The first installment of this blog was a preliminary look at a Washington Post article “Is Amazon Getting Too Big?” by Steven Pearlstein. That article promoted strong opinions of Yale law school student Lina Khan based largely on (1) faulty market concentration estimates from President Obama’s Council of Economic Advisers and (2) a selective 40-year survey of mergers as evidence of some current problem linking concentrated markets to rising prices.
There was another bit of indirect evidence in the Obama CEA memo which merits discussion. A graph from former CEA Chair Jason Furman showed large recent gains in “returns on invested capital” among public nonfinancial firms, as measured by McKinsey & Co. The CEA insinuated that this shows a recent surge in “rents” (receipts larger than needed to attract capital) which they wrongly defined as “greatly in excess of historical standards.” There is a simpler explanation.
Return on invested capital is notoriously difficult to estimate and, as McKinsey explains, returns look relatively larger by this measure because invested capital has become smaller as the economy shifted from capital-intensive manufacturing to services and software:
“What if the invested-capital side of the equation approaches zero, as it increasingly does among companies that use outsourcing and alliances and thus reduce the capital intensity of parts of their businesses? Other businesses, such as software development and services, also have inherently low capital requirements or take advantage of atypical working-capital dynamics, including prepayment by customers for licenses and payment by suppliers for inventory. Even traditional businesses are shedding capital: the median level of invested capital for US industrial companies dropped from around 50 percent of revenues in the early 1970s to just above 30 percent in 2004.”
Like the CEA’s mention of a rising share of sales by Top 50 firms in 10 industries between two years, the CEA’s return on invested capital data also failed to uncover any new “market concentration” problem to be solved by the Democratic Party’s mysterious “Better Deal.”
Neither Khan, Pearlstein, nor their cited sources provide any evidence of (1) the alleged widespread increase in market share held by 3 or 4 firms, nor of (2) higher prices outside of federally-regulated and subsidized industries, nor of (3) any connection between concentration and monopoly pricing, nor of (4) any connection between return on invested capital and concentration or monopoly pricing.