Because of expanded government subsidies for baby formula, price signals don’t work as they should.
Because of expanded government subsidies for baby formula, price signals don't work as they should.
F amilies across the country are grappling with baby-formula shortages, causing a considerable amount of anxiety for parents who depend on formula to help feed their infants.
About 40 percent of major brands were sold out at the end of April, which is nearly four times the rate in November. Walmart, Target, Kroger, CVS, and Walgreens are all limiting formula purchases at their stores in an effort to discourage people from hoarding. At Amazon, many popular varieties are unavailable.
This is concerning because some mothers are not able to successfully breastfeed and many others who do breastfeed depend on formula as a supplement if their babies require more milk than they are able to produce. Nearly one in five babies receive formula within two days of birth, according to CDC data. By three months, just 47 percent of babies are being exclusively breastfed.
The seemingly obvious culprits for the shortage are what everyone has blamed for everything over the past year: supply chains and labor shortages. But that can’t be the answer here. It is true that baby-formula manufacturers face the same shipping problems and hiring challenges that most other industries are dealing with — yet most other industries don’t have 40 percent of their products sold out nationwide. Something else must be at play.
The proximate cause of this shortage is a recall of baby formula made by Abbott Labs. In February, Abbott recalled three types of baby formula after four infants became sick; two of them have since died. The illnesses are thought to be linked to cronobacter or salmonella contamination in baby formula produced in one of Abbott’s plants in Michigan (although further investigation has been unable to confirm any link to that plant). Since Abbott is one of the country’s leading baby-formula manufacturers, the recalls have exacerbated the shortages.
But one brand recalling some of its product lines should not cause shortages across the country. It’s not as though Abbott is the only major formula producer: Nestle and Reckitt Benckiser make multiple types of formula each.
In a free market, widespread shortages shouldn’t occur. The price should rise as supply gets low, which encourages more production. The increased production should prevent a prolonged shortage before it has a chance to get started, then bring the price back down as well.
The overarching problem is that price signals in the baby-formula market don’t work well to begin with. A 2010 study from the USDA’s Economic Research Service estimated that 57 to 68 percent of all baby formula sold in the U.S. was purchased through the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC).
That means over half of the baby formula that’s consumed in the U.S. isn’t really bought and sold on a free market at all.
The federal government started WIC on a temporary basis in 1972, then made it permanent in 1975, as a way to help impoverished mothers afford food for their babies. As Douglas Besharov and Douglas Call pointed out for the American Enterprise Institute in 2017, it has expanded far beyond its original purpose. “Various formal and informal changes have liberalized eligibility criteria so that, according to the Census Bureau’s Current Population Survey (CPS), in 2014, about 24 percent of WIC recipients lived in families with annual incomes above WIC’s putative income cap of 185 percent of poverty, and about 8 percent in families with annual incomes at or above 300 percent of poverty,” they wrote.
WIC is a federally funded program, overseen by the USDA, that is administered by the states. To be eligible for WIC purchases, baby-formula makers bid on contracts with state governments. A 2015 Wall Street Journal story explains:
Fierce bidding for those state contracts has led the three biggest formula makers to offer steadily deeper discounts—on average 92% below wholesale prices—eroding profits on WIC sales. But winning a state’s contract makes a formula maker the dominant player on a state’s grocery store shelves, where the companies try to make up for their money-losing WIC sales.
With government responsible for over half of the country’s baby-formula purchases, price signals don’t work as they should. As research firm Datasembly noted, the baby-formula market was beginning to go awry before the Abbott recall. The out-of-stock percentage moved from its normal range into double digits in July of last year. Yet “overall prices didn’t increase when out-of-stock percentages started to increase,” it found.
Such behavior would be very strange in a free market, but it makes perfect sense when you consider that predetermined contracts with state governments are responsible for such a large segment of total purchases. The USDA is fully aware of these problems, noting in a 2015 article that “WIC essentially replaces price-sensitive consumers of infant formula with price-insensitive consumers.” A 2015 USDA report finds that lack of price sensitivity also contributes to the long-term increase in baby-formula prices, as both manufacturers and retailers have steadily raised their prices above the overall rate of inflation for years. We don’t get short-term price increases when they would help prevent shortages, but we do get long-term price increases that slowly make formula less and less affordable — which further encourages WIC expansion.
That rising sticker price doesn’t help the companies who make formula, either, because WIC contracts are discounted so steeply. The major baby-formula makers do business in many other markets as well, so it’s hard for them to justify continuing to lose money on steeply discounted government-contracted baby formula when they could focus their efforts elsewhere. Reckitt Benckiser, for example, also owns Lysol, Mucinex, and Durex, among many other brands, and it’s currently trying to sell its baby-formula division — or, what’s left of it, since it already sold the Chinese portion of that division last year.
The government’s involvement in the baby-formula market also counteracts the government’s goal of getting more women to breastfeed, as Chris Edwards pointed out for the Cato Institute in 2015. The CDC says that breastfeeding “helps protect against childhood obesity.” The Office on Women’s Health, part of the Department of Health and Human Services, says that breastfeeding lowers the risk of asthma, ear infections, eczema, and even diabetes and leukemia. Without judging the medical merits of those suggestions, it’s counterproductive for government to subsidize a substitute for breastfeeding if it wants women to breastfeed. And sure enough, a USDA report from 2019 found that infants receiving WIC benefits are less likely to be breastfed than infants who don’t receive benefits, regardless of income level.
With WIC expanded to cover the majority of baby-formula consumption, manufacturers have less incentive to meet demand. When a negative supply shock, such as the Abbott recall, happens, the normal market mechanisms that would thrust other manufacturers into overdrive fail to function as they should. Increased government involvement in the baby-formula market, while coming from the best of intentions, sets it up for shortages like the one families are currently experiencing.