The Problem With Innovation: The Biggest Companies Are Hogging All the Gains

Economists trying to explain a long-term slowdown in productivity increasingly believe gains are not spreading through the economy, as they once did

By Jason Douglas, Jon Sindreu and Georgi Kantchev of The WSJ. Excerpts:

"Lately, economists have discovered an unsettling phenomenon: While top companies are getting more productive, gains are stalling for everyone else. And the gap between the two is widening, with globalization and new technology delivering outsize rewards to the titans of the global economy."

"big firms can exploit economies of scale offered by new technology and global markets. Companies with more orders can better shoulder upfront investments because each new unit produced will be less expensive."

"Since the 2008 financial crisis, U.S. productivity has grown by about 1.2% a year. That is half the rate it clocked in the 1970s and around one-third of what it was in the decades after World War II, once adjusted to strip out the temporary effects of economic booms and busts. Japan and Europe—especially the U.K. and Italy—have fared even worse.

Researchers have blamed the productivity slowdown on a range of factors including ultralow interest rates, mismeasurement of output in a digital world and a decline in humanity’s innovative prowess. Most theories don’t seem to explain the whole puzzle.

Researchers now are zeroing in on diffusion. According to data on advanced economies from the Organization for Economic Cooperation and Development, the most productive 5% of manufacturers increased their productivity by 33% between 2001 and 2013, while productivity leaders in services boosted theirs by 44%.

Over the same period, all other manufacturers managed to improve productivity by only 7%, while other service providers recorded only a 5% increase."

"nearly all of the increase in wage inequality in the U.S. since 1978 stems from pay disparity between workers at different companies. Pay gaps within companies remained mostly unchanged."

"one-quarter of U.S. productivity growth between 1995 and 2000 was driven by retailers, with almost one-sixth of that by a single company, Walmart Inc. Smaller rivals were left in its wake, if they survived at all."

Data show the most productive companies are usually the biggest. Globalization allowed them to grow bigger, while giving some specialized niche firms a big enough market to succeed.

For digital titans such as Amazon, Google parent Alphabet Inc. and Facebook Inc., the benefits of scale are substantial. Not only are their customers not limited by geography, but whenever more sellers sign up in Amazon’s platform or more users join Facebook’s social network, the service they offer gets more valuable for everyone else.

Another advantage: Researchers have found that bigger firms are better at protecting their technological advantages by patenting them. Only 25 companies accounted for half of all tech-related patents filed with the European Patents Office between 2011 and 2016, official data show.

Scale makes it possible to experiment with advanced technology that is out of reach for many companies. A separate McKinsey Global Institute report, published in April, found early adopters of artificial intelligence may already have gained “an insurmountable advantage” in earnings over competitors who have yet to take the plunge.

Gains at the top have been the key driver of productivity since the days of the industrial revolution, and the whole economy benefited. What is different now?

Some economists say it could be that good managers have flocked to top firms—enticed by the larger pay offered by multinationals—and the laggards need to catch up. According to the World Management Survey, smaller firms are consistently worse run and are responsible for most differences in management across countries."

"Globalization made it easier to automate sectors that produce goods and services that can be traded around the world, but this means those sectors now employ far fewer people than they did 40 years ago. Recent research finds that the result may be a shift in employment toward lower-productivity jobs such as delivering fast food by bike or cleaning offices—much harder tasks to automate."

"Jürgen Maier, chief executive of the U.K. arm of Siemens AG , says reviving diffusion is in the interests of the biggest, most productive companies, because many laggards are their suppliers. “If we get our supply chains more productive, more agile, delivering in time, that’s good for everybody in the ecosystem,” Mr. Maier says."

Here is something from Nobel prize winning economist Paul Krugman that is related. See The Accidental Theorist. Excerpts:

"Imagine an economy that produces only two things: hot dogs and buns. Consumers in this economy insist that every hot dog come with a bun, and vice versa. And labor is the only input to production."

"It so happens that I am about to use my hot-dog-and-bun example to talk about technology, jobs, and the future of capitalism. Readers who feel that big subjects can only be properly addressed in big books--which present big ideas, using big words--will find my intellectual style offensive. Such people imagine that when they write or quote such books, they are being profound. But more often than not, they're being profoundly foolish. And the best way to avoid such foolishness is to play around with a thought experiment or two.

So let's continue. Suppose that our economy initially employs 120 million workers, which corresponds more or less to full employment. It takes two person-days to produce either a hot dog or a bun. (Hey, realism is not the point here.) Assuming that the economy produces what consumers want, it must be producing 30 million hot dogs and 30 million buns each day; 60 million workers will be employed in each sector.

Now, suppose that improved technology allows a worker to produce a hot dog in one day rather than two. And suppose that the economy makes use of this increased productivity to increase consumption to 40 million hot dogs with buns a day. This requires some reallocation of labor, with only 40 million workers now producing hot dogs, 80 million producing buns."

"Yes, technological change has led to a shift in the industrial structure of employment. But there has been no net job loss; and there is no reason to expect such a loss in the future. After all, suppose that productivity were to double in buns as well as hot dogs. Why couldn't the economy simply take advantage of that higher productivity to raise consumption to 60 million hot dogs with buns, employing 60 million workers in each sector?

Or, to put it a different way: Productivity growth in one sector can very easily reduce employment in that sector. But to suppose that productivity growth reduces employment in the economy as a whole is a very different matter. In our hypothetical economy it is--or should be--obvious that reducing the number of workers it takes to make a hot dog reduces the number of jobs in the hot-dog sector but creates an equal number in the bun sector, and vice versa. Of course, you would never learn that from talking to hot-dog producers, no matter how many countries you visit; you might not even learn it from talking to bun manufacturers. It is an insight that you can gain only by playing with hypothetical economies--by engaging in thought experiments."