Category: markets

Who Earns the Food Dollar?

Part 2 on the Farmers’ Share of the Food Dollar (see Part 1 here).

The ag value chain involves a wide array of participants to get food products from ground to grocery store–or increasingly, from research to restaurant. Every dollar spent on food has to be divided between all the different players. As the number of participants grows, and as more value is added at different stages of the value chain, the percentage of food dollar going to any one group is likely to decline.

This is why the farmers’ share of the food dollar has been on the decline for, well, pretty much the past century at least.

Sen. Elizabeth Warren and, more recently, Sen. Bernie Sanders have proposed aggressive antitrust enforcement of “Big Ag” companies—whether farm input companies like Bayer or early-stage processors like JBS or Tyson in the meat industry. The Senators claim that cracking down on these big companies will be beneficial for farmers and increasing farmers’ share of the food dollar. In my previous post, I explained why those arguments are wrong. In fact, those arguments are not even consistent with the data being used to justify the claims.

To really understand why farmers’ share of the food dollar has declined, one has to understand how—and where—value is created in the value chain. More specifically, one has to understand how value is added to the agricultural products that farmers produce. And how existing farm sector institutions work to make farmers’ share lower than it might otherwise be.

A recent (March 2019) McKinsey & Co. article titled “A Winning Growth Formula for Dairy” illustrates this value creation story. The article describes the challenge facing dairy company executives globally, and particularly in the U.S. Dairy farmers have been struggling with low raw milk prices resulting from continued over-production of milk relative to demand for dairy products. You would think large dairy companies would be bathing in profits with the cost of their primary input depressed—even below the cost of production, according to some farmer groups. And yet, return on invested capital in the dairy industry (ROIC; i.e., the economic value generated by their businesses) has been declining because growth in revenue and margins has not kept pace with an increasing cost of capital. The reason? Consumption of milk and dairy products in the U.S. has been on a long-term decline.

The authors go on to explain that dairy executives are faced with the challenge of how to create new value opportunities in the face of more milk being produced than there are uses for currently. New product development. New market development. These are expensive investments with uncertain outcomes. But that is where the value is being created for raw milk—not at the farm gate. In fact, one might argue that the value being created by dairy processors is in spite of having to overcome the value decreasing activities of dairy farms that, collectively, are overproducing.

This problem is not unique to the dairy industry. Whether corn, meat proteins, wheat, or any number of other agricultural commodities, agricultural producers are increasingly reliant on processors and refiners to transform producers’ crops into products consumers are willing (or required) to buy, and in a form consumers desire. It is not at all surprising, therefore, that more and more of the food dollar is being captured by firms beyond the farm gate. That’s where value is being added. That’s where more of the food dollar is being earned.

An Open Letter to President Trump

Eighty-eight years ago on the third of May, 1,028 economists signed an open letter to Congress to oppose the Smoot-Hawley Tariff Act, explaining that protectionist tariffs are harmful to the U.S. economy. On May 3, 2018, over 1,100 economists (including yours truly) signed an open letter to President Trump and Congress expressing concern about the President’s threatened (and enacted) trade tariffs–using substantially the exact same letter that was sent 88 years before. That is because–and to illustrate that–the basic economic principles have not changed. Protectionist tariffs harm consumers, harm a large majority of producers, and harm the economy overall .

The letter has been covered by a variety of news sites, including:

The Smoot-Hawley Act is generally viewed as having contributed to the severity of the Great Depression, despite Congress’s (misguided) intent. While the modern economic environment is not necessarily in as fragile a state as it may have been in 1930, and the extent of the implications may not be as severe, the current administration’s threats of trade restrictions nonetheless risk a dampening of economic activity and reduced social well-being.

This is the kind of thing that happens when people don’t pay attention to history.

Or even pop culture…

The Labeling Problem, Part 2

In The Labeling Problem, I explained how the presence of a label, whether on a college course or a food item, does more than just identify the product. It actually can influence consumers’ perceptions about the attribute the label identifies. As a result, it can also influence consumers’ perceptions of similar products that don’t have the label.

Consequently, labels have the potential not just to inform consumers, but to misinform them; particularly when the label is for an attribute that consumers do not fully understand. For instance, with genetically modified (GM), or genetically engineered (GE), food products.

There is another dimension of the labeling issue that I promised to return to: what makes economic sense? Remember the Three Simple Rules? What makes economic sense comes down to this: What’s the marginal benefit of providing the additional information? What’s the marginal cost of providing that information? And because we’re talking about a diverse set of consumers with different interests, that leads to the question of “who should pay for it?”

So What’s the Marginal Benefit?

Information is economically valuable only if it will change the outcome of a decision. Consequently, a GM label would create personal (or private) benefit only if the label would change the consumer’s decision to purchase the product. A Pew Foundation study found only 1-in-6 people (16%) “care a great deal about the issue of GM foods.” Another 37% “care some.” But do they care enough that it would make them willing to change their behavior even if it cost them additional money to buy the GMO-free product? Some scholars have attempted to estimate consumers’ willingness-to-pay (WTP) for GMO-free products as a measure of the value of labels (for instance, see here and here). The results tend to show individual consumers, on average, are willing to pay at least a little more for GMO-free products, whether the label denotes the presence–or the absence–of GMOs. Of course, this is also based on the fact that a large percentage of consumers lack knowledge about what GMOs are.

From a public policy perspective, the label only has value if it would lead consumers to make decisions that improve public well-being. The consensus of the scientific community is that there is no substantive nutritional, quality. or health safety difference between food containing GM ingredients and GMO-free foods (see here, here, and here). That suggests that there is no real public benefit to having the information provided.

What’s the Marginal Cost?

A wide range of numbers have been thrown around about the potential cost of mandatory labeling. At the low end, the Consumers Union (a pro-labeling group) commissioned a study that found the cost would be only $2.30 per person (or about $740 million) per year. That estimate is based primarily on the costs of labeling itself. It does not include costs of regulatory enforcement or increased costs in sourcing inputs, keeping the inputs segregated to prevent contamination by GM inputs, and product reformulation. Other studies (funded by anti-labeling groups) have suggested costs on the order of $450 per household (or about $56.7 billion) per year. In addition to including a more systemic view of the costs, these studies also make assumptions about manufacturers shifting more of their products to being GMO-free to avoid the negative stigma of having a “contains GMOS” label.

So while the predicted cost is wide-ranging, one thing is clear: The costs are bigger than zero.

Sound economic decision making (and therefore sound policy) requires the marginal benefits of any action to be at least as big as the marginal costs of the action. From a public perspective, the benefits are arguably zero, while the costs are greater than zero. That suggests a regulation requiring labels would not make economic sense.

Does that mean there should be no labels? Not at all. It simply means it doesn’t make sense to have a law that forces all consumers (many of whom are not concerned about GMOs anyhow) to pay for a regulation that has little or no public benefit in the first place.

But the fact that there are potential private benefits to labeling suggest that voluntary labeling may be desirable. Clearly, the value of labeling information to some consumers is greater than zero. And some of those consumers would both pay for that information and change their consumption decision based on it. Manufacturers who believe they can deliver that value at a low enough cost to make a profit on it have every incentive to make that happen. And in fact, that’s exactly the situation we have now in the US with voluntary “GMO-Free” and/or “Organic” labeling.

One might still object that these voluntary labels may create a negative stigma about non-labeled products. And that’s a fair point. But that also means that industry has an incentive to more proactively educate consumers about the science behind GM-foods, so they won’t be fooled into paying more for something that may not provide the benefits they think.

Cass Sunstein, a Harvard law professor, summarizes the whole point fairly well in the abstract of a recent paper:

Many people favor labeling GM food on the ground that it poses serious risks to human health and the environment, but with certain qualifications, the prevailing scientific judgment is that it does no such thing. In the face of that judgment, some people respond that even in the absence of evidence of harm, people have “a right to know” about the contents of what they are eating. But there is a serious problem with this response: there is a good argument that the benefits of such labels would be lower than the costs.

Consumers would obtain no health benefits from which labels. To the extent that they would be willing to pay for them, the reason (for many though not all) is likely to be erroneous beliefs, which are not a sufficient justification for mandatory labels. Moreover, GMO labels might well lead people to think that the relevant foods are harmful and thus affirmatively mislead them.

 

 

 

Legalized Price-Fixing in Public Construction?

Imagine you wanted to have your house painted, remodeled, or even have a new house built, but all the contractors had agreed to charge the same prices. What if your local government passed a law requiring you to pay the same price no matter which contractor you chose? Sound like a good idea?

For over 100 years, US antitrust law has prohibited sellers from conspiring to fix prices. According to the US Federal Trade Commission’s “Guide to Antitrust Laws” price fixing is defined as:

“…an agreement (written, verbal, or inferred from conduct) among competitors that raises, lowers, or stabilizes prices or competitive terms. Generally, the antitrust laws require that each company establish prices and other terms on its own, without agreeing with a competitor. When consumers make choices about what products and services to buy, they expect that the price has been determined freely on the basis of supply and demand, not by an agreement among competitors. When competitors agree to restrict competition, the result is often higher prices. Accordingly, price fixing is a major concern of government antitrust enforcement.”

Compare that first line to the following language:

“…a wage of no less than the … wages for work of a similar character in the locality in which the work is performed shall be paid to all workmen employed…”

One might think that sounds like an agreement to “stabilize prices or competitive terms” for labor services. But in fact, it’s an excerpt from Missouri Revised Statutes Section 290.220, otherwise known as the Prevailing Wage Law, which reads:

“It is hereby declared to be the policy of the state of Missouri that a wage of no less than the prevailing hourly rate of wages for work of a similar character in the locality in which the work is performed shall be paid to all workmen employed by or on behalf of any public body engaged in public works exclusive of maintenance work.”

The effect of the prevailing wage law is to require all public construction projects, from State to local school districts, from new building construction to repainting existing buildings, to pay workers a wage determined by the Missouri Department of Labor as being the ‘prevailing wage’ for the specific type of work in that local area. From a practical perspective, the prevailing wage law amounts to little more than a legalized form of price fixing, facilitated by the State.

Proponents of the law–particularly labor unions and contractors that hire union workers–argue the law helps ensure higher quality work because it eliminates contractors’ incentive to hire lower skilled labor. Critics argue that the law does nothing but protect union interests by eliminating competition in the labor market, and increases the cost to tax payers of all public construction projects. (Some critics would add that the law infringes on individuals’ freedom to contract).

Empirical research on the effect of prevailing wage laws is mixed. Some researchers find that prevailing wage laws increase the cost of public works projects by anywhere from 9 to 30%. Other researchers have found that even though the cost of public projects is significantly higher in prevailing wage states, those differences are negligible when other factors are controlled for.

However, what does not seem to get much attention in the empirical literature is how the prevailing wage is determined, and how that process itself may affect the cost of construction projects in both the private and public sectors due to the incentives the process creates.

At least in Missouri, the Annual Wage Order is based on wage information voluntarily reported by contractors. Contractors are “heavily encouraged” to submit wage reports for any commercial construction projects. Only contractors that participate in public contract bidding have incentive to submit wage reports since they are the only ones with an interest in the established wage. This incentive to report may inflate the prevailing wage calculation because companies that specialize in private commercial construction may pay lower wages in attempt to be more competitive.

Because accepting a public contract would require paying (higher) “prevailing wages”, contractors whose business is primarily private commercial construction may have even less incentive to participate in public project bidding. Contractors may find it difficult to pay their workers more for some projects than for others. Accepting public contracts may put the contractor in a position of being less competitive in the private construction market, since it would not be able to lower wages for those projects. The end result? Only higher wage contractors participate in public bidding and report their wages to the Department of Labor, further skewing the “prevailing wage”.

To the extent contractors participate in both public and private construction projects and do manage to pay different wage rates, contractors still can be selective in which wages they report to the Department of Labor. Contractors can submit wages for their public contracts and their more generous private commercial contracts and withhold information about any lower-wage contracts.

This endogenous wage-setting problem is even more likely in the case of construction projects that are uniquely public in nature. Almost all road construction in the US is done by public entities. Companies that specialize in road construction are the only firms submitting wage reports that determine the prevailing wage for road construction work. As a result, there is absolutely no competitive check on the potential escalation of wages for such projects.

There are some testable hypotheses implied by the arguments above. One would be the degree of specialization in public versus private construction projects by contractors. Another would involve the trend or serial correlation of prevailing wages for construction projects that are uniquely public in nature versus construction projects that have a mix of public and private buyers. And if one were able to get the data, a third would be to test whether the types of projects for which wages are reported to the Department of Labor are systematically biased in a way that would result in biased estimates of the ‘prevailing wage’.

Private firms that engage in price fixing, even by tacit collusion (that is, by informally following one another’s lead) are subject to fairly strict antitrust prohibitions. State prevailing wage laws, especially ones that are based on selective, voluntary reporting, amount to little more than a legalized form of State-sponsored price fixing. It’s worth thinking about why price fixing should be illegal when individuals pay for things themselves, but not when politicians and bureaucrats use taxpayers’ money to buy things for them.

A(n Ethanol) Subsidy By Any Other Name?

’Tis but thy name that is my enemy; Thou art thyself though, not a Montague.
What’s Montague? it is nor hand, nor foot, nor arm, nor face, nor any other part
Belonging to a man. O! be some other name: What’s in a name? that which we call a rose
By any other name would smell as sweet; So Romeo would, were he not Romeo call’d,
Retain that dear perfection which he owes without that title.
~ Juliet, “Romeo & Juliet,” Act II, Scene II
William Shakespeare

It seems ethanol interests have a similar attitude toward the word “subsidy” as did Juliet toward Romeo.

Growth Energy, a biofuels lobbying organization, is currently holding its 2018 Executive Leadership Conference. The opening panel was titled “Up The Road: Does Ag Need Biofuels.” Not too surprisingly, the overwhelming conclusion was “Yes!”, as reported by the Iowa Renewable Fuels Association (RFA). And it’s true that biofuels are important for the corn and soy belt. According to the USDA’s Economic Research Service, 37% of corn (see Table 5) and 27% of soybeans (see Table 6) were used to make ethanol and biodiesel, respectively, in the 2016/17 marketing year. Of course, that use of biofuels is almost entirely the result of artificial demand created by government regulations that mandate use of ethanol, in particular, and biofuels more generally, in automobile fuel supplies. So when leaders in the ag industry affirm the importance of biofuels to the ag sector, they are essentially confessing the industry is dependent on an implicit subsidy in the form of consumer mandates.

That was the point I made in retweeting Iowa RFA’s tweet above.
By declaring a dependence on government mandates, these leaders in agriculture are effectively saying they cannot thrive in a competitive market and need government assistance. And these regulations do have the effect of thwarting innovation to the detriment of all fuel consumers. The rationale for incorporating ethanol in gasoline is to serve as an oxygenate to help the fuel burn cleaner, thereby reducing engine emissions. The Clean Air Act requires oxygenates be added to fuel to reduce air pollution. The Energy Policy Act of 2005 (Title XV) introduced the Renewable Fuels Standard that specifically mandates ethanol as the oxygenate that must be used, thereby discouraging research and development of alternate, potentially more cost efficient or environmentally beneficial, oxygenates.

The Iowa RFA was quick to reply, pointing out that biofuels “do not currently receive federal tax subsidies.” And that’s technically true–but it’s also disingenuous. As Juliet might say, a subsidy by any other name (like a renewable fuel standard) is no less a subsidy. It’s just a different channel of subsidy than direct tax dollar payments. But judging by the responses from other beneficiaries, it seems an important distinction. Kind of like a Capulet’s attitude about a Montague.

Some may think of subsidies as involving a direct payment to producers–like direct income payments to farmers or cost underwriting for crop insurance. But subsidies can also take the form of artificially inflating demand to increase the price and quantity demanded of the subsidized good. This is the tool the US government used to subsidize farms prior to the late 1980s; implementing commodity price supports by buying up the excess supply. It’s the same basic tool that is currently used to subsidize the electric car industry (via tax credits to car buyers; you’re welcome, Elon Musk). And, until the recent tax reform bill, it was one of the ways to help subsidize health insurance companies by mandating that individuals–particularly healthy individuals who are less costly to insure–purchase health insurance. In each case, the government subsidizes producers either directly, by giving them payments to cover costs, or indirectly, by bolstering demand (or in the case of health insurance, both).

It’s difficult when the things we love carry names, labels, or associations that are more convenient to ignore or deny than to embrace. It helps to call them something else, whether to deceive others or ourselves. But when it comes to consumer mandates, like the Renewable Fuels Standard, a subsidy by any other name is still a subsidy.

 

Shifting the (Online) Sales Tax Burden

Recently a friend (and former student) Tweeted about the politics of regulation (see the Tweet below). Today, the city (and county) where I live is voting on a new “use tax” that would be applied to all “purchases made from out-of-state vendors”. Ostensibly, this is to offset lost sales tax revenue due to online shopping–the bugaboo of many local retailers and governments.

This morning I lectured on the relationship of demand elasticity to the question of who pays for a sales tax. As illustrated in the simple example below, both the consumer and the seller pay portions of the sales tax–provided neither Demand nor Supply are perfectly elastic (flat) or inelastic (vertical). When the supply curve shifts up due to the tax, it reduces how many units consumers buy (Q1 vs Q). Consumer pay more than they would have without the tax (P1 vs P), and sellers receive a lower price (net of the tax) than they would have without the tax (Ps vs P). So both sides bear some of the burden of the sales tax. The question is, which side pays more? It’s a pretty simple exercise to show that the “steeper” curve pays the bigger share just by redrawing the picture with lines of different relative steepness. Try it for yourself using this simple graph as an example.

The steepness of the curve reflects the sensitivity of consumers (on the Demand side) and sellers (on the Supply side) to changes in price. The more sensitive either side is, the more their quantity decision will change when price changes. More sensitivity means ‘flatter’ lines. Less sensitivity means ‘steeper’ lines.

Consider demand for something that’s very important to the consumer, like insulin. Even if the price goes up, insulin-dependent consumers will not reduce their consumption of insulin very much at all–unless the price really goes up a lot. In that case, the Demand line would be very steep.

What affects the steepness of Demand? Lots of things, but one of the biggest is the availability of other goods that provide the same (or very similar) benefits to the consumer. For instance, if you need insulin, you don’t have many alternatives. Orange juice, on the other hand, has several. If the price of orange juice goes up much, I might choose another juice, milk, or just plain water.

What else has substitutes? Stuff sold in local stores that can also be bought online. If I’m willing to wait two days, a large percentage of the things I might buy locally can be delivered right to my doorstep without me having to leave my house. If the price of buying things online is lower than the price of things sold locally, buying online is a really good substitute–if I can exercise a little patience. And if the local sales tax does not apply to my online purchases, that gives online sellers an automatic price advantage over local sellers–as much as 4.5% where I live (and that doesn’t count State sales tax).

So, what does that have to do with who pays the sales tax or Per’s tweet above?

First, demand for local purchases is more price-sensitive because the price of substitute items (from online sellers) is lower. If we impose (and actually enforce) a use tax on online sales, that will make consumers a little less price sensitive in their demand for local stuff, i.e., their Demands for local goods will get steeper. That means the relative tax burden will shift from local sellers to consumers. And this is even before the retailer’s ability to increase prices (or to not lower them as much to compete with online sellers). Little wonder local retailers are more than happy to “level the playing field” with online sellers by imposing the tax. They get to increase prices and pay less of the sales tax themselves; a win-win.

Second, the process giving rise to this proposed tax follows exactly the process Per outlines:

  1. Government imposes a regulation (a sales tax) that makes local retailers less competitive in the market place. There are other forms of taxing municipalities can and do use. Ours chooses to use a sales tax (for lots of things).
  2. Higher sales taxes encourage more people to buy online to avoid the sales tax, which not only reduces local sales, but local government tax revenue. Two problems for the price of one!
  3. Blame “The Market” for the loss of sales and tax revenue. Our City Manager even suggested it is immoral for people to live in the City and use City services while buying stuff online.
  4. Demand new regulations (i.e., the use tax) to “fix” the problem created in Step 1.

So here we are on election day in Boone County, Missouri. The voters that bother to show up will get to decide: who should pay more of the tax burden? Consumers or retailers?

Epilogue
Record low voter turn out (suggesting few people cared–if they were even aware of the special election) and the proposed use taxes failed 49.2-50.8 and 45.3-54.7 in the city and county, respectively. Not surprisingly, those residents for whom brick-and-mortar shopping is even less convenient voted even more to keep the price of the substitute lower.

 

Calling a Cost a Cost: NY Anti-Free Speech Edition

Seems the State of New York is going to the Supreme Court for another of its protectionist regulatory policies. Yesterday the US Supreme Court granted a petition to hear the case of Expressions Hair Design v. Schneiderman. As the WSJ explains, at issue is whether New York’s regulations concerning credit-versus-cash retail prices constitute a First Amendment speech violation.

The problem stems from the fact that the State of New York has attempted to have its cake and eat it to by ignoring economic rcredit-card-1520400_1280ealism and prohibiting retailers from calling a cost a cost. The State prohibits retailers from charging customers a fee for using a credit card, but allows retailers to give customers a discount if they use cash. A group of hair salons, led by Expressions Hair Design, sued the state for infringing on its right of free commercial speech. The salons won their initial case, which was reversed on appeal. Now SCOTUS will have an opportunity to weigh in.

The Cost of Using Credit
From an economic perspective, the issue is fairly simple. Credit card companies charge vendors a fee every time a consumer pays with plastic. How much depends on the credit card company, whether the transaction is run as debit or credit, and the amount of the transaction. But typically, the fee is around 2-4% of the amount of the purchase. This reduces the amount of revenue retailers receive when the customer uses plastic. Put another way, when customers choose to use plastic, it raises the retailer’s cost of doing business for that sale.

In a free economy, retailers could choose one of three options: 1) force the credit card user to pay the additional transaction fee, which raises the price at the point of sale, 2) charge the same price for all buyers, implicitly charging cash users more for the product to subsidize the costs of the plastic users, or 3) pass the transaction fee savings on to cash users by giving them a discount. The only economic difference between 1 and 3 is what the sticker price is relative to the price actually paid. In #1, credit card users pay more than the sticker price; in #3, cash users pay less than the sticker price. In #1, the credit card fee is made explicit by adding it on just for those consumers who use plastic. In #3, the sticker price includes (i.e., hides) the cost of using a credit card and by default is the price everyone pays unless they are aware of the cash discount. In either case (1 or 3), the retailer is price discriminating between cash and plastic users. Or the retailer could simply post two sets of prices, one for credit and one for cash, which would then beg the question of “why the difference?” And that is where the NY regulations become a problem.

The NY regulation prohibits retailers from choosing #1 but allows them to choose #3. In other words, the regulation allows retailers to price discriminate, but only if they present it as a discount for cash users rather than a surcharge for credit card users. In short, NY allows the exact same price discrimination between two sets of consumers, but restricts the speech of retailers in how they are allowed to describe that price difference. As Expressions Hair Design argues in their complaint, this places a burden on the business in how it is allowed to explain or justify what is otherwise a perfectly legal two-price pricing system since the regulations make it illegal for employees to explain that the difference between the cash price and the credit price is due to the cost of the credit transaction. It would be like passing a law prohibiting a restaurant from explaining the cost of its steaks went up relative to its pork chops because the price of beef rose.

Framing matters
Why would the State of New York prohibit credit card surcharges but not prohibit cash discounts? Consumers respond to price signals, so how those signals are presented matters. If consumers are charged an extra fee for using their credit card, it makes the cost (price) of using the credit card very obvious to the consumer and she is more likely to change her behavior by using cash instead. This would be bad for the banks that make a significant amount of money on credit card swipe fees. Not surprisingly, banks support laws prohibiting explicit credit card surcharges. However, as noted in #2 above, charging cash and plastic users the same forces cash users to subsidize the purchases of plastic users, which also tends to penalize lower income persons relative to wealthier shoppers. So allowing retailers the opportunity to provide cash discounts is socially superior to not allowing differential pricing. However, the NY’s prohibition on calling a cost a cost and explaining the price difference for what it is, is not only an infringement on speech, but unjustifiable as anything other than an attempt to mislead consumers and protect credit card issuers.