Thomas Philippon’s The Great Reversal is an important book in which he warns of the decline of competition in many U.S. product markets. Not having studied antitrust issues for some time, I will leave criticism of his general thesis—that competition has indeed declined and that this is owing to lax antitrust enforcement—to my Cato colleagues writing about that issue. (You can start here.)
But I do want to take issue with Philippon’s argument that finance is one of the industries in which competition has declined. Philippon devotes a whole chapter of the book to the financial services industry, giving it the punchy title, “Why Are Bankers Paid So Much?,” while Martin Wolf, in his Financial Times review of the book, called finance a “rent-extraction machine.”
There are two serious problems with this view of U.S. finance. The first is that two central pieces of evidence Philippon cites in support of his general thesis, high concentration and rising profit rates, are simply missing in the financial sector. Another popular symptom of market power, namely slowing entry, is present in banking but directly attributable to regulators’ actions following the financial crisis.
The second problem is that Philippon’s argument on finance relies heavily on a 2015 paper reporting that the costs of financial intermediation had been largely unchanged for 130 years. From this, Philippon concludes that “improvements in information technologies do not appear to have led to a significant decrease in the unit cost of intermediation.” But because the 2015 paper does not break costs by category, it is not clear whether the mix of costs has also remained stable over the years, or whether (as I suspect) there has in fact been a decline in “market operating” costs, thanks to technology and economies of scale, that has been offset by rising regulatory (including lobbying) costs.
Philippon’s diagnosis of uncompetitive markets may therefore be accurate for U.S. finance, but for reasons to do with government intervention rather than the absence of competitive enforcement by government.
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