Joseph Stiglitz writes: For 200 years, there have been two schools of thought about what determines the distribution of income – and how the economy functions. One, emanating from Adam Smith and nineteenth-century liberal economists, focuses on competitive markets. The other, cognizant of how Smith’s brand of liberalism leads to rapid concentration of wealth and income, takes as its starting point unfettered markets’ tendency toward monopoly.
For the nineteenth-century liberals individuals’ returns are related to their social contributions. Capitalists are rewarded for saving rather than consuming. Differences in income were then related to their ownership of “assets” – human and financial capital. Scholars of inequality thus focused on the determinants of the distribution of assets, including how they are passed on across generations.
The second school of thought takes as its starting point “power,” including the ability to exercise monopoly control or, in labor markets, to assert authority over workers. Scholars in this area have focused on what gives rise to power, how it is maintained and strengthened, and other features that may prevent markets from being competitive. Work on exploitation arising from asymmetries of information is an important example.
In the West in the post-World War II era, the liberal school of thought has dominated. Yet, as inequality has widened and concerns about it have grown, the competitive school, viewing individual returns in terms of marginal product, has become increasingly unable to explain how the economy works. So, today, the second school of thought is ascendant.
After all, the large bonuses paid to banks’ CEOs as they led their firms to ruin and the economy to the brink of collapse are hard to reconcile with the belief that individuals’ pay has anything to do with their social contributions.
In today’s economy, many sectors – telecoms, cable TV, digital branches from social media to Internet search, health insurance, pharmaceuticals, agro-business, and many more – cannot be understood through the lens of competition.
US President Barack Obama’s Council of Economic Advisers has attempted to tally the extent of increase in market concentration. The top ten banks’ share of the deposit market, for example, increased from about 20% to 50% in just 30 years, from 1980 to 2010.
Some of the increase in market power is the result of changes in technology and economic structure: consider network economies and the growth of locally provided service-sector industries. Some is because firms have learned better how to erect and maintain entry barriers, often assisted by conservative political forces that justify lax anti-trust enforcement and the failure to limit market power on the grounds that markets are “naturally” competitive. Large banks, for example, lobbied the US Congress to amend or repeal legislation separating commercial banking from other areas of finance.
The consequences are evident in the data, with inequality rising at every level, not only across individuals, but also across firms.
Joseph Schumpeter, one of the great economists of the twentieth century, argued that monopolies would only be temporary. There would be fierce competition for the market and this would replace competition in the market and ensure that prices Today’s markets are characterized by the persistence of high monopoly profits.
The implications of this are profound. If markets are based on exploitation, the rationale for laissez-faire disappears. Indeed, in that case, the battle against entrenched power is not only a battle for democracy; it is also a battle for efficiency and shared prosperity.