The world is an economics classroom if we allow ourselves to learn from it. Every day we’re bombarded with puzzles that the economic way of thinking can help solve. One of the more recent examples of this is the infant-formula shortagethat plagued an industry already confounded by pandemic-related supply chain issues. An investigation by the U.S. Food and Drug Administration (FDA) of Abbott Laboratories discovered traces of a carcinogen in the powdered baby formula produced in Abbott’s Sturgis, Michigan, plant. This led the FDA to recall several brands of powdered formula, including Similac, Alimentum, and Elecare, all of which rely on the formula produced in that same plant.
In response to the resulting shortage, the FDA called for greater flexibility in the importation of infant formula. This brings us to the economic puzzle. The stated point of regulation in many cases is to protect public health and consumer safety. The assumption driving these regulations is that the market cannot or will not regulate itself, or perhaps won’t regulate itself enough. This generates calls for the state to use its regulatory apparatus to get the “right” level of regulation. But how do we know what the “right” level of testing and, in this case, labeling guidelines are the correct ones? Bureaucrats and regulators face the same knowledge constraints as anyone else, whether civilians or entrepreneurs.
Regulators must balance different types of errors. Type I errors occur when a drug or product has been introduced that is unsafe or ineffective. Type II errors occur when safe drugs and products have been either prevented from entering the market or delayed because of too much testing. The FDA needs to have the appropriate incentives to ensure that, ideally, we don’t commit either type of error. What we’re seeing with the infant formula shortage is an example of a Type II error.
The U.S. typically produces 98% of the formula it consumes, with formula it does import coming mainly from Mexico, Ireland, and the Netherlands. A 2019 medical study reported that most European formulas do not meet FDA labeling requirements. Let’s think about that for a moment. The formula is clearly safe, as millions of European mothers feed it to their babies daily, and Europe is the world’s largest formula producer and exporter, and just not to the U.S. Yet the labels do not satisfy the FDA guidelines in part because the ingredients are not listed in the order designated by the FDA and the instructions for how to use the formula are not approved. If that weren’t bad enough, the FDA maintains a red list of items subject to immediate seizure upon importation, and some brands of European formula are on that list.
This is a clear case of a Type II error. Stringent labeling requirements imposed by the FDA exacerbated the crisis caused by the contamination, and the formula market couldn’t easily adapt. The beauty of markets is their adaptability, which is precisely what is needed in a crisis. Without these stringent labeling requirements, there would have been more formula imports and a more competitive market. Yet these regulations were put into place to help insulate U.S. manufacturers from European competitors, and that’s bad news for consumers any day but especially during a crisis.
The FDA’s recent decision to relax labeling guidelines raises another puzzle: If the regulations aren’t needed in a crisis, were they ever truly useful?
Today four U.S. companies control 90% of the American formula market. That would not necessarily be the case if it were easier to produce and import formula. Adding to the problem are high tariffs, up to 17.5% on formula, which also acts to insulate U.S. producers from foreign competition. Regulations tend to have that effect—protecting insiders by creating a system of winners and losers. They also have the unintended consequence of generating hyperbolic reactions to crises.
For example, the Biden administration invoked the Defense Production Act to help U.S. formula makers be first in line to receive the ingredients they need to increase production. The administration also appealed to the Defense Department to use its contacts with commercial airlines to bring in more formula. The Defense Production Act was enacted in 1950 in response to the Korean War and allows the president to alter patterns of production and commerce in the name of security. It is far more reasonable to deregulate these markets than to respond with wartime measures.
We should both eliminate tariffs and encourage freer trade in infant formula. We should relax stringent labeling guidelines that don’t help but, in this case, do great harm. This would open the formula market and reduce industry concentration—free the market to solve the shortage. These Type II errors harm families and, in some cases, create an illicit market for formula—something we clearly don’t want for genuine safety reasons. Freeing the market may not be the politically viable alternative but it’s the one that actually solves the problem and helps consumers. And as should be clear, this economic way of thinking is applicable far beyond the current infant-formula crisis.