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Keynes Fund

 

Summary of Project Plan


Productivity growth has fallen across advanced economies. Despite the rapid emergence of digital technologies, productivity in countries like the United States has grown at less than half its long- term rate since the early 2000s. At the same time, there were fundamental changes in the business environment. Reallocation of workers to new jobs declined, and the number of start-ups as a fraction of all firms fell by 50%. There was also a steady increase in market concentration and corporate profits, which caused the share of profits in GDP to triple to 15%.

This project explores whether the decline in business dynamism and the rise of corporate profits explains why productivity growth is slowing. The hypothesis is that the rise of digital technologies and intangible assets as production factors has led to a shift from marginal costs to fixed costs of production. This has two opposing effects on productivity growth and innovation. On the one hand, innovation is stimulated because leading firms can sell products on a larger scale because marginal costs have fallen. This allows firms that are particularly good at adopting new technologies, the Amazons of the world, to expand rapidly into new markets and to dominate existing ones. On the other hand, the rise of digital technologies reduces the incentive to innovate at firms that are unable to reduce marginal costs through digitization as effectively. While start- ups might be able to invent more innovative products, an incumbent with lower marginal costs could deter entry by lowering prices. This lowers the rate of ‘creative destruction’, increases market concentration and raises profitability.

The purpose of the project is to (1) establish the theory above formally, (2) empirically assess the relative magnitude of the positive or the negative effects of digitization on innovation, and (3) propose policies that can remedy the negative effects on growth and profitability.

The project’s objectives are directly in line with the Keynes Fund’s, on three grounds. First, the project studies a new form of market failure. Digitization causes market failure because the emergence of large firms with low marginal costs (a) reduces the rate of start-ups and innovation below the social optimum, and (b) reduces output through an increase in mark-ups. While previous work has outlined that the fixed-cost nature of digital or intangible inputs creates economies of scale, this project is the first to analyse how this affects the process of growth through innovation. Second, the project enhances our understanding on the effect of a fundamental structural change (digitization and the rise of intangibles) on both economic growth and income/wealth inequality. Third, the project delivers an answer to a highly debated policy question: how regulators should respond to the rise of market concentration. The fact that the annual Jackson Hole Economic Policy Symposium was centred around this issue highlights how topical it is. This project will enable, for example, a quantitative assessment of the effect of posing limits to the growth of giants like Amazon and Google. Importantly, this project enables both static (on profits) and dynamic (on innovation and productivity growth) analysis of such action.

 

 

Maarten De Ridder

 

Maarten De Ridder is a PhD candidate at the Faculty of Economics, University of Cambridge. He works on macroeconomics, productivity and firm dynamics. In September he will join the LSE as an Assistant Professor.

 

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