Arnold Kling  

Jerry Hausman on Wal-Mart

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At the MIT economics alumni event this morning, Jerry Hausman spoke about his research on Wal-Mart. He says that Wal-Mart lowers prices to consumers primarily by bargaining down the prices charged by suppliers, such as Procter and Gamble. It also uses cost-saving logistics. Lower labor costs may contribute to its low prices, but not as much as the other factors.

Hausman argues that driving down prices of suppliers is a benefit, because prices are being driven closer to marginal cost. In welfare-economics terms, you can think of Wal-Mart as a substitute for a regulator who would try to improve efficiency by forcing imperfectly competitive producers to move down the demand curve.

The magnitude of the benefit is enormous. Hausman looked at food, and for that category alone Wal-Mart increases consumer welfare by 25 percent (I'm a bit worried that the theory behind his calculations holds only for much smaller differences, but I don't have an alternative.) Since food is about 12 percent of GDP, multiplying .25 by .12 gives a benefit of .03, or 3 percent of GDP from Wal-Mart.

But the most interesting fact of all is that government statistics hide Wal-Mart's benefits from view. The Consumer Price Index acts as if Wal-Mart's lower prices are offset dollar-for-dollar in reduced quality of service. However, Hausman's estimation technique allows for consumer valuation of service quality. So the Bureau of Labor Statistics is taking an indefensible position.

Oh, and by the way, Hausman finds that poor people get 50 percent more benefit from Wal-Mart than rich people.

Remember the magnitude of these findings whenever you read the stories about stagnant real incomes for the middle class. That stagnation is probably a statistical mirage.

Here is the paper. A previous Hausman critique of the BLS is here.


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TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/598
The author at amcgltd in a related article titled Wal-Martinomics writes:
    Just because it's tacky doesn't mean it's bad: The magnitude of the benefit [Wal-Mart brings to the economy] is enormous. Hausman looked at food, and for that category alone Wal-Mart increases consumer welfare by 25 percent ... Since food... [Tracked on November 8, 2006 11:46 AM]
COMMENTS (11 to date)
RogerM writes:

...a benefit of .03, or 3 percent of GDP from Wal-Mart

McKinsey & Co has an article on their site in which the credit Wal-Mart for most of the productivity gains of the 1990's because other retailers adopted Wal-Mart's business model. So the gains from Wal-Mart are probably even greater!

Lord writes:

They are indeed greater, but it also means they haven't been missed. Walmart may have lowered prices but other retailers have also had to to compete so most of this is little more than self deluded fantasy.

Nick writes:

With Wal-Mart driving down the prices of the suppliers, the suppliers will get closer to there marginal cost. So I have to wonder how long it will take for Wal-Mart to start a monopoly. Cause once they drive the suppliers under their marginal cost they will have to shut down and Wal-Mart will be able to buy the whole suppliers plants and soon they will have a monopoly.

Randy writes:

Nick,

That is one possibility. But a more likely possibility is that Walmart will soon face serious competition from retailers who copy the business model. Same with Microsoft. Neither company was very big before the mid 80s. Two decades of dominance is impressive, but there's plenty of capital, financial and human, available for others who want to compete. I give it a decade, tops.

John Thacker writes:

Cause once they drive the suppliers under their marginal cost they will have to shut down and Wal-Mart will be able to buy the whole suppliers plants and soon they will have a monopoly.

And why would Wal-Mart necessarily want to produce goods rather than buy them from suppliers at marginal cost? And why would this be a monopoly when other retailers exist, and other suppliers for those retailers? And how would Wal-Mart make more money from this monopoly, unless they raised prices after buying the suppliers, and then wouldn't the other retailers and suppliers benefit?

Oh, and by the way, Hausman finds that poor people get 50 percent more benefit from Wal-Mart than rich people.

Well, duh. Wal-Mart and Target's wages are essentially identical in similar areas. Target just concentrates on only opening stores in wealthier suburban areas, and avoids small towns, whereas Wal-Mart opens stores in both. Target also goes after a more upscale customer base than Wal-Mart, with somewhat more emphasis on decor and such in their stores, among other things.

Don Robertson writes:

A few months ago, I actually went to Walmart. Now, while that's an economic evaluation method that's not so much in vogue today, I actually went looking at the goods offered.

What I found astounded me.

Of all the goods at Walmart, I didn't see much worth buying at any price. Plug that into the economic model that says Walmart is benefitting consumers by offering lower prices, and you generally come up with a big fat goose egg.

Walmart caters to the consumer crowd, and I don't see any measure that says this crowd is growing, rather the opposite. Consumable goods consumption seems to decline as real wages decline and as real costs for entitlements-to-your-paycheck rise, and, they certainly are rising for most.

Walmart's advance on market share, and hence its now overly-ballyhooed raise for working class consumers, is also being gnawed at by newer and even lower end merchandisers in every segment.

The problem is, there's a saturation point, and soon enough, enough consumers will decide they've bought enough of the junk you see at Walmart. When that happens, it'll likely put Walmart into a just-send-it-back-to-China tailspin.

Don Robertson, The American Philosopher
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spencer writes:

I think you are misquoting the Hausman results.

He finds that WMT grocery prices are 25% lower then in other grocery stores. Not that it improves consumer welfare by 25%. For this to be true WMT grocery store sales would have to account for all of consumer spending. Given the weight of WMT in total grocery store sales this means that the food at home component of the CPI overstates food inflation by about one percentage point per year. Since food at home is less then 10% of the CPI the BLS not including WMT in the grocery store sample implies that the CPI is overstated by about 0.1 percentage point per year. This estimate would come closer to an estimate of the consumer benefit of WMT's lower grocery prices.

In general WMT does generate large consumer benefits because it does provide lower prices while it payroll is pretty much competitive with what other retailers pay. So the lower prices are a positive that are not offset partially by lower wages.

But in the grocery store sector this is not generally true. WMT generally pays much lower wages then other and unionized grocery store chains so some of the welfare benefit of the low grocery prices to the low income population segments is offset by the cost of lower wages to WMT grocery store labor. But the net benefit for low income individuals is still very large even when you adjust for this factor.

Randy writes:

Spencer,

Good point about wages in the grocery sector. Its something I've always wondered about. When I was in high school (back in the 70s), I worked at a grocery store for a little better than minimum wage. Most of the workers in the store were also high school students. A decade later, most of the workers in grocery stores I went to were suddenly older and unionized - and getting paid wages that were fantastically better than what I had received. It struck me as odd. I wasn't sure how the unions had been able to get a foothold in the first place. But it doesn't strike me as odd now that Walmart is able to undercut them with its non-unionized work force. It seems to me that unions somehow won a short term victory, but are losing the war.

rfschro writes:

Don;

Walmart caters to the consumer crowd.

Of course they do - that is their target market - nothing wrong with that.

Of all the goods at Walmart, I didn't see much worth buying at any price.

That sounds rather elitist. Not everyone can, or wants to, buy their groceries at a Whole Foods store, or their underwear at Saks, or their jeans at a Gap store, or their sheets and pillowcases at a trendy Linens n Things etc. Wal-Mart fills a need for everyday folks and does it at a low price.

Seymour writes:

Walmart's annual revenue in 205 was about US$ 310. Let's say $250 bn of that represents food sales. Let's say consumers would have paid $325bn for food if Walmart represents a generous 30% savings.

that saving of $75 billion is about .63% of GDP, still large but much less than the 3%

Shawn Mallison writes:

There is always much debate about the advantages or disadvantages that come with a proposed Wal-Mart store but I would agree that from 30,000ft the positives outweigh the negatives. Wal-Mart does provide a great alternative for groceries. The exact impact may be a bit difficult to pin down but it’s safe to say that on a national level it is significant. I also agree that Wal-Mart creates increased efficiencies in many areas. Small local retailers often complain that they are being pushed out, and maybe they are, but I would argue that they can survive if they are willing to think and to change. They must look for a way to differentiate themselves. Supply something Wal-Mart does not. Quality products and reasonable service are good options. In the end competition forces resourcefulness, creativity and greater efficiencies.

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