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The Hidden Cause of Economy-Wide Inflation?

Platform Most-Favored Nations clauses turn private unilateral market power into economy-wide inflation.

It’s fair to say that no one has any good explanations for why post-pandemic inflation has been so hard to tame. But plenty of people think they know what isn’t the cause: concentration and market power on a macroeconomic scale that enables dominant firms to raise prices without fear their customers will leave for the competition (since there isn’t any). Critics, like Washington Post columnist Catherine Rampell and NYU economist Chris Conlon, derisively call this hypothesis “greedflation” to lampoon the suggestion that a sudden epidemic of greed has caused powerful firms to exploit the market power they previously had, but weren’t using, at least not against consumers.

But the idea that dominant firms generally — and platforms in particular — had market power they weren’t using used to be commonplace. And it’s entirely sensible that if they weren’t using their market power then (so as to accumulate more of it), they would use it now. The strategy of predatory pricing is to set a low price to lock in customers and drive out the competition, then charge high prices later to “recoup” losses. For many decades, the prevailing view has been that predatory pricing is unlikely because charging monopoly prices in the recoupment phase will just attract entry, which will make the initial predatory phase irrational to attempt. As Justice Powell wrote in the 1986 case of Matsushita v. Zenith Radio Corp., “predatory pricing schemes are rarely tried and even more rarely successful.” In the 1993 case Brooke Group v. Brown & Williamson, the court held that there must be a “dangerous probability” of recoupment for a predatory pricing claim to succeed. The DOJ last tried a predation theory against American Airlines in 1999 for its conduct defending its monopoly hub at the Dallas-Fort Worth airport. That claim ultimately failed, an underappreciated inflection point in the oligopolization of the airline industry that’s responsible for today’s high prices.

My claim is that platform MFNs are a hidden cause of the current macroeconomic inflation. An economy full of dominant intermediaries, all of whom use MFNs and their non-price equivalents, is an economy primed to turn private unilateral market power into widespread macroeconomic inflation when it comes time for recoupment.

The reason predatory pricing isn’t supposed to work is that recoupment invites entry. But instead, imagine that during the recoupment phase, the incumbent doesn’t just charge a high price for his own product; he also gets to dictate that no one else is allowed to charge a lower price. Then entry isn’t such a potent threat, because entry or no entry, the incumbent doesn’t have to worry about being undercut. That is exactly what so-called Most-Favored Nations (MFN) clauses allow.

The phrase “Most-Favored Nations” clause refers to international trade negotiations, in which two (or more) trading partners agree by treaty to give one another as favorable trading terms as are given to any other trading partner. Such clauses are stronger than setting tariffs at any given level, because they automatically adjust if other trading partners are given better terms, preventing discrimination.

When wielded by a dominant platform, however, an MFN can be anticompetitive. Platform MFNs have a similar structure, but much different economic significance since they are typically imposed by one dominant platform on upstream sellers on the platform, rather than mutually agreed to by trading partners. By using an MFN, a platform is restricting the autonomy by which sellers on the platform can set prices on other platforms, other sales channels (such as brick-and-mortar retail), or direct-to-consumer sales. The point is to prevent other channels from getting preferential terms from the seller, and attracting consumers away from the dominant platform with discounts. Given that the dominant platform can’t be undercut, they don’t have to worry about entry. That, and not assumptions about mechanistic two-sided network effects, is the real reason so many platform industries are monopolized.

Now, consider what happens when a platform starts raising its take rate, the share of gross seller revenue the platform takes as its cut from any sale. In response to this increase in the marginal cost of selling on that platform, the seller would most likely increase price on that channel and decrease the price elsewhere to create a price differential that induces customers to switch. Savings from the lower take rate on the rival platform can be shared with the customer in the form of lower prices. But the MFN bars the seller from steering its customers that way, effectively serving as an anti-steering provision. Moreover, the MFN says that if the seller increases price on the one platform that increased its take rate to cover the higher cost of selling there, it has to raise prices on all channels in order not to steer customers elsewhere. Therein lies the mechanism by which the unilateral increase in the take rate imposed by one dominant platform translates into price rises across all channels of distribution. And dominant platforms have been increasing their take rates quite a bit in the past few years.

How prevalent are platform MFNs? It’s fair to say that most of the platforms that have come to dominate each market segment use them, including rideshare and food delivery apps, mobile app stores, travel booking, and private temporary accommodation. They are typically one of several varieties of anti-steering restraint that dominant platforms impose to lock in counterparties both upstream and downstream. Credit card companies are notorious for preventing merchants from discounting their items for users who don’t pay with a credit card (or pay with a card with a lower interchange fee), requiring them instead to raise their prices for all customers when credit card fees go up. Merchants are even prohibited from simply telling customers that they, the merchant, prefers they pay with cash (or use a lower-fee card). The upshot is a giant transfer of wealth away from customers whose credit isn’t good enough for the cards that offer decent rewards (but still have to pay the high prices merchants charge everyone), with credit card companies taking the lion’s share and the wealthiest customers getting crumbs by way of rewards programs that they think are a great deal.

My claim is that platform MFNs are a hidden cause of the current macroeconomic inflation. An economy full of dominant intermediaries, all of whom use MFNs and their non-price equivalents, is an economy primed to turn private unilateral market power into widespread macroeconomic inflation when it comes time for recoupment. And investors in dominant platforms have been clear that now is when they want a return on their investment. As dominant platforms have increased take rates to recoup the low prices they charged to monopolize the market, in order to reassure their investors during an equity market decline, especially for tech stocks, the MFN means everyone else has to follow suit. That looks to consumers (and apparently to economic policy pundits) like a general price increase that can’t be tied to individual firms, even though, in fact, it can.

You can thank the conservative Supreme Court majority for the current inflation.

How is this allowed, you may ask? Beyond the weakening of predatory pricing caselaw thanks to simplistic theories that disregard the possibility of MFNs, the other area where antitrust enforcement has lost its teeth is against vertical restraints imposed by dominant firms to bind dependent affiliates (of which MFNs are one, potent example). This decades-long failure culminated most recently in the 2018 Supreme Court case Ohio v. American Express.

The majority opinion in that case, written by Clarence Thomas and co-signed by Justices Roberts, Alito, Kennedy, and Gorsuch, gave a green light not only to American Express to raise its take rate without fear that its anti-steering restraints would face challenge, but to two-sided platforms with market power more broadly. It said that harm had to be shown to consumers from the challenged conduct, and that since credit card transaction volume was increasing, output hadn’t been restrained on the downstream side of the platform and therefore consumers hadn’t been harmed. It didn’t even entertain the possibility that anti-steering restraints would enable higher credit card fees and therefore higher prices across the board, and that the higher the fees they enable, the more credit card companies would want to subsidize consumers to use their cards in preference to cash. You can thank the conservative Supreme Court majority for the current inflation.

But that just follows on decades of crediting ostensibly economic justifications for anticompetitive vertical practices like loyalty pricing, which encourages consolidation, monoculture, and supply-chain vulnerability such as we saw earlier this year with the baby formula shortage. It occurred because of a safety violation at one of a very few plants that manufacture baby formula at scale. The reason there are so few is the loyalty-pricing practices invited by state-level Women, Infant, and Children (WIC) programs, which enter monopolistic requirements contracts in exchange for bulk discounts. The original idea was supposed to be that this would save money on a public program and thus be fiscally responsible. The only problem is that it drove consolidation, thus making the industry catastrophically vulnerable to disruptions.

The real “Inflation Reduction Act” should have been a wholesale overturning of the lax jurisprudence of vertical restraints that the federal judiciary has imposed since 1977.

Beyond bad caselaw, however, the other culprit is the absence of any will on the part of Congress to change it. As far as I know, no federal legislation has been proposed to overturn Ohio v. American Express and the whole panoply of lax antitrust jurisprudence of vertical restraints imposed by dominant market actors—despite the fact the 2020 House Majority Report of the Antitrust Subcommittee explicitly called for such legislation. Even as Congress has spent the last year or more decrying high inflation, and the Fed has been tasked with preventing it with the only tool it has, a severe economic slowdown, none of the legal levers available to enhance platform competition and threaten the profits of the economy’s most powerful gatekeepers and middlemen has been pulled.

Any policy agenda to curtail price increases and clamp down on anticompetitive business models like predatory pricing and recoupment should disregard the kinds of theoretical arguments that underlay their legalization in the first place: that consumers somehow benefit from economic coercion, and that entry would “naturally” fix any competitive problem before a court does. The real “Inflation Reduction Act” should have been a wholesale overturning of the lax jurisprudence of vertical restraints that the federal judiciary has imposed since 1977 along these lines.

The good news is that some economists are beginning to recognize the nexus between inflation and market power. Last week, the OECD released a report spelling out the connection in detail, documenting the empirical literature that links higher prices to the exercise of power. Unfortunately, gatekeeping economists — as well as their hangers-on in the tech-billionaire-owned media — still scoff at the claim that market power might be to blame for inflation without considering it on the merits. They should reconsider their tendency to discredit outsiders who might have a better sense of how the economy works than they do. At the very least, they should remember that the first rule of scientific inquiry is to keep an open mind.

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