Technological change is often proposed as the main driver behind the enormous rise in inequality in the UK and elsewhere in the last four decades.
Some workers have become extremely productive, be it because their skills have become much more valuable because the falling prices of capital goods such as tech products enhance their productivity, or because the reach of what they produce now extends so far in a global economy that any small differences in ability are amplified, with enormous winner-take-all benefits. In contrast, those less fortunate have seen stagnating wages. An open question is what the role is of firms, and of inequality of firms. And because firm size is intimately related to market power, the question is what the role is of market power for inequality in the labour market. Does market power offer an alternative (and complementary) explanation to technological change for the rise in inequality?
The chapter by De Loecker, Obermeirer and Van Reenen (2022) offers a fascinating account of the role of firms and inequality in the UK economy. In broad lines, their facts confirm the trends in the United States and in countries in the European Union. Productivity growth has slowed down, firm productivity dispersion has increased, mark-ups, mark-up dispersion and concentration have increased, and there is a rise in the concentration of large firms. At the same time, this evolution that is transforming the distribution of firms is accompanied by fundamental changes in the labour market: wage growth has slowed down, wage dispersion across firms has increased, and business dynamism (firm creation and labour reallocation) have declined.
Firm inequality (in mark-ups, profits, employment, sales, etc.) is closely intertwined with market power. Firms that exert market power tend to be larger for two reasons: (1) market power often stems from a smaller number of competitors, which means the same market is served by fewer firms who have higher market shares; (2) even if the number of competitors remains the same, market power often originates in technological advantage and hence heterogeneity in productivity – with more productivity dispersion, mark-ups, as well as mark-up and firm size dispersion, increase. For much of what follows in this discussion, I focus on labour market inequality due to market power. And while market power has the obvious efficiency implications and loss of consumer surplus, it also affects the labour market and inequality.
As De Loecker, Obermeirer and Van Reenen argue, society does not care about inequality between firms per se, only about inequality among people. Inequality between firms comes at the centre of the inequality debate if there is a link between firm inequality and inequality between people. When output and labour markets are perfectly competitive, the firm size and its distribution does not affect inequality in the labour market. Workers are paid their marginal product and firms generate such a marginal product in the most efficient way, whether that be in large or small firms.
Things are different when firms have market power. The first and most obvious source of inequality is the rise in profits and a decline in labour income. In this commentary, I discuss the findings in the chapter regarding the labour share in the UK. Even if inequality between workers does not change, this change in the distribution of resources will show up in an increase in inequality between capital and labour income, which will affect wealth inequality. Moreover, the increase in market power and firm inequality leads to an increase in the concentration of profits, which in turn affects the distribution of wealth. But there is not merely an issue of redistribution between profits and wages (or capital and labour). I also discuss the effect of market power on wage inequality between workers. Finally, I analyse the policy implications and the impact on welfare.
Cite this as:
Eeckhout, J. (2022), ‘Market power and labour market inequality’, IFS Deaton Review of Inequalities, https://ifs.org.uk/inequality/market-power-and-labour-market-inequality