Market power, growth, and wealth inequality

In recent decades, the United States has experienced a notable rise in markups, a slowdown in productivity growth, and an increase in wealth inequality. We present a framework that unifies these trends into a common driving force. In particular, increased barriers to entry raise markups and boost corporate profits. Rising profits elevates firm valuations, fuels the demand for capital, and drives up asset returns. At the same time, the reduction in competition stifles overall economic growth. Wealth inequality is shaped by the return gap, r - g, which represents the difference between asset returns and the economy’s growth rate. The rise in capital demand together with a reduction in growth leads to a widening of the return gap, which amplifies inequality by affecting the saving patterns of households in different ways across the wealth distribution, deepening the divide between the rich and the poor. These trends result in substantial welfare losses for the majority of households, while only the top 1%, and especially the top 0:1%, experience gains.

Non-Technical Summary

From Washington to Brussels, policymakers are grappling with the dominance of a few companies in key industries, slowing productivity growth, and rising wealth inequality. These issues, highlighted by recent research, are central to today’s economic challenges. In the U.S., the average markup—the difference between the price firms charge and production costs—have surged since the 1980s, rising from 20% to 55% by 2020, reflecting increased market power. Meanwhile, productivity growth has slowed, and wealth inequality has reached levels not seen since the Gilded Age. These trends are interconnected, and understanding their links is crucial for effective policymaking.

But what exactly is the link between market power, growth, and inequality? We provide a framework that ties these trends together, offering new insights into how market power shapes the economy. Piketty popularised the idea that wealth inequality is driven by the difference between the rate of return on assets and the growth rate of the economy, or the return gap. A higher return gap increases inequality as wealthier households, who own more assets, benefit from higher returns and save more, further increasing their wealth. Poorer households, who rely more on wages, see their incomes stagnate due to slower growth and higher markups. This dynamic deepens the divide between the rich and the poor, leading to a more unequal society.

How does market power affect the return on assets and the growth rate? To answer this question, we build a macroeconomic model where large firms invest in innovation to gain market shares and where aggregate innovation pushes overall productivity growth. Uninsurable income risk generates wealth diversity across households.

Aggregate innovation contributes to the economy’s overall stock of knowledge, which functions as a public good. Firms continuously learn from one another, fostering a cycle of innovation and progress. However, when competition declines, this knowledge-sharing process weakens, reducing the efficiency of innovation and ultimately slowing economic growth.

In addition, lower competition also conveys some bad news for labour income, both in the present and in the future. Higher markups create a wedge between the price of goods and the associated marginal costs: wages. As markups rise, real wages fall. Additionally, slower economic growth further exacerbates this outcome, dampening the prospects for future wage increases, which are closely tied to productivity growth.

Why does a rise in the return gap exacerbate wealth inequality? Our theory demonstrates that a widening return gap exacerbates inequality by affecting the saving behaviour of households in distinct ways across the wealth spectrum. Poorer households, driven by the need to buffer against income risk, predominantly save for precautionary reasons, whereas richer households – having attained a high level of self-insurance – primarily save for intertemporal reasons. An increase in asset returns enhances the incentives for intertemporal substitution but has little impact on the precautionary motive. As a result, wealthier households respond more strongly to rising returns, increasing their savings at a higher rate than asset-poor households and further accumulating wealth.
Finally, we find that the increase in markups and the slowdown in growth since 1980 have led to substantial welfare losses for most households. For the bottom 80% of the wealth distribution, these losses amount to roughly 34% of long-run consumption. In contrast, the top 1% of households have seen significant gains, with the top 0.1% experiencing a 30% increase in consumption.

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