One of the oddities of our times is the disconnect between how ordinary Americans feel about the economy and how (most) economists describe it. Simply put, Americans are generally glum, while economists see things as pretty decent.
Only a quarter of all Americans view the economy as ‘good or excellent’. That figure is dragged down by respondents who identify as Republicans and who might be expected to take a dour view of anything for which a Democratic president could take credit. But even among Democrats, less than half feel the economy is performing well.
Economists, on the other hand, see a US economy that has grown faster since the pandemic than any other major developed country or region, has attained full employment, has successfully overcome a nasty bout of inflation without enduring a recession, is free of major private sector imbalances, and has delivered strong real (i.e., inflation-adjusted) income growth over the past several years. Those features paint a picture of economic vitality, resilience, and stability. The contrast to public perceptions could not be greater.
Americans’ downbeat feelings about the economy make it difficult for candidate Harris to campaign on the accomplishments of the Biden/Harris administration. In the recent debate, for example, Harris sidestepped her opening question as to whether Americans are better off today than they were four years ago. For economists, the answer would have been: No duh! But for someone with decent political antennae, as Harris has, a feel-good answer would have been an affront to many Americans, including some coveted swing voters.
Various arguments are put forth about why Americans are dissatisfied with the economy. High (as opposed to rising) prices are one explanation. Nobody likes to pay them. Nor does it matter that most Americans have seen their take-home pay go up faster than inflation over the past few years. Behavioral psychology tells us that losses weigh on us more than equal-sized gains comfort us. We are, it seems, preternaturally pessimistic when it comes to dollars and cents.
Anxiety about rapid economic change and what it might mean for our jobs and our children’s futures is another possible explanation for widespread public pessimism about the economy. This century, Americans have endured a jolting financial crisis, waves of globalization, technological upheaval, and a devastating pandemic. Their concerns are amplified by social and conventional media all-to-eager to focus on the negative. It’s no wonder Americans have some economic post-traumatic stress disorder.
But something else may also be at work—a shrinking consumer surplus.
Economists are familiar with the term consumer surplus. But it can be a difficult concept to convey to non-specialists.
Essentially, consumer surplus is the additional worth, benefit, or utility that we get from purchases of goods and services that exceeds the price we pay. If you’ve ever left a restaurant so satisfied that you say to yourself, I would have paid double for that scrumptious food, then you are describing your consumer surplus. Pretty much any time you say, ‘geez, that was worth it’, you are reveling in consumer surplus.
It is also a truism in economics that perfectly competitive markets are productively and allocatively efficient. There is no outcome, and certainly not one that the government could engineer, that will make things better for producers or consumers without coming at some cost to the other party. Typically, therefore, our consumer surplus is greatest when free and competitive markets prevail.
But that happy situation exists only under rather demanding assumptions. It requires markets comprised of many buyers and sellers, complete information equally shared by all participants, and the absence of positive or negative spillovers (i.e., ‘externalities’ such as pollution). Should any of those aspects be absent, markets become inefficient. The implication is that superior outcomes are possible, which can be achieved by proper government policy intervention.
Over the past several decades, much academic research (follow hyperlinks below) has focused on how markets have become less competitive, to the detriment of consumers. It turns out that across swathes of the economy, consumers have been getting a raw deal.
This has nothing to do with the recent bout of inflation. Rather, it is mostly the by-product of growing industry concentration (a shrinking number of producer-sellers) and the exploitation of consumers by producers who have informational advantages.
For example, the Federal Reserve has noted rising industrial concentration this century (i.e., the tendency for a few firms to dominate) in the retailing, transportation, finance, and technology sectors, among others. The more concentrated an industry is, the more likely producers are to exert market power to restrict output, raise prices, and shrink consumer surplus.
Firms are also getting the upper hand in other ways. The use of ‘personalized pricing’ has increased as businesses have used big data, artificial intelligence, and other tools to enable them to charge different customers different prices for the same good. Frequent flyers have decades of experience with the same seat, on the same flight, offered at different prices to travelers with different needs. By charging each customer different prices, rather than a uniform one, studies show that ‘personalized pricing’ can shrink consumer surplus by over 20%.
Other examples exist. It has been long established, for instance, that pharmaceutical companies make higher profits on drugs to cure diseases than they do on vaccines to prevent them. That’s because already ill patients are, understandably, willing to pay more than those who seek a preventative vaccine. That, too, is a form of price discrimination that reduces consumer surplus.
Firms have other ways to shrink consumer surplus. The Spanish retailing giant
Zara (Inditex) is famous for rapid design shifts to capture shifting consumer preferences. By perfecting the art of delivering according to demand, Zara reduces inventory of less desired items, which otherwise might have to be put on sale. Tailoring production to demand tends to deliver higher average selling prices, to Zara’s profit but to the detriment of consumer surplus.
Lastly, dynamic pricing, where prices change instantaneously according to demand conditions, shifts consumer surplus to producers in the form of higher profits. Few companies have perfected dynamic pricing as well as Uber, whose fares adjust instantaneously depending on factors such as the weather, time of day, or traffic conditions. Dynamic pricing allows Uber to ‘pick off’ consumers along their individual demand schedules, with the result that they pay closer to their maximum price for each ride than would be the case if pricing were flat rate, as used to be the case when ordinary taxis were the norm.
Shifting consumer surplus to producers, in the ways just described, has two consequences.
First, firms are more profitable, which almost all measures (e.g., profit share in US GDP) indicate has been taking place over the past quarter century.
Second, it creates resentment. Increasingly, polls show that Americans of all political persuasions believe the playing field is tilted against them.
For years, politicians have blamed foreigners for Americans’ economic woes. ‘Unfair’ trade, whether from China, Mexico, or even our western European allies, drew opprobrium and, in recent years, tariffs. Immigrants were seen as taking our jobs (and, more recently, our pets), spurring calls to close the border and deport many.
But maybe, instead, the problem lies closer to home. Maybe Americans and our politicians don’t realize that rising industry concentration and information asymmetries are allowing companies to profit at the expense of their customers.
Instead of railing against foreigners and imposing counter-productive tariffs (which only make goods more expensive), perhaps policymakers should act to level the playing field between producers and consumers. Encouraging competition, breaking up monopolies, and curbing the abuse of information that enables companies to exploit consumers would help restore what is missing in our economy, namely a sense of fairness.
