TREND WATCH: What’s Happening? Many Americans today—especially those who work in financial markets—see their economy as pushing at the bleeding edge of entrepreneurship, innovation, and competition. In every annual letter to shareholders, Warren Buffett continues to extoll this country’s “economic dynamism,” which (he says) is looking “better than ever.” Sure, worry about debts or deficits or tariffs or taxes if you want. Just don’t worry about the untamable energy and swagger of 21st-century market capitalism.
Our Take: In reality, there is a large and growing body of evidence that U.S. business dynamism is in trouble—and may indeed be experiencing an accelerating decline. Possible reasons range from demographic aging and generational change to network effects and regulatory capture. “Declining business dynamism” is a hot topic today among economists and policymakers. This note serves as an introduction to our visual guide through the evidence and the issues.
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Americans often view their economy as increasingly fast-paced, competitive, and entrepreneurial, full of disruption and accelerating turnover: Just look at the overnight success of Facebook and Airbnb, or the sudden demise of Toys R Us and The Limited.
Let’s define “business dynamism” as the process of Smithian or Schumpeterian creative destruction by which jobs, firms, and ideas are reshuffled to their most productive uses. By that measure, most Americans probably think their economy is doing pretty well. To wit, they are likely to believe the following:
- Spurred by huge technological gains and an ongoing economic recovery, productivity growth is surging.
- Jobs and firms are being created and destroyed at an unprecedented rate to meet the new needs of our innovation-driven economy.
- More Americans are being matched with better jobs thanks to mobile IT and online networking, leading to higher rates of job churn and geographic mobility.
- Creative disruption has turned the market into a revolving door. The average U.S. firm has gotten younger and leaner.
- The rise of billion-dollar IPOs is evidence of higher turnover at the very top of the market.
- Most industries are becoming more competitive due to the speedier transmission of “best practices” to rival firms.
- Pricing power is waning in an economy in which more firms are pressing up against the productivity frontier.
It makes for a compelling story. But all of it is untrue. In fact, most of the data we have on business dynamism are pointing in the opposite direction.
THE THREAT POSED BY DECLINING DYNAMISM
The emerging literature on declining business dynamism traces back to 2014 and 2015, when experts began noticing that the economy wasn’t bouncing back as strongly as expected. Upon further digging, they uncovered a wide variety of “symptoms” pointing to an extended decline in business dynamism that predates the financial crisis—symptoms including everything from a decline in new firm formations to a rise in monopoly power.
In this report, we divide these symptoms into nine categories:
- declining rates of job creation and destruction
- declining rates of job churn and geographic mobility
- declining rates of company start-ups and firm turnover
- declining number of total firms and (especially) listed firms
- growing age and size of typical firm
- declining turnover/turbulence in S&P 100 giants
- weakening firm response to productivity gaps
- rising market concentration
- a widening divide between winners and losers
Taken together, these symptoms are evidence of a disease that may threaten America’s long-term economic future. Business dynamism is inextricably linked to labor productivity growth: Higher dynamism enables more efficient reallocation of economic resources to the most productive firms, which boosts aggregate productivity growth. Lower dynamism, by contrast, constrains productivity growth—and by extension, GDP growth.
POSSIBLE CAUSES
There are a wide range of factors that could be contributing to declining business dynamism. Some are rooted in demographics, like workforce aging and generational change. Some are triggered by globalism and the new IT revolution, like network effects and infinite returns to scale. Still others are linked to America’s political economy, like regulatory capture and new antitrust policies that favor incumbent giants. The list includes:
- demographic aging
- generational change
- rise of IT & global markets
- dysfunctional IP/patent system
- regulatory capture
- ebbing antitrust enforcement
- productivity exhaustion
- policy sclerosis & civic distrust
IMPLICATIONS FOR POLICY AND FOR MARKET PERFORMANCE
Because of the disparate factors at play, there are a wide range of policy fixes that might plausibly help resuscitate business dynamism.
The political right tends to favor policies that strip away regulations and limit governmental overreach. The left tends to favor policies that break up big companies, enhance the bargaining power of labor, and redistribute income. Increasingly, leaders on both sides are coming to an agreement on middle-ground policies, including:
- stricter “economic” antitrust policy
- reform of patent/IP law
- deregulate professions
So how should investors play the situation?
In the near term, bet on the global superstars. Size, scale, and future pricing power beat value picks in today’s market. Global superstars with higher productivity, higher margins, higher ROA, and stronger business moats than their competitors are the clear winners.
Proof? One recent study followed a long-short portfolio favoring listed firms in industries experiencing the most rapid concentration gains. In the decades before 2001, this portfolio generated negligible alpha. But in the years since 2001, it beat the market by an impressive 7.2% annually. On a range of measures (total return on assets, profit margin, patent generation), the best recent gainers have been firms that enjoy pricing power. Peter Thiel aptly sums up today’s success formula: If you want to create and capture lasting value, build a monopoly.
But longer term, these firms are no lock. Beware: At some point in the future, the tide will shift—and it may do so abruptly. This shift could be kicked off by any one of three factors (or some combination thereof):
- falling market and economic slowdown
- geopolitical shock
- populist/authoritarian backlash
History shows that eras of corporate “bigness” don’t last forever. Sometimes it takes a downturn or a geopolitical scare for markets to recalibrate (the Great Recession, for instance). Other times, policymakers respond to public backlash by retilting the playing board (the breakup of the Bell System). Either way, there will come a time when size and incumbency are seen as flaws, not features. Be prepared.
