The Four Mechanisms
Market failures that have blocked value diffusion for 30+ years—all diagnosed, none solved
The economic literature has extensively documented four distinct market failures that prevent productive economic activity from translating into broad-based prosperity:
- Sellers’ Inflation – Market power enables persistent markups
- Financialisation – Short-term extraction over long-term investment
- Monopsony Power – Wage suppression despite productivity gains
- Innovation Inflation – Value trapped before diffusion (NEW)
Critical insight: Despite extensive academic documentation and repeated policy attempts, zero implemented solutions exist for any of these mechanisms. PRICI is the first unified framework to address them all simultaneously.
1. Sellers’ Inflation (Market Power)
Persistent markups despite efficiency gains
The Literature
Seminal Work:
De Loecker, Eeckhout & Unger (2020): “The Rise of Market Power and the Macroeconomic Implications” (QJE)
- Average markup rose from 1.21 (1980) to 1.61 (2016)
- Concentrated in firms with highest market power
- Linked to declining labour share of income
Supporting Evidence:
- Autor et al. (2020): “Winner-take-most” dynamics in digital markets
- Gutiérrez & Philippon (2017): Rising concentration correlates with declining investment
The Mechanism
Technology reduces marginal costs → Competition should force prices down → Instead: Market power (digital moats, network effects, capital requirements) enables sustained high markups → Value captured as producer rent
The Solution Gap
Too slow, one firm at a time
Political resistance
Create shortages
Profit shifting
Status: Extensively diagnosed, zero implemented conduct-based solutions
How PRICI Addresses This
PI (Price Intensity) component catches unjustified price increases above sector median:
- Firms can’t sustain high markups without offsetting investment
- High PI + Low IC = Penalty
- Forces: moderate pricing OR increase productive deployment
2. Financialisation (Short-Termism)
Extraction prioritized over reinvestment
The Literature
Foundational Work:
Lazonick (2014): “Profits Without Prosperity” (HBR)
- $3.4 trillion in buybacks by S&P 500 firms (2003-2012)
- Extraction crowds out productive investment
- CEO stock-based compensation incentives
Haldane (2015): “Who Owns a Company?” (Bank of England)
- Investment horizons shortening despite low rates
- “Patient capital” disappearing from public markets
The Mechanism
Stock-based compensation + activist pressure + private equity incentives → Optimise for quarterly earnings and distributions → Extract cash (dividends, buybacks) → Underinvest in long-term growth (CapEx, R&D, human capital)
The Solution Gap
Firms switch to buybacks
Legally entrenched
Gaming through repricing
Status: Extensively documented, political economy prevents action
How PRICI Addresses This
ES (Extraction Signal) component directly measures extraction behaviour:
- ES = (Dividends + Buybacks + Related Distributions) ÷ Owner Earnings
- Multi-year smoothing catches lumpy distributions
- ES > 1.0 = automatic penalty (extracting more than generating)
Forces: reduce extraction OR increase investment to offset
3. Monopsony Power (Wage Suppression)
Workers don’t share in productivity gains
The Literature
Core Work:
Azar, Marinescu & Steinbaum (2020): “Labor Market Concentration” (JHR)
- Widespread labor market concentration using HHI measures
- 10% increase in concentration → 0.9-1.3% wage decline
- Affects majority of US labor markets
Benmelech, Bergman & Kim (2022): “Strong Employers and Weak Employees”
- Declining labor share linked to employer concentration
- Wage growth suppressed despite tight labor markets
The Mechanism
Industry consolidation + occupational licensing + geographic concentration + non-compete clauses → Employers gain wage-setting power → Wages suppressed below marginal product → Productivity gains don’t flow to workers
The Solution Gap
Doesn’t scale with productivity
Political resistance
State-level patchwork
Status: Accepted in labor economics, political gridlock prevents action
How PRICI Addresses This
IC (Investment & Commitment) median wage component:
- Explicitly rewards firms that increase median worker pay
- Not just executive compensation (median is key)
- Weighted significantly (e.g., 40% in Spain calibration)
Forces: share productivity gains with workers OR face penalties on extraction
4. Innovation Inflation (NEW CONTRIBUTION)
Value trapped before diffusion—explains Productivity Paradox
This is PRICI’s novel contribution to economic literature. It explains the microeconomic mechanism behind the Productivity Paradox: why massive technology investment doesn’t boost measured productivity.
The Gap in Literature
The Productivity Paradox has been documented but not explained at microeconomic level:
- Solow (1987): “We’d better watch out” (introduced the paradox)
- Brynjolfsson & McAfee (2014): Puzzle deepens with ICT investment
- Syverson (2017): Ruled out measurement error—real puzzle remains
The Definition
Innovation Inflation (II) is the economic condition where profound technologies, despite inherent efficiency and low marginal cost, lead to sustained premium prices because value is captured as producer rent (Profit Capture) or consumed as systemic institutional cost (Process Capture), rather than diffusing to consumers.
Two Pathways
Pathway A: Profit Capture II (Producer Rent)
Mechanism: Digital/capital moats → Near-zero marginal cost but sustained high markups → Efficiency gains flow to shareholders as extraction → Value doesn’t diffuse
Examples:
- Cloud computing: 60-70% margins, near-zero marginal cost, prices stay high
- Streaming services: Low content delivery costs, subscription prices anchored high
- EVs: Manufacturing efficiency gains, but prices anchored at premium via capital moats
Pathway B: Process Capture II (Stagflationary Innovation)
Mechanism: Regulatory ratchet + institutional friction → Technology efficiency consumed by bureaucratic costs → High prices but low producer returns → Value destroyed as “complexity rent”
Example:
UK Nuclear sector (Fingleton 2025):
- EPR reactor design should enable cost reduction through standardization
- Instead: “tens of thousands of pages” of documentation
- Value consumed by consultancy ecosystem, not captured by developer or consumer
Why This Explains the Productivity Paradox
Technology creates value, but it doesn’t show up in measured productivity (GDP per hour) because it’s trapped before diffusion—either as shareholder extraction (Profit Capture) or consumed as institutional waste (Process Capture). Innovation Inflation identifies the microeconomic mechanism the literature was missing.
How PRICI Addresses Innovation Inflation
Combined formula addresses both pathways:
- Against Profit Capture: High PI (price anchoring) + High ES (extraction) without High IC (investment) = Penalty
- Against Process Capture: IC excludes “complexity rent” to intermediaries, only verified productive investment counts
- Forces: diffuse value through prices, investment, OR wages
The Unified Problem
All four mechanisms share a common feature: Value creation is blocked from diffusing to workers (wages), consumers (prices), or future productivity (investment).
The Critical Gap
Despite extensive documentation and repeated policy attempts,
ZERO IMPLEMENTED SOLUTIONS EXIST FOR ANY OF THESE MECHANISMS
Diagnosed ✓
Solution ✗