Macro Roundup

Meghana Ayyagari, Asli Demirguc-Kunt, and Vojislav Maksimovic, “The Rise of Star Firms: Intangible Capital and Competition,” Social Science Research Network, June 8, 2020, https://papers.ssrn.com/sol3/papers.cfm

Note their return on invested capital is pre-tax

Figure 3 shows adjusting for intangibles lowers ROIC as the increase in invested capital is > uptick in earnings.

Paper goes on to adjust the markups:“…. Furthermore, once we adjust markups based on operating expenses for investment in intangible capital, we only find a modest increase in market power especially in high skilled industries. Star firms tend to be larger, younger, and have higher markups. While they may have more pricing power than other firms, at each level of markup star firms tend to produce more than other firms. We also find no evidence that star firms are differentially affected by import competition compared to other firms in the economy. Overall, we see little evidence that these star firms are using their market power to reduce output and raise prices to achieve super normal returns more than other firms.However, there may be reason for concern regarding a smaller subset of elite publicly-listed firms. The usual suspects for membership in such an elite group are Apple, Facebook, Google, Amazon, and Microsoft. When we examine these firms individually, the ROIC and markups of most of these elite firms do not seem extraordinary initially and then explode but again only for a couple of firms that have built up a large enough market. Even for these firms, the critical policy concern may not only be the regulation of their use of market power today, but also the need to maintain contestable markets that allow the creation of independent technologies in the future….”

“…Figure 1 shows that there is a large rise in capital returns over the past three decades where the ratio of the 90th percentile ROIC firm to the median ROIC firm has increased by over 69%. We also see that the divergence of the top decile of firms from the rest of the economy really takes off in the 1990s…conventional financial statements do not capitalize R&D expenditures or organizational capital. Once we adjust firms’ returns to capital to address these shortcomings, there is little evidence that the most profitable 10% of firms are pulling away from the rest of the economy, and the differences in firm returns in highly skilled and other industries shrink dramatically…”

More pushback at market power hypothesis. Paper finds that the divergence btw “star” firms and the rest of the economy is largely explained by mismeasurement of intangible capital. The leading firms produce and invest more per dollar of invested capital:

Laura Italiano, "People whose parents divorced when they were kids have lower ‘love hormone’ levels,"New York Post, September 10, 2020, https://nypost.com/2020/09/10/study-says-these-people-have-lower-love-hormone-levels/

“…The Baylor study, published in the Journal of Comparative Psychology, adds to the understanding of how early, parental stress — and the suppression of oxytocin that may result — could also be linked to adult outcomes. “What we found was that oxytocin was substantially lower in people who experienced parental divorce compared to those who did not,” Boccia said….”

James Bessen, Erich Denk, Joowon Kim and Cesare Righi, "Declining Industrial Disruption," Boston University School Of Law, February 2020, https://papers.ssrn.com/sol3/papers.cfm

“…Displacement hazards rose for several decades since 1970 but have declined sharply since 2000. Using a production function-based model to explore the role of investments, acquisitions, and lobbying, we find that investments by dominant firms in intangibles, especially software, are distinctly associated with greater persistence and reduced leapfrogging. Software investments by top firms soared around 2000, contributing substantially to the decline.Also, higher markups are associated with greater displacement hazards, linking rents positively with industry dynamism. While technology is often seen as disrupting industry leaders, it now appears to help suppress disruption…Instead, the evidence is most consistent with an explanation that emphasizes the role of proprietary software. We find that software stocks are significantly related to lower displacement rates across a variety of datasets and measures. Moreover,investments by large firms in self-developed software increased by an order of magnitude beginning in the late 1990s. This surge can account for most of the decline in leapfrogging rates and an instrumental variable analysis suggests the relationship is causal. Viewing these investments as endogenous sunk costs (Sutton 1991) provides a parsimonious explanation for the decline in Schumpeterian competition. Enabled by new technology, leading firms made large investments in managing complexity to improve the quality of their products and services, differentiating themselves from rivals and creating a “natural oligopoly.”Thus, it seems that technology has begun to play a new and different role in the economy. New technologies have been generally associated with increased disruption of industries and technology continues to disrupt industries and business models in general (newspapers, music). But now, it seems, information technology allows dominant firms to suppress their own “creative destruction,” decreasing disruption in this particular dimension…”

They find markups are actually associated with churn, “…We find, in fact, that higher markups are associated with greater industrial dynamism reflected by the displacement of industry leaders… We find that industries with higher markups actually have higher rates of displacement, implying that markups are not a reliable indicator of industry dynamism. Displacement hazards are negatively associated with industry concentration…”

Second they find the drivers of those shifts, “…explore the roles of different capital stocks in accounting for these shifts. We find that rising investments in intangibles generally and in software in particular can account for most of the drop in displacement and leapfrogging hazards since 2000. Intangible and software investments by top firms appear to impose a negative externality on second-tier firms, reducing their leapfrogging probabilities. Dominant firms increased their investment in software by an order of magnitude around 2000. Even relative to second-tier firms ranked 5-8, the top four firms more than doubled their software stocks. Moreover, using Census microdata and BEA industry data,it appears that this relationship is largely driven by own account (self-developed) software, which is substantially dominated by large firms. An instrumental variable analysis provides some support for the idea that the impact of own-account software on displacement hazards may be causal. We discuss why software might be playing this role….”

Their first finding is“…displacement and leapfrogging hazards exhibit a sharp break in trend: after rising robustly for many decades, they fell sharply starting around the year 2000… The picture that emerges is this: turnover of market leaders rose substantially from 1970 through the 1990s, but around 2000 the turnover rates began dropping. The change was sharp and substantial and across most sectors, suggesting a major shift in the nature of Schumpeterian competition…”

They measure turnover two ways, “…the annual displacement hazard that a firm ranked top four by sales in its industry falls out of the top four, and… theannual hazard that a firm ranked fifth through eighth leapfrogs into the top four….”

New Bessen looking at the turnover of dominant firms finds the inflection point was the late 1990s, when it rose substantially over previous decades but has since dropped as the internal proprietary software investment that drove churn now help to protect incumbents.

Thomas Astebro, Serguey Braguinsky, Yuheng Ding, "Declining Business Dynamism among Our Best Opportunities: The Role of the Burden of Knowledge," National Bureau Of Economic Research, September 2020, https://www.nber.org/papers/w27787

As evidence for this they point to, “…Consistent with the burden of knowledge increasing for founders,the years of work experience among founders shows a steady increase. The regression results imply thatthe average founder had about 14 percent longer post-PhD work experience in 2017 than in 1997.See Table A11. Further,Figure 2 illustrates a pronounced decline over time in the earnings of less experienced founders relative to their more experienced peers. Here, we separate less and more experienced founders by the median number of years after PhD (13 years), although other reasonable cut-offs lead to similar results. Between 1997 and 2001, founders with postPhD experience at or below the median earned more than the rest of the sample (consistent with Ouimet and Zarutskie, 2014), but by the 2010s, the situation is reversed, with less experienced founders earning on average 30-40 percent less than other founders. Prior work experience apparently is becoming much more valuable for founders over time. The earnings of less experienced founders declined not just in relative but also in absolute terms. The average inflation-adjusted earnings of founders with below the median post-PhD experience were $72,616 in 1997, whereas 20 years later their earnings were $57,517, a decline of more than 20 percent (Table A3 presents full survey data)…”

They suspect the driver of this trend is higher barriers to entry “the burden of knowledge”“…We argue and find that an increasing burden of knowledge also leads to fewer hightech high-opportunity startups. We argue and find that it also leads PhDs to amass greater work experience before becoming a founder, to shoulder more R&D tasks as founders, and not being rewarded for that extra work. Working for existing firms has, therefore, become considerably more attractive….”

They find, “….employ the nationally representative Survey of Doctorate Recipients to show a decline over the past 20 years in both the rate of startups founded and the share of employment at startups by the highest-educated science and engineering portion of the U.S. workforce….Figure 1 displays the large decline over the past two decades in the share of founders among PhDs in science and engineering. In 1997, 34 percent reported being a founder of a startup, but by 2017 this rate had declined to 21 percent, a decline of 38percent. This observation alone would not be sufficient to conclude that high-tech high-opportunity startups are on the decline because there could be fewer founding teams, but each could be getting larger. However, as also shown in Figure 1, the employment share of science and engineering PhDs at startups is also falling over time.4 The downward trend is not driven by any particular category of PhDs. For example, figures similar to Figure 1 for males versus females, whites versus non-whites, California versus the rest of the U.S., and for U.S. versus non-U.S. born PhDs differ in levels but their dynamics are almost exactly the same as those in Figure 1. See Figures A1-A6. The dramatically falling share of founders and employment at startups raises the prospect of a drying up of high-tech, high-opportunity startups.

Great new NBER paper implicitly supports Bloom'sAre Ideas Getting Harder To Find. They find that since 1997 the startup formation has declined for firms run by PhD's in science and engineering as “The Burden Of Knowledge” has increased, implies that institutional capabilities have grown even more important.

Matthew Klein, "Sure, the U.S. Can Cut Its Reliance on China. But Is It Worthwhile?,"Barrons, September 11, 2020, https://www.barrons.com/articles/sure-the-u-s-can-cut-its-reliance-on-china-but-is-it-worthwhile-51599854414

He read the same Setser post we did, “….As Brad Setser at the Council on Foreign Relations has noted, the lack of large trade imbalances elsewhere in the world right now means that America’s roughly $1 trillion trade deficit in manufactured goods is effectively funding China’s $1 trillion surplus, which in turn is supporting Chinese companies far above and beyond what they could earn from selling to their domestic market. That “could reinforce the return of pre-2008-style trade imbalances,” Setser warns, which would mean some combination of higher U.S. borrowing and lower U.S. employment. Chinese officials recognize the danger of their continuing dependence on the rest of the world’s consumers, but for various reasons, they haven’t been able to alter their own domestic political economy to change things. If the country that most desperately wants to “decouple” from the U.S. still hasn’t been able to pull it off—despite significant progress in doing so by some measures—it probably means that Americans determined to cut themselves off from China will have a tough slog ahead…..”

Matt Klein on US decoupling from China, it’s achievable (note these numbers are from 2015 so they don’t reflect the current deficits)“…At first glance, the costs of decoupling look modest, for the simple reason that China provides relatively little value to the U.S. economy to begin with. Using the Organization for Economic Cooperation and Development’s “trade in value added” data, less than 3% of U.S. domestic demand is ultimately satisfied by Chinese production. Most Americans’ needs are met by American companies and workers, whether it’s housing, health care, education, food, energy, or entertainment. Even in higher-value manufacturing industries where imports are far more important, such as pharmaceuticals, metals, machinery, electronics, and motor vehicles, Chinese production satisfies less than 9% of Americans’ needs.With enough time—and enough inducements to shift supply chains and offset the losses on the nearly $300 billion of investments that American companies have made in China over the past three decades—a determined push to reduce Chinese imports could therefore be successful…..”