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Why Are Judges Encouraging Inflation?
Three judges - two appointed by Bill Clinton and one by Barack Obama - just issued yet another decision making it easier for big business to raise prices.
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Today I’m writing about a little-noticed court decision last week that could have a big impact on the ability of big business to raise prices.
A Nation of Price-Fixing
With first Covid and now the war in Ukraine, supply and demand shocks abound in our economy, driving up prices and increasing volatility in general. I’ve been tracing the effect of consolidation for years, and one of the consequences of consolidation is that these kinds of shocks more often lead to price spikes, volatility, and shortages. It’s not just that supply chains are more brittle, but firms simply have pricing power, and now have an excuse to use it even when they aren’t threatened by supply chain disruptions. Visa and Mastercard, for instance, who have control of the payments system, are raising the fee they take from merchants for accepting credit cards. There’s no reason for this price hike; both firms are highly profitable, and there’s really no increase in input costs to justify it. They are raising prices simply because they can, and doing so in what looks like a coordinated manner.
These kinds of price hikes should be illegal, and a few years ago, they probably were. I’ll get to the law in a second, but what’s important to understand is that what Visa and Mastercard are doing is not an isolated incident. It’s pervasive. Last month, for instance, Unilever’s Chief Financial Officer, Graeme Pitkethly, told investors that his firm is raising prices. I particularly like Pitkethly’s comments not because they are unusual, but because they are overt. “We are the price leader,” he said on his call to analysts. “Competition is following in pricing, and we're measuring that.”
Unilever is a global giant with many lines of business, from food to beauty products to air purifiers, and 400+ well-recognized brands. The firm is hiking prices not because costs are going up, but for two different reasons. First, consumers are willing to pay more. And second, there’s no competition offering better pricing to take market share.
The markets in which Unilever operates are quite concentrated, though it is not a monopoly. In that, the firm is similar to Visa and Mastercard, who have immense market power, a shared monopoly, but not an explicit monopoly. This idea of a shared monopoly isn’t obvious at first; most of Unilever’s lines of business have rivals who ostensibly compete over price and quality. But Pitkethly said he’s not worried about losing market share, because the entire industry is acting in concert to raise prices. As Pitkethly then put it, the industry is “protected.”
These comments are important for two reasons. First, Pitkethly is bragging to investors about pricing power, thus giving an explanation for some parts of the inflationary increases we’re seeing. Back in December, I did a back of the envelope calculation that 60% of the inflationary increases are a result of pricing power. Unilever’s choices are an illustration of that dynamic. Second, Pitkethly is also signaling to competitors that they should not compete over market share by lowing prices. He’s sending a message, a form of tacit collusion.
In other words, one way to understand what Unilever is doing with this public signaling is the firm is price-fixing, or exploiting the collective power of the small number of firms competing in its various lines of business. Wall Street likes to use euphemisms for market power, like ‘price leader,’ ‘disciplined industry,’ ‘low price elasticity,’ ‘rational competition,’ but they all mean the same thing, and have for more than 100 years. A concentrated industry is colluding to elevate prices to monopoly levels, untethered from supply and demand. These days, especially in this inflationary environment, there are plenty of executives like Pitkethly and plenty of firms like Unilever raising prices in concentrated industries, from Tyson Foods to Pepsi to D.H. Horton, and doing it in concert.
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A conspiracy to raise prices can be understood as price-fixing, and price-fixing is a felony according to Section One of the Sherman Antitrust Act, passed in 1890. The statute says “Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce.. is declared to be illegal.” From the 1890s onward, explicit price-fixing with no other context except profiteering, was understood as illegal. What Unilever is doing, signaling of pricing moves in a concentrated industry, known as ‘tacit collusion,’ is potentially such a conspiracy. In the 1970s the Federal Trade Commission and judges considered that exchanging information while moving prices in concert was an illegal method of fixing prices.
But for years, courts have been loosening antitrust law, including those against price-fixing. In 2017, for instance, the Third Circuit Court of Appeals, in a case called Valspar Corp. v. E.I. Du Pont De Nemours & Co, not only found that tacit collusion was legal, but that in the case of a concentrated industry, it’s rational. And so they wouldn’t even let it get to a jury.
In Valspar, several firms selling titanium dioxide raised prices in concert 31 separate times, with the price change having no relationship to costs, or supply and demand. These firms were also exchanging information with one another as they were changing prices, and holding suspicious meetings right before price increases. Yet the court dismissed the case before it got to a jury and without even letting the plaintiffs even get internal documents that might show a formal conspiracy, which is known as the ‘discovery’ phase of a case.
Dismissing a case before it gets to discovery is brutal. The way that antitrust laws work is that the ten thousand antitrust attorneys who advise corporate America tell executives what they can and can’t do, warning them of risks of engaging in certain actions. Once courts start saying that it’s almost impossible to bring a price-fixing case unless outsiders can somehow get their hands on internal documents showing evidence of private conspiracy, then executives will begin raising prices and bragging about it on investor calls. And that is, of course, what is now happening.
Valspar was a weird ruling. It was a two to one decision. One judge, a Republican-appointee, dissented, noting that circumstantial evidence of a conspiracy was more than enough to get to a trial. (He pronounced it shocking and against common sense and precedent that the court dismissed the case that early). But the two other judges found that small set of firms likely coordinating to increase prices, regardless of cost, supply, or demand was “largely irrelevant” to whether they were price-fixing. The reason these judges didn’t believe evidence of a coordination could indicate a conspiracy but did not warrant a trial was, you guessed it, economists.
What the judges argued was that firms in a concentrated market who exchange lots of information with one another and raise or lower prices in a coordinated manner might be part of a conspiracy. But economists have models, these judges asserted, that show though they might be colluding, it’s also possible they were not. And thus there is no possible way they could be breaking the law.
According to these economic models, in markets with just a few firms, economists argue it’s theoretically easier to coordinate price increases without an agreement. A businessman only has to watch the one or two meaningful rivals raise or lower prices, and he will know he can change his price. Thus in these markets, prices rise above competitive levels, as if there’s a monopoly, when there may actually be a few players in the market. (This idea of a shared monopoly by a few firms, known as interdependence theory or sometimes as monopolistic competition, is one economic justification for opposing corporate concentration in general. Larger firms can collude more easily and become a shared monopoly.)
In non-concentrated markets, which is to say markets with a lot of buyers and sellers, it’s easy to know whether there’s a conspiracy to raise prices. Since no one actor has much power over price, it doesn’t make that much sense for an individual firm to raise prices unless costs go up. If you do, rivals will take your market share. If prices of a bunch of firms go up in a coordinated way, then everyone would agree there’s probably a broad cartel-like agreement.
Now, firms in concentrated markets do often collude, the idea that they coordinate without explicit cooperation is just a theory that economists have. So usually the way to figure out if there’s price-fixing occurring is to allow lawsuits with sufficient evidence of such bad behavior - like dozens of coordinated price hikes - to proceed, so that lawyers can look for internal documents and make the case to a jury. But these judges ruled otherwise. Still, that was only the Third Circuit, not everywhere in the country.
Last week, however, the Ninth Circuit handled down another bad decision along the same lines. In this case, memory chip makers Samsung, Micron, and SK Hynix - who control 96% of the market for such chips - were being sued for price fixing. Until 2016, prices of memory chips had been dropping as these firms competed for market share. Then, Samsung unilaterally began producing less, and announced it would keep production lower as long as other industry participants did so. Micron and SK hynix followed suit, and prices of chips, as well as the cartel’s profits, skyrocketed. These firms also cut their investment in factories in unprecedented ways to reduce output, lost money by deliberately withdrawing supply from the market, publicly encouraged each other to engage in supply cuts, and exchanged information relating to future supply and demand.
The plaintiffs, who were the buyers who had been overcharged, sought to look for internal documents to see if there was some sort of formal cartel arrangement. There had even been a history of price-fixing in this industry. So you’d think there would be enough here to move forward. The court, however, dismissed this case, because it said that it was impossible to know if these firms, as they are in a concentrated industry, had raised prices in concert due to a conspiracy (illegal) or just because it was easy for them to tacitly collude by watching each other change pricing and announce things publicly (as if that’s not a conspiracy!).
It didn’t matter how much evidence there was of coordination. The courts said that plaintiffs couldn’t even ask for internal documents that might show a conspiracy, let alone get to a jury. There was no possible way, these judges said, that illegal price-fixing was going on.
Such decisions are, to put it plainly, insane. They change the law and effectively immunize large firms from price-fixing, while penalizing small ones, which is of course an incentive for consolidation writ large. In industries with lots of firms, it’s much easier to show price fixing, because raising prices in concert is not easy without a formal agreement. That means you can more easily get to discovery and demand internal firm documents just by showing prices changed. But in industries with just a few firms, coordinating prices to a monopoly level is theoretically possible without a formal agreement to do that. And judges increasingly say that you can’t get to the discovery phase in such cases, even if there’s a lot of evidence that there is price-fixing going on.
What’s also interesting here is the breakdown of ideology. Typically antitrust observers see conservatives as more hostile to antitrust enforcement, and progressives as more favorable to it. But in this case, that line didn’t hold. The Third Circuit is ideologically mixed. In the Valspar case, two out of three judges were appointed by George W. Bush, and one was appointed by Bill Clinton. With a 2-1 vote, the judges adopted a strong pro-big business posture, and the lone dissenter was one of the conservatives. The Ninth Circuit is considered a more progressive place, and the judges in this case were all appointed by Democrats - William A. Fletcher (Clinton), Johnnie B. Rawlinson (Clinton), and Cathy Ann Bencivengo (Obama). Fletcher in particular is known as a stalwart left-winger, with strong progressive views on the death penalty, immigration, free speech, the environment, gun control, gender equity, etc. And yet, on the question of big business, these progressive legal minds were in lockstep with the Fortune 500.
As we watch CEOs continue to brag about profits and price hikes, it’s easy to blame corporate greed for taking advantage of this emergency situation. And that is fair, since corporations have a lot of political power. But corporations act the way they do because of the law. We’ll fix this problem eventually, either through statute modifying price-fixing rules, or with new case law. But in the meantime, it’ll be harder for ordinary people and firms to get their day in court when they are victims of a price-fixing conspiracy. And that’s because yesterday, three judges appointed by Democrats just decided that Unilever’s “price leadership” is a-ok.
What I’m Reading
Big Four Accounting Firms Come Under Regulator’s Scrutiny, Wall Street Journal
Reining In Monopoly Power: A Concept Paper for Small Business, The Main Street Alliance
Envision Healthcare Hits the Skids, The American Prospect
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