The dirty secret of business investment: oligopolies are killing it

Yesterday the Business Council of Australia got some free advertising by “releasing” modelling from EY about the economic impact of the pandemic.

The modelling showed “the way we manage the recovery will be critical to ensuring people who have already lost their jobs do not fall into the trap of long-term unemployment”, according to the BCA, a statement of truly profound obviousness.

Once you saw the modelling, however, the reason for “no shit, Sherlock” stuff became clear: the EY modelling was two PowerPoint slides. What it “modelled” was what would happen to the economy if the government shut everything down and provided no assistance.

This turns out to be that — you wouldn’t pick it — a lot of people lose their jobs. Also, the path of the recovery depends on “how safely and quickly restrictions can be eased”. There’s even three different lines on a graph showing three different recovery scenarios with three different costs in lost economic growth.

Given the government, erm, has provided assistance to the economy, over $200 billion worth, the effort from EY was not merely obvious but pointless. Given EY is a BCA member, hopefully the luminaries at Australia’s biggest business lobby group didn’t pay actual money for this rubbish.

Still, that didn’t stop John Kehoe at the Financial Review reporting it as if it was actual news, or The Australian from running an op-ed from Jennifer Westacott urging — again, you’ll never guess — “simplification” of industrial relations, deregulation and “an efficient and competitive tax system that actually encourages investment to our shores”.

Westacott constantly talks about investment. “We should act on the quick reforms that will get new investment flowing,” she said in the media release accompanying the guff from EY.

In the BCA’s view, the only way to achieve that is to cut company taxes. In 2017, a rather sad ensemble of business leaders travelled to Canberra to lobby politicians, claiming that company tax cuts would encourage investment and pledging to spend more if the Turnbull government’s proposed tax cuts were passed.

Cruelly, however, reality has since intervened: we know from the US experience that company tax cuts don’t encourage investment, which fell in the US last year, but instead fuel share buybacks and dividends payouts. The entire Business Council argument has been discredited.

Ostensibly, this defies economic theory, which says investment must rise if tax is cut. So why did those cuts fail to deliver?

When it examined the US tax cuts, the world’s premier neoliberal policy body the International Monetary Fund ended up endorsing the growing body of work from economists, including Labor MP Andrew Leigh and previous work by the IMF itself, that the high and growing level of corporate concentration in markets (reflected in higher company mark-ups) is leading to lower investment in markets around the world.

The IMF concluded that this meant company tax cuts had little impact in the US:

We find that companies with higher markups in 2016 increased investment by less in 2018… The results suggest that the change in capital expenditure growth was less positive for companies with greater markups in 2016… Overall, our results suggest that market power has played a significant role in shaping the response of corporate investment to the [tax cuts]. When combined with the observation that market power has increased in recent decades, the results help to explain why investment growth may have fallen short of predictions based on the historical relation between tax changes and investment.

Why do firms with more market power invest less? A host of reasons have been advanced, but one of the most basic is that dominant firms that face little threat from competitors have less incentive to innovate than firms that face a constant battle against new entrants and rivals.

Those large, dominant firms instead prefer to return money to shareholders rather than invest.

This finding is even more important now than when the BCA was peddling its snake oil a couple of years ago. Lifting investment will be crucial to the post-crisis economy. We entered the crisis with business investment in a serious slump, courtesy of years of flagging growth as a result of wage stagnation.

We need to lift investment not just back to pre-crisis levels, but to pre-Morrison levels, even if we can never recover to the levels of the mining investment boom under Wayne Swan.

But how can that be achieved when the Australian economy is — as Leigh and his colleagues have pointed out — even more concentrated than the US economy?

As a smaller market with less robust competition laws, Australia’s key industries are dominated by duopolies or oligopolies, with mergers and acquisitions surging over the last two decades, while the rate of new business formation has fallen. And this has been reflected in a large increase in the level of mark-ups by Australian firms.

Given its more concentrated state, the Australian economy is likely to see even less investment response to tax cuts than in the US — and faces a persistent problem of under-investment caused by concentration.

As it stands, what is a key impediment to lifting investment and thus post-crisis growth is barely on the economic agenda — unsurprising given our media itself is one of the most concentrated in the world, and much business journalism subsists on a steady diet of speculation about mergers and acquisitions among the companies it panders to.

Nor would we expect the Business Council — which is primarily composed of oligopolists and multinationals — to be too interested in the threat of market concentration.

But the questions raised by economists about the broken link between investment and concentration may yet prove crucial for the recovery ahead.