Mass Production and Competition

I evaluate the optimality properties of a two sector market economy consisting of a mass production sector with market power and a competitive sector with small scale production. Adam Smith's results hold: the presence of market power renders production and innovation inefficient, as higher prices for mass produced goods deviate resources from inputs to profits. Aggregate production, wages and innovation in both sectors are suboptimal. The higher the large scale sector market power, the more important small scale sector innovation is for salary levels. An approximation to the first best in production and innovation can be achieved by a product-specific market power tax rewarding production rather than profit rates, with zero taxes levied at equilibrium. Innovation, but not production, can be optimized by taxing profits and subsidizing innovation. The concentration of property inherent in the large scale sector also helps to explain the inequality pointed out by Piketty in “Capital in the Twenty’First Century”. These results hold for leading countries or for countries lagging in levels or in growth rates. In lagging countries differing only in institutional and fixed productivity effects, the small scale sector is relatively more backward than in leading countries. This provides an explanation for the existence of large informal and other excluded sectors. Pro-poor growth reduces market power in the large scale sector and promotes technologies in the small scale sector. La concentracion de la propiedad inherente del sector de producción masiva también ayuda a explicar la desigualdad que señala Piketty en “Capital in the Twehty’First Century”.