The real story behind inflation: Monopoly in supply chains
NEIL TRACEY: As prices continue to rise, there is no bigger domestic issue than inflation. Last month, inflation soared to 7.5% – the highest it has been since 1982. Rising inflation rates is not an abstract economic concept but a real problem that makes it harder for the poorest members of our society to buy food, clothing, and other essential products they need. Despite the dire consequences of inflation, many people do not understand why inflation is happening in the first place. The answer that Democrats, including the White House, have pushed is that inflation is caused by supply chain complications resulting from COVID-19. While it is true that supply-chain issues have helped contribute to inflation, what has made our supply chain system so weak?
The answer to this question lies in massive consolidation that has happened in the past 40 years among industries in the supply chain. This consolidation has virtually eliminated all competition in several key industries, including railways and freighter shipping (both of which we will explore). As a result of this loss of competition, there is little incentive for companies to invest in infrastructure within their industries, treat their employees well, or innovate. The result has been that our supply chain was already especially vulnerable to the shock of COVID-19. Any discussion of inflation, and particularly the role of supply chains for inflation, must be understood within this context.
In order to tackle this somewhat thorny issue, we will highlight two essential components of the global supply chain: freighter shipping and railways.
The International Freighter Shipping Cartel:
The first thing to understand about the freighter shipping industry is that it is massive. It was valued at over 8.9 billion USD in 2019 and it is expected to reach 12 billion dollars by 2027. Moreover, there are not many good alternatives to shipping. When moving products in bulk, it is simply more costly to use a plane than a boat. As such, around 95% of all cargo that is shipping internationally relies on freighters.
To understand the modern international freighter system, we have to start with the concept of common carriership. Common carriership dates back to the 15th century in England and mandates that a given company has to give the same prices and services to all their customers. Common carriership is premised on the idea that some services are so essential that everyone deserves equal access to them. The Shipping Act of 1916 (which was the first formal law governing the freighter shipping industry) regulated shipping as a public utility and, most importantly, classified it as a common carrier. This common-carriership was enforced by mandating price transparency; every company using shipping services could see the rates their competitors were getting, and were naturally incentivized to report if anyone was getting a better deal.
Starting in the 1970s, policymakers began to systemically deregulate industries. This deregulation arrived for the shipping industry in 1998 with the passage of the Ocean Shipping Reform Act. This legislation got rid of common carriership and pricing transparency.
The 1998 deregulation led to massive consolidation in the freighter shipping industry. The increased consolidation in the industry is shown below (through the Herfindahl Index, which is a standard measure of industry concentration). The chart below shows how the freighter shipping industry is more concentrated today than ever before.
The increase in consolidation shown in this graph is likely understated. Today, the top 10 firms control 80% of all ocean freight. These 10 firms are organized into three “alliances,” or cartels, which dominate the industry. Making matters worse, it is reasonable to expect that individual firms have larger shares than their industry average at any particular port. For example, one ocean freighter company could be the sole servicer for a given port. Therefore, even if there are multiple freighter companies globally, consumers for that given port only have access to one company.
The effect of this concentration has been great for industry profits but harmful for virtually everyone else. For instance, in 2021 amid the pandemic, the industry posted some of its highest ever returns; Maersk, one of the largest carriers, had its highest profits in 117 years. At the same time, these companies have failed to invest in new ships. Without competition, there is no pressure for companies to invest in the infrastructure (in this case ships) that would otherwise be essential to maintain their competition edge. Instead, they have been running heavier and heavier loads on existing ships. This increases wait times at ports and, in this way, harms their clients. It is also likely part of the reason behind the recent Ever Given failure where an extremely overloaded ship blocked the Suez canal.
The Railway Cartel:
Turning our attention back home to our domestic supply chains, we see much the same story: rigid regulation in the early 1900s gave way to deregulation, and finally to consolidation. Indeed, the railways were one of the flash-points in the anti-monopoly progressive era of the early 1900s. The early railroads were regulated with the 1906 Hepburn Act and the 1910 Mann-Elkins Act which mandated that railroads serve as common carriers and gave the newly created Interstate Commerce Commission (the predecessor of the FTC) the power to regulate prices.
However, in the 1970s, regulators and academics became concerned about the long-term viability of the American Railroad Industry. The railroad industry faced increasing competition from trucking, airlines and other transportation industries, and suffered years of plummeting profits as a result. In an attempt to revitalize the railroad industry, Congress passed significant deregulations through the Staggers Act in 1980, which limited the authority of regulators over the railroads, eliminated common carriership and eliminated all price controls.
As we saw with the shipping industry, these deregulations led to the formation of massive monopolies within the railroad industry. Today, the US railroad industry is controlled by four companies; two “majors” west of Chicago and two “majors” east of Chicago. The impact of this concentration on shippers can not be understated. The following graphs show the distribution of grain shipping before and after the implementation of the Staggers Act.
This increased concentration for buyers has resulted in increased prices, decreased capital investment, and decreased service for buyers.
How does reduced competition lead to inflation?
Some may wonder why prices are only starting to rise more now if there has been increased concentration in key supply-chain markets since the 1970s. There are several possible explanations for this:
First, it is important to clarify that no one is asserting that there are no impacts from COVID-19 on supply chains. Rather, the impact of COVID-19 on supply chains is exacerbated by the lack of capital investment. In recent years, relieved from any significant competitive pressures, the freighter and railway industries have used their high profits to buy back stocks rather than investing in capital and infrastructure improvements. It should be no surprise that when a global pandemic stress-tested the global supply chain infrastructure, it failed.
Second, the real impacts of COVID-19 on the supply chain can serve as a cover for price gouging. Price increases are unlikely to be scrutinized by antitrust enforcers or consumer protection groups when there are price raises across the entire economy. This can be seen in industries like meat and ammunition which have seen a higher increase in prices. In these industries, increased prices are not attributable to supply chain increased costs, but to the higher corporate profit margins. Infact, profit margins, on the whole, are expanding, not shrinking. This is a clear indication that increased prices are not solely due to increased supply chain costs.
Lastly, COVID-19 has led to drastic increases in market concentration and power. The tumult of the pandemic led to a surge in mergers and acquisitions, meaning that there has been a significant increase in market concentration, exacerbating existing competition issues. In addition, the supply chain issues have meant that markets that previously faced steep competition from other countries and nations are increasingly regionally isolated, increasing market power in that market.
What can be done?
The good news is that the answer for how to combat anti-competitive conduct's role in inflation is simple: go after anticompetitive conduct. The Biden Administration has already made some important steps to go after the international shipping cartel, including an executive order that beefs up the Federal Maritime Commission (FMC). The FMC is formally charged with regulating the U.S. International Ocean Transport System and has the power to go after anticompetitive conduct in the industry. However, with a budget of roughly 30 million, the FMC does not have the resources to adequately do that job. The Biden executive order creates a partnership with the DOJ so that the joint agencies have the resources and industry expertise to go after the shipping cartel. Moreover, The Biden Administration has expressed support for the Ocean Shipping Reform Act, which has already passed the House with bipartisan support. This act would increase the FMC’s power to regulate prices and prevent ocean carriers from discriminating between different clients.
Additionally, there has recently been similar scrutiny of the railroad industry. The railroad industry is regulated through the Surface Transportation Board (STB), which has the power to make rules concerning competition in the industry. The STB has currently undertaken a slate of proposed rule changes that promise to increase competition in the industry. Notably, the STB has a pending hearing on a reciprocal switching rule which would allow clients only served by one railroad to be allowed to switch to another one at the nearest location they can.
Even with all this progress, there is still a long way to go to fight transportation monopolies. The first, and most important step is to change the public discourse. Unfortunately, there is immense pushback to the fact that corporate monopolies are at the heart of inflation. In an op-ed, the Washington Post, informed by economist Larry Summers, had this to say about the Biden administration’s recent claim that inflation is connected to monopoly:
“Inflation, which was relatively low for years, did not suddenly rise in recent months because businesses decided now was the ideal time to squeeze their customers.”
The dismissive reaction of the economics field to the claim that anti-competitive markets play a significant role in inflation is due to the way that economics is usually structured and taught. In a recent interview, Matt Stoller explained that conventional economists are trained to think about macroeconomic questions as completely separate from microeconomic questions. Microeconomists entertain the idea that imperfect competition exists (through the subfield of Industrial Organization). However, because macro and micro economics are so divided, macroeconomic theory has no place for imperfect competition. Macroeconomics is, therefore, dependent on the assumption of competitive markets. But what if that assumption is wrong? The whole of macroeconomic theory would be thrown into jeopardy. It is clear to see why Larry Summers and similar economists are so quick to defend the presumption of competitive markets.
As we have seen, however, inflation is not akin to a “natural force” inflicted upon the country. Inflation, at least the drastic extent of it that we have seen, is the result of deliberate actions and corporate greed. Only by changing this discourse will we see real change.
Neil is a Junior in the College majoring in Government and Economics with a minor in Philosophy. Originally from Arlington, MA, he enjoys running, grilling and considers himself a coffee connoisseur.