one explanation...

[Jim Devine <jdevine03@xxxxxxxxx>]

June 12, 2005/New York TIMES. 

Yes, Virginia, There Is an Answer
By DANIEL ALTMAN

WEIRD things are happening in this economy.

It's not the first time. Three decades ago, economists working with
simple models were confused by stagflation - the one-two punch of high
inflation and weak demand.

Today, a different mystery confronts them. Economic growth has
strengthened, but inflation remains low. On top of that, the stock
market is slumping. Throw in the combination of a sagging dollar and a
string of record trade deficits, and you have a full-blown enigma.

Or do you? There is an explanation that fits all these facts. It may
not be the only one, and it may not even be the best for any single
fact, on its own. Still, it's worth considering.

It has to do with one of the most fundamental aspects of the American
economy: competition.

Competition is the magic ingredient that determines who wins big in
markets. Whatever group faces less competition - the buyers or the
sellers - tends to get the upper hand. When a market has only one
buyer or seller, that person or company can grab all the bargaining
power, setting the most advantageous price.

The federal government has watched over markets, ostensibly to ensure
some degree of competition, since the Sherman Antitrust Act became law
in 1890. The government has generally focused on the supply side and
on companies doing business nationwide, like the old Bell Telephone
and Microsoft.

At the state and local levels, enforcement has been harder to come by.
Yet the very size of those markets naturally works against
competition. In a small suburb, a rural area or in any geographically
isolated region, it's easier for one or two businesses to corner a
market.

And that's where the changes have occurred. Creating a local monopoly
is harder than it used to be. For one thing, television, telephones
and the Internet are powerful tools for reaching into local markets.
When a home shopping channel appears on cable television, or when
someone sets up a store on an auction Web site, it's just like a new
shop opening on Main Street in every town in America.

As a result, sellers of goods and services have less power in
thousands of markets. Competing against one another, they end up
supplying their products at prices closer to their costs. The sellers'
profits fall, but the well-being of consumers rises; they're getting
the same useful things for less money.

In theory, society is better off when this happens. But at the very
least, there's a redistribution of well-being from sellers to buyers.
Shareholders are probably the primary losers, at least in the short
run. Even consumers who don't use the Internet or shopping channels
benefit, as long as other consumers use them.

If the first competitive force pushing down prices seems obvious, the
second is even more so. It's Wal-Mart Stores, and all the other
enormous retailers of its ilk.

Wal-Mart has another kind of market power, that of the top buyer. The
company wrings enough out of its own suppliers that it can keep prices
low for consumers - and the regulators quiet. Hypothetically, Wal-Mart
could decide one day to become a local monopolist, taking over small
markets and then pushing prices sky-high. For now, however, that
doesn't seem to have happened.

Nevertheless, wherever Wal-Mart goes, it instantly becomes the biggest
player. Smaller stores have to lower their prices, find other ways to
hang onto customers, or fold. Again, at least from the standpoint of
price, all consumers win, even if they don't shop at Wal-Mart.

So what's the upshot? The economy keeps growing. Profits lag, so the
stock market stays mired in the muck. In the long term, lower profits
may mean less money invested in capacity and innovation.

In the short term, consumers can take advantage of lower prices. They
may even use the money they save to buy more imports. But exports
aren't necessarily less expensive - market conditions may not have
changed abroad - so the trade balance may deteriorate.

IT'S rare that a single phenomenon can explain a whole set of economic
circumstances. But it's also rare that a logical explanation for such
circumstances is completely wrong. If new sources of competition are
indeed affecting prices, the situation presents a challenge for policy
makers, especially the Federal Reserve.

Usually, the Fed tries to monitor the economy for overheating, which
happens when spiking demand for goods and services sends prices
spiraling higher. To cool the economy down, the Fed raises interest
rates.

In this case, prices are under control, and not because of weak
demand. The need for much higher interest rates is remote. Yet the Fed
still has to be vigilant. The two trends that put a leash on prices
will run their course, perhaps even at the same time. If that happens,
let's hope that the Fed hasn't been lulled to sleep at the switch.

-- 
Jim Devine
"Segui il tuo corso, e lascia dir le genti." (Go your own way and let
people talk.) -- Karl, paraphrasing Dante.