US Baby Formula Shortage: Why Do We Always Subsidize Demand, Rather Than Encourage Supply?

You have likely heard that there has been yet another American supply chain issue that is causing great stress for some people. This time, the issue is occurring within the US' baby formula industry.

Unlike some of the past panics, the baby formula issue is both very serious and very unfortunate.

The basics:

  • A recall of some Similac formula infected with bacteria in February has combined with a supply crisis when the Abbott plant that created said formula was shut down for several months.

  • This has meant that, nationwide, 21% of powdered baby formula was listed as out of stock in early May, according to the research firm IRI.

  • This shortage is especially acute for specialized formula for certain babies that might, for instance, be allergic to diary,

After the last two years all of this sounds pretty familiar!

But it is also pretty different than some of other supply chain SNAFUs: desperate American families scrambling for formula supply for their infants is, even by the high standards of 2022, a terrible scene.

It is also very serious in a way that - and please do take offense - sourdough starter or canning jars or dumbbells just wasn't.

Why is this happening?

Despite what the nightly news might tell you, the real reason this has occurred has very little to do with an individual plant in Michigan being shut down.

  • Rather, it has to do with how we regulate vital goods like baby formula and also what happens when, in a rush of short sighted foolishness, we decide that price controls are the answer.

There is a lesson here. And one for both sides of the political aisle.

Let's start at the beginning:

It is important to understand that the current shortages may be a bit greater than what is reported but they also likely feel greater regardless of the precise numbers. One of the underrated aspects of supply chain shortages is they are very unevenly distributed.

One of the core reasons people become panicked is precisely this lumpy distribution. One region or town has a few stores with empty shelves that then gets broadcast out and - shocker! - this causes people to become concerned and they started buying more which, in turn, creates more shortages.

It doesn't take much for reality to start matching up to the hysteria.

That is exactly what happened in this case. The recall this winter meant that a particular region of the country started experiencing shortages which suddenly became a "thing."

Here is the Wall Street Journal back in January:

Laura Modi, co-founder of Bobbie, an online organic baby-formula startup, said even intermittent shortages can lead parents to stockpile. She said her company has seen an influx of demand from parents rattled by the lack of availability of big-name formula brands. “It can take one post in a Facebook moms group to send some into a panic,” she said.

This creates an obvious spiral: some worried parents begin to overbuy and the ripples start to widen no matter how hard the industry tries to play catch up.

But the real acceleration of the problem isn't so much the panic buying but rather the government and regulatory response.

Not the regulatory response to the current crisis - though that is really bad too and you can read about it here - but instead the regulatory approach to the industry overall.

Three reasons as to why:

  1. The US already over regulates AND taxes the industry.

  2. The US government is the largest single buyer of milk formula and, by law, sets a price floor that discourages competition and investment.

  3. Despite the ongoing crisis and constantly claiming otherwise, the US government is actively harming the efforts of the global formula industry to bring in new supply.

It's all very familiar and so very tiresome.

  • On the first point, the US government imposes a needless 17.5% tariff on formula imports to protect the politically very powerful dairy industry. This tariff rises higher still when certain quota thresholds are hit (like during an emergency shortage with a panic when you would need more....)

They do this deliberately to make it too costly and pointless for major European formula producers to set up an import practice. In turn, this means that these producers don't bother to even try which means that during an emergency.....there is no excess capacity with the ability to send emergency shipments.

  • The second point is the worst of the bunch. The US government helpfully provides low income parents with vouchers for formula through the Special Subsidized Nutrition Program for Women, Infants and Children (usually know as WIC) at approved retailers.

This program is not small. Nor is it simple. However, it is very important. "WIC: serves about 1.5M infants and could constitute about half (!) the amount of formula sold in the US by some accounts.

The only problem is that producers must compete for the (very large) contracts and do so by generally offering below wholesale prices. This means that, to generalize somewhat, the largest US contract on offer for baby formula is inherently below cost.

This keeps prices down for both parents and taxpayers (an overall positive) but it creates a very bad incentive pattern for formula producers. Namely, it creates two problems simultaneously:

  1. Discourages new entrants

  2. AND investment by the current big players

Because, after all, a lot of their business will be, almost inherently, at a loss.

Why invest in an industry where you have to offer goods below cost to be the biggest player? Would you enter that business? Would you build a new plant?

This has the side effect of discouraging foreign entrants as well. Why would a European (or Canadian etc) producer bother to enter a market where it would likely have to sell half its product at a loss?

They do this at the best of times but even in this crisis and despite the present government promising to do everything in their power to alleviate the (legitimate) concerns of worried fathers and mothers, they have not changed the labeling requirements, even temporarily.

For shame.

Put it all together, and the takeaway is pretty simple:

  • In anything even remotely approaching free market, these types of shortages wouldn't occur.

However, the government is manipulating and distorting and over regulating the formula market - often to absurd proportions - and then blaming evil capitalist corporations for Americans being unable to feed their babies.

That is quite a feat!

Sounds like an overreach? Overly harsh on our good friends in Washington?

Here is the Custom and Border Patrol bragging about stopping the import of some 600 cases of high quality German formula and acting as if they had cracked a major drug crime ring.

Or you could hop on a place to Mexico, that noted bastion of the free market, that neither restricts imports nor hampers their domestic producers. Amazingly, they do not have a shortage at all. As if by magic, they are able to somehow solve these problems.

This isn't purely a criticism of instinctive Democratic policies either. The power of Big Dairy (quietly but devotedly supported by rural Red State Senators and for the usual financial reasons) and the concentration of the overall sector, are also contributing.

Everything is geared around letting the industry make more profits. And even now that we are in a major crisis with babies under threat we are still not able to change. That should tell you something.

Prices control don't just distort prices. They also create asset allocation problems. And regulatory capture. And a lack of competition because it is uneconomic to enter a business where you have to lose money to get the biggest contracts.

We are seeing all three of these issues act in concert right now and the consequences can be seen on the faces of parents (or on the walls of their Facebook Groups) everywhere.

When you see a crisis in the supply chain ask yourself this question:

Is this because the market is too regulated or too unregulated? And don't just take someone's words for it. And if those same individuals are proposing price controls as a solution as yourself a follow up question:

Will proposing price solve the problem at hand or will it create a far bigger one? Now and in the future? And are the controls necessary because corporations are innately greedy and uncaring or is it because we have a poorly functioning market that is subject to terrible incentives that don't just hurt the market's ability to provide cheap and reliable goods but also hurt the ability to help alleviate the crisis.

Thanks to price controls in US baby formula, you may not have to worry about the price of baby formula but you do have to worry about finding baby formula.

There is a lesson there and it is one we have already learnt time and time again:

If you restrict prices you are inherently subsidizing demand. You will get more demand and less supply, as a result.



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