Daily Comment (October 26, 2016)

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] Global equity markets are weaker this morning off some disappointing earnings reports.  This shift in sentiment is routine during earnings season.  It does appear that the EU-Canadian free trade deal may be back on track as the Walloons are reportedly moderating their opposition.[1]  Still, with the deadline looming tomorrow, it will take an eleventh hour negotiation to prevent the deal from collapse.

With stagnant economic growth and high margins, companies have had the “urge to merge” in order to acquire market share and revenue.  A NYT article today suggests that regulators are beginning to rethink current policy.  At present, regulators have been open to “vertical” mergers, where a company buys a supplier or a distributor.  They have been less sanguine about “horizontal” mergers, where a company buys a competitor.  The economics of generally approving vertical mergers is fairly straightforward; it is more difficult for a firm to gain market power in a vertical merger.  As long as the upstream or downstream entity can still sell to competitors, the government has generally not opposed such combinations.

However, the NYT report suggests that some legal scholars are suggesting that economics may not be sufficient to analyze vertical mergers.  Instead, they argue that such combined firms may acquire political power due to their size.  In other words, although the public may not be directly harmed, they aren’t necessarily helped, either.  Given the evolving tone of the political situation, we may see greater opposition to vertical mergers based on size alone.

There is another element of mergers gaining attention as well.  The Council of Economic Advisors published a paper[2] this month suggesting that part of the reason workers’ wages are not growing very fast is due to increasing industry concentration.  The term for this is either “monopsony” or “oligopsony,” which means “one buyer” or “few buyers,” respectively.  When there is only one employer in an industry or an area, one sees the “company town” phenomenon emerge.  If there is little competition for workers, these few firms can pay lower wages.  Although industry concentration is just one element of monopsony, it is one that regulators could lean against via anti-trust policy.  What this means for investors is that the windfalls that sometimes occur when an equity in a portfolio is acquired may become less frequent.

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[1] For background on Belgium and the divisions between Wallonia and Flanders, see WGR, Wallonia versus Flanders, 11/19/2007.

[2] https://www.whitehouse.gov/sites/default/files/page/files/20161025_monopsony_labor_mrkt_cea.pdf