Essays in macroeconomics

Resumo

During the last three decades, there have been many fundamental changes regarding the evolution of most advanced economies, particularly the United States. Some remarkable trends characterizing this evolution are the decline in business dynamism, the increase in average profits and average markups of firms, the rise in market concentration, the rise of robotization and automation, the decline in the labor share, the decline in the entry rate of new firms, and the stagnation of productivity growth. The combination of these facts has raised concerns, among others, about increasing inequality, declining entrepreneurship due to the crowding-out of new entrants, and declining consumer purchasing power. Although identifying the reasons underlying these facts is crucial from a policy-making perspective, there is little agreement on these macroeconomic trends’ underlying cause(s). This dissertation consists of two chapters that attempt to shed light on this discussion. In the first chapter, ‘Inside the decline of the labor share: Bringing the tales together’, I analyze the decline in the U.S. labor share, the part of national income allocated to labor compensation. The labor share is a key variable in economics, being crucial for the analysis of, for example, technological change or inequality. I use U.S. industry-level data from 1998 to 2016 to examine the evolution of the labor share and its main components. At the same time, I also examine the contemporaneous structural change process, characterized by the relative reallocation of production inputs (namely employment and capital stock) from manufacturing to services industries and the increasing contribution to value added generation of the latter. This analysis establishes the following facts: 1. The evolution of the labor share has been quite heterogeneous across industries: a. The (linear) trend of the labor share shows a steeper decline in manufacturing than in services industries. The decline in the manufacturing labor share is roughly five times higher than in services. b. The evolution of compensation of employees - the main component of the labor share - exhibits a different pattern between manufacturing and services industries. In manufacturing, the average wage has grown faster than value added, while employment has declined during the last two decades. On the contrary, in services industries, employment has grown, while the growth rate of value added has been higher than that of the average wage. 2. There has been a strong (relative) reallocation of labor and capital from manufacturing to services industries. The reallocation of labor has been more intense than that of capital. At the same time, the share of value added generated by services industries has increased. 3. Substantial capital deepening has taken place during the last two decades: a. Consequently, the capital-labor ratio of the U.S. economy measured in real 2009$ per hour worked has increased from 69.5 in 1998 to 91.4 in 2016. In manufacturing, the capital-labor ratio strikingly increased from 69.2 in 1998 to 137.5 in 2016. b. The economy’s capital-output ratio has also increased from 1.55 in 1998 to 1.61 in 2016, especially during the Great Recession. Despite starting at similar levels in 1998, the capital-output ratios of manufacturing and services have diverged during the last two decades. Previous literature has highlighted two reasons that underlie the decline in the labor share: technological change (e.g., in the form of automation) and changes in market power (reflected in the increasing profits and concentration of firms). As the labor share of an economy can be computed by appropriately weighting industry-level labor shares, the previous analysis highlights an additional source of variation for the labor share. Provided that the labor shares of manufacturing and services are different, an increase in the relative importance of services in the production of total value added will be reflected in the economy’s labor share. Therefore, the strong process of structural change from manufacturing to services has an obvious effect on the labor share’s evolution. In this chapter, I use structural change data as an additional source of information that allows me to quantify the contribution of technological change and market power in explaining the decline of the labor share and the process of structural change itself. To do this, I develop a two-sector model of structural change which stresses the supply side’s role on the process of structural change. Specifically, the model allows for industry-specific technological change and production technology differences across industries. To enrich this framework, I incorporate heterogeneous competition levels across sectors, which I model as the ability to charge (exogenous) industry-specific time-varying markups. While the effect of markups in explaining the decline of the labor share are well-known in the literature, the novel part of the model is that markups also play a role in explaining structural change. The idea is simple: if one industry can charge higher markups than others, it will affect the relative price between industries. Therefore, higher prices driven by higher markups in one industry will affect the quantity demanded of output from other industries. I use the model to perform a quantitative analysis where I study the joint evolution of the labor share (both at the aggregate and industry-level) and the process of structural change. First, I obtain the time series of the value of capital and labor from the data and feed them into the model as an endowment. Second, by repeatedly using the first order and market clearing conditions that characterize the static equilibrium, I retrieve the evolution of technological change and market power that match quantitatively the evolution of both industry labor shares and the process of structural change between sectors. The model can explain up to 87.4% of the decline in the labor share of the economy. Moreover, I find that the increase in markups in the manufacturing and services industries is the main reason underlying the decline. Specifically, market power accounts for 64.1% of the decline, being more relevant in manufacturing. The remaining part is accounted for by technological change, which after 2008 becomes more important in explaining the decline in the labor share, especially in services industries. Although market power also affects the pace of structural change from manufacturing to services, I show that technological change is its fundamental driver. Ultimately, this chapter’s results are aligned with the stream of the literature on the labor share decline that argues it has been caused by a reduction in the levels of competition. Besides, other phenomena as automation or the rise of artificial intelligence (which may be understood as a type of biased technological change) also affect the labor share, albeit smaller. However, these phenomena are key to understand the process of structural change from manufacturing to services. Consequently, this chapter contributes to two strands of the economic literature. First, to the literature on the labor share decline, where I bring both technological and competition explanations together, developing a model where both can potentially explain the decline. Second, to the literature on structural change. I show that if the sectors of an economy experience differences in the evolution of competition, that will affect the relative allocation of capital and labor across sectors and, consequently, the sectoral production. In other words, differences in the level of competition can affect the pace of structural change. In the second chapter, ‘Provider-driven complementarity and firm dynamics’, I focus on the decline in business dynamism that has been experienced in the U.S. since the mid-1980s. The recent debate on increasing firm concentration and profits highlights some troubling facts regarding declining business dynamism and competition in the United States. This literature documents that nowadays markets are more concentrated and less competitive than they were decades ago. Adding to this literature, this chapter reviews a series of trends on declining business dynamism using data from Compustat, Business Dynamics Statistics, and World Development Indicators. These trends are as follows: 1. The entry rate of new firms has declined. 2. Market concentration, measured by the share of sales accruing to the biggest firms, has increased. 3. Expenditure on R&D activities, measured both as a fraction of total cost or of total sales, has increased. 4. The growth rate of the economy has slowed down. Taken together, while the entry rate of new firms has been declining, the so-called ‘superstar’ firms have become bigger and more profitable. In turn, this has raised concerns regarding dominant firms crowding out new entrants and reducing entrepreneurship. Simultaneously, economic growth has been sluggish during the last decades, though R&D efforts have increased substantially. I propose a theoretical framework that explains increasing R&D expenditures and concentration yet decreasing entry rates and economic growth. The key novelty of the model is introducing provider-driven complementarities into an otherwise standard quality ladder model. Provider-driven complementarity makes initially independent products become complements when provided by a single firm. It boils down to the idea that during the process of product innovation - the introduction of new and improved products to the market - firms can incorporate differential characteristics to their products. These firm-specific characteristics, which can be associated with the brand, software, or product design, are such that, absent quality differences across products, consuming several goods from a single provider is preferable to purchasing each good from a different firm. Theoretically, I build a model of endogenous growth through R&D. The economy is formed by a representative household and an endogenous measure of firms. Each firm owns a product portfolio that supplies monopolistically to the market. All firms have access to the same production technology, and product quality grows on a ladder through stochastic quality arrivals arising from investment in R&D. Firms’ R&D is of two types: internal (improve the quality of a product within its portfolio) and external (improve the quality of a product outside its portfolio). I model provider-driven complementarity as a demand shifter embedded in the production process, increasing in the number of (different) products supplied by the same firm. Therefore, upon entering the economy, any firm is ex-ante able to generate the same complementarity level. In a standard quality-ladder model, successful R&D improving the quality of a variety enables the innovator to price-out a lower-quality incumbent. However, when firms generate provider-driven complementarity, consumers do not necessarily switch to the state-of-the-art highest quality product. Instead, they may remain attached to the lower-quality incumbent if the provider-driven complementarity derived from this firm is sufficiently large. In equilibrium, each market is supplied by its market leader: the firm that can offer the highest quality, adjusted by provider-driven complementarity, relative to its market price. This bears an important effect on R&D decisions: when there exists provider-driven complementarity, the size of the quality improvement that an innovator requires to become a market leader depends not only on the size of its product portfolio but also on the size of the product portfolio of the incumbent. In particular, the probability of obtaining an innovation that allows replacing an incumbent - labeled a successful innovation - is a function of the product portfolio size. Specifically, firms with large portfolios are ex-ante more likely to obtain successful innovations than smaller ones. Put differently; smaller firms need to obtain larger quality innovations than bigger firms to offset the provider-driven complementarity effect of a given incumbent. Therefore, firms conduct R&D for two reasons: i) it allows increasing their market share by selling higher quality goods and/or capturing more markets, and ii) it increases the provider-driven complementarity effect as firms increase their product portfolio. As a result, firms’ R&D decisions affect the industrial organization of firms and can ultimately deter firm entry, because provider-driven complementarity generates an endogenous barrier to entry in new markets. In other words, a key novelty of the provider-driven complementarity framework is that the equilibrium distribution of products across firms affects firms’ R&D decisions, which in turn affect aggregate variables. I use the theory of provider-driven complementarity to perform a quantitative exercise in which I reduce the size of the average quality jump stemming from any successful innovation. This exercise is motivated by the recent literature on ideas becoming harder to find and can also be thought of as innovations becoming less radical over time. The reduction in the average innovation step size mechanically generates a slowdown in the economy’s growth rate. Most importantly, it introduces rich dynamics in the R&D decisions of firms when they generate provider-diver complementarity. By targeting the decline in the U.S. growth rate, I show that there is less entry, while incumbents become bigger and spend more resources on R&D, even as the economy’s overall growth rate declines. This contrasts with the predictions of a standard quality ladder model without provider-driven complementarities, which implies the reverse. The interaction between innovative step size and provider-driven complementarity in determining which firm supplies each product in equilibrium is key to the previous results. When the average innovative step size declines, the probability of obtaining a successful innovation also does. Moreover, this has a direct implication on the rate of creative destruction. As it turns out, this rate -- which is a decreasing function of a firm’s number of products -- declines as innovators find it more challenging to come up with successful innovations. Therefore, all else equal, small firms -- and mainly potential entrants -- find it more challenging to become market leaders. In particular, more quality innovations that would be successful in the absence of provider-driven complementarity do not find their way into the markets. The decline in the probability of obtaining a successful innovation can be broken down into two components. The first one is mechanical: reducing the average step size innovation makes firms less likely to obtain successful innovations. The second component is the change in the distribution of firms that affects firms’ incentives to conduct R&D. As a result, firms’ industrial organization matters for equilibrium outcomes if firms generate provider-driven complementarity, a novel and crucial feature of this framework. Additionally, the reduction in the step size of innovation affects incumbents and potential entrants asymmetrically in the provider-driven complementarity framework. This results from the interaction between two forces: the market effect and the quality effect. The market effect captures the increase in the value of the discounted stream of profits associated with being a market leader, which enhances the incentives to conduct R&D. In equilibrium, the interest rate, and the rates of creative destruction decline, and so does the effective discount rate of firms’ profits. The quality effect captures the decline in the productivity of investing in quality. When the step size of innovation declines, firms find it more difficult to come up with successful innovations and obtain smaller quality improvements if successful. Both effects decrease the incentives to conduct R&D. I show that when the step size of innovation declines, incumbents conduct less internal R&D (the quality effect dominates the market effect) and more external R&D (the market effect dominates the quality effect). Consequently, this leads to an overall increase in the R&D expenditure of incumbent firms. However, potential entrants -- that only conduct external R&D and do not generate complementarity upon entry -- conduct less R&D due to the decline in the probability of obtaining a successful innovation (the quality effect dominates the market effect). This decline drives down the entrants’ innovation rate, which reduces the entry rate of new firms. The joint effect of the decline in entry and the increase in external R&D innovation rates of incumbents is a reduction in the number of active incumbents in equilibrium. Accordingly, the equilibrium firm size distribution shifts to the right as a substantial share of firms become bigger. In turn, this yields an increase in the concentration of sales. This chapter relates to two strands of the economic literature. First, to the growing literature on declining business dynamism. I offer a novel explanation based on the role of provider-driven complementarity, a simple mechanism that shifts demand as a function of firm size. This theory can explain many empirical findings on business dynamism through the asymmetries that provider-driven complementarity generates between small and big firms. Second, this chapter is tightly related to the literature on (quality ladder) endogenous growth models. In the theory I propose, firms’ industrial organization is a determinant not only of individual firm decisions, but also for aggregate outcomes. A key novelty of the provider-driven complementarity framework is that the probability of obtaining a successful innovation that allows entering a market, and the rate of creative destruction experienced by an incumbent, crucially depend on the number of products that each firm supplies to the market. Ultimately, this implies that the distribution of products across firms is not a residual equilibrium outcome like in most growth models, but a key element that affects firms’ optimal R&D decisions. I show that, although this substantially complicates the solution of the model, the modeling choice of provider-driven complementarity remains tractable and allows obtaining analytical solutions.