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