RDP 2025-05: How Costly are Mark-ups in Australia? The Effect of Declining Competition on Misallocation and Productivity 1. Introduction

There is substantial evidence that the degree of competition in the Australian economy declined over the decade or so leading up to the COVID-19 pandemic. This is evident when looking at a number of different proxies for competition: industries became more concentrated, with the few biggest firms accounting for a larger share of sales in their industries; industry leaders became more entrenched, and less likely to be displaced by new and growing firms; and estimates of mark-ups (the ratio of price to marginal cost and the most theoretically sound measure of market power) increased (Andrews, Dwyer and Triggs 2023; Hambur 2023).

At the same time, productivity growth has slowed. This has significant implications for living standards, as productivity growth is the main source of increases in income, and so consumption and living standards, over the medium term.^[1] Slower productivity growth also has implications for fiscal and monetary policy. Slower productivity growth means slower growth in government revenue, and so impacts fiscal sustainability. It also implies slower trend growth and a lower neutral rate of interest, meaning that monetary policy is more likely to be constrained by the effective lower bound on interest rates (all else equal).

Declining competition and productivity may be linked. A decline in the degree of competition has the potential to weigh on productivity through a number of channels. It can blunt firms' incentives and ability to invest, innovate, improve, and adopt new technologies (Gutiérrez and Philippon 2017; Andrews, Criscuolo and Gal 2019; Andrews and Hansell 2021; Andrews et al 2022).^[2] Declining competition can also reduce the rate at which inputs are reallocated to more productive uses, which lowers aggregate productivity in the economy (De Loecker, Eeckhout and Unger 2020; De Loecker, Eeckhout and Mongey 2021; Hambur 2023). And more generally, theory states that higher mark-ups (which reflects lower competition) are a distortion that mean the economy is smaller, and prices higher, than it otherwise would be if there was perfect competition and no mark-ups.

A number of recent papers have highlighted that its not just the level of competition and mark-ups that matter, but how they differ across firms (Baqaee and Farhi 2020; Edmond, Midrigan and Xu 2023). In particular, if some firms (or industries) have higher mark-ups, they will be producing too little at too high a price, relative to other firms with lower mark-ups. It would be a more productive use of resources to have them produce a little more, and another firm to produce less. So this dispersion in mark-ups represents a misallocation of resources and production in the economy across firms. This means lower aggregate productivity in the economy.

Understanding to what extent declining competition has led to lower productivity is important, as it can improve our understanding of the structural drivers of slowing productivity growth. In turn, this can help us to think about future productivity outcomes, and therefore potential growth and neutral interest rates, as well as future government revenues and fiscal position. And it can also help us think about the effects of future reforms.

Some previous work has tried to assess the effects of declining competition on productivity and output in Australia using simple, back-of-the-envelope approaches. These included looking at how reallocation of resources between high- and low-productivity firms, and the pace of firm-level productivity improvement, changed as mark-ups rose (Andrews et al 2022; Hambur 2023). Such approaches can provide some useful insights, but have a number of shortcomings. They tend to take a partial equilibrium approach (just looking at one piece of the puzzle and not the flow-on effects), be subject to noise, and, while they might be motivated by theory, they often lack a fully fleshed out model to motivate them. As a result of these shortcomings, they can be hard to express in terms of aggregate costs, such as the effect on the level of productivity and GDP.

In this paper, we take a more systematic approach, using the seminal general equilibrium model from Edmond, Midrigan and Xu (2023) (EMX) calibrated to the Australian economy. We use this model to answer the following question: If the degree of competition in the Australian economy had not declined from the mid-2000s, how much higher would aggregate productivity and GDP be due to resources being better allocated across firms throughout the economy?

We choose the EMX model for this exercise because it has a strong theoretical link between competition and mark-ups on one hand and productivity on the other. It has clear and transparent mechanisms, making it easy to interpret. And these are well captured by a few key economic parameters and relationships, so it is easy to apply to the Australian data.

In assessing the effects of declining competition on productivity, we focus on one specific channel: the misallocation of resources between firms. Previous work has indicated that this is a first-order issue in Australia, and so it deserves direct investigation. Still, as a result the estimates should be thought of as a lower bound. For example, they abstract from the effects that weaker competition might have on the impetus to invest in improved technologies and approaches, as explored in Andrews et al (2022). We also estimate the overall effect that high levels of mark-ups could have on household welfare by reducing aggregate output and investment, and so the size of the economy (deadweight loss channel). But these are not the main focus of the paper as they rely on a broader set of modelling assumptions and are less precise.

Overall, we find that, as of 2017 (when our estimates end), if the economy could have returned to mid-2000s levels of competition, productivity would have been around 1–3 per cent higher. The upper end of this range equates to around $3,000 per person in today's dollars. The findings are robust to accounting for fixed costs, different ways of aggregating measures of industry concentration and mark-ups, and different competitive structures. Accounting for the broader costs of mark-ups, in particular the effect of the level of mark-ups on firm choices about how much to produce (deadweight loss channel), leads to much larger estimates in terms of lost economic activity, though the range of estimates is quite large. As such our main estimates may be seen as conservative.

A key innovation of this paper is that we exploit the rich administrative data in Australia to understand productivity costs for the whole economy, unlike most other papers like EMX and Baqaee and Farhi (2020) which focus just on either the manufacturing sector or large publicly listed firms. As such our estimates should be more representative of aggregate economic costs.

Moreover, this allows us to look beyond the aggregate and think about how the costs differ across sectors. This is an important dimension for two key reasons. First, it may provide some indication of where reforms might have the largest productivity impacts, at least by lowering misallocation. And second, because there is a growing literature showing that input-output linkages can play an important role in amplifying industry-level distortions, with distortions in upstream industries tending to have larger aggregate effects (e.g. Jones 2011; Liu 2019; Andrews et al 2025). So by identifying sectoral heterogeneity in productivity losses due to declining competition, we can potentially get a sense of whether the main aggregate results could be under or overstated based on their sectoral outcomes.

We find that there is significant heterogeneity in productivity losses across sectors. In general, these firm-to-firm distortion costs have grown the most in upstream sectors like manufacturing and wholesale trade. As such, the aggregate effects may be even larger, and this could be quantified in future work.

Overall then, while the range of estimates is large, these findings suggest that declines in the degree of competition have significantly dragged on aggregate productivity over the period – an important finding for policymakers. That said, at least through the lens of this model, this represents a level shift down in productivity and past declines in competition should not weigh on future productivity growth. But looking beyond the model, if weaker competition does weigh on firms' impetus to improve and converge to the global frontier (which is not accounted for in this model), or if competition continues to weaken, there could still be ongoing effects.

Footnotes

For a discussion of the Australian productivity slowdown, and its relationship to household consumption and incomes, see Duretto, Majeed and Hambur (2022) and Plumb (2025). [1]

It is important to note that theoretically greater competition can lead to more or less innovation and investment, depending on the exact market structure. For example, market power can raise the potential profits from innovation and therefore incentivise innovative activity (Agion et al 2005). Though empirically in Australia, market power has been found to weigh on innovation. [2]