Category Archives: competition

16/7/18: Wither Free Market America


Prior to the 1990's, “U.S. markets were more competitive than European markets”, with the U.S. having a lead-start on the EU of some decades, if not centuries, when it comes to the anti-trust laws and anti-true enforcement. In fact, as noted by Germán Gutiérrez and Thomas Philippon in their new paper “HOW EU MARKETS BECAME MORE COMPETITIVE THAN US MARKETS: A STUDY OF INSTITUTIONAL DRIFT” (NBER Working Paper 24700 http://www.nber.org/papers/w24700 June 2018), it was Europe that largely copied the U.S.  legal and regulatory frameworks for dealing with excessive concentration of the market power. Thus, given the “initial conditions, one would have predicted that U.S. markets would remain more competitive than European (EU) markets.” Except they did not. As Gutiérrez and Philippon show, the U.S. “experienced a continuous rise in concentration and profit margins starting in the late 1990s. And, perhaps more surprisingly, EU markets did not experience these trends so that, today, they appear more competitive than their American counter-parts.”

“Figure 1 illustrates these facts by showing that profit rates and concentration measures have increased in the US yet remained stable in Europe. In addition, note that the U.S the increased integration among EU economies essentially shifts the appropriate measure of concentration from the red dotted line towards the blue line with triangles – which further strengthens the trend."

Figure 1: Profit Rates and Concentration Ratios: US vs. EU

Source:  Gutiérrez and Philippon (2018)

So, in summary, today, “European markets have lower concentration, lower excess profits, and lower regulatory barriers to entry.” even looking at specific industries “with significant increases in concentration in the U.S., such as Telecom and Airlines, and show that these same industries have not experienced similar evolutions in Europe, even though they use the same technology and are exposed to the same foreign competition” (see chart below).


Source:  Gutiérrez and Philippon (2018)

Of course, the point of reduced degree of competition in the U.S. markets is hardly new. I wrote about this on numerous occasions, including covering evidence on the U.S. markets monopolization, oligopolization and markets concentration risks (see links here: http://trueeconomics.blogspot.com/2018/05/24518-america-medici-cycle-and.html) and I wrote about these phenomena in the context of the growing trend toward de-democratization of the U.S. politics (see: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3033949).  Hence, the main issue with this evidence is: “what explains the U.S. trend in contrast to the EU?”

Gutiérrez and Philippon (2018) argue that politicians care about consumer welfare but also enjoy retaining control over industrial policy. We show that politicians from different countries who set up a common regulator will make it more independent and more pro-competition than the national ones it replaces.” In other words, once politicians surrender control to a multinational institution (e.g. the EU or ‘Brussels’ or, in the case of Switzerland, to the umbrella-type Federal Government), they tend to favour such new institutional arrangement to be more independent from national politics.

Hence, as Gutiérrez and Philippon (2018) more, “European institutions are more independent than their American counterparts, and they enforce pro-competition policies more strongly than any individual country ever did. Countries with ex-ante weak institutions benefit more from the delegation of antitrust enforcement to the EU level. “ These dynamics are reflected in the switch from the ’average of the nation states’ red dotted line in the chart above, toward a unified EU-wide measure reflected by the blue line.

This theoretical view produces three treatable hypotheses: if Gutiérrez and Philippon (2018) are correct, then:
1. EU countries agree to set up an anti-trust regulator that is tougher and more independent than their old national regulators (and the US)
2. US firms spend more on lobbying US politicians and regulators than EU firms.
3. Countries with weaker ex-ante institutions benefit more from supra-national regulation.

For Hypothesis 1, the authors look at merger and non-merger reviews and remedies that form “an EU-level competency”. Gutiérrez and Philippon (2018) “show that DG Comp is more independent and more pro-competition than any of the national regulators, including the U.S.” Furthermore, “enforcement has remained stable (or even tightened) in Europe while it has become laxer in the U.S.” More ominously (for the consumption-based economy like the U.S.), product market regulations, usually a shared competency between the member state and the EU, the authors “find that the EU has become relatively more pro-competition than the U.S. over the past 15 years. Product market regulations have decreased in Europe, while they have remained stable or increased in the U.S.”

For Hypothesis 2: Gutiérrez and Philippon (2018) look at political expenditures, and show that “U.S. firms spend substantially more on lobbying and campaign contributions, and are far more likely to succeed than European firms/lobbyists.”

For Hypothesis 3: Gutiérrez and Philippon (2018) show that “EU countries with initially weak institutions have experienced large improvements in antitrust and product market regulation. Moreover, we find that the relative improvement is larger for EU countries than for non-EU countries with similar initial institutions.”

There is, of course, a remaining issue left unaddressed by the three hypotheses above: does more enforcement by more independent regulators inhibit innovation and competition? In other words, is European advantage over the U.S. a de facto Trojan Horse by which inhibiting regulation enters the markets? Gutiérrez and Philippon (2018) “find no evidence of excessive enforcement in Europe: enforcement leads to lower concentration and profits but we find no evidence of a negative impact on innovation. If anything, (relative) enforcement is associated with faster future (relative) productivity growth, although the effects are small.”

So, put simply, part of the increasing market concentration and power in the U.S. can be explained by the tangible politicization of the American regulatory environment. Of course, as noted in my own posts on the subject (see link above), this political channel for monopolization reinforces industry structure channel (ICT ‘disruption’ channel) and other channels that support increased market power for dominant firms. All of this, taken together, means one thing: the U.S. is falling dangerously behind in terms of the degree of its economy openness to challengers to the dominant firms, resulting in barriers to entrepreneurs, innovators and smaller enterprises. The costs of this ‘Google Syndrome’ are mounting, ranging from depressed wages, to jobs insecurity, to lack of investment and productivity growth, to growing voters unease with the status quo.

The premise of the Free Markets America no longer holds. Worse, Social(list) Europe is now beating the U.S. in its own game.

18/4/16: Rollover Risk, Competitive Pressures & Capital Structure of the Firm


Capital structure of the firm, as we discussed in our MBAG 8679A: Risk & Resilience:Applications in Risk Management class in recent weeks, is about counter-balancing equity (higher cost capital with greater safety cushion for the firm) against debt (lower cost capital with higher risk associated with leverage risk). As we noted in some extensions to traditional models of leverage risk, decision to take on new debt as opposed to issue new equity can also involve considerations of timing and be linked to future expected funding demands by the firm.

An interesting corollary to our discussions is what happens when risk of debt roll-over at maturity enters the decision making tree.

A recent paper by Gianpaolo Parise, titled “Threat of Entry and Debt Maturity: Evidence from Airlines” (April 2016, BIS Working Paper No. 556: http://ssrn.com/abstract=2758708) tries to address this question.

In the presence of low-cost competition airlines, traditional, large airlines tend to alter their debt structure. This effect, according to Parise, is pronounced in the case of legacy airlines forced to defend their strategically important routes from new entrants. Per Parise, “…the main findings suggest that airlines respond to entry threats trading off financial flexibility for lower rollover risk.”

More specifically, Parise found that “…a one standard deviation increase in the threat of entry triggers an increase of 4.5 percentage points in the proportion of long-term debt held by incumbent airlines (a 7.4% increase relative to the baseline of 60%). This effect is particularly strong for airlines whose debt is rated as “speculative” and that are financially constrained, i.e., airlines that have in general a more difficult access to credit.”

On the other hand, “the threat of entry has no significant effect on the leverage ratio.”

Overall, “threatened airlines issue debt instruments with longer maturity and with covenants” and that debt issuance aiming to increase maturity comes via intermediated lending (loans) rather than via bond markets (direct market).

“The results are consistent with models in which firms set their optimal debt structure in the presence of costly rollover failure As Parise notes, “Longer debt maturity allows firms to reduce
rollover (or liquidity) risk, i.e., the risk that lenders are unwilling to refinance when bad news
arrives. Rollover risk enhances credit risk…, magnifies the debt overhang problem…, weakens investment,… and exposes the firm to costly debt restructuring…”

A very interesting study showing dynamic and complex interactions between capital structure of the firm and exogenous pressures from competitive environments, in the presence of systemic roll-over risks in the financial system.