power. However, in a highly concentrated market, there are very few viable competitors who can provide a specific good/service. Should the dominant firm in such a market choose to raise their prices to pad their bottom line, consumers have few (or no) alternatives, so they might have to stomach higher prices. This is an example of a market where a firm has high market power, where one firm has a relatively high amount of control over prices. When governments intervene to restrict mergers or break up monopolies through antitrust enforcement, part of their rationale for action is to limit the market power of large firms so consumers are not stuck with prices higher than they would pay in a competitive market.

Most economists seem to agree that extreme market concentration contributes to many social and economic problems, and that some steps must be taken to ensure markets remain open and competitive. Recent decades have seen a noticeable increase in market concentration across the developed world, particularly in the United States and Japan.^[5] European countries have also experienced increased concentration to a lesser extent, with the average industry’s concentration increasing by 4 to 8% across 10 European countries between 2000 and 2014.^[6] This could be a troubling trend for a number of reasons. Mike Konczal and Marshall Steinbaum argue that high market concentration can increase economic inequality and limit labor mobility. If a firm is very dominant in its industry, then it has sufficient market power to set prices artificially high, which will increase their profits dramatically while costing consumers considerably more money. Additionally, workers will not have a viable competitor to work for in a highly concentrated market, so they might be ‘stuck’ working for a firm unable to take their labor elsewhere.^[7]

Additionally, there is evidence that high market concentration might blunt productivity growth and, by extension, economic growth. Industrial concentration is strongly correlated with increased profits and lower returns to productive factors.^[8] Dominant firms in a highly concentrated market do not have to worry about competitors cutting into their market share, which removes a key incentive to develop new innovations that increase productivity and decrease costs. Basically, without competition firms can rest on their laurels, so they have less drive to increase their productivity.

To avoid these undesirable effects, many governments actively work to promote competition through antitrust proceedings and regulatory reform. Governments need to approve large mergers between firms, and if they realize a merger would result in too great an increase in market power, then they will reject it. Additionally, in extreme cases firms may be broken up into smaller firms for the same reason. However, the antitrust regime in the United States has become increasingly unwilling to intervene to prevent mergers since the 1970s, with the guidelines for what constitutes too much market power becoming increasingly permissive over the last 50 years.^[9]

While the increase in top-line indicators suggests that markets have become more concentrated in the last fifteen years, the imprecision of these measures coupled with the difficulty defining what constitutes a market has caused some economists and political actors to suggest that the market concentration problem is overstated. One key example is the DOJ and FTC’s insistence that claims of increasing concentration were “unsupported by data for meaningful markets” because they are often based on industrial sectors, which include firms specializing in the production of varied goods that cannot substitute for each other, such as pencils and wooden blocks.^[10] This raises an interesting point about market definition that you will be encouraged to consider in the questions below.

^[1] “Factsheet on How Competition Policy Affects Macro-Economic Outcomes.” Accessed April 18, 2023. https://www.oecd.org/daf/competition/2014-competition-factsheet-iv-en.pdf. oi

^[2] “The United States Has a Market Concentration Problem – Roosevelt Institute.” Accessed April 20, 2023. https://rooseveltinstitute.org/wp-content/uploads/2020/07/RI-US-market-concentration-problem-brief-201809.pdf.

^[3] Konczal, Mike, and Marshall Steinbaum. “Declining Entrepreneurship, Labor Mobility, and Business Dynamism: A Demand-Side Approach.” New York, NY: The Roosevelt Institute. Retrieved October 15 (2016): 2016.

^[4] Kenton, Will. “What Is Market Power (Pricing Power)? Definition and Examples.” Investopedia. Investopedia, November 9, 2022. https://www.investopedia.com/terms/m/market-power.asp.

^[5] “The United States Has a Market Concentration Problem – Roosevelt Institute.” Accessed April 20, 2023, https://rooseveltinstitute.org/wp-content/uploads/2020/07/RI-US-market-concentration-problem-brief-201809.pdf. , p. 2

^[6] Bajgar, Matej, Giuseppe Berlingieri, Sara Calligaris, Chiara Criscuolo, and Jonathan Timmis. “Industry concentration in europe and north america.” (2019).

^[7] Konczal, Mike, and Marshall Steinbaum. “Declining Entrepreneurship, Labor Mobility, and Business Dynamism: A Demand-Side Approach.” New York, NY: The Roosevelt Institute. Retrieved October 15 (2016): 2016.

^[8] Barkai, Simcha. “Declining labor and capital shares.” The Journal of Finance 75, no. 5 (2020): 2421-2463.

^[9] Barkai, Simcha. “Declining labor and capital shares.” The Journal of Finance 75, no. 5 (2020): 2421-2463., p1.

^[10] “The United States Has a Market Concentration Problem – Roosevelt Institute.” Accessed April 20, 2023, https://rooseveltinstitute.org/wp-content/uploads/2020/07/RI-US-market-concentration-problem-brief-201809.pdf. , p. 2