Firm profits, markups, product market concentration, and inequality in the United States are at their highest level in recent history. This has fueled the concern that since the rich disproportionately own firms, the higher profits only accrue only to them, thus increasing inequality and hurting the poor. This concern has led to numerous calls to rethink competition policy to incorporate distributional concerns. Motivated by these calls, my research with Virgiliu Midrigan studies the design of product market policy when the policymaker is concerned not only with economic efficiency but also with redistribution.

Intuitively, the policymaker faces the following trade-off. On one hand, since larger firms have higher markups, they charge prices that are too high and so they face too little demand and therefore they produce too little relative to what would maximize economic efficiency. Increasing economic efficiency thus requires that large firms produce even more, and so a higher degree of product market concentration is desirable. On the other hand, if larger firms produce more, their owners earn more profits, which increases wealth and income inequality. 

We evaluate this trade-off by studying an economy with a large number of households that differ in their labor market earnings and their entrepreneurial talent. We assume that larger firms have more market power and so are able to charge higher markups. Our framework is consistent with the large wealth and income inequality and product market concentration in the United States, so it can serve as a useful laboratory to evaluate the effects of policies that change product market concentration. 

We find that a policy that increases product market concentration is desirable. Specifically, a subsidy to the largest 0.5% of firms that is financed by taxing the remaining firms benefits 95% of households. Even though such a policy increases concentration by reducing the number of firms by 30%, it reallocates employment towards more productive firms, thus increasing labor productivity and wages. The increase in wages primarily benefits poor households for whom this is the main source of income. The majority of households gain from such a policy despite the increase in income and wealth inequality. 

In contrast, a policy that reduces concentration by halving the market share of the largest firms, thus mimicking recent policy proposals, backfires. Such a policy reduces markups and inequality but leads to substantial reallocation of production towards smaller, less efficient firms. This reduces wages by nearly 10%, leaving 97% of households in a worse position.

Our findings imply that, in contrast to conventional wisdom and implicit calls for breaking up large firms, optimal policy prescribes an even greater degree of product market concentration than observed in the data. They suggest that anti-trust authorities should primarily be concerned with maximizing economic efficiency and that product market concentration in and of itself does not hurt the poor, even in an economy with high inequality and market power by large firms. In follow-up research, we study what are more efficient ways to redistribute in an unequal society and find that optimally set flat income taxes go a long way, even when the tax authority can use more complex instruments such as progressive income and wealth taxes.