Production Chain Length and Boundary Crossings in Global Value Chains

Production Chain Length and Boundary Crossings in Global Value Chains

 

From Structure and length of value chains

In a value chain, value is added in sequential production stages and is carried forward from one producer to the next in the form of intermediate inputs. Value chains driven by the fragmentation of production are not an entirely new economic phenomenon, but the increasing reliance on imported intermediate inputs makes value chains global.

According to a 2013 report by the OECD, WTO and UNCTAD for the G-20 Leaders Summit, “Value chains have become a dominant feature of the world economy” (OECD et al., 2013).

Obviously, this dominant feature of the world economy needs measuring and analyzing. Policy-relevant questions include, but are not limited to:

  • what is the contribution of global value chains to economy GDP and employment? how long and complex are value chains?
  • what is the involvement and position of individual industries in global value chains? do multiple border crossings in global value chains really matter?

These and related questions generated a considerable amount of investigations proposing new measures of exports and production to account for global value chains. Some of those were designed to re-calculate trade  flows in value added terms, whereas other provided an approximation of the average length of production process.

A relatively new stream of research focuses on a deep decomposition of value added or final demand ( rather than exports or imports ) into components with varied paths along global value chains and measurements of the length of the related production processes. Consider, for example, a petrochemical plant that generates some value added equal to its output less all intermediate inputs used. We would be interested to know which part of this value added, embodied in the petrochemicals, is used entirely within the domestic economy and which part is exported.

We would also inquire how much of the latter satisfies final demand in partner countries and how much is further used in production and, perhaps, in exports to third countries and so on. We would be interested, in particular, in counting the number of production stages the value added in these petrochemicals passes along the chain before reaching its final user.

 

From Structure and length of value chains

APL

 

 

From Structure and length of value chains

A natural question is whether this method can be applied to the real economy with myriads of products, industries and dozens of partner countries? It can surely be applied if the data on inter-industry transactions are organized in the form of input-output accounts, and the computations are performed in block matrix environment. In fact, the measurement of the number of production stages or the length of production chains has attracted the interest of many input-output economists. The idea of simultaneously counting and weighting the number of inter-industry transactions was formalized by Dietzenbacher et al. (2005). Their “average propagation length” (APL) is the average number of steps it takes an exogenous change in one industry to affect the value of production in another industry. It is the APL concept on which we build the count of the number of production stages from the petrochemical plant to its consumers in our simplified example above. The only difference is that Dietzenbacher et al. (2005), and many authors in the follow-up studies, neglect the completion stage. First applications of the APL concept to measure the length of cross-border production chains appear in Dietzenbacher and Romero (2007) and Inomata (2008), though Oosterhaven and Bouwmeester (2013) warn that the APL should only be used to compare pure interindustry linkages and not to compare different economies or different industries.

Fally (2011, 2012) proposes the recursive definitions of two indices that quantify the “average number of embodied production stages” and the “distance to final demand”.  Miller and Temurshoev (2015), by analogy with Antras et al. (2012), use the logic of the APL and derive the measures of “output upstreamness” and “input downstreamness” that indicate industry relative position with respect to the nal users of outputs and initial producers of inputs. They show that their measures are mathematically equivalent to those of Fally and the well known indicators of, respectively, total forward linkages and total backward linkages. Fally (2012) indicates that the average number of embodied production stages may be split to account for the stages taking place within the domestic economy and abroad. This approach was implemented in OECD (2012), De Backer and Miroudot (2013) and elaborated in Miroudot and Nordstrom (2015).

Ye et al. (2015) generalize previous length and distance indices and propose a consistent accounting system to measure the distance in production networks between producers and consumers at the country, industry and product levels from different economic perspectives. Their “value added propagation length” may be shown to be equal to Fally’s embodied production stages and Miller & Temurshoev’s input downstreamness when aggregated across producing industries.

Finally, Wang et al. (2016) develop a technique of additive decomposition of the average production length. Therefore, they are able to break the value chain into various components and measure the length of production along each component. Their production length index system includes indicators of the average number of domestic, cross-border and foreign production stages. They also propose new participation and production line position indices to clearly identify where a country or industry is in global value chains. Importantly, Wang et al. (2016) clearly distinguish between average production length and average propagation length, and between shallow and deep global value chains.

This paper builds on the technique and ideas of Wang et al. (2016) and the derivation of the weighted average number of border crossings by Muradov (2016). It re-invents a holistic system of analytical indicators of structure and length of value chains. As in Wang et al. (2016), global value chains are treated here within a wider economy context and are juxtaposed with domestic value chains. This enables developing new indices of orientation towards global value chains. The novel deliverables of this paper are believed to include the following. First, all measurements are developed with respect to output rather than value added or final product  flows. This is superior for interpretation and visualization purposes because a directly observable economic variable ( output ) is decomposed in both directions, forwards to the destination and backwards to the origin of value chain. It is also shown that at a disaggregate country-industry level, the measurement of production length is equivalent with respect to value added and output. Second, the decomposition of output builds on a factorization of the Leontief and Ghosh inverse matrices that allows for an explicit count of production stages within each detailed component. Third, the system builds on a refined classication of production stages, including final and primary production stages that are often neglected in similar studies. Fourth, the paper re-designs the average production line position index and proposes new indices of orientation towards global value chains that, hopefully, avoid overemphasizing the length of some unimportant cross-border value chains. Fifth, a new chart is proposed for the visualization of both structure and length of value chains. The chart provides an intuitive graphical interpretation of the GVC participation, orientation and position indices.

It is also worth noting that both Wang et al. (2016) and this paper propose similar methods to estimate the intensity of GVC-related production in partner countries and across borders. This is not possible with previous decomposition systems without explicitly counting the average number of production stages and border crossings.

 

 Key Terms:

  • Average Propagation Length
  • National Boundaries
  • Networks
  • Value Chains
  • Supply Chains
  • Upstreamness
  • Downstreamness
  • Structure of Chains
  • Smile Curves
  • Vertical Specialization
  • Fragmentation of Production
  • Shock Amplifiers
  • Shock Absorbers
  • Production Sharing
  • World Input Output Chains
  • WIOD
  • Counting Boundary Crossings
  • Production Staging
  • Slicing Up Value Chains
  • Mapping Value Chains
  • Geography of Value Chains
  • Spatial Economy

Key Sources of Research:

 

 

Characterizing Global Value Chains

Zhi Wang

Shang-Jin Wei

Xinding Yu and Kunfu Zhu

GLOBAL VALUE CHAIN DEVELOPMENT REPORT 2016
Background Paper Conference

Beijing, 17-18 March 2016

https://schar.gmu.edu/sites/default/files/faculty-staff/cv/Characterizing_Global_Value_Chains.pdf

 

 

The Great Trade Collapse: Shock Amplifiers and Absorbers in Global Value Chains

Zhengqi Pan

2016

http://gpn.nus.edu.sg/file/Zhengqi%20Pan_GPN2016_008.pdf

 

 

CHARACTERIZING GLOBAL VALUE CHAINS:PRODUCTION LENGTH AND UPSTREAMNESS

Zhi Wang
Shang-Jin Wei
Xinding Yu
Kunfu Zhu
March 2017

http://www.nber.org/papers/w23261.pdf

 

 

 

Characterizing Global Value Chains

Zhi Wang
Shang-Jin Wei,
Xinding Yu and Kunfu Zhu

September 2016

http://cepr.org/sites/default/files/Wang,%20Zhi.pdf

https://www.gtap.agecon.purdue.edu/resources/download/8178.pdf

 

 

MEASURING AND ANALYZING THE IMPACT OF GVCs ON ECONOMIC DEVELOPMENT

GLOBAL VALUE CHAIN DEVELOPMENT REPORT 2017

International Bank for Reconstruction and Development/The World Bank
2017

https://www.brookings.edu/wp-content/uploads/2017/07/tcgp-17-01-china-gvcs-complete-for-web-0707.pdf

 

 

 

Global Value Chains

http://www.coris.uniroma1.it/sites/default/files/Lecture%20Global%20Value%20Chains.pdf

 

 

MAPPING GLOBAL VALUE CHAINS

4-5 December 2012
The OECD Conference Centre, Paris

https://www.oecd.org/dac/aft/MappingGlobalValueChains_web_usb.pdf

 

 

 

Structure and length of value chains

Kirill Muradov

http://www.gws-os.com/downloads/ioworkshop/IO-Workshop-2017_Muradov_abstract.pdf

http://gws-os.com/downloads/ioworkshop/IO-Workshop-2017_Muradov_ppt.pdf

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3054155

 

Production Staging: Measurement and Facts

Thibault Fally

August 2012

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.717.7092&rep=rep1&type=pdf

 

 

 

TRACING VALUE-ADDED AND DOUBLE COUNTING IN GROSS EXPORTS

Robert Koopman
Zhi Wang
Shang-Jin Wei

November 2012

https://www0.gsb.columbia.edu/mygsb/faculty/research/pubfiles/5852/w18579.pdf

 

 

 

GIVE CREDIT WHERE CREDIT IS DUE: TRACING VALUE ADDED IN GLOBAL PRODUCTION CHAINS

Robert Koopman
William Powers
Zhi Wang
Shang-Jin Wei

September 2010

https://www.bea.gov/about/pdf/NBER%20working%20paper_1.pdf

 

 

 

Measuring the Upstreamness of Production and Trade Flows

By Pol Antràs, Davin Chor, Thibault Fally, and Russell Hillberry

2012

http://scholar.harvard.edu/files/antras/files/acfh_published.pdf

http://www.nber.org/papers/w17819.pdf

 

 

 

Using Average Propagation Lengths to Identify Production Chains in the Andalusian Economy

 

https://idus.us.es/xmlui/bitstream/handle/11441/17372/file_1.pdf?sequence=1&isAllowed=y

 

 

Production Chains in an Interregional Framework: Identification by Means of Average Propagation Lengths

 2007

 

http://journals.sagepub.com/doi/abs/10.1177/0160017607305366

 

 

 

Vertical Integration and Input Flows

Enghin Atalay

Ali Hortaçsu

Chad Syverson

2013

http://faculty.chicagobooth.edu/chad.syverson/research/verticalownership.pdf

 

 

 

The Rise of Vertical Specialization Trade

Benjamin Bridgman

January 2010

https://www.bea.gov/papers/pdf/the_rise_of_vertical_specialization_trade_bridgman_benjamin.pdf

 

 

 

THE NATURE AND GROWTH OF VERTICAL SPECIALIZATION IN WORLD TRADE

David Hummels
Jun Ishii
Kei-Mu Yi*

March 1999

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.475.3874&rep=rep1&type=pdf

 

 

Accounting for Intermediates: Production Sharing and Trade in Value Added

Robert C. Johnson

Guillermo Noguera

First Draft: July 2008
This Draft: June 2009

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.211.9707&rep=rep1&type=pdf

First Draft: July 2008
This Draft: May 2011

http://siteresources.worldbank.org/INTRANETTRADE/Resources/Internal-Training/287823-1256848879189/6526508-1283456658475/7370147-1308070299728/7997263-1308070314933/PAPER_4_Johnson_Noguera.pdf

 

 

 

FRAGMENTATION AND TRADE IN VALUE ADDED OVER FOUR DECADES

Robert C. Johnson
Guillermo Noguera

June 2012

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.679.6227&rep=rep1&type=pdf

 

 

 

Can Vertical Specialization Explain The Growth of World Trade

Kei-Mu Yi

1999

https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr96.pdf

 

 

CAN MULTI-STAGE PRODUCTION EXPLAIN THE HOME BIAS IN TRADE?

Kei-Mu Yi

Federal Reserve Bank of Philadelphia
June 2008
This revision: November 2008

https://www.philadelphiafed.org/-/media/research-and-data/publications/working-papers/2008/wp08-12r.pdf?la=en

 

 

 

Global Value Chains: New Evidence for North Africa

D. Del Prete, G. Giovannetti, E. Marvasi

2016

https://www.disei.unifi.it/upload/sub/pubblicazioni/repec/pdf/wp07_2016.pdf

 

 

 

Slicing Up Global Value Chains

Marcel Timmera Abdul Erumbana Bart Losa
Robert Stehrerb Gaaitzen de Vriesa

Presentation at International Conference on Global Value Chains and
Structural Adjustments,

Tsinghua University, June 25, 2013

http://www.rug.nl/ggdc/docs/session4_timmer.pdf

 

 

 

On the Geography of Global Value Chains

Pol Antràs

Alonso de Gortari

May 24, 2017

https://scholar.harvard.edu/files/antras/files/gvc_ag_latest_draft.pdf

 

 

Counting Borders in Global Value Chains

Posted: 12 Jul 2016

Last revised: 29 Aug 2016

Kirill Muradov

 

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2808130

 

 

Determinants of country positioning in global value chains

Kirill Muradov

May 2017

https://www.iioa.org/conferences/25th/papers/files/2932_20170627121_Muradov2017_countrypositioninGVC_1.1.pdf

 

 

THE CONSTRUCTION OF WORLD INPUT–OUTPUT TABLES IN THE WIOD PROJECT

ERIK DIETZENBACHERa*, BART LOSa, ROBERT STEHRERb, MARCEL TIMMERa and GAAITZEN DE VRIES

2013

 

https://unstats.un.org/unsd/trade/events/2014/mexico/documents/session6/WIOD%20construction.pdf

 

 

 

 

On the fragmentation of production in the us

Thibault Fally

July 2011

http://www.etsg.org/ETSG2011/Papers/Fally.pdf

http://voxeu.org/article/has-production-become-more-fragmented-international-vs-domestic-perspectives

A New Measurement for International Fragmentation of the Production Process: An International Input-Output Approach

Inomata, Satoshi

http://www.ide.go.jp/English/Publish/Download/Dp/175.html

Output Upstreamness and Input Downstreamness of Industries/Countries in World Production

Ronald E. Miller

Umed Temurshoev

 

Date Written: July 9, 2015

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2700845

Input-Output Calculus of International Trade

Kirill Muradov

 

Date Written: June 1, 2015

Posted: 9 Sep 2015 Last revised: 5 Oct 2015

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2643098

 

 

 

 Made in the World?

S. Miroudot

Hakan Nordstrom

Date Written: September 2015

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2658562

 

 

 

The Average Propagation Length Conflicting Macro, Intra-industry, and Interindustry Conclusions

October 2013
Jan Oosterhaven

Maaike C. Bouwmeester

https://www.researchgate.net/publication/258142955_The_Average_Propagation_Length_Conflicting_Macro_Intra-industry_and_Interindustry_Conclusions

 

 

 

Accounting Relations in Bilateral Value Added Trade

Robert Stehrer

May 2013

https://wiiw.ac.at/accounting-relations-in-bilateral-value-added-trade-dlp-3021.pdf

Whither Panama? Constructing a Consistent and Balanced World SUT System including International Trade and Transport Margins

Robert Stehrer

https://wiiw.ac.at/whither-panama-constructing-a-consistent-and-balanced-world-sut-system-including-international-trade-and-transport-margins-dlp-2905.pdf

https://wiiw.ac.at/p-2905.html

Quantifying International Production Sharing at the Bilateral and Sector Levels

Zhi Wang, Shang-Jin Wei, Kunfu Zhu

NBER Working Paper No. 19677
Issued in November 2013, Revised in March 2014

http://www.nber.org/papers/w19677

Measuring Smile Curves in Global Value Chains

Ming YE, Bo MENG , and Shang-jin WEI

August 2015

http://www.ide.go.jp/English/Publish/Download/Dp/530.html

 

 

 

 FOLLOW THE VALUE ADDED: BILATERAL GROSS EXPORT ACCOUNTING

by Alessandro Borin and Michele Mancini

2015

 

http://www.bancaditalia.it/pubblicazioni/temi-discussione/2015/2015-1026/en_tema_1026.pdf

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Intra Industry Trade and International Production and Distribution Networks

Intra Industry Trade and International Production and Distribution Networks

 

Inter Industry Trade is known as One way Trade.

Intra Industry Trade is known as Two way Trade.

 

Intra Industry Trade (IIT)

  • Can be Intra Firm or Inter Firm (Arms’ Length)
  • Can be Vertical or Horizontal (VIIT and HIIT)

Intra Industry Trade is measured using G-L Index among other indices.

Import and Export of Parts and Components (Intermediate Goods) causes measurement issues of IIT.

 

From Structure and Determinants of Intra-Industry Trade in the U.S. Auto-Industry

Intra-industry trade is defined as the simultaneous export and import of products, which belong to the same statistical product category. According to Kol and Rayment (1989), three types of bilateral trade flows may occur between countries: inter-industry trade, horizontal IIT and vertical IIT. Historically, the international trade between countries has been inter-industry form, which is described as the exchange of products belonging to different industries. Traditional trade models, such as Heckscher-Ohlin model or Ricardian model, have tried to explain this type of trade based on comparative advantage in relative technology and factor endowments. However, a significant portion of the world trade over the last three decades took the form of the intra-industry trade rather than inter-industry trade. As a result, the traditional trade models has been considered to be inadequate in explaining this new trade pattern because in these models there is no reason for developed countries to trade in similar but slightly differentiated goods.

 

From Structure and Determinants of Intra-Industry Trade in the U.S. Auto-Industry

Horizontal IIT has been defined as the exchange of similar goods that are similar in terms of quality but have different characteristics or attributes. The models developed by Dixit and Stiglitz (1977), Lancaster (1980), Krugman (1980, 1981), Helpman (1981), and Helpman and Krugman (1985) explain horizontal IIT by emphasizing the importance of economies of scale, product differentiation, and demand for variety within the setting of monopolistic competition type markets. In these models, IIT in horizontally differentiated goods should be greater, the greater the difference in income differences and relative factor endowments between the trading partners.

 

From Structure and Determinants of Intra-Industry Trade in the U.S. Auto-Industry

In contrast, vertical IIT represents trade in similar products of different qualities but they are no longer the same in terms unit production costs and factor intensities.5 Falvey (1981) and Falvey and Kierzkowski (1987) have shown that the IIT in vertically differentiated goods occurs because of factor endowment differences across countries. In particular, Falvey and Kierzkowski (1987) suggest that the amount of capital relative to labor used in the production of vertically differentiated good indicates the quality of good. As a consequence, in an open economy, higher- quality products are produced in capital abundant countries whereas lower-quality products are produced in labor abundant countries. This will give rise to intra-industry trade in vertically differentiated goods: the capital abundant country exports higher-quality varieties and labor abundant country exports lower-quality products. The models of vertical IIT predict that the share of vertical IIT will increase as countries’ income and factor endowments diverge.

From Structure and Determinants of Intra-Industry Trade in the U.S. Auto-Industry

Various ways of calculating intra-industry trade have been proposed in the empirical literature, including the Balassa Index, the Grubel-Lloyd (G-L) index, the Aquino index. The most widely used method for computing the IIT is developed by Grubel and Lloyd (1971). However, beside aggregation bias, the traditional G-L index has one major problem often cited in the empirical literature. The unadjusted G-L index is negatively correlated with a large overall trade imbalance. With national trade balances, the level of IIT in a country will be clearly underestimated. To avoid this problem, Grubel and Lloyd (1975) proposed another method to adjust the index by using the relative size of exports and imports of a particular good within an industry as weights.

 

From Structure and Determinants of Intra-Industry Trade in the U.S. Auto-Industry

iit

 

From Structure and Determinants of Intra-Industry Trade in the U.S. Auto-Industry

IIT2IIT3IIT4

 

From:  World Trade Flows Characterization: Unit Values, Trade Types and Price Ranges

 

IIT5

 

 

Key Terms:

  • Intra Industry Trade
  • Inter Industry Trade
  • Horizontal IIT
  • Vertical IIT
  • Ricardo’s Theory of Comparative Advantage
  • Factor Inputs
  • Factor Endowments
  • Factor Prices
  • Heckscher-Ohlin Model of Trade
  • Stolper-Samuelson Theorem
  • Grubel – Lloyd Index
  • Fontagné and Freudenberg index (FF)
  • New Economic Geography (NEG)
  • Spatial Economy
  • UN COMTRADE
  • SITC Codes
  • Balassa Index
  • Acquino Index
  • Bilateral Trade Flows

 

Please see my related posts:

Understanding Trade in Intermediate Goods

Trends in Intra Firm Trade of USA

FDI vs Outsourcing: Extending Boundaries or Extending Network Chains of Firms

Relational Turn in Economic Geography

Understanding Global Value Chains – G20/OECD/WB Initiative

 

 

Key Sources of Research:

 

 

International Production and Distribution Networks in East Asia:  Eighteen Facts, Mechanics, and Policy Implications

Fukunari Kimura

2006

http://www1.doshisha.ac.jp/~ccas/eng/Eseminars/e2007-11b.pdf

 

 

 

The Formation of International Production and Distribution Networks in East Asia

 

Mitsuyo Ando and Fukunari Kimura

 

http://www.nber.org/chapters/c0194.pdf

 

 

“The mechanics of production networks in Southeast Asia: the fragmentation theory approach”

Fukunari Kimura

July 2007

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.600.7481&rep=rep1&type=pdf

 

 

 

“Fragmentation in East Asia: Further Evidence”

May 2006

Mitsuyo Ando

Fukunari Kimura

http://venus.unive.it/mvolpe/Articolo%204.pdf

 

 

 

Modern International Production and Distribution Networks: the Role of Global Value Chains

Fukunari Kimura

2016

https://www.cepchile.cl/cep/site/artic/20161006/asocfile/20161006141226/presentation_fukunari_kimura.pdf

 

 

 

Two-dimensional Fragmentation in East Asia: Conceptual Framework and Empirics

Fukunari Kimura and Mitsuyo Ando

http://www.computer-services.e.u-tokyo.ac.jp/p/seido/output/Ishikawa/046.pdf

 

 

 

Deepening and Widening of Production Networks in ASEAN

Ayako Obashi

Fukunari Kimura

2016

http://www.eria.org/ERIA-DP-2016-09.pdf

 

Global production sharing and trade patterns in East Asia

Prema-chandra Athukorala

June 2013

http://www.waseda.jp/gsaps/eaui/educational_program/PDF_2/TU_VIROT,%20Ali_Reading2_Global%20Production%20Sharing%20and%20Trade%20Patterns%20in%20East%20Asia.pdf

 

 

 

PRODUCTION SHARING IN EAST ASIA: CHINA’S POSITION, TRADE PATTERN AND TECHNOLOGY UPGRADING

Laike Yang

http://unctad.org/en/PublicationChapters/gdsmdp20152yang_en.pdf

 

 

 

 

International Production Networks:  Contributions of Economics to Policy Making

Fukunari Kimura

2016

https://www.jstage.jst.go.jp/article/internationaleconomy/19/0/19_ie2016.03.fk/_pdf

 

 

 

 

Production networks in East Asia: What we know so far

Fukunari Kimura and Ayako Obashi

No. 320
November 2011

https://www.econstor.eu/bitstream/10419/53625/1/67543923X.pdf

 

Structure and Determinants of Intra-Industry Trade in the U.S. Auto-Industry

Kemal Turkcan and Aysegul Ates

2010

 

http://www2.southeastern.edu/orgs/econjournal/index_files/JIGES%20DECEMBER%202009%20TURKCAN%203-10-2010%20Turkcan_Ates_JIGES.pdf

 

 

 

Vertical Intra-Industry Trade: An Empirical Examination of the U.S. Auto-Parts Industry

Kemal TÜRKCAN and Ayşegül ATEŞ

(This version October 2008)

 

http://www.etsg.org/ETSG2008/Papers/Turkcan.pdf

 

 

 

Intra-industry trade, fragmentation and export margins: An empirical examination of sub-regional international trade

Yushi Yoshida

 

https://www.iseg.ulisboa.pt/aquila/getFile.do?method=getFile&fileId=501284

 

 

A Practical Guide to Trade Policy Analysis

WTO

https://www.wto.org/english/res_e/publications_e/wto_unctad12_e.pdf

 

 

 

Intra-Industry Trade between Japan and European Countries: a Closer Look at the Quality Gap in VIIT

Yushi Yoshida, Nuno Carlos Leitão and Horácio Faustino

http://pascal.iseg.utl.pt/~depeco/wp/wp532008.pdf

 

 

Evolving pattern of intra-industry trade specialization of the new Member States (NMS) of the EU: the case of automotive industry

Elżbieta Kawecka-Wyrzykowska

2008

 

http://ec.europa.eu/economy_finance/publications/pages/publication14289_en.pdf

 

 

VERTICAL AND HORIZONTAL INTRA-INDUSTRY TRADE BETWEEN THE U.S. AND NAFTA PARTNERS

2009

 

http://www.scielo.cl/pdf/rae/v24n1/art02.pdf

 

 

 

Globalizing Production Structure and Intra-Industry Trade: The Case of Turkey

Emine Kılavuz

Hatice Erkekoğlu

Betül Altay Topcu

2013

https://www.econjournals.com/index.php/ijefi/article/viewFile/563/pdf

 

 

 

On the Measurement of Vertical and Horizontal Intra-Industry Trade: A Geometric Exposition

A.K.M. Azhar Robert J.R. Elliott

http://www.ibrarian.net/navon/paper/On_the_Measurement_of_Vertical_and_Horizontal_Int.pdf?paperid=1018522

 

 

 

 Determinants of United States’ Vertical and Horizontal Intra-Industry Trade

2013

 

https://espace.curtin.edu.au/bitstream/handle/20.500.11937/41590/197560_110710_GEJ_2013.pdf?sequence=2

 

 

 

World Trade Flows Characterization: Unit Values, Trade Types and Price Ranges

Charlotte Emlinger & Sophie Piton

2014

http://www.cepii.fr/PDF_PUB/wp/2014/wp2014-26.pdf

Understanding Trade in Intermediate Goods

Understanding Trade in Intermediate Goods

 

One of the key source of International Trade statistics is a document published by the UNCTAD since 2013:

Key Statistics and Trends in International Trade

Please see references below to access reports for 2015 and 2016.

 

In 2014, out of USD 18.5 trillion in global trade, about USD 8 trillion was in intermediate goods.

 

From TRADE IN INTERMEDIATE GOODS AND SERVICES

Introduction: the international dimension of the exchange of intermediate inputs

1. Trade in intermediate inputs has been steadily growing over the last decade. However, despite the internationalisation of production and the increasing importance of outsourcing and foreign investment, some studies have found little rise in intermediate goods trade as a share of total trade1. More than half of goods trade is however made up of intermediate inputs and trade in services is even more of an intermediate type with about three quarters of trade flows being comprised of intermediate services. Trade in intermediate goods and services thus deserves special attention from trade policymakers and so far few studies have investigated how it differs from trade in consumption goods or services.

2. An intermediate good can be defined as an input to the production process that has itself been produced and, unlike capital, is used up in production3. The difference between intermediate and capital goods lies in the latter entering as a fixed asset in the production process. Like any primary factor (such as labour, land, or natural resources) capital is used but not used up in the production process4. On the contrary, an intermediate good is used, often transformed, and incorporated in the final output. As an input, an intermediate good has itself been produced and is hence defined in contrast to a primary input. As an output, an intermediate good is used to produce other goods (or services) contrary to a final good which is consumed and can be referred to as a “consumption good”.

3. Intermediate inputs are not restricted to material goods; they can also consist of services. Thelatter can be potentially used as an input to any sector of the economy; that is for the production of the same, or other services, as well as manufacturing goods. Symmetrically, manufacturing goods can be potentially used to produce the same, or other manufacturing goods, as well as services.

4. An important question we can ask is how to identify inputs among all goods and services produced in an economy. Many types of goods can be easily distinguished as inputs, when their use excludes them from final consumption. Notable examples include chemical substances, construction materials, or business services. The exact same type of good used as an input to some production process can however be destined to consumption. For instance, oranges can be sold to households as a final good, as well as to a factory as an input for food preparation. Telecommunication services can be sold to individuals or to business services firms as an intermediate input for their output. The United Nations distinguish commodities in each basic heading on the basis of the main end-use (United Nations, 2007). It is however recognized that many commodities that are traded internationally may be put to a variety of uses. Other methodologies involve the use of input-output (I-O) tables to distinguish between intermediate and consumption goods.

5. The importance of intermediate goods and services in the economy and trade is associated with a number of developments in the last decades. Growth and increased sophistication of production has given birth to strategies involving fragmentation and reorganisation of firm’s activities, both in terms of ownership boundaries, as in terms of the location for production. In what follows, the international dimension of the exchange of intermediate goods and services is explored by clarifying terms and concepts as well as the links between trade in intermediate inputs and FDI.

From Key Statistics and Trends in International Trade 2015

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From Key Statistics and Trends in International Trade 2015

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 From Key Statistics and Trends in International Trade 2015

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From Key Statistics and Trends in International Trade 2015

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From Key Statistics and Trends in International Trade 2015

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From Key Statistics and Trends in International Trade 2015

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From Key Statistics and Trends in International Trade 2015

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From Key Statistics and Trends in International Trade 2015

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From Key Statistics and Trends in International Trade 2015

Trade networks relating to global value chains have evolved during the last 10 years. In 2004, the East Asian production network was still in its infancy. Most trade flows of parts and components concerned the USA and the European Union, with a number of other countries loosely connected with these two main hubs. As of 2014 trade of parts and components was much more developed. The current state is characterized not only by the prominent role of China, but also by a much more tightly integrated network with a much larger number of countries many of which have multiple connections to different hubs.

From Mapping Global Value Chains: Intermediate Goods Trade and Structural Change in the World Economy

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Key sources of Research:

 

TRADE IN INTERMEDIATE GOODS AND SERVICES

OECD Trade Policy Working Paper No. 93
by Sébastien Miroudot, Rainer Lanz and Alexandros Ragoussis

2009

https://www.oecd.org/trade/its/44056524.pdf

 

 

An Essay on Intra-Industry Trade in Intermediate Goods

Rosanna Pittiglio

2014

http://file.scirp.org/pdf/ME_2014051916452646.pdf

 

 

The Rise of International Supply Chains: Implications for Global Trade

http://www3.weforum.org/docs/GETR/2012/GETR_Chapter1.2.pdf

 

 

 

Growing Trade in Intermediate Goods: Outsourcing, Global Sourcing or Increasing
Importance of MNE Networks?

by
Jörn Kleinert
October 2000

https://www.ifw-kiel.de/ifw_members/publications/growing-trade-in-intermediate-goods-outsourcing-global-sourcing-or-increasing-importance-of-mne-networks/kap1006.pdf

 

 

 

Imported Inputs and the Gains from Trade

Ananth Ramanarayanan
University of Western Ontario
September, 2014

https://www.economics.utoronto.ca/index.php/index/research/downloadSeminarPaper/49816

 

 

 

Key Statistics and Trends in International Trade 2015

Division on International Trade in Goods and Services, and Commodities
United Nations Conference on Trade and Development

http://unctad.org/en/PublicationsLibrary/ditctab2015d1_en.pdf

 

 

 

Key Statistics and Trends in International Trade 2016

Division on International Trade in Goods and Services, and Commodities
United Nations Conference on Trade and Development

http://unctad.org/en/PublicationsLibrary/ditctab2016d3_en.pdf

 

 

Integration of Trade and Disintegration of Production in the Global Economy

Robert C. Feenstra
Revised, April 1998

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.39.7178&rep=rep1&type=pdf

 

 

 

GLOBAL VALUE CHAINS: CHALLENGES, OPPORTUNITIES, AND IMPLICATIONS FOR POLICY

OECD, WTO and World Bank Group
Report prepared for submission to the G20 Trade Ministers Meeting Sydney, Australia, 19 July 2014

https://www.oecd.org/tad/gvc_report_g20_july_2014.pdf

 

 

Trade in Value Added: Concepts, Estimation and Analysis

Marko Javorsek* and Ignacio Camacho

20015

http://www.unescap.org/sites/default/files/AWP150Trade%20in%20Value%20Added.pdf

 

 

The Similarities and Differences among Three Major Inter-Country Input-Output Databases and their Implications for Trade in Value-Added Estimates

Lin Jones and Zhi Wang, United States International Trade Commission Li Xin, Beijing Normal University and Peking University Christophe Degain, World Trade Organization

December, 2014

https://www.usitc.gov/publications/332/ec201412b.pdf

 

 

Advanced Topics in Trade
Lecture 9 – Multinational Firms and Foreign Direct Investment

Heiwai Tang – SAIS
April 8, 2015

http://www.hwtang.com/uploads/3/0/7/2/3072318/lecture_8_new.pdf

 

 

Efforts to Measure Trade in Value-Added and Map Global Value Chains: A Guide

Andrew Reamer

May 29, 2014

https://gwipp.gwu.edu/files/downloads/Reamer_ISA_Trade_in_Value_Added_05-29-2014.pdf

 

 

 

Global Value Chains for Value Added and Intermediate Goods in Asia

N Shrestha

20015

http://www.econ.ynu.ac.jp/cessa/publication/pdf/CESSA%20WP%202015-07.pdf

 

 

 

Global Value Chains: The New Reality of International Trade

Sherry Stephenson
December 2013

http://e15initiative.org/wp-content/uploads/2015/09/E15-GVCs-Stephenson-Final.pdf

 

 

Asia and Global Production Networks Implications for Trade, Incomes and Economic Vulnerability

Benno Ferrarini

David Hummels

20014

https://www.adb.org/sites/default/files/publication/149221/asia-and-global-production-networks.pdf

 

 

Participation of Developing Countries in Global Value Chains:
Implications for Trade and Trade-Related Policies

by
Przemyslaw Kowalski, Javier Lopez Gonzalez, Alexandros Ragoussis
and Cristian Ugarte

https://www.die-gdi.de/uploads/media/OECD_Trade_Policy_Papers_179.pdf

 

 

GLOBAL VALUE CHAINS: SURVEYING DRIVERS, MEASURES AND IMPACTS

João Amador
Sónia Cabral

2014

https://www.bportugal.pt/sites/default/files/anexos/papers/wp20143.pdf

 

World Intermediate goods Exports By Country and Region

2014

WITS World International Trade Statistics

http://wits.worldbank.org/CountryProfile/en/Country/WLD/Year/2014/TradeFlow/Export/Partner/all/Product/UNCTAD-SoP2

 

 

Trade in global value chains

2013

WTO

https://www.wto.org/english/res_e/statis_e/its2013_e/its13_highlights4_e.pdf

 

 

The Rise of Trade in Intermediates: Policy Implications

  • February 10, 2011

http://carnegieendowment.org/2011/02/10/rise-of-trade-in-intermediates-policy-implications-pub-42578

 

 

International trade with intermediate and final goods under economic crisis

Elżbieta Czarny, Warsaw School of Economics
Paweł Folfas, Warsaw School of Economics
Katarzyna Śledziewska, Warsaw University

http://www.etsg.org/ETSG2012/Programme/Papers/375.pdf

 

 

 

Trade in Intermediate Goods: Implications for Productivity and Welfare in Korea

Young Gui Kim

Hak K. PYO

Date Written: December 30, 2016

 

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2929118

 

 

Growing Together: Economic Ties between the United States and Mexico

BY CHRISTOPHER WILSON

https://www.wilsoncenter.org/sites/default/files/growing_together_economic_ties_between_the_united_states_and_mexico.pdf

 

 

Mapping Global Value Chains: Intermediate Goods Trade and Structural Change in the World Economy

Timothy J. Sturgeon
Olga Memedovic

https://www.unido.org/fileadmin/user_media/Publications/Research_and_statistics/Branch_publications/Research_and_Policy/Files/Working_Papers/2010/WP%2005%20Mapping%20Glocal%20Value%20Chains.pdf

 

India’s Intermediate Goods Trade in the Inter Regional Value Chain:
An examination based on Trade data and Input Output Analysis

Simi Thambi

https://www.jsie.jp/Annual_Meeting/2013f_Yokohoma_n_Univ/pdf/10_2%20fp.pdf

 

Global Supply Chains

https://www.usitc.gov/publications/332/pub4253_2.pdf

 

 

Global value chains in a changing world

Edited by Deborah K. Elms and Patrick Low

https://www.wto.org/english/res_e/booksp_e/aid4tradeglobalvalue13_e.pdf

 

Rising Profits, Rising Inequality, and Rising Industry Concentration in the USA

Rising Profits, Rising Inequality, and Rising Industry Concentration in the USA

 

There is a need for holistic/systemic understanding of causal relations among

  • Low Economic Growth
  • Low Real Long Term Interest Rates
  • Decreased Business Investment
  • Mergers and Acquisitions Activity
  • Industry Concentration
  • Decreased Competition
  • Rising Profits
  • Income Inequality
  • Shareholder Capitalism
  • Dividends Payouts
  • Buyback of Shares
  • Superstar Firms
  • Too Big to Fail
  • Oligopoly Economy / Oligarchy
  • Decreased Number of Stocks/Equities
  • Focus on Costs Minimization
  • Increased Outsourcing
  • Global Value Chains
  • Free Trade Agreements
  • Market Power (Increased Market Share)
  • Decreased Dynamism
  • Herding by Suppliers
  • Labor Vs Executive Compensation
  • Unemployment
  • Concentration in Occupations

And don’t forget managerial focus on

  • Economic Value Added (EVA) since 1990s

 

There are two views to look at these issues

  • Aggregated View – Corporate Agglomeration and Spatial Dispersion / Extension
  • Disaggregated View – Micro Motives, Macro Behavior ( Bottom up Agent based view)

 

As the research papers below indicate, the scholarship is recent and need much more attention by the Economists and Policy makers.

 

From Is There a Connection Between Market Concentration and the Rise in Inequality?

The rise in wealth and income inequality has been at the forefront of the political debate in the U.S. in the last few years. At the same time, issues like market power and concentration, bigness, and antitrust have also come back into prominence, propelled by a growing body of research that points to diminishing competition across multiple American industries.

The possible connection between inequality and market concentration, however, has been relatively understudied for many years—until recent years, that is, when a sheafof new studies examining the interactions between concentration, market power, and inequality began to appear.

A 2015 paper by Jonathan Baker and Steven Salop, for instance, examined the connection between inequality and market power and argued that “because the creation and exercise of market power tend to raise the return to capital, market power contributes to the development and perpetuation of inequality.” Harvard Law School’s Einer Elhauge also found that horizontal shareholding likely leads to anti-competitive price raises and has regressive effects. Daniel Crane of the University of Michigan, however, contends that the connection between antitrust and wealth inequality has been grossly oversimplified by advocates of tougher antitrust enforcement.

Asked if there was a connection between concentration and inequality, Chicago Booth professors Austan Goolsbee, Steven Kaplan, and Sam Peltzman pointed to data being inconclusive. Goolsbee said: “Probably [there is a connection]. But we don’treally know more than correlations at this point.” Kaplan said his own research “suggests that winner-take-all markets (driven by technology and scale) play a rolein inequality. However, they may not play the most important role.” And Peltzmansaid that “The timing suggests so, but there are a lot of unconnected dots in this question.”

Is rising inequality connected to monopolies, rent-seeking, and concentration, or is it a result of larger forces like globalization and technology? Can antitrust be used effectively to mitigate inequality, or is concentration a sign of greater efficiency? These questions, and others, were debated by economists and legal scholars during a panel at the recent Stigler Center conference on concentration in America.

The panel featured Peter Orszag, Vice Chairman and Managing Director of the financial advisory and asset management firm Lazard Freres; Justin Pierce, a Senior Economist at the Board of Governors of the Federal Reserve; Lina Khan, a fellow at Open Markets program at New America; Sabeel Rahman, an Assistant Professor of Law at Brooklyn Law School; Simcha Barkai, a PhD Candidate at the University of Chicago Booth School of Business; and German Gutierrez, a PhD Candidate at the New York University Stern School of Business. The panel was moderated by Matt Stoller of the Open Markets program at New America, who opened by observing that “a new kind of Brandeis School of antitrust is emerging, in terms of thinking about political economy.”

Much of the panel focused on the dramatic rise in corporate profits. A recent, much-discussed Stigler Center working paper by Simcha Barkai found that over the past 30 years, as labor’s share of output fell by 10 percent, the capital share declined even further. This finding goes against the argument that the labor share went down due to technological changes, or as Barkai put it: “We used to spend money on people, today we’re spending money on robots.”

Barkai’s paper finds no evidence to support the technological argument. “We’re spending less on all inputs. If you think of this from the perspective of a firm, this is terrific. After accounting for all of my costs—material inputs, workers, capital—I am left with a large amount of money, much more so than in the past.” What Barkai does find, however, is that profits have gone way up. From 1984 to 2014, the profit share increased from 2.5 percent of GDP to 15 percent.

“To give you a sense of how large these profits are, if you look over the past 30 years and you ask, ‘How much have profits increased?’ you can give a number in dollars. A better way to think about that is, “Per worker, how much have these dollars increased?” It’s about $14,000 per worker. That’s a really large number because, in 2014, personal median income was just over $28,000. It’s about half of personal median income,” said Barkai.

Barkai went on to say that these findings were more pronounced in industries that experienced an increase in concentration. “Those industries that have a large increase in concentration also have larger declines in the labor share,” he said. Barkai’s conclusions were echoed by a separate study that was recently published by David Autor, David Dorn, Lawrence Katz, Christina Patterson, and John Van Reenen, in which they found that higher concentration is connected to the fall in the labor share.

One way to consider the question of concentration and inequality, said Pierce, is to look at what happens to firms’ efficiency and markups as a result of a merger. In a recent paper with Bruce Blonigen, Pierce was able to utilize new techniques in order to isolate the effects of mergers in the manufacturing sector. Comparing data from factories that were acquired during mergers to similar factories that weren’t, and to factories where an acquisition has been announced but not yet completed, Pierce and Blonigen found no evidence of the standard argument that mergers benefit consumers by increasing efficiency, reducing production costs, and, in turn, lowering prices. Quite the opposite: they found evidence that mergers increase market power, allowing firms to generate higher profits by raising prices.

“What we find when we do this is that mergers on average are associated with increases in markups in a magnitude of 15 to 50 percent. When we look at the effect on productivity, we actually don’t find a statistically significant effect on productivity associated with mergers,” said Pierce.

Gutierrez, meanwhile, spoke about his 2016 paper with Thomas Philippon, in which the two found that concentrated industries with less entry and more concentration invest less. Before 2000, he explained, firms funneled about 20 cents of every dollar of surplus into investments. Since 2000, however, investments dropped by half—to 10 cents on the dollar.

Their findings, he said, rule out the argument that the drop in investments is related to control by the stock market. The data also rule out other theories, such as financial constraints, safety premiums, or globalization. “What we’re left with is competition, or lack of competition and governance,” said Gutierrez.

“What we find is that most industries have become more concentrated. That leads to a decrease in investment. It means less investment by leaders in particular, and at the industry as a whole. Some manufacturing industries have seen increased competition from China. For the U.S. in particular, we see that leaders invest more. They try and hold onto their position, but the overall effect is somewhat negative on aggregate investment in the U.S.”

How is this drop in investments connected to an increase in concentration? Gutierrez offered two hypotheses: one, that superstar firms, such as digital platforms, are more productive and are therefore capturing more market share. The second, he said, is increased regulation: “In particular, if you look at the cross section of industries, industries where regulation has increased have also tended to become more concentrated and have invested less.”

Orszag, the former head of the Office of Management and Budget and former Director of the Congressional Budget Office, co-authored a 2015 paper with former Obama economic adviser Jason Furman that explored the rise in “supernormal returns on capital” among firms that have limited competition. In the panel, he spoke about what he described as a “dramatic rise” in dispersion among firms in productivity and wages as an understudied driver of inequality.

“In general, if you look at most textbooks on economics and most discussions of public policy, firms are seen as this uninteresting thing that you have to deal with but don’t want to really get into the innards of. Why do some firms behave differently than others? Having now spent a bunch of time in the private sector, the culture in firms really is quite different. Firms do behave differently from one to another beyond just market structure. Within the same market in the same field, Firm A is not the same as Firm B, as people who work inside those firms know.”

Orszag pointed to OECD data that showed that top global firms have been largely exempted from the decline in productivity that advanced economies experienced over the last 10-15 years. “If there’s a structural explanation for that, whether it’s polarization or market structure or innovation, why is it affecting only the laggards in the industry and not those at the frontier? Secondly, why aren’t there more spillovers from the frontier firms within each sector to others? What is happening to the flow of information or the flow of technique or what have you that’s causing this broad, significant rise in productivity deltas across firms, even within the same sector?” he asked.

Orszag also suggested that contrary to media narratives that present growing gaps between CEO wages and median workers within each firm as a prominent driver of inequality, the bulk of the rise in wage gaps is happening between firms, and not within the firms themselves. Studies, he said, show a dramatic increase in between-firm wage inequality “and very little movement except at the very, very largest firms in within-firm inequality.”

Orszag added: “We don’t know exactly what’s causing this. This may be a sorting of workers. It may be sharing of rents in the form of wages for the top firms. It may be a whole variety of different things. What I do suggest is the vast majority of the discussion on income-and-wage inequality seems to just glide over this whole thing as if it doesn’t exist.”

A holistic approach to inequality and concentration

Khan, who in a recent paper with Sandeep Vaheesan explored the role of monopoly and oligopoly power in perpetuating inequality, argued that the way to understand the connection between market concentration and inequality is to take a more holistic approach.

The connection between excessive market concentration and inequality, she said, has been understudied for a long time. “We were really surprised to see that at the time, in 2014, there really wasn’t much research on this connection at all. The most comprehensive paper that we found was from 1975 by William Comanor and Robert Smiley, which found that monopoly power did in fact transfer wealth to the most affluent members of society and suggested that a more competitive economy would have more progressive redistributive effects,” said Kahn. “One way to understand why this connection between market concentration and inequality has been understudied is that the law decided that it wasn’t really important. Once we shifted from an antitrust approach that took a more holistic and multidimensional view of the effect of market power to an approach that privilege means prices, the research on these effects also took a hit.”

In their paper, Khan and Vaheesan argue that inequality not only harms efficiency, but also that firms use their market power to raise prices “above competitive levels to consumers and push prices below competitive levels for small producers.” The paper makes a case for more rigorous enforcement of antitrust laws, arguing that reinvigorating antitrust could be one possible remedy for the regressive redistributive effects of concentration and the political power of monopolies.

“I think at a very basic level, our current political economy reflects 30 years of doing antitrust in a very particular way,” said Khan, who listed several industries such as airlines, healthcare, pharmaceuticals, and telecom, where prices have risen following mergers and industry consolidation.

“New business creation and growth have been on a secular decline. It’s worth recalling that in an earlier era, owning one’s own business was a form of asset building for the middle class, a way of passing on wealth to one’s children. This is especially still true in immigrant communities, where owning your own bodega or your own dry-cleaning service is a path of upward mobility. You can imagine how markets that shut out independent businesses are also effectively closing off that path of asset building,” said Khan.

Khan went on to discuss the political implications of excessive market power and how they can further entrench inequality. “Big firms and concentrated industries enjoy a level of political power that they can use to further entrench their economic dominance. Politics is another vessel by which we see this,” she said.

Rahman, author of the book Democracy Against Domination (Oxford University Press, 2016), also advocated for a wider view of the issue. “When we’re worried about the problem of concentration, I think it goes much broader than the specific areas of mergers and firm size, although that’s a big part of it,” he said.

“When we think about the good things that we want from the economy, we want it to be dynamic, we want it to be innovative, we want it to enable mobility. These things are not natural products. They are a property of the underlying structure of firms, of labor markets, of financial markets, and of policies, including antitrust,” said Rahman, who went on to discuss two aspects of the rise in concentration: digital platforms and the “Uber-ization” of more and more economic sectors, and what he described as a “growing geographic concentration of wealth, income, and opportunity between rural and urban.”

Rahman suggested that other tools, not just antitrust, could be used to combat excessive market power—particularly when it comes to the power of digital platforms. “The way I want to frame this is as a problem of concentration and inequality that warps the structure of opportunity in our economy,” said Rahman. “You have antitrust and public utility law, corporate governance, and labor law as three parts of the larger ecosystem of law and regulation that, coming out of that Progressive era debate about power, were the three complements that together, it was hoped, would produce a high-opportunity, a high-mobility economy that was open to all.”

 

Please also see my related post.

Low Interest Rates and Business Investments : Update August 2017

 

In addition to papers listed above, also see papers and articles mentioned in the references below.

Key sources of Research:

 

Rising Corporate Concentration, Declining Trade Union Power, and the Growing Income Gap: American Prosperity in Historical Perspective

Jordan Brennan

March 2016

 

http://piketty.pse.ens.fr/files/Brennan2016.pdf

They Just Get Bigger: How Corporate Mergers Strangle the Economy

Jordan Brennan

Feb 2017

http://evonomics.com/corporate-mergers-strangle-economy-jordan-brennan/

 The Oligarchy Economy: Concentrated Power, Income Inequality, and Slow Growth

Jordan Brennan

April 2016

http://evonomics.com/the-oligarchy-economy/

Declining Labor and Capital Shares

Simcha Barkai

November 2016

 

https://research.chicagobooth.edu/~/media/5872FBEB104245909B8F0AE8A84486C9.pdf

 

Lack of market competition, rising profits, and a new way to look at the division of income in the United States

Nov 2016

http://equitablegrowth.org/equitablog/lack-of-market-competition-rising-profits-and-a-new-way-to-look-at-the-division-of-income-in-the-united-states/

Rising U.S. business concentration and the decline in labor’s share of income

January 2017

http://equitablegrowth.org/equitablog/rising-concentration-declining-labor-share/

 

Concentrating on the Fall of the Labor Share

By DAVID AUTOR, DAVID DORN, LAWRENCE F. KATZ, CHRISTINA PATTERSON AND JOHN VAN REENEN

January 2017

http://www.nber.org/papers/w23108

Declining Competition and Investment in the U.S.

German Gutierrez and Thomas Philippon

March 2017

https://www8.gsb.columbia.edu/faculty-research/sites/faculty-research/files/finance/Macro%20Lunch/IK_Comp_v1.pdf

 

Dynamism in Retreat:  Consequences for Regions, Markets, and Workers

2017

 

https://eig.org/wp-content/uploads/2017/02/Dynamism-in-Retreat.pdf

 

The Oligopoly Problem

 

NewYorker

 

http://www.newyorker.com/tech/elements/the-oligopoly-problem

 

 

DOES INDUSTRY CONCENTRATION MATTER?

John J. Phelan

2014

Journal of Economics and Economic Education Research, Volume 15, Number 1, 2014

 

 

http://www.alliedacademies.org/articles/does-industry-concentration-matter.pdf

 

 

Increased Concentration of Occupations, Outsourcing, and Growing Wage Inequality in the United States

Elizabeth Weber Handwerker

U.S. Bureau of Labor Statistics

April, 2017

 

http://www.sole-jole.org/17733.pdf

 

 

Measuring occupational concentration by industry

2014

 

https://www.bls.gov/opub/btn/volume-3/pdf/measuring-occupational-concentration-by-industry.pdf

 

 

Rising wage dispersion between white-collar and blue-collar workers and market concentration: The case of the USA, 1966-2011,

D. Ilhan

(2017)

 

https://www.econstor.eu/bitstream/10419/162859/1/893982539.pdf

 

 

 

Rising Profits Don’t Lift Workers’ Boats

2016

https://www.bloomberg.com/news/articles/2016-05-05/rising-profits-don-t-lift-workers-boats

Is There a Connection Between Market Concentration and the Rise in Inequality?

 A Firm-Level Perspective on the Role of Rents in the Rise in Inequality

Jason Furman Peter Orszag
October 16, 2015

 

http://gabriel-zucman.eu/files/teaching/FurmanOrszag15.pdf

 Evidence for the Effects of Mergers on Market Power and Efficiency

Blonigen, Bruce A., and Justin R. Pierce

(2016).

https://www.federalreserve.gov/econresdata/feds/2016/files/2016082pap.pdf

 

 

Market Power and Inequality: The Antitrust Counterrevolution and its Discontents

11 Harvard Law & Policy Review 235 (2017)

24 Apr 2016Last revised: 22 Feb 2017

Lina Khan / Sandeep Vaheesan

 

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2769132

 

Too much of a good thing

Economist

March 26 2016

https://www.economist.com/news/briefing/21695385-profits-are-too-high-america-needs-giant-dose-competition-too-much-good-thing

 

 The Fall of the Labor Share and the Rise of Superstar Firms

David Autor, MIT and NBER

David Dorn, University of Zurich

Lawrence F. Katz, Harvard University and NBER

Christina Patterson, MIT

John Van Reenen, MIT and NBER

May 1, 2017

https://economics.mit.edu/files/12979

 

 

BENEFITS OF COMPETITION AND INDICATORS OF MARKET POWER

https://obamawhitehouse.archives.gov/sites/default/files/page/files/20160502_competition_issue_brief_updated_cea.pdf

 

 

 Market Concentration Grew During Obama Administration

SAM BATKINS, CURTIS ARNDT, BEN GITIS |

APRIL 7, 2016

 

https://www.americanactionforum.org/print/?url=https://www.americanactionforum.org/research/market-concentration-grew-obama-administration/

 Antitrust, Competition Policy, and Inequality

JONATHAN B. BAKER AND STEVEN C. SALOP

2015

http://scholarship.law.georgetown.edu/cgi/viewcontent.cgi?article=2474&context=facpub

Horizontal Shareholding, Antitrust, Growth and Inequality

Are US Industries Becoming More Concentrated?

Gustavo Grullon   Yelena Larkin   Roni Michaely

Date Written: April 23, 2017

 

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2612047

Horizontal Shareholding

109 Harvard Law Review 1267 (2016)

Harvard Public Law Working Paper No. 16-17    22 Apr 2016

 

Einer Elhauge

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024

IS THERE A CONCENTRATION PROBLEM IN AMERICA?

MARCH 27–29, 2017

Conference at University of Chicago / Stigler Center

https://research.chicagobooth.edu/stigler/events/single-events/march-27-2017

 

 

“Reigniting Competition in the American Economy”

Senator Elizabeth Warren

Keynote Remarks at New America’s Open Markets Program Event June 29, 2016

 

https://www.warren.senate.gov/files/documents/2016-6-29_Warren_Antitrust_Speech.pdf

 

 

The Rise of Market Power and the Macroeconomic Implications

Jan De Loecker† Jan Eeckhout‡

August 24, 2017

http://www.janeeckhout.com/wp-content/uploads/RMP.pdf

The Rise of Market Power and the Decline of Labor’s Share

The Financialization of the U.S. Economy Has Produced Mechanisms That Lead Toward Concentration

 June 2017

“No Convincing Evidence That Concentration Has Been a Major Factor in Explaining Poor U.S. Economic Performance”

 March 2017

Economists: “Totality of Evidence” Underscores Concentration Problem in the U.S.

“I Suspect the Major Reason for the Rise in Concentration Is Technological Change, Particularly in IT”

“The Increase in Common Ownership Corresponds to the Concentration Increase That Several Large Mergers Would Create”

Worried About Concentration? Then Worry About Rent-Seeking

“There Is Unambiguous Evidence That Concentration Is on the Rise and Widespread Over Most Industries”

A Second Gilded Age: The Consolidation of Wealth and Corporate Power

AMERICAN CONSTITUTION SOCIETY

JUNE 16, 2017

 

Low Interest Rates and Banks’ Profitability : Update July 2017

Low Interest Rates and Banks’ Profitability : Update July 2017

 

Please see my previous posts.

Impact of Low Interest Rates on Bank’s Profitability

Low Interest Rates and Banks Profitability: Update – December 2016

 

Since December 2016, there are several new studies published which study low interest rates and Banks profitability.

 

 

Liberty State economics – a Blog of New York Federal Reserve has published a new column in June 2017.

Low Interest Rates and Bank Profits

 

 

Reduced Viability? Banks, Insurance Companies, and Low Interest Rates

CFA Institute

2016

CFA Institute Blog: Low Interest Rates and Banks

 

 

Changes in Profitability for Primary Dealers since the Financial Crisis

Benjamin Allen

Skidmore College

2017

Changes in Profitability for Primary Dealers since the Financial Crisis

 

 

Deloitte Consulting has published a new report in 2017 on Bank Models viability in environment of low interest rates.

Business model analysis European banking sector model in question

 

THE EFFECT OF NEGATIVE INTEREST RATES ON EUROPEAN BANKING
July 7, 2016
International banker

 

https://internationalbanker.com/banking/effect-negative-interest-rates-european-banking/

 

 

Low interest rates place a strain on the banks

bank of Finland

2016

https://www.bofbulletin.fi/en/2016/2/low-interest-rates-place-a-strain-on-the-banks/

 

 

The profitability of EU banks: Hard work or a lost cause?

KPMG

October 2016

 

https://assets.kpmg.com/content/dam/kpmg/xx/pdf/2016/10/the-profitability-of-eu-banks.pdf

 

 

The influence of monetary policy on bank profitability

Claudio Borio

2017

http://onlinelibrary.wiley.com/doi/10.1111/infi.12104/abstract

 

 

Can Low Interest Rates be Harmful: An Assessment of the Bank Risk-Taking Channel in Asia

2014

Asian Development Bank

 

https://www.adb.org/sites/default/files/publication/31204/reiwp-123-can-low-interest-rates-harmful.pdf

 

 

Determinants of bank’s interest margin in the aftermath of the crisis: the effect of interest rates and the yield curve slope

Paula Cruz-García, Juan Fernández de Guevara and Joaquín Maudos

 

http://www.uv.es/inteco/jornadas/jornadas13/Cruz-Garcia,%20Fernandez%20and%20Maudos_XIII%20Inteco%20Workshop.pdf

 

 

Dutch Central Bank has published a new study in November of 2016 on Banks’ Profitability and risk taking in a prolonged environment of Low Interest Rates.

Bank profitability and risk taking in a prolonged environment of low interest rates: a study of interest rate risk in the banking book of Dutch banks

 

 

Net interest margin in a low interest rate environment: Evidence for Slovenia

Net interest margin in a low interest rate environment: Evidence for Slovenia

 

Global Financial Stability Report, April 2017: Getting the Policy Mix Right

IMF

2017

IMF Global Financial Stability Report April 2017

 

 

Negative Interest Rates: Forecasting Banks’ Profitability in a New Environment

Stefan Kerbl, Michael Sigmund

Bank of Finland

Negative Interest Rates: Forecasting Banks’ Profitability in a New Environment

 

 

Low Interest Rates and the Financial System

Remarks by Jerome H. Powell
Member Board of Governors of the Federal Reserve System
at the 77th Annual Meeting of the American Finance Association
Chicago, Illinois
January 7, 2017

https://www.federalreserve.gov/newsevents/speech/powell20170107a.pdf

 

 

Bad zero: Financial Stability in a Low Interest Rate Environment

Elena Carletti  Giuseppe Ferrero

18 June 2017

https://www.dnb.nl/en/binaries/paper%20Carletti_Ferrero_18June2017_tcm47-360758.pdf

Short term Thinking in Investment Decisions of Businesses and Financial Markets

Short term Thinking in Investment Decisions of Businesses and Financial Markets

 

When companies buyback shares and pay dividends rather than investing in new capacity, it leads to low economic growth and low aggregate demand.

Central Banks respond by cutting interest rates.  Yet Businesses do not invest in new capacity.

Many studies attribute this to short term thinking dominant in corporate investment decisions.  Pressures from shareholders push corporate managers to be short term oriented.

Many economists and thinkers have criticized this recently as advanced economies are suffering from anemic growth.

Larry Summers has invoked Secular Stagnation.  He says one of the reason for Secular Stagnation is short term thinking.

Andy Haldane of Bank of England has criticized short term thinking as it prevents investments and causes low economic growth.

Key Terms:

  • Quarterly Capitalism
  • Secular Stagnation
  • Short Term Thinking
  • Low Economic Growth
  • Business Investments
  • Real Interest Rates
  • Monetary Policy
  • Income and Wealth Inequality
  • Aggregate Demand
  • Productive Capacity
  • Productivity growth
  • Long Term Investments
  • Share Buybacks
  • Dividends
  • Corporate Cash Pools

 

Capitalism for the Long Term

The near meltdown of the financial system and the ensuing Great Recession have been, and will remain, the defining issue for the current generation of executives. Now that the worst seems to be behind us, it’s tempting to feel deep relief—and a strong desire to return to the comfort of business as usual. But that is simply not an option. In the past three years we’ve already seen a dramatic acceleration in the shifting balance of power between the developed West and the emerging East, a rise in populist politics and social stresses in a number of countries, and significant strains on global governance systems. As the fallout from the crisis continues, we’re likely to see increased geopolitical rivalries, new international security challenges, and rising tensions from trade, migration, and resource competition. For business leaders, however, the most consequential outcome of the crisis is the challenge to capitalism itself.

That challenge did not just arise in the wake of the Great Recession. Recall that trust in business hit historically low levels more than a decade ago. But the crisis and the surge in public antagonism it unleashed have exacerbated the friction between business and society. On top of anxiety about persistent problems such as rising income inequality, we now confront understandable anger over high unemployment, spiraling budget deficits, and a host of other issues. Governments feel pressure to reach ever deeper inside businesses to exert control and prevent another system-shattering event.

My goal here is not to offer yet another assessment of the actions policymakers have taken or will take as they try to help restart global growth. The audience I want to engage is my fellow business leaders. After all, much of what went awry before and after the crisis stemmed from failures of governance, decision making, and leadership within companies. These are failures we can and should address ourselves.

In an ongoing effort that started 18 months ago, I’ve met with more than 400 business and government leaders across the globe. Those conversations have reinforced my strong sense that, despite a certain amount of frustration on each side, the two groups share the belief that capitalism has been and can continue to be the greatest engine of prosperity ever devised—and that we will need it to be at the top of its job-creating, wealth-generating game in the years to come. At the same time, there is growing concern that if the fundamental issues revealed in the crisis remain unaddressed and the system fails again, the social contract between the capitalist system and the citizenry may truly rupture, with unpredictable but severely damaging results.

Most important, the dialogue has clarified for me the nature of the deep reform that I believe business must lead—nothing less than a shift from what I call quarterly capitalism to what might be referred to as long-term capitalism. (For a rough definition of “long term,” think of the time required to invest in and build a profitable new business, which McKinsey research suggests is at least five to seven years.) This shift is not just about persistently thinking and acting with a next-generation view—although that’s a key part of it. It’s about rewiring the fundamental ways we govern, manage, and lead corporations. It’s also about changing how we view business’s value and its role in society.

There are three essential elements of the shift. First, business and finance must jettison their short-term orientation and revamp incentives and structures in order to focus their organizations on the long term. Second, executives must infuse their organizations with the perspective that serving the interests of all major stakeholders—employees, suppliers, customers, creditors, communities, the environment—is not at odds with the goal of maximizing corporate value; on the contrary, it’s essential to achieving that goal. Third, public companies must cure the ills stemming from dispersed and disengaged ownership by bolstering boards’ ability to govern like owners.

When making major decisions, Asians typically think in terms of at least 10 to 15 years. In the U.S. and Europe, nearsightedness is the norm.

None of these ideas, or the specific proposals that follow, are new. What is new is the urgency of the challenge. Business leaders today face a choice: We can reform capitalism, or we can let capitalism be reformed for us, through political measures and the pressures of an angry public. The good news is that the reforms will not only increase trust in the system; they will also strengthen the system itself. They will unleash the innovation needed to tackle the world’s grand challenges, pave the way for a new era of shared prosperity, and restore public faith in business.

1. Fight the Tyranny of Short-Termism

As a Canadian who for 25 years has counseled business, public sector, and nonprofit leaders across the globe (I’ve lived in Toronto, Sydney, Seoul, Shanghai, and now London), I’ve had a privileged glimpse into different societies’ values and how leaders in various cultures think. In my view, the most striking difference between East and West is the time frame leaders consider when making major decisions. Asians typically think in terms of at least 10 to 15 years. For example, in my discussions with the South Korean president Lee Myung-bak shortly after his election in 2008, he asked us to help come up with a 60-year view of his country’s future (though we settled for producing a study called National Vision 2020.) In the U.S. and Europe, nearsightedness is the norm. I believe that having a long-term perspective is the competitive advantage of many Asian economies and businesses today.

Myopia plagues Western institutions in every sector. In business, the mania over quarterly earnings consumes extraordinary amounts of senior time and attention. Average CEO tenure has dropped from 10 to six years since 1995, even as the complexity and scale of firms have grown. In politics, democracies lurch from election to election, with candidates proffering dubious short-term panaceas while letting long-term woes in areas such as economic competitiveness, health, and education fester. Even philanthropy often exhibits a fetish for the short term and the new, with grantees expected to become self-sustaining in just a few years.

Lost in the frenzy is the notion that long-term thinking is essential for long-term success. Consider Toyota, whose journey to world-class manufacturing excellence was years in the making. Throughout the 1950s and 1960s it endured low to nonexistent sales in the U.S.—and it even stopped exporting altogether for one bleak four-year period—before finally emerging in the following decades as a global leader. Think of Hyundai, which experienced quality problems in the late 1990s but made a comeback by reengineering its cars for long-term value—a strategy exemplified by its unprecedented introduction, in 1999, of a 10-year car warranty. That radical move, viewed by some observers as a formula for disaster, helped Hyundai quadruple U.S. sales in three years and paved the way for its surprising entry into the luxury market.

To be sure, long-term perspectives can be found in the West as well. For example, in 1985, in the face of fierce Japanese competition, Intel famously decided to abandon its core business, memory chips, and focus on the then-emerging business of microprocessors. This “wrenching” decision was “nearly inconceivable” at the time, says Andy Grove, who was then the company’s president. Yet by making it, Intel emerged in a few years on top of a new multi-billion-dollar industry. Apple represents another case in point. The iPod, released in 2001, sold just 400,000 units in its first year, during which Apple’s share price fell by roughly 25%. But the board took the long view. By late 2009 the company had sold 220 million iPods—and revolutionized the music business.

It’s fair to say, however, that such stories are countercultural. In the 1970s the average holding period for U.S. equities was about seven years; now it’s more like seven months. According to a recent paper by Andrew Haldane, of the Bank of England, such churning has made markets far more volatile and produced yawning gaps between corporations’ market price and their actual value. Then there are the “hyperspeed” traders (some of whom hold stocks for only a few seconds), who now account for 70% of all U.S. equities trading, by one estimate. In response to these trends, executives must do a better job of filtering input, and should give more weight to the views of investors with a longer-term, buy-and-hold orientation.

If they don’t, short-term capital will beget short-term management through a natural chain of incentives and influence. If CEOs miss their quarterly earnings targets, some big investors agitate for their removal. As a result, CEOs and their top teams work overtime to meet those targets. The unintended upshot is that they manage for only a small portion of their firm’s value. When McKinsey’s finance experts deconstruct the value expectations embedded in share prices, we typically find that 70% to 90% of a company’s value is related to cash flows expected three or more years out. If the vast majority of most firms’ value depends on results more than three years from now, but management is preoccupied with what’s reportable three months from now, then capitalism has a problem.

Roughly 70% of all U.S. equities trading is now done by “hyperspeed” traders—some of whom hold stocks for only a few seconds.

Some rightly resist playing this game. Unilever, Coca-Cola, and Ford, to name just a few, have stopped issuing earnings guidance altogether. Google never did. IBM has created five-year road maps to encourage investors to focus more on whether it will reach its long-term earnings targets than on whether it exceeds or misses this quarter’s target by a few pennies. “I can easily make my numbers by cutting SG&A or R&D, but then we wouldn’t get the innovations we need,” IBM’s CEO, Sam Palmisano, told us recently. Mark Wiseman, executive vice president at the Canada Pension Plan Investment Board, advocates investing “for the next quarter century,” not the next quarter. And Warren Buffett has quipped that his ideal holding period is “forever.” Still, these remain admirable exceptions.

To break free of the tyranny of short-termism, we must start with those who provide capital. Taken together, pension funds, insurance companies, mutual funds, and sovereign wealth funds hold $65 trillion, or roughly 35% of the world’s financial assets. If these players focus too much attention on the short term, capitalism as a whole will, too.

In theory they shouldn’t, because the beneficiaries of these funds have an obvious interest in long-term value creation. But although today’s standard practices arose from the desire to have a defensible, measurable approach to portfolio management, they have ended up encouraging shortsightedness. Fund trustees, often advised by investment consultants, assess their money managers’ performance relative to benchmark indices and offer only short-term contracts. Those managers’ compensation is linked to the amount of assets they manage, which typically rises when short-term performance is strong. Not surprisingly, then, money managers focus on such performance—and pass this emphasis along to the companies in which they invest. And so it goes, on down the line.

Only 45% of those surveyed in the U.S. and the UK expressed trust in business. This stands in stark contrast to developing countries: For example, the figure is 61% in China, 70% in India, and 81% in Brazil.

As the stewardship advocate Simon Wong points out, under the current system pension funds deem an asset manager who returns 10% to have underperformed if the relevant benchmark index rises by 12%. Would it be unthinkable for institutional investors instead to live with absolute gains on the (perfectly healthy) order of 10%—especially if they like the approach that delivered those gains—and review performance every three or five years, instead of dropping the 10-percenter? Might these big funds set targets for the number of holdings and rates of turnover, at least within the “fundamental investing” portion of their portfolios, and more aggressively monitor those targets? More radically, might they end the practice of holding thousands of stocks and achieve the benefits of diversification with fewer than a hundred—thereby increasing their capacity to effectively engage with the businesses they own and improve long-term performance? Finally, could institutional investors beef up their internal skills and staff to better execute such an agenda? These are the kinds of questions we need to address if we want to align capital’s interests more closely with capitalism’s.

2. Serve Stakeholders, Enrich Shareholders

The second imperative for renewing capitalism is disseminating the idea that serving stakeholders is essential to maximizing corporate value. Too often these aims are presented as being in tension: You’re either a champion of shareholder value or you’re a fan of the stakeholders. This is a false choice.

The inspiration for shareholder-value maximization, an idea that took hold in the 1970s and 1980s, was reasonable: Without some overarching financial goal with which to guide and gauge a firm’s performance, critics feared, managers could divert corporate resources to serve their own interests rather than the owners’. In fact, in the absence of concrete targets, management might become an exercise in politics and stakeholder engagement an excuse for inefficiency. Although this thinking was quickly caricatured in popular culture as the doctrine of “greed is good,” and was further tarnished by some companies’ destructive practices in its name, in truth there was never any inherent tension between creating value and serving the interests of employees, suppliers, customers, creditors, communities, and the environment. Indeed, thoughtful advocates of value maximization have always insisted that it is long-term value that has to be maximized.

Capitalism’s founding philosopher voiced an even bolder aspiration. “All the members of human society stand in need of each others assistance, and are likewise exposed to mutual injuries,” Adam Smith wrote in his 1759 work, The Theory of Moral Sentiments. “The wise and virtuous man,” he added, “is at all times willing that his own private interest should be sacrificed to the public interest,” should circumstances so demand.

Smith’s insight into the profound interdependence between business and society, and how that interdependence relates to long-term value creation, still reverberates. In 2008 and again in 2010, McKinsey surveyed nearly 2,000 executives and investors; more than 75% said that environmental, social, and governance (ESG) initiatives create corporate value in the long term. Companies that bring a real stakeholder perspective into corporate strategy can generate tangible value even sooner. (See the sidebar “Who’s Getting It Right?”)

Creating direct business value, however, is not the only or even the strongest argument for taking a societal perspective. Capitalism depends on public trust for its legitimacy and its very survival. According to the Edelman public relations agency’s just-released 2011 Trust Barometer, trust in business in the U.S. and the UK (although up from mid-crisis record lows) is only in the vicinity of 45%. This stands in stark contrast to developing countries: For example, the figure is 61% in China, 70% in India, and 81% in Brazil. The picture is equally bleak for individual corporations in the Anglo-American world, “which saw their trust rankings drop again last year to near-crisis lows,” says Richard Edelman.

How can business leaders restore the public’s trust? Many Western executives find that nothing in their careers has prepared them for this new challenge. Lee Scott, Walmart’s former CEO, has been refreshingly candid about arriving in the top job with a serious blind spot. He was plenty busy minding the store, he says, and had little feel for the need to engage as a statesman with groups that expected something more from the world’s largest company. Fortunately, Scott was a fast learner, and Walmart has become a leader in environmental and health care issues.

Tomorrow’s CEOs will have to be, in Joseph Nye’s apt phrase, “tri-sector athletes”: able and experienced in business, government, and the social sector. But the pervading mind-set gets in the way of building those leadership and management muscles. “Analysts and investors are focused on the short term,” one executive told me recently. “They believe social initiatives don’t create value in the near term.” In other words, although a large majority of executives believe that social initiatives create value in the long term, they don’t act on this belief, out of fear that financial markets might frown. Getting capital more aligned with capitalism should help businesses enrich shareholders by better serving stakeholders.

3. Act Like You Own the Place

As the financial sector’s troubles vividly exposed, when ownership is broadly fragmented, no one acts like he’s in charge. Boards, as they currently operate, don’t begin to serve as a sufficient proxy. All the Devils Are Here, by Bethany McLean and Joe Nocera, describes how little awareness Merrill Lynch’s board had of the firm’s soaring exposure to subprime mortgage instruments until it was too late. “I actually don’t think risk management failed,” Larry Fink, the CEO of the investment firm BlackRock, said during a 2009 debate about the future of capitalism, sponsored by the Financial Times. “I think corporate governance failed, because…the boards didn’t ask the right questions.”

What McKinsey has learned from studying successful family-owned companies suggests a way forward: The most effective ownership structure tends to combine some exposure in the public markets (for the discipline and capital access that exposure helps provide) with a significant, committed, long-term owner. Most large public companies, however, have extremely dispersed ownership, and boards rarely perform the single-owner-proxy role. As a result, CEOs too often listen to the investors (and members of the media) who make the most noise. Unfortunately, those parties tend to be the most nearsighted ones. And so the tyranny of the short term is reinforced.

The answer is to renew corporate governance by rooting it in committed owners and by giving those owners effective mechanisms with which to influence management. We call this ownership-based governance, and it requires three things:

Just 43% of the nonexecutive directors of public companies believe they significantly influence strategy. For this to change, board members must devote much more time to their roles.

More-effective boards.

In the absence of a dominant shareholder (and many times when there is one), the board must represent a firm’s owners and serve as the agent of long-term value creation. Even among family firms, the executives of the top-performing companies wield their influence through the board. But only 43% of the nonexecutive directors of public companies believe they significantly influence strategy. For this to change, board members must devote much more time to their roles. A government-commissioned review of the governance of British banks last year recommended an enormous increase in the time required of nonexecutive directors of banks—from the current average, between 12 and 20 days annually, to between 30 and 36 days annually. What’s especially needed is an increase in the informal time board members spend with investors and executives. The nonexecutive board directors of companies owned by private equity firms spend 54 days a year, on average, attending to the company’s business, and 70% of that time consists of informal meetings and conversations. Four to five days a month obviously give a board member much greater understanding and impact than the three days a quarter (of which two may be spent in transit) devoted by the typical board member of a public company.

Boards also need much more relevant experience. Industry knowledge—which four of five nonexecutive directors of big companies lack—helps boards identify immediate opportunities and reduce risk. Contextual knowledge about the development path of an industry—for example, whether the industry is facing consolidation, disruption from new technologies, or increased regulation—is highly valuable, too. Such insight is often obtained from experience with other industries that have undergone a similar evolution.

In addition, boards need more-effective committee structures—obtainable through, for example, the establishment of a strategy committee or of dedicated committees for large business units. Directors also need the resources to allow them to form independent views on strategy, risk, and performance (perhaps by having a small analytical staff that reports only to them). This agenda implies a certain professionalization of nonexecutive directorships and a more meaningful strategic partnership between boards and top management. It may not please some executive teams accustomed to boards they can easily “manage.” But given the failures of governance to date, it is a necessary change.

More-sensible CEO pay.

An important task of governance is setting executive compensation. Although 70% of board directors say that pay should be tied more closely to performance, CEO pay is too often structured to reward a leader simply for having made it to the top, not for what he or she does once there. Meanwhile, polls show that the disconnect between pay and performance is contributing to the decline in public esteem for business.

Companies should create real risk for executives.Some experts privately suggest mandating that new executives invest a year’s salary in the company.

CEOs and other executives should be paid to act like owners. Once upon a time we thought that stock options would achieve this result, but stock-option- based compensation schemes have largely incentivized the wrong behavior. When short-dated, options lead to a focus on meeting quarterly earnings estimates; even when long-dated (those that vest after three years or more), they can reward managers for simply surfing industry- or economy-wide trends (although reviewing performance against an appropriate peer index can help minimize free rides). Moreover, few compensation schemes carry consequences for failure—something that became clear during the financial crisis, when many of the leaders of failed institutions retired as wealthy people.

There will never be a one-size-fits-all solution to this complex issue, but companies should push for change in three key areas:

• They should link compensation to the fundamental drivers of long-term value, such as innovation and efficiency, not just to share price.

• They should extend the time frame for executive evaluations—for example, using rolling three-year performance evaluations, or requiring five-year plans and tracking performance relative to plan. This would, of course, require an effective board that is engaged in strategy formation.

• They should create real downside risk for executives, perhaps by requiring them to put some skin in the game. Some experts we’ve surveyed have privately suggested mandating that new executives invest a year’s salary in the company.

Redefined shareholder “democracy.”

The huge increase in equity churn in recent decades has spawned an anomaly of governance: At any annual meeting, a large number of those voting may soon no longer be shareholders. The advent of high-frequency trading will only worsen this trend. High churn rates, short holding periods, and vote-buying practices may mean the demise of the “one share, one vote” principle of governance, at least in some circumstances. Indeed, many large, top-performing companies, such as Google, have never adhered to it. Maybe it’s time for new rules that would give greater weight to long-term owners, like the rule in some French companies that gives two votes to shares held longer than a year. Or maybe it would make sense to assign voting rights based on the average turnover of an investor’s portfolio. If we want capitalism to focus on the long term, updating our notions of shareholder democracy in such ways will soon seem less like heresy and more like common sense.

While I remain convinced that capitalism is the economic system best suited to advancing the human condition, I’m equally persuaded that it must be renewed, both to deal with the stresses and volatility ahead and to restore business’s standing as a force for good, worthy of the public’s trust. The deficiencies of the quarterly capitalism of the past few decades were not deficiencies in capitalism itself—just in that particular variant. By rebuilding capitalism for the long term, we can make it stronger, more resilient, more equitable, and better able to deliver the sustainable growth the world needs. The three imperatives outlined above can be a start along this path and, I hope, a way to launch the conversation; others will have their own ideas to add.

The kind of deep-seated, systemic changes I’m calling for can be achieved only if boards, business executives, and investors around the world take responsibility for bettering the system they lead. Such changes will not be easy; they are bound to encounter resistance, and business leaders today have more than enough to do just to keep their companies running well. We must make the effort regardless. If capitalism emerges from the crisis vibrant and renewed, future generations will thank us. But if we merely paper over the cracks and return to our precrisis views, we will not want to read what the historians of the future will write. The time to reflect—and to act—is now.

 

Please see my other related posts.

Business Investments and Low Interest Rates

Mergers and Acquisitions – Long Term Trends and Waves

 

 

Key sources of Research:

Secular stagnation and low investment: Breaking the vicious cycle—a discussion paper

McKinsey

http://www.mckinsey.com/global-themes/europe/secular-stagnation-and-low-investment-breaking-the-vicious-cycle

Case Still Out on Whether Corporate Short-Termism Is a Problem

Larry Summers

http://larrysummers.com/2017/02/09/case-still-out-on-whether-corporate-short-termism-is-a-problem/

Where companies with a long-term view outperform their peers

McKinsey

http://www.mckinsey.com/global-themes/long-term-capitalism/where-companies-with-a-long-term-view-outperform-their-peers

How short-term thinking hampers long-term economic growth

FT

https://www.ft.com/content/8c868a98-b821-11e4-b6a5-00144feab7de

Anthony Hilton: Short-term thinking hits nations as a whole, not just big business

http://www.standard.co.uk/comment/comment/anthony-hilton-short-term-thinking-hits-nations-as-a-whole-not-just-big-business-10427294.html

Short-termism in business: causes, mechanisms and consequences

EY Poland Report

http://www.ey.com/Publication/vwLUAssets/EY_Poland_Report/$FILE/Short-termism_raport_EY.pdf

Overcoming the Barriers to Long-term Thinking in Financial Markets

Ruth Curran and Alice Chapple
Forum for the Future

https://www.forumforthefuture.org/sites/default/files/project/downloads/long-term-thinking-fpf-report-july-11.pdf

Understanding Short-Termism: Questions and Consequences

http://rooseveltinstitute.org/wp-content/uploads/2015/11/Understanding-Short-Termism.pdf

Ending Short-Termism : An Investment Agenda for Growth

http://rooseveltinstitute.org/wp-content/uploads/2015/11/Ending-Short-Termism.pdf

The Short Long

Speech by
Andrew G Haldane, Executive Director, Financial Stability, and Richard Davies

Brussels May 2011

http://www.bankofengland.co.uk/archive/Documents/historicpubs/speeches/2011/speech495.pdf

Capitalism for the Long Term

Dominic Barton

From the March 2011 Issue

https://hbr.org/2011/03/capitalism-for-the-long-term

Quarterly capitalism: The pervasive effects of short-termism and austerity

https://currentlyunderdevelopment.wordpress.com/2016/05/10/quarterly-capitalism-the-pervasive-effects-of-short-termism-and-austerity/

Is Short-Term Behavior Jeopardizing the Future Prosperity of Business?

http://www.wlrk.com/docs/IsShortTermBehaviorJeopardizingTheFutureProsperityOfBusiness_CEOStrategicimplications.pdf

Andrew G Haldane: The short long

Speech by Mr Andrew Haldane, Executive Director, Financial Stability, and Mr Richard
Davies, Economist, Financial Institutions Division, Bank of England,
at the 29th Société
Universitaire Européene de Recherches Financières Colloquium,
Brussels, 11 May 2011

http://www.bis.org/review/r110511e.pdf

THE UNEASY CASE FOR FAVORING LONG-TERM SHAREHOLDERS

Jesse M. Fried

https://dash.harvard.edu/bitstream/handle/1/17985223/Fried_795.pdf?sequence=1

The fringe economic theory that might get traction in the 2016 campaign

https://www.washingtonpost.com/news/wonk/wp/2015/03/02/the-fringe-economic-theory-that-might-get-traction-in-the-2016-campaign/?utm_term=.932bc0b97758

FCLT Global:  Focusing Capital on the Long Term

Publications

http://www.fcltglobal.org/insights/publications

Finally, Evidence That Managing for the Long Term Pays Off

Dominic Barton

James Manyika

Sarah Keohane Williamson

February 07, 2017 UPDATED February 09, 2017

https://hbr.org/2017/02/finally-proof-that-managing-for-the-long-term-pays-off

Focusing Capital on the Long Term

Dominic Barton

Mark Wiseman

From the January–February 2014 Issue

Is Corporate Short-Termism Really a Problem? The Jury’s Still Out

Lawrence H. Summers

February 16, 2017

Yes, Short-Termism Really Is a Problem

Roger L. Martin

October 09, 2015

Long-Termism or Lemons

The Role of Public Policy in Promoting Long-Term Investments

By Marc Jarsulic, Brendan V. Duke, and Michael Madowitz October 2015

Center for American Progress

https://cdn.americanprogress.org/wp-content/uploads/2015/10/21060054/LongTermism-reportB.pdf

 

Overcoming Short-termism: A Call for A More Responsible Approach to Investment and Business Management

https://corpgov.law.harvard.edu/2009/09/11/overcoming-short-termism-a-call-for-a-more-responsible-approach-to-investment-and-business-management/

 

 

Focusing capital on the Long Term

Jean-Hugues Monier – Senior Parter – McKinsey & Company

Princeton University – November 2016

http://jrc.princeton.edu/sites/jrc/files/jean-hugues_j._monier_slides_final.pdf