Market power, technological innovation and income inequalities: A structural equation modeling approach

Estimates based on reduced-form models of technological innovation and inequalities may be compromised by failure to control for market power as a confounding variable that affects both innovation and inequalities at the same time. We address this issue through a structural equation model (SEM), where market power is a common predictor of innovation, capital share and inequalities as simultaneously determined endogenous outcomes. Evidence from an unbalanced panel of 34 countries observed from 2000 to 2018 indicates that: (i) technological innovation is skill-biased and responds to market power non-monotonically; (ii) the capital share in income increases with both market power and innovation; (iii) the effect of innovation on inequalities is smaller than that of market power and varies between different inequality measures; and (iv) the effect of market power is always adverse and larger than that of technological innovation. Our findings, which remain robust across different samples and market power measures, indicate that the main driver of inequalities is not technological innovation per se, but the degree of market power that enables successful innovators to extract innovation rents