A recent NBER working paper by Gutiérrez & Philippon has attracted attention from observers who see oligopoly everywhere and activists who want governments to more actively “manage” competition. The analysis in the paper is fundamentally flawed and should not be relied upon by policymakers, regulators, or anyone else.
As noted in my earlier post, Gutiérrez & Philippon attempt to craft a causal linkage between differences in U.S. and EU antitrust enforcement and product market regulation to differences in market concentration and corporate profits. Their paper’s abstract leads with a bold assertion:
Until the 1990’s, US markets were more competitive than European markets. Today, European markets have lower concentration, lower excess profits, and lower regulatory barriers to entry.
This post focuses on Gutiérrez & Philippon’s claim that EU markets have lower “excess profits.” This is perhaps the most outrageous claim in the paper. If anyone bothers to read the full paper, they’ll see that claims that EU firms have lower excess profits is simply not supported by the paper itself. Aside from a passing mention of someone else’s work in a footnote, the only mention of “excess profits” is in the paper’s headline-grabbing abstract.
What’s even more outrageous is the authors don’t define (or even describe) what they mean by excess profits.
These two factors alone should be enough to toss aside the paper’s assertion about “excess” profits. But, there’s more.
Gutiérrez & Philippon define profit to be gross operating surplus and mixed income (known as “GOPS” in the OECD’s STAN Industrial Analysis dataset). GOPS is not the same thing as gross margin or gross profit as used in business and finance (for example GOPS subtracts wages, but gross margin does not). The EU defines GOPS as (emphasis added):
Operating surplus is the surplus (or deficit) on production activities before account has been taken of the interest, rents or charges paid or received for the use of assets. Mixed income is the remuneration for the work carried out by the owner (or by members of his family) of an unincorporated enterprise. This is referred to as ‘mixed income’ since it cannot be distinguished from the entrepreneurial profit of the owner.
Here’s Figure 1 from Gutiérrez & Philippon plotting GOPS as a share of gross output.
Look at the huge jump in gross operating surplus for U.S. firms!
Now, look at the scale of the y-axis. Not such a big jump after all.
Over 23 years, from 1992 to 2015, the gross operating surplus rate for U.S. firms grew by 2.5 percentage points. In the EU, the rate increased by about one percentage point.
Using the STAN dataset, I plotted the gross operating surplus rate for each EU country (blue dots) and the U.S. (red dots), along with a time trend. Three takeaways:
- There’s not much of a difference between the U.S. and the EU average—they both hover around a gross operating surplus rate of about 19.5 percent; and
- There’s a huge variation in gross operating surplus rate across EU countries.
- Yes, gross operating surplus is trending slightly upward in the U.S. and slightly downward for the EU average, but there doesn’t appear to be a huge difference in the slope of the trendlines. In fact the slopes of the trendlines are not statistically significantly different from zero and are not statistically significantly different from each other.
The use of gross profits raises some serious questions. For example, the Stigler Center’s James Traina finds that, after accounting for selling, general, and administrative expenses (SG&A), mark-ups for publicly traded firms in the U.S. have not meaningfully increased since 1980.
The figure below plots net operating surplus (NOPS equals GOPS minus consumption of fixed capital)—which is not the same thing as net income for a business.
Same three takeaways:
- There’s not much of a difference between the U.S. and the EU average—they both hover around a net operating surplus rate of a little more than seven percent; and
- There’s a huge variation in net operating surplus rate across EU countries.
- The slope of the trendlines for net operating surplus in the U.S. and EU are not statistically significantly different from zero and are not statistically significantly different from each other.
It’s very possible that U.S. firms are achieving higher and growing “excess” profits relative to EU firms. It’s also very possible they’re not. Despite the bold assertions of Gutiérrez & Philippon, the information presented in their paper provides no useful information one way or the other.