To spare the economy from the pain of further interest rate hikes, the President should aggressively pursue anticompetitive conduct by companies in concentrated industries and ignore the guidance of neoliberals.
With an endless faith in markets to solve all problems, neoliberal economists are engaging in Olympic-level logical gymnastics to avoid blaming market power in the US economy for any portion of the current inflation levels. Despite the fact that firms with market power set prices and do so across successive time periods, inflation has no nexus whatsoever to market power—or so the seemingly monopoly-besotted neoliberal crowd tells us.
Per their telling, raising interest rates represents the only policy lever that the government has at its disposal to curb inflation. Higher interest rates will bring about a recession, which will shift inward the demand for goods and services, leading to lower prices. This is an admission of the sky-high economic costs of their preferred intervention. Even worse, the neoliberals’ plan is regressive, as workers, the most vulnerable economic actors in the economy, will bear the brunt of the pain, as they did with the Volcker Shock.
Indeed, for Larry Summers, the oft-quoted leader of the neoliberal tribe, workers deserve the blame for inflation. He recently told the Washington Post that there can’t be a “durable reduction in inflation without a meaningful reduction in wage growth,” implying that only by reducing wage growth will inflation come down. The problem with this diagnosis, however, lies with the fact that zero correlation exists between industry-level wage growth and industry-level inflation. And two studies, one by the Economic Policy Institute and another by the Institute for New Economic Thinking, estimate that the contribution to inflation from higher profit margins are between two and three times as large as that of higher nominal wages.
To see the clear nexus between inflation and market power, consider the pharmaceutical industry. Patent protection permits pharmaceuticals to command monopoly power—the ultimate form of pricing power. According to a new study in the Journal of American Medical Association, average prices for newly marketed prescription drugs in the United States grew by 20 percent per year from 2008 to 2021, outpacing the one-to-three percent inflation of other health care services over the same period. These price hikes clearly reflect manufacturers’ pricing power, as drug prices escalate upon annual renegotiations with pharmacy benefit managers. And these annual price hikes directly contribute to the Consumer Price Index (CPI).
Or take oil refineries, another industry beset with market power. Refineries have been consolidated into the hands of a few firms, with Saudi Aramco extending its (upstream) oil production power into (downstream) refineries in China, Japan, Indonesia, and South Korea. When an industry is cartelized, suppliers can coordinate on capacity reductions. According to The Economist, refining capacity has plunged by three million barrels per day since the start of the pandemic. Raising prices over competitive levels by restricting output, or in this case capacity, is the very essence of market power. (David Dayen has a terrific new piece explaining how the capacity drawdown among refineries occurred via consolidation.) It should be no surprise, then, that oil-refining margins from 2017 through 2021 hovered around $10 per barrel, but have shot to a staggering $60 per barrel in 2022. These price hikes have resulted in record-high prices for gas at the pumps, which when stacked across periods, generates inflation and also contributes directly to CPI.
These are extreme examples of monopolized (or near-monopolized) industries. But the same phenomenon can occur in highly concentrated industries, in which a handful of firms dominate production. To arrive at monopoly-like prices, oligopolists must coordinate in their pricing (or capacity) decisions, which, absent a collusive agreement, presents a substantial hurdle. One way to overcome such a challenge is through the sharing of competitively sensitive information. Antitrust agencies recognize that sharing future pricing or capacity decisions is potentially anticompetitive, as it permits firms in concentrated industries to collude.
Consider an industry dominated by two firms, A and B, each with half the market. If firm A raises prices without a commitment by firm B to follow its lead, A’s price could be undercut by firm B, resulting in losses for A. Now suppose firm B commits to matching firm A’s price increase through an earnings call. This is what happened in October 2008, when AirTran’s CEO announced that AirTran would never impose a first-bag fee unilaterally, but would follow Delta’s bag fee if Delta were to go first. Economists refer to such overtures as “pre-play communications,” or “signaling devices,” which facilitate coordinated pricing. Sure enough, AirTran’s signal broke the logjam, and both firms quickly imposed first-bag fees shortly thereafter. (Disclosure: I was the consumers’ economic expert in a class action lawsuit against the two airlines.)
Recent earnings calls contain this same kind of communication. Groundwork Collaborative has documented myriad episodes in which CEOs boasted about their newfound ability to exercise pricing power made possible by the cover of inflation, sometimes telegraphing future price increases. One would not expect these communications to affect prices in unconcentrated industries, as coordination there would be like herding cats. But in concentrated industries, CEOs can feel their way towards monopoly-like prices by committing, via public communications, to raise prices in the future. For example, United’s CEO announced in April of this year that his airline expected to collect 17 percent more revenue on a per-seat, per-mile basis from April to June than it did in the same period in 2019. In February, Lamb Weston Holdings, the leading supplier of frozen French fries sold to restaurants, announced its intention to raise prices in April; according to the Capitol Forum, two of its rivals matched the price increases identically within days. The CEO of Kimberly Clark, a conglomerate making paper towels and diapers, stated his intention on a recent earnings call to continue raising prices throughout the year. To an antitrust economist, these overtures can be understood as an invitation to collude.
To test the hypothesis that concentrated industries are more susceptible to coordinated price hikes, I gathered industry concentration data from Standard & Poor’s Compustat Capital IQ on all publicly available firms in 2020. I then used these data to predict price hikes from December 2020 to December 2021. It turns out that the largest price hikes in 2021 tended to come from the most concentrated industries. The relationship between the two variables was statistically significant at the highest levels, and it was robust to how concentration was measured. The Census Bureau’s latest concentration data, which covers all firms (including private firms), is from 2017, which given significant consolidation in the US economy in the last five years, is not an ideal predictor of inflation in 2021. However, I was able to replicate my results using Census Bureau concentration data when aimed at inflation from 2017 to 2018; once again, the largest price hikes across all firms in 2018 tended to come from the most concentrated industries in 2017.
My results were corroborated by a recent study by the Boston Federal Reserve, which found that the “pass-through rate”—or the rate at which cost increases were passed onto consumers—was about 25 percentage points higher than it would have been had the US economy not experienced the consolidation that it did since the beginning of the century. This study defies the doctrinal teachings of industrial organization economics—namely, that monopolists “do a service” for their customers by absorbing a portion of any cost increase. In any event, pass-through is not my preferred lens to explain the nexus between concentration and inflation; concentration facilitates price coordination, regardless of what’s happening to firms’ costs. And companies are exploiting a small bout of inflation to soften the proverbial beachheads and to serve as a focal point for future price hikes.
We cannot easily determine how much these information exchanges by publicly traded companies during earnings calls contribute to inflation. But even if they only contributed a percentage point or two, regulatory authorities should stamp them out aggressively, particularly if doing so avoids another regressive interest rate hike. The Federal Trade Commission (FTC) holds the unique power to police invitations to collude under the Federal Trade Act. Ideally, the next CEO who telegraphs her company’s future pricing plans (or capacity reduction) would trigger a very public FTC investigation, putting every other CEO on notice. Despite the seemingly glacial process of antitrust cases, making a public lesson of one CEO could have an immediate and significant deterrent effect on firms throughout the economy. The FTC could also deputize the Department of Justice to prosecute firms under the FTC’s authority.
Longer term, legislative action could modify the Sherman Act to allow state attorneys general and private enforcers to pursue cases involving the exchange of competitively sensitive information via earnings calls. The American Economic Liberties Project issued a model piece of legislation that would accomplish this goal. The Biden Administration could get behind this reform, as well as legislation sponsored by Senator Warren that would give the FTC broad powers to go after gasoline price manipulation.
Biden needs to communicate to the public that he supports efforts to tamp down inflation outside of the traditional interest-rate-hike paradigm. Progressives in his party did not vote for Republican-lite; they want to see someone who will fight for the interests of workers. These interventions meet with popular approval, and contra the positions of neoliberal economists, actual find support in economics and in the data.
Hal Singer is managing director at the consulting firm Econ One, and he teaches advanced pricing to MBA candidates at Georgetown’s McDonough School of Business.
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