The government’s approach to antitrust violations is due for an overhaul. And regulators need to pay more attention to protecting economic vitality and consumer well-being — and less to industry lobbyists.

The short answer: It’s complicated. Innovation superstars like Google have created winner-take-most markets largely by exploiting network effects, not through predatory behavior. However, research from the wider economy (including the tech sector) uncovers classic signs of unhealthy concentration: rising profits, weak investment, and low business dynamism.

There’s no question that most American industries have become more concentrated. Economists are trying to understand whether this is necessarily a bad thing for competition.

In Brief The Issue There’s no question that most American industries have become more concentrated. Economists are trying to understand whether this is necessarily a bad thing for competition. The Evidence The short answer: It’s complicated. Innovation superstars like Google have created winner-take-most markets largely by exploiting network effects, not through predatory behavior. However, research from the wider economy (including the tech sector) uncovers classic signs of unhealthy concentration: rising profits, weak investment, and low business dynamism. Recommendations The government’s approach to antitrust violations is due for an overhaul. And regulators need to pay more attention to protecting economic vitality and consumer well-being—and less to industry lobbyists.

Despite their undeniable popularity, Apple, Amazon, Google, and Facebook are drawing increasing scrutiny from economists, legal scholars, politicians, and policy wonks, who accuse these firms of using their size and strength to crush potential competitors. (Their clout caught the attention of European regulators long ago.) The tech giants pose unique challenges, but they also represent just one piece of a broader story: a troubling phenomenon of too little competition throughout the U.S. economy.

There’s no question that most industries are becoming more concentrated. Big firms account for higher shares of industry revenue and are reaping historically large profits relative to their investment. This is not necessarily a bad thing. As an all-star quintet of economists—David Autor, David Dorn, Lawrence Katz, Christina Patterson, and John Van Reenen—points out, concentration and higher profits can be benign, perhaps even welcome, consequences of technological innovation. We now operate in a winner-take-most world, the argument goes, in which superstar firms with higher productivity capture a larger slice of the market; Amazon, Apple, Facebook, and Google have risen to the top because of their propensity to innovate. According to James Bessen of Boston University, the increasing share of revenue captured by the top firms in industries outside of high-tech is explained by those firms’ adoption of proprietary, mission-critical information technology: They’re bigger because they’re better.

Mounting evidence, however, strongly suggests that harmful forces are also at play. “Concentration could arise from anticompetitive forces,” Autor and his colleagues note, “whereby dominant firms are increasingly able to prevent actual and potential rivals from entering and expanding.” Indeed, research shows that incumbent firms in a wide range of industries — airlines, beer, pharmaceuticals, hospitals — are wielding market power in ways that prevent rivals from emerging and thriving. The winners are winning bigger, while the number of new start-ups is falling. With waning competitive pressure, productivity growth slows, wages stagnate, and the gap between winners and losers widens.

The underlying problem is not “bigness” per se. Rather, it’s the combined effect of size, concentration, and, importantly, incumbent-friendly regulation on the healthy competition that propels economic growth. In this article, I examine the troubling effect of industry consolidation on competition. I then look at the role of antitrust law and regulation in shaping today’s economic environment and explore strategies to improve the flow of innovation, enhance dynamism in business and in labor markets, and ultimately deliver higher standards of living for all.

The Warning Signs

Ten years ago, the top four U.S. airlines collected 41% of the industry’s revenue. Today, they collect 65%. Although competition is stiff on the most heavily traveled air routes, 97% of routes between pairs of cities have so few competitors that standard antitrust metrics would deem them “highly concentrated.” In 1990, 65% of hospitals in metropolitan areas were “highly concentrated.” By 2016, 90% were. It’s a similar story in the beer business. Despite the proliferation of craft breweries, four brewers hold nearly 90% of the U.S. beer market.

These are not isolated cases. In a 2002 study, Lawrence White, a New York University economist, concluded that economy-wide concentration had fallen from the beginning of the 1980s to the end of the 1990s. When he took another look, in 2017, the story had changed. With scholarly caution, he noted “a moderate but continued increase in aggregate concentration.” The Economist, using U.S. Economic Census data, found a similar trend. Of the 893 industries it examined — from dog food and battery makers to airlines and credit cards — two-thirds had grown more concentrated since 2007. Weighted by size of industry, the top four firms’ share of revenue had risen to 32% in 2012 from 26% in 1997.

Clearly, industry concentration is on the rise. But does that mean there is less competition or that consumers are worse off? The best way to discern if increasing concentration is worrisome economically is to look at profits, investment, business dynamism, and prices. In most (though not all) cases, the data points to a lack of competition.

Profits.

High and rising profits in an increasingly concentrated market are typically a sign of lessening competition and increased market power by dominant firms. Today, profits are up in industries in which a shrinking number of players have a growing share of the business. Recent research suggests that the average markup — the difference between the prices firms charge and products’ marginal cost — is rising in American business, and rising fastest for the most profitable firms. Using data for all publicly traded U.S. firms from 1950 to 2014, Jan De Loecker of Princeton and Jan Eeckhout of University College London found that markups rose from about 18% in 1980 to 67% in 2014. That’s good for shareholders, of course, but it’s not so good for consumers or the overall economy.

Investment.

Another signal of declining competitive pressure is firms’ ability to increase profits without much investment; in competitive markets, companies are driven to invest more to stay ahead of their rivals. Business investment across the economy has perked up lately, but it is not as robust as one might expect given the surge in profits, the extraordinarily low-cost of equity and debt, and the amount of cash on corporate balance sheets. Measured against GDP, corporate after-tax profits are almost double what they were 25 years ago — and higher than at any time since World War II — yet business investment as a share of GDP is up only 13% over the same period. “Investment is weak relative to profitability and valuation,” NYU’s Thomas Philippon and German Gutierrez concluded in a 2017 analysis built on the historical relationship between investment and the ratio of the market value of a company’s debt and equity to the replacement cost of its assets.

Business dynamism.

In a healthy economy, companies continually are born, fail, expand, and contract, while new jobs are created and others are destroyed. A slowdown in business dynamism means that entrenched firms have less to fear from upstarts; as a result, the economy suffers as innovation slows and job growth stalls. In the U.S., the rate of birth of new firms (as a percentage of all firms) fell from above 13% in the late 1980s to around 8% in 2015, according to the most recent official data. The number of jobs created by businesses less than a year old dropped from a peak of 4.7 million in the late 1990s to 3 million in 2015.

John Haltiwanger, a University of Maryland economist, notes that the decline in dynamism in the U.S. originated in the retail sector in the 1980s and 1990s. But even as the number of retailers starting up and dying off plunged, the industry became more productive. This was dubbed “the Walmart effect,” because of the impact of the giant retailer not only on the efficiency of its industry but on the entire U.S. economy. Lately, though, declining dynamism has spread to the tech sector. That’s more worrisome, Haltiwanger says, because it portends slower productivity growth.

Prices.

Economic theory suggests that oligopolies — industries in which a few firms dominate without much competition — lead to increases in price and reductions in output. In determining whether competition is on the decline, a review of prices by some researchers yields an inconclusive result. Sharat Ganapati of Dartmouth, for instance, looks at data from 1972 to 2012 and concludes that increased concentration in manufacturing is correlated with higher prices, which is consistent with declining competition, but also with stable output, which is not. Outside of manufacturing, industry concentration is correlated with higher output and stable prices, neither of which conforms to the theory of oligopoly and declining competition.

The preponderance of evidence across the proliferating body of research suggests that industry consolidation is causing a troubling decline in competition, limiting the country’s capacity to innovate, create jobs, and sustain overall economic health.

Heroes or Villains?

Despite an overall picture of declining competition, it’s not always easy to determine whether or to what extent consumers in a particular industry are harmed by consolidation. Are companies that rise to the top “heroes” or “villains”?

Consider Facebook and its 2017 acquisition of TBH (for “To Be Honest”), a mobile app popular with teenagers that allows them to anonymously answer questions about their friends. When Facebook snapped it up, the app was only two months old but had attracted more than 5 million users and logged more than a billion sent messages. TBH is only one of more than 60 such acquisitions by Facebook since 2010.

Seen through the hero lens, the prospect of selling out to Facebook (or Google or Apple) offers many economic advantages. The promise of a generous payout is a huge incentive to innovative entrepreneurs. On a broader scale, the capacity of Facebook’s platform to spread innovation throughout the economy means that benefits from technological advances accrue faster and more broadly than they would in the hands of a start-up. Seen through the villain lens, however, Facebook’s relentless swallowing up of promising young firms effectively squashes the potential of upstarts to become competitors. We’ll never know what TBH or Halli Labs or Orbitera or Instagram or WhatsApp or Oculus VR might have become had Facebook not absorbed them — or what companies might have been started had prospective founders not figured that it would be impossible to compete with Facebook.

In some industries, concentration clearly is driven less by innovative superstars than by anticompetitive behavior. Consider beer. Despite the proliferation of craft breweries, two producers dominate the U.S. market: Anheuser-Busch InBev (Beck’s, Budweiser, Corona, Michelob, Stella Artois) and MillerCoors (Blue Moon, Coors, Miller, Molson). Recent research pins rising beer prices to greater concentration in the industry. When SABMiller and MolsonCoors (the number two and three brewers at the time) combined U.S. operations, in 2008, prices abruptly rose — and not only for their beers but also for those of competitor Anheuser-Busch. Economists Nathan Miller of Georgetown and Matthew Weinberg of Drexel estimated that prices were at least 6% and 8% higher than they would have been without the joint venture and suggested that the competing brewers coordinated pricing. In 2015, the Justice Department, citing corporate documents in its initial objection to a subsequent Anheuser-Busch acquisition, said the brewer’s strategic plan for pricing “reads like a how-to manual for successful price coordination.”

Health care is another stark example. A wave of hospital mergers and consolidations across the country, driven in part by a push for better coordination of care and greater efficiency, has strengthened hospitals’ bargaining power relative to insurers’ without much sign of the hoped-for benefits in productivity. “Although provider concentration could produce efficiencies that benefit purchasers of health care services, the evidence does not point in that direction,” Berkeley’s Brent Fulton concludes in a 2017 review of the literature. Concentration in hospital markets is also associated with higher prices, with surges of up to 20% following mergers. A 2010 analysis found that the typical private-insurer payment for inpatient hospital stays in San Francisco (a highly concentrated market) was about 75% higher than in the more fragmented Los Angeles market.

The promise of a generous payout is a huge incentive to innovative entrepreneurs.

So are industry leaders heroes or villains? Probably a bit of both. “Most firms are actively engaged in protecting their source of competitive advantage through a mixture of innovation, lobbying, or both,” says Luigi Zingales of the University of Chicago. To the extent that firms are being driven to innovate, there is little to worry about. But when corporations use their market power to shape the policy and regulatory environment in ways that crush competition, problems arise. And unfortunately, there’s more than enough evidence to conclude that a substantial portion of the U.S. economy suffers from a lack of competition.

Reshaping the Antitrust Framework

In remedying the harmful effects of industry consolidation and declining competition, an obvious place to start is antitrust regulation and enforcement. The U.S. approach to antitrust has evolved significantly over the past century. In the 1950s and 1960s, many mergers — even ones that would have led to relatively modest increases in concentration — were routinely challenged, but in the 1970s the antitrust framework began to shift toward challenging many fewer mergers. Lawyer-judges Robert Bork and Richard Posner and Nobel laureate economists George Stigler and Oliver Williamson laid the intellectual foundation for this shift, which spread to the policy arena and the courts in the early 1980s.

The more lenient approach relied on three ideas: that harm from increased concentration had to be weighed against the efficiencies to be achieved, that horizontal mergers between competitors were harmful only if they led to less output, and that vertical mergers between supplier and buyer generally were not a problem. This thinking solidified under the Reagan Justice Department, and for better or worse, the antitrust authorities stood by over the coming decades as the economy grew more concentrated. In the 2000s, under Barack Obama, the stance became somewhat more aggressive, but it remains unclear whether his executive orders to promote competitive markets, issued in the closing innings of his administration, were mere symbolism or a serious effort.

It is time for antitrust authorities to renew their scrutiny of traditional mergers. A comprehensive review of retrospective studies of the thousands of mergers and joint ventures over the past 25 years by Northeastern University economist John Kwoka judged that antitrust authorities had been too tolerant both in letting certain types of mergers go unchallenged and in imposing conditions on mergers that were cleared. Prices following a subset of these mergers rose by an average of 4.3%, holding other factors constant, Kwoka found. The increases were particularly large in the airline and health care industries. “The diminished attention to mergers involving somewhat lower market shares and concentration appears to have resulted in approval of significantly more mergers that prove to be anticompetitive,” he wrote in a 2015 book.

Kwoka’s meta-analysis suggests that antitrust authorities should be more inclined to block mergers in order to increase competition. Consider the wireless telephone business. In 2011, AT&T sought to acquire a struggling competitor, T-Mobile USA, in a $39 billion deal that would have reduced the number of major competitors in the industry from four to three. Unable to overcome the opposition of the Obama administration, however, AT&T abandoned the deal five months after announcing it. After the merger fell through, some argued that T-Mobile was doomed. It wasn’t. As writer Mark Rogowsky recounted in Forbes, “Within a year, T-Mobile hired John Legere as its new CEO and he threw out the business-as-usual approach. Legere dumped subsidies, lowered prices, offered more data and often poked fun at rivals.” T-Mobile thrived, signing up 4.4 million new subscribers in 2013. By 2017, competition among wireless carriers was so stiff that Federal Reserve Chair Janet Yellen cited falling prices for cell phone service as a cause of low inflation.

Antitrust authorities must also tackle the vexing question of what constitutes illegal “predatory” pricing in today’s market. Consider Amazon’s alleged use of below-cost pricing to pressure and ultimately acquire a potential competitor. After the e-commerce company Quidsi — the owner of Diapers.com — rejected a 2009 acquisition overture from Amazon, Amazon responded by cutting prices for diapers and other baby products by as much as 30% on its site and rolling out Amazon Mom, which offered discounts and free shipping. Quidsi struggled, flirted with Walmart, but eventually sold itself to Amazon. By 2012, Amazon had begun raising prices and had slashed the benefits of Amazon Mom.

These are live issues. In 2015, for instance, the Federal Trade Commission considered whether the merger of real estate sites Zillow and Trulia would reduce both companies’ incentives to develop new features for consumers. The FTC decided that it wouldn’t, and the merger went through. But in the same year, FTC sought to block a merger between Steris and Synergy Health, the number two and three companies in the health care facility-sterilization business. Because Synergy didn’t do business in the United States at the time, the FTC argued, a merger would preclude any competition that might result from Synergy’s eventual entrance into the U.S. market. A federal judge disagreed, and the merger was consummated.

When corporations use their market power to crush competition, problems arise. RedBall Project by Kurt Pershke; Photography by Brit Worgan

Even-more-complicated issues will arise as the economy evolves. How should the authorities view the unprecedented power of the new digital giants to crush competitors? Should they be more skeptical about mergers that might lessen “potential competition,” which occurs when one firm buys another in an adjacent market (think Google’s acquisition of YouTube or Microsoft’s acquisition of LinkedIn)? How about when a big firm swallows a tiny firm that might have grown into a mighty oak?

The argument for reexamining current merger guidelines — and, where appropriate, challenging the case law that is said to make Department of Justice and FTC lawyers reluctant to bring cases — is very strong. The economy is more concentrated. Evidence that there’s too little competition is accumulating. Acquisitions that in the past were too small to attract the usual antitrust scrutiny can eliminate potential competition, especially in a world where a company like WhatsApp can grow in just a few years to reach a billion users a day. Indeed, the power of new tech giants to use their potent networks and the vast amounts of data they collect to thwart competition is one of the biggest challenges facing antitrust authorities today.

Rethinking Regulation

The worrisome aspects of increasing industry consolidation can’t be addressed solely through antitrust enforcement. Policymakers also need to scrutinize regulations that restrict competition across the economy. Owing in part to incumbent firms’ influence in shaping policy to preserve their positions at the expense of start-ups and other would-be competitors, the United States is no longer held up as an exemplar of free markets and regulatory restraint. In fact, in a dramatic change from the late 1990s, the Organization for Economic Cooperation and Development says the U.S. now regulates product markets more heavily than many developed economies including Australia, Canada, France, Germany, and Japan.

Take the pharmaceutical industry. Although the United States doesn’t regulate pharmaceutical prices, as most rich countries do, it offers makers of brand-name drugs patent protection, periods of exclusivity, and other ways to recoup their investment in expensive research that produces new drugs. Once those protections expire, however, prices theoretically should fall as makers of generics enter the market. And that does happen — sometimes.

Does Common Ownership Dampen Competition? Institutional investors and index funds have experienced spectacular growth over the past several decades. The economic effect of this growth is that huge investors increasingly hold substantial stakes in all major competitors in an industry. In 1980, only 10% of U.S. public companies had institutional investors that held 5% or more of their shares while simultaneously holding shares in rival firms in the same industry; in 2014, 60% did. How does this rise in cross-ownership by institutional investors affect competition? Recent research by the University of Michigan’s Martin Schmalz and colleagues argues that cross-ownership discourages big companies from competing aggressively against one another. Take airlines. In the first quarter of 2017, Berkshire Hathaway, BlackRock, Vanguard, and Primecap owned a combined 23% stake in Delta, 29% in United, 31% in American, and 38% in Southwest. Research from Schmalz’s team estimates that U.S. airfares are, on average, 3% to 7% higher than they would be without overlapping institutional-investor ownership. They find a similar pattern in banking. Schmalz and his colleagues don’t allege explicit collusion; rather, they claim that common ownership reduces the incentive to compete. Industries in which cross-ownership is greater, they note, tend to have corporate compensation packages that offer less reward for beating the competition than do industries with little cross-ownership. Their research also suggests that when index funds and other institutional investors hold stakes in all the big firms in an industry, they are less likely to be activist shareholders, thereby entrenching incumbent managers and breeding inefficiencies. This line of thinking is controversial. Critics argue that index funds by design hold stakes in large numbers of companies—some of which compete with one another, some of which buy and sell to one another. And BlackRock is hardly the reincarnation of John D. Rockefeller; the firm is managing other people’s money. Critics also take issue with Schmalz’s methods, pointing out that the research relies on the way money managers are required to report holdings, which combines shares held for all sorts of clients. And they cite anecdotal evidence undermining the notion that institutional holders are reluctant activists: For example, in the 2017 showdown between Procter & Gamble and activist Nelson Peltz, Vanguard sided with P&G, while State Street and BlackRock voted almost all their shares for Peltz. The research on whether common ownership harms competition may be inconclusive, but the work is increasingly vital as the stakes in major companies held by large institutional investors continue to rise dramatically. Should evidence mount that competition is suffering because of this trend, cross-ownership by institutional investors should take its place alongside antitrust and regulation as a lever in managing the troubling decline in competition across the U.S. economy.

According to Yale economist Fiona Scott Morton, however, over the past 10 to 15 years “industry participants have managed to disable many of these competitive mechanisms and create niches in which drugs can be sold with little to no competition.” For example, the marketing of some drugs with particularly severe side effects is now very tightly controlled through the FDA’s Risk Evaluation and Mitigation Strategy, or REMS. The makers of those drugs, in some instances, cite the restrictions as a reason not to supply a generic maker with a sample to recreate the drugs. For example, it took Hikma Pharmaceuticals nearly seven years of litigation to get what it needed to produce, in accordance with REMS restrictions, a generic version of Jazz Pharmaceuticals’ major product, Xyrem, a $1-billion-a-year drug used to treat narcolepsy. The 2017 settlement allows Hikma to begin marketing the generic version only after January 1, 2023. Early in his tenure as President Trump’s FDA commissioner, Scott Gottlieb vowed to change the REMS rules to prevent drug makers from using them to thwart generic competition and in November announced a preliminary plan to do so.

It is time for antitrust authorities to renew their scrutiny of traditional mergers.

Regulations in the labor market, along with certain employer practices, can also conspire to constrain competition, by limiting workers’ ability to seek new or higher-paying jobs. As the famed economist Adam Smith warned, corporations continue to behave in ways that seek “always and everywhere in a sort of tacit, but constant and uniform combination, not to raise the wages of labor.” One way companies do this is by requiring workers to sign noncompete agreements. When enforced, these agreements inhibit a worker’s ability to switch jobs and constrain the ability of new firms to hire talent. Software engineers and CEOs are not the only ones affected by such regulations: Among employees earning $40,000 or less, about one in seven (13.5%) is bound by a noncompete. In an eyebrow-raising 2017 study, Princeton’s Alan Krueger and Orley Ashenfelter found that 58% of major chains (Burger King, Jiffy Lube, H&R Block, and dozens more) restrict and sometimes prohibit one franchisee from hiring workers away from another, to the obvious detriment of people seeking to change jobs.

The explosion of state occupational licensing rules also harms both workers and new entrants. In the 1960s, only 10% of U.S. workers had an occupational license. At last count, 22% do. Much of the increase is a result of states extending the occupations for which licenses are required. Some of the requirements are motivated by an urge to protect consumers, but others were clearly orchestrated through lobbying from trade associations eager to raise barriers to entry, limit the number of players in their profession, and raise prices. Louisiana requires florists to be licensed. Michigan requires 1,460 days of training for athletic trainers, but only 26 days for emergency medical technicians. California’s Board of Barbering and Cosmetology requires 1,600 hours of education and hands-on training before a person can take the licensing exam, and another 3,200 hours of apprenticeship and 220 hours of related training are required for licensure. States generally don’t recognize credentials issued by other states, making it hard for licensed workers to move across state lines and protecting existing license holders in any state.

Such regulatory restraints on competition are coming under increasing scrutiny. The Federal Trade Commission has been in a long-running battle with dentists’ organizations over various state rules that limit the services hygienists and teeth-whitening clinics can offer. Creating a category of “dental therapists” to provide some routine services “could benefit consumers by increasing choice, competition and access to care, especially for the underserved,” the FTC said. The dentists are not happy.

In 2014, under pressure from the Federal Communications Commission, the wireless phone industry finally agreed to allow consumers to unlock their cell phones if they wanted to change providers. And with bipartisan enthusiasm and the blessing of the Food and Drug Administration, Congress in 2017 instructed the FDA to make it easier for consumers to buy hearing aids at Costco and other retailers, just as they can buy reading glasses at nonspecialty stores such as CVS. The notion was to spur competition and lower prices, discouraging the practice of some audiologists of bundling an exam with the purchase of a hearing aid.

This is a start, but regulators and policymakers have more work to do.

The Way Forward

Ultimately, curing what ails the U.S. economy requires political commitment and resolve to protect the robust competition that spurs productivity growth and improves American living standards, even when well-resourced interests resist.

If we’re slow to take action to bolster competition — perhaps because incumbents successfully wield their power or because of a distaste for regulation of any sort — we risk diluting the dynamism of the economy and restricting the flow of innovations and new ideas, darkening the prospects for our children and grandchildren.