Welfare Loss due to Concentration in the food industry By: Matthew Rousu

Transcription

1 Welfare Loss due to Concentration in the food industry By: Matthew Rousu Introduction Throughout history, there has been opposition to big businesses and large corporations. In 1776, in his classic book The Wealth of Nations, Adam Smith criticized monopolies because, among other reasons, they result in lower efficiency than competitive markets. From then on, most economists have opposed monopolies because they result in welfare loss. However, no one has been able to precisely say how much loss results from monopolies, or from a similar situation, oligopolies. The food industry has its share of large firms, causing many to question the efficiency of these markets, and the loss of welfare because of concentration in the food industry. Like other industries, no one knows for sure what the exact loss is from this concentration. There have been many different studies trying to estimate welfare loss due to concentration in the food industry, but the estimates of welfare loss have differed dramatically. This paper is going to examine the welfare loss due to concentration in the food industry. To fully examine the issue, this paper will be split into several sections. First, an examination of why there seems to be so many problems in estimating welfare loss from concentration. Second, we will examine where welfare loss might occur, looking at consumer loss on both the producer side or on the consumer side. Next there will be an examination of several different studies that estimate the welfare loss in the food

2 2 industry. This will involve looking at the different results by separate studies, and how welfare loss differs among different sectors in the food industry. Fourth, the results obtained in these studies will be analyzed and critiqued. To conclude, the question of how the welfare loss estimates may improve in the future will be examined, along with a summary of the welfare loss due to concentration in the food industry. Why are there difficulties measuring consumer loss by concentration? With so many economists in agreement that heavy concentration in an industry often causes welfare loss, one would think that there would be consistent results among the different studies of consumer loss. This is not the case. The studies on welfare loss due to concentration in the food industry have different results. This leads one to ask, why has there been so much trouble getting reliable estimates of welfare loss from concentration in the food industry? There are several possible reasons for these different results; next is a brief discussion of some of the possible reasons. Advancement of industrial organization theory has played a major role in the differences in the estimates of the consumer loss by concentration in the food industry. Just over twenty years ago, a study by well-respected economists had the title Estimates of Consumer Loss Due to Monopoly in the U.S. Food Manufacturing Industries. There is no problem with the title except that the study was measuring the loss from oligopolies. The recent advancements should make accurate measurements of consumer loss in the food industry easier to attain. The interpretation of consumer loss would have a major impact on the estimation of consumer loss from concentration. Some studies claim that when a consumer buys a

3 3 brand name product over a generic product, there is welfare loss involved. Many economists would disagree with this analysis, claiming that you could not have loss when the consumer makes the choice to buy one product over another. At least one study counted on comparing returns to equity to a base return on equity. This method was criticized by some in an article critique, but defended by the authors. If people do not agree on what the rate of return should be, the estimates of welfare loss will be very different. Data sets are never perfect, and that may be causing some of the differences in the estimates. Most of these studies use completely different data sets, and although they might be similar, slight differences in the data sets could lead to significant differences in the welfare loss estimations. Where might welfare loss occur? There are two main areas where welfare loss might occur in the food industry. Welfare loss might occur because producers are too concentrated and can pay individuals who raise animals and grow crops too little, or it may occur because the companies that make food might have too much market power and charge customers too much. The loss on the production side would occur if there were to few buyers to make a competitive buying situation. The loss on the consumer side would occur if there were too few sellers, and the lack of competition caused an increase in the prices consumers pay. The low prices paid to farmers recently have prompted many to say that the concentration of producers in the agriculture industry is to blame. Those who are making these claims have little or no evidence to back up there statements however, as no one has

4 4 been able to show that there is any pricing powers by the major producers. The National Farmers Union, in their newsletter, has often had articles about how the concentration in the food industry is damaging. This view has gained some popularity among several politicians, including Iowa Senator Tom Harkin, who are calling for investigations of the major producers in the food industry. There was a major study done on the concentration in red meat industry recently, but the results could not verify any use of pricing power. There might be some welfare loss because of producer concentration, but if there is, the welfare loss has not been large enough to be verified. On the consumption side, there have been many studies about welfare (mostly consumer) loss due to concentration. Most of the studies have been about one of two areas of concentration, grocery store concentration or concentration of those who make the food products. The studies done on concentration of grocery stores seem to be inconclusive or contradictory, with no major evidence of welfare loss from concentration of grocery stores. The studies of welfare loss because of concentration of those who make food all tend to indicate some welfare loss because of concentration. How the welfare loss occurs will now be examined. The food industry is a highly concentrated industry for those who manufacture name brand products. Many of the product classes have the top four firms with a market share over 80-85%. This high level of concentration leads many to think that there might be welfare loss from because of the high concentration. If the few companies with a high market share had the power to price their products that would indicate the possibility of welfare loss. The problem for companies (and the good news for consumers) is that there are many generic brands of almost every product, so prices can not be set too high or

5 5 people will substitute the generic product for the name brand product. These facts were used in some of the studies that will be examined in the next section of this paper. Results from studies on Welfare Loss from Concentration in the Food Industry As mentioned earlier in the paper, the results from different studies vary dramatically. The estimates of welfare loss range from almost nothing to around fifteen billion dollars. There have been several studies examining the welfare loss by concentration in the food industry. Once again, these studies all focus on the welfare loss on the consumption side, because there are no conclusive studies showing welfare loss on the production side. Results from some of these studies will be examined below. A 1979 study by Russell Parker and John Conner titled Estimates of Consumer Loss Due to Monopoly in the U.S. Food Manufacturing Industries used three different methods to estimate loss. The price-cost margin was the first method, the difference between name brand and generic brand goods was the second method, and the third method came from previous estimates of consumer loss. All three estimates gave similar results, with welfare loss being between $12.4 and $13.7 billion. The percentage of welfare loss compared to expenditures on food products was between five and six percent of total food purchases. The authors make a note that the estimates of welfare loss will be too high for a couple of reasons. The first reason is that this study ignores the increased welfare of firms, and the other reason is that the benefits from increased advertising were not considered in the study. This study was highly criticized for their methods, and since this article there have been many other studies with lower loss estimates.

6 6 John Connor again did studies on consumer loss in the 1990 s with Everett Peterson. They did three different studies, one in 1992, one in 1995, and one in Their study in 1992 focused on the difference between the price of national brands to private label brands. They discovered that there is a relationship between the difference in prices between national brands and generic goods and the amount of market concentration and advertising. The price margins between name brand good and generic goods tend to widen with more concentration or with more advertising. The 1995 study by John Connor and Everett Peterson was looking at oligopoly welfare losses in U.S. food manufacturing. They examine the welfare loss as a percentage of the total food sales. In this study, six of the eight studies estimate welfare loss at 1.09% or less, and the other two estimates were 4.65 and 5.15 percent. Six of the eight estimates are about one-fifth of the late 1970 s study on consumer loss. This study does consistently show that there is loss due to concentration, but most estimates have the loss being much smaller then they had previously estimated. The 1996 study by John Connor and Everett Peterson had similar results. This study looked at loss in the food industry by examining the loss in each sector of the food industry. They concluded that most of the welfare loss in the food industry occurred in fifteen industries. They suggest that antitrust enforcement should be focused on those fifteen industries. All three studies by Connor and Peterson suggest that there is welfare loss, but the size of the welfare loss varies depending on the model used to estimate loss. There are two recent studies by Sanjib Bhuyan and Rigoberto A. Lopez examining oligopoly power and welfare loss in the food and tobacco industry. Because this paper is focused on the loss in the food industry, we will ignore the welfare loss

7 7 results that the study finds in the tobacco industry. Their 1995 study estimated loss in two different ways and their results estimated the average loss at two percent and one percent in the two different ways they estimated loss. Like the study from Connor and Peterson, the amount of welfare loss differed drastically among the various industries. Butter, Cereal, malt beverages, and distilled liquor are some of the industries with higher welfare losses due to concentration. Meatpacking, milk, flavored extracts and syrups, and wet corn milling are some of the industries that have very little welfare loss due to concentration. The second study by Sanjib Bhuyan and Rigoberto A. Lopez was in 1997, and that study measured which sectors within the food industry exercised significant oligopoly power. They found that thirty-three out of thirty-six food sectors they examined exhibited significant oligopoly power in setting output prices. The results from their 1997 study were similar to the results from the previously completed studies. Analysis and Critique of the Studies The studies on welfare loss from concentration in the food industry have all seem to have the common theme that there is some welfare loss by consumers because of the concentration in the food industry. These studies also come up with much different estimates of the welfare loss. Even within the same study, different ways to model welfare loss can come up with vastly different estimates of consumer loss. Different studies have also come up with different estimates of welfare loss because of concentration.

8 8 The estimates of loss have not come without controversy. The Connor and Parker study in the late 70 s was heavily criticized for many reasons. There were three different articles where people commented on the study, two in 1981, and one in These replies help indicate why the conclusions reached may be invalid. In their comment, A. Desmond O Rourke and W. Smith Greig point out many possible flaws in the methodology. One being that the study uses a base rate of return to try to determine what firms should earn, and then compares that to what firms actually earn. They also claim that the assumptions made about dead-weight loss are valid only for monopolies, not for oligopolies. O Rourke and Greig also object to the fact that the study has seemed to ignore linkages among companies. A comment by Bruce Bullock also pointed out that the assumptions of dead-weight loss were invalid. Bullock s comments also pointed out that Connor and Parker did not give solutions to the problem of concentration. Bullock asked if splitting up the oligopoly would be more efficient than leaving the oligopoly in place? The 1984 comment was by Donald R. Marion and Gerald Grinnell. They brought up the point that it would be difficult to classify the purchase of name brand goods as loss. They also thought the rate of return Connor and Parker used as a base return was far too low (5.7%), saying that the study would have been better suited to use the rate of return allowed for public utilities (approximately 12%). Connor and Parker did reply to these comments and the defended their work, but many questioned their results. The replies to the 1979 Connor and Parker article helped make the next studies more reliable. Most studies done after this did not try to estimate dead-weight loss as if the market were in a monopoly. The rate of return estimation method seems to have

9 9 disappeared also, as there are too many flaws in that method to get an accurate estimation of welfare loss do to concentration. Despite the improvements, the methods used to estimate welfare loss in the more current studies could be questioned. One example is there use of the generic prices and comparing them to the name brand prices. A key to many of the estimates of welfare loss due to concentration is the fact that the difference in prices between generic and name brand products is welfare loss if the consumer buys the name brand product. This is a very questionable claim. Many of the studies make the assumption that there is no difference in quality between generic product and the name brand product. Many people would disagree with this assumption. Even if this assumption were true, could this be considered loss? Many economists would argue that if the consumer had the choice among different products, there is no possible way that could be classified as welfare loss. One of the greatest economists of the twentieth century, Milton Friedman, has sold millions of copies of a book Free to Choose, where he argues that choice is fundamental aspect that consumers must have for an economy to be successful. If the difference in price between the name brand product and the generic product were not considered loss, then the welfare loss estimates would be lower. Another method that could be questioned is the use of advertising. Many of the studies claim that advertising helps make the product appear differentiated, and people pay more for the name-brand product. The excess that is being paid is often considered welfare loss. These studies do not have a way of estimating the welfare gains because of advertising. One possible welfare gain is that people may have more information about a

10 10 product. Another possible welfare gain is that a customer may feel safer, knowing the firm was making such an investment it has more of an incentive to make sure that their food is safe. This may indicate that the loss estimated in the studies should not be considered loss, but a premium paid for a less risky product. Summary and Future Implications For as many studies done on the topic of welfare loss due to concentration in the food industry, not much is known. There is a consensus in the literature that there is some welfare loss, but the amount of the loss is questionable. The estimates in the studies range from less than 1 percent of expenditures on food to more than 5 percent of expenditures on food. The more recent studies seem to show that the welfare loss is on the lower end of the estimates, but there are still differences in the estimates. Another issue that was raised in a comment was if there was any better structure for the food industry to have so that loss could be minimized. If there is a lot concentration because there are many large firms that have lower average costs than small firms, would it be smart to break apart the large firms? Another question is if the welfare loss is large enough to warrant more attention from the United States Government? As industrial organization theory becomes more effective, the estimates of welfare loss due to concentration should keep getting more accurate. These estimates have fallen over the past twenty years, and as the studies become more reliable, the loss estimates will probably continue to fall. The question is, will they fall far enough where no intervention is needed, or will the welfare loss due to concentration in the food

11 11 industry require government attention? Only time will tell the answer to this important question. Works Cited Concentration in the Red Meat Packing Industry, USDA GIPSA, February Bhuyan, Sanjib and Rigoberto, Lopez A. 1995, Welfare Losses Under Alternative Oligopoly Regimes: The U.S. Food and Tobacco Manufacturing Industries, Journal Agriculture and Applied Economics, 27, pp Bhuyan, Sanjib and Rigoberto, Lopez A. 1997, Oligopoly Power in the Food and Tobacco Industries, American Journal of Agricultural Economics, 79, pp Bullock, Bruce J. 1981, Estimates of Consumer Loss Due to Monopoly in the U.S. Food-Manufacturing Industries: Comment, American Journal of Agricultural Economics, 63, pp Conner, John M. and Peterson, Everett B. 1992, Market-Structure Determinants of National Brand-Private Label Price Differences of Manufactured Food Products, The Journal of Industrial Economics, 40, pp Conner, John M. and Peterson, Everett B. 1995, A comparison of Oligopoly Welfare Loss Estimates for U.S. Food Manufacturing, American Journal of Agricultural Economics, 77, pp Conner, John M. and Peterson, Everett B. 1996, Consumer Welfare Loss Estimates for Differentiated Food Product Markets, Review of Agricultural Economics, 18, pp Cotterill, Ronald W Market Power in the Retail Food Industry: Evidence from Vermont, The Review of Economics and Statistics, pp Friedman, Milton and Rose, 1990, Free to Choose, Harcourt Brace & Company Lipsey, Richard; Courant, Paul; Ragan, Christopher, 1999, Microeconomics, twelfth edition. Addison-Wesley. Marion, Donald R. and Grinnel, Gerald, 1984, Estimates of Consumer Loss Due to Monopoly in the U.S. Food-Manufacturing Industries: Comment, American Journal of Agricultural Economics, 66, pp

12 12 National Farmers Union News 1998, 1999, several issues O Rourke, A. Desmond and Greig, W. Smith, 1981, Estimates of Consumer Loss Due to Monopoly in the U.S. Food-Manufacturing Industries: Comment, American Journal of Agricultural Economics, 63, pp Parker, Russell C. and Connor, John M. 1979, Estimates of Consumer Loss Due to Monopoly in the U.S. Food-Manufacturing Industries, American Journal of Agricultural Economics, 61, pp Parker, Russell C. and Connor, John M. 1981, Estimates of Consumer Loss Due to Monopoly in the U.S. Food-Manufacturing Industries: Reply, American Journal of Agricultural Economics, 63, pp Parker, Russell C. and Connor, John M. 1984, Estimates of Consumer Loss Due to Monopoly in the U.S. Food-Manufacturing Industries: Second Reply, American Journal of Agricultural Economics, 66, pp