Equity market investors are convinced that the US has a competition problem. They are signaling that many non-financial corporations are protected by barriers to entry, because they are valuing these corporations at levels that are only consistent with an ability to earn rates of profit that measurably exceed competitive levels.
This signal can be detected by looking at the ratio of the equity market value of corporations to the replacement cost of the physical and intangible capital stock that they employ. This ratio—called “Tobin’s Q”—should be equal to 1 under competitive market conditions. When it is larger than 1, the equity market value of a firm exceeds the replacement cost of its capital, which we wouldn’t expect to see in a competitive market. Values of Q greater than 1 indicate that a firm is earning returns above the competitive level—in other words, in addition to competitive profits, they are earning what are called “economic rents.”
The above excerpt was originally published in ProMarket.
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