A Guardian of Global Capitalism Warns Capitalism Has A Problem

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It's springtime again in Washington, D.C., when flowers bloom, birds chirp, and thousands of wonks from all over the world descend on the Spring Meetings of the International Monetary Fund and World Bank, Planet Money included. Since World War II, the IMF and World Bank have served as guardians of global capitalism. The IMF, in particular, has a long history of bailing out countries in financial crises and using its power to push a free-market agenda. That's why we were surprised to hear IMF officials suggest capitalism is running amok.

We heard it at the wonkiest part of this wonkfest, the IMF's "analytical corner." Throughout the week, IMF economists presented research on a small stage with a giant projector screen and big block letters that spelled "IMF" behind them. It looked sort of like a TED Talk, but the speakers weren't wearing those cheesy Backstreet Boy headset microphones.

Wenjie Chen, an economist in the IMF's Research Department, presented the findings of an impressive study that can be found in Chapter 2 of the IMF's World Economic Outlook. Chen gave us the sense that something fundamental in the economy has changed and that capitalism may be going haywire. The reason: companies are getting too powerful.

Why pay more?

Chen began her talk with a personal story. In 2016, Chen's six-month-old daughter, Lily, suffered a severe allergic reaction from eating dairy. Lily is okay now, but Chen and her spouse now carry EpiPens in case Lily has another attack. The first time Chen bought the epinephrine device, she was outraged by the cost: more than $600 for a two pack. As has been widely reported, the company had raised their price by 500% since 2009.

The EpiPen pricing tale provides an extreme example of what economists call a "price markup," which is when a company charges a price for something that is higher than the cost of producing it. In the fairytale version of capitalism, competition takes away the power of companies to mark up their prices and forces them to sell their products at the price it costs to make them. When companies can markup their prices over this competitive level, economists say they possess "market power."

Fairytale Fact Check

Chen and colleagues recently studied the price markups of a jaw-dropping number of companies — almost one million! — across 27 countries. They found that market power is growing, especially in advanced countries, where companies increased their markups by an average of 8% between 2000 and 2015. This increase in market power has occurred in a wide range of industries, from tech to pharmaceuticals to energy to finance.

"What is really remarkable here is that we find it's a small fraction of firms within each industry that's really driving this increase in market power," Chen said. These top-tier firms increased their markups by over 30% over the last couple decades.

This is about more than just consumers having to pay more at the store. The IMF's economists connect rising market power to a range of worrisome trends in the overall economy: lackluster business investment, sluggish productivity growth, declining innovation and increasing inequality. They estimate that if price markups had remained at their 2000 levels, GDP in the average advanced country would be about one percent higher. "If market power is not kept in check, these negative impacts might actually worsen," Chen warns.

Leading Firms Are Running Away From The Pack

As for why we're seeing a rising tide of market power, the IMF doesn't have solid answers. The fact that it's occurring in virtually every industry across the developed world suggests it may be broad technological changes that reward winning. One driver may be "network effects," which makes a service get even better as more people use it, and thus, harder to compete against it. An example is Google. With billions of searches a day, each one making the next work a little better, Google's self-reinforcing popularity has become like a moat filled with sharks for competitors.

There's nothing inherently wrong with a product being provided by a bigger company. If that's the most efficient way it's done, economists usually don't pass judgment. But the IMF says increased concentration is having nasty side effects that are slowing growth. When companies build stable pipelines of profits and don't have to worry about competition, they don't have to invest and innovate as much. Others warn economic power leads to political power, which can lead to another kind of moat that blocks competition.

OK, IMF, Are You Gonna Fix It?

The IMF's recommendations are a far cry from saying we need to start breaking up companies. Instead, they say countries should ensure "a level playing field," and they offer some some pretty modest ways to do that, including cutting red tape on startups, opening up trade restrictions, and potentially loosening intellectual property and patent laws. (A growing chorus of American wonks have been calling for more aggressive antitrust enforcement. Give a listen to our recent three-part antitrust series on this for all the gory details).

The story about EpiPens has a (somewhat) happy ending. Following public outcry, congressional hearings and lots of news coverage, generic versions of the device hit the market. In 2017, CVS began selling a generic version of the EpiPen that costs about one-sixth the cost Chen had to pay for hers in 2016. It's an example of competition doing what it's supposed to do. Now we just need to somehow make that happen like a gazillion more times.

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