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The Labor Impact of Superstar Firms

Written by

Paula Klein

van reenen

Increasingly, labor accounts for less and less of GDP in most countries.  Not only does this trend undermine decades of traditional economic thinking about the stability of the labor share, it heightens concerns about employment and wages. Where are jobs going and who will be most impacted?

Theories abound about the extent of the decline and the causes. Some believe that increased use of IT is a key contributor, while others point to increased trade exposure, especially, from China.

John Van Reenen, Professor in the MIT Department of Economics and Sloan School of Management (pictured, above), acknowledges these factors, but doesn’t think they are the primary drivers of the labor gap. He and his co-authors offer another explanation in a new working paper, “The Fall of the Labor Share and the Rise of Superstar Firms.”

Discussing his findings at a recent IDE seminar, Van Reenen said that Chinese competition alone wouldn’t account for declines in non-manufacturing labor sectors such as retail and wholesale markets, transportation and even finance. Similarly, purely U.S.-specific factors such as antitrust law or weakening labor institutions don’t explain the more extensive changes taking place worldwide. Neither would “susceptibility to routine-replacing technical change” and digital technology. 

More sales, Market Concentration

In Van Reenen’s view, the ongoing, international, and cross-industry fall in labor can best be explained by a “Superstar Firm Model,” which builds on an earlier research, including work with MIT’s David Autor. “Our hypothesis is that technology or market conditions—or their interaction—have evolved to increasingly concentrate sales among firms with superior products or higher  productivity, thereby enabling the most successful firms to control ever greater shares of their markets.”

“Because these superstar firms are more profitable,” the authors write, “they will have a smaller share of their labor in total sales or value added. Consequently, the aggregate share of labor falls as the weight of superstar firms in the economy grows.”

As more and more industries become characterized by “winner take most” competition, a small number of highly profitable (and low labor share) command growing market share.

In other words, sales are becoming concentrated in a smaller number of large firms. As that occurs, labor will decline due to a reallocation of labor among firms in an industry. The findings also mean that workers are getting a shrinking slice of a slower-growing economic pie, according to Van Reenen. The risk is that this will be a cause of wage stagnation in both rich and emerging economies.

Greater Antitrust Scrutiny Needed?

The research analyzes 30 years of data from the U.S. Economic Census as well as international data to conclude that “product market concentration will rise as industries become increasingly dominated by superstar firms with high profit margins and a low share of labor. As the importance of superstar firms increases, the aggregate labor share will fall.”

One implication of these trends is that the need for anti-trust scrutiny becomes ever greater, Van Reenen said. Although superstars may gain their dominance by legitimately competing on the merits of their innovation and efficiency, there is a strong risk that they can use their power to squeeze out rivals and deter entrants, either through business policies or by lobbying governments for favorable regulations. 

Read on our Medium publication here.

Read more in this Harvard Business Review blog.

Watch the video of the seminar on YouTube here.