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**Kaldor and Piketty’s facts: The Rise of Monopoly Power in the US**

Gauti Eggertsson Jacob Robbins Ella Getz Wold Brown University

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**Kaldor’s “stylized facts” not facts anymore**

In social sciences, especially economics, a stylized fact is a simplified presentation of an empirical finding. A stylized fact is often a broad generalization that summarizes data, which although essentially true may have inaccuracies in the detail. -- Constant interest rates -- Constant Labor and Capital Share ”Is no doubt that they are stylized, though it is possible to question whether they are facts” Robert Solow, 1969

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**Failure of Kaldor’s facts associated with several broader pattern’s including Piketty’s “puzzles”**

Wealth to output ratio has increased while savings gone down and capital to output stagnant. An increase in pure profits with a decrease in the capital and labor share.

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**Other “puzzles” from perspective of neoclassical model**

3. A decrease in the real interest rate while the measured average return on capital is relatively constant 4. An increase in Tobins Q to a level permanently above A decrease in investment to output, even given historically low borrowing costs and a high value of empirical Tobins Q.

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(1) “Wealth is back”

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**Wealth was accumulated despite historically low savings rates**

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Wealth accumulation Wealth is not embodied in new productive capital goods. Replacement value of capital to output has stagnated. Instead, wealth was accumulated through capital gains Capital gains of 3% per year from 1970 to the present on wealth

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**(2) Growth in Tobin’s Q macrodata**

Bob Hall (2001) Phillipon and Gutierres (2017) 𝑄= 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑅𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙

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Compustat Tobin’s Q microdata

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**(3) Interest rates have decreased**

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**(3) … but the average return on capital has stayed constant**

Gomme, Ravikumar, and Rupert (2011)

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**(4) Labor/capital share has decreased, pure profit share has increased**

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**(5) Despite low interest rates / high Tobin’s Q, investment has been sluggish**

NIPA Phillipon and Gutierres (2017)

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**Summing up: Want to to explain**

Five

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**Key Hypothesis 1: Increase in market power**

Council of Economic Advisors

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**Increase in concentration**

Source: Philippon & Gutierrez (2017)

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**Rise in monopoly power: markups**

Source: De Loecker, Eekhout (2017)

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**Key hypothesis #2: Decrease in r***

Decrease in natural rate of interest rate, combined with increase in markups, can potentially explain constant average return on capital In conjunction with markups, can also explain trends for investment and capital

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**Key hypothesis #2: Decrease in r***

Follow Eggertsson, Mehrotra, Robbins (2017) and model r* as being driven down by slower productivity and population growth

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Test Hypothesis (1) Build quantitative model that can explain joint evolution of all five macro trends (2) Estimate the change in markups from 1970 to the present / decline in interest rates (3) Quantitatively test hypothesis

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Literature review Each of these facts has been the subject of intense recent debate and interest Wealth to output, Tobin’s Q: Piketty (2014), Piketty, Saez, Zucman (2016) Labor share: Karabarbounis and Neiman (2013), Elsby et. al. (2013). Pure profit share / markups: Barkai (2017), De Loecker and Eekhout (2017) Average return on capital versus interest rates: Gomme et al (2011,2015), Eggertsson, Mehrotra, Robbins (2017) Slack investment and relation to Tobin’s Q: Guttierez and Phillipon (2016) Decrease in competition in the US: Autor et. al. (2017), CEA (2016), Furman (2015)

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How we are difference Our model quantitatively explains the joint evolution of five variables. Most other consider smaller pieces of the story. We synthesize, quantify, formalize previous work. We have new estimates for how much markups have increased Our quantitative model has several novel features, and matches the data well

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Our model Standard neoclassical model cannot address many of the changes seen over the past 40 years Cannot explain divergence between wealth and capital, average and marginal return, or increase in pure profit shares

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**Modifications to basic neoclassical model**

General model of market power that nests a number of specific market structures (Monopolistic competition, Cournot, Bertrand, Monopoly, etc) Claims to the pure profits are traded as assets Structure in which r* can change Major implication for macro

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**Model – focus on production**

Unit mass of identical final goods firms Production function Final good aggregate Symmetric equilibrium

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Final goods firms Crucial assumption: final goods firms have market power Markups follow AR(1) process Aggregate profits are given by

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Firm dynamics Introduce simple, reduced form, firm entry and exit dynamics Firm exit a la Melitz (2003). Each period, a final goods firm i has a probability Δ of exiting Entry is also exogenous – each period, mass Δ of new final goods firms enters.

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Asset pricing There are security markets in which the rights to the future profits of final goods firms are bought and sold Securities S(t) are traded, receive dividend d from final goods firms with price X(t). 1 share outstanding. For entering firms, shares distributed to individuals as ‘IPO Securities’

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**Intermediate goods firms**

Representative firm Adjustment costs as in Jermann (1998)

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Wealth and Tobin’s Q Define aggregate wealth as the total market value of physical capital and securities Empirical Tobin’s Q is defined as Note that the existence of securitized pure profits allows there to be a wedge between wealth and capital, and allows Tobin’s Q to be permanently above one

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**Asset Pricing – Long run risk**

Long-run productivity risk enters our model as in Bansal and Yaron (2004) and Croce (2014) Will allow us to match equity premium

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**Household preferences**

Unit mass of individuals with Epstein-Zin utility: D is additional wedge between current and future utility Used as reduced form way of modeling factors such as demographics that affect the real interest rate in non rep-agent models

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Budget constraint

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Equilibrium

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**Model discussion Model nests a number of specific market structures:**

Perfect competition: μ=1, no entry and exit Standard New Keynsian monopolistic competition: Δ= 0, Dixit-Stiglitz (1977)

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Model discussion Bilbiie, Ghironi and Melitz (2012), Etro and Colciago (2010), Melitz (2003) – monopolistic competition, Bertrand, Cournot competition Set G(.) in line with love of variety, Δ in line with entry and exit, add fixed costs in line Since these models nest the endogenous growth models of Aghion and Howitt (1992), Romer (1990), and Grossman and Helpman (1991), our model does as well

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**Comparative statics – increase in markups**

Effect of a permanent increase in μ is straightforward: Increase in security value X, and thus increase wealth to output and Tobin’s Q

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**Comparative statics – increase in markups**

Also leads to an increase in the profit share And a corresponding decrease in the labor and capital share

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**Comparative statics – increase in markups**

Increase in the average return on capital And a larger gap between the average return and the risk free rate

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**Comparative statics – increase in markups**

Finally, the increase in the markup means a larger wedge between the MPK and the rental rate of capital This depresses investment

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All together now…

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Effect of change in r Now consider a decrease in r, perhaps due to a slowdown in productivity or demographics Average return is thus pulled down

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Effect of change in r Note that this is the opposite effect of a change in markups Thus an increase in markups combined with a decrease in r could lead to a unchanged average return on capital.

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Effect of decrease in r Decrease in r would also tend to increase investment and the capital to output ratio Once again pushing in the opposite direction of markups

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**Quantitative Analysis**

We’ve seen how an increase in monopoly power combined with a decrease in r can potentially account for the five facts But are these effects quantitatively important? We need an estimate of how markups have changed Use 3 estimates: De Loecker, Nekarda & Ramey, our own estimates

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**Markups: De Loecker and Eeekhout**

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**Markups from Nekarda and Ramey (2013)**

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**Old method for estimating markups**

With Cobb Douglas / CES preferences, easy formula for markup:

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Our method We use the fact that under CRTS production markups are proportional to the profit share of the economy. We can thus estimate markups as

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Implied markups

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Compared to Ramey et. al.

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**Quantitative exercise**

Test to what extent the increase in markups, along with changes in the real interest rate, can explain the five facts discussed above

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**Exercise Comparative statics exercise, 1970 to 2015**

Calibrate the model to 1970 data Then “plug in” (1) changes in markups from (2) changes in other fundamentals from that will effect equilibrium r Compare changes in model moments to changes in data moments

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**Quantitative Exercise**

Several categories of parameters Markup μt estimated from before Second category taken from literature Third category chosen to match 1970 data Minimize objective function

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**Parameters chosen from the literature**

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**Parameters calibrated to 1970 moments**

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Calibration results

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Calibration Note that we are choosing parameters to match only 1970 moments In particular, we do not choose any parameters to match 2015 moments, or to try and match any change in the moments from 1970 to 2015 The success or failure of the exercise will be comparing changes in our model moments to change in the data moments

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**Results – change in markups**

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**Results – change in markups, interest rates**

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**Results – De Loecker Markups**

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**Implication #1: Inequality**

Income inequality: greater share of income go to owners of equity capital (upper portion of the distribution), lesser share goes to labor Wealth inequality: huge rise in stock prices once again benefits the owners of equity capital

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Implication #2: Growth With higher markups, lower investment, capital, and labor supply. Leads to lower GDP Indirect costs of monopoly power: rent seeking Traditional political rent seeking Spending on product differentiation, branding, and advertising

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**Implication #3: Tax policy**

Economic theory suggests it is a good idea to tax pure profits, perhaps not such a good to tax capital income With moderate levels of pure profits, relatively high levels of corporate income taxes are optimal Result is amplified with interest deductibility and accelerated depreciation

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**Implication #4: Income and wealth accounting**

Measuring level of pure profits in the US economy is of first order importance Whether intangible investment should be capitalized depends on whether it is productive or spending purely to increase barriers to entry

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Conclusion Analysis relies heavily on estimates of markups, which are difficult to measure. Having said that, an increase in markups should lead to… Negative impact on GDP growth Increase in income inequality and wealth inequality Changes analysis of tax on capital income

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**Intangible capital story**

Another story --- there is a still a large stock of unmeasured intangible capital This would lead to a high measured Q, average return, and W/Y

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However… Last two revisions to NIPAs have included massive revisions of intangible capital Most expenditures on R&D, software, training, etc are now counted as investment What potential intangible investment is missing? Advertising, marketing, etc. But is this investment? In any case not large enough.

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Back to the 5 facts (1) Increase in W/Y, stagnation in K/Y: match pretty well (2) Increase in Q: match pretty well the change. Don’t get levels – Q is measured very poorly in the data! (3) Decrease in r*, slightly increasing average return: match r* decrease, have a moderately increasing average return

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Back to the 5 facts (4) Increase in pure profit share, decrease in labor share and capital share: markups were essentially estimated to match this fact (5) Decrease in I/Y, despite low r*: we have too large a decrease in I/Y. We better match data if we used net investment, since depreciation has increased substantially over the time period (see Gutierrez and Phillipon (2016))

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Profit distribution

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**Impulse Response Function**

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Change in D

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**Change in productivity growth**

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