Robin Hanson’s take on the rising margins debate, Karl Smith too

He has a long post, with many points of interest, here is the concluding section:

If, like me, you buy the standard “free entry” argument for zero expected economic profits of early entrants, then the only remaining explanation left is an increase in fixed costs relative to variable costs. Now as the paper notes, the fall in tangible capital spending and the rise in accounting profits suggests that this isn’t so much about short-term tangible fixed costs, like the cost to buy machines. But that still leaves a lot of other possible fixed costs, including real estate,  innovation, advertising, firm culture, brand loyalty and prestige, regulatory compliance, and context specific training. These all require long term investments, and most of them aren’t tracked well by standard accounting systems.

I can’t tell well which of these fixed costs have risen more, though hopefully folks will collect enough data on these to see which ones correlate strongest with the industries and firms where markups have most risen. But I will invoke a simple hypothesis that I’ve discussed many times, which predicts a general rise of fixed costs: increasing wealth leading to stronger tastes for product variety. Simple models of product differentiation say that as customers care more about getting products nearer to their ideal point, more products are created and fixed costs become a larger fraction of total costs.

As always, I am very pleased to have Robin as my colleague and friend.  And from Karl an excellent post, his conclusion:

The sweeping away of the small generalized firm made room for the rise of increasingly specialized local businesses, offering what might think of as a more artisanal experience. These firms have increased markups, but those markups don’t represent a lack of competition. Instead, they represent a return to the particular skills or vision necessary to make a specialized product. Economists refer to this market pattern as monopolistic competition, and it is the source of variety that consumers in a wealthy developed economies desire.

If my story is correct, then the trend towards higher markups is indeed linked to the major changes sweeping the American economy. However, it isn’t the cause of them. Its another consequence of the massive changes introduced by globalism and the radical changes in retailing.

There are additional points of interest at the link.


Or maybe massive immigration in recent decades has given capitalists the upper hand over labor?

Nail, meet Steve Sailer's hammer. If that were the case, corporate profits would be much higher than they are, as Tyler and others have pointed out.

Corporate profits are much, much higher than in, say, the early 1980s.

Corporate profits are high. How high do they need to be before this explanation becomes convincing to those like Tyler?

Maybe when the share of the economy, not to mention the share of profits, devoted to the financial industry goes back to its early 80s share too?

'As the New Deal regulations were slowly dismantled, the financial sector growth accelerated along with risks and speculation. The employment and total sales of the finance industry grew from 10% of GDP in 1970 to 20% by 2010. The emphasis was no longer on making things - it was making money from money.

At the same time the manufacturing industry fell from 30% of GDP in 1950 to 10% in 2010. The finance industry swelled as the rest of the economy weakened. The disproportionate growth of finance diverted income from labor to capital. Wall Street profits rose from less than 10% in 1982 to 40% of all corporate profits by 2003.'

"‘As the New Deal regulations were slowly dismantled . . . " Please provide list.

Anyhow, some call it "financial fascism." The Fed and banks (the ones working people use) have kept interest rates far too low for far too long. Recently, as the Fed raised the Federal Funds targets and prime rate rose from 3.5% to 4.25%, banks' net interest margins have risen largely because (loan growth has been 3%, or so) banks reap escalating spreads on loans while refusing to raise rates on FDIC-insured deposits.

Of course, deposits are guilty of not voting with their feet.

The free lunch economics central planners do everything possible to promote high profits for everything they can control, and if high profits are not possible, seek to export the sector from the US after consuming and liquidating all capital in the sector.

The latter called liberating wealth, or similar, by the "activist investors". For example, Sears suffered from this activism. Consider that Sears was the original Amazon. Sears eliminated most of its mail order just as mail order was resurgent with LL Bean, Lands End, and others plus home shopping network TV. Flash in the pan Internet retailers like Buy.Com could quickly deliver orders using the warehouse order shippers created for the home shopping networks which expected to offer instant online ordering using set top boxes.

So, with 80 years experience in mail order, how is it that Sears sealed it's doom?

Hey, it had to generate high profits by cutting labor costs and assuming that everything will remain constant: brink and mortar is big shopping malls. Mail order was the past in the 80s with zero future, so Sears should cut costs by ending it, and definitely not increase wasteful spending paying workers to cater to a niche market of shut-ins.

What Walmart is doing to compete with Amazon, ship to store, or home, and return to store, Sears did in the 60s a lot, because my family poured through Sears catalogs in the store to order stuff rather than mail in forms, and then returned in a week or two to pick up our order, without shipping charge.

I never stopped doing mail order because of my interests in electronics, but I also ordered books mail order in the 70s and 80s because there were no book stores that handled technical books until B&N where I lived. But the same was true for many other interests.

Sears originally carried everything as far as I understood them, but Walmart carried just three, cheap, middle, premium, because that cut stocking costs and higher unit volumes meant lower unit costs, customer presence be dawned.

Rather than focusing on not being Walmart or Kmart, Sears tried to become them, but it could not overcome it's built in costs, like high value real estate or upscale expecting customers.

The value of the Sears brand is likely lost to most, as I'm 70 and grew up when Sears was as well known and trusted as Amazon today.

Another obvious change besides the impact of immigration over the last 35 years or so is the collapse of interest in anti-trust (anti-cartel/monopoly) enforcement.

For example, Piketty's bestseller implies that criticism of Carlos Slim is racist. Slim's crooked monopoly that has extracted a vast amount of money from the pockets of ordinary Mexicans is simply not a concern anymore even for a left wing economist like Piketty.

Is it all that surprising that capital benefits enormously when anti-cartel laws are seen as out of date?

Globalist theory asserts that cartels that cross international borders are virtually impossible. Yet there was Matt Damon movie ("The Informant!") about a notorious international price-fixing scam.

Here's a fun example brought to my attention by MR about economist John Connor who has gotten rich by specializing in the study of international cartels, which he testifies against:

If you read Hanson & Smith's posts, both focus on the stylized fact that virtually all of this increase in markup is coming from small businesses. So anti-trust seems right out. Is there a reason we should expect immigration to be particularly important for small businesses relative to large ones?

A third suggestion is that business is simply more ruthless today about maximizing stockholder wealth than in, say, the 1970s.

The key historical figure in this shift, to my mind, would be Michael Milken.

That he got sent to prison by Republican Administrations probably slowed the shift. But the reluctance of the last two Democratic Presidents to send financiers to jail has probably cemented Milken's legacy.

I would be surprised if the data support the "higher fixed costs" assumption. As a recently retired business person (not an economist), the trend i saw was much more to increase the share of variable cost in the P&L via outsourcing, use of consultants vs. paid staff, etc. I have not read the margin article, but would wonder if the rise in "mark-up/margins" has more to do with industry mix.

If margins are rising so much, wouldn't we see this in earnings numbers?

Between 1960 and 2016, S&P500 earnings per share grew by 6.6% per year on average (CAGR).

Over the last 50, 40, 30, 20, and 10 years, earnings per share have grown 6.3%, 6.1%, 6.8%, 4.9%, 3.1%.

I'm sorry, can you repeat the question?

Does anyone really trust reportted earnings these days? And which measure of earning?

As a big cap tech analyst, I see three key dynamics driving extraordinary profitability. First, these companies are global and can scale fixed costs (mostly R&D) across a larger customer set, simultaneously driving down per user costs, driving up product performance, and increasing profits. Second, they benefit from increasing economies of scale due mostly to network effects - most highly profitable tech companies are really networks of customers/developers/advertisers. This means that the networks become more socially valuable as more users are added. They are natural monopolies/oligopolies, in winner-takes-all industries, though the various tech monopolies tend to invade each other's turf. Third, they are mostly structured as design/software companies, where the most valuable slice sits atop a larger dollar, low margin hardware infrastructure, such as the Internet (though certain network operators have nice profits too). Apple is an example of a hybrid, though even Apple outsources its hardware manufacturing. Thus, the low margin part gets outsourced, mostly to other countries, and we don't see those costs, while the high margin part gets reported in US GDP and shown to investors.

As far as the finance industry, the economic structure is very different. Portions are very fragmented into high return partnerships due to labor's control over the intellectual property, while distribution gets concentrated with lower returns, with significant tension between the two.


Imagine if Apple had to run all those factories in China instead of just placing order to them. I suspect margin would go down big time.

Also, notice how Apple has its own stores: disintermediation has occurred in almost all industries now.

By removing layers of wholesalers and distributors, you would increase average margin, but through competition, actual prices would stay the same or even be lower.

Imagine a product that is imported from China by an importer, who sells to a wholesaler, who sells to a distributor, who sells to a retailer...this is how it worked back in the day.

So, mark up might be: 30%, 30%, 50%, 100%. Average is around 50%.

Now imagine a chain store that imports directly from China. It keeps the same 100% mark-up. The other people die off. Average has now doubled. But consumer price could actually be lower.

Should modern economics jetison or significantly revise it's view of fixed costs when taking account of the modern treatment of (often very accellerated) depreciation that allows complete recaputre of the costs?

To the ABC group, how well would the treatment of such tax laws fit with malinvestment and cycle theory?

Karl's interpretation is the only one that makes sense of the strangely overlooked observation in the Princeton - Univ of London paper that markups have been higher in smaller firms. Which observation perplexes me for a variety of reasons. Although one explanation may be the decisions of a handful of giant firms like WalMart & Amazon to favor scale over margin.

I think Robin's points are all well taken, although they don't integrate well with the observation above. Branding-to-scale is non-formulaic (Lamborghini; Apple).

Outsourcing, downsizing, cost reduction missions generally, and corporate breakups, will explain a lot. There is a synthetic fabric operation in the Midwest, name slips my mind, that was owned by Solutia, a diversified chemicals company. When nat gas was $4-5, plant was uneconomic. They were going to shut it down but at the last minute, a tiny LBO firm took it off their hands for like $1 million. Then shale gas happened. With nat gas in the $2s, the one-plant firm mints money. But the larger firm's margins also appear to have risen because the plant's losses were removed from its overall books.

I think the categories of fixed/variable/marginal cost, like all attempts to place definitions on complex human activity, are of limited utility. Two years ago, the break-even price per barrel of shale oil was around $50. Now it's in the $30s. In just two years. What was fixed / variable marginal in that? A number of exploration leases are 3 years long. Is that fixed or variable?

The company I could not remember was Ascend Performance Materials, and the purchase price was $50 million. One year later, it was valued at over $1 billion. It's fun to read Solutia's Q2 2009 earnings call, how they didn't think nylon had a long term future.

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