Powell, Draghi, Kuroda, et al.: Did ya see this NBER study?
This is something we have seen since the Financial Crisis all around us: The concentration and consolidation of corporate market power in entire industries, largely via mergers and acquisitions, made possible by abundantly available funding at ultra-low interest rates for the largest companies; and the concurrent slow-growth economy dogged by perplexingly slow productivity growth. This has occurred across the board for years in developed markets with zero or negative-interest-rate policies, such as the US, the Eurozone, and Japan.
But now the National Bureau of Economic Research (NBER) – which also calls out the official US recessions – released a study that gives an additional major reason for how low long-term interest rates lead to concentration of corporate power that then drags down productivity growth and economic growth on the production side of the economy.
The study “provides a new theoretical result that low interest rates encourage market concentration by giving industry leaders a strategic advantage over followers, and this effect strengthens as the interest rate approaches zero,” the authors say.
Via this market concentration, low interest rates are then associated with “reduced dynamism, a widening productivity-gap between industry leaders and followers, and slower productivity growth.”
The authors point out just how counter this is to traditional economic thinking, where low interest rates are considered an expansionary mechanism for the production side of the economy. They cite the example of a firm facing an investment decision. Declining interest rates increase the net present value of future cash flows (this is classically how a company is valued). This motivates the firm to invest immediately to increase future cash flows. This is why traditionally lower interest rates are associated with higher growth on the production side.
Then they question this traditional theory and the “existing literature” upon which part of the current low-interest rate monetary policies are based:
However, these models do not take strategic competition and market structure into account. Is it reasonable to assume that a significant reduction in the long-term interest rate would have no impact on the competitiveness of an industry?
Based on their model, the authors conclude:
The focus of this paper is on understanding how the production side of the economy responds to a reduction in long-term interest rates driven by consumer-side forces. The existing literature in growth either assumes no production-side response to declining interest rates, or a positive response driven by an increased incentive to invest in the face of a higher discounted present value of future profits.
Where the authors diverge from the literature is by including competition within an industry into their model to determine how lower interest rates would affect the nature of competition:
A reduction in long-term interest rates tends to make market structure less competitive within an industry. The reason is that while both the leader and follower within an industry increase their investment in response to a reduction in interest rates, the increase in investment is always stronger for the leader. As a result, the gap between the leader and follower increases as interest rates decline, making an industry less competitive and more concentrated.
When interest rates are already low, this negative effect of lower interest rates on industry competition tends to lower growth and overwhelms the traditional positive effect of lower interest rates on growth.
This produces a hump-shaped inverted-U production-side relationship between growth and interest rates.
While the study points out that low long-term interest rates are only a contributing factor, and not the only factor, in the slowdown, it suggests that low long-term interest rates may be “the common global ‘factor’” as they increase market concentration and market power, and also make “industry leadership and monopoly power more persistent,” which in turn weigh heavily on productivity growth and economic growth.
It is interesting that the NBER would offer this delectable food for thought in an era when interest rate repression by central banks — zero-interest-rate policies, negative-interest-rate policies, and QE to repress long-term interest rates — have become all the rage in combating economic slowdowns.
Yet, confusingly, the biggest market with negative interest rates, the Eurozone, is currently sinking deeper into a broad-based economic slowdown, if not a recession. Japan, which has had a zero-interest-rate policy in effect for 20 years, has been mired in a slow-growth economy with several recessions over those 20 years. And US economic growth following the Financial Crisis and the Fed’s interest rate repression has been woefully lethargic.
Clearly, the NBER is onto something, and perhaps its study was designed for the eyes of the central bankers in charge of the current interest rate repression.