Market concentration: source of inflation at the local level?

Faced with reductions in operating costs, there have been fewer companies that have adjusted their prices on the Island, delaying the adjustment of prices for an average of 5 months, writes Emanuelle Alemar.

Inflation has become a persistent and problematic phenomenon in Puerto Rican daily life for more than a year. From November 2020 to April 2022, the Consumer Price Index in Puerto Rico has been on the rise for 18 consecutive months. In large part, this is due to exogenous factors such as the stimulus granted by the federal government until last year, the dislocations in global distribution chains due to the continuity of the pandemic, and the recent Russian invasion of Ukraine. On the other hand, certain endogenous factors could be exacerbating inflation at the local level, one of the main ones being the high concentration of local markets.

By 2017, Puerto Rico had fewer registered establishments than each of the 50 states, adjusting for population, implying a higher market concentration in Puerto Rico, on average, than in the United States. These market shares have historically been divided among no more than 4-5 major competitors. Firms in concentrated industries, due to little competition, may raise prices in the face of increases in their costs above what they would rise in a competitive market. Similarly, they may be slow to lower, or not lower, their prices in response to cost reductions.

Likewise, legal provisions such as Law 75 of 1964, as amended, aggravate the problem of lack of competition by protecting distributors if a retailer wants to terminate or amend a distribution contract. This lengthens the duration of the contracts in the economy and the prices stipulated in said contracts. In inflationary periods, this may mean that prices take longer to rise, but once these contracts expire and prices are readjusted, they may take the same or longer to fall.

In my thesis, I make estimates of the proportion of companies that do not readjust their prices during periods of cost reductions, incorporating assumptions of monopolistic competition, and I find that this proportion has been 14% higher in Puerto Rico than in the United States, while has increased during the deflationary period of the recession. This implies that, in the face of reductions in operating costs, there have been fewer companies that have adjusted their prices on the Island, delaying the adjustment of prices for an average of 5 months. In the future, this would imply that, even as oil and food costs begin to decline globally, prices in Puerto Rico could take longer to readjust accordingly downwards.

Based on anecdotal and empirical evidence of high concentration in local markets as a factor that can exacerbate and extend inflationary pressures at the local level, it is essential to evaluate actions that can be taken to mitigate the part of inflation that is generated this way. Some public policy actions that could mitigate this part of the inflation are the possible revision of legal statutes that grant protection to companies in concentrated industries, as well as the consideration of other measures that would eliminate barriers of entry to said industries for new competitors, being a one of these the continuous simplification of the permit system. Given the uncertainty at the global level, it becomes even more important to evaluate these measures as possible public policy options to reduce the contribution of the said route to locally generated inflation. The willingness to assess how to mitigate it at the local level through this and other means will determine how quickly the current upward trend in inflation can be reversed.

This piece was originally published in Spanish in El Nuevo Dia

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