Responding to Reich, Part 9: The Corporate Concentration Theory of Inflation

The ninth myth in Robert Reich’s series on economic myths is titled “Wage Increases Cause Inflation.”

He opens the video as follows:

You hear this rubbish all the time: “Inflation is caused by too much government spending along with wage increases.” Bunk! Higher wages and government spending don’t push up consumer prices. In many cases mega-corporations raise prices to increase their profits. They can do this because they face such little competition.

He goes on to give some examples of high concentration in various industries:

Worried about sky-high airfares and lousy service? That’s largely because airlines have merged from 12 carriers in 1980 to only four today. Concerned about drug prices? Between 1995 and 2015, 60 leading pharmaceutical companies merged to only ten. Upset about food costs? Four large companies now control 85 percent of beef processing, 70 percent of the pork market, and 54 percent of poultry. Worried about grocery prices? Just three giants—Albertsons, Kroger, and Walmart—control 70 percent of the grocery sales in 167 cities.

Reich concludes by calling for stricter antitrust enforcement as a means of tackling inflation:

Monopolies can raise prices and keep them high because there’s not enough competition to charge lower prices and grab their consumers away.

…An important way to avoid inflation would be to fight it at the source: break up monopolies using antitrust laws so that a handful of private companies can’t artificially raise prices.

Reich’s reasoning may sound compelling, but there are a number of problems with his argument.

Three Theories of Inflation

Reich begins by raising and immediately dismissing two common explanations for inflation: wage increases and government spending. It would have been nice if he had actually explained what these theories say and where he thinks they go wrong. But instead, he effectively says, “They’re wrong because this other theory (concentration) is right.”

Even if he’s correct about corporate concentration being an important factor behind inflation, that’s not much of a rebuttal.

Briefly, then, the wage-increase theory says that when wages go up—perhaps because of union pressure—employers respond by passing the higher costs on to consumers in the form of higher prices. Thus, wage increases result in price inflation.

As it happens, Reich is correct to call this particular explanation a myth. In fact, free market proponents have been calling out this myth for decades. Here is Ludwig von Mises, for example, writing in 1958:

Some people assert that wage raises are “inflationary.” But they are not in themselves inflationary. Nothing is inflationary except inflation, i.e., an increase in the quantity of money in circulation and credit subject to check (checkbook money).

The reason this explanation is fallacious is that it assumes employers can simply “pass on” higher costs to consumers. But as sound economics reveals, that’s just not true.

This point has been echoed by Hans Sennholz, Leonard Read, Dwight Lee, John Phelan, Henry Hazlitt, Henry Hazlitt again, and Milton Friedman, among others. So the free market camp is clearly guilt-free on this question.

The government-spending theory of inflation, which we would argue is the correct theory, says that government spending—specifically deficit spending—leads to an increase in the money supply, and an increase in the money supply causes prices to rise.

Since Reich seems so confident that this explanation for inflation is a myth, it should take him little effort to demonstrate where it goes wrong. But since he offers no real rebuttal, there’s not much more to say on this point.

What Reich does offer is an alternative theory of inflation. However, there are many reasons to doubt his explanation.

Problems with the Concentration Theory

Reich contends that inflation can largely be explained by increasing market concentration in various industries. Since there is less competition, he reasons, greedy corporations can get away with price hikes, leaving consumers with no choice but to pay more.

Similar to the position raised in Part 8, this idea is nothing new. This one dates back to at least the ’70s, and—again as with Part 8—free market proponents were pushing back on it soon after it came on the scene.

The first and most important issue with the concentration theory is that inflation is a general phenomenon. Even if higher concentration explains price increases in certain industries, that hardly explains why prices are rising across the board. Economists Brian Albrecht and Alexander Salter stressed this point in a 2022 article for The Hill:

Inflation is a general economic phenomenon. It affects all markets at once. To explain rising inflation, then, you need to find a change in the basic economic environment. Antitrust, in contrast, deals with business conduct in a particular market.

…Collusion, when it happens, does drive up prices… But that doesn’t explain the broad inflation of the entire market. For collusion to be the cause, it would require collusion in nearly every sector of the economy.

Another issue with Reich’s theory is that market concentration is a poor proxy for competitiveness. Albrecht makes this point in a different piece about the concentration theory. “As I’ve stressed many times in my research and the newsletter,” he writes, “the number of competitors does not tell us much (anything?) about the level of competition in a market. Remember that standard Bertrand competition has two competitors and is still perfectly competitive; price equals marginal cost.”

Imagine I set up a lemonade stand and charge $2.00 for a cup that cost me $0.50 to make. You set up a stand next to me and charge $1.90 for the same cup, undercutting me. A price war ensues until we’re both charging close to $0.50 a cup.

Real-world competition clearly has important differences from this model. But the basic insight that it sometimes only takes one other seller to make a market vigorously competitive is fairly applicable to real-world markets.

Reich complains that “three giants—Albertsons, Kroger, and Walmart—control 70 percent of the grocery sales in 167 cities.” This may be true, but does that mean competition in the grocery industry is lacking? Their profit margins—1.25%, 1.85%, and 2.92%, respectively—suggest that these three are battling it out quite ruthlessly.

A Better Way to Increase Competition

A further issue with Reich’s approach is that it overlooks the fact that in many cases it is the government itself that is restraining competition. If Reich is so enthusiastic about vigorous competition, why is his first instinct to reach for antitrust laws and not to advocate for repealing the thousands of laws and regulations that are making it difficult for small players to compete?

It’s just like Mises said, “As a remedy for the undesirable effects of interventionism they ask for still more interventionism.”

Reich’s complaint about the meat processing industry is a good example here. He bemoans the fact that “Four large companies now control 85 percent of beef processing, 70 percent of the pork market, and 54 percent of poultry.” But a little digging reveals that there are significant government-imposed barriers to entry in this sector. Consider the testimony of rancher Paul Schwennesen:

Overregulation of food processing has done more to hurt ranching families than they even know. The reason for this is that heavy regulation makes it extremely difficult to enter the slaughter and processing sector since the risks are high and the regulatory hurdles immense. It’s easier to build a centralized feedlot/packing house if you are a Cargill with huge capital reserves and an army of technicians than it is to build a USDA certified mom-and-pop packing facility. The reason is simple: reams of paperwork, tests, constantly updated procedures, and risk create an almost insurmountable barrier to entry.

…As both a cow-calf producer and owner of a tiny packinghouse myself, I can attest to the forbidding array of regulatory restrictions that hamper creativity and production.

…Government’s genuine concern over safe food has created a megalithic bureaucracy that aims to eliminate all food-borne risk, even if it comes at the cost of local, small-scale food production.

As Hayek notes in his essay “The Meaning of Competition,” overt government suppression of competition is likely a far bigger problem than the “imperfections” that antitrust proponents care about. “What our theoretical models of separate industries conceal is that in practice a much bigger gulf divides competition from no competition than perfect from imperfect competition,” he writes. “Yet the current tendency in discussion is to be intolerant about the imperfections and to be silent about the prevention of competition.”

Why is there not more competition in the meat processing industry? Because such competition has been practically outlawed. In such a regulatory regime, it’s almost laughable to call for antitrust action, as if this is somehow the free market’s fault. Here’s a radical idea: how about we try removing the blatantly anti-competitive laws first and see if that does the trick?

Courtesy of FEE.org

*********