Is There a Market Failure in the Market for Prepared Foods?

Is There a Costs vs. Benefits Rationale for Government Intervention?

A recent article in the NYT, “Citing Hazard, New York Says Hold the Salt” by William Neuman, discusses how the government of New York City plans to “encourage” manufacturers to decrease the salt content in their prepared foods:

On Monday, the Bloomberg administration plans to unveil a broad new health initiative aimed at encouraging food manufacturers and restaurant chains across the country to curtail the amount of salt in their products.

The plan, for which the city claims support from health agencies in other cities and states, sets a goal of reducing the amount of salt in packaged and restaurant food by 25 percent over the next five years.

Public health experts say that would reduce the incidence of high blood pressure and should help prevent some of the strokes and heart attacks associated with that condition.

… the changes it [the city’s salt campaign] prescribes require cooperation on a national scale, city officials said, because major food companies cannot be expected to alter their products for just the New York market.

And removing salt from many products can be complicated. Salt plays many roles in food, enhancing flavor, preventing spoilage and improving shelf life. It helps bread to rise and brown.

… While most food companies say they agree at least with the goal of reducing salt, some medical researchers have questioned the scientific basis for the initiative, saying insufficient research had been done on possible effects. While agreeing that reducing salt is likely to lower average blood pressure, they say it can lead to other physiological changes, some of which may be associated with heart problems.

As a free market economist, my instant reaction to such government intervention was one of horror. After I had calmed down, I tried to take a more rational approach to the issue by looking for any economic rationale to explain the government's action. That is, I asked myself: When would it be the government’s place to intervene in the market for prepared foods and “encourage” manufacturers to use less salt?

Is There a Market Failure in the Market for Prepared Foods?

Generally speaking government intervention into a free market can be justified if there is a market failure, which Wikipedia defines as follows (emphasis mine):

In economics, a market failure exists when the production or use of goods and services by the market is not efficient. That is, there exists another outcome where market participants' overall gains from the new outcome outweigh their losses (even if some participants lose under the new arrangement). Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient – that can be improved upon from the societal point-of-view…

Market failures are often associated with non-competitive markets, externalities or public goods. The existence of a market failure is often used as a justification for government intervention in a particular market.

Is the Market for Prepared Foods Non-Competitive?

Non-competitive markets are markets with only one (monopoly) or a few (oligopoly) large suppliers and where the suppliers can effectively dictate terms to buyers. Essentially what you have in non-competitive markets is a take-it-or-leave-it option for buyers.

[There can also be non-competitive markets in which there is only one (monopsony) or a few (oligopsony) buyers, in which case the buyers dictate terms to sellers, but this is less often the case than that of monopoly or oligopoly].

If the market for prepared foods is non-competitive because of barriers to entry, then suppliers could add “too much” salt to their foods, and consumers would have no recourse. In this case, if there is sufficient market demand for low salt alternatives, non-competitive suppliers may offer such products, but they would not be compelled to do so from the forces of competition. If this is, in fact, the case, then government may be justified in “encouraging” manufacturers to decrease the salt content in their foods.

If, on the other hand, the market for prepared foods is competitive, then suppliers would be much more responsive to market niches, such as low salt, low fat, or low carb alternatives, in an attempt to gain market share from competitors. Under this scenario, the result would be a wide variety of offerings, and lower prices. If the market is competitive and alternatives such as low salt, low fat, or low carb do not appear on the shelves, then it would suggest that there is not enough demand to make such alternatives profitable for suppliers to provide. In this situation, having government “encourage” suppliers to decrease salt content may lead to fewer sales and/or lower profitability associated with consumers who prefer high salt content.

At the same time, however, the existence of product proliferation, that is, many varieties within the same product category, such as such as low salt, low fat, and/or low carb alternatives, may also be a sign of non-competitive markets. An incumbent supplier will use a product proliferation strategy to increase the costs of entry by new suppliers; that is, by forcing new entrants to provide a large variety of offerings in order to be able to successfully compete with the incumbent. If this is, in fact, the case, then incumbents will be able to raise their prices without attracting new entry. Under this scenario, the result would be a wide variety of offerings, but higher prices. In this situation, having government “encourage” suppliers to decrease salt content may lead to fewer sales and/or lower profitability associated with consumers who prefer high salt content.

In order to get a closer look at what’s actually going on, I chose a prepared food category – frozen pizza – and looked at total sales by supplier. This is only one category of frozen foods, so it certainly doesn’t tell us precisely what’s going on, but I figured that if the same suppliers provide many of the other categories of prepared foods, then a look at this market might provide some indication of what’s going on in the other market categories for prepared foods.

In the table and graph titled "Frozen Pizza Sales by Vendor", we see that while there are many suppliers of frozen pizza, the top two suppliers provide more than half the total sales for the category (see columns [B] and [C] ), and they charge among the highest average prices (see column [F]). To get a better idea of market concentration, I calculated the Herfindahl-Hirschman Index (HHI), which is defined as the sum of the squares of the market shares (see column [D]). A category total HHI above 0.18 indicates that the industry is highly concentrated.

To see if the market for frozen pizzas is concentrated with “too little” variety of “too much” variety, I took a look at relative sizes of the frozen pizza brands, where I assume that the number of brands is a rough proxy for the level of variety. The numbers suggest (see “Frozen Pizza by Brand” table and graph below) that there is ample variety (in both offerings and price) in the market for frozen pizzas.

This quickie analysis of the market for frozen pizzas suggests that this particular market (and perhaps also the market for all prepared foods) is highly concentrated, but that there is ample variety of offerings and prices. As such, to the extent that consumers like low salt options, this niche should already be provided for. So any government intervention to lower the salt content in frozen pizzas would end up forcing people who prefer more salt to consume less (or add their own salt at home), which will likely lead to fewer sales and/or lower profits associated with people who prefer more salt.

Are There Externalities in the Market for Prepared Foods?

Wikipedia defines an externality as follows:

In economics, an externality or spillover of an economic transaction is an impact on a party that is not directly involved in the transaction...

In a competitive market, the existence of externalities would cause either too much or too little of the good to be produced or consumed in terms of overall costs and benefits to society. If there exist external costs such as pollution, the good will be overproduced by a competitive market, as the producer does not take into account the external costs when producing the good. If there are external benefits, such as in areas of education or public safety, too little of the good would be produced by private markets as producers and buyers do not take into account the external benefits to others. Here, overall cost and benefit to society is defined as the sum of the economic benefits and costs for all parties involved.

The only externality I can think of that could possibly be associated with the market for prepared foods is an indirect one: To the extent that prepared foods contribute to health problems (too many calories, too much fat, too much salt, etc.), and due to of the nature of the US healthcare system (Medicare, Medicaid, etc.), consumers of prepared foods end up paying less than the costs of the health care they ultimately receive, then there is an externality which will lead people to consume too much prepared foods (or too many calories or too much fat or salt).  But this is really a problem with the health care system, not with the market for prepared foods.  As such, the government could try to indirectly address the health care problem by limiting salt in prepared foods, it would certainly not be an efficient way to do it.

Is There a Public Good Problem in the Market for Prepared Foods?

Wikipedia defines a public good as follows:

In economics, a public good is a good that is non-rivalrous and non-excludable. This means that consumption of the good by one individual does not reduce availability of the good for consumption by others; and that no one can be effectively excluded from using the good…

Non-rivalness and non-excludability may cause problems for the production of such goods. Specifically, some economists have argued that they may lead to instances of market failure, where uncoordinated markets driven by parties working in their own self interest are unable to provide these goods in desired quantities.

Common examples of public goods are national defense, clean air, broadcast television, information, and health and safety standards.  On the issue of Food Safety as a Public Good in the United States,

In the United States, there are many laws designed to guarantee the food supply is safe. The rules and regulations governing food manufacturing and marketing are scientifically based and exist for the purpose of consumer protection. Food manufacturers are held accountable for producing products that are safe for consumption, and the government is responsible for enforcement of applicable laws…

Principles Guiding the U.S. Food Safety System

• Marketed foods must be safe and wholesome.

• Regulatory decisions must be grounded in science.

• Enforcement of food safety regulations is a governmental responsibility.

• Food industry businesses are expected to comply with regulations

• Businesses that do not comply are held liable.

• The food safety regulatory process is visible to the public.

So then this begs the question: Is the government justified in intervening into the market for prepared foods under the auspices of public health and safety?

I would argue no.  First, “too much salt” (however you may define it) is not a problem for everyone, as is too much lead or mercury or radiation.  Second, the government already mandates product labeling, so people can see exactly how much salt is in the food they’re buying.  Third, through product proliferation and/or competition, suppliers are currently providing low salt alternatives.  Taken together, these last two points suggest that to the extent that people are buying prepared foods with high salt content, they are doing so because they prefer those foods to the lower salt alternatives. 

Finally, at what point do you draw the line?  Using whatever reasoning the government is using to justify its intervention into the market for prepared foods, it can equally well justify limiting fat, sugar, or calories.  Is the government really justified in telling people they cannot eat what they want?

Is There a Costs vs. Benefits Rationale for Government Intervention?

Finally, let’s take a completely different approach to the issue of government intervention into the market for prepared foods and ask if the overall benefits associated with limiting people’s salt intake outweighs the costs of the intervention.

Assume that the government’s intervention will indeed lead people to consume less salt in their diet.  This is surely not a given, since people can simply add their own salt to the prepared foods they buy, among other possibilities.  And assume that because people consume less salt, they suffer fewer health problems associated with high blood pressure, and thus use less medical care.  What’s the value of better health and/or a longer life?  In a previous blog entry I discussed how the government places a higher value on the average life than the market does.  Surely the government’s actions here also overvalue good health for purposes of justifying market intervention. Regardless, the actual value created here is that associated with

• lower healthcare costs and/or
• living a few extra years and/or
• living more years in better health.

The costs associated with lower government-mandated salt intake include:

• From the article: “While agreeing that reducing salt is likely to lower average blood pressure, they [some medical researchers] say it can lead to other physiological changes, some of which may be associated with heart problems.”
• The costs to suppliers of prepared foods associated with re-engineering their foods to contain less salt.
• Lower profits associated with fewer sales and/or lower prices due to less demand from consumers who prefer prepared foods with high salt content.
• The lost value (utility) associated with consumers not being able to eat what they prefer.

Do the benefits outweigh the costs?