Are Markups Too High? Competition, Strategic Innovation, and Industry Dynamics

63 Pages Posted: 6 Oct 2019 Last revised: 15 Jan 2020

See all articles by Laurent Cavenaile

Laurent Cavenaile

University of Toronto - Rotman School of Management; University of Toronto at Scarborough

Murat Alp Celik

University of Toronto - Department of Economics

Xu Tian

University of Toronto

Date Written: August 1, 2019

Abstract

Since the 1970s, there have been significant changes in firm dynamics within and across industries in the US. Industries are increasingly dominated by a small number of large firms ("superstars"). Markups, market concentration, profits, and R&D spending are increasing, whereas business dynamism, productivity growth, and the labor share are in decline. We develop a unified framework to explore the underlying economic mechanisms driving these changes, and the implications for economic growth and social welfare. The model combines a detailed oligopolistic competition model featuring endogenous entry and exit with a new Schumpeterian growth model. Within each industry, there are an endogenously determined number of superstars that compete a la Cournot and a continuum of small firms which collectively constitute a competitive fringe. Firms dynamically choose their innovation strategy, cognizant of other firms' choices. The model is consistent with the changes in the macroeconomic aggregates, and it replicates the observed hump-shaped relationship between innovation and competition within and across industries. We estimate the model to disentangle the effects of separate mechanisms on the structural transition, which yields striking results: (1) While the increase in the average markup causes a significant static welfare loss, this loss is overshadowed by the dynamic welfare gains from increased innovation in response to higher profit opportunities. (2) The decline in productivity growth is largely driven by the increasing costs of innovation, i.e. ideas are getting harder to find.

Keywords: innovation, markups, growth, strategic investment, industry dynamics, business dynamism

JEL Classification: E20, L10, O30, O40

Suggested Citation

Cavenaile, Laurent and Celik, Murat Alp and Tian, Xu, Are Markups Too High? Competition, Strategic Innovation, and Industry Dynamics (August 1, 2019). Available at SSRN: https://ssrn.com/abstract=3459775 or http://dx.doi.org/10.2139/ssrn.3459775

Laurent Cavenaile

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

University of Toronto at Scarborough ( email )

1265 Military Trail
Scarborough, Ontario M1C 1A4
Canada

Murat Alp Celik (Contact Author)

University of Toronto - Department of Economics ( email )

150 St. George St.
Toronto, ON M5S 3G7
Canada

HOME PAGE: http://muratcelik.faculty.economics.utoronto.ca/

Xu Tian

University of Toronto ( email )

150 St George Street
Toronto, Ontario M5S 3G7
Canada
647-606-0709 (Phone)

HOME PAGE: http://www.xutianur.com

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