For the last four months, the collapse of America’s baby formula production and distribution has terrified mothers across the country. “It is easier for me to get a pound of weed than a pound of formula,” a young father told me a few days ago.
Why is this crisis happening? The baby formula market is highly consolidated, with Abbott Labs, the firm at the center of the crisis, controlling 43% of the market. The Food and Drug Administration shut down one of Abbott’s major plants after a whistleblower alleged that the plant was dangerously unsanitary and falsifying records to cover it up.
Many policymakers think that the combination of slow regulation, corporate greed, and heavily consolidated supply chains is unique to baby formula. TV commenters ask how could the richest country in the world be unable to feed its babies. Or they shake their heads and say, “it’s a perfect storm.”
But shortages of vital, life-preserving goods are routine in America. We all saw the images of nurses wearing garbage bags during the initial stages of Covid, and heard of ventilator shortages. More recently, rapid Covid tests weren’t in stock while the nation dealt with the Delta and Omicron variants. Those too were overly regulated by the FDA, which refused to approve dozens of manufacturers making tests for Europe. That scandal even includes Abbott Labs, which was one of two firms approved to make tests here.
As 60 Minutes recently reported, there are hundreds of vital pharmaceuticals out of stock, as well as a host of medical supplies like contrast dye for hospital imaging. One hospital employee told me there are “new shortages cropping up all the time in healthcare. Right now, there’s a lidocaine shortage. Before that it was opioid pain medication, medications to sedate and/or paralyze patients on ventilators, N95 masks, and respirators. It always seems as if you solve one issue, and another crops up to replace it.” The problem is so dire that the FDA warned in 2019 that younger physicians increasingly do not know how to treat people with high standards of care, because they aren’t used to having the right medicines available.
At what point do we realize that this isn’t a perfect storm, but the weather?
Shortages are not inevitable. They were not common prior to the 2000s, and all these shortages have a core feature in common. As the White House supply chain taskforce quietly noted at the beginning of the Biden administration, the culprit is sole-source contracts with entities that control a market.
In the case of baby formula, the government buys about half of all formula in the US, and it uses its buying power and a complex scheme of rebates to lower the cost to taxpayers. But these lower costs are not free. Baby formula monopolists give special prices to state governments in return for an exclusive contract to supply an entire state for the Special Supplemental Nutrition Program for Women, Infants, and Children. The net effect is that baby formula, if you are covered by the government, is free or low-cost, but if you are not getting government assistance, it’s much more expensive. By comparison, European formula prices are about half of US prices. This monopolized distribution system blocks new entrants from the market, so we are dependent on corporations like Abbott Labs. Layer on an extremely risk-averse regulator at the FDA, and you get a series of monopolies, a fragile supply situation, and boom: shortages.
It’s easy to blame the government for this shortage, but the reality is that the government is merely operating as what’s called a “power buyer”, or an entity buying so much that it can structure the entire market. Power buyers like Walmart and Amazon are so important in terms of access to consumers in packaged goods that they can dictate terms to suppliers. But there are power buyers across the economy, and not just famous ones like Walmart and Amazon, or the federal government.
For hospital supplies in shortage, power buyers are giant firms called group purchasing organizations, or GPOs. These are corporations you’ve never heard of – Vizient, Premier, HealthTrust, and Intalere – and they manage in aggregate $300bn of hospital purchasing, or 90% of medical supplies in the United States. There are also three distributors – McKesson, AmerisourceBergen and Cardinal Health – with a similar chokehold. Just three firms buy 92% of generic medicines.
These power buyers, like the government with baby formula, extract rebates from suppliers, in return for sole-source contracts. Then, when a factory of one of these suppliers is taken offline, there’s a shortage. In a highly consolidated market, these kinds of shortages are inevitable, not just because there’s only one or two providers, but because the middlemen extract so much in fees and rebates in return for sole-source contracts that medical manufacturers end up cutting corners on safety to preserve whatever margin they have left.
All these middlemen exist as a result of policy. We have laws against exclusive contracts in the antitrust statutes of the Clayton Act and the Robinson-Patman Act, but we stopped enforcing them. Congress passed a 1987 law that provided an exemption to anti-kickback rules for GPOs. Lax antitrust policy also led to a wave of mergers of these middlemen from the 1980s to the 2000s.
As shortages pop up over the past fifteen years, Congress has usually responded with some variant of “tell the regulator that there’s a shortage.” At the behest of Congress, FDA has been publishing a list of drugs in shortage since 2012. But having a list doesn’t help. Or sometimes, GPOs or other power buyers pretend to take on the problem by forming coops to manufacture the drugs in shortage, like Civica RX. But this worsens the underlying problem, since already-battered suppliers will now have to compete directly with the power buyers they sell to. Finally, imports are often suggested as an answer, but this trades sole-source dependency on domestic manufacturers for dependency on a Chinese factory that shuts down, which is the root of the imaging dye shortage doctors are currently screaming about.
The way to attack the problem is conceptually simple. We need to restore open and competitive markets. That means taking a couple of steps. First, policymakers should stop allowing exclusive contracts in return for rebates. That means means restructuring baby formula buying policy, but it also means repealing the anti-kickback exemption for GPOs, and enforcing laws against exclusive contracts and price discrimination in the form of rebates more generally. It also means breaking up power buyers where it’s possible to do so, reversing the merger waves that led to this problem. Moving these changes through the courts will take time, so in the meantime Congress should pass a law mandating that under all markets regulated by the FDA, either food or medical markets, no large buyer can purchase more than 20% of its supply of any commodity from any one supplier. This full spectrum approach would reorder our industries and end the pervasive shortage economy.
Regardless, this problem isn’t going away until policymakers act at the source, which is the buying monopolies who consolidate power and induce fragility in supply chains. Today it’s baby formula, but tomorrow it could be your blood pressure medication. We did not used to be a nation of shortages. And if we make the right policy choices, we no longer need to be one.