Market power, innovation and inequality

In economics issues of competition, growth, and the distribution of their benefits have long been central concerns with the growing concentration of market power in the hands of corporations. Governments are faced with significant economic challenges:

• Why do a few companies dominate entire industries?

• Why has productivity growth slowed?

• Why is wealth inequality at levels not seen since the late 19th century?

In the US since the 1980’s market power has increased with average markups – price vs cost of production – have surged from 20% to 55% by 2020. However at the same time productivity growth has stalled with total factor productivity slowing from 1.55% in 1960 to 1980 period and just 0.77% in further decades. This has coincided with a significant increase in wealth inequality.

Market power and the inequality gap

Thomas Piketty in his book “Capital in the Twenty-First Century” explained his theory that revolves around the idea that economic inequality tends to increase over time, particularly when the rate of return on capital (r) exceeds the rate of economic growth (g) known as the return as the return gap ( r – g). A higher return gap increases inequality as wealthier households, who own assets, benefit form higher returns and save more, further increasing wealth. Poor households, who rely more on wages, see their incomes stagnate due to slower growth and higher markups. This leads to a more unequal society.

Barriers to entry and higher profits

There are many barriers to entry for new firms – economies of scale, brand loyalty, capital requirements etc. see mindmap below. When obstacles to entry into a market become stronger the incumbent firms can markup their prices and made additional profit. The higher profit increase the value of these firms, driving up asset prices and returns. However there is a downside to this in that when firms are dominating in the market there is the issue of complacency. If competition declines the knowledge sharing process weakens as opportunities for exchanging ideas diminish, reducing the efficiency of innovation and slowing economic growth. Furthermore, higher prices by dominant firms creates a wedge between the price of goods and the associated marginal costs i.e. wages. Therefore as prices rise real wages fall and slower growth means less chance of wage increases.

Growing wealth inequality gap

The wealth inequality gap is exacerbated by the saving behaviour of households. There are two reason for saving:

• Intertemporal substitution – for consumption in the future – pension, assets etc.

• Precautionary motive – unanticipated future spending needs

The lower income groups predominately save for precautionary reasons in case of adverse events while higher income groups provide savings for known events such as retirement or buying a house. An increase in asset returns encourages saving rather than spending now, but has little impact on those who are saving as a precaution against losing their income. Therefore wealthier households increase their savings at a higher rate than asset-poor households and further accumulating wealth.

Research found that with the increase in mark-ups and the slowdown in growth since 1980 have negatively impacted most households:

• The bottom 80% of wealth distribution – long-term spending reduced by roughly 34%

• The top 1% of wealth distribution gained with 0.1% long-term spending power increase by 30%

This shows that the rise in market power has benefitted a small fraction of the population. Weak competition lets dominant firms raise prices, suppress wages and stifle growth.

Source: The price of power: why markups hurt innovation and widen inequality. Centre Piece Summer 2025.

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