Winner-Take-All Markets

Abstract

In recent decades, explosive growth in the salaries of top earners, combined with income stagnation or decline for most others, has formed a renewed challenge to the claim that a free market serves the public interest. These trends lend new urgency to understanding why some people earn so much more than others and what the consequences of growing income gaps are for economic growth and well being. In this article, we build on earlier work by Alfred Marshall and Sherwin Rosen to argue that it is the distribution of opportunities, not the distribution of talent, that has been changing in recent decades. The reason for this shift is partly technological. As the revolution in information processing and transmission continues, there is increasing leverage for the talents of those who occupy top positions, and correspondingly less room for others to find a lucrative niche. In effect, the reward structure common in entertainment and sports—where thousands compete for a handful of big prizes at the top—has now permeated many other sectors of the economy. The payoffs in these markets are not only skewed but depend more on rank order than productivity in the traditional sense. We describe general conditions under which markets organized like tournaments will attract a wastefully large share of inputs. The article’s conclusions do not fit comfortably into any one intellectual camp. We begin with the presumption that markets work (low transaction costs, free entry) and that observed trends reflect underlying economic forces. But unlike many economists, we conclude that markets do not always serve the public interest well—indeed, that much of the rivalry for society’s top prizes is both costly and unproductive. And unlike most economists, we conclude that rising inequality is more likely to curtail economic growth than to stimulate it. We argue that cooperative agreements to reduce the top prizes and curb some forms of competition need not lead inevitably to socialist squalor.