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Picture of Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Formula for a crisis: good intentions and bad policy

The ongoing shortage of baby formula has many desperate parents asking how, in 21st century America, we could find ourselves in such a dire situation over something so elemental. The proximate cause is the precautionary February shutdown of a manufacturing plant following the deaths of 2 infants from bacterial infections. However, the lack of resilience to such an isolated disruption is in large part the result of policy errors and politics dating back over 30 years that have hindered the healthy functioning market forces.

Perhaps unsurprisingly, formula for infants is the most heavily regulated of any food item in the country, rivaling pharmaceutical products. This necessarily limits the number of firms with the size and scope to manufacture and distribute their products in the $4 billion US market. In addition, the FDA process for obtaining certification is costly, cumbersome, and bureaucratic, creating significant barriers to entry. As a result, a small number of players dominate the domestic market: four firms control 80% of US formula sales and the largest, Abbott Laboratories, owns nearly half of the market. But regulation is only one of factor in explaining industry concentration.

Fully half of all the formula sold in the US is purchased by the US Department of Agriculture and distributed through the Special Supplemental Nutrition Program for Women, Infants, and Children, commonly known as WIC. Only 3 manufacturers are authorized suppliers to WIC, and each state individually contracts exclusively with one of the manufacturers for its entire supply. This means the Federal program confers monopoly power on a manufacturer within each state, sharply limiting competition. In addition, the WIC monopoly has been shown to carry over in greater market share of the non-subsidized half of the market, as supermarkets tend to allocate precious shelf space to the dominant supplier.

The potential for a supply squeeze resulting from the narrow market is hardly a surprise. The USDA’s own Economic Research Service highlighted the risks of this hyper-concentration due to government-created oligopoly in a research paper in 2011.

It is also no accident most of the food assistance programs like WIC and the SNAP (food stamps) programs fall under the aegis of the USDA, whose primary mission is to promote the interests of American farmers. Milk and soybeans are the principal ingredients in baby formula.

In addition to protecting major producers from domestic competition, Government trade policy has effectively barred foreign competition as well by erecting regulatory and tariff barriers.

The European Union is the world’s largest producer of baby formula, and it is objectively true that the quality of EU products is generally equal to or superior to US brands and that they are subject to more stringent regulatory oversight. Yet due to complex and often insurmountable obstacles including labeling, application, inspection, and a host of other protectionist hurdles, European formula has effectively been excluded from the US market. Only 2% of all US sales in 2021 were imported.

As if to add insult to injury, the United States insisted that crippling import restrictions be imposed on Canada as part of President Trump’s rework of NAFTA. The US-Mexico-Canada Agreement (USMCA), which came into effect in 2020, imposed punitive tariff rates of up to 17.5% as well as export quotas on Canadian infant formula, even though Canadian plants generally meet all US FDA standards. The President reportedly viewed this as a way to punish China, which had announced plans to invest in a Canadian factory producing infant formula for export to Chinese consumers. In the end, like most trade barriers, the penalties ended up harming to American families in the form of higher costs and now critical supply shortages. President Biden has been slow to reverse many of these hurtful trade barriers.

The pandemic provided the final climatic elements necessary to create the perfect storm. As with toilet paper and hand sanitizer, beleaguered consumers hoarded baby formula throughout 2020. In 2021, as the pandemic waned, formula sales declined as parents worked off excess stockpiles, prompting producers to cut output accordingly. Meanwhile, during the early months of the pandemic, the US birth rate declined sharply, further crimping the demand for formula into 2021, only to see births spike above the 2019 level in the second half of the year. Add to this a marked decline in the percentage of mothers breastfeeding, and you have a recipe for the demand shock we are witnessing. Then, shutter a manufacturing plant that produces 20% of all US supply, and you have a bona fide crisis.

Congress and the President are taking steps to address the current shortages, including rationalizing import restrictions and staging military airlifts of acceptable substitutes from EU trading partners. The broader question is whether policymakers will learn from this textbook example of protectionist interference in market forces. History suggests we should not be too optimistic.

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