Regulatory policy

Formula for a Crisis: Good Intentions and Bad Policy

The continued shortage of infant formula has many desperate parents wondering how, in 21st century America, we could find ourselves in such dire straits over something so basic. The immediate cause is the precautionary closure in February of a manufacturing plant following the deaths of two infants from bacterial infections. However, the lack of resilience to such an isolated disruption is largely the result of political mistakes and policies dating back more than 30 years that have hampered the proper functioning of market forces.

Unsurprisingly, infant formula is the most regulated food in the country, rivaling pharmaceuticals. This necessarily limits the number of companies with the size and scope to manufacture and distribute their products in the $4 billion US market. Additionally, the process of obtaining certification from the United States Food and Drug Administration is expensive, cumbersome, and bureaucratic, creating significant barriers to entry. As a result, a small number of players dominate the domestic market. Four companies control 80% of formula sales in the United States, and the largest, Abbott Laboratories, has nearly half of the market. But regulation is only one of the factors explaining industry concentration.

Half of all infant formula sold in the United States is purchased by the United States Department of Agriculture and distributed through the Special Supplemental Nutrition Program for Women, Infants, and Children, commonly known as WIC. Only three manufacturers are authorized suppliers of WIC, and each state individually contracts exclusively with one of the manufacturers for all of its supply. This means that the federal program gives monopoly power to one manufacturer in each state, severely limiting competition. Also, the WIC monopoly has been shown to hold a larger market share of the unsubsidized half of the market, as supermarkets tend to allocate valuable shelf space to the dominant supplier.

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The possibility of tighter supply resulting from tight market conditions is hardly a surprise. The U.S. Department of Agriculture’s Economic Research Service highlighted the risks of hyper-concentration due to government-created oligopoly in a research paper in 2011.

It’s also no coincidence that most food assistance programs like the WIC and the Supplemental Nutrition Assistance Program, also known as food stamps, are under the auspices of the USDA, whose mission first is to promote the interests of American farmers. Milk and soy are the main ingredients in infant formula.

In addition to protecting major producers from domestic competition, the government’s trade policy effectively prohibited foreign competition by erecting regulatory and tariff barriers.

The European Union is the world’s largest producer of infant formula and it is objectively true that the quality of EU products is generally equal to or better than US brands and that they are subject to stricter regulatory oversight. Yet, due to complex and often insurmountable hurdles, including labeling, enforcement, inspection and a host of other protectionist hurdles, the European formula has effectively been shut out of the US market. Only 2% of all US sales in 2021 were imported.

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As if to add insult to injury, the United States has insisted that crippling import restrictions be imposed on Canada as part of President Donald Trump’s overhaul of the Northern Free Trade Agreement -American, known as NAFTA. The United States-Mexico-Canada deal, which came into effect in 2020, imposed punitive tariff rates of up to 17.5% and export quotas on Canadian infant formula, even though Canadian factories generally meet all US FDA standards. The president reportedly saw 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. Ultimately, like most trade barriers, the penalties ended up hurting American families in the form of higher costs and critical supply shortages. President Joe Biden has been slow to break down many of the harmful trade barriers.

The pandemic has provided the last climatic elements needed to create the perfect storm. As with toilet paper and hand sanitizer, beleaguered consumers hoarded formula throughout 2020. In 2021, as the pandemic waned, formula sales declined as parents cleared inventory surpluses, prompting producers to reduce their production accordingly. Meanwhile, in the early months of the pandemic, the US birth rate fell sharply, further reducing demand for infant formula in 2021, only to see births surpass 2019 levels in the second semester. Add to that a marked drop in the percentage of breastfeeding mothers and you have the recipe for the demand shock we are witnessing. Then shut down a manufacturing plant that produces 20% of all US supply, and you have a real crisis.

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Congress and the President are taking steps to address current shortages, including streamlining import restrictions and arranging military airlifts of acceptable substitutes from EU trading partners. The larger question is whether policymakers will learn from the classic example of protectionist interference with market forces. History suggests that we shouldn’t be too optimistic.

Christopher A. Hopkins is a Chartered Financial Analyst in Chattanooga and co-founder of Apogee Wealth Partners.