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A Conversation on “Buying Power”: The High Cost of Low Prices

February 9, 2011

This post comes from a conversation I had with another blogger on the dangers to efficient markets from purchasers with monopolistic or ogligopolistic bargaining power.

The topic seems to be one which is gaining some increasing attention in academic economics with the emergence of low-cost, low-pricing business models. And is even related to the current NFL collective bargaining agreement and potential player walk-out. Click here to see the conversation, and some follow-up commentary:

This posting is the result of a discussion I had with another blogger. The blogger asked that I respond with a post on my blog, so this is my response and thoughts on the topic.

 

Recently large market moving purchasers have been making headway in the U.S. economy, from retailers like Wal-Mart to manufacturers like Apple; large companies with significant buying power have been able to purchase goods and inputs at below the market price. This phenomenon is nothing new, as noted by economist Roger G Noll of Stanford:

“The first of the federal government’s antitrust suits against the Great Atlantic and Pacific Tea Company found that A&P had violated the antitrust laws by obtaining discounts on its wholesale purchases of food products that were not available to others. Numerous antitrust cases in professional sports have found that monopoly sports leagues violate the antitrust laws by adopting practices that substantially restrict competition among teams in the market for players.”

The problem with this type of behavior is the same complaint raised by conservatives when worker labor unions organize collectively to raise wages. The use of market power to manipulate prices away from Pareto-optimum market levels creates loss. Or in other words, when prices aren’t set in the open market place, someone ends up getting a bad deal. While some such as Adam Ozimek argue savings are passed on to consumers, these proponents of the free-market forget that any non-market outcome (according to their models) is sub-optimal, even if its being done to the advantage of big-business.

Stanford Economist Roger Noll calls these new big-business purchasers Monopsonies, and states:

“In this article, I argue that the consequences of monopsony and monopoly are the same, so that the only basis for differential treatment is to place a different social value on the welfare of competitors in upstream markets and buyers in down-stream markets. While some have argued that increases in concentration on the demand side of an input market are likely to be beneficial to consumers, these arguments are based on an incomplete analysis of incentives and outcomes in monopsonized markets. The argument for prohibiting monopsony practices, but not the corresponding monopoly practices, has no theoretical or empirical foundation in economics.”

-Basically what he’s saying is what people who have fought against Wal-Mart have been saying all along. A monopsony may pass savings on to consumers, but it does so at the expense of those who make its goods. In the case of Wal-Mart, it is likely that these savings come at the expense of workers and companies in China who are forced to sell a portion goods at prices below what they are worth in order to maintain a sufficient flow of business. While this benefits the poor in the United States, it doubtlessly does not benefit the working poor in China. This is of course apart from some of Wal-Mart’s other seedy business practices, some of which I mention in the conversation with Adam below.

Economist Roger Noll was not the only economist warning of anti-competitive buying practices. Much earlier, in 1998, the British Office of Fair Trading released a research paper called “The Welfare Consequences of the Exercise of Buying Power”. The paper highlighted similar concerns to those of Roger Noll, but also noted that this buying power led to problems in the supplier markets as well as with consumer welfare and fair-competition between the monopsony and other sellers:

“Moreover, it is not just consumer welfare and downstream competition which should be taken into consideration. The long-term viability of firms within the supplying industry may also be undermined by the exercise of buying power, as may producer investments when opportunistic behavior by buyers is anticipated.”

Basically what you are seeing in these two papers is a traditional critique of monopoly power in reverse. Its bad for those who are forced to pay unfair non-market prices because of the market-power of monopolists (in this case manufacturers). Its bad for competition because smaller firms without market power cannot compete if they are paying different prices. Its bad for all consumers because it distorts the market for goods, leading to what economists term dead-weight loss, which is a shift in consumption habits that occurs when prices aren’t correct. In the sense: you wouldn’t eat as much pizza if it cost 30$ for a pie, and while you might eat something else… the food choice wouldn’t be as optimal if you had wanted pizza.

In the end monopsony power is bad in the same way monopoly power is bad. The only reason some fail to see this problem is because they’ve become convinced that anything that’s good for big business is good for us all. When in truth if its bad for the market and distorts prices or creates unfair advantages, you cannot remain firm with the neo-classical economic doctrine or libertarian ideologies while still supporting big-business when they take these actions.

There are a few more papers on this subject, but I felt as though these two provide enough background information on the subject. Let me know if anyone wants additional sources on the topic.

 

Here is the original blog posting which argues that you shouldn’t worry about the large price-giving power of monopolies because it lowers consumer prices, my argument with the blogger is what led to the analysis presented above. What follows is the original conversation:

While big businesses often can do a better job of providing cheaper goods (but in general at the cost of worse and less personal “service”) , they should be dealt with cautiously because of this fact. Economies of scale are useful in lowering costs, however if you’ve studied economics one of the basics is that these economies of scale coupled with high fixed entry cost actually lead to market inefficiencies in the production and distribution of goods. This means that on “fair and free market” (fair only as in Pareto efficient) principles alone we should at least be somewhat resistant to market consolidation.
    • Hey Adam,Regarding Walmart, typical monopolistic-oligopoly models, assume that initially prices are lowered below the market rate (in Walmart’s case possibly due to economies of scale) in order to drive competition out of business… then in the second moment prices are able to be raised above market rates as there are no remaining competitors (and fixed costs at this point are high because the monopolist-oligopoly has taken over the available market space and capital investments). You see this pattern pretty clearly with Walmart… and even if they don’t necessarily raise prices in the long-term, they do use economies of scale to gain sub-market rates on their inventory purchases… and use their size as an employer to put employee-related costs onto the government: Healthcare, welfare, and food-stamps. So the risks to Pareto efficient markets from Walmart’s dominance in the organic food market remain. 

      As for farming being competitive, that is just false. Farming is one of the most subsidized industries in the United States. From water subsidies, to land-use subsidies, to price-support subsidies, and more… Furthermore farming is an industry with extremely massive economies of scale. That is why they had the land-enclosure acts 200 years ago, and why today most farms are owned by multimillionaires (the small ones all but went under or where acquired by the 1980s).

      From this quite useful report:
      http://www.ers.usda.gov/publications/EIB12/EIB12c.pdf

      Large-scale farms (more than $250,000 gross annually) account for 73 percent of U.S. production. “Farms averaged 441 acres in 2002 versus 155 acres in 1935. But averages can be deceiving. Because of the diversity of today’s farms, very few are near the average.”

      So with due respect, I believe your last comment on farms is a little off-base.

      I’ve never seen any evidence that Walmart does anything but lower prices, have you? Hausman, I believe, has some good research on this and suggests the price drops are substantial. I’ve never seen any real studies suggesting Walmart pushes costs onto states more than mom or pop groceries do. Have you seen such studies? Even if this were the case, and I doubt it is, it’s again government policy which is the source of the inefficiency, not economies of scale per se.Re: farming, you’re agreeing with me: any inefficiencies resulting from scale are due to government policies. You’ve said farming is dominated by large farms, and that farming receives massive subsidies, but how does one cause the other? 

  • This is only true if the fixed costs deter entry enough to to allow firms to raise prices above competitive levels, which would be a strange charge to level at Walmart. All the studies on this have shown they lower food prices.Likewise farming is a quintessentially competitive industry where market power isn’t much of a concern per se. And to the extent that it is it’s more to do with government policy rather than economies of scale. 

Walmart does not raise consumer prices, but instead uses its monopoly power to demand lower prices from distributors. This forced re-pricing goes outside of market forces… its the same thing that conservatives complain labor unions do. So no… its not Pareto efficient.Further, Walmart receives substantial subsidies. It is so well known it is mentioned in a textbook (which cites a study):
http://books.google.com/books?id=kSNMI2RiLZ8C&pg=PA35&lpg=PA35&dq=wal-mart+wage+subsidy&source=bl&ots=ou12bRItIo&sig=wQtVXMPTCggL91EfSQCs_JImWNs&hl=en&ei=IchQTfj8FZG-tgfLp53ICQ&sa=X&oi=book_result&ct=result&resnum=6&ved=0CDQQ6AEwBQ#v=onepage&q=wal-mart%20wage%20subsidy&f=false 

Here is an article on subsidies to Walmart from a Pulitzer prize winner:
http://www.globalresearch.ca/index.php?context=va&aid=8431

    How is it that Walmart forces a supplier to sell it products below cost without decreasing quantity sold? Sounds quite impossible to me. Unions raise prices and decrease employment, which you can easily demonstrate with supply and demand curves. I’d be curious to see you demonstrate Walmart’s supposed inefficiency here like that instead of waving you hands at “forced re-pricing” that is “outside of market forces”, whatever that means. Walmart forces efficiencies up and down the supply chain and engages in intense price competition.And yes, poor people work at Walmart, and we provide welfare to poor people. Poor people also work at mom and pops and other grocery stores that Walmart replaces. What’s the conclusion you’d have us draw from this? That we should favor one over the other? Poor people also work at the Salvation Army, and in fact I assure you they are on average poorer than Walmart, who they compete with. Should we favor Walmart over the salvation army? 

    Nobody has presented convincing evidence that Walmart lowers wages or employment, and the studies are extremely mixed.

And regarding farming… I’m not agreeing with you.As my previous statement highlighted BOTH economies of scale and government intervention as proof that this statement: 

“farming is a quintessentially competitive industry”

was completely false

    • Economies of scale by definition do not have a competitive equilibria. Therefore, economies of scale by definition do not produce competitive results. I don’t know what textbooks you use… but see Mas-Colell:See Mas-Colell 

      pg 324
      “This firm’s cost function is continuous and differentiable but not convex. (Note: this means increasing returns to scale) In the figure, the light curve is the graph of the firm’s marginal cost function. As the figure illustrates, (the cost function) fails to be nondecreasing. The heavier curve is the firms actual supply correspondence (function). The graph of the supply correspondence no longer coincides with the marginal cost curve and, as is evident in the figure, no intersection exists between the graph of the supply correspondence and the demand curve. Thus, in this case, no competitive equilibrium exists.”

      or

      pg376
      “The failure of (the profit function) to be concave can create problems for both centralized and decentralized solutions to the externality problem. “

      Scale economies are obviously diminishing at some level of output in the real world. The world is not as frictionless as MWG, and economies of scale in agriculture top out. Once you’re large enough to be an industrial farm I’d say the most important economies of scale are exhausted.
  • As I’m sure you know, simply having a concentrated industry as a result of economies of scale is not sufficient to produce uncompetitive results. You can have 2 firms and perfectly competitive prices. Given that farms produce very homogenous products, and even with economics of scale entry barriers are not significant, textbooks will frequently mention agriculture as a market that absent government intervention would be very competitive.In any case, given the level of government intervention, subsidies, and price supports, worrying that marginal economies of scale pretty besides the point. 

Adam, I agree with what you just said regarding interpreting Mas-Collel Whinston and Greene.And your statement:
“Once you’re large enough to be an industrial farm I’d say the most important economies of scale are exhausted.” 

supports my point:

Mainly my dis-agreement with your statements:

“Likewise farming is a quintessentially competitive industry where market power isn’t much of a concern per se.”

“Given that farms produce very homogenous products, and even with economics of scale entry barriers are not significant”

Economies of scale (and certainly associate high fixed costs for land and technology as barriers to entry) are very significant in farming. Irregardless of subsidies. Farm products are homogenous… but the costs are not.

Ok, I don’t think we disagree too much here then. Given that economies of scale become exhausted, there is a minimum ATC which can serve as a benchmark against which to measure equilibrium prices to judge how far from perfectly competitive they are. Given the homogeneous nature of agriculture products, you don’t necessarily need zero entry costs to get prices very close to competitive levels. This is what I mean when I say economies of scale barriers to entry aren’t significant: they won’t likely cause prices to diverge significantly from competitive levels. I don’t mean that they aren’t large such that an industrial farm wouldn’t have cost advantages over a small farm.This is why I don’t think market power is much of a concern per se. Sure, cartelization is as possible as it is in any other industry. But that’s not the argument here… note that market power is especially not a concern when you have companies like Walmart ensuring prices do stay as close to possible minimum ATC. 

Ok Adam, I see now where the disagreement and lies between us.
With increasing returns to scale brought about by non-convexities in the cost function, as I mentioned above… no competitive equilibrium exists. As you state, you have to benchmark prices to some arbitrary minimum average total cost established by real world market frictions. Note: the minimum ATC you mentioned is established by frictions facing larger firms (not smaller less efficient ones).I’m saying that given sufficient market power you can have an industry in which increasing returns to scale lead to multiple equilibria. As a result larger firms use size to bring down input costs below what faces smaller firms… this creates consolidation which is due to and reinforces economies of scale coupled with bargaining power (both non-competitive forces in that they lead to dis-equilibrium prices). As I originally stated this is what conservatives always complain labor unions do. However, in that case the input is priced over the market rate not under. 

What matters in this scenario is not the final price of the good, but the price of the inputs. This is what Walmart makes money from. For large farms non-convexities have a similar effect on costs in the production function.

It only makes it worse that there are subsidies to these industries (Walmart/Farms as linked to above), but they are not necessary.

You’re going to have to elaborate on why bringing down input costs is inefficient, and how the prices can be pushed below the market rate and why from a welfare and efficiency perspective we should be concerned. If you elaborate on you’re blog I’ll be happy to respond, but the case as you’re making it does not make a lot of sense to me and I think needs to be more fleshed out. I think you’ve identified our disagreement correctly, and I think that is the crux of it both with respect to farms and Walmart.

As an aside, I am not defending farm policy status quo and don’t like the litany of subsidies and the inefficiencies they cause.

While big businesses often can do a better job of providing cheaper goods (but in general at the cost of worse and less personal “service”) , they should be dealt with cautiously because of this fact. Economies of scale are useful in lowering costs, however if you’ve studied economics one of the basics is that these economies of scale coupled with high fixed entry cost actually lead to market inefficiencies in the production and distribution of goods. This means that on “fair and free market” (fair only as in Pareto efficient) principles alone we should at least be somewhat resistant to market consolidation.

    • Hey Adam,Regarding Walmart, typical monopolistic-oligopoly models, assume that initially prices are lowered below the market rate (in Walmart’s case possibly due to economies of scale) in order to drive competition out of business… then in the second moment prices are able to be raised above market rates as there are no remaining competitors (and fixed costs at this point are high because the monopolist-oligopoly has taken over the available market space and capital investments). You see this pattern pretty clearly with Walmart… and even if they don’t necessarily raise prices in the long-term, they do use economies of scale to gain sub-market rates on their inventory purchases… and use their size as an employer to put employee-related costs onto the government: Healthcare, welfare, and food-stamps. So the risks to Pareto efficient markets from Walmart’s dominance in the organic food market remain. 

      As for farming being competitive, that is just false. Farming is one of the most subsidized industries in the United States. From water subsidies, to land-use subsidies, to price-support subsidies, and more… Furthermore farming is an industry with extremely massive economies of scale. That is why they had the land-enclosure acts 200 years ago, and why today most farms are owned by multimillionaires (the small ones all but went under or where acquired by the 1980s).

      From this quite useful report:
      http://www.ers.usda.gov/publications/EIB12/EIB12c.pdf

      Large-scale farms (more than $250,000 gross annually) account for 73 percent of U.S. production. “Farms averaged 441 acres in 2002 versus 155 acres in 1935. But averages can be deceiving. Because of the diversity of today’s farms, very few are near the average.”

      So with due respect, I believe your last comment on farms is a little off-base.

      I’ve never seen any evidence that Walmart does anything but lower prices, have you? Hausman, I believe, has some good research on this and suggests the price drops are substantial. I’ve never seen any real studies suggesting Walmart pushes costs onto states more than mom or pop groceries do. Have you seen such studies? Even if this were the case, and I doubt it is, it’s again government policy which is the source of the inefficiency, not economies of scale per se.Re: farming, you’re agreeing with me: any inefficiencies resulting from scale are due to government policies. You’ve said farming is dominated by large farms, and that farming receives massive subsidies, but how does one cause the other? 

  • This is only true if the fixed costs deter entry enough to to allow firms to raise prices above competitive levels, which would be a strange charge to level at Walmart. All the studies on this have shown they lower food prices.Likewise farming is a quintessentially competitive industry where market power isn’t much of a concern per se. And to the extent that it is it’s more to do with government policy rather than economies of scale. 

Walmart does not raise consumer prices, but instead uses its monopoly power to demand lower prices from distributors. This forced re-pricing goes outside of market forces… its the same thing that conservatives complain labor unions do. So no… its not Pareto efficient.Further, Walmart receives substantial subsidies. It is so well known it is mentioned in a textbook (which cites a study):
http://books.google.com/books?id=kSNMI2RiLZ8C&pg=PA35&lpg=PA35&dq=wal-mart+wage+subsidy&source=bl&ots=ou12bRItIo&sig=wQtVXMPTCggL91EfSQCs_JImWNs&hl=en&ei=IchQTfj8FZG-tgfLp53ICQ&sa=X&oi=book_result&ct=result&resnum=6&ved=0CDQQ6AEwBQ#v=onepage&q=wal-mart%20wage%20subsidy&f=false 

Here is an article on subsidies to Walmart from a Pulitzer prize winner:
http://www.globalresearch.ca/index.php?context=va&aid=8431

    How is it that Walmart forces a supplier to sell it products below cost without decreasing quantity sold? Sounds quite impossible to me. Unions raise prices and decrease employment, which you can easily demonstrate with supply and demand curves. I’d be curious to see you demonstrate Walmart’s supposed inefficiency here like that instead of waving you hands at “forced re-pricing” that is “outside of market forces”, whatever that means. Walmart forces efficiencies up and down the supply chain and engages in intense price competition.And yes, poor people work at Walmart, and we provide welfare to poor people. Poor people also work at mom and pops and other grocery stores that Walmart replaces. What’s the conclusion you’d have us draw from this? That we should favor one over the other? Poor people also work at the Salvation Army, and in fact I assure you they are on average poorer than Walmart, who they compete with. Should we favor Walmart over the salvation army? 

    Nobody has presented convincing evidence that Walmart lowers wages or employment, and the studies are extremely mixed.

And regarding farming… I’m not agreeing with you.As my previous statement highlighted BOTH economies of scale and government intervention as proof that this statement: 

“farming is a quintessentially competitive industry”

was completely false

    • Economies of scale by definition do not have a competitive equilibria. Therefore, economies of scale by definition do not produce competitive results. I don’t know what textbooks you use… but see Mas-Colell:See Mas-Colell 

      pg 324
      “This firm’s cost function is continuous and differentiable but not convex. (Note: this means increasing returns to scale) In the figure, the light curve is the graph of the firm’s marginal cost function. As the figure illustrates, (the cost function) fails to be nondecreasing. The heavier curve is the firms actual supply correspondence (function). The graph of the supply correspondence no longer coincides with the marginal cost curve and, as is evident in the figure, no intersection exists between the graph of the supply correspondence and the demand curve. Thus, in this case, no competitive equilibrium exists.”

      or

      pg376
      “The failure of (the profit function) to be concave can create problems for both centralized and decentralized solutions to the externality problem. “

      Scale economies are obviously diminishing at some level of output in the real world. The world is not as frictionless as MWG, and economies of scale in agriculture top out. Once you’re large enough to be an industrial farm I’d say the most important economies of scale are exhausted.
  • As I’m sure you know, simply having a concentrated industry as a result of economies of scale is not sufficient to produce uncompetitive results. You can have 2 firms and perfectly competitive prices. Given that farms produce very homogenous products, and even with economics of scale entry barriers are not significant, textbooks will frequently mention agriculture as a market that absent government intervention would be very competitive.In any case, given the level of government intervention, subsidies, and price supports, worrying that marginal economies of scale pretty besides the point. 

Adam, I agree with what you just said regarding interpreting Mas-Collel Whinston and Greene.And your statement:
“Once you’re large enough to be an industrial farm I’d say the most important economies of scale are exhausted.” 

supports my point:

Mainly my dis-agreement with your statements:

“Likewise farming is a quintessentially competitive industry where market power isn’t much of a concern per se.”

“Given that farms produce very homogenous products, and even with economics of scale entry barriers are not significant”

Economies of scale (and certainly associate high fixed costs for land and technology as barriers to entry) are very significant in farming. Irregardless of subsidies. Farm products are homogenous… but the costs are not.

Ok, I don’t think we disagree too much here then. Given that economies of scale become exhausted, there is a minimum ATC which can serve as a benchmark against which to measure equilibrium prices to judge how far from perfectly competitive they are. Given the homogeneous nature of agriculture products, you don’t necessarily need zero entry costs to get prices very close to competitive levels. This is what I mean when I say economies of scale barriers to entry aren’t significant: they won’t likely cause prices to diverge significantly from competitive levels. I don’t mean that they aren’t large such that an industrial farm wouldn’t have cost advantages over a small farm.This is why I don’t think market power is much of a concern per se. Sure, cartelization is as possible as it is in any other industry. But that’s not the argument here… note that market power is especially not a concern when you have companies like Walmart ensuring prices do stay as close to possible minimum ATC. 

Ok Adam, I see now where the disagreement and lies between us.
With increasing returns to scale brought about by non-convexities in the cost function, as I mentioned above… no competitive equilibrium exists. As you state, you have to benchmark prices to some arbitrary minimum average total cost established by real world market frictions. Note: the minimum ATC you mentioned is established by frictions facing larger firms (not smaller less efficient ones).I’m saying that given sufficient market power you can have an industry in which increasing returns to scale lead to multiple equilibria. As a result larger firms use size to bring down input costs below what faces smaller firms… this creates consolidation which is due to and reinforces economies of scale coupled with bargaining power (both non-competitive forces in that they lead to dis-equilibrium prices). As I originally stated this is what conservatives always complain labor unions do. However, in that case the input is priced over the market rate not under. 

What matters in this scenario is not the final price of the good, but the price of the inputs. This is what Walmart makes money from. For large farms non-convexities have a similar effect on costs in the production function.

It only makes it worse that there are subsidies to these industries (Walmart/Farms as linked to above), but they are not necessary.

You’re going to have to elaborate on why bringing down input costs is inefficient, and how the prices can be pushed below the market rate and why from a welfare and efficiency perspective we should be concerned. If you elaborate on you’re blog I’ll be happy to respond, but the case as you’re making it does not make a lot of sense to me and I think needs to be more fleshed out. I think you’ve identified our disagreement correctly, and I think that is the crux of it both with respect to farms and Walmart.As an aside, I am not defending farm policy status quo and don’t like the litany of subsidies and the inefficiencies they cause. 

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17 Comments leave one →
  1. Adam Ozimek permalink
    February 10, 2011 12:01 pm

    I am going to get around to reading this paper. But what do you mean by saying that negotiations between suppliers and there buyers are “non-market outcome”? Unions are a non-market outcome because arbitration and labor laws can in effect force unions onto firms, meaning the exchange is not voluntary. What is the comparable coercion here? Even a natural monopolist is a market outcome.

    • February 10, 2011 1:07 pm

      I mean that the price received for the good is not the same price that the purchaser would have paid in the open market. The price the purchaser negotiates is based on a monopsony power rather then on supply and demand. If you look at the two graphs above, it should be clear that it is a monopoly mark-up in reverse. The welfare loss that occurs is a similar concept as well, what the Roger Noll paper highlights is that the only way you can say it doesn’t matter is if you privileged the social welfare of one side of the transaction over the other.

      In this sense it is the same as a non-market outcome for union wages based on labor-power. Note, what you said about labor laws is not entirely correct. The principle reason that labor unions can bargain is because of their size (market-power) (in an equilibrium model with close to full employment). For proof of theory imagine a labor union that encompassed 100% of the population, they would be complete price-makers and labor laws wouldn’t be necessary for that capability.

      • Adam Ozimek permalink
        February 10, 2011 1:58 pm

        Close to full employment does a lot of work there in that last paragraph. Without that assumption unions face the same problems cartels do (and possibly with it, I haven’t fully thought it through). In reality the more unionized an economy is the farther from full employment we will be.

      • February 10, 2011 3:10 pm

        “Close to full employment does a lot of work there in that last paragraph.”

        Agreed. But this doesn’t take away from my point, namely that economic understandings of how labor unions operate is based on market power. This is because if we are talking about first-best Pareto cases (i.e. efficient markets), the assumption of close to full-employment is always necessary for any analysis at all. Starting from a dis-equilibrium any focus on labor laws ect… are from the get go problematic because we don’t know in which way the dis-equilibrium in the labor market is going… it could well be that there is underemployment due to the very issues labor laws are attempting to rectify, just as much as there could be underemployment because of those same labor laws.

        But the conversation is not about labor unions explicitly, rather about the effect of non-convexities in the cost curve in this case due to monopsony buying power.

  2. Adam Ozimek permalink
    February 10, 2011 4:58 pm

    As a general comment I think you’re overly tied to a strict MWG style world of “how would I model this exchange economy in general equilibrium?”. There is a lot we can say in life about efficiency on the margin without worrying about these fully specified theory problems. There is much we can say about efficiency on the margin in the real world without having to make assumptions of full employment. For instance, I don’t think it’s a stretch to say that the efficient functions of labor laws -to counter monopsonies and give workers voice- does not suffice to outweigh the inefficiencies they cause in a way that makes them on net efficient. The union wage premium is a fairly certain empirical phenomenon, yet union productivity effects are questionable and as or more likely to be negative. A wage premium without productivity gains spells inefficiency unless you believe monopsony power far more prevalent then I think is defensible.

    But anyway, you’re right, this is besides the point. I should be focusing on reading that paper…

    • February 10, 2011 7:34 pm

      “For instance, I don’t think it’s a stretch to say that the efficient functions of labor laws -to counter monopsonies and give workers voice- does not suffice to outweigh the inefficiencies they cause in a way that makes them on net efficient… A wage premium without productivity gains spells inefficiency unless you believe monopsony power far more prevalent then I think is defensible. ”

      I am not particularly wedded to general equilibrium models, and I think you understand why I’m using them. Instead here you are making statements based on conjecture that I would disagree with, as the above quote illustrates. The reason I’m using general equilibrium models is because they give us a mutually understood starting point to analyze the effects of non-convex input costs and monopsony buying power rather than subjective opinion and conjecture, and chances are that these monopolistic effects are actually stronger in a more restrictive and consolidated real world market which has additional anti-competitive features such as subsidies and barriers to entry.

      And please note this is a sidebar but…
      Besides, as I mentioned if we start from a dis-equilibrium analysis anything is possible based on our perspective of what the source of disequilibrium is and here we are not likely to agree even in starting. And just on an aside, as someone who seems to be defending business, if you believe there are market disequilibria (outside of just government actions) then one is forced to engage in some sort of retrospection as to why ideologically emphasize the value of markets if they regularly fail anyways.

      • Adam Ozimek permalink
        February 11, 2011 7:31 am

        These are the disagreements of an empiricist and a theorist I suppose.

        And to your aside, I’ll happily embrace your institutions that don’t regularly fail once that you identify them. The biggest problems with farming have little to do with market structure per se, but the insane amount of government subsidies and perverse regulations, and also the governments failure to do what it should do, which is tax externalities. Here is an example where the government does everything it shouldn’t and nothing it should.

  3. Adam Ozimek permalink
    February 11, 2011 7:44 am

    Also, your preference for starting with precisely defined theory may delay the point where you have to say “I think”, but if you ever want to say anything about the real world your statements will require that as well… you’re simply delaying the point at which you say it.

    • February 11, 2011 3:04 pm

      Hey Adam,

      I’m not a fan of big government myself. Regarding your first set of comments, I fully agree that government intervention in the farming market is for the most part terrible. That being said market imperfections also play a huge role in creating inefficient resource distributions in the farming sector. Remember those non- convex cost curves (the entire subject of this post) that you’ve continually failed to address? Just because one institution is problematic does not mean we should become blind ideologues of its supposed counter, especially when that “counter” also fails regularly (isn’t this why you don’t like equilibrium analysis?).

      As for: “These are the disagreements of an empiricist and a theorist I suppose.” And
      “Also, your preference for starting with precisely defined theory may delay the point where you have to say “I think”, but if you ever want to say anything about the real world your statements will require that as well… you’re simply delaying the point at which you say it.”

      You have laid out nary an empirical or theoretical statement addressing my original claims. I have given both. You are aware of my original point, as I posted an entire post elaborating on this request: “You’re going to have to elaborate on why bringing down input costs is inefficient, and how the prices can be pushed below the market rate and why from a welfare and efficiency perspective we should be concerned.”

      I have yet to see you address anything I said in the blog post. If it makes it any simpler for you to actually comment on what I have said, my argument is a monopsony is a monopoly in reverse.

  4. Adam Ozimek permalink
    February 13, 2011 9:41 am

    Ok, I read the paper. This is a really interesting paper, and I do want to thank you for drawing my attention to it. I don’t think author draws the same conclusion you do about Walmart though. After all, you point out the parallel to A&P, but Noll says:

    “Most antitrust scholars have concluded that the A&P case was wrongly decided. Like big-box retailers, A&P, as the first grocery chain, realized efficiency gains that enabled it to offer greater product variety and lower prices, which in turn gave it sufficient market share that it could exercise monopsony power in some wholesale food markets. The ultimate source of A&P’s market power was superior technology that later was copied successfully by others. The A&P innovation did not cause the retail grocery store market to be monopolized, but it did cause a dramatic change in the identities and characteristics of the successful suppliers. Now that the A&P decision is a dead letter and private label foods are a common feature of grocery chains, any claim that consumers are worse off because grocery chains successfully acquire low-priced private-label foods justifiably would be greeted with great skepticism.”

    He even explicitly argues there is no policy implication for Walmart that arises from this issue:

    “The concerns about Wal-Mart parallel the thinking that gave rise to the A&P case. While the ultimate outcome of the big-box retail sales innovation has yet to be played out, Wal-Mart hardly is the only firm that has adopted this strategy. Thus far, Wal-Mart is simply the most successful. At this point, a plausible long-run consequence of the Wal- Mart innovation is that several chains of big-box retailers will displace a variety of existing retail stores, including, perhaps, some chain grocery stores and department stores, as well as small, independent shops. At the local level, one can imagine a community legitimately deciding that a big-box retailer imposes a sufficiently large external cost on downtown retail districts to be unacceptable, but this argument is distinct from the competition policy issue and so does not support a national policy to curtail the exercise of monopsony power by big-box stores”

    He also says that monopsony power can lead to efficient price descrimination against sellers with market power. I think that’s a pretty apt description of what’s going on here. Yes, he points out that the monopsonist may not descriminate perfectly, but I’m pretty sure Walmart is going to do it as perfect as anyone. As Jerry Hausman says, think of Walmart as performing the function of regulator who seeks to lower prices of a firm with market power, except with better information than any regulator is likely to have.

    A lot of his concerns relate to prices not being lowered for consumers, but clearly this is not the case here. Other indicators that there are inefficient monopsony is output goes down, and suppliers going out of business. Do you have any evidence that either of these are occurring?

    The positive welfare effects that Hausman finds from Walmarts price lowering are massive, in the neighborhood of 3% of GDP (http://econlog.econlib.org/archives/2006/11/jerry_hausman_o.html) . You’d need to identify evidence of some pretty large examples of the negative outcomes Noll says are possible for welfare to decrease on net from Walmart. The author of this paper doesn’t seem to think this is the case, and I’m not sure why you would.

    But I do understand your argument now about how a monopsonist can drive input costs down inefficiently low. I just don’t think it implies anything negative about Walmart. Noll seems to agree.

    • February 16, 2011 3:56 pm

      Hey Adam,

      Sorry for my delayed response to your comment, my work schedule is pretty irregular at this point. Also, as you’ve taken the time to read the article I wanted to make sure I adequately responded to your comments.

      As you’ve found in the article, there is a bit of gem for your position, whereby Prof. Noll after discussing the market distortions of Monopsonies mentions that the policy prescription for big-box retailers is unclear because the welfare distorting effect is potentially net sum zero if there are supplier rents. This because what may be occurring is that Walmart passes on producer profits to consumers. This is where the conversation lies.

      For this to occur, we need to assume that Walmart passes on the entirety of its lower prices to the consumer (if it does not then this is clearly a case where Walmart is extracting rents itself). I believe that this is partially true, empirical evidence suggests Walmart passes on a substantial portion (but not all) of its savings to consumers. We know this only from reports of companies that have done business with Walmart; despite being public Walmart is pretty private with a lot of its revenue information.

      The problem with this is that the slight deviations here constitute market welfare loss, whereby Walmart becomes the rentier, and these rents are felt at the supplier level and damage the relative profitability of retail competitors. Further Walmart is also capturing significant rents from the accompanying market size, government subsidization, and fixed costs necessary to gain its increasing returns to scale it receives. Prof. Noll touches on this but fails to discuss the market distortions that these cause beyond a brief statement that they did not apply in the A&P case.

      Now if we understand the primary rents Walmart is extracting from suppliers to be Ricardian in nature: due to variability across input prices of manufacturers (in this case low-wages in China versus the rest of the world) what we see is Walmart profiting from low labor costs in China. The problem with this is that, by accepting this narrative (which is necessary to argue that its monospony purchases are non-distortionary) you tacitly admit that Walmart’s business model drives down wages internationally. This means that the rent Walmart partially passes on to the consumer, is from driving down the international wage standard of the “working-class”.

      So the final picture is, if Walmart is pocketing any of the price difference between its below-market costs and consumer prices… then there is a net-welfare loss for the consumer. Further, even if it perfectly passes on all savings to the consumer, this rent in the form of low purchase and sale prices (which the consumer now receives) is helping sustaining a business model which exhibits increasing returns to scale at a certain level, diminishing wages and labor standards, and ensuring other quasi-rents persist (due to Walmart’s market size).

      I acknowledge Walmart does help efficiency, the problem is it does so at the cost of labor standards globally and undermines retail competition in the United States through a business model based on non-convexities its cost curve and market subsidies and imperfections. Personally, I feel as though these costs to the average working consumer are heavier than any efficiency gains.

      You’ll note that throughout this whole argument is the fact that Walmart’s business faces an enormous pressure towards generating market ineffiency. All that is necessary is that low prices aren’t passed one for one onto the consumer, furthermore efficiency gains from Walmart’s business structure must be greater than the market distortions it causes due to its size. This is a pretty difficult test pass.

      I feel as though some of the points I mentioned here might need some clarification, so let me know if there is a point I should elaborate on.

      As for farming, this article seems to take farming as its base case for an un-competitive market due to productivity and cost differentials, which probably undermines your other point that absent government intervention it would be a perfectly competitive industry.

  5. Adam Ozimek permalink
    February 13, 2011 9:42 am

    The formatting of that comment I just left is really ugly. Feel free to edit it and put the quotes in block quoting format.

  6. Adam Ozimek permalink
    February 16, 2011 4:40 pm

    I’m going to reply to a couple things quickly, probably more later:

    “For this to occur, we need to assume that Walmart passes on the entirety of its lower prices to the consumer (if it does not then this is clearly a case where Walmart is extracting rents itself).”

    I don’t see why this needs to be the case. If Walmart takes rents and gives back, say, 50% of it to consumers, then this is a huge net reduction in rents, so it is an increase in welfare and efficiency. What am I missing here?

    So I also disagree that the welfare effect is only potentially “net sum zero”, when it potentially -I would say almost certainly- positive. I think your supposing some counterfactual where all rents are dissipated, but really the counterfactual is rents continue to rest with suppliers. Also note that Hausman suggests Walmart takes a lower profit margin then competing grocery stores, so it is apparently reducing rents there as well, not just supplier rents.

    “I acknowledge Walmart does help efficiency, the problem is it does so at the cost of labor standards globally”

    This is a huge claim which you should offer some evidence for if you have it. Are you arguing that Chinese laborers have were previously accumulating rents that Walmart is bargaining down from consumers? I see no indication why that should be the case, and given the quickly raising wages in China I’d be very surprised if it were true. Also, there are examples of Walmart clearly creating public goods when they operate in China by effectively enforcing laws in a way that corrupt local governments don’t. I’ve written about this here:

    http://modeledbehavior.com/2010/03/07/walmart-globalization-and-exporting-the-rule-of-law/

    You’ve also claimed again that Walmart benefits from “market subsidies”, but again consider the counterfactual. It’s not “no low wag jobs”, it’s “low wage jobs in other grocery stores”. Is there evidence Walmart benefits more per worker compared the correct jobs counterfactual?

    • February 23, 2011 3:26 pm

      Hey Adam,
      Thanks for your reply and sorry for my delayed response. Last week was busy. I like your response and agree that most of the points you’ve brought up are sounds theoretically… however I don’t think my previous post was clear enough on the point I was trying to make so your comments aren’t quite addressed to what I meant. I’ve created a new post here, so the comment thread doesn’t run on too long.

Trackbacks

  1. Economics Headlines for the Week: 2/21/2011 « floodingupeconomics
  2. A Conversation on “Buying Power”: How the Wal-Mart Monopsony Damages Wages and Competition « floodingupeconomics

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