Robin Hanson’s take on the rising margins debate, Karl Smith too

August 25, 2017
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He has a long post, with many points of interest, here is the concluding section:

If, like me, you buy the standard “free entry” argument for zero expected economic profits of early entrants, then the only remaining explanation left is an increase in fixed costs relative to variable costs. Now as the paper notes, the fall in tangible capital spending and the rise in accounting profits suggests that this isn’t so much about short-term tangible fixed costs, like the cost to buy machines. But that still leaves a lot of other possible fixed costs, including real estate,  innovation, advertising, firm culture, brand loyalty and prestige, regulatory compliance, and context specific training. These all require long term investments, and most of them aren’t tracked well by standard accounting systems.

I can’t tell well which of these fixed costs have risen more, though hopefully folks will collect enough data on these to see which ones correlate strongest with the industries and firms where markups have most risen. But I will invoke a simple hypothesis that I’vediscussedmanytimes, which predicts a general rise of fixed costs: increasing wealth leading to stronger tastes for product variety. Simple models of product differentiation say that as customers care more about getting products nearer to their ideal point, more products are created and fixed costs become a larger fraction of total costs.

As always, I am very pleased to have Robin as my colleague and friend.  And from Karl an excellent post, his conclusion:

The sweeping away of the small generalized firm made room for the rise of increasingly specialized local businesses, offering what might think of as a more artisanal experience. These firms have increased markups, but those markups don’t represent a lack of competition. Instead, they represent a return to the particular skills or vision necessary to make a specialized product. Economists refer to this market pattern as monopolistic competition, and it is the source of variety that consumers in a wealthy developed economies desire.

If my story is correct, then the trend towards higher markups is indeed linked to the major changes sweeping the American economy. However, it isn’t the cause of them. Its another consequence of the massive changes introduced by globalism and the radical changes in retailing.

There are additional points of interest at the link.

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