Edward Conard

Top Ten New York Times Bestselling Author

  • “Unintended Consequences should be read by anyone who takes for granted the superiority of progressive taxation and has not thought carefully about the trade-offs involved.” - The New Republic
  • “…reminds us that inequality sends a signal of what society lacks most, in America’s case, entrepreneurship and risk taking.” - Lawrence Lindsey, CEO, The Lindsey Group, former Director of the National Economic Council
  • “There are an amazing number of good ideas and interesting points made in Unintended Consequences. The thinking underlying it, and the obvious depth of understanding of the author, are very impressive.” - Steven Levitt, coauthor of Freakonomics; 2004 John Bates Clark Medal
  • “A full-throated defense of economic dynamism.” - The Wall Street Journal
  • “…a very valuable contribution.” - Larry Summers, former Secretary of the Treasury and director of the National Economic Council, president emeritus, Harvard University
  • “…serious thinking for serious thinkers. …a thought-provoking blueprint for growing middle- and working-class incomes.” - Mitt Romney, former Governor of Massachusetts
  • “…a very valuable contribution.” - Larry Summers, former Secretary of the Treasury and director of the National Economic Council, president emeritus, Harvard University
  • “…serious thinking for serious thinkers. …a thought-provoking blueprint for growing middle- and working-class incomes.” - Mitt Romney, former Governor of Massachusetts
  • “…a fresh argument for the productive value of inequality.” - David Autor, Professor of Economics, Massachusetts Institute of Technology
  • “…a comprehensive explanation of the modern economy.” - Julian Robertson, Founder, Tiger Management
  • “…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
  • “Unintended Consequences offers deep and well-argued analyses on almost every issue.” - The New York Times
Upside of Inequality Oxford Unintended Consequences

Cronyism

Research on favoritism, rent seeking, regulatory capture, subsidies, political connections, and barriers that protect incumbents. Coverage examines how cronyism weakens competition, misallocates capital, and limits productivity and growth.

AI Summary. An antitrust remedy barring Google from making payments or revenue-sharing deals for search distribution would spur more innovation and competition from both Google and its rivals, benefiting consumers. This approach is the opposite of European Union regulation, which pushes toward product stasis.

Ben Thompson Stratechery
Date Posted:

.@BenThompson argues that Google “stagnates by being too nice” to potential competitors. Banning default search deals, like the one that generates profits of ~$20B/year for Apple, would promote competition and ultimately benefit consumers.

Would banning payments for search distribution spur more innovation and competition?

Core argument: The author argues the remedy should be an injunction barring Google from making any payments or revenue share for search, on the view that consumers and Google are both better off if the company has more enemies.

I would also note that the behavior I am calling for — more innovation and competition, not just from Google’s competitors, but Google itself — is the exact opposite of what the European Union is pushing for, which is product stasis. I think the E.U. is mistaken for the exact same reasons I think Judge Mehta is right. There’s also the political point: I am an American, and I share the societal sense of discomfort in dominant entities that made the Sherman Antitrust Act law in the first place; yes, it’s possible this decision doesn’t mean much in the end, but it’s pushing in a direction that is worth leaning into. This is why, ultimately, I am comfortable with the implications of my framework, and why I think the answer to the remedy question is an injunction against Google making any sort of payments or revenue share for search; It has been very profitable to be Google’s friend; I think consumers — and Google — are better off if the company has a few more enemies.

Takeaways by Macro Roundup® AI

  1. The author argues the remedy should be an injunction barring Google from making any payments or revenue share for search, on the view that consumers and Google are both better off if the company has more enemies.
  2. The author contends the goal should be more innovation and competition from Google itself as well as its competitors, the opposite of the European Union's push for product stasis, which he considers mistaken.
  3. The author supports Judge Mehta's decision, citing the discomfort with dominant entities that made the Sherman Antitrust Act law, while allowing the ruling may not mean much in the end.

Related Articles:

  • Lax Merger Enforcement Is a Myth — A study of 84,985 mergers reported to U.S. antitrust agencies, of which 1,477 were challenged in court, finds that the likelihood agencies win fully litigated cases and the likelihood challenged mergers proceed to litigation both increased following the Chicago School's influence. The authors read this as a shift toward stricter judicial enforcement standards.
  • Trends in Competition in the United States: What Does the Evidence Show? — The authors argue the ratio of price to marginal cost, not market concentration, is the meaningful measure of market power. U.S. corporate pretax profits rose from 8.6% of GDP in the 1990s to 11.9% in the 2010s, but domestic profits were far flatter, with much of the gain from foreign operations.

AI Summary. The authors argue the ratio of price to marginal cost, not market concentration, is the meaningful measure of market power. U.S. corporate pretax profits rose from 8.6% of GDP in the 1990s to 11.9% in the 2010s, but domestic profits were far flatter, with much of the gain from foreign operations.

Carl Shapiro and Ali Yurukoglu National Bureau of Economic Research
Date Posted:

.@CarlShapiro finds that empirical evidence does not show a widespread decline in US competition and that “observed changes are likely to reflect competition in action.” For example, rising corporate profits % of GDP result from rising foreign earnings.

Does rising corporate profit share show weakening domestic competition?

Core argument: U.S. corporate accounting profits before tax averaged 9.0% of GDP in the 1970s, 7.7% in the 1980s and 8.6% in the 1990s, then rose to 9.8% in the 2000s and 11.9% in the 2010s.

Concentration metrics have no chance of being informative regarding product-market power. The ratio of price to marginal cost is a far more direct and meaningful measure of market power than market concentration. The left-hand panel of Figure 1 shows corporate accounting profits before tax as a share of GDP. Corporate profits averaged 9.0% of GDP during the 1970s, 7.7% during the 1980s, and 8.6% during the 1990s, then rose to 9.8% during the 2000s and 11.9% during the 2010s. A significant portion of the rise in corporate profits as a share of GDP is attributable to the foreign operations of U.S. firms, as shown in the right-hand panel of Figure 1. [If] U.S. antitrust policy was too lax over the past 40 years, one would expect to see a significant increase in domestic profits relative to GDP. But the time series of domestic profits over that time period is significantly flatter than the time series of total profits. The increase in the income/GDP earned on foreign operations by U.S. firms is likely driven by factors such as lower trade barriers, lower transportation costs, greater value abroad of the intellectual property owned by U.S. firms, and increased trade in services.

Takeaways by Macro Roundup® AI

  1. U.S. corporate accounting profits before tax averaged 9.0% of GDP in the 1970s, 7.7% in the 1980s and 8.6% in the 1990s, then rose to 9.8% in the 2000s and 11.9% in the 2010s.
  2. A significant portion of the rise in U.S. corporate profits as a share of GDP is attributable to the foreign operations of U.S. firms, and the domestic profit series is significantly flatter than the total profit series.
  3. The ratio of price to marginal cost is a more direct and meaningful measure of market power than market concentration, which the author argues has no chance of being informative about product-market power.

Related Articles:

  • Rising Markups and Declining Business Dynamism: Evidence From the Industry Cross Section — Across industries, larger increases in markups are not associated with larger declines in business dynamism—measured by new business entry rates and gross job or worker flows—and the correlation may even be positive. The authors conclude that rising markups as commonly measured are not a major explanatory factor behind declining dynamism.
  • The Economics of Inequality in High-Wage Economies — Information technology created investment opportunities exceeding the supply of properly trained talent, while trade with low-wage economies, low-skilled immigration, trade deficits, and aging demographics eased constraints on low-skilled labor and risk-averse savings. The author argues this framework, rather than rising cronyism, explains high returns to success, slowing productivity growth, and low interest rates.
  • The Concentration Conundrum; What To Do About Market Dominance — The largest US stocks make up a bigger share of the equity market than during the 2000 technology bubble, yet their valuations are lower than in earlier bubble episodes including the Nifty 50 of the early 1970s and Japan's late-1980s bubble. Today's dominant companies are also more profitable with stronger balance sheets.

AI Summary. Aggregate markups have stayed roughly constant during the current recovery and the recoveries following the 1991, 2001, and 2008 recessions, making their recent path unexceptional by historical standards.

Sylvain Leduc, Huiyu Li and Zheng Liu Federal Reserve Bank of San Francisco
Date Posted:

.@sffed analysis shows that “markup fluctuations have not been a main driver of the ups and downs of inflation during the post-pandemic recovery.” @huiyu_li @zliu001

Are markups driving the ups and downs of inflation?

Core argument: Aggregate markups have stayed roughly constant throughout the current recovery and the recoveries following the 1991, 2001, and 2008 recessions, making the path of the past three years not unusual by historical comparison.

The path of aggregate markups over the past three years is not unusual compared with previous recoveries. Figure 4 shows the cumulative changes in aggregate markups since the start of the current recovery (dark blue line), alongside aggregate markups following the 1991 (green line), 2001 (yellow line), and 2008 (light blue line) recessions. Aggregate markups have stayed roughly constant throughout all four recoveries.

Takeaways by Macro Roundup® AI

  1. Aggregate markups have stayed roughly constant throughout the current recovery and the recoveries following the 1991, 2001, and 2008 recessions, making the path of the past three years not unusual by historical comparison.

Related Articles:

  • How Do Firms Adjust Prices in a High Inflation Environment? — Interviews and a survey of about 700 businesses find average cost-to-price passthrough in the 60% range during a period of elevated inflation, with wide variation and some firms reporting passthrough above one. Firms report that demand strength, steady profit margins, labor and nonlabor costs, and competitors' prices shape pricing decisions.
  • “Greedflation” and the Profits Equation — The increase in nominal pretax U.S. business income since late 2019 equals about 17% of the increase in consumer spending excluding imputed rent over the same period, below the roughly 21% share of such spending that quarterly pretax business income has historically represented. On this measure, profit growth has been slightly low relative to a naive expectation.
  • Corporate Profits in the Aftermath of COVID-19 — Nonfinancial corporate profit margins—profits as a share of gross value added—rose to about 19% before easing to 15%, compared with about 13% before the pandemic. The authors attribute much of the increase to large direct government support for small and medium-sized U.S. businesses and to lower net interest expenses under accommodative monetary policy.

AI Summary. Government efforts to spur innovation raise the risk of expropriation through corruption, clientelism, or political favors, misallocating effort and resources. Corruption measures show a strong negative correlation with most innovation indicators, with research and development spending and researcher counts relative to output and population differing by 100% between the least and most corrupt countries.

Jose-Miguel Benavente, Claudio Bravo-Ortega, Pablo Egaña-delSol and Bronwyn Hall National Bureau of Economic Research
Date Posted:
Is Database:
Database

A cross-country statistical study provides robust evidence that expropriation risk such as corruption negatively impacts innovation by reducing productivity-enhancing activities including R&D. @NBERpubs

Does corruption reduce innovation and research spending across countries?

Core argument: R&D expenditure and the number of R&D researchers, measured relative to GDP and population, differ by 100% between the lowest and highest values of the authors' corruption index.

[Government activity to increase innovation] increases the risk of expropriation, such as corruption, clientelism or political favors, by the government, leading to a misallocation of efforts and resources. The International Country Risk Guide (ICRG) corruption index [evaluates] a country’s practices by asking if there are demands for special payments and bribes, exchange controls, tax assessments or police protection for those involved with trade and financial transactions, along with patronage, nepotism, job reservations, secret party funding, and ties between politics and business. We present the simple correlation between our corruption index and some innovative activity indicators. There is a strong negative correlation between most of the selected variables and our variable of interest. Relative to GDP and population R&D expenditure and the number of R&D researchers differ by 100% between the lowest and highest values of the corruption index.

Takeaways by Macro Roundup® AI

  1. R&D expenditure and the number of R&D researchers, measured relative to GDP and population, differ by 100% between the lowest and highest values of the authors' corruption index.
  2. The authors report a strong negative correlation between their corruption index and most selected indicators of innovative activity.
  3. The authors argue that government activity intended to increase innovation raises the risk of expropriation through corruption, clientelism, or political favors, leading to a misallocation of efforts and resources.

Related Articles:

  • Big Firms Have Different Incentives — Inventors who move to incumbent large firms and those who move to young small firms show indistinguishable patenting and earnings paths beforehand, then diverge afterward. The authors suggest large firms pay inventors more but assign them projects less likely to yield patents, including innovations less likely to threaten existing product lines.
  • Where Have All the “Creative Talents” Gone? Employment Dynamics of US Inventors — Data on over 760,000 US inventors show they are increasingly concentrated in large incumbent firms and less likely to work for young firms or become entrepreneurs; inventors hired by incumbents rather than young firms see earnings rise 12.6% while innovative output falls 6–11% over four years.
  • Mega Firms and Recent Trends in the U.S. Innovation: Empirical Evidence from the U.S. Patent Data — Analysis of US patent data finds that the largest firms are more likely to file novel patents even after controlling for size, industry, and patent counts, and that firms produce more novel patents as they become mega firms. Venture-backed startups also account for a disproportionate share of novel patents.

AI Summary. Market share is not a consistent indicator of firm performance, and many industries show a negative relationship between market share and profitability. Among industry-leading public firms in the dataset, 90 companies — 56% — have profit margins below their industry's median.

Daniel Rasmussen Verdad
Date Posted:
Is Database:
Database
Is Important:
Important

After examining all US and Canadian private and public firms with >$10mm in sales, @verdadcap concludes that the relationship between a firm’s market share and return on assets/equity is “virtually non-existent.”

Does higher market share mean higher profitability?

Core argument: Of the industry-leading public firms in the dataset, 90 companies—56%—have profit margins below their industry median, and it is rare for the number-one company in an industry to earn far above-market margins.

Market share is not a consistent indicator of firm performance. This finding holds true across industries, with many illustrating a negative relationship between market share and profitability. Companies earn their market share through a better product, better pricing, better service, or a litany of other firm-specific strategic decisions. It's actually quite rare to see the number-one company in an industry earning far above-market profit margins. In our dataset, 90 companies—or 56% of the industry-leading public firms—have margins below the industry median.

Takeaways by Macro Roundup® AI

  1. Of the industry-leading public firms in the dataset, 90 companies—56%—have profit margins below their industry median, and it is rare for the number-one company in an industry to earn far above-market margins.
  2. Market share is not a consistent indicator of firm performance, a finding that holds across industries, with many showing a negative relationship between market share and profitability.
  3. Companies earn market share through a better product, better pricing, better service, or other firm-specific strategic decisions.

Related Articles:

  • Rising Markups and Declining Business Dynamism: Evidence From the Industry Cross Section — Across industries, larger increases in markups are not associated with larger declines in business dynamism—measured by new business entry rates and gross job or worker flows—and the correlation may even be positive. The authors conclude that rising markups as commonly measured are not a major explanatory factor behind declining dynamism.
  • Surging Business Formation in the Pandemic: Causes and Consequences? — Shifts in consumer demand and in preferences for work and lifestyle during the pandemic created entrepreneurial opportunities, and applications to start businesses produced new firms and establishments that hired workers in large numbers. The authors argue these new businesses drew in quitting workers as founders or hires, implying economic restructuring across industry, geography, and firm size and age.
  • The Economics of Inequality in High-Wage Economies — United States Income, Wealth, Consumption, and Inequality Diana Furchtgott-Roth

AI Summary. Across industries, larger increases in markups are not associated with larger declines in business dynamism—measured by new business entry rates and gross job or worker flows—and the correlation may even be positive. The authors conclude that rising markups as commonly measured are not a major explanatory factor behind declining dynamism.

Brian Albrecht and Ryan Decker Federal Reserve Board
Date Posted:
Is Database:
Database
Is Important:
Important

Industries with the largest increase in markups between 1980 and 2016 saw smaller declines in dynamism. Larger increases in markups are not associated with larger declines in dynamism at the industry level.

Do rising markups explain declining business dynamism across industries?

Core argument: Across industries over 1980–2016, the authors find no negative correlation between changes in markups and changes in business dynamism, measured by new business entry rates and gross job or worker flows.

Looking across industries we do not find a negative correlation between changes in dynamism [new business entry rates and gross job or worker flows] and changes in markups over the 1980-2016 period; and the correlation may even be positive. In other words: larger increases in markups are not associated with larger declines in dynamism at the industry level. Our evidence strongly suggests that rising markups—as commonly measured in the literature on broadly rising market power—are not a major explanatory factor behind declining dynamism.

Takeaways by Macro Roundup® AI

  1. Across industries over 1980–2016, the authors find no negative correlation between changes in markups and changes in business dynamism, measured by new business entry rates and gross job or worker flows.
  2. The industry-level correlation between markup increases and dynamism may even be positive, so larger increases in markups are not associated with larger declines in dynamism.
  3. The authors conclude their evidence strongly suggests that rising markups, as commonly measured in the literature on broadly rising market power, are not a major explanatory factor behind declining dynamism.

Related Articles:

  • Surging Business Formation in the Pandemic: Causes and Consequences? — Shifts in consumer demand and in preferences for work and lifestyle during the pandemic created entrepreneurial opportunities, and applications to start businesses produced new firms and establishments that hired workers in large numbers. The authors argue these new businesses drew in quitting workers as founders or hires, implying economic restructuring across industry, geography, and firm size and age.
  • America’s New Business Boom — The share of US workers employed by young firms is rising for the first time in decades, with 11.3% of jobs at firms less than 5 years old and 8.6% at firms 6–10 years old. Gains in the share of jobs at firms under 5 years old were larger in transportation and warehousing, management and information, and manufacturing.
  • The Economics of Inequality in High-Wage Economies — United States Income, Wealth, Consumption, and Inequality Diana Furchtgott-Roth

AI Summary. U.S. patent ownership has grown more concentrated over recent decades, a pattern that can affect how innovation spreads, alongside a rise in patent litigation. Annual litigation cases per 100 granted patents rose from about 1.2 in the early 1990s to roughly 1.5 in 1995–2010 and above 1.8 in 2010–2015.

Ufuk Akcigit, Sina Ates and Craig Chikis Economic Innovation Group
Date Posted:

A new paper documents weaker technological diffusion in the economy and relates that to higher concentration of patents and a rise in patent litigation, factors that benefit incumbents and harm new entrants. @ProfUfukAkcigit @UChi_Economics

Has U.S. patent ownership grown more concentrated alongside rising patent litigation?

Core argument: U.S. patent litigation cases filed per 100 granted patents rose from about 1.2 in the early 1990s to roughly 1.5 between 1995 and 2010, then above 1.8 between 2010 and 2015, receding only marginally since.

Patent concentration, which can affect diffusion, has risen over the past several decades with a concurrent surge in patent litigation cases. In the post-1980 period, a parallel trend concerning patents in the U.S. has been the dramatic increase in the number of patent cases filed, which some authors have dubbed the “patent litigation explosion.” The annual number of litigation cases filed per 100 granted patents rises from about 1.2 in the early 1990s to an average of about 1.5 between 1995 and 2010, before rising again to more than 1.8 between 2010 and 2015 and only receding marginally since then.

Takeaways by Macro Roundup® AI

  1. U.S. patent litigation cases filed per 100 granted patents rose from about 1.2 in the early 1990s to roughly 1.5 between 1995 and 2010, then above 1.8 between 2010 and 2015, receding only marginally since.
  2. Patent concentration in the U.S. has risen over the past several decades alongside a surge in patent litigation, a post-1980 trend some authors have dubbed the "patent litigation explosion.".
  3. Rising patent concentration can affect the diffusion of innovation.

Related Articles:

AI Summary. The authors propose that the divergence between rising US aggregate profit rates and falling financial market rates reflects a mismatch: national accounts measure returns on capital for all firms, while market rates capture the cost of capital for public firms only. They find public-firm profit rates halved while private-firm profit rates rose, averaging 10% above public firms.

Carter Davis, Alexandre Sollaci and James Traina Social Science Research Network
Date Posted:
Is Database:
Database
Is Important:
Important

Public firms’ returns on the book value of assets are down ~ 50% from 1980 and private firms’ returns have doubled. @EconTraina @ASollaci @CarterDavisFin

Why do aggregate profit rates rise while market rates fall?

Core argument: Public-firm profit rates halved since 1980, matching trends in financial markets and suggesting low market power, while aggregate profit rates in the national accounts rose—a mismatch the authors attribute to measuring the return on capital for all firms versus the cost of capital for public firms only.

Why have US aggregate profit rates increased while financial market rates decreased since 1980? We propose a mismatch hypothesis: Profit rates in the national accounts track the return on capital for all firms, while financial market rates track the cost of capital for public firms only. We show public-firm profit rates halved since 1980, matching trends in financial markets and suggesting low market power. Mechanically, this residual private capital return series shows private capital returns had to have increased substantially to account for this secular break between aggregate and public firm profitability. The degree of this shift is significant: Private firms’ profit rates are on average 10% higher than public firms’ in the post-2000 period. Nonfinancial domestic private-firm profit rates doubled, suggesting high market power or risk. Size and sector differences cannot explain the divergence, though intangible-intensity might. Our results indicate substantial biases in extrapolating public-firm trends to the aggregate economy.

Takeaways by Macro Roundup® AI

  1. Public-firm profit rates halved since 1980, matching trends in financial markets and suggesting low market power, while aggregate profit rates in the national accounts rose—a mismatch the authors attribute to measuring the return on capital for all firms versus the cost of capital for public firms only.
  2. Private firms' profit rates averaged 10% higher than public firms' after 2000, and nonfinancial domestic private-firm profit rates doubled, which the authors say suggests high market power or risk.
  3. Size and sector differences cannot explain the divergence between private and public firm profitability, though intangible-intensity might, and the authors conclude that extrapolating public-firm trends to the aggregate economy carries substantial biases.

Description automatically generated “…Why have US aggregate profit rates increased while financial market rates decreased since 1980? We propose a mismatch hypothesis: Profit rates in the national accounts track the return on capital for all firms, while financial market rates track the cost of capital for public firms only. We show public-firm profit rates halved since 1980, matching trends in financial markets and suggesting low market power. Mechanically, this residual private capital return series shows private capital returns had to have increased substantially to account for this secular break between aggregate and public firm profitability. The degree of this shift is significant: Private firms’ profit rates are on average 10% higher than public firms’ in the post-2000 period. Nonfinancial domestic private-firm profit rates doubled, suggesting high market power or risk. Size and sector differences cannot explain the divergence, though intangible-intensity might. Our results indicate substantial biases in extrapolating public-firm trends to the aggregate economy….”

The Evidence

Public-Firm Profits Have Fallen

“…Figure 8 shows the return on book capital with separate corrections for R&D and goodwill. This figure shows our adjustments make little difference to the series. Indeed, our results show book capital profit rates are decreasing and other results in this paper are robust are a variety of different treatments of R&D and goodwill. We show the book profit rates Rb for both the IMA data and the Compustat sample in Figure 9. The two series follow each other fairly closely until the mid 1990s, when the publicly listed firm book profit rate drops markedly below the IMA book profit rate. Since then, public firm profits have fallen relative to profits in the national accounts. Figure 9 illustrates the importance of using a representative sample of firms to measure the cost of capital. Since the profit rates of public firms are different from those of private firms, it is not appropriate to apply measures of the cost of capital from public firms to the aggregate economy, which includes private firms….”

“…One alternative to analyzing the return on book in public-firm and aggregate data is to impute the replacement value of capital in Compustat using information from the IMAs. The IMAs provide the replacement and book values of the aggregate capital stock. By assuming the ratio of replacement-to-book values is the same in Compustat, we can infer the return on capital R of publicly listed firms. This approach highlight the quantitative differences in the two profit rates and their secular divergence in recent decades The left panel of Figure 10 shows the ratio of the replacement value of capital to the book value for inventories; property, plant, and equipment (PPE); and intellectual property products (IPP). Since the replacement value is typically above the book value, most of these series are above one most of the time. We can use these three series to transform our book capital profit rates back into our profit rates from above with replacement capital values, assuming Compustat firms have the same replacement-to-book ratios as in the IMA data. The right panel of Figure 10 shows this replacement-to-book ratio from the IMA data, leading to the same conclusion as before: public company profit rates have fallen….”

Increase in Private-Firm Profit Rates

“…If there is no mismeasurement of foreign and domestic activity, this residual return constitutes the return on capital for private firms in the US. We label this the private return on capital, with the important caveat that this measure has issues of measurement of foreign vs domestic activity. Figure 14 shows these results. Mechanically, this residual private capital return series shows private capital returns had to have increased substantially to account for this secular break between aggregate and public firm profitability. The degree of this shift is significant: Private firms’ profit rates are on average 10% higher than public firms’ in the post-2000 period….”

Potential Causes of Divergence

“…The first hypothesis we consider is that Compustat overrepresents large firms, so perhaps the secular shift is just driven by changes in the profit rates of large firms relative to those of smaller firms. The second hypothesis we consider is that public and private firms generally operate in different sectors Our third hypothesis posits that the disparity in profit rates between public and private firms can be attributed to the relative concentration of intangible assets capital as intangible instead of physical. To investigate this theory, we will examine whether the difference in profit rates between firms that are heavily invested in intangible assets and those that have a lower concentration of such assets explains the gap in return on the capital between public and private companies….”

“…To understand exactly how representative public firms are of the aggregate economy, we plot the number of employees, as a fraction of aggregate employment, of various types of firms. We use both BDS and Compustat employment data to make the comparison. The left panel of Figure 16 shows the employment share of primarily goods-producing (instead of primarily service-providing) Compustat and BDS firms. The BDS series shows goods production has declined in aggregate in terms of employment shares. The Compustat series shows this decline has been less pronounced for public firms. The right panel of this figure shows the fraction of employment of mega-firms in the economy overall (see the BDS series) and the fraction of public mega-firm employment from Compustat. Note that a fairly stable 30% of aggregate employment is at mega-firms, while 80% or more of total public-firm employment is at mega-firms. Unsurprisingly, Compustat is not representative in terms of sector or firm size…”

“…Figure 17 combines the weights from 16 and shows neither the firm size nor sectoral composition hypotheses alone can explain the public and private firm mismatch. The left panel shows the rewighted Compustat book returns for both the goods and services sectors. The service sector has lower returns than the goods sector, so the over-representation of goods-producing firms in Compustat means the public and private firm mismatch is all the more puzzling. The right panel shows the reweighted book returns for Compustat mega-firms and other Compustat firms, revealing that mega-firm trend returns are higher than small-firm returns. Since public firms are disproportionately mega-firms, this also fails to explain the mismatch. Note the figure only shows public firm returns by sector and size because private firm returns are not freely available. Neverthless, reweighting suggests that neither size nor sectoral composition alone can explain the divergence in profit rates of public and private firms–otherwise we would expect to see the same divergence in trends between those groups within public firms….”

“…To determine if the trend of the public-private mismatch is influenced by firms that are heavily invested in intangible assets, we compared the return on capital of firms with R&D to book capital ratios above the median to those with lower ratios. The results, depicted in Figure 18, reveal there is no significant difference in returns on capital between the two groups of firms. This suggests the discrepancy in the concentration of intangible assets between public and private firms is not a driving factor behind the public-private return on capital mismatch….”

The Brass Tacks

“…In the US, aggregate profit rates have increased while financial market rates have decreased since 1980. We call their gap the “puzzle rate” and its rise the “profit puzzle.” The profit puzzle has led to suggestions that rising markups, risk, or intangible capital are contributing factors. In this paper, we propose an alternative hypothesis: Profit rates in the national accounts track the return on capital for all firms, while financial market rates track the cost of capital for public firms only. The capital profiles of public and private firms differ and vary over time, which can lead to financial market rates misrepresenting the cost of capital faced by a representative firm. Supporting this view, there is a large literature in asset pricing documenting higher returns for private firms compared to public firms. We call thisexplanation the “mismatch hypothesis.” To test our hypothesis, we analyze data on public-firm profit rates and find they have halved since 1980, matching trends in financial markets. Our results are robust to assumptions about the capitalization of R&D and goodwill, as well as the measurement of capital stocks at book or replacement value. When adjusted for differences in depreciation and tax rates, we find a tight link between the return on and cost of public-firm capital. The puzzle rate for public firms is small and well within statistical discrepancy. Hence, we view the mismatch hypothesis as a promising solution to the profit puzzle. Subsetting to nonfinancial domestic firms so we can compare Compustat and the IMAs, we estimate public firms represent 60% of the capital stock. Inferring from the residual, we find private-firm profit rates moved in lockstep until 1980, when they diverge. Private-firm profit rates are now over twice as high as public-firm profit rates. We show this secular shift is not driven by differences in the representation of size or sector of public-firms, though intangible-intensity offers a promising direction for future research….” Carter Davis, Alexandre Sollaci and James Traina, “Profit Puzzles,” Kelley School of Business Research Paper, February 1, 2023, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4015573

Steve Comment: had a few questions about your “Profit Puzzle” paper. I’m sitting here looking at Figure 14 and find the results really surprising. Could the divergence btw private and public firm profits (given your using return to capital) largely be a function of the lower capital the intensity of private service firms? I’m shocked at the public firm series. I would have thought that would have had an upward slope given US firms’ international profits. Are taxes skewing this (Apple booking stuff in Ireland, etc)?

James Traina Comment: Thank you for reading! Capital intensity and tax differences are good hypotheses here. For the former, could you expand on what you have in mind? e.g. Are you thinking about physical vs financial capital differences? For the latter, we show in the “Solving the Puzzle” section that public vs aggregate tax rate differences are there, but they’re small and actually pointing the other way — they’re higher for public firms. That also relates to the rise of S-corps, which folks have attributed to tax advantages. The international dimension is much harder because we don’t have good data on it. Basically, there’s still a mismatch when we make our comparisons because “domestic” in Compustat means US incorporation, while “domestic” in the IMAs means US operation. It’s hard to say which direction this would bias our results. One thing that I find helpful to think about, but we didn’t fit into the paper: You can find the same kinds of results in *all* the standard profits / capital measures, e.g. ROA, ROIC, etc. So any explanation would have to work for all these measures jointly.

Steve Comment: Yes I have in mind firms of engineers, architects, or lawyers that have little physical or financial capital, but a lot of human capital. Could those firms be driving the high ROI of private firms relative to public? I’m genuinely curious about this, because it feels like a failure of economic efficiency to have private firms yielding so much more than public firms.

James Traina Comment: Ah yes, that’s possible! You’d need an accounting mismeasurement, though, where it doesn’t show up in labor income. You might be interested in this paper: https://bfi.uchicago.edu/insight/research-summary/the-rise-of-pass-throughs-and-the-decline-of-the-labor-share/ Public firms’ returns on the book value of assets are down ~ 50% from 1980 and private firms’ returns have doubled. @EconTraina @ASollaci @CarterDavisFin (135)