Recent studies indicate that the U.S. economy has been underperforming for the last two decades, with corporations investing a smaller portion of their profits into production expansion. This trend has resulted in an average annual GDP growth of 2.2% over the past 20 years, a decline from the previous rate of 3.2%. Economists attribute this slowdown to a lack of substantial investment opportunities.

However, research by two assistant finance professors from Texas McCombs suggests an alternative cause: the increasing size of companies. According to researchers Michael Sockin and Daniel Neuhann, industries have become more concentrated, leading to fewer, larger firms. This concentration has discouraged these companies from reinvesting their capital, particularly in sectors like U.S. banking, where the four largest banks control 53% of total assets.

The researchers argue that such concentration leads to capital misallocation, with firms underinvesting in areas like R&D and equipment, reducing overall productivity and economic welfare. This scenario is further compounded by the reluctance of large corporations to borrow, influenced by higher interest rates imposed by lenders on substantial loans.

This dynamic was particularly evident following the Great Recession of 2007-2009 when the U.S. economy recovered slowly despite low interest rates set by the Federal Reserve to spur borrowing and investment. Instead of leveraging these conditions, companies like Apple accumulated cash, choosing to save on interest costs rather than expand their operations.

Sockin and Neuhann’s model, which utilized economic data from 2002, accurately predicted various economic outcomes 14 years post-recession, highlighting persistent underinvestment despite lower borrowing costs. The contrast with the rapid economic recovery post-COVID-19, driven by substantial government stimulus, underscores their argument that market concentration can significantly hinder economic growth, particularly in challenging times when government intervention becomes crucial to ensure proper market functioning.

More information: Daniel Neuhann et al, Financial market concentration and misallocation, Journal of Financial Economics. DOI: 10.1016/j.jfineco.2024.103875

Journal information: Journal of Financial Economics Provided by University of Texas at Austin