Declining Competition and Investment in the U.S

The US business sector has under-invested relative to Tobin’s Q since the early 2000s. We argue that declining competition is partly responsible for this phenomenon. We use a combination of natural experiments and instrumental variables to establish a causal relationship between competition and investment. Within manufacturing, we use Chinese imports as a natural experiment to test the main prediction of competition-based models of investment and innovation, namely that competition forces industry leaders to invest (innovate) more. We establish external validity beyond the manufacturing sector by showing that excess entry in the 1990s, which is orthogonal to demand shocks in the 2000’s, predicts higher industry investment given Q. Finally, we provide some evidence that the increase in concentration can be explained by increasing regulations and, to a lesser extent, stronger winner-takes-all effects in some industries. Gutiérrez and Philippon (2016) show that investment is weak relative to measures of profitability and valuation, and that this weakness starts in the early 2000s. Investment is not low because Tobin’s Q is low, but rather despite high Q. This simple observation rules out a long list of potential explanations, from low expected growth – be it supply or demand-driven – to high discount factors. They also find that financial frictions, measurement errors (due to the rise of intangibles, etc.), or globalization do not explain the lack of investment. On the other hand, they show that the investment residuals – at the firm level and at the industry level – are well explained by measures of competition.1 Controlling for current market conditions, industries with less competition and more concentration (traditional or due to common ownership) invest less. We are grateful to Holger Mueller, Janice Eberly, Olivier Blanchard, René Stulz, Boyan Jovanovic, Tano Santos, Charles Calomiris, Glenn Hubbard, Alexi Savov, Philipp Schnabl, Ralph Koijen, Ricardo Caballero, Emmanuel Farhi, Viral Acharya, and seminar participants at Columbia University and New York University for stimulating discussions. New York University New York University, CEPR and NBER Governance is the other variable that explains investment residuals. Within each industry-year, the investment gap is driven by firms owned by quasi-indexers and located in industries with more concentration/more common ownership. These firms spend a disproportionate amount of free cash flows buying back their shares. We do not discuss governance here because the natural experiments and instruments that we use are focused on investment. One should keep in mind, however, that there are important interactions between governance and competition. For instance, Giroud and Mueller (2010) shows that the impact of governance is stronger in noncompetitive industries. A companion paper studies the causality between increased quasi-indexer ownership and investment; as well as the interaction between ownership and competition (Gutiérrez and Philippon, 2017b).