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Why Stock Markets Boomed While Economic Growth and Employment Stagnated
Economists have been unable to explain why the stock market has been booming while the economy has been stagnating. Perhaps one reason is that they have ignored the economic theory that could explain it.
The most important contribution to economics in the twentieth century got little recognition from economists. Prof. Edward Chamberlain of Harvard invented monopolistic competition which unlike perfect competition describes most of the economy. It is not “imperfect competition”, economist Joan Robinson’s phrase. All enterprises have some monopoly power except for producers of agricultural products, raw materials, and minerals whose prices are determined by nearly perfect markets. The degree of monopoly varies from nearly zero to 100 percent. Producers of homogeneous natural resources and farm products operate in nearly perfectly competitive markets. Automakers and nearly all manufactures not protected by patents all have some degree of monopoly power largely created by advertising (illusory product differentiation) and with varying degrees of real product differentiation. Some businesses enjoy location advantages such as greater accessibility, better access to transportation, parking, etc. And many enterprises gain greater confidence by its consumers and their competitors enjoy simply as the result of the experience of their customers.
As a result, enterprises enjoy varying power in their ability to charge higher prices than their competitors.
It is true, as many economists believe, that monopolistic-competitive enterprises are affected by changes in demand and production cost as are predicted in the case of perfect competition. But as Prof. Chamberlin points out, “Its thesis is that both monopolistic and competitive forces combine in the determination of most prices, and therefore that a hybrid theory affords a more illuminating approach to the study of the price system than does a theory of perfected competition, supplemented by a theory of monopoly… A comparison of the conclusions with those of pure competition indicates that that economic theory is often remote and unreal, not because the method is wrong, but because the underlying assumptions are not as closely in accord with the facts as they might be.” Where monopoly elements are present, the equilibrium set of prices, each of the prices set by each competitor, is inevitably higher than the one indicated by the theory of perfect competition. The forces of product differentiation, whatever the causes of the differences, are omitted altogether in the theory of perfect competition.
Even pure monopolies, like patent monopolies, face competition from products produced by others that satisfy some similar consumer wants. They have to set a market price below the profit-maximizing monopoly price though it remains above the price that would be established by perfect competition.
What is significant about the fact that nearly all production and distribution takes place under conditions of monopolistic completion is that, while prices are established by the forces of supply and demand, all entrepreneurs have some control over prices. Under perfect competition, prices are determined by market forces over which neither buyers nor sellers have no control. Those with greater monopoly power have more control.
This is where the large firms have their greatest advantage. Illusory differentiation is largely determined by the amount of advertising expenditures. The ability of large firms to spend large amounts of advertising gives them a great advantage compared with small firms and small proprietorships. This fact may explain the phenomenon of the stock market booming while the economy is still in recession and wages and employment are stagnating.
Of course, innovation, increased efficiency (cutting costs!) and out-sourcing to countries with lower costs are principal causes of rising earnings. But few listed firms are innovators and out-sourcers. What explains the fact that the vast majority of listed firms participated in the stock market boom while the economy was in the doldrums? Increased effdiciency? Some, maybe. A possible explanation is that most producers have some control over the price of their product. As pressure mounted on their earnings, they raised prices.
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