Monopoly and protectionism: a formula for hungry babies

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Adam Smith's "Wealth of Nations" in 1776 argued famously that market forces lead to competitive outcomes and lower prices — if governments can resist the temptation to connive with business to protect monopolies from foreign competition.

The baby formula shortage debacle is a perfect illustration of what Smith meant.

In a desperate move to placate panicked parents having trouble finding formula for their infants, the Biden administration this week invoked Korean War era legislation, the Defense Production Act, to allow additional supplies of formula to get to market.

What exactly is the problem? Two words sum it up: monopoly and protectionism.

Just four companies currently control 90% of the U.S. infant formula market, reflecting the stranglehold of the pharmaceutical industry of which they are a part. Just as domestic monopoly in the insulin market has allowed Big Pharma to play God with diabetic lives, hungry babies are another market with "inelastic demand" — meaning that parents will pay almost any price to keep their young ones fed.

In a less than ringing call for more oversight of this price-gouging monopoly power, Robert Califf, Food and Drug Administration (FDA) head, said May 16 that more "diversity in supply … will be much discussed and needs to be considered in light of the levers that we have to make that happen."

Government enters the picture because the U.S. Department of Agriculture benefits from single sourcing of baby formula from the same monopolies, guaranteeing contracts to these sellers for the Women, Infants and Children (WIC) Program.

WIC buys over half of all formula sold in the U.S. This means that on the buy side of the market, the USDA operates as a "monopsonist." Private baby formula buyers are caught between monopoly on the sellers side and monopsony on the buyers side, a form of "bilateral monopoly."

In technical terms, they are caught between a rock and a hard place.

The second element Uncle Adam would recognize is the tight relationship between lobbyists for the monopoly baby formula industry and officials in government. Congress and the White House are jointly responsible for setting U.S. tariffs and other forms of protection against foreign manufacturers of infant formula, such as Canada and the European Union.

As a result, 98% of U.S. baby formula is sold by these domestic monopolies. U.S. trade restrictions dating to the Trump administration, reinforced by "just-in-time" inventory management practices, have further squeezed the supply to keep monopoly profits as high as possible.

These tariffs were put in place by Trump at a level of 17.5% to protect U.S. dairy interests from Canadian and other imports of infant formula.

Just to clarify that protectionism is bipartisan, Trump's tariffs were put in place at the behest of Democrat Tom Vilsack, former Iowa governor who was then head of the U.S. Export Dairy Council and is now Joe Biden's agriculture secretary, a post he also held in the Obama administration.

According to the trade publication American Shipper, additional non-tariff barriers, such as a 90-day waiting period for shippers to distribute baby formula in the U.S., also act to limit foreign imports. FDA labeling requirements further restrict these imports, so that European Union formula cannot enter U.S. markets except for personal use.

In short, a panoply of protective tariffs, quotas, non-tariff barriers and labeling requirements have the U.S. market locked up for the monopolists as tight as a tick. Adam Smith would agree that these monopolists, like ticks, are bloodsuckers, feeding on the body politic.

When supply bottlenecks are added to this formula, the situation gets worse, as it has in recent months. Willy Shih, a logistics expert at the Harvard Business School, observes in The Hill that just-in-time inventory management is all about making money, but leaves the system extremely vulnerable to unforeseen interruptions. Yet he notes that for products that impinge importantly on human health, like baby food or insulin, more than profit is at stake. Recalling a visit to the Novo Nordisk factory in Denmark, where half the world's insulin is produced, Shih noted that the company sees it as its responsibility "never to run short since lives depended on insulin." As a result, they keep a five-year supply at their own expense in inventory, just in case.

Here at home, the Biden administration has been forced to further underwrite the cost of supplying baby formula, at taxpayer expense, by using Defense Department contracts with commercial airlines to transport European formula to the U.S. after waiving most of the protectionist barriers already in force. Operation Fly Formula, as it is known, only underscores the absurdity resulting from these protectionist policies.

It is currently fashionable to deride economics and economists for a failure to account sufficiently for equity. In the case of infant formula, Smith's classical economics teaches clearly that monopoly and protectionism, aided and abetted by government for hire, sacrifice consumers and taxpayers in egregious ways. What could be more inequitable than that?

Carlisle Ford Runge is Distinguished McKnight University Professor of Applied Economic and Law, University of Minnesota.