An Indirect Cost of Record Public Debt: Crowding Out Market Competition?

By: Peter Ormosi (Competition Policy Blog)

When Rishi Sunak announced the fourth Covid related support package in October 2020, UK government debt had already been at the unprecedented level of £2 trillion, exceeding 100% of the country’s GDP for the first time since the 1960s. But whereas the main worry on Sunak’s mind right now must be the likely interest rates on the national debt, the related risks, and to keep finances flowing, one should not dismiss the importance of how high government debt is likely to affect the real economy. This short blog considers some little-discussed side-effects that could have a long-term impact on competition.

When governments turn to credit markets, they often compete with private borrowers for loans, thus crowding out private investment. Crowding out can impact market competition in several ways. For example, the increasing cost of borrowing might increase the cost of new investment thereby contributing to increased entry barriers especially in credit constrained environments. There are numerous studies that have established the role of credit constraints in market entry. Such constraints are often more binding on small firms and on firms in sectors that are more dependent on external finance [1]. Concentrated markets, where incumbent businesses are likely to be realising large rents, are more supportive of the incumbents’ ability to reinvest optimally, irrespective of the exact changes in funding conditions [2]. On the other hand, potential entrants, who are more susceptible to changes in credit markets will be more vulnerable and will face higher entry barriers if the cost of borrowing increases. At a time of increasing market power across numerous industries, such weakening of potential competitors can have long-lasting negative effects on competition.

Another likely source of financial risk is inflation. With having to pay back billions in interest rates, it might be tempting for the Government to allow inflation to pick up pace and inflate some of the debt away. But reduced price-stability can be harmful in product markets. For me one of the most important of these is the increased levels of misperception as inflation muddles the price signals necessary for well-functioning markets –  lot depends on how much businesses can anticipate inflation to improve their judgement of whether a price increase is a sign of extra profit or just inflation. Moreover, the increase in shoe-leather costs (the effort by firms and individuals to minimise the effect of inflation on the diminishing purchasing power of money), and menu costs (the direct cost firms incur from changing prices) lead to larger fixed costs which disproportionately favour large incumbent businesses. These are not purely speculative hypotheses. The impact of inflation on market power has been documented in a number of studies…

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